The biggest problem for airlines is generally that their core business is rotten.
Carriers sell a perishable commodity in a fiercely competitive market where many of their rivals are government-backed, and they must invest heavily in costly, fast-depreciating equipment in order to do so. A seat on a Thursday flight from Kuala Lumpur to Bangkok expires today, and is much the same whether you fly AirAsia Bhd, Thai Airways International PCL, Malaysia Airline System Bhd, Bangkok Airways Pcl, or Malindo Airways.
That’s why the announcement that AirAsia will sell 84 planes and 14 engines to aviation lessor BBAM Ltd at an enterprise value of $2.85 billion is somewhat mystifying.
Co-founder Tony Fernandes has been trailing the move for more than a year, and on some measures it makes sense. At a stroke, the sale will wipe out most of the 7.43 billion ringgit ($1.89 billion) in net debt on the balance sheet at the end of December. It will also lift the odour of suspicion that’s clung to AirAsia’s leasing business since a short-seller in 2015 criticized its accounting.
At the same time, though, Fernandes is losing one of the carrier’s best businesses—one that’s often accounted for as much as a fifth of revenue.
As Gadfly has long argued, AirAsia’s status as one of Airbus SE’s biggest customers has made its leasing unit a source of consistent, handsome profits—in stark contrast to its core flying business. One in 13 orders for the new version of the A320 are destined for AirAsia.
Ancillary sales such as in-flight food, airport check-in services and baggage fees make up another fifth of revenue—and they, too, appear to be under scrutiny for a spin-off, judging by AirAsia’s rhetoric about “realizing value from non-core operations."
What’s the point of all this? AirAsia has long traded at a discount to the European budget carriers against which Fernandes benchmarks himself, but that seems as much a function of different markets as anything more profound—and it’s been narrowing in recent months, anyway. Cebu Air Inc., the Philippines’ dominant low-cost airline, is valued more cheaply than AirAsia on forward price-earnings metrics, while India’s InterGlobe Aviation Ltd, or IndiGo, enjoys a handsome premium to even EasyJet Plc.
The disposal is particularly fruitless given upcoming changes to the accounting treatment of aircraft operating leases. The new rules, which come into effect next year, will mean that aircraft on longer-term operating leases come back onto the balance sheet—so we’ll hardly have got used to the new capital-lite AirAsia before it bulks up again.
More to the point, lessors like BBAM rarely get the discounts on buying new planes that airlines do, so outsourcing this operation means AirAsia’s fleet costs are likely to go up to cover BBAM’s higher purchase prices.
Fernandes’s journey in taking AirAsia from a one-ringgit purchase in 2001 into a carrier that’s threatening venerable businesses like Singapore Airlines Ltd and Malaysia Airlines make it seem presumptuous to second-guess his plans. But AirAsia’s array of non-core operations, in his eyes a weakness, in many ways represents one of the airline’s greatest strengths.
In choosing to slash his parachute in this way, Fernandes may be making his airline more nimble—but should it ever hit an air pocket, he may come to regret the loss of security. Bloomberg Gadfly