Under Current Terms Only LIC is Likely to Buy Air India

LIC

India’s three main airlines, IndiGo, Jet Airways and SpiceJet, have made it clear that they are not interested in buying Air India, in the current form it is being offered in. (As I finished writing this column, a Reuters journalist tweeted to suggest that the Tatas are also unlikely to bid for Air India, as well. Guess, nostalgia, doesn’t always work). The government of India wants to:

A) Sell 76% of Air India.

B) 100% of Air India Express, the low-cost arm of Air India.

C) 50% of SATS, a gateway solution and food services provider. Against this sale, the government, wants the buyer:

a) To take on two-thirds of the debt of Air India. As on March 31, 2017, the total debt of the company was at Rs 48,447.37 crore. Two-thirds of this works out to Rs 32,298 crore.

b) The buyer also needs to give a guarantee that none of the permanent employees of the airline will be sacked for a year. After that the buyer can offer them a voluntary retirement scheme.

In return, the buyer, along with the aircrafts of Air India, will also get 2,543 international landing slots negotiated with many countries, over the years. The landing slots is for what any airline will want to buy Air India. The real estate of Air India, which includes the famous Air India building in Nariman Point, will continue to remain with the government.

What also works for the prospective buyer is that Air India has 12% market share in the domestic market in India. While, this has fallen from a 100% market share once upon a time, when private airlines were not allowed to operate in India, it needs to be taken into account that only 3% of Indians have travelled by air. Hence, the potential is immense. India is one of the last big airline markets that remains untapped.

Also, the airline has a 17% share in flights in and out of India.

All these factors work for the buyer. But there are other factors which don’t. As mentioned earlier, the airline had a debt of close to Rs 48,447 crore as on March 31, 2017. Two-thirds of this debt has to be picked up by the buyer.

The working capital loans constitute Rs 31,088 crore of this debt. This is a little lower than the amount of debt that the government wants the prospective buyer of Air India to pick up. It is worth asking how has this debt accumulated over the years? The airline loses money every year and in order to continue operating it needs to borrow.

The banks lend money to the airline because it is ultimately deemed to be lending to the government and a government doesn’t usually default. A private enterprise in the place of Air India, would have had to shut down by now.

The larger point is that by asking a prospective buyer to take on two-thirds of the debt, the government basically wants the buyer to take on the overall accumulated inefficiency of the airline.

Rs 33,298 crore is a lot of money and is basically a deal breaker as far as the sale of Air India is concerned. This kind of debt it could even bring down the airline that decides to buy Air India. (In fact, we had said the same thing in a column which appeared on January 15, earlier this year).

Other than the working capital loans of Rs 31,088 crore, the remaining Rs 17,360 crore is basically loans that have been taken for buying aircrafts. If this portion of the loan is passed on to the buyer, there is at least some justification given that there are airplanes that were bought using the loan.

Also, any prospective buyer will adjust for these loans before deciding on the price it wants to buy for Air India. But on the whole, the debt will drive away most prospective buyers.

Further, it is worth remembering that airline has lost a lot of money over the years and it continues to lose money. The airline lost Rs 41,657 crore between 2010-2011 and 2016-2017. These losses have continued in 2017-2018 (for the period between April to December 2017). Take a look at Table 1.

Table 1:

Domestic (Rs. in lakh)International (Rs. in lakh)
Traffic Revenue505,9641,044,676
Total Cost676,2311,334,296

Source: Loksabha Questions PDF 

Table 1 tells us that between April to December 2017, the airline lost a further Rs 4,599 crore. This basically means that the accumulated losses of the airline between April 2010 and December 2017, stand at Rs 46,256 crore.

Now that’s a lot of money. Other than the airline borrowing money to keep itself going, the government has also pumped in money into the airline over the years. Take a look at Table 2.

Table 2:

YearEquity Infused Rs. in (crore)
2011-121.200
2012-136,000
2013-146,000
2014-155,780
2015-162,500
2016-171,713
2017-18 (till date)1,800
Total Cost26,545.21

Source: Loksabha Questions PDF 

This infusion is a part of a restructuring plan which provides Rs 30,231 crore of equity infusion from the government into the airline, until 2021. It is clear that the restructuring plan is not working given that the airline continues to lose more than what the government has invested in it, over the last few years.

