Singapore Airlines looks to diversify its portfolio with possible investment in Korean LCC Jeju Air

Singapore Airlines (SIA) is looking at acquiring a stake in Korean LCC Jeju Air as a potential next step in further expanding and diversifying its portfolio of airlines. Jeju would be SIA’s first investment in North Asia, following recent investments in Australia, India and Thailand.

SIA-Jeju is an unusual combination as there would initially at least be limited network synergies, although it would be a relatively inexpensive investment for SIA. Jeju Air is keen to stick with its pure point-to-point short-haul LCC model, resisting the need to establish deep partnerships, pursue transit traffic or launch a long-haul low-cost operation.

Jeju could potentially be persuaded by SIA to make changes and pursue partnerships or joint ventures with SIA’s two LCC subsidiaries, Tigerair and Scoot. But most likely SIA’s potential stake in Jeju will be primarily an investment – at least in the initial phase – with some opportunities for the airlines to learn from each other without having to rebrand or forge formal partnerships.

It certainly offers SIA a much needed presence in North Asia. Jeju's long-term opportunity is travel within Northeast Asia, and especially in the Korea-China corridor. SIA's talks with Jeju could spark needed consolidation in Korea's LCC sector, with smaller players combining or receiving a foreign suitor as well.

SIA Group casts a wide net as it seeks out airline investment opportunities

SIA Group’s 17-Mar-2015 announcement that it been discussing a possible equity investment in Jeju Air, which has been preparing for a 4Q2015 initial public offering, comes somewhat as a surprise. More than anything else it indicates that SIA has cast a very wide net in its search of potential suitors.

The SIA Group has repeatedly stated it is interested in further expanding its portfolio of airline investments, continuing a strategy that starting after Goh Choon Phong took over as CEO at the beginning of 2011. Mr Goh’s first move was to acquire a 9.9% stake in Virgin Australia in 2012, which was increased in 2013 to 19.9%. The Group subsequently established two new joint venture carriers in overseas markets, with India’s Vistara launching services in Jan-2015 and Thailnd’s NokScoot preparing to launch services in May-2015.

See related report: Thailand's NokScoot ready to enter Japan, China & Korea once frustrating launch delays are overcome

Mr Goh also has grown the SIA Group airline portfolio in Singapore by launching fully-owned long-haul LCC subsidiary Scoot in mid-2012 and expanding its investment and role in short-haul LCC Tigerair in late 2014. Tigerair is now a majority owned subsidiary of the SIA Group and has begun pursuing closer cooperation with Scoot.

SIA is keen to expand its investment portfolio to North Asia

For some time North Asia has been an SIA Group target for potential investment. But the Group’s preference has always been to pursue a tie-up in mainland China, which is a much bigger market compared to South Korea.

China is SIA Group’s third largest overseas market after Indonesia and Australia while South Korea is not even among the top 10 (but could be if bilaterals permitted). Thailand is the group’s fourth largest overseas market, just behind China.

SIA Group seat capacity by country: 16-Mar-2015 to 22-Mar-2015

SIA has Australia covered with its close partnership and investment in Virgin Australia. Thailand will be partially covered with NokScoot. The new JV between Scoot and Thai Airways' short-haul LCC affiliate Nok will focus on the medium-haul sector, where SIA sees the most growth opportunities as Thailand’s short-haul and domestic markets are relatively saturated.

The group also has considered and will continue to assess potential investments in Indonesia. But investing in an Indonesian airline is not seen as a strategic necessity as the proximity of Indonesia to Singapore gives the group an opportunity to continue to rely entirely on its Singapore hub to serve the fast-growing Indonesia market including secondary cities.

See related report: Garuda & Citilink 1Q losses widen. Potential Singapore Airlines investment poses intriguing option

China is clearly the largest white spot. SIA has tried to pursue an investment in China for several years, including its 2007 attempt to acquire a stake in China Eastern. With the doors still closed on a Chinese investment the group has understandably started to look at other North Asian markets as it seeks to further diversify its portfolio.

Singapore-Korea market has seen rapid growth but bilateral constraints limit opportunities

Korea is not a large market for the SIA Group, with only about 22,000 weekly seats. SIA is the seventh largest foreign airline group in the Korean market, behind the three big Chinese groups (Air China, China Eastern and China Southern) as well as Thai Airways, Cathay Pacific and Vietnam Airlines.

