a study of mergers in aviation industry

7/29/2019 A Study of Mergers in Aviation Industry

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A Study of Mergers & Acquisitions in Aviation Industry in India and

Their Impact on the Operating Performance and Shareholder Wealth

Nisarg A Joshi

Ahmedabad Institute of Technology

Jay M Desai

Ahmedabad Institute of Technology

ABSTRACT

The objective of this paper is to study, why organisations take the inorganic mode

of expansion. However, the main focus is on studying the operating performance

and shareholder value of acquiring companies and comparing their performance

before and after the merger. To conduct a uniform research and arrive at an

accurate conclusion, we restrict our research to only Indian companies. To get aperspective on India, we study aviation sector.

We will test feasibility that mergers improve operating performance of acquiring

companies. However on studying the cases, we conclude that as in previous

studies, mergers do not improve financial performance at least in the immediate

short term.


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INTRODUCTION

The air travel market grew up originally to meet the demand of business travelers

as companies became increasingly wide-spread in their operations. On the other

hand, rising income levels and extra leisure time led holidaymakers to travel to

faraway places for their vacation. A further stimulus to the air travel market was

provided by the deregulation and the privatization of the aviation industry. State-

owned carriers that hitherto enjoyed monopoly status were now exposed to

competition from private players. However, one development that changed the

entire landscape of the industry was the emergence of low cost carriers (LCCs).

These carriers were able to offer significantly cheaper fares on account of their

low-cost business models and thereby attract passengers who might not otherwise

be willing to fly. LCCs have achieved rapid growth in market share in the U.S.

domestic market, short-haul market in Europe and recently in Asia. Since 1970, the

international passenger traffic has grown by an average rate of more than 6%,compared to a 7% increase in the domestic passenger traffic.

The aviation industry is highly cyclical. However, in times of recession, the decline

in the industry growth rate is much sharper when compared to the world economy.

After witnessing a strong growth during the late 1990s, the industry saw a sharp

reversal in fortune as a result of a global economic downturn in 2001. The situation

was further aggravated by 9/11 attack, the Iraq war and the SARS epidemic. The

mammoth financial losses incurred by the scheduled carriers during this period led

to a long-overdue restructuring among the full service carriers (FSCs). Many

airlines embarked upon severe cost-cutting and fleet-rationalisation programmes as

they struggled to remain afloat. The conditions for FSCs were further worsened

with the advent of budget carriers in the U.S. and Europe.


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There was however a strong rebound in traffic in 2004, led by a strong recovery in

the world economic growth and which continued for the next two years (2005 and

2006). According to ICAO (International Civil Aviation Organisation), the revenue

per passenger kilometers (calculated as the number of seats multiplied by the

kilometers flown) for international services has grown by 8.5% in 2005 and is

estimated to have grown by 6% in 2006. The strong growth in the traffic and

recovery of higher fuel cost through surcharges resulted in strong revenue growth

for airline companies. However, this did not translate into a recovery in

profitability, primarily on account of a significant increase in fuel costs. According

to IATA, the combined losses posted by the world's scheduled carriers amounted to

US$ 6 bn in 2005, following a cumulative loss of US$ 36 bn in the previous four

years.

Future Outlook: As per the estimates of aircraft manufacturers and other industry

bodies, the world passenger traffic is expected to grow at 5% p.a. in the medium to

long-term. The growth will however be slower in matured economies, but faster in

under-penetrated and growing economies like India and China. The primary reason

for the increase in passenger traffic over the years has been decline in airline

passenger yields. As per an estimate, after adjusting for the general inflation, the

average airline yields (revenue per passenger kilometers) have almost halved since

1970. During the same period, the real revenue growth (by combining growth in

traffic and decline in yields) has averaged only 2% to 3%. Since aviation industry

is a high fixed cost industry, a small increase in operating cost can have a sharp

impact on the profitability of the companies. High fuel prices, congestion cost,

higher security and insurance cost can increase the overall cost of operations and

thereby impact the demand for air travel services. However, there is room for cost

reduction in the form of distribution cost and cost synergies from industry


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consolidation. Overall, we believe that consolidation is the only solution for

addressing the problem of excess capacity and poor financial ratios of the

company.

