Malaysian Airlines: the final restructuring September 2014

Malaysian Airlines (MAS) is attempting to turn itself into a “NewCo” in a last-ditch attempt to keep the Malaysian flag carrier alive. Does a new version of an airline that dates back to 1937 have any chance of succeeding? Following the twin disasters of MH370 in March and MH17 in July, in which 537 passengers and crew lost their lives, the Malaysian flag carrier faces an immense challenge to stay solvent.

Comparing July 2014 figures (the last month for which figures are available) with July 2013, overall passengers carried has fallen from 1.5m to 1.3m, with load factor dropping from 83.3% to 75.2%. That effect is skewed more towards domestic traffic, with domestic passengers carried falling by almost a quarter over the 12 month period, compared with a 5% drop in international passengers.

In the last reported quarter — the three months to the end of June 2014 — MAS reported a 7.2% fall in operating revenue (compared with the same quarter in 2013) to RM3.3bn ($1bn), with a RM228m ($72m) EBITDA in April-June 2013 turning into a RM33m ($10m) loss at that level this year. The net loss for the 2014 second quarter was RM307m ($97m), and with an expected very poor second half of the year to come once the full effects of MH370 and MH17 are felt, the full 2014 figure will most likely be terrible. So yet another year of losses is guaranteed for an airline that had made neither operating nor net profit since 2010 (see chart, right). Indeed over the 2011-2013 period MAS has racked up more than US$1bn of operating losses and US$1.34bn of net losses

Rescue plan

Reports out of Malaysia say that the airline is losing more than US$2m a day, and it was therefore inevitable that Khazanah Nasional, the Malaysian state’s sovereign investment fund that owns 70% of the airline, would produce some sort of plan to save the airline. In late August it announced a 12-point plan that envisages a “NewCo” being launched by July 2015, which will be a slimmed-down, privatised version of MAS with significant job losses and a much smaller route network.

The key points of the 12-point plan are:

• Delisting of the existing MAS by the end of 2014 and transfer of operations and assets to NewCo by July 2015. But the NewCo will “critically involve a significantly corrected cost and operational structure and workforce, properly benchmarked to competitive industry practices and norms”. The plan is for NewCo to return to profitability by the end of 2017, and then to relist sometime between 2018 and 2020, which will include a complete or partial disposal of Khazanah’s stake at that time.

• An injection of up to RM6bn ($1.9bn) in the airline over the period to 2016. Net gearing is planned to come down from the current 290% to a targeted range of between 100% and 125%, to be achieved largely through debt-to-equity swaps.

• An operational overhaul, to include:

  • A rationalisation to switch from being a global airline to becoming a largely regionally-focussed carrier, with global connections mainly provided through oneworld (which it joined in February 2013) and other codeshare partners.

  • Significant cost savings, to be achieved largely though renegotiated supply contracts, new labour agreements and moving the HQ from Subang to Kuala Lumpur International Airport. The workforce is to be cut from 20,000 currently at MAS to 14,000 at NewCo.

• A change in leadership. After three years in the job the contract of Ahmad Jauhari Yahya — Managing Director/Group CEO of MAS — was recently extended for another year, to run until September 2015. His task is to guide the airline through the transition, though in the meantime Khazanah Nasional will look for his replacement and an announcement is expected to be made by the end of 2014 — providing a suitable candidate can be found.

One MAS executive says that it is almost certain that NewCo will operate under a new brand given the perceived damage to its reputation from the MH370 incident, with the Malaysian Airlines name consigned to history.

The key question is: will the 12-point plan be implemented as envisaged and — even if this happens — will it be enough to save the new MAS. As to the former question, MAS undoubtedly has a window of opportunity to restructure itself given the recent disasters, though inevitably the key challenge will be the 30% reduction in the workforce, where a loss of 6,000 jobs is a huge blow to the workforce and unions.

Winning the unions’ support will be critical. The most important is the Malaysia Airlines System Employees Union, which was at the forefront of opposition to an attempted share swap with AirAsia in 2011 (see page 5). There is already a long—running battle in Malaysia over an attempt by 1,500 MAS cabin crew to represent themselves through the National Union of Flight Attendants Malaysia, an entity that the airline’s management refuses to recognise and which has led to an ongoing legal dispute.

Interestingly, many hundreds of cabin crew have voluntarily left MAS since the start of 2014, and union sources say that morale among MAS staff is at rock bottom. But that will not necessarily means that unions will agree to a 30% cut in staff numbers without a fierce fight — in fact the carrier’s dire state may make unions more intransigent, since they may feel they have nothing to lose. What it will probably come down to is just how much redundancy payment the staff that do leave will receive, and clearly voluntary redundancies will be far less traumatic than forced ones.

