Proposed merger of two airlines: Can everyone fly now? — Ooi Bee Hong and Annabel Kok

MAY 5 — The rumoured merger between our national flag carrier, Malaysia Airlines Berhad (MAS), and our largest low-cost airline carrier, AirAsia Group (AirAsia), has been the talk of the town for a few weeks amid the Covid-19 pandemic.

With many airlines across the globe slumping into voluntary administration, including Virgin Australia Group (Virgin), Australia's first big corporate casualty of the pandemic, the aviation industry faces a threat of significant decline of market competition.

For instance, the falling of Virgin may prompt Qantas Airways Limited (Qantas) to arise as the only significant airline player in Australia, leading to plummeting competitive levels in Australia. The aviation market there had been previously duopolised by both Virgin and Qantas.

According to Australian authorities, swift action in enforcing competition laws will be taken by its antitrust watchdog3 against anti-competitive behaviour such as attempts to swamp airline routes, artificially push down prices or lock in exclusive deals with airports and suppliers in a bid to ensure that airlines are able to compete effectively as the industry rebuilds.

It is therefore clear that although the primary goal of an airline merger is to enable parties to eliminate duplicative operating costs, thereby reducing their total costs on labour, service and operations whilst maximising revenue, the after-effects of a merger involving two major competing airline titans raises far-reaching concerns.

Anti-competitive practices may tend to arise including an increase in airfares, reduction of flight frequencies and deteriorating service quality due to a lower degree of competition. This article is aimed at discussing some competition law issues which may ensue from a merger between MAS and AirAsia.

Voluntary merger control

Since March 2016, the primary legislation relating to aviation services is the Malaysian Aviation Commission Act 2015 (MACA 2015). Currently, the MACA 2015 is the only legislation in Malaysia which provides for a voluntary merger control regime in addition to prohibiting anti-competitive agreements and abuse of dominance in the aviation services market.

Section 54 of the MACA 2015 states that any merger which “have resulted or may be expected to result in a substantial lessening of competition in any aviation service market” is prohibited.

As any notification regarding an anticipated merger or merger under MACA 2015 is on a voluntary basis, parties are required to assess whether a merger may result in a “substantial lessening of competition” (SLC) and determine whether a merger notification should be made to the Malaysian Aviation Commission (MAVCOM), an independent entity established under the MACA 2015 to regulate economic and commercial matters related to civil aviation in Malaysia.

Guidance for determining what constitutes a SLC is contained in the ‘Guidelines on Substantive Assessment of Mergers’ published by MAVCOM. Essentially, a four-step SLC test is to be conducted, covering the following considerations —

(a) Defining the relevant aviation service market;

(b) Developing a “theory or theories of harm” which would help identify the possible harm and effects on competition in the relevant aviation service market arising from a merger. Such possible harm and effects on competition will then be compared with the counterfactual merger i.e. the conditions and degree of competition in the relevant aviation service market in the absence of such a merger;

(c) Developing a counterfactual scenario which refers to the conditions and degree of competition in a relevant aviation service market in the absence of such a merger, based on prevailing conditions of competition in a relevant aviation service market. Examples of changes to the prevailing conditions of a relevant market include the entry of a new competitor, the expansion plans or exit of an existing competitor, the imminent failure of a merger party and regulatory changes; and

(d) Assessing the competition in a relevant aviation service market and comparing it with a counterfactual scenario.

Factors such as market power and market concentration, competitive effects arising from horizontal mergers and vertical mergers should also be considered. Typical competition issues applicable to the airline industry would include code-sharing, price-fixing, airport capacity and slots allocation, frequent flyers programme, corporate discount schemes, travel agent commissions and tariff coordination.

Present market position

It is reported that, at present, AirAsia controls approximately 50 per cent of the aviation market, whilst MAS’ market share stands at about 30 per cent. A merged entity formed between both parties would therefore be in a position to control a significant portion of the aviation market share in Malaysia, at approximately 80 per cent, creating room for the merged entity to behave, to an appreciable extent, independently of its competitors, customers and ultimately of the consumers.

Potentially, MAVCOM, would have to consider the terms of the proposed merger, the potential impact on the aviation market as well as whether the merger would result in excessive market domination and the results of a SLC test.

Historically, mergers have the ability to create efficiency gains arising from economies of scale and scope, but a newly merged corporation which has a dominant position in the relevant market may exert market power and charge higher fares to consumers or steal market share from competitors.

The “Guidelines on Abuse of Dominant Position” issued by MAVCOM, provides that in general, an enterprise holding market share above 60 per cent serves as an indicator that such enterprise holds a dominant position in a relevant aviation service market.

Combined with other relevant factors in totality including the ability to impose excessive, predatory or discriminatory pricing and the capacity to profit from a price above competitive levels for a sustainable period, that would indicate that the enterprise holds significant market power and the potential for abuse of its dominant position may arise.

Highlighting some anti-competition concerns that may be brought by the merger, MAVCOM had in its “Commentary on Government Assistance to the Aviation Industry amid the Covid-19 Pandemic” issued in March 2020 (MAVCOM Commentary) noted that a proposed merger between the two domestic airlines may potentially result in a high concentration of the Malaysian domestic aviation market with the merged entity holding a monopoly status in many domestic routes, distorting the aviation market in the long run.

