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Foreign LCCs line up for JVs in South Korea as aviation market changes

21-Jan-2013

As liberalisation and more progressive thinking spreads across North Asia, the region's pan-Asian LCCs are looking at how to have a local presence in South Korea. While South Korea in the middle of last decade became the first North Asian country to see the launch of LCCs, there has been stagnation at the expense of cost bases, creating room for a new LCC with a lower cost base to enter. An effort in 2008 from Tiger Airways to establish Tiger Incheon backfired, which, combined with weak performances at some incumbents, has caused foreign LCC groups to look at acquiring an existing carrier.

AirAsia is understood to have looked but left, leaving Tiger as most likely Asian LCC group to enter the South Korean market because Jetstar is now bedding down growth elsewhere and following from its Vietnam experience does not take a positive view towards acquiring another carrier. Indeed, global examples of LCC mergers are few, but this may be the platform necessary for South Korea.

It has no domestic market like Japan but a thriving international market with surprising numbers of liberalised air services, the spark to generate growth. Whether an acquisition pans out or not, South Korean aviation is in need of a shake-up.

Tiger Airways cited as possible investor in struggling Korean airline T'way

Tiger appears to be nearing a possible new subsidiary following a 04-Jan-2013 statement saying that "approximately S$9.0 million of the proceeds raised from the Company's initial public offering has been utilised for the investment in a new joint venture airline." The investment, however, could be in one of many growing regions in Asia that could potentially support a Tiger JV operation. In addition to South Korea, Tiger has been looking at establishing new affiliates in several Asian countries including China and Myanmar, as it seeks to grow its portfolio beyond Singapore, Australia, Indonesia and the Philippines.

T'way is the fourth smallest of South Korea's five LCCs: Jeju Air, Jin Air, Eastar Jet and Air Busan. The carrier currently accounts for less than 3% of total capacity in South Korea.

South Korea system seats per week by carrier: 14-Jan-2013 to 20-Jan-2013

T'way's history for the last year was difficult and its future on shaky ground after its single largest shareholder, Tomato Savings Bank, shut down in 2011. The Korea Deposit Insurance Corporation took over the carrier and on 20-Mar-2012 opened the carrier to bids in an effort to recoup money it invested in the bank. All of the initial bids, however, came in under the KRW20-30 billion (USD18.8-28.3 million) estimated the carrier was worth and KDIC was seeking. A second round proceeded in Apr-2012 but also failed to attract bidders.

T'way's reputation was lower then – it has used the intervening period to expand and shore up consumer and investor confidence – as it was still coming out of a difficult history under which it operated as Hansung Airlines, launched in 2004, suspended in 2005 and then again in 2008. When it was re-launched in 2010, the previously quiet Korean market was adjusting to four new LCCs.

In early 2012 a Korean construction company was reportedly interested but could not finalise a deal due to price. Jeju Air, the country's third oldest airline and generally considered most successful of the new entrants, said it would take a look at T'way, but nothing eventuated either.

By mid-2012 the AirAsia Group was understood to be interested in T'way but also failed to reach a deal. That led AirAsia co-founder and CEO Tony Fernandes to say in Oct-2012 of T'way: "There is nothing going on right now,” but added he would "never say never" as "Korea has become a very strong cultural centre for Asia, and we would love to be in this market". Mr Fernandes in Jan-2013 reiterated he has no interest in establishing an AirAsia affiliate in Korea.

Finally in Dec-2012 local reports indicated Yearimdang Publishing acquired 73.2% of T’way Airlines' shares for KRW7 billion (USD6.5 million). Prior to the acquisition, Yearimdang Publishing held 9.6% of shares in T’way Airlines. KDIC held approximately 73% of T'way.

Immediate synergies were not clear, and in Jan-2013 Yearimdang was reported to be in discussions with five companies for foreign investment with an announcement due in Feb-2013. Tiger Airways was cited as the most likely winner, an ironic twist given the carrier's history in the region.