OVERVIEW OF WORLD MARKET

Air travel remains a large and growing industry. It facilitates economic growth,

world trade, international investment and tourism and is therefore central to the

globalization taking place in many other industries.

In the past decade, air travel has grown by 7% per year. Travel for both business

and leisure purposes grew strongly worldwide. Scheduled airlines carried 1.5

billion passengers last year. In the leisure market, the availability of large aircraft

such as the Boeing 747 made it convenient and affordable for people to travel

further to new and exotic destinations. Governments in developing countries

realized the benefits of tourism to their national economies and spurred the

development of resorts and infrastructure to lure tourists from the prosperous

countries in Western Europe and North America. As the economies of developing

countries grow, their own citizens are already becoming the new international

tourists of the future.

Business travel has also grown as companies become increasingly international in

terms of their investments, their supply and production chains and their customers.

The rapid growth of world trade in goods and services and international direct

investment has also contributed to growth in business travel.


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Worldwide, IATA, International Air Transport Association, forecasts international

air travel to grow by an average 6.6% a year to the end of the decade and over 5%

a year from 2000 to 2010. These rates are similar to those of the past ten years. In

Europe and North America, where the air travel market is already highly

developed, slower growth of 4%-6% is expected. The most dynamic growth is

centered on the Asia/Pacific region, where fast-growing trade and investment are

coupled with rising domestic prosperity. Air travel for the region has been rising

by up to 9% a year and is forecast to continue to grow rapidly, although the Asian

financial crisis in 1997 and 1998 will put the brakes on growth for a year or two. In

terms of total passenger trips, however, the main air travel markets of the future

will continue to be in and between Europe, North America and Asia.

Airlines' profitability is closely tied to economic growth and trade. During the first

half of the 1990s, the industry suffered not only from world recession but travel

was further depressed by the Gulf War. In 1991 the number of international

passengers dropped for the first time. The financial difficulties were exacerbated

by airlines over-ordering aircraft in the boom years of the late 1980s, leading to

significant excess capacity in the market. IATA's member airlines suffered

cumulative net losses of $20.4bn in the years from 1990 to 1994.

OVERVIEW OF AVIATION INDUSTRY IN INDIA

Air Traffic: The Airport Authority of India (AAI) manages total 122 Airports in

the country, which include 11 International Airports, 94 domestic airports and 28

civil enclaves. Top 5 airports in the country handle 70% of the passenger traffic of

which Delhi and Mumbai together alone account for 50%. Passenger and cargo

traffic has growth at an average of about 9% over the last 10 years.


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Growth: Estimated domestic passenger segment growth is at 12% per annum.

Anticipated growth for International passenger segment is 7% while the growth for

International Cargo is likely to grow at a healthy rate of 12%.

Privatization: Privatization of International Airports is in offing through Joint

Venture route. Three Greenfield airports are getting developed at Kochi,

Hyderabad and Bangalore with major shareholding of private sector. The work on

Bangalore airport is likely to commence shortly. Few selected non-metro airports

are likely to be privatized.100% foreign equity has also been allowed in

construction and maintenance of airports with selective approval from Foreign

Investment Promotion Board.

Air movements: The total aircraft movements handled in October 2003 has shown

an increase of 15.4 percent as compared to the aircraft movement handled inOctober 2002. The international and domestic aircraft movements increased by

15.4 percent each during the period under review. The reason for increase in

aircraft movements is due to increase of operation of smaller aircraft by airlines

and the introduction of new airlines viz., Air Deccan in southern region and

international airlines (Air Canada, Polar Air Cargo, Qatar Airways (Freighter),

Turkish Airways, Air Slovakia at IGI Airport with effect from October 2003.

Passenger Traffic: International and Domestic passenger traffic handled in

October 2003 has increased by 15.4 percent and 6.7 percent over the period of

October 2002 leading to an overall increase of 9.4 percent. The total passenger

increased by 9.2 percent, 7.6 percent, 8.9 percent and 17.0 percent respectively at


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five international airports six developing international airports, eight custom

airports and 26 Domestic airports.

