According to a forecast released by Boeing, in the next 20 years, approximately half of the world’s air traffic growth will be driven by travel to, from, or within the Asia-Pacific region. Approximately a third of all new airplanes will be headed to the region with Asian airlines expected to require some 11,450 new airplanes valued at $1.5 trillion. Boeing also anticipates that 70 percent of its orders will be for single aisle airplanes, the aircraft of choice for most low-cost carriers (LCCs). Clearly, if the time for LCCs is now, the place is certainly here.
“The growth of LCCs is phenomenal," says Shukor Yusof, an aviation analyst at Standard and Poor’s. “We are forecasting a growth rate of at least 12 percent to 15 percent annually until the end of the decade, and that 35 percent of passenger air travel in Asia will be on LCCs by 2020.”
Malaysia’s AirAsia was the first of the LCCs to arrive in Asia in 2001, with the vision “to be the largest low-cost airline in Asia and serve the three billion people who are currently underserved with poor connectivity and high fares.” The first few years were not easy. But over the past six or seven years, the Asian LCC market has boomed. In fact today, the Centre for Asia-Pacific Aviation (CAPA) lists the number of LLCs operating in the Asia-Pacific region as 50.
“There are 3.9 billion people in Asia,” says Neil McCarthy, senior associate, aviation at Norton Rose, “and a massive growing middle class.”
“There’s exceptional growth in disposable income,” agrees Siva Subramaniam, partner, asset finance at Watson, Farley & Williams, “and (a) lack of safe and reliable land-based transport infrastructure.”
Another factor that has aided the growth of air travel is the Internet by raising awareness of airlines, and making the booking of your next flight just a click away. LCCs have particularly tapped into this with easy booking systems, and discounted Internet offers.
However, as with all business ventures, a large part of the success comes down to correct timing. LCCs were in the right place at the right time when the 2008 financial crisis ushered in an era of corporate austerity. “The LCC market shone in the downturn,” says Paul Ng, global head of aviation at Stephenson Harwood, adding: “LCCs are nimble footed by nature.” In contrast to the legacy carriers, which are often seen as conservative and bureaucratic, LCCs react faster when an opportunity presents itself - react they did, with the introduction of business or premium services for business travellers.
“LCCs tend to be led by charismatic innovators who see opportunities everywhere, are prepared to take more risks, and want to do everything immediately,” says Ng. “LCC CEOs drive the growth of their companies very hard. For their lawyers, it can be a challenge to keep up. Since I joined Stephenson Harwood in 2009, our team has tripled in size and is still growing. Their mission to expand air travel to the masses is a noble one, and we want to help."
This ability to adapt can be seen in the evolving LCC business models, the original of which was the LCC short haul – flights between one to three hours. It proved to be very successful with customers happy to pay less for tickets that did not include the hidden costs of “free” services they did not want or need.
With the arrival of the airbus A380 and the potential to carry over 800 passengers in economy seats, the idea of long haul LCC was born. In 2007, AirAsia X, the low-cost long haul division of AirAsia, took to the skies.
However this has proven to be a more challenging business model for AirAsia X, perhaps evidenced by the recent cancellation of unprofitable routes to Mumbai, Delhi, Paris, and London. However, Ng sees this as a strategic move rather than a failure of the business model. “It is an astute move,” he says, “better utilisation of their aircraft on shorter, quicker turnaround routes.” AirAsia has called it a “realignment” to enable them to focus on their core markets of Australasia, China, Taiwan, Japan, and Korea – a move to the medium-long haul business model to be adopted by Tiger Airways’ new “cub” Mandala, and Scoot, Singapore Airlines‘ medium long haul low-cost prodigy.
A further example of seizing opportunities can be seen in Indonesia with LCCs developing their own full-service, operational offsprings. “Indonesia has a huge middle and upper class,” explains McCarthy, “and there is a growing reaction against flying LCCs. So LCCs are setting up full-service or premium providers, catering to this domestic premium market. This trend is evidenced by the arrival of Space Jet, Lion Air’s business charter start up, due to start operations later this year and the new Indonesian start up Pacific Royale, also due to take to the skies in 2012.