Tiger in 2008 was bullish on growth, having opened a subsidiary in Australia and initially planning new JVs for every 18 months. One of those included Tiger Airways Incheon, a propose JV between Singapore-based Tiger and City of Incheon, home to Seoul's largest airport and who would take a majority stake to satisfy local majority ownership requirements. Incheon was seeing the new LCC start-ups prefer Gimpo airport, closer to the Seoul city centre. There was incredibly fierce local opposition and government lobbying as carriers argued Tiger Incheon would effectively be controlled by foreign entities, paper ownership aside. Heavy campaigns by peers spread to the media, inflating the message.

The project was subsequently cancelled, marking the start of Tiger's bubble being popped. Tiger subsequently faced several other setbacks in launching new JVs, including its first attempt in the Philippines and in Thailand, before the carrier finally succeeded at launching its third and fourth affiliate in 2012 in Indonesia and the Philippines.

As it re-examines South Korea, Tiger will again face questions of proving which nationalities have control over a potential Tiger-T'way combination, even if it has local majority control. Tiger will reap benefits by using its brand, know-how and executives from head office in Singapore – but this will fuel competitors' concerns the carrier is not controlled locally.

Airlines prefer fresh JVs to mergers or acquisitions, but Tiger is not in first place

LCCs generally prefer to expand by a joint venture if they are bilaterally constrained. The EU common market, and ascension of new members to the bloc, has been a boon to the like of easyJet and Ryanair, able to expand with few legal formalities. That is not the case elsewhere, and in Asia-Pacific carriers have had to form joint ventures to pass local ownership requirements. (An exception is Australia, which permits foreign majority owned domestic – but not international – carriers.)

Despite various AirAsia and Jetstar franchises having the same identity, legally they have different ownership structures, as Jetstar did in Singapore and Vietnam and, most recently, Japan and soon Hong Kong. Malaysia-based AirAsia now has franchises in Indonesia, the Philippines, Japan and Thailand.

There have been dabbles with expansion via mergers or acquisitions. Jetstar took a stake in Vietnam's Pacific Airlines and re-branded it Jetstar Pacific, but the deal quickly became the source of agitation from the Vietnamese government. Tensions climaxed when Australian executives of Jetstar Pacific were detained for a number of months, with the situation elevating to high political offices. That left Jetstar with as firm a mind as ever to expand from scratch rather than take the baggage of another carrier.

In addition to debt and bloated cost bases from carriers that could be acquired, one of the largest but least quantifiable challenges is lacking the mindset to be low-cost. The Jetstar Group is now looking to bed down operations: Singapore has become over-saturated, leading to declined profitability while Jetstar Pacific received a breath of life with a new ownership deal involving Vietnam Airlines; Jetstar Japan is less than six months old; and Jetstar Hong Kong is yet to launch. With all this on its plate, Jetstar is unlikely to forge new subsidiaries soon.

See related article: Jetstar Pacific to become Vietnam Airlines’ low-cost carrier in salutary move to both

Indonesia AirAsia in 2012 announced plans to acquire rival Batavia Air in a bid to boost its market share in a fast-growing market with other muscly competitors including Lion Air (of multiple-hundred-aircraft-order fame) and Garuda Indonesia's Citilink. The deal was fraught with logistical questions from the start: a mixed-matched fleet including widebodies, the fact Batavia was more of a full-service carrier than strictly LCC AirAsia, and there remained the possibility AirAsia would keep the Batavia brand. The arrangement was ultimately dropped.

Prior to that, AirAsia had considered taking a stake in Vietnamese proposed start-up VietJet and to re-brand the operation with the AirAsia name, which the government did not permit, leading AirAsia to withdraw its interest. VietJet has since launched and AirAsia, looking with hindsight at the complexity of Jetstar Pacific, is content the time is not right for itself in Vietnam.