South Korea top 10 foreign airline groups ranked by seat capacity: 16-Mar-2015 to 22-Mar-2015

Rank Airline Group Weekly Seats
1 China Eastern Air Holding Company 67,056
2 China Southern Air Holding Company 58,424
3 Air China Limited 44,696
4 Thai Airways Group 28,798
5 Cathay Pacific Group 25,792
6 Vietnam Airlines Corporation 24,908
7 Singapore Airlines Group 22,088
8 ANA Holdings Inc. 21,616
9 Japan Airlines Co., Ltd. 20,496
10 AirAsia X Group 18,850

But South Korea has emerged as one of the hottest and fastest growing markets for Singapore, driven by a spike in visitor numbers. As CAPA highlighted in Feb-2015, Korea has become a key market for Singapore Changi as the growth rate from other markets has slowed significantly, leading to an overall slowdown in Changi’s passenger numbers.

See related report: Singapore Aviation Part 3: North Asia will drive growth as China recovers and Japan, Korea expand

Singapore’s Tourism Board reported a 14% increase in tourist arrivals from South Korea in 2014 to 537,000. Arrivals from South Korea, which is now Singapore’s eighth largest source market, has roughly doubled since 2009.

Singapore annual tourist arrivals from South Korea: 2009 to 2014

South Korea tourist arrivals from Singapore were up 15% in 2014 to 201,000. Visitor numbers from Singapore have more than doubled since 2009.

Singapore is now the tenth largest source market for South Kea’s tourism sector, noteworthy given Singapore’s population is only about 5 million.

South Korea annual tourist arrivals from Singapore: 2009 to 2014

There are currently 53 weekly non-stop flights from Singapore to Seoul, including 28 from SIA, 18 from Korean Air (KAL) and seven from Asiana. Scoot also serves Seoul with three weekly flights via Taipei while one of SIA’s four daily Seoul flights continues onto San Francisco.

Singapore is hoping to expand the restricted air services agreement with South Korea in 2015 as there are currently no available traffic rights for Singaporean carriers. But with an investment in Jeju Air SIA could risk a cold shoulder from South Korean authorities as they are asked by their Singaporean counterparts to consider an expansion of the current cap.

South Korea over the years has resisted liberalisation, bowing to requests by its flag carriers. KAL and Asiana could view an SIA stake in Jeju as a threat and lobby Korea to not expand the air services agreement with Singapore. Such an outcome would limit the ability of SIA and Scoot to expand in a relatively underserved market that would become more strategic if a stake in Jeju was acquired.

Jeju Air is unlikely to serve Singapore

A partnership with Jeju could open an opportunity to expand in the Singapore-Seoul market using traffic rights on the Korean side. But this would require Jeju operating widebody aircraft - unlikely as Jeju at least for now is focused on maintaining an all-737-800 fleet, which cannot sustainably reach Singapore.

Jeju is not interested in adding a second aircraft type, including regional jets, turboprops or widebodies, as it views having a common fleet as a critical component of its model. Jeju has even rejected taking 737-900s, although 737-900s enjoys over 90% commonality with the 737-800.

Jeju currently operates a fleet of 18 737-800s. The airline has added one 737-800 so far this year and plans to add three additional aircraft by the end of 2015 for a total of 21 737-800s. Its fleet plan, as outlined by Jeju at CAPA’s Fleet and Finance Summit in Singapore on 2-Mar-2015, envisions four additional aircraft per annum over the medium to long-term.

Jeju has insisted it is not interested in considering following Korean Air budget subsidiary Jin in launching long-haul services. Jin began operating its first widebody, a 777-200, in late 2014.

See related report: Jin Air launches 777, becoming first North Asian widebody LCC. Jeju Air plans for 40 aircraft fleet

Jeju Air is Korea’s largest and most successful LCC

Jin Air and Jeju are two of five LCCs competing in the emerging South Korean LCC sector. A sixth Korean LCC is now preparing to launch services by the end of 2015 – Seoul Air, which will be the second Asiana budget subsidiary, after partially owned Air Busan.

Jeju Air has emerged as Korea’s largest and most successful LCC. Among South Korea’s five existing LCCs Jeju has the largest fleet and carried the most passengers in 2014.

Korean LCCs ranked by current fleet size and 2014 passenger numbers

Rank Airline Number of aircraft 2014 passengers
1 7C Jeju Air 18 5.5m
2 BX Air Busan 14 4.1m
3 LJ Jin Air 13 3.6m
4 TW T'way Air 10 2.9m
5 ZE EastarJet 10 2.9m

Jeju Air’s passenger traffic increased by 20% in 2014 to 5.5 million, including 3.398 million domestic and 2.150 million international. Jeju flew 1.7 million passengers at Seoul Incheon in 2014, making it the third largest airline at Korea’s main international gateway after KAL and Asiana.