Low cost legal services?
So do LCCs require different legal services compared to flag or legacy carriers?
“LCCs are very cost conscious,” says Ng. “However, legacy carriers are going the same way; it’s the current commercial reality.”
However, Subramaniam believes that in this complex financial climate, legal costs may “no longer be a primary differentiator. As traditional bank funding sources become scarcer and more complex structured finance solutions are taken up by LCCs, the level of expertise required from external counsel will also increase. This higher level of expertise, meanwhile, will come with a higher price tag. LCCs will see these higher legal costs as part of the higher transactional costs involved. But the cost savings delivered by such products should offset these higher costs. Law firms with more structured finance capacity (especially capital markets capability) would have a competitive advantage.”
Another growth area for legal services is joint ventures. With Asian air rights being still highly regulated, consolidation or strategic alliances are a useful way to access markets. “This has spurned a wave of joint ventures,” says Ng, “Tiger Airways’ joint venture with Thai Airways forming Thai Tiger, AirAsia’s joint venture with ANA (All Nippon Airlines) in the formation of AirAsia Japan, and Jetstar’s joint venture with JAL forming Jetstar Japan.”
Of the three “divisions” of aviation work, namely financing and leasing of aviation assets, “metal” contracts (operation, maintenance and acquisition) and litigation and regulatory advice, “metal” contracts is often taken to be the most time consuming. However, it is the orders and finance side that attracts the most media attention and none more so than the Boeing-Lion Air deal, valued at $22.4 billion. It is the largest commercial aircraft deal to date with its memorandum of agreement having been officiated by President Obama in November 2011. The deal is expected to create 100,000 new U.S. jobs over the next 10 years. So how did it feel to lead the legal team for Lion Air on this deal?
“With the amount of press coverage around the transaction,” says Ng, “there was a lot riding on getting this deal done. Pressure was tremendous. I had to deploy multiple teams to deal with the various aspects of the transaction - all of which had to be done concurrently. It was not only the fact that the transaction was for an unprecedented number of aircraft, but that it was also for a new model of aircraft which was to be delivered over a long period. There are many uncertainties when we are dealing with aircraft to be delivered years from now. As counsel for the airline, we try to anticipate probable events and cater for them - some would say we are pessimists. But I would rather say we are realists. We, and the documents we prepare, are our client’s first line of defence. This is a history-making transaction - one to tell the grandchildren.”
Crowded skies but empty pockets?
So who is footing the bill? With Europe facing an economic crisis and the implementation of Basel III, there is talk of a liquidity gap growing in the aviation market. “It’s a genuine concern,” says Leigh Borrello, partner and head of Asia aviation finance at Norton Rose, “given the position of Europe and the lack of U.S. dollars in the market.”
There seems no doubt that the traditional funding sources have reduced in number with certain institutions having disappeared from the market all together. “ECA stepped in during the last recession – now we’re seeing less activity,” says Borrello.
However, what is still available from the international financial houses is coming to Asia, and any shortfall is being picked up by local sources. China, for example, has traditionally funded the domestic aviation market. But it is has now moved to an international level with aircraft financial services company ICBC Financial Leasing being particularly active in the market. “It’s no longer unusual to see foreign airlines these days at air finance conferences in China,” says Ng.
“Over the last 18 months, we have done a lot more work for Asian banks,” says Borrello, adding that, “Australian banks are also seeing it as a good opportunity to get into the market.”
But while the funds might be available, they may be harder to come by. “One of the issues for borrowers is that there are fewer players in the market. Rates are higher and lenders more selective; they can choose best creditors and ask (for) high prices,” says McCarthy.
A third and a new source of funding in Asia is the bond market. The first Asian airline to issue a U.S. Ex-Im backed bond was Air China (at the end of 2011). A South Asian one is imminent.
