The growing rivalry between AirAsia and Lion is leading each to expand aggressively
Asia's leading narrowbody operators will be taking delivery of huge numbers of aircraft next year, even though aircraft financing remains an issue and the global economic outlook continues to be adverse.
Lion Air group plans to receive 24-900ERs and 12 in 2013, says the group's CEO, Rusdi Kirana. He says in 2014 they plan to receive even more 737s. Industry executives also tell Aviation Week that Rusdi is negotiating with , with a view to placing an order for . Rusdi, however, declined to comment on this.
group, meanwhile, has ordered 100 additional A320-family aircraft, of which 36 are the current model A320 and 64 are A320NEOs. This order is on top of the 200 A320-family aircraft AirAsia ordered in June 2011. AirAsia is based in Malaysia but has affiliate carriers in other countries. The group says it plans to receive 33 A320 aircraft next year. Ten are for AirAsia Malaysia, seven for Thai AirAsia, nine for Indonesia AirAsia, four are for AirAsia Japan and three are for AirAsia Philippines.
Another low-cost carrier that is expanding rapidly is Cebu Pacific Air in Manila. Candice Iyog, vice president of marketing and distribution, says they plan to add seven A320s and two-300s next year. The airline's CEO-advisor, Garry Kingshott, told Aviation Week in late August that the airline may place an order for more aircraft. “We've got a large number of deliveries in 2013 and 2014 and it looks like this may be enough, but we will look at the possibility [of getting more],” said Kingshott. This is because the airline's A319s are being retired early and Cebu Pacific may need to respond to Philippine Airlines, which is expanding its fleet in 2013-14, he said.
The accelerated fleet expansion among Asian low-cost carriers is a boon for aircraft makers.says it delivered its 377th 737 for the year on Dec. 3, making it the highest number of a single commercial family ever delivered by the manufacturer in one year. The year-end figure is likely to be close to 390. Airbus recently increased production of its A320-family aircraft to 42 per month.
Some of Lion's aircraft will be for Malindo Air, a joint venture between Lion and privately owned Malaysian company National Aerospace & Defense Industries. Malindo is based atand aims to start flying in March, once it secures an air operator certificate. Malindo CEO, Chandran Ramamuthy, says the airline aims to have a fleet of 10-12 aircraft by the end of 2013. These will be 737-900ERs and each will have WiFi and back-of-seat inflight entertainment, he says.
AirAsia group CEO Tony Fernandes says Lion's entry into Malaysia with Malindo is “a wake-up call” for AirAsia. He says AirAsia already has 60% of the Malaysian market. “But there's a lot of growth in Malaysia. I've been pressing Aireen to expand the fleet more aggressively,” says Fernandes, referring to Aireen Omar, who was recently promoted to CEO of AirAsia Malaysia.
Fernandes says AirAsia can beat Malindo in Malaysia, as Malindo will have a higher cost base. This is because Malindo will have the added expense of offering inflight entertainment and other “frills,” he says. Rusdi has said that offering frills, such as inflight entertainment is in response to market demand. Increasingly, passengers who fly low-cost carriers are demanding a better standard of inflight service, he says.
Like Rusdi, Fernandes has been financing aircraft using export credit agency (ECA)-backed financing. The interest rates are lower, but the buyer has to have the cash to cover the upfront fees and make a sizeable deposit on the aircraft,
AirAsia has the cash, because it is profitable. In the nine months ending Sept. 30 it had a net profit of 1.528 billion Malaysian ringgit ($500 million) compared to 428 million ringgit in the corresponding period last year. Publicly listed Cebu Pacific had net income of 2.27 billion pesos ($55 million) in the first nine months of this year, up from 2.21 billion pesos for the same period last year. Lion is a private company that never discloses its financial results other than to financiers and the tax office, but it is understood to be profitable.
Rusdi's Malaysia move, however, could potentially lead to a price war that will drive down yields. A report from Citibank's equity research division in September states: “Malindo is a brave attempt by Lion, [but] we highly doubt that it will become profitable as its business strategy does not make commercial sense, and it is also squeezing into a well-penetrated Malaysian LCC market monopolized by AirAsia.”
But there are other ways to measure success. AirAsia group has been funding its international expansion into Rusdi's home market—Indonesia—with profits from AirAsia Malaysia. If Rusdi can turn Fernandes' Malaysian “gold mine” into a black hole, Rusdi may consider that a successful outcome.
But AirAsia and Lion's fleet expansion coincides with a weak period in the global economy. Europe is still grappling with financial crises, and the U.S. economy may contract next year if the government is forced to cut spending.