This isn’t surprising given that the cost of operation of the airline is very high. As a recent report by Kotak Institutional Equities points out, the operational costs of Air India are Rs 4.74 per available seat kilometre, in comparison to Rs 4.33 for Jet Airways, Rs 3.6 for SpiceJet and Rs 3.16 for IndiGo.

The airline also has a huge number of employees, backed by powerful trade unions which can be a huge nuisance. As on January 1, 2017, the airline had 18,049 employees. In comparison, IndiGo had 14,576 employees as on March 31,2017. IndiGo also employed 8,225 employees on a temporary/contractual/casual basis. Indigo has 40% share in India’s domestic airline business. Air India has 12%.

Also, 37.6% of Air India’s employees are retiring over the next five years. The trouble is that no prospective buyer will be willing to wait for five years, so that the airline can then have the right number of employees. Any quick turnaround will only happen if the buyer is allowed to fire employees.

The larger point here is that the airline is clearly not a family jewel that the government considers it to be (like all other public sector enterprises). It is basically a dangerous wound which has been bleeding the government and continues to bleed it. This bleeding needs to be stopped and it can only be stopped if the government decides to be a lot more flexible about the terms on which it is willing to sell the airline.

In fact, the government is more likely to attract bidders if it tries selling different parts of the airline, separately. For starters, the domestic business and the international business of Air India, need to be offered separately. In fact, even Air India Express, which primarily has flights to the middle east should also be offered separately. This might attract different buyers.

Further, the buyer should be allowed the flexibility of the doing what he deems fit to run the airline. The government cannot sell the airline and then want to continue running it through the backseat, by implementing terms and conditions.

Also, if this means that a few thousand Air India employees lose their jobs, then so be it. They have had a good time at the expense of the taxpayer, for many years now. This is as good a time, as any, to end it. If the government continues to run the airline, it will have to continue pumping money into it. This is money that is taken away from many other important areas like education, defence, health and agriculture. Further, the debt that the airline takes on will also eventually end up in the books of the government.

Under the current terms, the only institution that is likely to buy Air India, is the Life Insurance Corporation(LIC) of India. Given its past record under different governments in buying public sector enterprises, it won’t be surprising if the financial institution is forced to come to the rescue of the government and pick up a stake in the beleaguered airline. Funnier things have happened.

The column originally appeared on Equitymaster on April 11, 2018.

