Merpati Nusantara Airlines faces crisis. Should the Indonesia government pull the plug?

Merpati faces financial crisis

Merpati currently serves approximately 50 domestic and one international destination with a fleet of about 10 older generation 737s and about 20 turboprop aircraft. Merpati has been seeking for time to restructure and secure new capital in attempt to reduce its debts, which reportedly is about USD580 million.

The situation has become urgent in recent weeks as government-owned oil company Pertamina has stopped on a few occasions supplying fuel to Merpati because of the carrier's high debt level. While Merpati has so far been able to continue operating, it needs new capital.

The carrier has tried repeatedly in recent years to partially privatise but there has been limited to no interest. The government has indicated it will not bail out or restructure the airline and that if it fails to secure private capital it may be required to shut down.

Once Indonesia's second largest airline, Merpati is now number seven domestically

Merpati is one of Asia's oldest airlines, having launched services over a half century ago in 1962. The carrier was part of Garuda from the late 1970s to late 1990s but has been independent since 1997.

Garuda has been transformed over the last decade while Merpati, after an initial period of expansion around the turn of the century which saw it even launch flights to Melbourne and Perth in Australia, has languished. After being Indonesia's second largest airline for a long period, Merpati has seen its market share steadily drop over the past several years.

Merpati's current annual passenger traffic base is slightly more than 2 million, giving it less than a 3% share of Indonesia's domestic market. In 2007 and 2008, Merpati captured over 7% of the Indonesian domestic market. Over the past five years, Indonesia's domestic market has doubled in size while Merpati's passenger traffic has dropped by roughly 15%.

Lion Air and two other new entrants, Batavia and Sriwijaya, quickly expanded after launching in the early part of last decade and were all larger than Merpati by 2006, based on annual passenger numbers. Indonesia AirAsia, which is mainly an international operator, became a larger domestic carrier than Merpati in 2008. Another two LCCs, Garuda subsidiary Citilink and Lion regional subsidiary Wings Air, overtook Merpati in 2012.

Merpati is currently the seventh largest domestic carrier, behind Lion, Garuda, Sriwijaya, Wings, Citilink and Indonesia AirAsia. Tigerair Mandala and Lion's full-service subsidiary Batik Air are currently smaller than Merpati but are new carriers which are growing fast and will probably overtake Merpati in the domestic market by the end of 2014, assuming Merpati survives.

Top 10 domestic carriers in Indonesia ranked by seat capacity

Rank	Airline		Total Seats
1	JT	Lion Air	860,978
2	GA	Garuda Indonesia	417,590
3	SJ	Sriwijaya Air	203,196
4	IW	Wings Air	127,686
5	QG	Citilink	123,480
6	QZ	Indonesia AirAsia	84,960
7	MZ	Merpati Nusantara Airlines	67,292
8	ID	Batik Air	31,500
9	IL	Trigana Air	27,662
10	RI	Tigerair Mandala	25,200

Source: CAPA - Centre for Aviation & Innovata
Note: Capacity figures are not exact. Some Merpati small turboprop routes are excluded from the figures.

While there are huge growth opportunities in Indonesia's domestic market, which is the world's fifth largest with over 70 million annual passengers, the market could benefit from consolidation. Competition is intense and yields are low. Most of the country's domestic carriers, particularly the smaller and medium-size operators, continue to be unprofitable.

Batavia, which mainly operated on trunk routes with a fleet of 737s, A320s and A330s, collapsed in early 2013. Other airlines were able to quickly fill the void. The market would benefit from further consolidation.

See related reports:

• Mandala, Indonesia AirAsia and Citilink to benefit most from Batavia bankruptcy
• Indonesia poised for more rapid domestic growth in 2013, driven by low-cost carriers

Merpati continues to compete on some trunk routes, including Jakarta-Surabaya

While Merpati is mainly a regional carrier, it continues to compete against Indonesia's main carriers on several trunk routes. These routes in many cases are suffering from too much capacity and irrational competition. Reducing the number of players by one more would still leave six or seven carriers on the trunk routes Merpati serves - providing more than sufficient competition.

Merpati currently operates three routes from Jakarta - Bali, Makassar and Surabaya - according to Innovata data. Jakarta-Surabaya is the largest domestic route in Indonesia and the sixth largest domestic route in the world, based on current seat capacity. Bali is the second largest domestic route in Indonesia and Makassar is the third largest.

Merpati is one of eight carriers currently serving the Jakarta-Surabaya market. But its three daily 737 flights on the route only give it about a 4% share of capacity, according to CAPA and Innovata data.

Lion, Indonesia's largest domestic carrier, is the market leader on the Jakarta-Surabaya route with a 41% share of capacity. Garuda has a 22% share followed by its budget subsidiary Citilink with a 14% share. Sriwijaya has a 7% share and Indonesia AirAsia a 6% share. Only Tigerair Mandala and Batik are smaller than Mandala with 3% and 2% shares respectively but are likely to add capacity on the route as they expand.

