07-Feb-2016 1:00 PM

Singapore Airlines takeover bid of Tigerair succeeds. Tigerair-Scoot merger may be next

Analysis

Singapore Airlines (SIA) has increased its stake in Tigerair to above 90%, enabling the group to privatise the short haul low cost airline and fully integrate Tigerair into its portfolio. Taking over Tigerair boosts the outlook for the SIA group, particularly for medium/long haul low cost subsidiary Scoot.

Scoot is now in the black, having just reported its first ever quarterly profit. However, Scoot needs a more robust relationship with Tigerair as it doubles in size over the next few years.

Only approximately 5% of Scoot traffic now connects to Tigerair. SIA's takeover of Tigerair and Tigerair's upcoming transition to the Scoot reservation system will significantly boost transit traffic between the two LCCs, but ultimately a merger may be necessary for the synergies to be fully realised.

SIA wins battle to secure 90% of Tigerair

SIA announced on 5-Feb-2016 that it had secured a more than 90% stake in Tigerair and will delist its short haul LCC subsidiary. Tigerair has been listed on the Singapore Exchange since early 2010, at which point SIA had a minority share and limited influence.

SIA increased its stake in late 2014 to approximately 56%, and on 6-Nov-2015 launched a conditional offer to buy the remaining 44% for SGD41 cents (USD29 cents) per share. The initial offer valued Tigerair at just over SGD1 billion (USD710 million) and gave shareholders until 28-Dec-2015 to accept the proposal.

SIA encountered resistance from some minority shareholders. SIA initially responded by extending the deadline to 8-Jan-2016, hoping that the extra two weeks would enable it to secure the 90% required for a delisting. On 4-Jan-2016 SIA increased its offer to SGD45 cents (USD32 cents) per share and further extended the deadline to 22-Jan-2016.

In a final attempt to close the deal, on 11-Jan-2016 SIA announced a further extension of the deadline until 5-Feb-2016 and changed the offer from conditional to unconditional. This meant that SIA would still acquire all tendered shares even if it failed to secure the 90% required to delist the company, and also prohibited SIA from further increasing its offer.

The final roll of the dice was effective at swaying enough shareholders. The battle to secure 90% was harder than initially anticipated as some Tigerair shareholders were bitter, having initially purchased the stock at a much higher price. Tigerair's IPO price was SGD1.50, or more than three times the offer price. However, SIA eventually got its way and paid a relatively reasonable premium of 45%, compared with the SGD31 cents closing price when the offer was initially made on 6-Nov-2015.

SIA needed full control of Tigerair

Not securing 90% would have prevented SIA from fully implementing its multi-brand strategy, an important component of the group's overall long-term strategy. Tigerair would have had to maintain its listing, and it would essentially have had the same status in the SIA Group that it has had since SIA increased its stake to 56%.

Tigerair began participating in SIA Group network planning meetings after SIA became a majority shareholder. However, decisions were not binding and Tigerair's independent board members, representing the minority shareholders, in many cases were reluctant to approve proposals that were in the best interest of Scoot and the SIA Group overall. Even an 89% stake in Tigerair would not have eliminated this issue.

Having exceeded the 90% threshold, SIA will no longer have to worry about Tigerair independent board members. SIA still does not have a 100% stake in Tigerair but reaching a full 100% is not necessary. Still, SIA will likely come close to 100% as it has further extended the deadline of its offer to 19-Feb-2016. This gives the remaining holdouts an opportunity to sell, now that they realise the company will be delisted and they will lose any influence.

Once the offer period expires the shares will be formally delisted. The privatisation of Tigerair is now a certain outcome, giving SIA Group management relief as they can now plan the next step of Tigerair's integration into the SIA Group. SIA was able to pursue some integration after taking a majority stake, but in several areas full integration was not possible without a takeover.

Tigerair-Scoot merger would be sensible

SIA never indicated what changes could occur at Tigerair if the group succeeded at taking over control and delisting the subsidiary, although SIA executives have stated that there will be no job losses. SIA likely has developed a plan for Tigerair that it will now be able to pursue and start sharing with Tigerair employees. Careful internal communication will be important as Tigerair has suffered in recent years from high turnover and low employee morale.

Tigerair has been independent since it commenced operations in 2004 with a minority and passive stake from SIA. Scoot was also set up as an independent company, although it has been 100% owned by SIA since its mid-2012 launch. SIA's full service regional subsidiary SilkAir is less independent, with essentially all non-operational decisions made by SIA.

