By Zheng Mingqiao & Sun Juncheng
On November 27, East Star Airlines, a non-state-owned company headquartered in Wuhan, signed a Letter of Intent with Airbus for the purchase of 10 A320s plus a firm lease deal with GE Commercial Aviation Service (GECAS) for another 10 A320s. The leased aircraft are scheduled for delivery in batches from the second quarter of 2006. Nevertheless, people show more concerns for how East Star Airlines, a corporation with its registered capital of only RMB80 million that was founded less than half a year ago, could manage to raise funds for these 20 aircrafts.
The aviation industry requires high investment and emphasizes economy of scale. According to the previous experiences in this industry, an airline company should possess at least 10 aircrafts to balance its revenues and expenditures, while to put 10 aircrafts into operation will cost about RMB300 million per year.
In June 2004, the foundation of Okay Airways, United Eagle Airlines and Spring Airlines, three non-government airline companies, were authorized by General Administration of Civil Aviation of China; and in March 2005, Okay Airways began its first flight. During this period of time, all non-government airline companies' introduction of aircrafts was carried out slowly. There is only one Boeing aircraft at service for Okay Airways and two Airbus aircrafts for Spring Airlines till now.
But East Star Airlines does not follow the persistent modus operandi of the other airline companies with its attempts barter its prospects in the market in future for a rapid expansion in terms of the scale of its fleet.
It is introduced that these 20 aircraft will be delivered in batches rather than all together. Therefore, East Star Airlines is not required to pay in one lump sum. And East Star Airlines intends to use financial lease and seller's credit to avoid huge financial risks.
The purchase and leasing of the 20 aircrafts would be implemented step by step and 3 of them would be delivered to East Star Airlines in March 2006, announced by Mr. Lan Shili, President of East Star Group. If the average price of each aircraft is RMB600 million (assumed that prices for leasing and a purchase are similar) and East Star Airlines is allowed to pay the installments in 10 years, the first year's payment will be RMB180 million and the yearly payment will increase gradually later until the yearly payment increase to RMB1.2 billion at most between the sixth year and the tenth; after that, the yearly payment will begin to decrease.
Mr. Lan, born in 1966, is a well-known young entrepreneur with a M.A. from Wuhan University. He repeatedly emphasized that both GECAS and Airbus thought highly of the "scale of investment, operation status and business schedule" of East Star Airlines. This year, GECAS cancelled the banker's guarantee. Heretofore, GECAS had already sent its risk evaluation organization in Asia to Wuhan to investigate about the strength of East Star Airlines for several times.
In the direct operating costs of domestic airlines, the maintenance costs for one aircraft include: 39 percent for aviation fuel, 15 percent for takeoff and landing costs collected by airports, 11% for Aero-Materials Consumption, plus depreciation of the engines and other parts, labor costs, meals aboard, and so on. It is calculated that the maintenance fees for the 3 Airbus A320s to be delivered to East Star Airlines next year will amount to about RMB30 million per month.
Mr. Lan admitted frankly that in a short time, the costs for supporting these aircraft to open to service will depend on the profits earned by other businesses of East Star Group, such as real estate, road construction and travel agency. He said that East Star Airlines would adopt a flexible pricing means, and seize market shares mainly by improving service levels while ensuring competitive price; the best prospects was to balance its revenues and expenditures in 3 years and begin to gain a little profits in 5 years. It is disclosed that East Star Airlines plan to make its first flight in next May with 3 aircrafts and 10 airlines. All the flights, which give priority to chartered flights for the purpose of sightseeing, will directly fly to Beijing, Shanghai and provincial capitals nearby Wuhan.
Nevertheless, some experts doubt how East Star Airlines can maintain its capacity of 20 Airbus aircrafts in Wuhan, where there is only a small aviation market. Furthermore, though East Star Airlines can solve the problem of aircrafts, the Wuhan Subsidiary of China Eastern Airlines and the Hubei Subsidiary of China Southern Airlines have already taken control of almost all the important domestic airlines departed from Wuhan. In the circumstances, how can East Star Airlines exploit its own new airlines?
An industrial insider holds that since non-governmental airline companies are "born", they have been trapped in a predicament of tight financial chain. We can wait and see whether East Star Airlines can sustain to the day of profit-making in face of fierce competitions in the market.