Korean Air to become a top 10 world airline - but challenges abound
Korean Air’s plan to take over rival Asiana Airlines will cause one of the biggest-ever shakeups in the South Korean airline industry, and the competitive implications will also be felt elsewhere in the Asia-Pacific region and globally.
The purchase is seen by the government and Asiana’s creditors as the best way to ensure the continuation of Asiana’s operations, albeit under another airline’s identity. Asiana was struggling even before COVID-19 emerged, and the onset of the pandemic torpedoed an earlier buyout attempt by another corporation.
Merging the two airlines will reduce competition, but there are very few alternative paths available that would retain Asiana as a strong competitor. There is limited appetite for outside investment into airlines thanks to COVID-19, particularly for carriers that were financially shaky before the pandemic.
Absent this deal the most likely outcome for Asiana was dramatic downsizing or perhaps eventual collapse. The government has obviously decided that reducing competition was preferable to mass job losses.
The government’s support for a merger of this magnitude would have been difficult to imagine before COVID-19. But this is yet more evidence that the pandemic has shaken up industry norms.
Summary:
- Korea's government sees merger as best option to preserve jobs after earlier deal collapsed
- The combined carrier could potentially be among the world’s 10 largest by traffic and capacity
- Full ramifications for fleet, networks and subsidiaries are yet to be determined
- Some aircraft types are common to both, but the deal will still mean a more complex fleet
- Asiana would initially be a subsidiary, and full integration could take years
State bank will support Korean Air's $1.6B takeover of Asiana
Korean Air said on 16-Nov-2020 that its board has agreed to buy a majority stake in Asiana for KRW1.8 trillion ($1.6 billion). State-owned Korea Development Bank (KDB) is investing KRW800 billion to support the deal, and Korean Air will issue new shares next year to raise KRW2.5 trillion which will be used to fund the acquisition.
Korean’s CEO Walter Cho has stressed that protecting employee job security will be a priority. However, questions regarding how much of Asiana’s fleet and network will be retained are yet to be determined. There will be some degree of overlap to be addressed, and for deals of this magnitude regulators sometimes require carveouts to address dominance in certain markets.
Merged airline would have entered top tier in 2019 passenger volume
Whatever the degree of streamlining involved, the deal would still mean a dramatic size increase for Korean Air.
The airline highlighted this point by saying it expects to be ranked as one of the top 10 airlines in the world once the acquisition is completed. The resulting expansion of its routes, fleet and capacity will give the airline better ability “to compete with global mega-airlines,” Korean Air said. The airline believes that because South Korea has two major full-service carriers, its airline industry is at a “competitive disadvantage” compared to countries such as Germany, France and Singapore which have a single major airline.
Korean Air was ranked 18th in terms of international passenger volume in 2019, and Asiana was 32nd, according to statistics from the International Air Transport Association. Their combined total would have ranked 10th globally, and first for Asia-Pacific airlines. In terms of revenue passenger kilometers, the pair would rank 11th overall.
…and pre-COVID combined seat capacity would have ranked even higher
The potential scale of the merged airline is also indicated by data from CAPA and OAG.
In Dec-2019, before the COVID-19 crisis began, Korean Air was ranked 18th globally for weekly international seats and Asiana was 38th. Combining their seat totals would put them in eighth place.
The combination would also rank eighth as measured by weekly international available seat kilometers. The list below shows the airlines currently in the top 10 for international seat capacity.
Top 10 airlines ranked by weekly international seats, week of 2-Dec-2019
Both carriers are particularly strong in cargo, and the merger will amplify their position. Korean ranks fifth globally in terms of international scheduled cargo tonne-kilometers, with Asiana 23rd , according to IATA data. When added together, they would be third on the list, behind only Qatar Airways and Emirates.
The two airline groups will have a dominant share of local market
The acquisition deal will expand Korean Air’s already leading share of the South Korean market. And by enhancing the airline’s network and adding to connecting opportunities, the merger will strengthen the standing of Seoul Incheon International Airport as an Asian hub, Korean Air says.
For the week of 2-Dec-2019, Korean Air accounted for 22.4% of the international seats in the South Korean market, according to data from CAPA and OAG. Asiana was second with a 15.4% share. Together, Korean Air and Asiana would have provided 37.8% of seats in this market, or 48.1% when including their LCC subsidiaries.
Market share for weekly international seats in South Korea, week of 2-Dec-2019
At Incheon, Korean’s 25.3% share of seats and Asiana’s 17.9% share of seats would have combined for 43.2% for the week of 2-Dec-2019, and about 50% with their LCCs. This level of dominance occurs at some other large airline hubs, with Cathay Pacific, the SIA Group and the Lufthansa Group among those with similar or higher share at their main bases, CAPA data indicates.
Korean, Asiana and their subsidiaries hold a combined 67% share of seats in the Seoul-Jeju market, which is South Korea’s most important domestic route and the world’s busiest domestic route.
Korean Air says consolidation will help streamline congested market
Consolidation of some kind in the crowded South Korean market has appeared likely for some time, and the latest crisis made it more pressing. In addition to the two full-service carriers, there are seven LCC or hybrid carriers based in Korea, and two more are set to join the market.
“Korea's aviation market was oversaturated even before the pandemic, and we have growing concerns [regarding] the industry’s uncertainty post COVID-19,” said Korean Air President Kee Hong Woo.