There has been a high degree of coordination between Scoot and SIA from the beginning, while coordination between Tigerair and SIA or Scoot has been limited. Tigerair, along with Scoot, should continue to be managed independently from their full service parent as it is important to maintain a low cost DNA. However, a merger between Tigerair and Scoot would be logical.

Tigerair and Scoot now have several overlapping functions. A merger would result in synergies on the cost side, as well as better alignment of commercial activities.

Even if they merge, Tigerair and Scoot could still maintain separate operator certificates and - at least initially - separate brands. A joint brand should eventually emerge, but such a decision could always be made later. A decision on a merger is more pressing in the short term.

Scoot needs more feed from Tigerair

Scoot needs full integration with Tigerair in order to succeed over the long term. While Scoot is now profitable it is committed to rapid expansion, resulting in a much bigger operation that is likely only viable with more feed from Tigerair.

Currently only approximately 5% of Scoot's passengers transfer to Tigerair - a woefully insufficient figure given Scoot's network model. Even when including Scoot to Scoot transfers and connections with SIA and SilkAir, the number of Scoot passengers connecting to flights within the SIA Group is less than 10%.

In comparison, over 50% of passengers at Malaysian long haul LCC AirAsia X now transfer to flights within the AirAsia Group. (This includes mainly connections from AirAsia X to AirAsia short haul affiliates but also some connections between long haul flights.)

AirAsia X portion of connecting passengers: 2011 to 3Q2015

There will be opportunities for Scoot to grow Scoot to Scoot connections as it expands its network and grow transit traffic with its full service sisters. However, by far the largest opportunities come with Tigerair, which serves a network of 39 destinations. Scoot currently has 17 destinations, including four that are also served by Tigerair (Bangkok, Guangzhou, Hong Kong and Taipei).

Shared reservation platform to boost Scoot-Tigerair connections

SIA's takeover and delisting of Tigerair will clearly improve the Tigerair-Scoot relationship. Tigerair is also transitioning to the Scoot reservation system in Apr-2016, which will make it easier to sell connecting itineraries.

Tigerair and Scoot both use Navitaire, but different versions. The two LCCs have been able to offer connecting itineraries through an interline arrangement, which was initiated two years ago. However, the current link between the reservation systems does not allow the sale of ancillaries, and has other limitations.

A common reservation system alone, however, will not be enough to boost transfer traffic to the desired levels. A merger would enable Scoot and Tigeriar to be aligned commercially, with common goals and key performance indicators.

Scoot and Tigerair need to become more commercially aligned

Without a merger Tigerair will have its own commercial objectives, which typically favour point to point over network traffic. This is a natural consequence of separately managed LCC subsidiaries.

From the perspective of its own P&L, Tigerair is better off filling up its aircraft with local passengers. This is particularly the case on routes where Tigerair already enjoys high load factors and is unable to expand because of bilateral or slot constraints. Setting aside seats for large groups of passengers connecting from a Scoot flight is not commercially in Tigerair's interest as it results in a lower yield. However, for the SIA Group overall Tigerair is better off accommodating these passengers.

Scoot particularly needs access to seats beyond Singapore for large tour groups from China, and soon India and Saudi Arabia, in order to fill up its 787s in these markets. A large portion of passengers, or potential passengers, from these markets are not heading to Singapore but to other markets in Southeast Asia that are not served by Scoot.

Scoot has also been selling connecting flights on SilkAir and SIA since early 2013 - in part because it initially struggled to get access to Tigerair seats. These interlines will be maintained as SilkAir and SIA offer some regional destinations that are not served by Tigerair, and in some cases better timings for overlapping routes.

There are still opportunities to improve the Scoot-SIA/SilkAir relationship. For example SIA is currently not selling Scoot's business class. SIA began selling Scoot-operated flights in mid-2015 but is now only offering its passengers economy seats on Scoot bundled with meals, drinks, seat assignments and checked luggage. Scoot's business class should eventually be offered to SIA premium passengers in connecting markets not served by SIA, and in overlapping markets where Scoot offers a significantly shorter transit time.

Scoot to add interlines outside SIA Group

Scoot will also continue to build up its portfolio of partners outside the SIA Group. Scoot currently interlines with Thai short haul LCC Nok Air, their medium long haul joint venture NokScoot and Virgin Australia.

The Virgin Australia partnership gives Scoot domestic feed in Australia, its largest market, as it has been unable to forge an interline with Tigerair Australia, which is now 100% owned by Virgin Australia. Nok provides Scoot and NokScoot with domestic feed in Bangkok.

NokScoot already shares Scoot's reservation platform, which from Apr-2016 will also host Tigerair. Nok will continue to use its own reservation system, although there is a link to the Scoot system enabling passengers to connect from Nok to Scoot or NokScoot.