Network shrinkage

The current route network (see chart, left) will look very different under NewCo. It has already changed significantly in recent years anyway. The long-haul route network has already been cut year-after year for the last decade or so, with — for example — the proportion of widebody seats in the total fleet falling from 72% in 2008 to 57% in 2013. As recently as 2012 MAS had routes to destinations such as Rome, Johannesburg, Cape Town, Buenos Aires, Los Angeles and Rome, but it cut its long-haul network almost in half that year.

The only long-haul routes outside the Asia/Pacific area that currently remain are to London Heathrow, Paris CDG, Amsterdam, Frankfurt, Istanbul, Jeddah and Dubai — but many of those are likely to go over the next year as part of the transition to NewCo.

This will impact the fleet significantly, which currently stands at 125 aircraft (see table on page 4) and which includes a single 747-400, 13 777-200s, 14 A330-300s and six A380s. The A380s are used primarily on routes from Kuala Lumpur to London and Paris, and as “in-fill” on Kuala Lumpur-Hong Kong in order to increase aircraft utilisation. But the future reliance on oneworld for most (if not all) of NewCo’s long-haul routes may see Kuala Lumpur to CDG and LHR served by alliance partners. If just one of those destinations went then NewCo would be left with an uneconomic fleet of A380s; but are there any potential buyers for a couple of second-hand A380s — let alone six of them?

Overall, the long-haul network is under attack from the Super-Connectors and Air Asia X (which has 100-odd A330neos and A350s on order), while British Airways has just announced the resumption of flights to Kuala Lumpur after 14 years (implying the withdrawal of MAS services but some form of revenue sharing within the oneworld alliance).

Network rationalisation won’t stop at long-haul. Routes within Asia/Pacific region are also likely to be trimmed, or potentially even culled significantly. Following public reaction to MH370 many (if not all) routes to China are believed to be unprofitable; currently MAS operates to Beijing, Guangzhou, Kunming, Shanghai and Xiamen, but it’s probable that only one or maybe two of these will still be in the network 12 months from now.

Can NewCo survive?

Even assuming that the 12 point plan is adopted without too many problems, will the NewCo be sufficiently lean to survive in a fiercely competitive Asian/Pacific aviation market?

It’s not just in the 2010s that MAS has been unprofitable — it has struggled both operationally and financially for year after year, decade after decade, and the blame for that must go on the revolving door of poor management and an even poorer owner in the Malaysian state, which has failed to establish the airline as a stable company with consistent profitability.

Significantly MAS has attempted to restructure itself five times in the last 15 years, and all these attempts have been abject failures — a fact that even Khazanah admits. The Malaysian government injected RM17.4bn ($5.5bn) in those restructurings — money that has been largely wasted, with Khazanah stating that “previous piecemeal changes involved MAS cancelling unprofitable routes and selling non-core assets ultimately failed to resolve the core challenge: an inflated cost structure with the revenue to offset it”.

The gap between MAS and its rivals is remarkable, whether looking at the revenue or cost side. Revenue per employee is half of Cathay Pacific’s and 63% below Singapore Airlines’ (SIA). Against its low-cost carrier competitors, MAS’s cost base is around 40% higher.

The performance of the share price over the last seven years (see chart on page 5) has been nothing short of disastrous, and even the posting of operating profits in 2007, 2008 and 2010 has done little (if anything) to stop the continual loss of investor confidence in MAS. Whatever management and government has done has failed to work, and that’s because of one external factor — the continuing rise of ruthless competition from the Gulf Super-Connectors on routes from Europe, Middle East and Africa through the Gulf and onto the Asia/Pacific region, and from the LCCs within the Asia/Pacific region itself.

Indeed the “Big Three” Gulf carriers have essentially killed MAS’s long-haul network entirely on their own. Between them Qatar Airways (ironically a fellow oneworld member), Emirates and Etihad have long offered more weekly seats to/from Malaysia as MAS offers in its entire long-haul network — and MAS simply has had no response to this.

Worryingly for the NewCo, the same end result may happen in short- and medium-haul — the areas that NewCo is now retreating into — with MAS seemingly powerless to combat the challenge within the Asia/Pacific region from the LCCs.

No answer to AirAsia

The threat from AirAsia (see Aviation Strategy, August 2013) — an LCC with 170 aircraft and with 322 A320s on order — is of course well-known, but MAS was sluggish to react as its rival grew through the 2000s, and MAS’s current strategy of engaging in fare wars with AirAsia (in which each has accused the other of “dumping fares”) has proved very costly; the old MAS and almost certainly the NewCo too will never be able to match its rival’s cost base.