Acquiring Asiana “will give us a strong competitive edge,” said Mr. Woo. “After integration, we will be able to operate our fleets, routes, and schedules more flexibly and efficiently. We can also maximize synergies by sharing both airlines' infrastructure, such as cargo terminals, flight training centers, and maintenance facilities.”
Integrating Asiana aircraft risks increasing Korean’s fleet complexity
There are significant fleet implications from the merger. Korean Air has a mainline passenger and cargo fleet of 170 aircraft, of which 64 are inactive, according to the CAPA fleet database. Asiana has a fleet of 83 including 18 inactive.
The pair operate some passenger types in common, including Airbus A380s, A330s, Boeing 777s, and 747 freighters.
They use different narrowbody models, with Korean Air mainly relying on 737s and Asiana using A320/A321s. Korean Air has 737 MAXs on order, but it has also recently added 10 A220s, and both carriers have ordered A321neos.
A major point of difference is that Korean Air is refreshing its widebody fleet with Boeing 787s while Asiana has turned to A350s. Korean already has 10 787-9s in service and 10 -9s and 20 -10s on order. Asiana has 11 A350-900s in its fleet, with another 10 -900s and nine -1000s on order.
This means the enlarged Korean Air could have an even more diverse fleet than it does currently. However, the airline has already proved it is willing to operate similar types from both manufacturers, as it has bought A380s and 747-8s, and Boeing MAXs and Airbus Neos.
Asiana’s financial woes will add to merger challenges
Another notable aspect of the merger is that Korean Air is taking on a financially troubled and heavily indebted company. This would be a difficult enough prospect at any time, but Korean will be coping with the assimilation at the same time as it attempts to recover from the coronavirus-related downturn.
Asiana was under financial pressure before the pandemic hit. Its parent Kumho Group had agreed to sell its controlling stake in Asiana to Hyundai Development Corp. (HDC), but the deal collapsed in Sep-2020 after airline values declined due to COVID-19. This effectively put Asiana under the control of KDB and other creditors.
The new acquisition deal is expected to close during 2021. Approval from various governments will be required, which may take some time. Another hurdle is a court challenge from an activist investor group that is a major shareholder in Korean Air’s parent Hanjin-KAL.
It will take time for Korean to fully absorb Asiana
Korean Air has said Asiana would initially be operated as a subsidiary of Korean Air. Ultimately the Asiana brand would disappear, but the process would take years, an airline spokesperson said.
Whether Asiana stays in the Star Alliance will be discussed during the acquisition process, according to Korean. Korean Air is a member of SkyTeam, and has an important partnership with fellow SkyTeam member Delta on U.S.-Korea international routes. It seems obvious that Asiana will exit Star at some point, which will drastically reduce that alliance’s ability to tap into the South Korean market.
LCC units are likely to be consolidated during merger
Asiana’s LCC subsidiary Air Seoul and its controlling stake in Air Busan will be included in the deal. However, whether the LCC subsidiaries would be retained or merged with Korean Air LCC subsidiary Jin Air is still to be decided.
The assumption is that the LCC fleets would be incorporated into Jin Air. Air Seoul is much smaller than the other two LCCs, so the disappearance of that brand would cause few ripples. Air Busan may be a different case, as a large proportion of its operations are into or out of South Korea’s second-largest city Busan. An argument could be made for retaining this brand identity.
State bank will become a part-owner of Hanjin-KAL after investment
The details of this deal are complex. Under the acquisition agreement, KDB will invest KRW800 billion in Korean Air’s parent Hanjin-KAL. This amount will be immediately loaned by the parent to Korean Air. Korean Air will use KRW300 billion to acquire perpetual convertible bonds from Asiana. Another KRW300 billion will be used as a down payment on the Asiana acquisition price.
Together, these investments will provide Asiana the funding needed for its operations until the end of the year and improve its financial position.
The agreement with KDB will see the state bank gain a stake of about 10% in Hanjin-KAL. This could help shore up the position of Walter Cho as chairman of Hanjin-KAL, as a rival coalition has accumulated a substantial shareholding and is challenging his leadership. The coalition is led by activist shareholder group Korea Corporate Governance Improvement (KCGI), and includes Cho’s sister Heather Cho.
Hanjin KAL says it chose to receive the KDB funding by issuing new shares, rather than by borrowing from the bank, in order to “maintain a stable financial structure.” KDB’s shares will give it voting rights, and the bank will “monitor and make sure Hanjin KAL and Korean Air follow through with the acquisition plan,” Korean Air says.
Existing Korean Air stakeholders – including Delta – will have their holdings diluted after the KDB share purchase.
The merger offers huge upside if it can be completed successfully
The takeover could be regarded as something of a coup for Korean Air’s leadership, who have seized an opportunity presented by the pandemic. But completing the deal and satisfying regulators will require a balancing act. Korean Air will have to live up to its promise to preserve jobs, but it will also need to avoid being dragged down by adding duplicative services or excess capacity.
Close scrutiny of the two fleets will be needed to avoid the added costs of complexity. Some degree of rationalization will have to occur for Korean to realize the potential benefits of greater scale.
One positive aspect will be that Korean will be in the undisputed role of South Korea’s national airline, and the government – which will be a stakeholder – may feel compelled to ensure its survival. Concerns about policy favoritism will be less problematic with just one major airline.
If everything goes well, the merger could turn Korean Air into one of the airline industry’s most powerful players. It could also help Korean Air more fully realize its ambition of turning its magnificent Incheon hub into one of the world’s major connecting airports. However, there is also a slim margin for error, particularly if international demand remains depressed for longer than expected.