Deal focus: VIG secures rare airline turnaround opportunity

Eastar Jet is one of three independent low-cost airlines operating in Korea, alongside Jeju Air and T'way Air. Three more carriers in this category – Air Busan, Air Seoul, and Jin Air – are subsidiaries of the two national airlines, Korean Air and Asiana Airlines. With Korean Air and Asiana set to merge, these three players must also be consolidated. And therein VIG Partners sees an opportunity.

"If the combined market share of those carriers exceeds 50% on any given route, they must take steps to bring it below that level. Right now, they are at 70% on many routes," said Jason Shin, a managing partner at VIG, which recently agreed to buy Eastar in a deal worth KRW 150bn (USD 121m). It is the first time a private equity firm has taken a controlling stake in a Korean airline.

"There are already high barriers to entry in the airline industry, given the challenges around getting licensed and getting the right routes and airport slots. Eastar has all those. On top of that, as a result of the Korean Air-Asiana merger, more routes should be given to the three independent guys."

Airlines worldwide have been challenged by COVID-19. Korean Air's KRW 1.8trn acquisition of Asiana, which was announced in November 2020 but is still waiting for various approvals, is one of the consequences. The government is backstopping the deal through Korea Development Bank.

Pandemic plus

VIG's purchase of Eastar is also a turnaround situation. The airline has been grounded for nearly three years and it was only released from a year-long rehabilitation programme by Seoul Bankruptcy Court in March 2022. Even that proved to be a false dawn as Sung Jung, a local property developer that had pumped KRW 110bn into the company, failed to get it relicensed and relaunched.

However, Eastar's problems didn't begin with the pandemic, though it did accelerate them. The company ran into trouble in 2019 following a period of mismanagement that resulted in Sang-jik Lee, its founder and formerly a member of Korea's National Assembly, being charged with embezzlement and breach of trust. He was given a six-year jail sentence in January 2022.

Established in 2007, Eastar launched services in 2009 and saw its business peak in 2014, when passenger numbers touched 10m. In 2019, 6.1m passengers were carried by the airline, with a nearly 50-50 split between domestic and international.

Shin noted that the last time the company posted "normal" financial results was 2018. Eastar used to generate two-thirds of its revenue from international routes within six hours of Seoul, chiefly to Japan and eastern China. A Korean boycott of Japanese goods and travel impacted financial performance in 2019. Then the pandemic arrived.

VIG made a move for Eastar on recognising that Sung Jung, having supported the rehabilitation process, was struggling to obtain a new air operator certificate (AOC) from local regulators. The private equity firm is only paying KRW 40bn to Sung Jung; the rest will be used to recapitalise the company. It was only willing to proceed with the transaction on the receipt of certain assurances.

"We did a lot of work with government officials," Shin explained. "The AOC will be restored right after we close the deal and inject new capital into the company in late January. We had to be sure all the routes were intact, and from March, we are going to get all the slots restored to where they were before the company ran into financial difficulties."

He compares the situation to that of Samyang Optics, a camera lens manufacturer VIG acquired in 2013 from an owner that had mismanaged the parent company and ultimately took public in 2017. "We are not going to buy companies where there are legacy and hidden liabilities we have to clean up and where we have to rebuild the brand and customer base," he said.

Returning to scale

Were it not for the pandemic, Eastar's former routes and slots would probably be unrecoverable. The reality is that most airlines haven't been able to operate international routes for the past three years, so they were not in a position to grab market share from a beleaguered rival.

VIG doesn't plan on changing Eastar's core business model. Commercial due diligence established that the optimal fleet size for a carrier serving locations within a six-hour radius is about 20 planes. Targeting more distant geographies – for example, Hawaii or the continental US, which are eight and 11 hours, respectively – involves different aircraft, different competitors, and different economics.

Eastar previously operated 20 aircraft, with a preference for the Boeing 737-800. Leases were given up as financial conditions worsened, leaving three planes in service. VIG will reactivate the approximately 500 employees still on the payroll and it plans to have four more aircraft in the air within six months of the deal closing. By the end of 2023, there will be 10 or 11.

"We want to get to 20 aircraft, maximise the profitability for all those profitable destinations within a six-hour range, and manage the company more efficiently than the previous owner ever did. If we can achieve that, we think we can easily exceed the company's most profitable year, which was 2017," Shin said.

The most likely exit is a trade sale, with only Korean-owned buyers permitted by regulators. VIG believes some chaebols would be interested in such a scarce asset or one of the other independent carriers might pursue a consolidation play. "There are only three operators. If you want to get into the game, this is the only way," Shin added.

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• Topics
• North Asia
• Consumer
• Buyouts
• Restructuring
• South Korea
• VIG Partners
• Travel
• Transportation
• Distress