MAS has never attempted properly to set up an LCC of its own (as most of its full-service contemporaries have done or at least tried to do). MAS has two regional subsidiaries — MASwings, founded in 2007 and with a fleet of 18 ATR 72s and DHC-6s, and Firefly, also launched in 2007 and which operates 15 ATR 72 s and a single 737-400 — but even though MAS tried an LCC model on domestic Firefly trunk routes, that was quickly discontinued.

MAS’s reluctance to launch an LCC of its own has probably been a mistake. The premium market that MAS had traditionally been targeting has been shrinking fast, and will do so even faster now that MAS is effectively abandoning any pretence of a long-haul network.

The challenge from AirAsia is immense. Today the AirAsia group offers direct routes from Kuala Lumpur to 88 destinations via AirAsia, its affiliate airlines and AirAsiaX — that’s a larger route network than MAS, which offers just over 50 destinations from Kuala Lumpur, even prior to the NewCo retrenchment. As MAS keeps on cutting destinations from Kuala Lumpur, so AirAsia keeps on adding them, and the reason for that is the underlying difference in the cost base at AirAsia and MAS.

AirAsia’s CASK figures at least 40% lower than MAS’s , and even if the NewCo 12 point plan is successfully implemented that gap will only come down to 20%, or 15% at the very best. That’s still not good enough, and in any case AirAsia will continue to drive down costs too.

The need to start from scratch and build an LCC from a blank sheet is still imperative but it’s something that MAS had always refused to countenance, and of course it’s too late now given that it has to restructure from the existing infrastructure and cost base at MAS (or “OldCo”).

One way (and perhaps the only way) out of MAS’s strategic dead-end would be to form an alliance with AirAsia, and indeed MAS did briefly agree a significant share swap with AirAsia back in 2011 in which Khazanah Nasional would receive a 10% stake in AirAsia, with AirAsia’s major shareholder — Tune Air — receiving 20.5% in MAS. But those plans collapsed the following year following opposition from unions and within certain parts of the Malaysian government.

Tony Fernandes, CEO of AirAsia, would probably feel that was a lucky escape, and he now expresses hope that “Malaysia Airlines is now going to be operated rationally. The airline was operated with a lot of subsidies, but that’s coming to an end and that’s good news for us.” Indeed fares have already started to rise in Malaysia, but this may be only a temporary phenomenon.

MAS also has to battle against Indonesia’s Lion Air (see Aviation Strategy, April 2014), which has more than 500 aircraft on firm order and also owns 49% of Kuala-Lumpur based LCC Malindo Air (which operates 15 aircraft and intends to increase its fleet to 100 strong).

A future?

Given that the Malaysian state has already pumped in many billions of rm into MAS with effectively zero return, now Khazanah Nasional is promising that (as part of its 12 point plan) after the final RM6bn ($1.9bn) injection of state support then no further help will be given. Some analysts are sceptical of that claim, but if true then the 12 point plan is the final chance for MAS.

The odds are that NewCo will not become the airline that the plan envisages. Jerry Lee, aviation analyst at RHB Research in Kuala Lumpur, says that: “On paper, it looks great — cut capacity, slash the workforce, improve productivity — but whether it can be implemented effectively, that’s still a question mark.”

Some analysts are worried about a perceived lack of detail in the 12 point plan, and a former senior executive at MAS is concerned about both corruption and “financial leakage” at the airline, and whether those issues will be addressed properly during the hectic switch to a NewCo. There’s no doubt that the timetable for action is very tight, given that the Association of Southeast Asian Nations’ “Open Skies” policy should launch by the end of 2015, under which unrestrained third, fourth and fifth freedoms will become the norm in the 10 member countries. Any hitch to implementation of the NewCo and its 12 point plan may well be fatal, and it’s probable that NewCo is being set up far more quickly than is sensible. But the OldCo has little choice — NewCo is its only option for survival.

What may ultimately sink NewCo is the quality of MAS’s management, which in places is dire. For example, in September the airline’s marketing department had to hastily rename a promotional competition on its website that had initially been called the “Ultimate Bucket List”, in which it gave Australian and New Zealand travellers the chance of winning tickets if they said what they would want to tick off on their bucket lists (i.e. before they died). Naturally the change only occurred after an outcry from the public and press — MAS had seen nothing wrong in what in what it was doing so soon after two major aviation disasters.

The worry is that a raft of poor, uncommercial senior and middle managers will make the transfer over to NewCo, while those leaving the company will be largely at the customer-facing end. The latter will save costs for the company, but if the former stay the consequences may be more significant.

Of course it’s possible that the NewCo will meet all its objectives, shrink and take out just enough of its costs base to be a going concern, at which point another airline might be tempted to ride to the rescue as a white knight (or more likely buy the airline at a bargain price).