Malaysian flag carrier Malaysian Airline System (MAS) has had a terrible 2014 so far. Like many state-founded and -funded airlines across the region, MAS has been suffering from the predations of low-cost carriers (LCC) AirAsia and Lion Air for years. On top of that, the MH370 disaster has badly damaged the airline’s reputation and income stream. And on July 17, Flight 17 was lost over Ukraine.

As MAS CEO Ahmad Jauhari Yahya said last month, the airline will find it impossible to survive if it continues to make incremental improvements. “Our only option at this point in our business evolution is radical or sweeping change,” he said. “We have had a lot of financial resets, but we have never had an operational reset.”

MAS faces a major shake-up at the board meeting this month of key shareholder Khazanah, the Malaysian sovereign wealth fund, which will weigh options including breaking up and selling off profitable operations such as the MAS Aerospace Engineering facility and subsidiaries Firefly and MASWings; filing for bankruptcy; selling part of the operations to another airline; or returning to private equity through an initial public offering (IPO).

Although none of these options is attractive for the company, MAS can take some consolation from the fact that it is not alone in Asia: Both the chairman and president of Thai flag carrier Thai Airways International resigned, and a general involved in the government coup, Air Chief Marshal Siwakiat Jayema, was appointed caretaker president.

Thai’s management shake-up comes on the back of a 5.65 billion baht ($174 million) net loss in the fourth quarter of its last financial year, compared to a 792 million baht profit in the same period in 2012, and a full-year net loss of 12 billion baht compared to a 6.2 billion baht profit the previous year. The airline blames the military coup and its impact on passenger numbers (arrivals were down 15% immediately following the coup) but also attributes its poor performance to the volatility of Thai baht operating costs, particularly fuel, in an industry that has to pay its bills in dollars.

Flag carrier Garuda Indonesia is also feeling the pressure. Despite an attempt to go public in 2011, only about 30% of the airline is owned by investors, and its investment grade has recently been cut by ratings agency Fitch to A- from A. It is also attempting to sell off as much as possible (up to 49%) of its Citilink LCC subsidiary, which lost $48 million on an income of $273 million last year, and helped push up Garuda’s 2014 first-quarter loss to $164 million, more than four times its loss in 2013.

Singapore Airlines (SIA) has not escaped a crimping, either. Its net profit in the third quarter of last year was $50 million, down from $93 million for the same period in 2012, a 65% drop. SIA says a 2.7% reduction in yields and “competitive environments and unfavorable exchange rate movements” were major contributors.

However, SIA’s woes were no doubt compounded by its money-sapping Tigerair LCC venture, along with relatively poor returns from its regional SilkAir offshoot. Tigerair lost $177 million last year, and SilkAir’s operating profit in 2013’s third quarter was $28 million lower than the previous year, as “passenger carriage growth lagged behind capacity injection to develop emerging destinations,” the carrier says.

Vietnam Airlines, although nominally profitable, is likewise facing difficulty attracting investors to its upcoming IPO. Originally scheduled for earlier this year, the IPO is now slated for the third quarter. “It is . . . possible that the holding company would do the IPO and organize its first shareholders’ meeting in the second half of 2014,” General Director Pham Ngoc Minh says, committing to nothing further.

While its 2013 gross profits of 533 billion dong ($25.3 million) were 35% above its predictions, the increasing competition from homegrown LCC VietJet Air and the Vietnamese government’s plans to hold on to a large slice of equity are beginning to give investors pause.

These cases illustrate two pressures facing Asian flag carriers: legacy costs and management practices, and cut-throat LCC competition. That means if the flag-carriers do not perform, their owners, in most cases national governments, must consider bailing them out or look at harsher options.

MAS was in the process of climbing back to profitability prior to the disappearance of MH370 in March, but it has seen its shares drop 16% in the last three months and more than 43% over the past year. The airline reported its worst first-quarter loss of 443 million ringgit ($137 million). Despite heavy fare-cutting and a domestic marketing campaign, the carrier has not been able to claw back significant business from increasingly aggressive regional short- and long-haul LCCs such as AirAsia, Lion Air and Thailand’s Nok Air.

