AirAsia: KISS principles lost
in Digital Lifestyle Oct/Nov 2020

The Felicitous Tony Fernandes, CEO of AirAsia, always seems to manage to find a way to put a positive spin on news. So, at the publication of AirAsia’s Q2 results he tried to suggest that AirAsia is more than an airline and happily mentioned as a key highlight of the year that the company had “successfully pivoted the airline into a digital lifestyle company”.

The group, stating “travel has changed and so have we”, has set up a new reporting division from its RedBeat Ventures (renamed as AirAsia Digital) which is to act as an “all-in-one digital travel and lifestyle ecosystem for ASEAN”. It includes:

• website platform AirAsia.com which, beyond selling its own flights, acts as an online travel agent selling flights on other airlines (piggy-backing on OTA aggregator kiwi.com), direct sourced hotels, travel packages, experiences, food and groceries. It has plans to expand its product offerings into Hajj and Umrah packages, Medical tourism and Corporate Travel. Apparently revenues grew by 137% year-on-year in the three months to June despite the fact that most of the airline fleet had been grounded.
• Teleport Anywhere — the group’s cargo operation — which this year has concentrated on last mile deliveries and developed home deliveries of “Food by AirAsia” and “Fresh by AirAsia”. It claims a unique position in the Asean region with available capacity of around 1bn parcels and a network reach of 85 cities;
• BigPay, a financial services application which provides a digital wallet for payment in Malaysia and Singapore (it expects to get licences for the Philippines and Thailand soon), international money transfer services to 18 countries from Malaysia and Singapore, with ambitions to provide billpayments, lending, wealth management and insurance;
• AirAsia Big Loyalty, its frequent flyer programme with 26m members. In September it rebranded as BIG Loyalty, as if to divorce it from the AirAsia brand.

To claim that this transformation is a success is going a bit far: in the first half of the year BigPay doubled its EBITDA losses to RM52m, AirAsia.com produced a RM21m loss from RM0.9m profit in the prior year period, and Teleport halved profits to RM58m, with a RM5m loss in the second quarter.

But these numbers pale into insignificance in comparison with the losses at the group’s airlines, which were all but effectively closed in the second quarter. The group announced a net loss of RM1.2bn (US$278m) for the three months to end June making a cumulative loss for the half year of RM2.1bn ($508m).

Total group revenues in the quarter were down by 97.5% at a mere RM68m. Yet the group managed to slash operating costs by 72% overall with staff costs cut by a third and maintenance costs by over 90% — concentrating the aircraft it did have in service on the newer equipment and those furthest away from major checks. Depreciation and interest costs in the P&L rose strongly following a spate of sale and leaseback transactions over the previous year. However, it had successfully negotiated payment holidays/deferrals with its lessors, and seems to have paid no cash on its lease commitments in the second quarter (although it still had to account for them as if it had).

Overall AirAsia did well to limit the overall cash outflow to RM1.7bn in the first half of the year — equally split between the two quarters — without massively increasing debt. It ended the period with cash and cash equivalents of RM1bn down from RM2.6bn at the start of the year; while net cash (including investment securities but excluding lease liabilities) stood at RM1.2bn down from RM3.1bn.

Strangely the company downplayed liquidity concerns in its announcement and presentation on the results. While admitting that it was in talks for government backed loans in Malaysia, the Philippines and Indonesia, had been approached by various investment banks to raise equity, and has “ongoing deliberations” for third party investments in some segments of its business, it stated “we have sufficient working capital to sustain the business operations”.

Problems before the pandemic

AirAsia is the second largest low cost airline group in South East Asia (behind the Indonesian-based Lion Air Group) and has grown strongly in the last decade. According to its published accounts, group revenues had increased at a compound annual average 14% a year since 2010 while at the same time it had been able (at least until 2017) to generate operating margins of 20%-30%.

But the company’s annual accounts, while no doubt reflecting a “true and fair view” of the state of affairs, lack clarity. If anything they highlight that AirAsia has not followed the key KISS (keep it simple, stupid) principle of the low cost model — not merely in its operating philosophy but also in its corporate structure (see chart). Apart from anything else, opening a restaurant in central Kuala Lumpur, or establishing its own record label as AirAsia did last year can only be a distraction.

As AirAsia has grown, it has expanded operations from its Malaysia base into neighbouring ASEAN countries. But while the bloc has been moving towards an open skies aviation regime, there has not been any agreement on rights of establishment and control. Consequently AirAsia has had to establish individual AOCs in each of the countries in partnership with local investors, and because it officially is not allowed to be a controlling shareholder, most of these are treated as associate companies (only AirAsia Philippines and AirAsia Indonesia are consolidated in the accounts).

