TAIWAN AVIATION - DIRECT LINKS, HIGH-SPEED RAIL,

C O N F I D E N T I A L SECTION 01 OF 03 TAIPEI 003446 SIPDIS SIPDIS STATE FOR EAP/TC, EB/TRA STATE PASS USTR COMMERCE FOR 3132/USFCS/OIO/EAP/WZARIT TREASURY FOR OASIA/LMOGHTADER USTR FOR STRATFORD, ALTBACH E.O. 12958: DECL: 10/02/2016 TAGS: EAIR ELTN ECON PREL TW CH SUBJECT: TAIWAN AVIATION - DIRECT LINKS, HIGH-SPEED RAIL, FUTURE OF UNCERTAINTY (PART 2 OF 3) REF: A. 05 TAIPEI 3752 ¶B. 05 TAIPEI 4161 ¶C. TAIPEI 3210 ¶D. TAIPEI 3414 Classified By: AIT Acting Director Robert S. Wang, Reason 1.4 d ¶1. (SBU) Summary: In the face of challenges detailed in ref D, Taiwan's small airlines are struggling. Taiwan's Civil Aeronautics Administration is encouraging them to merge, but the airlines are reluctant. To survive, they are expanding regional service and look to tap into profitable cross-Strait routes. Nevertheless, consolidation in the industry appears inevitable. End summary. ¶2. (U) This is the second of a three part report on the challenges facing Taiwan's aviation industry. This part will focus on the impact on Taiwan's airlines and their strategy for overcoming current challenges. Part three will look at the impact on U.S. companies. Small Independent Airlines at Risk -------------- ¶3. (U) Taiwan's domestic airlines face much poorer prospects as a result of the current difficult conditions in the aviation market. CAL and EVA Air are not directly affected by the drop in domestic air travel and the likelihood of even more dramatic declines after the opening of the high-speed rail. Among Taiwan's four small airlines, Mandarin and UNI Air are in much better shape than FAT and TransAsia. Mandarin and UNI are fully-owned affiliates of CAL and EVA, respectively. They benefit not only from stronger financial backing but also from cooperation with their larger partners. For example, on cross-Strait charter flights allocated equally to each airline, Mandarin routes have been operated by CAL with its larger aircraft. ¶4. (U) The current situation is most difficult for the two small independent airlines, FAT and TransAsia. Both suffered substantial losses in 2005. TransAsia's net losses totaled NT$91.8 million (about US$2.9 million), while FAT lost more than NT$541 million (US$16.8 million). Despite already high oil prices, the other irlines were able to maintain profitability in 2005. TransAsia managed to earn a profit in both 2002 and 2004, but not ¶2003. Over the last four years, FAT only managed to show a profit in 2004, when it earned a paltry NT$34.7 million (US$1.04 million). CAA Reduced Fees and Urging Mergers -------------- ¶5. (U) The Taiwan authorities have recently taken some steps to help alleviate the problems facing domestic airlines. On September 15, 2005, the Civil Aeronautics Administration (CAA) announced a package of measures, including reducing landing fees by up to 50 percent and airport usage fees by 10 percent with further reductions possible after the high-speed rail begins operations. At the same time, CAA increased overflight fees, which will affect only foreign carriers. ¶6. (C) The package also included possible incentives for airlines that merge such as tax benefits and further reduction of airport fees. However, CAA Air Transport Division Director Chen Tien-tsyh told AIT/T that no final decision has been made on what the incentives might include. He also mentioned possible priority consideration for allocation of cross-Strait charter flights. ¶7. (C) Airline executives have uniformly indicated to AIT/T that CAA's package of alleviation measures will not be enough to solve the current crisis. FAT Chairman Stephen Tsuei said that CAA had "let airlines bleed" for TAIPEI 00003446 002 OF 003 years. TransAsia Chairman Tony C.C. Fan similarly complained that the government had taken no action to help airlines for ten years after initiating the high- speed rail. He bitterly noted the authorities' decision to help finance the high-speed rail through the Civil Aviation Development Fund created to develop Taiwan's aviation industry. He also pointed out the aviation industry was highly regulated, citing the example of mandated discount fares for senior citizens. Fan believes the authorities, therefore, face a greater obligation to provide relief. Echoing this complaint, Mandarin Airlines President Harris Wang told us that CAA would not allow his airline to drop its unprofitable Taipei-Taichung route even though passenger load factors had dropped to 30 percent. ¶8. (C) Taiwan's carriers have