Cargo Traffic: The total cargo traffic handled in October 2003 has shown an

increase of 3.5 percent as compared to the cargo handled in October 202. The

international and domestic cargo traffic increased by 4.3 percent and 2.1 percent

respectively during the period.

India's domestic aviation market expansion has been the strongest in the world -

tripling in the past five years, according to the International Air Transport

Associations (IATA) report. India has also signed the bilateral Aviation Safety

Agreement (BASA) with the USA.

India is currently the ninth largest aviation market in the world, according to a

RNCOS report Indian Aerospace Industry Analysis. The Government's open skypolicy has attracted many foreign players to enter the market and the industry is

growing in terms of both players and the number of aircrafts. Given the strong

market fundamentals, it is expected that the civil aviation market will register a

compound annual growth rate (CAGR) of more than 16 per cent during 2010-2013.

India's domestic air traffic grew at a rate, which is the second highest after Brazil,

according to global figures for June 2011, compiled by IATA. The country's

domestic traffic grew by 14 per cent in the same period as against Brazil's 15.1 per

cent.

Indian airlines reported a continuous growth trend and a strong domestic passenger

growth rate of 22.3 per cent in July 2011. Passenger traffic has grown at 18 per

cent year on year (y-o-y) basis and the year 2010 closed at 90 million passengers


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both domestic and international. India is the fastest growing aviation market and

expected to be within 4-5 big aviation markets by 2020 and 3rd in terms of

domestic market after US and China.

In July 2011, airlines in India handled 5 million domestic passengers, according to

data released by the Directorate General Civil Aviation (DGCA) on September 12,

2011, marking the 11th consecutive month of double-digit growth. Indias

domestic market has witnessed passenger growth for 26 consecutive months now.

In July 2011, Indias airlines handled 1.3 million international passengers, an

increase of 8.5 per cent y-o-y, according to DGCA.

Passengers carried by domestic airlines during Jan-Aug 2011 were 39.63 million as

against 33.41 million during the corresponding period of previous year thereby

registering a growth of 18.6 per cent, according to data released by DGCA.

India is expected to cross the 450 million mark of domestic passengers by 2020.

During the last two decades from a fleet of only about 100, the scheduled operators

now have reached 435 aircrafts connecting the nation and the world.

Private carriers are anticipated to post a combined profit of US$ 350US$ 400

million for the fiscal years 2011-12, as reported by Centre for Asia Pacific

Aviation (CAPA) India, in its 2011-12 - Aviation Industry outlook. Domestic

capacity is also projected to grow by 12-14 per cent for the assessment period.

The Role of Aviation Industry in India GDP in the past few years has been

phenomenal in all respects. The Aviation Industry in India is the most rapidly

growing aviation sector of the world. With the rise in the economy of the country


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and followed by the liberalization in the aviation sector, the Aviation Industry in

India went through a complete transformation in the recent period.

Role of Aviation Industry in India GDP-Facts

With the entry of the private operators in this sector and the huge cut in airprices, air travel in India were popularized

On February 18, 1911, the first commercial flight was made from Allahabadto Naini by a French pilot named Monseigneur Piguet

Role of Aviation Industry in India GDP-Growth Factors

The growth in the Indian economy has increased the Gross DomesticProduct above 8% and this high growth rate will be sustained for a good

number of years

Air traffic has grown enormously and expected to have a growth whichwould be above 25% in the travel segment

In the present scenario around 12 domestic airlines and above 60international airlines are operating in India

With the growth in the economy and stability of the country India hasbecome one of the preferred locations for the trade and commerce activities

The growth of airlines traffic in Aviation Industry in India is almost fourtimes above international average

Aviation Industry in India have placed the biggest order for aircrafts globally Aviation Industry in India holds around 69% of the total share of the airlines

traffic in the region of South Asia

Role of Aviation Industry in India GDP-Future Challenges

Initializing privatization in the airport activities


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Modernization of the airlines fleet to handle the pressure of competition inthe aviation industry

Rapid expansion plans for the major airports for the increased flow of airtraffic

Immense development for the growing Regional AirportsRole of Aviation Industry in India GDP-FDI Policy

The Reserve Bank of India (RBI) announced that foreign institutional investors

might have shareholdings more than the limited 49% in the domestic sector.

