As ANA’S LCCs Peach & Vanilla merge, Qantas and JAL need to align strategy
IN THE EARLY HISTORY of dual brand strategies in Asia, airlines often took only a minority stake in an LCC. This half way house has proven strategically weak, since the lack of full ownership and control prevented the parent airline from using its LCC for strategic, integrated purposes. That was also at a time when conservative minds at the big two Japanese airlines were not fully convinced of the future for LCCs.
From a similar background, Singapore Airlines eventually paid dearly to take full control of former JV Tigerair, and now All Nippon Airways will again pay a premium to increase its stake in Peach Aviation. All up, ANA is investing USD400 million, which values Peach at USD1 billion, but ANA may need to pay a further USD300 million for full control.
LCC subsidiary history also includes nuanced chapters where multiple brands, often overlapping, prevailed. As Japan's LCC market becomes more dynamic, with existing and forthcoming local and foreign operators, ANA is putting its house in order to compete more effectively.
Peach will take over the 100% ANA owned LCC Vanilla Air. Peach will logically be the surviving brand from the merger, which is to be completed by Mar-2020. That is a relatively quick time frame, given the Japanese market, but underscores the strategic urgency after such a long wait while ANA negotiated with Peach's other two shareholders.
- ANA is investing $400 million to increase its stake in Peach Aviation and may spend an additional $300 million for full control.
- Peach Aviation will merge with ANA's wholly-owned LCC, Vanilla Air, with Peach being the surviving brand.
- The merger will result in changes in the aircraft market, as Peach operates new build aircraft and Vanilla Air has outstanding orders for three A320ceos.
- ANA's deal for Peach is considered better than Singapore Airlines' acquisition of Tigerair, as Peach has stronger growth opportunities and public reception.
- ANA's investment in Peach is significant but manageable, given its cash reserves and large aircraft order backlog.
- The merger between Peach and Vanilla Air puts pressure on Japan Airlines (JAL) and its LCC subsidiary, Jetstar Japan, to review their ownership and control strategy in order to compete effectively.
Summary
- Peach and Vanilla both operate A320ceos with CFM power plants. Peach's aircraft backlog includes seven A320ceos, 10 A320neos; while Vanilla has three A320ceos;
- ANA is investinging USD400 million to grow its stake in Peach, and could eventually spend a further USD300 million to take total control;
- ANA receives a better deal in Peach compared to SIA's acquisition of its LCC, Tigerair;
- Peach will be the post merger brand. Peach is stronger and larger, and was flying aggressively in Vanilla's home market;
- JAL needs a stronger LCC platform. Jetstar Japan should have been preparing for an eventual Peach-Vanilla merger, but the partners are at different stages.
Peach-Vanilla merger provokes Airbus and lessor changes
The merger of Peach and Vanilla will cause some small changes in the aircraft market. Peach operate only new build aircraft and places its own aircraft orders, having seven outstanding deliveries for the A320ceo and 10 orders for the A320neo. Vanilla Air has outstanding orders for three A320ceos. Vanilla Air has been able to acquire aircraft through ANA's backlog, and even through ANA's existing fleet. Vanilla Air briefly flew ex-ANA aircraft.
Both Peach and Vanilla A320ceo fleets use the CFM power plant, according to CAPA's Fleet Database. Vanilla Air's average fleet age is 2.5 years, while Peach's is 4.2 years.
ANA will have spent USD400 million, valuing Peach at USD1 billion
ANA will acquire a further 10.9% of Peach Aviation for USD107.9 million. Combined with its Apr-2017 share increase, ANA is investing USD398.2 million for greater control of Peach. Both share acquisitions value Peach at approximately USD1 billion. The 2017 share increase valued Peach at USD1.025 million, while the 2018 share increase valued Peach at USD990 million. Once the transaction closes in Apr-2018, ANA will have 77.9% of Peach, First Eastern will hold 7%, and INCJ 15.1%.
PEACH FLEET SUMMARY*
| Aircraft |
In service |
In storage |
On order (confirmed) |
On order (unconfirmed) |
| 20 | 0 | 7 | 0 | |
| 0 | 0 | 10 | 0 | |
|
Total |
20 | 0 | 17 | 0 |
PEACH AND VANILLA AIR FLEET OWNERSHIP & LESSOR PROFILE*
Assuming ANA wants full ownership of Peach, it will need to spend (at least) a further USD218 million.
Peach's other two shareholders, INCJ and First Eastern, probably have no reason to decrease their valuation on Peach. If anything, their asking price could increase as Peach continues to prove its worth and ANA becomes more eager for ownership control.
First Eastern and INCJ are equity firms with no other significant ties to ANA - a situation that should make them cash focused and with no need to buckle to any pressure from ANA.
ANA's Peach buyout is a good deal, compared to Singapore Airlines' Tigerair takeover
ANA moving to a presumed total buyout of Peach provides a comparison with Singapore Airlines (SIA) taking full ownership of Tigerair. Like ANA, SIA was initially a minority investor in its LCC. SIA wanted full control to merge Tigerair with Scoot, the long haul LCC 100% owned by SIA.
SIA's final takeover offer valued Tigerair at just over USD1 billion. The offer per share that SIA offered was a third of Tigerair's share price at the time of its IPO, but SIA's offer was still a 45% premium above Tigerair's share price at the time the offer was first announced.
ANA's deal for Peach is, by comparison, very good: Peach has stronger growth opportunities and public reception than Tigerair had. Alternatively, ANA may also be overpaying, but not by nearly as much as SIA did.
ANA investing USD400 million - and maybe later close to USD700 million - is no small sum.
