Japan’s airlines explore budget options

The Japan model is no exception despite the dominant position of Japan Airlines (JAL) and All Nippon Airways (ANA), both of which have close ties to the state. In February, Peach Aviation, a joint venture between ANA and Hong Kong-based First Eastern Investment, became the first LCC to receive official approval.

It will commence flights from Osaka's Kansai International Airport on March 1, 2012, offering services to Sapporo and Fukuoka.

In July of this year, ANA announced another LCC partnership, this time with Air Asia. It will be called Air Asia Japan. A month later, JAL got in on the act, entering into an agreement with Australia's Qantas to create a Japanese arm of its successful Jetstar budget operator. Each company will have a 42% stake in the venture, with the remainder held by Mitsubishi Corp.

Air Asia Japan and Jetstar Japan also plan to begin operations in 2012.

Target markets

For each of the LCCs there is a clear target market: Foreign visitors to Japan rose 26.8% year-on-year to 8.61 million in 2010, with arrivals from South Korea, China and Taiwan posting year-on-year increases of 53.8%, 40.4% and 23.8%, respectively, according to the Japan National Tourism Organization.

"Mobility is increasing and this is being helped by falling prices," says Caspar Baum, EC Harris Head of Aviation in Asia. "Furthermore, ‘budget' travel, especially in the air travel segment, has become part of people's lifestyles. Budget traveling in Asia will focus on the younger generation."

For JAL and ANA, there are clear financial objectives as well. Japan's air travel industry reflects the wider economy, with the global financial crisis taking a heavy toll on already sluggish consumer demand. JAL filed for bankruptcy last year with debts of more than $25 billion. In 2010, its revenues slumped by 26.4% to JPY 214.1 billion ($2.79 billion). ANA's revenue came in at JPY630 billion, down 9.8% year-on-year.

Neither carrier has a track record of cutting ticket prices on domestic flights, but economic troubles have forced a rethink. The advent of JAL and ANA's budget businesses signals an intention to forgo quality service - in terms of food and beverage, baggage allowances, and so on - in the interests of minimizing operational costs. They will also have to broaden their focus from the traditional target market of business executives to younger people traveling on tighter budgets.

Air Asia's similarly frugal approach saw net profit double to more than $500 million in 2010, as revenue rose 16.7% year-on-year to $1.9 billion and passenger numbers grew by 13.1% to 25.6 million.

"There is a large growth opportunity for LCCs in Japan, but I don't think it is an easy market given the other lower cost carriers competing business," says Minoru Matsuno, CEO of Value Search Asset Management.

He also doubts JAL's ability to enter the LCC space while simultaneously resolving its other problems. The airline is in the process of laying off 15,700 staff and closing down underperforming routes. Austerity doesn't sit well with a "amakudari" firm that has traditionally offered high-profile positions to Japanese bureaucrats looking to wind down their careers in the private sector.

Openings for PE

Should a sustainable LCC business model emerge in Japan, there is clearly potential for private equity involvement. Under its joint venture agreement with ANA, First Eastern has taken a 33.3% stake in Peach Aviation. ANA has a 33.4% holding and the remainder is controlled by Innovation Network Corporation of Japan, an investment fund owned by the government and a group of local enterprises. First Eastern pledged JYY5 billion of Peach's total initial capital of JPY10-50 billion and it reportedly plans to inject another JPY15 billion before services begin.

Japanese local carrier Star Flyer, which is based in Fukuoka, is owned by ANA and a host of private equity and venture capital firms, including SBI Broadband, Dream Incubator, NIF and Daiwa SMBC Principal Investment.

TPG's failed joint bid with American Airlines for JAL in late 2009 might suggest opportunities are limited for foreign private equity, but other firms have made headway elsewhere in Asia by targeting smaller carriers. Air Asia is a case in point; so too are India's SpiceJet and Singapore Tiger Airways, which are backed by Goldman Sachs and Indigo Singapore, respectively.

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• Topics
• North Asia
• Infrastructure
• Industrials
• First Eastern Investment Group
• Goldman Sachs