Airports

Foreign equity up to 100% is allowed by the means of automatic approvalspertaining to establishment of Greenfield airports

Foreign equity up to 74% is allowed by the means of automatic approvalspertaining to the existing airports

Foreign equity up to 100% is allowed by the means of special permissionfrom Foreign Investment Promotion Board, Ministry of Finance, pertaining

to the existing airports

Air Transport Services

Up to 49% of foreign equity is allowed by the means of automatic approvalspertaining to the domestic air transport services

Up to 100% of NRI investment is allowed by the means of automaticapprovals pertaining to the domestic air transport services


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OVERVIEW OF GROWTH OF AVIATION INDUSTRY

Growth Potential

In India, the industry sector continues to look promising. The liberalization of the

Indian aviation sector in the mid nineties resulted in significant growth due to the

entry of private service airlines. There was, and continues to be a strong surge in

demand by domestic passengers, due primarily to the burgeoning middle class with

its massive purchasing power, attractive low fares offered by the low cost carriers,

the growth of domestic tourism in India and increasing outbound travel from India.

In addition, the Government has also focused on modernizing non-metro airports,

opening up new international routes, establishing new airports and renovating

existing ones. Some estimate industry growth at 25% YoY.

Unfortunately, most major airline operators in India such as Air India, Indian

Airlines, Jet Airways and Kingfisher Airlines have reported large losses since2006, due to high aviation turbine fuel (ATF) prices, rising labor costs and

shortage of skilled labor, rapid fleet expansion, and intense price competition. The

problem was also compounded by new players entering the industry even before

the existing players could stabilize their operations. As a result of the already weak

domestic scenario, the airlines suffered even further when the recession, which

exacerbated all these factors, hit. Suffice to say, though that the Indian aviation

industry has been more resilient than its global counterparts.

Despite many private airlines being in the red, the industry itself remains robust.

According to Kapil Kaul, CEO India & Middle East, Centre for Asia Pacific

Aviation (CAPA), India's civil aviation passenger growth is among the highest in

the world. The sector is slated to cruise far ahead of other Asian giants like China


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or even strong economies like France and Australia. The number of passengers

who will be airborne by 2020 is a whopping 400 million. To keep pace with this

accelerated demand, existing players have been trying to increase fleets and widen

their footprint to regional destinations as well.

MAJOR COMPANIES IN THE INDUSTRY

An aircraft maintenance engineer (AME) is a licensed professional whose duties

include daily inspection and routine servicing of aircrafts to ensure that they fulfill

national and international aviation standard

Aviation - Market Players

During July 2011, Vijay Mallya-promoted Kingfisher was the largestdomestic standalone carrier with around 1.1 million passengers, based onCAPA calculations. Jet Airways/JetLite had a combined passenger level of

1.2 million passengers, or around 26 per cent of the market

IndiGo started its international air services from September 1, 2011 aftercompleting the mandatory five years of wholly domestic operations. The low

cost carrier (LCC), the largest in the domestic Indian market, marks the start

of its foray into international markets with direct services to Dubai, followed

by Singapore and Bangkok in the first phase connecting all key global

business hubs

Dubai's first low cost airline, flydubai, will start flights to the city ofAhmedabad in Gujarat from August 27, 2011. Ahmedabad is the world's


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third fastest growing city in the world and it will become the third Indian

city on flydubai's rapidly expanding network. The airline will offer seats

from Ahmedabad to Dubai beginning at Rs 7,500 (US$ 156.25) inclusive of

taxes and seven kilograms of hand baggage. The flights will operate once in

a week on Saturdays only.