The group’s greatest strength is in its home country of Malaysia. (This and subsequent country market comments refer to the charts). The domestic market is relatively small primarily linking the capital Kuala Lumpur with the main cities in peninsular Malaysia and providing essential links to those in Sabah and Sarawak on the island of Borneo. It has grown by a modest 5% a year over the last decade, but the troubled national flag carrier MAS (along with its regional subsidiary FireFly) has stultified in the the period — and especially after renationalisation in 2014) and AirAsia by 2019 had built up a 60% share of the market. (The other major player, with a 10% share, is Lion Air subsidiary Malindo). The international market has grown a bit faster, with an annual average 8% increase, and the AirAsia group in 2019 operated twice as many seats as MAS giving it a commanding 40% share. Malaysia had been the backbone of the group’s profitability, but a hefty domestic price war and a chase for market share in the last two years pushed AirAsia Malaysia into what seems to have been an underlying operating loss in 2019.

Its second most important market is Thailand. Here the growth in the past decade had been far more exciting. With an annual average rate of growth of over 10% the domestic market has nearly tripled in size since 2008. AirAsia has grown aggressively — at more than 15% a year on average — and has developed from being half the size of national flag carrier Thai International to being twice the size and having a 33% domestic market share. The international market, significantly larger than that of Malaysia, benefits from strong levels of inbound tourist demand and has grown at an average 7.5% a year.

AirAsia Thailand is the group’s most successful associate. Established in partnership with Asia Aviation (separately listed on the Bangkok stock exchange), it has at least produced an underlying operating profit in three of the last six years (see graph). But it is only an associate company and not consolidated in the AirAsia Group accounts (Asia Aviation on the other hand accounts for it as a joint venture).

AirAsia’s next largest operation in SE Asia is in the Philippines. Here it has around 20% of a domestic market that is roughly the same size as Malaysia’s and that has grown at an average annual rate of 8%. However in Cebu Pacific — the country’s largest operator — it has a strong low cost competitor. AirAsia Philippines, which by some deft sleight of hand is fully consolidated, seems to have produced an underlying profit in 2019 for the first time.

AirAsia has not had quite as much success in Indonesia. The country is huge — the world’s largest archipelagic state with over 17,000 islands covering 1.9m km² and a population of 270m. In the past decade the domestic market had grown by an average annual 13.5% — to a large extent driven by the growth of the Lion Air Group which by 2019 had built a market share of over 50%. AirAsia has not been able to follow this development and has seen its share of the local market fall to 2% from 5% ten years ago.

With a core competency in ASEAN, AirAsia has also tried to expand into other markets. It has a 49%-owned joint venture with Tata Sons in India which had built to a fleet of 30 aircraft and in 2019 carried 9m passengers (36% up on the previous year) allowing it to boast a 7% market share and the dubious accolade of receiving the least number of complaints among Indian LCCs. It had also set up a second version of AirAsia Japan (the first had folded in 2013) which by the end of 2019 had three A320s and carried 0.5m passengers. Plans in the last few years suggested that AirAsia was also planning to establish operations in Vietnam and China.

Until the beginning of this year AirAsia Group’s fleet plans continued to show strong growth ambitions. It had ended 2019 with 244 A320 family aircraft in its subsidiaries' and associates' fleets and had outstanding orders for 349 A321neos — planning net deliveries of around 30 units a year to build a fleet of 515 aircraft by 2028. But the Covid-19 crisis has changed all this (see last section below).

AirAsia X

The group went into long haul low cost with the establishment of AirAsia X. Founded in 2007 and floated on the Bursa Malaysia in 2013 it has been resoundingly unsuccessful, achieving an operating profit in only three of the past ten years. It has mirrored the convoluted structure of the AirAsia Group: AirAsia itself holds 13.8% of the equity, while Tony Fernandes and Kamarudin Meranun have 18% through their private company Tune Group as well as personal stakes of 2.7% and 8.9% respectively. It established an associate joint venture in Thailand, possibly in conjunction with Tassapon Bijleveld, (the Executive Chairman of AirAsia Thailand and major shareholder in Asia Aviation which holds 55% of AirAsia Thailand). For some reason it also seemed a good idea to set up an Indonesian joint venture — but this was more unsuccessful than usual and operated its last scheduled flight in January 2019.

While it has been financially unsuccessful, AirAsia X did carry 8.5m passengers in 2019 and generated revenue of RM4.2bn (US$1bn). But it has been searching for a métier for many years. It gave up on attempts to serve long haul routes to Europe, and tried to build connecting services with AirAsia at Kuala Lumpur (the “fly-thru” connecting product provided 4% of its ancillary revenues) reducing its ambitions to an aim of serving medium-to-long-haul routes within the region. Last year it even found itself operating its A330s for AirAsia Malaysia to provide services on the 300km route between KL and Singapore in face of capacity constraints at Singapore’s Changi airport.