See related articles:

Tiger, having to catch up to AirAsia and Jetstar, has not had that luxury of being selective. Its proposed joint venture in Thailand never took off, a prospect that became clear early on as the Thai government did not favour it but Tiger kept pushing publicly. An arrangement with grounded Indonesian carrier Mandala was rocky and took a couple of years to finalise but eventually came to fruition in the form of Tiger Mandala.

See related articles:

An initiative in the Philippines to take a stake in SEAir was also drawn out, partially as incumbents challenged – privately and very publicly – the deal. Although finally completed in 2012, it will not be until later in 2013 that SEAir adopts Tiger's branding, considered critical for an airline group to be pan-Asian and reap associated synergies in costs and public perception.

And of course Tiger's biggest blow to its image was the Australian safety regulator's month-long grounding of the Australian subsidiary in 2011 over effectively safety concerns. While public confidence was mostly restored (and Tiger in Jan-2013 announced it has appointed a creative agency to update its branding) investors across the region were shaky, and placated only with Virgin Australia's proposal to take over the carrier via indirect cash from a Singapore Airlines investment, which owned a stake of Tiger Australia.

As Tiger has (previously, at least) lacked the know-how to bring successful partnerships to fruition and battled image problems, it has not had the same expansion opportunities as better-managed AirAsia and Jetstar. Southeast Asia is crowded but with new franchise opportunities in countries such as Myanmar.

North Asia is more untouched. Japan is crowded with three new LCCs in 2012 and a fourth (Spring Airlines) proposed in 2013. South Korea becomes available, partially out of T'way's situation but also process of elimination. That is not to say it is a second-rate market.

South Korea has a small and crowded domestic network

South Korea for the week 14-Jan-2013 to 20-Jan-2013 has 1.2 million international seats and 430,000 domestic seats, giving a nearly 75:25 split in favour of international, the opposite for many countries. Korea's domestic market is the 22nd-largest in the world, behind the UK but above Vietnam.

For the LCCs, domestic routes are mainly confined to services to and from Jeju, a popular island getaway not convenient by ferry from major cities and not connected to the mainland by the high-speed rail in Korea, which is efficient, relatively inexpensive and popular – enough to keep LCCs away.

An exception is Asiana's LCC spin-off Air Busan, which took over Asiana's deeply loss-making Seoul-Busan services. While Air Busan is understood to have not brought profit to this mainland route as it competes with the high-speed rail, Air Busan has stemmed losses. South Korea's LCCs look heavily to international routes, a mixture of routes they compete on with full-service carriers but also new destinations to the country. Jin Air, the LCC spin-off owned by Korean Airlines, has in particular pursued this type of network expansion. The remaining LCCs, Eastar Jet and Jeju Air, are independently owned.

Domestic and International split for Korea's LCCs: 14-Jan-2013 to 20-Jan-2013

Domestic Domestic International
Air Busan  85%  15%
Eastar Jet 74% 26%
Jeju Air 58% 42%
Jin Air 63% 37%
T'way 71% 29%

Korea's aviation regulator most recently updated the fleet of Korean LCCs on 30-Sep-2012 as:

The domestic market is over-crowded and some ask if South Korea, like the Philippines, could do with fewer carriers. With T’way being the smallest, a history that has been continuously fraught and talk of plans that often do not eventuate, it is asked if T’way should exit the market. While less capacity in the present form would be good for the domestic Korean market, international services are very under-exploited but the carriers are not yet taking advantage of it.  The domestic market could also benefit from a carrier with an admirably low cost base that would force peers to become more competitive. With high forecasts of GDP (Korea is now part of the “MIST” grouping of high-growth countries: Mexico, Indonesia South Korea and Turkey), long-term growth opportunities are larger, especially once more liberalisation occurs, such as with China. The market will also lend itself to higher yields than, say, the Philippines.