Islamic financial sources are also being tapped, with rumours that AirAsia X is working on an Islamic bond similar to the recent Emirates bond, but perhaps to a lesser extent than had been anticipated.
The fourth route of finance is via the equity market: IPOs or further share issuances for those already listed. Rumours of possible LCC IPOs for 2012 include AirAsia X, Thai AirAsia (expected in the third quarter) and Spring Airlines, with Lion Air’s IPO getting delayed for 2012, but an imminent possibility for 2013.
After demand for service and finance, the next essential component for aviation expansion is air rights. In this context, the traditionally heavily regulated Asian sky has presented a challenge with its bilateral agreements leaving airlines constrained by allocated routes and quotas.
All that is set to change, thanks to the ASEAN Single Aviation Market (SAM) initiative. Signed in Manila in 2009 by the 10 ASEAN countries, the ASEAN Multilateral Agreement on Air Services and its air freight equivalent have paved the way for open ASEAN skies by 2015.
“This is ’very significant,” says Yusof. “ASEAN is a grouping of 600 million people. This has huge infrastructure implications in addition to passenger travel figures,” he adds. SAM is being introduced in phases with “freedoms of the air” restrictions being lifted to an agreed timetable. At least that is the plan. Although there are reports of heel dragging and lingering protectionism, but regardless of any air pockets encountered, this is a landmark initiative and one that is set to lead liberalisation across all Asian skies.
In the meantime, joint ventures or consolidations are being used to break into regulated markets, such as Tiger Airways’ recent venture into the lucrative Indonesian market through a 33 percent share acquisition in Mandala. “There is still a lot of protectionism in the region as seen by the unsuccessful attempts of Qantas to establish a premium carrier in Asia,” says Subramaniam. “However, the multitude of joint ventures between Asian carriers is an encouraging development for future consolidation of the aviation industry in Asia,” he says.
“Another country to watch (out for) is India,” says McCarthy. “In light of (the) Kingfisher (airline crisis), there is pressure on the government to allow foreign ownership. If that were allowed it would open up the market.”
Right now, with the Lion Wing deal and Tiger’s acquisition of Mandala, all eyes are on Indonesia - a vast archipelago which spans three time zones (prime aviation territory), but with poor land infrastructure. So where is the next hot hub?
“Indo-China,” says Yusof. “It has a low penetration of LCCs at the moment. But they (the Myanmar government) are quietly talking to Malaysia and Singapore about opening up their air infrastructure.”
“Pacific islands, like Fiji, with increased tourism could be (the) next boom,” says Subramaniam.
“China is still growing,” says Borrello, “and Thailand will become more established.”
So, it looks like busy times ahead for LCCs. But are there any clouds on the horizon?
“Fuel (prices) keeps aviation CEOs awake at night,” says Ng. “It’s the essential component whose cost can’t be controlled, at least not easily.”
“LCCs tend to use narrow bodied, newer aircrafts that are more fuel efficient. This combined with low operating costs and labour costs means they can be more maneuverable,” says Yusof, adding that “however, in the face of rising fuel costs, no one is immune.”
Fuel Hedging, if used properly, can flatten out the cost of fuel. But if misused, it can be a disaster. “2009 was one of the darkest years for aviation, and fuel hedging losses were a silent and material contributor to the poor performance of the industry,” says Ng. When fuel prices dropped dramatically, even the conservative airlines were losing money. Chinese carriers in total were reported to have lost about $1 billion.
So with the current rising fuel costs and tension in the Middle East, there must be a few CEOs counting sheep; or is that planes?
Fuel and financial concerns aside, LCCs in Asia still have higher heights to soar to. CAPA data shows that within South Asia, LCCs have moved from a market share of 0.1 percent in 2003 to 56.9 percent in 2012. It can only be imagined what they can do in another 10 years. So, it looks like busy times ahead for Asia-based aviation lawyers. Perhaps time to grab a holiday now while you can – I hear there are some pretty good deals on flights these days. ALB