It had 30 A330s in operation, and at the beginning of the year still seemed to have ambitious plans having outstanding orders for 76 A330neos (over a quarter of Airbus’s backlog for the type), ten A350s and 30 A321neos (see table) which it planned to operate on routes of between four and six hours duration. But the Covid-19 crisis changes all this (see below).

Pandemic reality

International borders may be effectively closed, but AirAsia has one modest benefit: it can still operate in the domestic markets. In the third quarter, its operations in Malaysia and Thailand resumed some semblance of services: statistics for AirAsia Malaysia show seat capacity down by only 75% in the three months ended September compared with the prior year period with load factors off by 15 points to 68%; AirAsia Thailand saw the number of seats down by 56% and load factors falling by 16 points to 65%. AirAsia India too flew 36% of the capacity it had operated in the same period in 2019. AirAsia Indonesia and AirAsia Philippines remained to all intents mothballed, while the group has given up on its Japanese associate and has liquidated AirAsia Japan.

The company suggested in August that it would be prepared and able to ride out the crisis purely on domestic operations through 2021. This may be possible, depending on how long its lessors are willing to defer lease payments, but even if it can get its rate of cash burn down to RM200m a month (from the first half RM270m per month) the group will need to find a significant level of liquidity to be able to do so.

There have been recent unconfirmed suggestions in the press that it has been granted RM1bn ($250m) loan from the government of Malaysia under its Danajamin Prihatin guarantee scheme for businesses affected by Covid-19. CEO Tony Fernandes has been quoted as saying that he would like to be able to raise nearer twice that amount to be comfortable.

It is highly likely that the group will look to the markets to raise new equity, but with a current market cap of only $450m a meaningful capital raising exercise may be difficult, and it may be necessary to dispose of other assets. The notable one could be AirAsia India, and there have been press rumours that Tata Sons may have been negotiating to acquire AirAsia’s 49% stake — although avoiding a fire-sale price will be difficult.

The AirAsia Group seems to have accepted that it will emerge from this crisis much smaller. Fernandes suggests it will have a fleet of 180 aircraft by the end of 2021 down from the current 242, but also stated that AirAsia will forego the chase for market share and concentrate on profitability. This will among other things necessitate extricating itself from most of its order for 349 A321neos.

But then he has a worse problem with AirAsia X. The long haul low cost airline, after six months of hibernation, is basically bust. At the end of June it had lease liabilities of RM5.8bn, long term debts of RM288m, unrestricted cash of RM212m and negative equity of RM1bn. Net current liabilities stood at RM2bn.

It has put an application to the courts for a debt and capital restructuring plan to reduce unsecured liabilities of RM63.5bn ($15bn) to RM200m. Most of that figure must refer to capital commitments to Airbus for its orders of A330s, A350s and A321neos (total capital commitments for aircraft purchases stood at RM141bn at the end of June), but other unsecured creditors include airports, the leasing companies and passengers who had booked flights and, notably, AirAsia Bhd, its subsidiaries and associate companies.

As part of the filing the company stated that its new business plan will revolve around a fleet of 25 aircraft, pursuing medium haul flight operations within the 5-6 hour range, and shift its focus from building market share to that of “sustainability, yield and profitability”.

That sounds familiar. But it says that it needs the debt and capital restructuring to put it in a position to raise RM500m in new equity (the current market capitalisation nominally is RM166m).

Objectors to the proposals include lessor BOC Aviation and Malaysian Airports. The latter, 33% owned by sovereign wealth fund Khazanah Nasional Berhad (KNB), is claiming that it should be treated as a secured creditor for the RM78m it is owed by AirAsia X.

These are tough times for all airlines. Looking beyond the crisis, a possible advantage for Fernandes and Kamarudin is that the governments in Malaysia and Thailand are not being that supportive of their national flag carriers.

Malaysia Airlines has also run out of cash. The government has vehemently said that it will not pump any more money into the national flag carrier, and that it will be up to its owner, the sovereign wealth fund KNB, to find a way to support it from its existing resources.

KNB, had said it would give it a RM5bn ($1.2bn) lifeline in 2021 as long as it succeeded in blackmailing its lessors into providing significant reductions in rentals, although that would only go part way to cover the losses of the past five years and further restructuring will be needed.

The alternative could be to close the carrier down, and switch flag carrier operations to its regional AOC firefly. Suggestions of any combination with AirAsia, which had been on the cards six (and ten) years ago, are unrealistic.

Meanwhile, in Thailand, Thai International has seen the government reduce its holding below the 50% that classified it as a state enterprise and itself filed for bankruptcy protection in May. It will be going through a court mandated restructuring programme. The third largest domestic operator, Nok Air (itself 13% owned by Thai International), also filed for bankruptcy protection in July.

AirAsia, in spite of the problems it has created for itself, is a well established brand which should regain its competitive advantage in a post-Covid world, if it refocuses on LCC principles.