Jakarta to Surabaya capacity by carrier (one-way seats per week): 19-Sep-2011 to 14-Apr-2014

Source: CAPA - Centre for Aviation & Innovata

Merpati competes against seven airlines on Jakarta-Bali and six on Jakarta-Makassar

The same eight carriers also serve the Jakarta-Bali route. Merpati is the smallest carrier in this market, with its one daily flight giving it only a 2% share of capacity.

Garuda is the market leader between Jakarta and Bali with a 35% share of capacity, followed by Lion with 31%, Indonesia AirAsia with 13%, Citilink with 9%, Sriwijaya and Batik with 4% each and Tigerair Mandala just over 2%. (Tigerair Mandala also has just one daily frequency but has a larger share of capacity as it operates 180-seat A320s while Merpati uses 158-seat 737-400s.)

Jakarta to Bali capacity by carrier (one-way seats per week): 19-Sep-2011 to 14-Apr-2014

Source: CAPA - Centre for Aviation & Innovata

There are currently seven carriers competing in the Jakarta-Makassar market. Tigerair Mandala and Batik are not yet on this route but Wings operates alongside Lion.

Merpati is again the smallest of the competitors, with 12 weekly flights giving it a 3% share of capacity. Lion has a market leading 40% share of capacity on Jakarta-Makassar followed by Garuda with 23%, Wings with 14%, Sriwijaya with 10% and Citilink and Indonesia AirAsia with 5% each.

Jakarta to Makassar capacity by carrier (one-way seats per week): 19-Sep-2011 to 14-Apr-2014

Source: CAPA - Centre for Aviation & Innovata

Merpati also competes in the Surabaya-Makassar market, which is the eighth largest domestic route in Indonesia and the country's largest route which does not touch Jakarta. Merpati has two daily flights on the Surabaya-Makassar route, giving it about an 8% share of capacity.

Lion, Wings, Sriwijaya, Indonesia AirAsia and Garuda also serve the Surabaya-Makassar route. Lion and Wings control a dominating 62% share of capacity in the Surabaya-Makassar market.

Other smaller trunk routes Merpati competes on include Surabaya-Bali and Surabaya-Bandung. These are the only other routes Merpati serves among Indonesia's top 30 domestic routes.

While Merpati only serves six of the 30 largest domestic routes in Indonesia, four of them are among its top 10 routes, which shows the significance that trunk routes still have in generating revenues. Jakarta-Surabaya and Surabaya-Makassar are its largest two routes, according to CAPA and Innovata data.

Merpati top 10 domestic routes based on capacity (seats): 28-Oct-2013 to 3-Nov-2013

Source: CAPA - Centre for Aviation & Innovata

The trunk routes have not been profitable given the intense competition and Merpati's insignificant size. But the carrier has continued to serve some to provide links to its regional services, particularly from Indonesia's two largest cities of Jakarta and Surabaya, both of which are located in the western Indonesian island of Java. Merpati's two largest regional bases are Bali and Makassar in central Indonesia.

Garuda establishes its own regional network after rejecting partnership with Merpati

Merpati would ideally partner with another carrier that operates on trunk routes. Garuda would be the most logical partner as the government remains the majority shareholder of both carriers. But Garuda in recent years has turned down Merpati's overtures to partner.

Garuda instead has begun to develop its own regional network, recognising that regional feed has played a key role in Lion's ability to become Indonesia's largest domestic airline group. Garuda could have instead opted to pursue a codeshare with Merpati, which competes against Wings on several regional routes. But it preferred to expand regionally using its own two brands. Merpati does not have the premium brand that Garuda enjoys and it does not have a stellar safety record. Lion also has said it is not interested in investing or partnering with Merpati.

Garuda began operating Bombardier CRJ1000 regional jets in late 2012. It currently operates 12 CRJ1000s and has six more on order, according to the CAPA Fleet Database. The new type is operated from four bases - Balikpapan, Makassar, Medan and Surabaya - and has allowed the carrier to open up new point-to-point routes. Previously the smallest aircraft in the Garuda group fleet was the 737-500.

Garuda's forthcoming ATR 72 routes to impact Merpati

Garuda also has committed to acquiring at least 25 ATR 72-600 turboprops, the first of which is slated to be delivered in Nov-2013. The ATR 72s are expected to be deployed from the same bases as the CRJ1000 as well as Bali. Initially the aircraft were allocated to Citilink but Garuda has since indicated that the type may be operated under both brands.

See related reports:

• Citilink regional expansion will further intensify competition between Garuda Indonesia and Lion Air
• Garuda Indonesia to focus on rapid domestic expansion before turning attention to international

Garuda CEO Emirsyah Satar recently told CAPA that Bali would be the first ATR 72 base and the carrier intended to launch services to neighbouring islands which are popular with tourists. He said that the carrier has been approached by several regional airports and governments that are keen to have Garuda service as it helps attract investment and stimulate the local economy.

