Has Air India hit a wall?

Today Urban Development Minister Kamal Nath called on all city dwellers to pay more for basic services as the government is pushing for massive privatisation in the infrastructure space. As private companies vie for a larger share of the country’s state-owned firms that are infamous for their poor services, the national carrier, mounted with debt worth Rs 20,000 crore, however, was left behind.

Competition on Air India’s bread-and-butter overseas routes is intensifying. This month, IndiGo said it will begin international flights, starting with Dubai, Bangkok and Singapore.

Is privatisation the key to win back lost market share? After all, a deficit-strapped government will have a hard time justifying throwing money at a continually loss-making firm. And even if the airline could attract investors, full privatisation is unlikely, given political constraints.

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On June 13, Giovanni Bisignani , the director general of International Air Transport Association, said the solution to the ailing airline lies in appointing an effective administrator with complete powers and political backing.

But for how long can Air India remain in a state of limbo?

“Increasing debts, mushrooming interest burden, and increasing fuel costs are financially crippling the company”, said company chairman and managing director Arvind Jadhav, in a letter to his employees last week.

[caption id=“attachment_28298” align=“alignleft” width=“380” caption=“Competition on Air India’s bread-and-butter overseas routes is intensifying. Photo by Brivvz/Flickr”]  [/caption]

Air India, a relic of state ownership threatened by losses, bloated costs and more nimble rivals, needs to secure a massive debt and operational overhaul if it is to survive in a market growing at 20 percent a year.

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The airline has not posted a profit since merging with former duopoly partner Indian Airlines in 2007 and relies on handouts from the government to survive. It is behind on its payroll obligations and was forced last month to cancel a handful of flights because it had not paid its fuel bills.

Adding to its woes, the national carrier has not paid its 33,000 employees their May salaries nor their productivity -linked incentives for April, which constitutes about 70 percent of their pay, reports Mint.

Air India and 26 banks are in talks to restructure $4 billion of working capital debt in a deal that would force lenders including State Bank of India to accept equity in the carrier and cut lending rates to about 8 percent from 11-13 percent, saving it $133 million in interest costs.

Banks are not happy about the plan but may have no choice.

“There is no other option for banks but to go for it. But what they are asking for is not reasonable,” said a banker involved in the ongoing negotiations. “If it is reasonable, we will approve it,” he said.

Even if it can persuade banks to revise a payment schedule for $3 billion in local currency debt due on June 30, Air India needs a drastic revamp or privatisation that may require more money and political will than the government can muster.

With New Delhi opposed to privatisation but unwilling to put it out of business and banks poised to agree to a restructuring for lack of a more attractive option, Air India may well limp along in its current zombie state.

“Fundamentally, Air India has reached a dead end,” said Kapil Kaul, chief executive for the Indian subcontinent and Middle East at the Centre for Asia Pacific Aviation (CAPA).

“From a business case standpoint it should have ceased to operate a few years back had it been a private company.”

Losing money, market share

Air India lost more than $1 billion in the year that ended in March 2010, the last year for which it posted figures. Its domestic market share has dropped to fourth from third, behind private sector rivals Jet Airways, Kingfisher Airlines and budget carrier IndiGo.

A recent 10-day pilot strike forced it to cancel 90 percent of domestic flights, costing it nearly $56 million , further denting an already battered image and prompting it to lure back customers with costly discounts.

Moreover private carriers, especially low-cost airlines like GoAir and Indigo have lined up major expansion plans. Last Thursday, budget carrier GoAir ordered 72 Airbus planes worth $7.2 billion. Earlier this year, IndiGo placed a $15.6 billion order with Airbus for 180 planes in what it called the biggest-ever commercial jet order.

But the competition doesn’t here. Telegraph reported today that private airlines like Indigo, SpiceJet and Emirates are competing with each other to recruit Air India pilots. More than 20 pilots have exited Air India in the past month for private airlines.

Officials from the Indian Commercial Pilots Association (ICPA), told Telegraph that five Air India pilots have resigned this month from Delhi and 17 more might follow suit.

Air India, which is desperate to hold on to its market share and is scheduled to take delivery of the first of its 27 Boeing Dreamliners by the end of the year, may defer some deliveries, said people familiar with the matter.

The government has been pushing for the airline to be restructured, but has otherwise been quiet on its future. An earlier turnaround plan by the airline was rejected by creditors and the government as unrealistic. Air India then hired consultants Deloitte Touche Tohmatsu to come up with another proposal.

The latest plan would focus on a hub-and-spoke route model, cut costs by redeploying staff and unload non-core real estate. It plans to lease some of the 14 vacant floors in its landmark building in south Mumbai to raise about $1 billion over five years, according to a banker.

“It’s a Catch-22 situation for them,” said one person familiar with the plan. “On the one hand you require more investments to regain market share, but your financial position does not allow you to invest.”

Managing mounting debt

Air India has more than $9 billion in debt as well as outstanding dues both to airport developers and state oil firms, which since December have forced it to pay for its fuel as it uses it, not on credit.

Lenders include ICICI Bank, a private sector player that in January won a mandate to refinance loans worth Rs 5,500 crore ($1.2 billion), and state-run Bank of Baroda, with exposure of 38 billion rupees, a banking source said.

State Bank of India, the country’s biggest lender, has a comparatively modest exposure of Rs 1,200 crore to Air India. SBI’s investment banking arm is managing the debt revamp.

[caption id=“attachment_28303” align=“alignleft” width=“380” caption=“Part of the airline’s debt would be converted to long-term loans at fixed rates of interest with the remainder converted into preference shares to be redeemed after 15 years. Image by jetalone/Flickr”]  [/caption]

According to the restructuring plan, part of the debt would be converted to long-term loans at fixed rates of interest with the remainder converted into preference shares to be redeemed after 15 years, giving the lenders equity in the airline.

Air India’s more-than $3 billion in overseas debt, held by lenders including Citibank, Standard Chartered and JP Morgan, is not part of the restructuring.

There is recent precedent for such a deal. Earlier this year, rival Kingfisher ceded a 5.68 percent stake to ICICI and a 23.4 percent stake to a group of 13 banks led by SBI as part of a debt restructuring.

Bankers say the Kingfisher deal was comparatively easy given what they believe are brighter prospects for the private sector carrier controlled by beer and liquor tycoon Vijay Mallya.

Indian banks rarely demand a major borrower’s assets and go to great lengths to avoid classifying a loan as non-performing.

Civil Aviation Minister Vayalar Ravi said last week that a restructuring plan had been approved by bankers and would head to the cabinet in coming weeks, although bankers said they have not yet signed off on it.

Political Headwind

Beyond buying breathing room from its bankers, Air India must tackle a bloated cost structure, a difficult task given a workforce that is heavily unionised.

Air India has 28,000 permanent staff, double Jet’s headcount. It operates 127 aircraft, compared with Jet’s 115.

Trimming unprofitable routes would be politically difficult because local officials would object to losing flights and such a move would go against the airline’s mandate as a public utility.

The airline’s former chief operating officer, Gustav Baldauf, an Austrian, quit his post in February less than a year into the job after he gave a newspaper interview in which he was quoted as speaking out against government interference in Air India’s day-to-day operations.

“Privatisation or denationalisation will not be politically acceptable. The politics of the day will not allow it,” said DH Pai Panandikar, president of the research group RPG Foundation. “They are overstaffed and it is very difficult to correct that situation unless they come out with bold policies, but that the government would not want to do,” he said.

(With inputs from Reuters)