Estimates suggest that Khazanah has already propped up MAS with injections of more than $1.6 billion over the last 10 years, with mixed results. It has failed to upgrade its aging fleet significantly and last quarter faced a fuel bill 14% higher than the previous year, reflected in a 9% drop in yields to a mere 5.3 cents per seat. It also has invested heavily in six new Airbus A380s at an estimated cost of $3 billion.

However, aside from government backers’ concerns about the value of slumping airline assets or how to a break up and restructure the business, an airline’s role as a flag carrier is crucial. Any state airline carries huge political significance as a symbol of national image and pride.

“We have to look at [any future strategy] from all angles,” says Malaysian Prime Minister Najib Razak. “[MAS] is a government-linked company . . . so there are certain repercussions in what we want to do.”

This makes it especially hard for the government to behave in a dispassionate and purely commercial manner when looking for solutions for the national airline. Usually these governments have very large  investments in flag carriers, too. Singapore’s Temasek Investment fund owns 56% of SIA; the Thai finance ministry Vayupak Fund owns 51% of Thai Airways; the Indonesian government has a 69.1% stake in Garuda; and the Vietnamese government is the sole owner of Vietnam Airlines.

Despite this, opinion is increasingly swinging to a strictly accounting-based decision process. Recent comments from Malaysian ex-prime minister Mahathir Mohamad have fueled the debate. His suggestions of privatization and a management change have been seized on by commentators concerned that Malaysian bumiputera culture (jobs for ethnic Malaysians) has loaded the company with under-performing management and workers.

The chairman of Thailand’s central bank likewise warned years ago of the difficulty of splitting ownership of the Thai carrier due to long-standing union agreements. Indeed, this has hindered plans to boost working efficiency at other flag carriers. A 2012 deal to swap 10% of AirAsia with 20.5% of Khazanah’s MAS shares was stymied by the airline’s internal union, Malaysia Airline System Employees Union (Maseu).

“[Malaysians] are in the majority. They need to be helped so that they would not be left behind,” Malaysia’s deputy finance minister, Datuk Ahmad Maslan, said last year about the difficulty of slimming legacy airline workforces. Maseu is flexing its muscles again in advance of any potential reshuffling, saying, “we will not be quiet” and calling for leadership changes but no cuts to the airline’s workforce—an almost impossible task.

With 20,000 staff on the payroll, any partial or whole sell-off or privatization of MAS that brings layoffs would no doubt affect the political fortunes of the current government.

Sovereign funds across the region are on the horns of this dilemma. They are faced with potentially huge ongoing investments in underperforming companies that carry huge political prestige and accompanying risk if they fail or are closed down. If they sell out, they risk voter backlash; if they pour in more money and retain the status quo, they will lose more millions, if not billions.

Asia-Pacific investors likely will want to buy into an IPO following a flag carrier sell-off only if major workplace changes are introduced. The current market value of most state airlines is relatively low. Almost all would need significant cash injections for new systems and fleet upgrades to achieve competitiveness.

One flag carrier in the region with a more optimistic outlook is Royal Brunei Airlines, which operates  just four Boeing 787s, four Airbus A320s and two A319s. Deputy Chairman Dermot Mannion acknowledges that the airline is small and operates in a very competitive region, but he says it can succeed if it concentrates on what it does best. It is crucial to avoid “the race to the top or to the bottom” in a simple search for either passenger numbers or reputation, Mannion says. 

“Customer standards here are high, so [airlines] must offer good service—but a highly efficient operation, too,” he says. Choosing an airline is becoming more of a lifestyle choice for passengers, he notes, and that is where flag carriers can succeed if they are prepared to restructure. “They will have to make hard decisions, buy new efficient aircraft, not overwhelm passengers with even more ‘me too’ offerings, but offer a unique service,” Mannion says. 

Regarding Khazanah’s options for MAS, Managing Director Azman Mokhtar explains the difficulty: “Malaysian Airlines has a special shareholder, which is the government. I think the final decision will have to be made by special shareholder.”