07-Jan-2014 10:00 AM

Cebu Pacific eyes Tigerair Philippines. Should Philippine authorities allow a takeover?

Analysis

Cebu Pacific's potential acquisition of Tigerair Philippines would cement its leading position in the Philippine domestic market and result in another round of consolidation in a market which has at times suffered from irrational competition. Domestic trunk routes would be left with competition from only three airline groups - Cebu Pacific, Philippine Airlines (PAL) and AirAsia - compared to five one year ago.

Philippine authorities will need to determine if three players are sufficient to maintain competition. With no available slots at Manila, it will be nearly impossible for a new carrier to enter the market.

A Cebu Pacific takeover of Tigerair Philippines could be seen as a defensive move to prevent another airline group from making a move. But with Tigerair Philippines unlikely to have many suitors, the acquisition should be viewed more as a smart strategic move to increase Cebu's slot portfolio at Manila. Divesting of its loss-making Philippine affiliate would also be a smart strategic move for Tigerair as it would allow the LCC group to focus on launching an affiliate in Taiwan and growing in Australia and Indonesia, bigger markets of more strategic importance.

Summary

Cebu Pacific's potential acquisition of Tigerair Philippines would solidify its leading position in the Philippine domestic market and result in further consolidation in the market.
The acquisition would leave only three airline groups - Cebu Pacific, Philippine Airlines (PAL), and AirAsia - competing on domestic trunk routes, compared to five a year ago.
The acquisition would allow Cebu Pacific to increase its slot portfolio at Manila, giving it a larger share of scheduled commercial aircraft slots at the airport.
Tigerair Philippines' international routes are from Clark and Kalibo, which do not have slot constraints, making the acquisition of its international operations less controversial.
The acquisition could have a significant impact on the domestic market and competition in Manila, as Tigerair Philippines currently holds a 4% share of slots at Manila.
The acquisition would be a smart strategic move for Tigerair as it would allow the LCC group to focus on launching an affiliate in Taiwan and growing in Australia and Indonesia, bigger markets of more strategic importance.

Cebu Pacific purchase of Tigerair Philippines seems to be in the works

The Philippine Civil Aeronautics Board (CAB) told Philippine media on 2-Jan-2013 that it is evaluating a proposal for Cebu Pacific to buy out Tigerair Philippines, formerly known as SEAir. The CAB expects to complete the review within the next couple of weeks.

In a 3-Jan-2014 statement Tiger Airways Holdings confirmed it is "negotiating a proposed transaction involving Tigerair Philippines". But it declined to provide any details and said no definitive agreement has yet been signed.

A definitive agreement could hinge on the carriers getting the green light from Philippine authorities. Tigerair Philippines is a small carrier, operating only five A320 family aircraft and transporting less than 5% of Philippine domestic passengers and less than 2% of international passengers in the first nine months of 2013. But a sale to Cebu Pacific could be closely scrutinised as Cebu Pacific is already the domestic market leader with a 51% share of the market in the first nine months of 2013 and in 3Q2013, based on Philippine CAB data.

Philippine domestic market share (% of passengers carried) by carrier: 3Q2013

Cebu Pacific is also the second largest international carrier in Philippines with about a 16% share of the market. Only PAL, which has about a 22% share of the international market, is larger.

Proposed deal would have limited impact on international market

Taking over Tigerair Philippines' international operation should not be even slightly controversial as the carrier's international routes are from Manila alternative airport Clark and Kalibo rather than Manila. Unlike Manila, Clark and Kalibo do not have any slot constraints and are completely open to new entrants.

Tigerair Philippines currently serves Bangkok, Hong Kong and Singapore from Clark and Singapore from Kalibo. Cebu Pacific also serves two of these routes - Clark to Hong Kong and Singapore - but with about half the capacity of Tigerair Philippines.

Tigerair Philippines international routes ranked by capacity (seats): 6-Jan-2014 to 12-Jan-2014

In assessing the impact of the proposed transaction, Philippine authorities could require that Tigerair maintains a presence on the Clark-Singapore and Kalibo-Singapore routes by using its Singapore-based affiliate. Tigerair Singapore already serves the Manila-Singapore route with 12 weekly flights but leaves the Clark and Kalibo routes to its Philippine affiliate.

