[Initial Perspective] Jo Won-tae's '1+1' Is

Passenger aircraft of Korean Air and Asiana Airlines are moving toward the runway at Gimpo Airport apron in Gangseo-gu, Seoul.

[Asia Economy Reporter Lim Jeong-su] The simple addition of '1+1' equals '2'. However, this arithmetic does not always hold true in corporate management. When a company acquires another (M&A), the reasonable expectation is that the company's size, performance, and value will at least double. If synergy is properly created, the sum can become 3 or more, but if it fails, it may drop to 1.5 or even below 1.

Hyundai Motor Group acquired the struggling Kia Motors, and SK Group took over the crisis-hit Hynix, elevating both to become undisputed global top companies. Kumho Group succeeded in acquiring Daewoo Engineering & Construction, but as the entire group became insolvent, it ended up losing not only Daewoo Engineering & Construction but also Asiana Airlines, which had been a cash cow. This shows that even a seemingly brilliant winner in M&A can find itself worse off than before the acquisition.

What will be the outcome of Chairman Cho Won-tae’s '1+1' with the mega airline (FSC; Full Service Carrier) formed by 'Korean Air + Asiana Airlines'?

The number of aircraft owned is 163 for Korean Air and 81 for Asiana Airlines, totaling 244 after integration. This surpasses Japan’s two major airlines, JAL (241 aircraft) and Singapore Airlines (203 aircraft), by a wide margin. Adding the 60 aircraft from affiliated low-cost carriers (LCCs) Jin Air, Air Seoul, and Air Busan brings the total to 304, comparable to Japan’s ANA Holdings (303 aircraft).

The combined asset size, including aircraft, exceeds 40 trillion KRW, and annual revenue reaches 20 trillion KRW. In terms of scale, it rises to a global top-tier airline that can compete anywhere. Korean Air, previously ranked outside the global top 20, would instantly become a top 10 airline.

However, from a financial perspective, concerns arise. The combined debt of the two airlines is 25 trillion KRW, with a debt ratio approaching 1000%. EBITDA was 3 trillion KRW in 2019 and only 2 trillion KRW from January to September 2020. Considering depreciation, both airlines are operating at a loss. The combined annual net loss exceeds 1.4 trillion KRW. If this trend continues, a company that erodes its equity by 1.4 trillion KRW annually will be created. If performance deterioration persists, Asiana Airlines’ capital erosion rate, currently at 58%, will reach 100%.

In response, the Korea Development Bank and Hanjin Group planned new capital injections into the two airlines. The Korea Development Bank will support Hanjin KAL with 800 billion KRW through a third-party allotment capital increase and exchangeable bonds (EB), and Korean Air will inject 2.5 trillion KRW in capital through a shareholder allotment capital increase involving Hanjin KAL’s participation (730 billion KRW). Asiana Airlines will increase its capital by 1.8 trillion KRW through another third-party allotment and perpetual bond issuance.

With capital injections into Korean Air and Asiana Airlines, the financial situation will somewhat improve. The combined equity of the two airlines will increase from 3.84 trillion KRW to 6.34 trillion KRW, and the debt ratio is expected to fall from 927% to about 561%.

However, compared to global top airlines whose debt ratios rarely exceed 300%, the financial position remains weak. Considering the ongoing net losses and continuous erosion of equity, it is not unlikely that the debt ratio will quickly climb back toward 1000%.

With the ongoing COVID-19 pandemic and strong opposition from labor unions regarding the acquisition of Asiana Airlines, the management environment is unfavorable. Under these adverse conditions, Chairman Cho must fulfill his promise to improve the financial structure and performance without restructuring. How close will the answer to Cho Won-tae’s '1+1' converge?