Jeju’s annual passenger traffic has more than doubled since 2010. Over half of the growth in recent years has come on international routes from Incheon. In 2012 it was only the seventh largest airline at Seoul Incheon with fewer than 800,000 passengers.

Jeju Air annual passenger traffic: 2010 to 2014

Jeju Air also has been profitable for four consecutive years. Its profits in 2014 were up 94% while revenues were up 18%.

There is huge potential for growth as Jeju leverages its leading position in Korea’s LCC market. Korean LCCs only accounted for 12% of total international passenger traffic in Korea in 2014, including a 7% share for Jeju Air. SIA obviously recognises the upside for Jeju as LCCs continue to expand in Korea’s international market.

Jeju is keen to stay with its current model

But, under experienced businessman Kyu Nam (Ken) Choi, Jeju has intelligently maintained a relatively low profile and a conservative approach to expansion. Jeju prefers to stick to the basic model that has made it successful since it transitioned to an LCC about seven years ago. Jeju Air initially launched services in 2006 following a regional carrier model and operating a fleet of Bombardier Dash 8 turboprops.

Jeju has also resisted integrated partnerships, believing interlines or codeshares add complexity and cost that would outweigh the benefits. The airline also has not followed several LCCs in Asia-Pacific in offering a transit product. Jeju however is interested in softer partnerships, such as marketing alliances, that could boost traffic without interlines or codeshares. This interest may be low-key but emphasised in order to curry support from Seoul, which is looking at ways to boost transit traffic after a decline in 2014.

See related report: Seoul Incheon airport confronts a new paradigm: Chinese/Japanese hubs take transfer traffic

Investment from SIA is unlikely to result in major strategic changes or significantly more ambitious expansion - at least not for the short-term. Network synergies between Jeju and SIA Group carriers would also be relatively limited.

Most of Jeju’s international capacity is to destinations in Japan that are already served by SIA. More than half of its international destinations are to the south and east, where there would be limited opportunities for connections for passengers originating in Singapore even if Jeju adjusted its model and invested in new IT systems to support partnerships.

Jeju international seat capacity by country: 16-Mar-2015 to 22-Mar-2015

The only international destinations that Jeju would add to the SIA Group network are Guam and Saipan in the South Pacific. But these are tiny markets with limited demand from Singapore or destinations beyond Singapore.

Jeju’s biggest growth market is mainland China. Jeju currently only operates 14 weekly scheduled flights to four destinations in mainland China, according to OAG data. But Jeju also operated 1,200 charter flights to over 20 secondary cities throughout China in 2015. It is hoping bilateral constraints will eventually be eased to allow more scheduled services.

The Korean domestic market would have limited appeal to SIA

The domestic market continues to account for well over half of passenger traffic at Jeju Air and all five of Korea’s LCCs. But with LCCs already accounting for about half of all passengers in Korea’s domestic market, the opportunities for further domestic growth are relatively limited.

See related report: Korean Air losing domestic marketshare but dual-brand strategy with Jin Air helps limit the decline

Most of Jeju’s domestic capacity is on Jeju-Seoul, which is one of the largest routes in the world. Jeju also links Jeju island with four secondary airports in South Korea. Air travel within continental South Korea is no longer common due to the introduction of high speed rail.

None of the SIA Group carriers currently serve Jeju island. But there is limited demand for Jeju from Singapore. Domestic connections would not be available on Jeju Air since domestic flights use Seoul Gimpo, not Seoul Incheon (used by SIA and Scoot).

Jeju and SIA Group has no overlap but could pursue joint marketing activities

The overlap between the Jeju Air and SIA Group networks is also very limited. Jeju does not currently compete with any SIA Group carrier on any of its routes.

The only potential overlapping route would be Seoul-Bangkok, which NokScoot is aiming to serve. Jeju currently operates two daily flights between Seoul and Bangkok, which is its longest route at about five hours, as well as one daily flight from Busan to Bangkok and two weekly flights from Daegu to Bangkok.