Another issue is aircraft financing. The ECA-backed financing Rusdi and Fernandes have been using will become more expensive. Under the 2013 Aircraft Sector Understanding rules, which establishes terms and conditions under which countries and their manufacturers can provide aircraft financing for commercial aircraft, interest rates will increase.
The other option is commercial bank financing Upfront fees and deposit are generally lower, but interest rates are higher because the financial institution is taking on more risk, as there is no government-backed guarantor. Many banks generally set the required deposit based on the underlying credit risk of the airline, not on the residual or asset value of the aircraft. This requires airlines to put quite a bit of equity into these deals.
Another problem is finding a bank willing to finance aircraft. European banks have been the biggest financiers for the airline industry, but the financial crisis in Europe has meant they are limiting their exposure to the volatile aviation industry; some are exiting the business altogether. HSH Nordbank shuttered its aviation lending business last year. AirAsia and other carriers have been encouraging banks from other parts of the world to fill the void left by the European lenders.
AirAsia's Omar says the Asian banks hope to fill the void, but this is questionable in the immediate future. She says Asian banks are relatively new to aircraft financing, while European and U.S. banks have more than 30 years experience. However, more Asian banks are entering because they want to have a stake in the growth of the aviation industry, she says, adding that many are taking their first steps by participating in syndicates. She also says AirAsia has had success with Malaysian banks. “RHB Bank, Maybank and Bank Islam Malaysia have been supporting us since 2007,” says Omar, adding that AirAsia has found that some Malaysian banks have a stronger appetite for aircraft deals than some foreign lenders.
Industry executives say one reason Fernandes thinks highly of Omar is because she was able to secure aircraft financing for AirAsia's fleet expansion, even during the 2008 financial crisis. Omar says she likes to “lock up deals as soon as possible so we don't take the risk” of the financial markets later turning bad. She says she has already secured the financing for AirAsia's 2013 deliveries, but needs to get started soon on securing financing for 2014. “We have been talking to banks about it already, but I need to keep engaging them,” she continues. Omar is still responsible for arranging financing for all AirAsia group's aircraft, even though she recently became AirAsia Malaysia CEO.
Her ties with the Muslim banking community have proven to be a boon, but can she keep tapping the same banks? One issue airlines face is that banks have limits on how much exposure they can have to any one carrier. Omar says this is a problem AirAsia has yet to encounter. She says some banks have decided to limit their exposure to the aviation industry as a whole and “become quite selective about which airlines they want to be exposed to. But they still want to deal with us. ”
Another option for airlines is to do aircraft sale-leasebacks, but Omar says “it's not something we prefer to do, unless it is competitive with what we would get from the debt market.”
While AirAsia tries to avoid lessors, Rusdi is embracing the aircraft leasing business in more ways than one. He has established an aircraft leasing company in Singapore called Transportation Partners, headed by John Duffy, who formerly worked in Singapore for HSH Nordbank as head of Asian transportation.
Rusdi's move has proven to be timely. The fact that some European banks have closed their aviation lending businesses means there are experienced executives he can recruit. Transportation Partners has Valerie Tay as senior vice president for marketing and finance. She was formerly vice president of origination aviation finance at HSH Nordbank. The company has also hired Chan Boonsiong as chief risk officer. He was previously withCapital Aviation Services in Singapore.
The purpose of Transportation Partners is to lease to Lion and Lion-affiliated airlines, as well as to outside carriers. Industry executives say Rusdi needs to place aircraft with other carriers because Lion has too many 737s on order to absorb on its own. According to the Aviation Week Intelligence Network (AWIN) database, Lion has 123 737-900ERs, eight 737-800s, 201 737 MAX and fiveaircraft on order. The fact that Rusdi now has an aircraft leasing company may explain why he would want to also have A320NEOs in his portfolio. Aircraft lessors generally have a diverse aircraft portfolio so as to minimize risk and cater to a broader group of airline customers.
Having some assets in Singapore, under the auspices of Transportation Partners, also minimizes risk because he no longer has all his aircraft tied up in Indonesia. And there is a tax benefit.
Aircraft leasing companies in Singapore can qualify for tax incentives under the Singapore Economic Development Board's Aircraft Leasing Scheme (ALS). The ALS and enhanced ALS provide preferential corporate tax rates of 10% and 5%, respectively. The tax concession depends on the funds an aircraft leasing company spends locally and how many employees it has in Singapore. The preferential rates apply only for a set number of years—usually five, although they are renewable.