International services are the lure to invest in South Korea, and shake-up the market

The domestic routes to Jeju are easy picking but the market is becoming crowded. Thankfully South Korea has favourable air service agreements that are being under-exploited by local carriers content with domestic routes or lacking the marketing power of an AirAsia or Jetstar persuade people to explore a new (international) destination.

Within Asia, Korea has open sky arrangements with Cambodia, China (Hainan and Shandong provinces only), Myanmar, Japan, Sri Lanka, Thailand and Vietnam. With the exception of Sri Lanka and parts of Malaysia, these countries are within narrowbody range from Seoul.

Japan alone is a significant open sky arrangement; the country is the largest source of international seats and fares are high.

South Korea top 10 international arriving seats by country: 14-Jan-2013 to 20-Jan-2013

Japan's significance to Korea underscores one of the challenges incumbent Korean LCCs face. With three new Japanese LCCs and possibly a fourth in 2013, their international focus will be heavily on South Korea. Like in South Korea, Japan's interest in its neighbour is high and fares have been low.

Peach Aviation, the first of the new LCCs to launch in Japan, has made possible same-day return trips between Osaka Kansai and Seoul Incheon, which it promotes as shopping trips (Korean fashion is known to be innovative and inexpensive), a concept that a mere year ago would have been seen as ludicrous. The Japanese LCCs boast of more competitive cost bases as well as sporting ancillary revenue and other principles that make the model work. They will be a major challenge for the Korean LCCs if they remain as they are. This has been identified by Jeju Air and its new CEO Kyu Nam Choi.

As CAPA previously wrote:

Jeju Air launched as a slimmed-down full-service carrier, setting a precedent for further entrants, but with Korea having a small domestic network, the carriers turned their focus to international services, although domestic seats still account for two-thirds of Jeju's network. As foreign LCCs entered Korea, the cost disadvantage of the not-quite LCCs has become apparent and a growing concern as carriers encircle Korea.

"Competing with the Jetstar and AirAsias of the world is very concerning," Mr Choi said during a panel discussion at CAPA's conference.

...
"We get tempted to apply that bare bones model to our structure but we think it may be better for us to wait. Instead of us leading the public, we would like the public to get accustomed to the LCC model in different scales,” Mr Choi said. Eventual progression – how far away is uncertain – does offer a bright spot in that a Korean LCC could have a lower cost than a Japanese counterpart due to Korea being a lower cost country than Japan, possibly offsetting the significant scale advantage AirAsia Japan and Jetstar Japan have from their larger parent groups.

See related article: Jeju Air, under new management, looks for partners and considers IPO as it weighs LCC transition

While a foreign airline investor may find gains in the Korean market, the Korean market will also benefit from foreign investment. Besides the typical (and not insignificant) gains to tourism, a competitive Korean LCC industry will ensure their share of the market is not swallowed by Japanese carriers. There is the potential for the reverse: Korea in theory could offer a much lower cost base than Japan.

Besides South Korea, there is room in Taiwan for LCCs – and then China

South Korea is not the limit for LCCs in North Asia. Taiwan is a candidate, although bilateral expansion will be necessary. From Taiwan, which has almost no domestic network, LCCs could serve both North Asia and Southeast Asia, a lucrative proposition.

The Taiwanese market is engaged in discussions about how LCCs might take root, although so far discussions have emanated from the smaller TransAsia compared to the big legacy operators China Airlines and EVA Air, who could arguably see greater success from having a LCC subsidiary. They might also feel greater pain from the lack of one.

See related article: Taiwan looks to foster home-grown low-cost carriers

And then of course there is mainland China with its vast domestic network (second largest in the world) and geography allowing narrowbody services to nearly every part of Asia. But far deeper structural changes and reforms await. While LCCs would naturally be interested, and even talking about the feasibility, short of rapid reform that market is some time away.  

If Tiger's reported interest in T'way comes to fruition, the market will not be a mere hand-me-down from more successful AirAsia. Tiger will benefit, and if its LCC know-how and systems are brought in and force change at other carriers, Korea could be an even bigger victor.


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