Hyderabad-based GVK Power & Infrastructure would be paying Rs 114(US$ 2.37) for each equity share to Siemens Project Ventures to buy the

latter's 14 per cent stake in Bengaluru International Airport Ltd (BIAL)

Name of the players Market

Share

Kingfisher Airlines and Kingfisher Red (previously

Air Deccan)

28%

Jet Airways and Jet Lite (previously Air Sahara) 25%

Air India and Indian (previously Indian Airlines) 16%

IndiGo 14%

SpiceJet 12%

GoAir 3%

Paramount Airways 2%

MDLR Airlines 0.004%


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AirlineCommenced

Operations

Ceased

Operations

Headquarters

Air Services of India 1936 1953 Kolkata

Airways (India) Limited 1945 1955 Kolkata

Archana Airways 1991 1999 New Delhi

Bhaarat Airways 1995 1999 Mumbai

Crescent Air Cargo 2000 2006 Chennai

Damania Airways 1993 1996 Kolkata

Deccan Airways 1992 2004 Mumbai

Darbhanga Aviations 1950 1962 Kolkata

East-West Airlines 1992 1995 Mumbai

Elbee Airlines 1995 2001 Mumbai

Gujarat Airways 1995 2001 Ahmedabad

Himalayans Air Transport &

Survey Limited1934 1935 Kolkata

Himalayan Aviation 1948 1953 Kolkata

Indian 1953 2011 New Delhi

Indian National Airways 1933 1945 Kolkata

Indian Overseas Airlines 1947 1950 Mumbai

Indian State Air Service

(ISAS)1929 1931 Kolkata


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Indian Transcontinental

Airlines1933 1948 Kolkata

Indus Airways 2006 2007 New Delhi

Irwaddy Flotilla & Airways 1934 1939 Chennai

Jupiter Airways 1948 1949 Mumbai

MDLR Airlines 2007 2009 New Delhi

ModiLuft 1994 1996 Mumbai

Sahara Airlines 1991 2006 Mumbai

Skyline NEPC 1947 1960 Chennai

Orient Airways 1946 1953 Kolkata

Tata Airlines 1932 1946 Mumbai

Vayudoot 1981 1997 New Delhi

VIF Airways 1993 1996 Mumbai

Vijay Airlines 1981 1997 Chennai

Paramount Airways 2005 2010 Chennai

Jet Airways:

This airline offers services to different countries like India,Hong Kong ,Italy ,

Japan ,Kenya, Kuwait,Malaysia, Mauritius, Nepal,New Zealand ,Oman,

Philippines ,Qatar ,Singapore and many more places.It also provides domestic as

well as international services.


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Flykingfisher.com:

With them flying is an experience beyond just getting from one place to another.

When you want to fly in style, you fly Kingfisher. They put a lot of stress on flyer

safety and in gaining their trust. See the flight schedules online. If you are a travel

agent you can become a member. There are a horde of services that this domestic

airline offers. Take a look to find out about all of them.

Paramountairways.com:

This domestic airline plies all over south India. So if you are traveling anywhere

between Bangalore and Vishakapattanam dont forget to check out their flight

details. You may retrieve your booking at any point of time. Find a flight, create a

profile, track a flight or check in with the internet, you can do all of this in this site.

Hurry up and take a look now.

Go air. in:

Still in its nascent stage, Go Air is quietly making a place for itself. It does not

however cover all the sectors like all the other big airlines. But for a start they have

covered quite a big sector. Take a look at their site and find out. Locate Go outlets

in your city and find out fares with this airline. Take a look now.


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LITERATURE REVIEW

There are various strategic and financial objectives that influence mergers and

acquisitions. Two organizations with often different corporate personalities,

cultures and value systems are bought together. The terms mergers and

acquisitions are often used interchangeably. In lay parlance, both are viewed as

the same. However, academics have pointed out a few differences that help

determine whether a particular activity is a merger or an acquisition.

A particular activity is called a merger when corporations come together to

combine and share their resources to achieve common objectives. In a merger, both

firms combine to form a third entity and the owners of both the combining firms

remain as joint owners of the new entity (Sudarsanam, 1995)[1]

.

An acquisition could be explained as event where a company takes a controllingownership interest in another firm, a legal subsidiary of another firm, or selected

assets of another firm. This may involve the purchase of another firms assets or

stock(Donald M. DePamphilis, 2008)[2]. Acquiring all the assets of the selling firm

will avoid the potential problem of having minority shareholders as opposed to

acquisition of stock. However the costs involved in transferring the assets are

generally very high. There is another term, takeover which is often used to

describe different activities.