Lessons from the collapse of SpiceJet


SpiceJet_Boeing_737-900ER_Vyas-1
Vivek Kaul

In June 2010, Kalanithi Maran took over SpiceJet. I wrote an article around the takeover, in the newspaper I used to work for at that point of time, starting with the line “It takes a brave man to buy an airline.”
Towards the end of the article I quoted Warren Buffett. This was something the Oracle of Omaha had written in his annual letter to Berkshire Hathaway shareholders, in February 2008. As Buffett wrote:
Now let’s move to the gruesome. The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down.”
What made Buffett say this? “The airline industry’s demand for capital ever since that first flight has been insatiable. Investors have poured money into a bottomless pit, attracted by growth when they should have been repelled by it. And I, to my shame, participated in this foolishness when I had Berkshire buy U.S. Air preferred stock in 1989. As the ink was drying on our check, the company went into a tailspin, and before long our preferred dividend was no longer being paid. But we then got very lucky. In one of the recurrent, but always misguided, bursts of optimism for airlines, we were actually able to sell our shares in 1998 for a hefty gain. In the decade following our sale, the company went bankrupt, wrote Buffett.
After a shorter version of this piece of wisdom from Buffett, I closed the article on SpiceJet, with the line: “Surely, Maran knows what he is up against.” As it has turned out, I was hoping against hope. SpiceJet is now in major trouble and has had to scale back its operations.
Between October 2013 and September 2014, the company faced losses of Rs 928.9 crore. During the period July to September 2014, the company made losses of Rs 310 crore. This, despite the fact that global oil prices fell during the period.
In the last few months the airline has also used what aviation industry insiders term as the “Christmas tree” option. This essentially means that the airline is taking out spare parts from its aeroplanes and using them for other planes in its fleet. Long story short: it doesn’t even have the money to pay for spare parts.
The commercial aviation business is a huge cash guzzler and has led many a capitalist to his ruin—Vijay Mallya being the latest such example. And as things currently seem Maran’s SpiceJet seems headed that way.
This is not only an Indian phenomenon, it seems to be the case globally. Economist Severin Borenstein examined the scenario in the United States
in a 2011 research paper. He found that the airlines had lost around $60 billion (2009 dollars) between 1978 when the aviation sector in the United States was deregulated and 2009. High taxes were a reason for the losses and so was the fall in demand after 9/11.
A February 2014, article in
The Economist suggests that profits margins of airlines have been less than 1% on average over the last 60 years. This makes me wonder why do businessmen still want to enter this sector?
Interestingly, airlines made a profit of only $4 per passenger in 2012. Another interesting study
carried out by McKinsey points out that in 2010, around $500 billion of capital was invested in the airline industry. The overall cost of capital for this stood at around 7-8%, whereas the return on invested capital was at 2.8%. No wonder investors constantly lose money on airline stocks.
What this tells us is that commercial aviation is a tough business to be in. And why is that the case?There are several reasons for the same:
a) It is a highly capital intensive industry.
b) There is a lot of competition.
c) It gets impacted by a lot of things that are not under its control (the overall economic sentiment, taxes, outbreak of illnesses, price of oil and so on)
d) While the industry has to face a lot of competition, the industries that airlines have to deal with are highly monopolistic. As an article in
The Economist puts it “Two firms—Airbus and Boeing—provide the majority of the planes, and airports and air-traffic control are monopolies.” Given this, airlines are not always in the best position to control their costs.
e) For a very long period of time, airlines were run by governments, and hence, profit was not the only motive. Over the last few decades, the world has seen a spate of low cost carriers being launched. These airlines have given tough competition to full service carriers.
These are general reasons as to why airlines find it tough to make money. Some of these reasons apply to SpiceJet as well. But there are other major reasons as to why the airline is in trouble. Unlike Vijay Mallya’s Kingfisher which was confused about being a full service carrier or a low cost airline, SpiceJet was always a low cost airline. There was no confusion on that front.
But like Mallya, aviation is not Maran’s primary business. His primary business is spread across television channels, a cable TV distribution network and newspapers in the state of Tamil Nadu and the other Southern states. Further, these businesses have always had the political protection of the DMK party (Maran is the grand-nephew of DMK boss M Karunanidhi).
Maran’s lack of experience in the aviation sector started to come out as soon as he took over the airline. After taking over the airline he went around installing his own people to run the place.
As a report in the Business World points out “With the change in ownership, everyone at the airline knew that the chief executive officer and chief financial officer would change…The replacements on the board were largely Maran’s own family members and trusted aides but not necessarily people with experience of running a business — leave alone an airline.”
The airline also saw a steady exit of employees who knew how the aviation business operated. Another major blunder committed by the airline was allowing IndiGo to capture the slots in the Delhi-Mumbai route, left vacant by Kingfisher, after it stopped flying.
As the Business World report referred to earlier points out “SpiceJet had roughly six to seven flights a day between the two metros and IndiGo had around seven to eight. Today, IndiGo has close to 15 flights between the two metros. Delhi-Mumbai drives the aviation business in India and accounts for almost 60 per cent of traffic in the country.”
This was more because of the lack of experience of running an airline than anything else. Moral of the story: It is one thing running a business with the protection of a political party and it is another thing running a business which has some semblance of competition.
To conclude, what the failure of airlines like Kingfisher, Air India and now SpiceJet, clearly tells us is that you cannot “also” be in the commercial aviation business. Mallya found this out the hard way. He also ran an airlines business, along with his primary liquor business, real estate business and some sports business. Maran seems to be headed Mallya’s way with his huge losses. The government owned Air India continues to accumulate losses, in a country where Railway infrastructure remains very poor.
A report in the Mint newspaper points out that combined losses of airlines in India over a period of seven years ending March 2014, stood at close to $8.6 billion.
What a mess!

The article originally appeared on www.equitymaster.com as a part of The Daily Reckoning, on Dec 9, 2014