So far interline volumes with Nok and NokScoot have been very low. However there are opportunities to increase transit traffic, particularly as Nok and NokScoot launch new destinations in China that are not part of the Scoot (or Tigerair) network. All four of NokScoot's current destinations are also served by Scoot from Singapore, but NokScoot plans to launch new destinations in mainland China in 2016 that are not served by Scoot.

Scoot is keen to work with more airlines. It would particularly be logical for Scoot to seek partnerships in Greater China. China is a key market for Scoot - accounting for a leading 28% share of its total seat capacity and 78% of seat capacity at NokScoot. Hong Kong and Taiwan are also among the top five international markets for Scoot.

Australia is Scoot's second largest market, while Thailand is its fourth largest. Scoot already has an offline presence in secondary Australian and Thai cities through Virgin Australia and Nok Air.

Scoot weekly seat capacity by country: 1-Feb-2016 to 7-Feb-2016

Scoot needs feed to maintain newfound profitability

All the partnerships should push up the transit portion of Scoot passengers from below 10% currently to potentially 20% by the end of 2016, and gradually 30% or eventually perhaps 40% or 50%. Tigerair will clearly be the biggest driver, particularly if a merger is pursued, but all the smaller partnerships also improve Scoot's outlook.

Scoot had its best quarterly operating performance in its history for the three months ending 31-Dec-2015 (3QFY2016). Scoot reported an operating profit of SGD18 million (USD13 million) for 3QFY2016, compared with an operating loss of SGD17 million (USD13 million) loss in 3QFY2015.

As CAPA has previously highlighted, Scoot incurred operating losses of SGD22 million (USD16 million) in 1QFY2016 and SGD2 million in 2QFY2016 (USD1.4 million), but was break-even in the first half when excluding fuel hedge losses. Scoot's result for the three months ending 30-Sep-2015 was better than any of the six long haul LCCs based in Southeast Asia.

Scoot is expected to post a profit for the full fiscal year, which ends 31-Mar-2016 (FY2016). In FY2017 Scoot will benefit from lower fuel costs as the SIA Group's more expensive hedges wind down, but could struggle to maintain profitability as ASKs are projected to increase by almost 50%, pressuring yields and load factors.

Scoot needs a large boost in partnership traffic, particularly from Tigerair, in order to support the upcoming expansion. Scoot is launching services to Saudi Arabia and India over the next few months - both of which will need connections beyond Singapore to be viable.

Scoot almost ready to start selling India flights

Scoot has already set a 1-May-2016 launch date for three weekly non-stop flights from Singapore to Jeddah. SIA is dropping Jeddah, which it has been serving via Dubai since terminating non-stops in Sep-2014, as Scoot takes over the route. As CAPA has previously highlighted, for Jeddah Scoot will rely heavily on connections to Indonesia, Malaysia and the Philippines.

For India, Scoot will rely heavily on connections to Australia and Bali. As Scoot has not been able to schedule its new India flights to connect in both directions with its Australia flights, it will need to rely on other SIA Group partners to operate at least one of the four sectors on India-Australia itineraries. In some cases, SIA will be used to operate an Australia-Singapore or Singapore-Australia sector while in other cases SIA, SilkAir or Tigerair will be used to operate an India-Singapore or Singapore-India sector.

India will become the second market along with China served by all four SIA Group airlines. With India for the first time all four brands may even serve the same destination.

Scoot has not yet set a launch date for services to India or announced specific destinations. Scoot is now aiming to set a launch date and begin ticket sales for multiple India routes within the next few weeks. As CAPA has previously highlighted, Scoot will serve a combination of Indian metros and secondary cities. For the metros, Scoot will take over a service now operated by another SIA Group airline, as bilateral restrictions preclude additional SIA Group capacity.

The first India route could launch by the end of its fiscal year in March, while the second route could launch early in the new fiscal year. Scoot already has the capacity to launch the first India route. The plan has been to use its tenth 787 for the first India route and Guangzhou, which was launched on 16-Jan-2016. Scoot is now underutilising its 787 fleet because it has not yet been able to launch planned fights to India.

Scoot was initially aiming to launch its first India route in early 2016, but has encountered delays in securing approvals from Indian authorities. Scoot is now close to securing approvals, which in India (unlike in other markets) are required to begin ticket sales.

The plan is to use Scoot's next 787 delivery to launch Jeddah, along with a second route to India. Scoot is slated to take its eleventh 787 in Apr-2016.