There could be implications for the domestic market

But the impact the transaction could have on the domestic market and on competition in Manila is much more significant. Of Tigerair Philippine's 182 domestic weekly flights, 168 or 93% are currently operated out of Manila, according to OAG data.

These flights give Tigerair Philippines almost a 4% share of slots at Manila. While this is not a huge number, Tigerair Philippines is the fourth largest holder of Manila slots after the PAL Group, Cebu Pacific and Zest Air (now operating as Zest AirAsia).

Manila Airport scheduled aircraft movement share by carrier: 6-Jan-2014 to 12-Jan-2014

Acquiring the Tigerair Philippines slots is significant as it would grow Cebu Pacific's share of scheduled commercial aircraft slots at Manila to about 38%, putting it ahead of PAL Group's 35% share (includes PAL mainline and regional carrier PAL Express). Cebu Pacific could use the additional slots to expand its already leading share of the domestic market or support further international expansion, where it is still smaller than PAL.

Cebu Pacific has been pursuing rapid international expansion using its A320 fleet and newly acquired A330s, which it has used to launch service to Dubai and add capacity on its largest regional routes. Cebu's international capacity was up 19% through the first 11 months of 2013 while its domestic capacity was up 8%. But PAL also has been pursuing rapid international expansion, with the resumption of flights in recent months to destinations in the Middle East and London. PAL and Cebu Pacific are also both pursuing rapid expansion to Japan using newly available traffic rights which Tigerair and AirAsia have also applied to use.

Three healthy players could be sufficient to maintain domestic competition

A re-allocation of domestic slots acquired from Tigerair Philippines to international flights or using the slots to increase domestic capacity would both lead to reduced competition in the domestic market. The Philippines domestic market has already seen a slight drop in domestic traffic in 2013 a result of consolidation in the LCC sector as PAL Express, formerly known as AirPhil, abandoned the LCC model and as AirAsia Philippines and Zest Air swapped equity.

Further consolidation could be viewed by authorities as a healthy outcome as the Philippine domestic market had been plagued by over-capacity and irrational competition. For a domestic market the size of the Philippines having three main competitors, along with several smaller regional carriers, is probably sufficient.

For example two other emerging countries with similar sized domestic markets, Malaysia and Colombia, have three main players competing on domestic trunk routes. In Malaysia, there are two LCC/hybrid players and one full-service carrier (AirAsia, Malindo and Malaysia Airlines). In Colombia, there is generally one LCC and two full-service carriers (VivaColombia, Avianca and LAN Colombia; a third full-service carrier, Copa Colombia, has significantly reduced its domestic operation in recent years and is no longer competing on several trunk routes).

Australia has a much larger domestic market but now essentially has a duopoly - with only the Qantas and Virgin Australia groups competing on the main routes - following the sale in 2013 of a majority stake in Tigerair Australia to Virgin Australia. The Australia case could be relevant as Australian competition authorities agreed, rather reluctantly, to approve the transaction after concluding Tigerair Australia would likely not be able to survive independently.

The same rationale could be applied to Tigerair Philippines. As CAPA reported in Jul-2013, Tigerair Philippines has struggled and faces an uphill climb given the competitive landscape:

The group believes the badly needed consolidation which came to the Philippine market in early 2013 significantly improves Tigerair Philippines' outlook. The consolidation resulted in the number of LCC players being reduced from five to three as AirAsia Philippines forged a tie-up with Zest, which now sees Zest operating under the AirAsia brand, while former LCC AirPhil Express adopted a full-service regional carrier model as it became PAL Express. But so far Tigerair Philippines has not benefitted from this consolidation as the carrier's financial position and market share has failed to improve.

...Tiger is in a precarious position as it will need to expand well beyond five aircraft to gain a meaningful presence in the Philippine market and enjoy economies of scale. But any expansion is risky given the stronger positions of Cebu Pacific, PAL and AirAsia.

Expansion would also require a capital infusion from Tiger Airways Holdings and its Philippine partners. So far it seems the owners of Tigerair Philippines are reluctant to make the commitment.

Tigerair's foray into the Philippines was a long drawn out affair

Singapore-based Tiger Airways Holdings acquired a 40% stake in SEAir in Aug-2012 and the airline was re-branded Tigerair Philippines in Jul-2013. The completion of the deal ended a long flirtation with SEAir which began in 2006 when the two carriers initially announced a tie-up. But nothing materialised until late 2010, when SEAir began operating two A319s subleased from Tigerair at Clark as part of a marketing partnership which included having the flights sold on Tigerair's website.