Takeover is slightly different than acquisition however the meaning of the later

remaining the same. When the acquisition is forced in nature and without the will

of the target companys management it is known as a takeover. Takeover normally

undergoes the process whereby the acquiring company directly approaches the


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minority shareholders through an open tender offer to purchase their shares without

the consent of the target companys management. In mergers and acquisitions

scenario the terms mergers, acquisitions, takeover, consolidation and

amalgamation are used interchangeably (Source: Chandra, 2001)[3].

Mergers of corporations in similar or related product lines are termed as horizontal

mergers. These mergers lead to elimination of a competitor, leading to an increase

in the market share of the acquirer and degree of concentration of the industry

(M&A, Milford Green, 1990)[51]. However there are strict laws and rules being

enforced to ensure that there is fair competition in the market and to limit

concentration and misuse of power by monopolies and oligopolies.

In addition to increasing the market power, horizontal mergers often tend to be

used to protect the dominance of an existing firm. Horizontal mergers also improve

the efficiency and economies of scale of the acquiring firm (Lipczynski, Wilson,2004)

[4].Recent examples of horizontal mergers in the international market are

those of the European airlines. The Lufthansa-Swiss International link up and the

Air France- KLM merger are cases of horizontal mergers (Lucey, Smart and

Megginson, 2008)[5].Horizontal mergers have been the most important and

prevalent form of merger in India. Various studies like those of Beena, 1998[6] has

revealed that post 1991 or post liberalisation more than 60% of mergers have been

of the horizontal type as cited in Mehta, 2006[7]. Recently there have been many

big mergers of this type in India like Birla L&T merger in the cement sector.

The aviation sector has also witnessed quite a few such mergers like the

Kingfisher airline Air Deccan merger and the Jet Airways Air Sahara

merger.


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A vertical merger is the coming together of companies at different stages or levels

of the same product or service. Generally the main objective of such mergers is to

ensure the sources of supply (Babu, 2005)[8].In vertical mergers, the manufacturer

and distributor form a partnership. This makes it difficult for competing companies

to survive due to the advantages of the merger. The distributor need not pay

additional costs to the supplier as they both are now part of the same entity

(learnmergers.com). Such increased synergies make the business extremely

profitable and drive out competition. Purchase of automobile dealers by

manufacturers like Ford and Vauxhall are examples of vertical mergers. Fords

acquisition of Hertz is an example of a vertical merger (Geddes, 2006)[9]. The

acquisition of Flag Telecom by Indian telecom company Reliance

Communications Ltd was a very significant vertical merger.

Conglomerate mergers occur between firms that are unrelated by value chain orpeer competition. Conglomerates are formed with the belief that one central office

would have the know-how or knowledge and expertise to allocate capital and run

the businesses better than how they would be run independently (Robert Bruner,

2004)[10]. The main motive behind the formation of a conglomerate is risk

diversification as the successful performers balance the badly performing

subsidiaries of the group (Brian Coyle, 2000)[11]. Conglomerate mergers can also

be explained as a merger between companies which are not competitors and also

do not have a buyer seller relationship. The general observation has been that such

conglomerate mergers are not very successful. Where only a few conglomerates

like General Electronics (GE) have been successful, most others have failed

(Patrick Gaughan, 2007)[12].


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Such acquisitions are not very commonly discussed while classifying mergers and

acquisitions. Such acquisitions are driven by the financial logic of transactions.

They generally fall under either Management Buyouts (MBOs) or Leveraged

Buyouts (LBOs) (H. Ross Geddes, 2006)[9].

Factor affecting mergers change with the changing legal, political, economic and

social environments (Kaushal, 1995)[13]. Business Organization literature has

identified two common reasons which are derived out of mergers and acquisitions

i.e. efficiency gain and strategic rationale (Neary, 2004)[14]. Efficiency gain means

the merger would result into benefits in the form of economies of scale and

economies of scope. Economies of scale and scope are achieved because of the

integration of the volumes and efficiencies of both the companies put together.

Secondly the strategic rationale is derived from the point that mergers and

acquisition activity would lead to change in the structure of the combined entity

which would have a positive impact on the profits of the firm. However, we shalldiscuss these and various other factors that lead to mergers and acquisitions.