Scoot will also add capacity to China in FY2017

Scoot is now slated to take three 787s in FY2017, with the second delivery around Oct-2016 and one in early calendar 2017 (4QFY2017). Scoot was initially planning to take four 787s in FY2017, but the last delivery has been postponed to early FY2018.

Scoot fleet summary: as of 6-Feb-2016

Aircraft	In Service	In Storage	On Order
Total:	11	1	10
Boeing 777-200ER	1	1	0
Boeing 787-8	4	0	6
Boeing 787-9	6	0	4

Scoot has been considering a third destination in India, as well as possible new destinations in North Asia. It is also planning to add capacity to some of its existing destinations in China and Taipei following its second and third delivery for FY2017.

Taipei may be increased from 10 to 14 weekly frequencies, while Shenyang may be decoupled from Qingdao and served with a new non-stop flight. Scoot had been considering several new destinations in China but instead is now focusing on thickening out its existing Chinese network. For example Scoot is increasing Nanjing service to daily from May-2016.

There could also be opportunities for Scoot to take over Tigerair flights as the two LCCs become more aligned and potentially merge. As CAPA previously wrote in the Nov-2015 report: "Scoot could also potentially take over peak hour or peak season Tigerair flights to short-haul destinations where slots are at premium such as Hong Kong, Phuket and Jakarta. Tigerair in turn could takeover Scoot's Singapore-Kaohsiung-Osaka route and some SilkAir routes to China. The possibilities and opportunities are myriad as SIA seeks to maximise the value of each airline subsidiary."

Tigerair outlook improves as well, but challenges remain

SIA's successful takeover and the increased alignment with Scoot also marks a new chapter for Tigerair. The LCC was also in the black in 3QFY2016, turning an operating profit of SGD9 million (USD6.4 million) compared with an operating profit of SGD4 million (USD3.1 million) in 3QFY2015. Tigerair was in the red in 1HFY2016 and will likely end the fiscal year with a break-even result or small profit.

SIA the parent airline and SilkAir were also in the black in 3QFY2016 as the group reported an operating profit of SGD288 million (USD205 million), its highest quarterly operating profit in nearly five years.

SIA Group financial highlights (in SGD million) by airline subsidiary: 3QFY2016 vs 3QFY2015

The CY2016 outlook for all SIA Group airlines is relatively bright as lower fuel costs should offset anticipated declines in yield. However, long-term challenges remain, including for Scoot and Tigerair.

For Scoot, rapid expansion over the next couple of years could impact its profitability. Tigerair is not planning to resume capacity expansion, which should enable it to improve its financial performance further, particularly if load factors improve as transit traffic from Scoot increases. However, from late 2017 Tigerair will again face excess aircraft issues, which drove significant losses in 2013 and 2014.

The 12 A320s Tigerair that subleased to India's IndiGo will return to Tigerair in late 2017 and 2018. Only one of these aircraft has a lease expiring when the subleases come up, meaning that Tigerair will need to take the aircraft back or again find an alternative home. Meanwhile, in 2018 Tigerair is slated to receive the first of 39 A320neos - an order it placed in order to cancel its last nine A320ceo commitments.

Tigerair currently operates 23 A320 family aircraft. The two stored aircraft listed below are in the process of being subleased to HK Express. In addition to the A320s currently at IndiGo and soon HK Express, Tigerair also has aircraft at Tigerair Taiwan. Tigerair has a 10% stake in Tigerair Taiwan, with China Airlines holding the remaining 90%, but Tigerair Taiwan is a competitor to Scoot in several markets.

Tigerair Singapore fleet summary: as of 6-Feb-2016

Aircraft	In Service	In Storage	On Order*
Total:	23	2	39
Airbus A319-100	2	0	0
Airbus A320-200	21	2	0
Airbus A320-200neo	0	0	39

Scoot's order book is reasonable if Tigerair feed materialises

The potential excess aircraft issue at Tigerair could become more manageable after the SIA takeover. SIA has huge leverage with Airbus and could reduce the A320neo commitment by converting some of the orders into widebody orders. Dealing with A320s coming back from IndiGo will be harder, but eventually the leases on these aircraft will expire and they will exit the SIA Group fleet.

Scoot's order book is also relatively ambitious, as the LCC is committed to doubling the size of its fleet by the end of 2019. However, it is the medium/long haul segment of the Singapore market that has the biggest growth opportunities since it is relatively undeserved by LCCs.

If Scoot can get the feed it needs from Tigerair the capacity added will be sustainable. The only lingering question is whether Scoot can get this feed without merging with Tigerair. A merger seems inevitable as there is potentially so much to gain, but little to lose.