There are several dozen small to medium size cities in Indonesia that have airports which cannot accommodate jets. Many of these cities are growing rapidly and can support more service. These markets are generally now served by Wings, Merpati and small independent regional carriers.

The Lion Air Group has so far been best positioned to cash in on the economic growth in Indonesia's smaller cities as it is the only player with the network and connections. Garuda will start to match this as it expands its new turboprop operation but Lion has a huge head start, with 24 ATR 72s already operating at Wings and another 35 on order, according to the CAPA Fleet Database.

Merpati is already struggling to compete against Wings, which has a much lower cost base and offers via Lion and now Batik a much wider range of connections onto trunk routes. Having to also compete against the new Garuda turboprop operation will make things even tougher for Merpati across its regional network. It will also impact traffic on its trunk routes as Merpati connecting passengers from regional destinations to Jakarta and Surabaya will start to have the Garuda option.

Garuda to initially compete against Merpati (and Wings) on short hops from Bali

For example, one of Garuda's first turboprop routes from its Bali base will include Komodo Airport on the island of Labuan Bajo, a popular island for tourists as it is home to the world's largest lizard, the Komodo Dragon. Merpati currently has nine weekly flights from Bali to Labuan Bajo while Wings currently serves the route with 11 weekly frequencies, according to Innovata data. Several smaller independent regional carriers also link Bali with Labuan Bajo and other nearby islands.

Merpati currently has four other turboprops routes from Bali - Bima, Lombok, Tambolaka and Waingapu, according to Innovata data. Wings Air also serves these routes and they are all candidates for the new Garuda turboprop operation.

Garuda already serves Lombok with 737s and has said it intends to use ATR 72s to launch services to Bima and Tambolaka. Other ATR 72 destinations Garuda intends to launch from multiple bases include Ambon, Banyuwangi, Bau-Bau, Ende, Jember, Kaimana, Luwuk, Mamuju, Poso, Tual and Wangi-Wangi. Most of these airports are served by Merpati and Wings.

Merpati also links Bali, which is its third largest base, with Dili in East Timor. Dili is served with one daily 737 flight and is Merpati's only international route. Bali-Dili is also served by Sriwijaya Air. There are currently no non-stop services between Dili and Jakarta or any other destination in Indonesia, according to Innovata data.

Merpati smaller turboprop routes are also becoming more competitive

At Makassar, Merpati's largest base, the carrier currently has five turboprop routes and nine jet routes. Wings competes only on two of the five turboprop routes, according to Innovata data.

A large number of Indonesian airports are unable to accommodate ATR 72s and can only be served with smaller turboprops. Merpati is able to access virtually all airports in Indonesia as it has three types of turboprops in its fleet, including 56-seat Xian MA60s, 20-seat PT Dirgantara/Casa 212s and 18-seat DeHavilland Twin Otters. All these types are known for their short take-off and landing capabilities. (Merpati's jet fleet consists of 737-200, -300s, -400s, and -500s, seating 117 to 158 in single-class configuration.)

Garuda is unlikely to acquire aircraft smaller than the ATR 72 but Wings has been looking at acquiring the N219, a new 19-seat turboprop being developed by PT Digantara (also known as Indonesian Aerospace). The Lion Group sees a role for a smaller turboprop as it would give it access to dozens of additional destinations, particularly in east Indonesia, a remote but fast-developing region which is rich in resources.

In the markets that can only accommodate smaller turboprops, Merpati now competes with several regional carriers, some of which have been expanding rapidly. The prospect of competition with Wings/Lion in these markets would significantly impact Merpati.

Historically Merpati has provided an essential role in smaller isolated communities. But as Indonesia's economy continues to develop rapidly, these communities are starting to attract more services from private regional carriers. As a result the potential loss of Merpati would not have nearly the economic or political impact on Indonesia as it would have several years ago.

Merpati network map

Source: Merpati

Merpati faces uphill battle as it tries to restructure

The Indonesian federal and local governments have the option of ensuring services are maintained to smaller communities by providing a subsidy to private carriers on a tender basis. This would be a much less expensive option than continuing to fund Merpati, particularly as the number of communities needing a subsidy to maintain air service is on the decline as there is now sufficient demand to support most services on an entirely commercial basis.

The government's ideal solution is to privatise Merpati but so far there has been only limited interest from several attempts to secure funds from Indonesian and international investors. The carrier's management team has come out with several new business plans in recent years which have not yet been implemented due primarily to the carrier's poor financial state. Fleet plans that never materialised included acquiring 737-800s or A320s as well as new 50-seat and 100-seat regional jets.

The carrier has talked in recent weeks about cutting its network in a bid to cut costs and survive. But at this point Merpati also needs a white knight.

Merpati's weak position in the domestic market does not make the carrier an attractive investment. The carrier's legacy structure leaves it in a particularly challenging position in what has become an intensely competitive market.

It will be nearly impossible for Merpati to dig itself out of the hole it now finds itself in and find a sustainable niche. As was the case with Batavia, several carriers will be ready and eager to fill the void.