Seoul-Taipei could become another overlapping route but so far Jeju has been unable to secure traffic rights for Taipei. Scoot’s 2013 launch of services between Taipei and Seoul was controversial within the Korean airline sector as there are bilateral constraints in the Korea-Taiwan market. Scoot was able to secure pick up rights for the Taipei-Seoul sector as fifth freedom rights are permitted under the Singapore-Korea bilateral. But Korea’s LCCs, including Jeju, have not yet been able to launch scheduled services in the Taipei-Seoul market, giving Scoot a competitive advantage.

Jeju Air could potentially help Scoot sell Taipei-Seoul and provide marketing support in Korea, even if the two carriers do not interline or codeshare. Jeju has established a strong brand in Korea which Scoot could leverage to build up local sales. But the benefit to Scoot would be relatively limited unless Singapore is successful at expanding the air services agreement with Korea. Without a breakthrough in the bilateral Scoot will not be able to increase its service to Seoul beyond the current three weekly flights.

Jeju could also potentially team up with SIA Group carriers in marketing their respective services in common markets such as China, Japan, the Philippines, Thailand and Vietnam.

The Tigerair Group pursued a South Korean joint venture back in 2008 in partnership with the Incheon city government. But the project was dropped in 2009 as the shareholders were unable to overcome regulatory hurdles and strenuous political opposition. Tigerair is no longer looking at establishing a portfolio of affiliates throughout Asia. A rebranding as Tigerair Korea would make little sense given Jeju’s success at developing a local brand for the Korean market. But there are still potential areas of cooperation between the two short-haul LCCs.

Jeju Air could potentially source 737-800s from SIA Group

Joint purchasing with the SIA Group is also a possibility, which could help Jeju build up scale that it would otherwise be able to achieve as an independent group. Jeju does not operate the same type of aircraft as Tigerair but it does operate the same type as SilkAir.

Jeju could potentially source 737s from the SIA Group, which will likely need to remarket some of its 737-800s or 737 MAX 8s. SilkAir placed orders in 2012 for 23 737-800s and 31 737 MAX 8s. But SilkAir, which has so far taken nine 737-800s, may not need all 54 aircraft as the order was based on a business plan that now seems overambitious.

SilkAir has expanded rapidly in recent years and was initially optimistic it could continue to pursue high double digit annual capacity growth for the rest of this decade. But SilkAir began slowing its expansion in 2014 by accelerating A320 retirements. As CAPA previously highlighted there could be a further acceleration of A320 phase outs, leading to a quicker than planned transition to an all-737 fleet. This would also create a need to adjust the 737 order as SilkAir may no longer have a need to double its fleet over the next five years.

See related report: SilkAir slows its expansion. Strategic adjustments may be necessary

SilkAir currently operates a fleet of 27 aircraft including nine 737-800s and 18 A320 family aircraft, according to the CAPA Fleet Database. The original fleet plan envisioned a fleet of 54 aircraft, including 23 737-800s and 31 737 MAX 8s, by the end of 2020.

Placing some of these aircraft at Jeju would be a mutually sensible option. Jeju has not committed to any additional aircraft and has been relying on leases that it typically secures less than a year prior to delivery. It also has not yet placed an order for 737 MAX aircraft.

SIA-Jeju Air pairing is unusual. It would help Jeju's IPO

SIA-Jeju Air is a relatively unusual and unexpected pairing - but there are many new developments in the Asian region which fall into that category. There are myriad opportunities still ripe for the picking and, provided the risk levels are muted, almost any partnership initiative can lead to synergies. Although network synergies specifically are limited in this case, there are potential benefits for both sides.

For SIA an investment in Jeju is low risk and relatively inexpensive. It would expand the group’s foothold in Korea while diversifying its portfolio. A long-haul LCC joint venture for the Korean market could also eventually become a possibility although this is not likely in the near term.

For Jeju Air, having SIA as a minority shareholder will bolster its financial position and generate global interest. SIA potentially coming in as a strategic investor during or prior to Jeju’s planned IPO should help make the offering a success. At the very least, SIA's mere interest in Jeju Air will boost Jeju's IPO interest even if SIA does not take a stake.

There are potential synergies even without a formal partnership. Jeju could benefit from simply exchanging ideas and learning from SIA’s budget subsidiaries, Scoot and Tigerair. Those LCCs however seem increasingly stretched. And the SIA Group is still challenged to function as a collective group.

There is no certainty any deal will materialise from the discussions that have so far taken place. SIA continues to search across Asia for potential investment opportunities.

SIA also has looked at several other Asian airlines from both the low-cost and full-service sectors which have been seeking to sell strategic stakes and or are pursuing IPOs. While Jeju represents a low-key option there are many other opportunities for cash-rich SIA.

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