After bankruptcy and makeover, Japan Airlines returns

Posted at 09/19/2012 3:49 PM | Updated as of 09/19/2012 3:49 PM

Before Kazuo Inamori, founder of electronics firm Kyocera Corp., was brought in as chairman of bankrupt Japan Airlines in 2010, he avoided flying on the carrier because he thought the service was bad.

"I really hated JAL," the 80-year old Inamori, who is now chairman emeritus, told Japanese television in June. "JAL was arrogant and didn't care about its customers."

As much as JAL has focused on slashing costs, it has also sought to close the service gap with local rival All Nippon Airways--putting in new seats, revamping in-flight menus and installing electronic toilet seats in some business and first class cabins.

That investment underscores JAL's belief that customers will pay a premium for full-service flights, including on shorter domestic routes even as low-cost carriers are expected to grow their share of Japan's market from just under 10 percent now.

"A lot of airlines, when they restructure, they go down more the low-cost route or just strip back on service. But they (JAL) actually did it by going upmarket," said Paul Sheridan, head Asia consultant at aviation advisory firm Ascend.

Now, less than three years after failing in one of Japan's biggest bankruptcies, JAL is set for a strong return to the stock market on Wednesday, highlighting the success of a swift but controversial state-led restructuring.

Everything about its collapse and revival has been big.

Its $8.5 billion initial public offering is the world's second-largest this year after social networking giant Facebook's $16 billion IPO. JAL's $2.5 billion operating profit in the past business year was top-of-the-class, and its balance sheet, saddled with $25 billion in debts when it failed in January 2010, has been scrubbed clean.

While the outlook for the former national flag carrier remains fraught--a mature home market, more competition from budget carriers and a shaky global economy that could dent its international expansion plans--investors appear willing to take a bet on its prospects.

A conservatively priced offering was comfortably oversubscribed and unofficial, pre-listing trading suggests a 10 percent first day "pop" above the IPO price.

"They've given themselves the best start they could. The challenge is to keep it up," said Ascend's Sheridan.

Bumper payback

The Enterprise Turnaround Initiative Corporation of Japan, a state-backed fund that injected 350 billion yen ($4.44 billion) into JAL in 2010, sold its entire 96.5% stake in the IPO, generating around $4 billion profit for national coffers.

The IPO price of 3,790 yen a share values Japan Airlines at 687 billion yen ($8.72 billion) and marks it with a price-to-earnings ratio of 5.3, around a third of the industry average.

The underwriters, led by global co-ordinator Daiwa Securities Group, left some money on the table to ensure the listing, which came at a difficult time for the airline industry, went without a hitch.

JAL shares traded at 4,150 yen each on the unofficial grey market on Tuesday, 9.5 percent above the IPO price, traders said. "We're pretty negative on the airline industry as a whole. There's so much new competition, low-cost carriers, and the outlook is pretty tough," said one Tokyo-based analyst, who asked not to be named. "But this thing looks like it's priced to go."

Held accountable

While it has invested in improving its service credentials, JAL has also taken a knife to its bloated cost structure--shedding about a third of its workforce to around 31,000, slashing pension payouts and retiring its line-up of gas-guzzling jumbo jets.

JAL's cost per available seat kilometer (CASK)--a commonly used metric equal to the cost of maintaining a seat over the distance travelled--has dropped to 11.4 yen ($0.14) from 13.8 yen before bankruptcy. ANA's CASK is 12.9 yen.

JAL executives credit Inamori's management system in which individual corporate units are held accountable for maximizing profitability--even divisions that are not directly generating revenue--for reviving the group.

Under that system, unit leaders meet once a month to share cost-saving ideas and competitive intelligence, and are directed to put that information to work immediately. Previously JAL's various divisions operated in silos and many gave little thought on how best to minimize costs, executives have said.

Controversy, risks

The question that came up most often from institutional investors during an overseas tour to market the IPO was whether JAL could maintain its cost discipline after becoming a private company again, according to a person familiar with the matter.

While JAL estimates that three-quarters of its efficiency gains are due to job cuts and other structural reforms, its jump from industry basket-case to profit leader would not have been possible without massive state and private aid.

Banks forgave about 520 billion yen in debt. The write-down of its ageing fleet has put a huge dent in its depreciation expenses. Perhaps most significantly, it is sitting on 1.1 trillion yen in loss carryforwards, which could translate into a $4.5 billion corporate tax break stretched over nine years.

JAL has used its new-found financial muscle to order 45 Boeing 787 Dreamliners, a fuel-efficient jet positioned as crucial in its efforts to trim costs and increase seat capacity on international routes by 25 percent over five years.

ANA has cried foul, charging the tax breaks and other aid have created an unfair playing field. Behind the scenes it has lobbied for concessions, such as preferential allocation of landing slots coming due at Tokyo's Haneda airport around 2014.

Analysts cite this issue as a risk for investors.

The main opposition Liberal Democratic Party, keen to criticize the ruling Democratic Party's restructuring of JAL, has called for steps to keep JAL's resurgence in check.

But the overriding fear among investors is that the carrier could slide back into its bad old ways.

"I believe JAL executives and employees will keep working hard, not becoming satisfied or complacent," Inamori told a briefing last month. "It won't be like the old JAL."