IndiGo punching above its weight in eyeing Air India? Analysts, investors seem unhappy with move

New Delhi: Within a span of less than 24 hours, domestic market leader IndiGo has emerged as a serious contender for Air India. Till the same time yesterday, the only tentative known buyer for the national carrier was the Tata Group. A source close to developments said “they are very serious about this” when asked about IndiGo’s unsolicited expression of interest in Air India. IndiGo President Aditya Ghosh wrote to Civil Aviation Minister A Gajapathi Raju yesterday, invoking nationalism by speaking of disproportionate Indian international traffic which the Gulf and South East Asian countries manage to attract. In the letter, Ghosh has also asserted his airline was best placed to buy Air India and that the target airline’s international operations are of prime interest.

Ghosh’s reasoning though, has failed to impress analysts, sector experts and investors. Will this be the right call for IndiGo, which has commanded respect for its integrated approach to domestic market leadership as a cost warrior? This Bloomberg report said the IndiGo shares continued to slide for a second day on the bourses. The scrip tumbled 5.2 percent to Rs 1,172.15 this morning, the biggest intra-day loss in five months. The two-day decline erased about $485 million or close to half a billion dollar in market value of IndiGo.

And analysts at brokerage IIFL equities said in a note to clients this morning that though Air India is the largest airline in the international segment and third largest in the domestic market, it has loss-making operations and debt of about Rs 50,000 crore despite many rounds of equity infusion by the government.  “Air India is not an ideal acquisition target. Even if the contours of the deal take care of balance-sheet stress, operational inefficiencies may be difficult to iron out. We continue to like IndiGo for its efficient cost structure and balance-sheet strength. However, potential acquisition of AI may create an overhang on the stock.”

 IndiGo punching above its weight in eyeing Air India? Analysts, investors seem unhappy with move


Remember, Air India derives two-thirds of its revenue from the international segment while its share of the domestic market is only 14 percent. It has made a net loss in each of the last 10 years and the debt on its books has steadily grown over the years. At Rs 50,000 crore, the debt pile is bigger than IndiGo’s market cap, the IIFL analysts noted. So in staking a claim for Air India, is IndiGo punching far above its weight?

The analysts also pointed out that in operating metrics in FY15 of the Indian airline industry, IndiGo was the most efficient while Air India was the least efficient (EBIDTAR 1.08 versus Air India’s 0.2). They also said Air India has been trailing on international load factors among competitors – IndiGo, Jet Airways, SpiceJet each carried more passengers per international flight than Air India in 2016-17. Ditto for domestic loads on Air India flights versus competitors.

Earlier this week, the Union Cabinet had given an in-principle approval to the disinvestment of government’s stake in Air India, and also formed a Group of Ministers headed by Finance Minister Arun Jaitley to oversee this process. IndiGo’s expression of interest arrived within hours of the Cabinet clearance.

In the carefully worded letter which Ghosh sent on the matter, he said “Over time, India has allowed disproportionate access to airlines of some of the city states in the middle east and south east Asia. The massive hubs that these airlines have built have significantly benefited at the expense of India. As a consequence of this, India’s air transportation hubs reside outside the geography of our country. It is time for India to take back its fair share of international traffic and bring back this economic wealth to where it rightfully belongs.”

The IIFL analysts have pointed out that purchasing Air India would work for IndiGo since this would mean scale of operations (mainly in the international segment), which would otherwise take years to build. IndiGo’s already strong domestic network would be able to feed into AI’s international network and vice versa. IndiGo would also benefit from access to international routes and slots at major international airports.

But the downside to the deal is significant.

1) The Indian domestic market is increasingly moving towards low-cost carriers. Full-service carriers such as AI are struggling due to its inability to command enough pricing premium to fully offset additional costs. AI’s international operations, although loss-making, would be relatively more attractive than the domestic business.

2) IndiGo has built a very efficient airline ground-up. However, as regards turning around AI, we believe the odds are stacked against it. Jet learned it the hard way after buying Air Sahara. Kingfisher bought Air Deccan, which turned out to be disastrous.

3) Integration issues range from multiple types of aircraft (which cannot be changed overnight), related high maintenance costs, and higher staff costs (not easy to retrench).

What Ghosh has invoked in his letter is the grant of Fifth Freedom rights (which allows an airline to carry revenue traffic between foreign countries as a part of services connecting the airline's own country) and Sixth Freedom rights (the right to carry passengers from a second country to a third country by stopping in one's own country) to carriers from the Gulf and from some Southeast Asian countries. This has allowed these airlines to develop hubs at Dubai, Abu Dhabi, Doha, Sharjah, Singapore, Kuala Lumpur etc. Perhaps largely due to flawed grant of bilateral flying rights to our worthy neighbours, Air India has been booking losses on its international operations. This situation has improved significantly in FY17 but the airline continues to book overall losses on international operations.

Ghosh has also aid in the letter that given IndiGo’s track record of having created a consistently profitable airline with a strong balance sheet, “kindly treat this letter as our expression of interest in acquiring the international airline operations of Air India and Air India Express. Alternatively, we are equally interested in all of the airline operations of Air India and and Air India Express. We would like to point out that our confidence and ability to build for our country one of the world’s largest international carriers is driven by the significant domestic network we have built over the years. In our view, no other carrier is better placed to realize this potential and we would not even dream of embarking on such a journey but for our domestic feed network”.

Not only will Ghosh likely have a tough time convincing his investors about the sagacity of wanting to bag Air India, there may be some deft political maneuvering also involved.

This Hindustan Times report shows how the Shiv Sena has already begun opposing Air India disinvestment.

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Updated Date: Jun 30, 2017 12:35:53 IST