cited several reasons why it is not in their interests to merge at this time. They have explained to CAA that because they operate different kinds of aircraft, merging offers few advantages. TransAsia's Fan said the problem is that with falling passenger loads there are simply too many planes and not enough passengers in Taiwan. In this situation, he argues merging will provide no benefit. In addition, Mandarin's Wang said previous mergers in the industry had resulted in major losses. He cited the example of the merger that formed UNI Air in 1998, producing NT$6 billion (US$180 million) in losses for the new firm, and Mandarin's own 1999 merger with Formosa Airlines, resulting in NT$1 billion (US$30 million) in losses. ¶9. (C) FAT appears to be the most likely target of a merger. When asked what airlines were good candidates, CAA's Chen said it was not the authorities' job to make that decision, but added none too subtly that FAT's financial situation was public knowledge. TransAsia's Fan also pointed to FAT as a more likely target. He suggested that FAT's financial situation could make it bankrupt soon while TransAsia could continue to operate for several more years. In our meeting with FAT's Tsuei, he presented a positive picture of the airline's financial status, even highlighting plans to replace its aging fleet. However, he also mentioned that a recent stock rights issue had given the airline enough capital "to make it through the winter." Looking Elsewhere - Regional Routes... -------------- ¶10. (U) Taiwan's domestic airlines have aggressively sought to expand their regional international routes to make up for declining domestic demand. Only UNI Air has continued to focus exclusively on the domestic Taiwan market. Mandarin flies to seven foreign destinations including two in the Philippines, three in Japan, and one each in Seoul and Rangoon. FAT flies to several destinations popular with Taiwan tourists including Seoul, Cheju, Palau, Bali and Kota Kinabalu, Malaysia. Many of these flights are operated on a charter basis. ...And Promise of the Mainland Market -------------- ¶11. (U) However, Taiwan airlines see their best chance for future prosperity coming from increasing demand for cross-Strait air travel. Direct air links is their eventual goal, and it appears there may be progress toward more frequent cross-Strait charter flights this year (ref C). However, Taiwan's airlines are not waiting for Taiwan and PRC authorities to reach an agreement on flights. ¶12. (C) Taiwan's small airlines are expanding their flights that feed connections to the Mainland. According to Mandarin's Wang, his firm is depending on Taichung- Hong Kong charter flights as an essential element of its strategy to develop Taichung as a profitable base for regional flights. Mandarin also offers service from TAIPEI 00003446 003 OF 003 Kaohsiung to Hong Kong. TransAsia is heavily promoting its relatively inexpensive connections to the PRC via flights to Macau and Cheju, South Korea. ¶13. (U) CAL and EVA are increasingly focused on expanding their access to China's growing air cargo market. The U.S.-China Aviation Agreement and expanding cargo capacity among PRC carriers has challenged the two Taiwan carriers to find new ways to get the Mainland's outbound air cargo onto Taiwan planes. The two companies have taken similar approaches to increase their access to PRC cargo, each investing in Mainland cargo carriers (ref A and B). EVA and Shanghai Airlines have formed a joint- venture cargo carrier. EVA along with other Evergreen Group affiliates owns 45 percent of the new carrier. CAL has purchased a 25 percent stake in Yangtze River Express (YRE),an affiliate of Hainan Airlines, which provides air cargo, ground transport and logistics services. Two Taiwan shipping companies, Wan Hai and Yang Ming, each own an additional 6 percent stake in the YRE. Comment - Consolidation Ahead -------------- ¶14. (C) Taiwan's small airlines will aggressively pursue their various strategies for dealing with further dramatic declines in domestic air travel. However, it seems clear that there are too many players in the shrinking market, and consolidation appears inevitable. Taiwan will probably have five and possibly only four airlines two or three years from now. Meanwhile, they will continue to find creative ways to expand services to the Mainland as the best opportunity for future growth. As FAT's Tsuei suggested, eventual consolidation in the industry could involve Mainland partners. WANG