Fernandes says AirAsia can beat Malindo in Malaysia, as Malindo will have a higher cost base. This is because Malindo will have the added expense of offering inflight entertainment and other “frills,” he says. Rusdi has said that offering frills, such as inflight entertainment is in response to market demand. Increasingly, passengers who fly low-cost carriers are demanding a better standard of inflight service, he says.
Like Rusdi, Fernandes has been financing aircraft using export credit agency (ECA)-backed financing. The interest rates are lower, but the buyer has to have the cash to cover the upfront fees and make a sizeable deposit on the aircraft,
AirAsia has the cash, because it is profitable. In the nine months ending Sept. 30 it had a net profit of 1.528 billion Malaysian ringgit ($500 million) compared to 428 million ringgit in the corresponding period last year. Publicly listed Cebu Pacific had net income of 2.27 billion pesos ($55 million) in the first nine months of this year, up from 2.21 billion pesos for the same period last year. Lion is a private company that never discloses its financial results other than to financiers and the tax office, but it is understood to be profitable.
Rusdi's Malaysia move, however, could potentially lead to a price war that will drive down yields. A report from Citibank's equity research division in September states: “Malindo is a brave attempt by Lion, [but] we highly doubt that it will become profitable as its business strategy does not make commercial sense, and it is also squeezing into a well-penetrated Malaysian LCC market monopolized by AirAsia.”
But there are other ways to measure success. AirAsia group has been funding its international expansion into Rusdi's home market—Indonesia—with profits from AirAsia Malaysia. If Rusdi can turn Fernandes' Malaysian “gold mine” into a black hole, Rusdi may consider that a successful outcome.
But AirAsia and Lion's fleet expansion coincides with a weak period in the global economy. Europe is still grappling with financial crises, and the U.S. economy may contract next year if the government is forced to cut spending.
Another issue is aircraft financing. The ECA-backed financing Rusdi and Fernandes have been using will become more expensive. Under the 2013 Aircraft Sector Understanding rules, which establishes terms and conditions under which countries and their manufacturers can provide aircraft financing for commercial aircraft, interest rates will increase.
The other option is commercial bank financing Upfront fees and deposit are generally lower, but interest rates are higher because the financial institution is taking on more risk, as there is no government-backed guarantor. Many banks generally set the required deposit based on the underlying credit risk of the airline, not on the residual or asset value of the aircraft. This requires airlines to put quite a bit of equity into these deals.
Another problem is finding a bank willing to finance aircraft. European banks have been the biggest financiers for the airline industry, but the financial crisis in Europe has meant they are limiting their exposure to the volatile aviation industry; some are exiting the business altogether. HSH Nordbank shuttered its aviation lending business last year. AirAsia and other carriers have been encouraging banks from other parts of the world to fill the void left by the European lenders.