MAVCOM reiterates that, “any step towards industry consolidation, in the name of keeping firms afloat, must adhere to the merger control provisions set out in MACA 2015 to safeguard industry and consumer interests. The immediate relief such consolidation may provide must be balanced against any risks to the long-term health and competitiveness of the aviation services market.”

The justification of a “failing firm defence” which may be raised in favour of the proposed merger amidst the Covid-19 pandemic is acknowledged by MAVCOM.

This defence, which has been typically used in merger proceedings as a last resort argument, contends that regardless of anti-competition issues which may arise as a result of the merger, the alleged failing party involved in the merger would exit the relevant aviation service market and competition provided by that party would be lost anyway.

With MAS’ financials deteriorating up to 94 per cent since flight restrictions were imposed across most countries to curb the Covid-19 pandemic, facing an estimated US$3.32 billion loss in revenue following lower demand and yields across Asia8, it is plausible for an argument to be made that MAS would have exited the aviation market in any case.

However, it is pertinent to note that “failing firm defences” are often rejected by competition authorities due to the significant amount of evidence required to support such an argument, including producing to their satisfaction, commercially-sensitive and confidential information relating to the failing party.

The “failing firm defence” must be substantiated with proof and evidence that a merger party is genuinely failing and that it would fail should the merger not occur.

In this regard, MAVCOM has asserted that it will strictly assess the merits of any such claim to ensure that parties are not abusing the law while acknowledging that aviation industry players are facing unprecedented challenges arising from the economic crisis caused by the Covid -19 pandemic.

The Korean experience

Interestingly, just recently in South Korea, the acquisition of Eastar Jet by its rival, Jeju Air, both being South Korean’s notable low-cost carriers, was approved by the country’s antitrust watchdog.

This was on the basis that Eastar Jet was deemed “unrecoverable” under its applicable competition legislation11 and was thus granted an exception from applicable competition laws notwithstanding that the acquisition relating to a horizontal merger would inevitably reduce competition in the aviation service market.

Competition in the aviation market in South Korea remains fierce notwithstanding the aforesaid merger, with the existence of 5 other budget carriers based in South Korea, namely Jin Air, Air Busan, Air Seoul, T'way and Fly Gangwon, with 2 new competitors, Air Premia and Aero K, slated to enter the aviation industry later this year.

Pursuant to the “Guidelines on Notification and Application Procedure for an Anticipated Merger or a Merger” issued by MAVCOM, the competitive effects of an anticipated merger or a merger will be gathered from various sources as MAVCOM deems appropriate including from the applicant, the merger party, buyers and competing enterprises in the relevant service market, third party data providers or other regulatory bodies and feedback received from public consultation.

Past issues

In the past, competition issues were raised by the Malaysian Competition Commission (MyCC) alleging that a collaboration agreement entered into between MAS’ predecessor, i.e. Malaysian Airlines System Berhad, AirAsia Berhad and AirAsia X Sdn Bhd which allowed, amongst others, parties to operate freely within separate market segments in the airline industry and to impose higher prices to maximise profitability, contravened provisions of the Competition Act 2010.

As at the date of this article, the High Court has set aside the decision of the Malaysian Competition Appeal Tribunal and reinstated the decision of MyCC in that the said collaboration agreement had distorted competition in the aviation sector in Malaysia, as it had the object of market-sharing within the Malaysian air transport services sector for the purpose of maximising commercial revenue.

It is pertinent to note that failure to adhere to the merger control provisions set out in MACA 2015 by notifying and applying for a decision of MAVCOM relating to an anticipated merger or a merger carries the risks of being investigated by MAVCOM if such merger falls foul of the MACA 2015.

MAVCOM is empowered to investigate an anticipated merger or merger where there is reason to suspect that is has resulted, or may be expected to result, in a substantial lessening of competition in any aviation service market. MAVCOM is more likely to do so (but is not in any way limited in its discretion to do so) if —

(a) the combined turnover of the merger parties in Malaysia in the financial year preceding the anticipated merger or merger is at least RM50 million; or

(b) the combined worldwide turnover of the merger parties in the financial year preceding the anticipated merger or the merger is at least RM500 million.

Conclusion

The trend of airlines forming alliances, consolidating and entering into mergers are not uncommon, especially so during a global recession. This may particularly ring true in light of the decreased demand for air travel due to numerous travel restrictions and border closures imposed by countries worldwide in response to the Covid-19 pandemic.

In the United States, the 2008 recession due to the financial crisis led to the creation of the big three airlines we see today, when Delta and Northwest, United and Continental, and American and US Airways merged, respectively.

It will therefore be interesting to observe the development of the talks of merger between MAS and AirAsia, which would probably be the largest merger between two civil aviation companies in Malaysia, if carried through.

* Ooi Bee Hong and Annabel Kok Keng Yen are with the Rosli Dahlan Saravana Partnership (RDS).

** This is the personal opinion of the writer(s) or publication and does not necessarily represent the views of Malay Mail.

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