Three Tigerair-sourced A320s were added in mid-2012 as the group finally closed in on completing the acquisition of the equity stake, which had been under negotiation for some time. Tigerair Philippines has since been operating the equivalent of three aircraft on domestic trunk routes from Manila while two aircraft continued to be based at Clark and used primarily for international services. SEAir's original turboprop fleet was divested in 2012, with Tigerair reallocating the slots SEAir had used for regional routes to enter domestic trunk routes, resulting in new competition for Cebu Pacific, the PAL Group and Zest Air.

At the time the PAL Group had two brands operating side by side on the trunk routes with AirPhil competing at the budget end and Philippine Airlines providing a full service. Philippines AirAsia and Zest were also operating independently in 2012. As CAPA reported in Aug-2012, Tigerair's entrance intensified competition, "putting further pressure on yields which have already been on the decline as a result of rapid capacity expansion by LCCs Cebu Pacific, AirPhil Express, AirAsia Philippines and Zest Air".

Tigerair now serves six of the largest domestic routes in the Philippines

Tigerair Philippines currently serves six domestic routes from Manila - Cebu (CEB), Bacolod (BCD), Kalibo (KLO), Puerto Princesa (PPS), Davao (DVO) and Iloilo (ILO). According to OAG data, Cebu is currently served four times per day; Bacolod, Kalibo and Puerto Princesa are each serviced twice per day; and Davao and Iloilo are served once per day. Tigerair Philippines also serves Davao and Kalibo from Clark but these routes are served less than daily.

Tigerair Philippines domestic routes ranked by capacity (seats): 6-Jan-2014 to 12-Jan-2014

Tigerair's six Manila domestic routes are all among the top seven domestic routes in the Philippines. The only exception is Manila-Cagayan de Oro (CGY).

Philippines top seven domestic routes ranked by capacity and year-over-year change: 6-Jan-2014 to 12-Jan-2014

Rank	Origin		Destination		Total Seats	1 Year Percentage Change
1	MNL	Manila Ninoy Aquino International Airport	CEB	Mactan Cebu International Airport	89,015	13.7%
2	MNL	Manila Ninoy Aquino International Airport	DVO	Davao Francisco Bangoy International Airport	55,018	13.4%
3	MNL	Manila Ninoy Aquino International Airport	KLO	Kalibo Airport	41,591	14.1%
4	MNL	Manila Ninoy Aquino International Airport	ILO	Iloilo Mandurriao Airport	36,394	0.5%
5	MNL	Manila Ninoy Aquino International Airport	CGY	Laguindingan International Airport	35,828	n/a
6	MNL	Manila Ninoy Aquino International Airport	BCD	Bacolod Airport	35,248	35.6%
7	MNL	Manila Ninoy Aquino International Airport	PPS	Puerto Princesa Airport	30,726	-4.9%

Cebu Pacific already operates all six of Tigerair's domestic Philippine routes. It is the market leader on all the routes except Kalibo and Puerto Princesa. AirAsia is the market leader on Manila-Kalibo while PAL Express is the market leader on Manila-Puerto Princesa and also has slightly more capacity than Cebu Pacific on Manila-Kalibo. These two routes are much more leisure focused than the other four as Kalibo is a gateway to the popular resort island of Boracay while Puerto Princesa is on the resort island of Palawan.

On all the routes Tigerair has the smallest share of the market, with between 5% and 15% of current capacity, according to CAPA and OAG data. PAL/PAL Express, AirAsia and Cebu Pacific are currently the only other competitors on all the routes.

A year ago major domestic city pairs essentially had six brands competing with Cebu Pacific, PAL, AirPhil, Zest, AirAsia and Tigerair. AirAsia at the time only operated at Clark but was serving the major domestic destinations from Clark in an ultimately unsuccessful attempt to compete against the Manila-based LCCs.

In Mar-2013 PAL Express transitioned from the LCC to regional full-service model and adopted a new network strategy which focuses on smaller and leisure markets. Under the AirPhil Express brand, the carrier had operated alongside PAL on almost all major domestic trunk routes with AirPhil focused on the budget end of the market. After the adjustment the two carriers stopped operating on the same routes with a couple of small exceptions.