But as CAPA previously noted, ANA has a significant cash pile, is generating profits, and has a large aircraft order backlog. ANA and JAL will outlay USD10.7 billion in capital expenditure over the next three years. This puts the Peach investment in perspective. ANA may be able to generate better synergies in Peach (and capture a higher share of profits) than if it used the cash to purchase aircraft for ANA mainline.
PEACH AVIATION SHAREHOLDING EVOLUTION*
LCC subsidiaries are too valuable for partial ownership or IPO
In hindsight it may seem that ANA and SIA should have immediately taken 100% ownership of their LCCs. In the past half decade, most LCCs established by a full service airline have been under total ownership.
Elsewhere in the world, IAG took full ownership of Vueling, and WestJet's new LCC Swoop is under full ownership. LEVEL and Joon are both under full ownership by their respective owners.
One exception for the trend is Korean Air's IPO for its LCC Jin Air. Korean Air retains a significant position and earned much needed cash. The business environment in Korea may mean that Korean Air retains effective control.
Peach was aggressively moving on Vanilla Air's Tokyo home
It is unsurprising that Peach will be the surviving brand from the merger. Peach's brand was more visible and was well received. Vanilla Air's branding was created quickly in the wake of AirAsia pulling out of AirAsia Japan. Peach is larger, has been more profitable, and has the stronger headquarters and back end office support.
For a long time Peach has made clear that it is the stronger LCC brand in ANA's portfolio. ANA's participation in AirAsia Japan arose out of concern that AirAsia would instead partner with then-independent Skymark. ANA's blocking move prevented the presence of an independent LCC, but meant that ANA had two LCCs.
PEACH AVIATION DAILY FREQUENCIES FROM TOKYO AND VANILLA AIR DAILY FREQUENCIES FROM OSAKA*
18 months after its launch, Peach began flying to AirAsia Japan's home base of Tokyo. In 2015, by which time AirAsia Japan had morphed into Vanilla Air, Peach grew its presence in Tokyo. At its peak, in late 2016, Peach flew (on average) 10 frequencies a day from Tokyo, including domestic at Narita and international from Haneda. There was strong messaging from Peach of being the first Japanese LCC to operate from Haneda.
As Peach expanded in Tokyo, Vanilla Air grew in Peach's base in Osaka. Vanilla Air briefly had five daily frequencies from Osaka, but mostly had four frequencies between Mar-2017 and May-2018. Both Peach and Vanilla are reducing their presence in each other's hub. Vanilla Air's reduction is driven by its exit from the Tokyo Narita-Osaka Kansai market.
Peach's operation out of Tokyo was more significant: not only was the volume of frequencies larger than the number Vanilla Air was flying out of Osaka, but Vanilla Air's relatively small presence in Tokyo meant that at its peak Peach was flying 60% as much from Tokyo as Vanilla Air was.
In comparison, Vanilla Air's flying from Osaka was only 13% the size of Peach's local Osaka network.
Jetstar Japan implications: JAL will have to review its ownership and control strategy
ANA's announcement was not unexpected. ANA has as a result thrown the competitive spotlight on part JAL-owned Jetstar Japan, as it will constitute a stronger competitor, and because the combined Peach-Vanilla operation will be larger than Jetstar Japan. Yet the ownership and operation of ANA's LCC was always an anomaly, and Jetstar Japan was surely making provisions for a more rational future.
Yet when considering the larger dynamics in Japan's LCC sector, from current and future airlines at home and abroad, the question for Jetstar Japan is whether Japan Airlines will remain content with what it can achieve with its minority ownership in Jetstar Japan, or if JAL needs to make changes to its LCC strategy.
The strength ANA is creating is not about the size and synergies of its LCCs, but rather ANA's ability to use its LCCs more effectively and to achieve strategic aims. With only a minority stake in Jetstar Japan, the new dynamic puts JAL at a disadvantage. This disadvantage is amplified by JAL being smaller than ANA in the domestic and international markets. Thus, JAL could potentially use LCCs to reinforce its position. But JAL has obligations to the Jetstar Group, and in turn the Qantas Group.
At a group level, Qantas is restricting capital expenditure to focus on return on investment in order to help convince shareholders Qantas is a long term, counter-cyclical business. As a result, airlines in the group may have to wait for capital expenditure. Jetstar's Australian long haul division should for example take more Boeing 787s, but must wait for Qantas to receive its own.
In comparison, like ANA, JAL has ample cash: more than it needs, and more than it appears able to spend. With JAL now free of restrictions that limit its business growth, it can consider all options to grow its business, including LCCs, and achieve strategic growth that ANA is gaining.
Qantas will need to re-examine its investment strategy and how it wants Jetstar to evolve
Unlike at Peach, where the other investors are willing to sell to ANA, Jetstar Japan's marquee investor - the Jetstar Group - may not be willing to give JAL majority or full ownership and control. The Jetstar brand is important to it and Qantas places a high priority on its Japan position.
PEACH AVIATION DAILY FREQUENCIES FROM TOKYO AS A PERCENTAGE OF VANILLA AIR LOCAL OPERATION AND VANILLA AIR DAILY FREQUENCIES FROM OSAKA AS A PERCENTAGE OF PEACH LOCAL OPERATION*
This changed dynamic, coupled with the pace of market growth and ANA's reinforced opportunities, will create pressure on JAL to find smarter ways of achieving an expanded LCC operation. At the same time, JAL's relationship with the Qantas Group is too important for it to be considering a path that would be less than helpful to Jetstar. JAL also benefits from Qantas' complete commitment to Jetstar Japan and the networking opportunities it delivers.
This may prompt Qantas to re-examine its priorities, given the importance of the Japan market - and its wider Jetstar strategy - now and in the future. As the Japanese LCC market matures, each of the Jetstar parents will have to take a long hard look at where their respective strategies are evolving.