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Business deals

Korean airline merger faces debt burden and antitrust concerns

Deal to combine KAL and Asiana not guaranteed to cure carriers' problems

Korean Air Lines is set to take control of Asiana in a deal assisted by the Korea Development Bank.   © Reuters

SEOUL -- When South Korea's state-owned development bank in mid-November unveiled its plan to create a "top 10 global airline" by backing a restructuring of the country's two main carriers, it seemed like an appeal to national pride -- but not everyone was buying it.

Inside Asiana Airlines, employees were shocked at the news that the larger Korean Air Lines, their bitter rival, was to be their new owner as part of Seoul's plan to help the domestic aviation sector weather the pandemic.

"I feel empty. We have tried to catch up to Korean Air for the last 30 years, but now we will lose our company name. That is frustrating," said an Asiana manager, asking not to be named. "[Korea Development Bank] CEO Lee Dong-gull said a few months ago that we can recover under our own power, but now he says we should be sold to Korean Air because we cannot survive. It does not make sense at all."

The hint of disenchantment and a clash of cultures to come is just one of the potential obstacles to getting the most out of the merger plan -- one of the most radical efforts so far unveiled to reshape Asian aviation as carriers across the region face mounting losses from months of disrupted travel.

KAL said it will buy new shares in Asiana worth 1.5 trillion won ($1.4 billion) as well as Asiana corporate bonds worth 300 billion won, taking the helm of an enlarged company. The KDB will inject 800 billion won into Korean Air's parent, Hanjin KAL, in exchange for a 10.66% stake in the holding company as well as three board directors.

KDB acted after a $2.2 billion acquisition deal between Asiana's parent, Kumho Industrial, and Hyundai Development Co. collapsed in September. KDB is a main creditor of Kumho.

KAL is strong in long-haul passenger services, connecting Seoul's main airport, Incheon, to key destinations in the U.S. and Europe. Asiana has wide networks in China. Both compete in the domestic market as well as on travel to Japan and Southeast Asia.

But both are struggling financially because of the pandemic. KAL's operating profit fell by 94% to 7.6 billion won in the third quarter from a year earlier, with revenue dropping 52% to 1.6 trillion won. Meanwhile Asiana posted 5.8 billion won of operating profit in the quarter, turning around 45.1 billion won of operating losses a year earlier. Asiana attributed this to improvements in cargo service as well as low costs for fuel, human resources and other operations. Still, its revenue fell by 53.2% to 731.1 billion won during the quarter.

This year's disruption exacerbated existing challenges, such as increased competition from low-cost rivals. Both have also become collateral damage as financial problems have emerged elsewhere in their conglomerate owners' business empires.

KAL's financial health was undermined in the past by the support it gave to Hanjin Shipping, an affiliate that filed for bankruptcy in 2017. Asiana has also faced risks stemming from the use of its assets as collateral for borrowing by Kumho Industrial.

While many industry analysts say a restructuring in the industry is needed for the long term, there are concerns that an integration of South Korea's two biggest airlines is an artificial solution that will do little to ease their serious financial problems.

Both companies are under heavy debt. Asiana's total debt reached 11.5 trillion won in September, with a debt-to-equity ratio of 2,431.9%. Korean Air has 22.7 trillion won of total debt and a debt-to-equity ratio of 693%.

"We believe that Asiana Airlines' debt will burden Korean Air continuously," said Yoo Seung-woo, an analyst at SK Securities.

Jay Lee, credit analyst at Shinhan Financial Investment, agreed. "The biggest concern is Asiana Airlines' condition. Asiana's debt ratio jumped sharply for the last two years due to accumulation of big losses," Lee said.

Lee said that injection of money from Korean Air may reduce Asiana's debt-to-equity ratio to 524%, but it is still unclear whether the integrated airline could rebound after the merger.

Still, some hope the size of the new airline will give it fresh impetus.

Kim Yu-hyuk, an analyst at Hanwha Investment & Securities, said the merger would boost the company's competitiveness in Asia and beyond while allowing it to cut costs through an integrated operating system and giving up duplicate landing slots as well as maintenance and repair departments.

"With this deal, we have a mega-airliner with a fleet of 245 aircraft. It is the global No. 10 by revenue passenger kilometers and the third-largest by freight ton kilometers," said Kim. "The airliner will enjoy monopoly status in the long-haul passenger services and cargo services. We need to focus on [the fact that this will lead to] better performance and profits."

That hints at a problem that the airlines must confront even before they complete their integration: the agreement they will need to secure from antitrust authorities in South Korea and beyond.

Joh Sung-wook, head of the country's Fair Trade Commission, said on Nov. 19 that the agency will look into whether the deal undermines competition in the industry. The two airlines' combined share in the domestic passenger market is 62.5%.

KAL also needs antitrust permission from other countries to complete the deal. For instance, HDC asked five countries -- the U.S., China, Russia, Turkey and Kazakhstan -- to approve its deal to buy Asiana earlier this year before it collapsed in September.

The Ministry of Transport said KAL needs to keep its size and routes after the merger to maintain its competitiveness, worrying that it may have to give up some routes due to the antitrust concerns.

"KAL wants to acquire Asiana to strengthen its competitiveness by making it bigger. Giving up too many routes will lead to undermining its base," said Kim Sang-do, a director at the ministry, in a news briefing.

Objections from a major Hanjin KAL shareholder are another risk. Korea Corporate Governance Improvement, an activist fund, opposes the deal, saying it undermines shareholder value. It has filed a petition with a Seoul district court to stop the deal.

"KCGI is waiting for the court's wise decision. We suggest open discussions for reshaping the aviation industry," the fund said in a statement.

If the deal does come to fruition, it could get close attention from rivals looking at their own financial problems stemming from the coronavirus pandemic -- and make South Korea a test bed for wider restructuring.

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