Meanwhile also in Mar-2013 Philippines AirAsia forged a partnership with Zest Air including an equity swap. The two airlines have since completed a virtual merger with Zest adopting the AirAsia brand.

Philippines AirAsia in late 2013 closed its base at Clark and moved to Manila. It currently operates alongside Zest, now known as AirAsia Zest, on routes such as Manila to Cebu, Davao and Kalibo. But as both are branded AirAsia and are sold on the AirAsia website, they are essentially one player.

Based on current capacity figures, the AirAsia brand has a 14% share of the Philippine domestic market compared to 48% for Cebu Pacific, 32% for the PAL Group and 5% for Tigerair.

Philippines domestic capacity share (% of seats) by carrier: 6-Jan-2014 to 12-Jan-2014

AirAsia and Tigerair Philippines ventures have both been choppy

AirAsia stands to benefit if Cebu Pacific takes over Tigerair as it will only have to compete in the domestic market against one LCC. The intense and at times irrational competition in the Philippine LCC sector has made it challenging for AirAsia. Philippines AirAsia, which is 40% owned by Malaysia-listed AirAsia Berhad, accumulated losses of MYR138 million (USD42 million) in its first 18 full months of operations (1-Apr-2012 to 30-Sep-2013). This includes a loss of MYR21 million (USD6 million) in the quarter ending 30-Sep-2013. Philippines AirAsia only operated a fleet of two A320s during this entire period.

Tigerair's losses in the Philippines have been equally staggering, providing a further indication that the market may not be able to support so many LCCs. Tigerair Philippines accumulated losses of SGD83 million (USD65 million) in the first 14 months that the carrier was partially owned by Singapore-listed Tiger Airways Holdings (Aug-2012 to Sep-2013). This includes a loss of SGD23 million (USD18 million) in the quarter ending 30-Sep-2013. As Tigerair Philippines transported about 1.5 million passengers in the Aug-2012 to Sep-2013 period with an average load factor of about 73%, the carrier lost an average of approximately SGD55 (USD43) per passenger.

With Tigerair Philippines continuing to be highly unprofitable, plans for fleet expansion have repeatedly been delayed. The carrier has been operating the same fleet of two A319s and three A320s since Jul-2013. In Sep-2013, Oct-2013 and Nov-2013 - the last three months of available operating data - Tigerair Philippines' ASKs were down year-over-year between 9% and 12%. (RPKs and passenger numbers however were up as the carrier's load factor has been on the rise.)

Tigerair could be reluctant to continue covering losses in the Philippines as its other current and planned affiliates are more strategically important to the group. Indonesian affiliate Tigerair Mandala also has struggled and faces challenges but Indonesia is a much bigger market than the Philippines. Indonesia-Singapore is also a large and strategically important market for Tigerair, which has used Mandala to significantly expand its presence.

Cebu Pacific purchase of Tigerair Philippines is a win-win but provisions should be made for potential new entrant

Tigerair Taiwan, which is expected to launch in 2014, represents a potentially better investment for the Tigerair group as Taiwan does not currently have a local LCC. Tigerair has the opportunity to establish first mover advantage in the Taiwanese market for a relatively small investment. Its 10% stake in Tigerair Taiwan is part of a new "asset light" strategy for the group which also involves forging partnerships with other LCCs.

See related reports:

If it has an opportunity to recover most or all of its investment in Tigerair Philippines the group would be smart to divest. Essentially trading Taiwan for the Philippines would allow the group to focus on launching Tigerair Taiwan while trying to improve profitability in Indonesia and Australia and restore profitability in Singapore.

Cebu Pacific is the most logical suitor because selling to AirAsia, which could potentially be interested in further expanding its Manila slot portfolio, would be unfathomable. The only other main player in the Philippine market, PAL, is no longer interested in the budget segment. Selling to another Asian LCC group which does not have a Philippine operation would be the other potential option but the new owner almost certainly would run into the same challenges as Tigerair. Competing against Cebu Pacific, Philippines AirAsia/AirAsia Zest and PAL/PAL Express, which often competes on price although technically are not LCCs, is a tall order for anyone.

Philippine authorities however should think carefully and leave the door open for potential new entrants. As more slots at Manila become available in future rules can be put in place to give priority to new entrants. Three strong domestic players should provide sufficient competition for the short to medium term but providing at least an opportunity at the main airport for new competition would improve the prospects for growth over the long term.