Synergy has been described as 2+2=5 (Pearson, 1999)[15]. In other words, the

whole would be greater than the sum of its parts (Sherman, 1998)[16]. It implies that

the combined handling of different activities in a single combined organisation is

better, larger or greater than what it would be in two distinct entities (Bakker,

Helmink, 2004)[17].The word synergy comes from a Greek word that means to co-

operate or work together (Bruner, 2004)[10]. Mergers theoretically revolve around

the same concept where two corporations with come together and pool in their

expertise and resources to perform better. Estimating synergies and its effect is an

important decision in the merger process, primarily for four reasons. Firstly,

mergers are meant for value creation and hence assessing the value that would be


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created by the synergies is important. Secondly, assessing how investors would

react to the merger deal is another important consideration. Thirdly, managers need

to disclose these strategies and benefits of such deals to investors and hence their

perfect estimation and knowledge is important. Lastly, valuing synergies is

important for developing post merger integration strategies (Bruner, 2004)[10].

However important valuing synergies may be, practically very few companies

actually develop a transactional team, draw up a joint statement regarding the

objectives of the deal or solve the post closing operating and financial problems

timely. Synergies can be further discussed as being financial, operating or

managerial synergies.

Operational synergies refer to those classes of resources that lead to production

and/or administrative efficiencies (Peck, Temple, 2002)[18]

. Product related

diversification mergers are often carried out keeping operational synergies in mind.

These synergies help firms bring down unit costs due to product relatedness.Common technology, marketing techniques like common brand and manufacturing

facilities like common logistics are essentially the components of operational

synergy (Peng, 2009)[19].Operational synergy can be explained as a combination of

economies of scale, which would reduce average costs as a result of more efficient

use of resources and economies of scope, which would help a company deliver

more from the same amount of inputs (Bakker, Helmink, 2004)[17].

Financial synergy refers to the impact of mergers and acquisitions on lowering the

cost of capital of the merged or newly formed entity (DePamphilis, 2005) [20].

Financial synergies lead to reduced cost of capital and / or increased borrowing

power (Hankin, Seidner and Zietlow, 1998)[21]. Conglomerate mergers generally

focus on financial synergies that increase the competitiveness for each individual


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unit controlled by one centralized parent company beyond what could have been

achieved by each unit competing individually (Peng, 2009[19]). Along with a lower

cost of capital, financial synergies also bring about a larger capital base which

helps funding of larger investments. In case of conglomerate mergers, financial

diversification can bring about various other advantages like more stable cash

flows, lower performance variations, insurance gains and other tax advantages

(Bakker, Helmink, 2004)[17]. Financial synergies are possible between related and

unrelated firms unlike operational synergies that take place only between related

firms. (Source: Peck, Temple, 2002).

Managerial synergy refers to the increased efficiency as a result of management

teams of two firms coming together. Often management teams have different

strengths and their coming together could result in improved managerial expertise

(Ross,Westerfield, Jaffe, 2004)[22].These synergies occur when competitively

relevant skills possessed by managers of previously independent companies can besuccessfully transferred to the merged entity (Hitt, Harrison, Ireland, 2001)

[23].

Growth is imperative for any firm to succeed. This growth can be achieved either

through organic or inorganic means. However, mergers (inorganic) are considered

a quicker and a better means of achieving growth as compared to internal

expansions (organic). Along with additional capacity, mergers bring with them

additional consumer demand as well (Sloman, 2006)[24].

One argument often presented in favour of mergers is that they help in diversifying

the groups lines of businesses and hence helps reduce risk. Risk could be

interpreted as risk from the point of view of shareholders, lenders i.e. insolvency

risk, business risk, etc.


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Mergers can benefit the corporations and individuals in their own way by helping

them reduce the tax bill. However, with stricter laws, undue advantage taken by

corporations of tax reduction can be managed. Often large profitable corporations

merge with certain loss making ones to help them take advantage of reduced

expenditure on taxation. However, small shareholders of acquired companies tend

to receive substantial tax benefits on merger with large corporations.

There is a tendency among managers, especially those of corporations where

ownership and control are distinct, to enter into mergers for the lure of a higher pay

packet and more rewards.

Mergers are often carried out to achieve a better standing in the market by means

of an increased market share and by becoming a leading player in the concerned

sector. Reducing competition is another key concern when contemplating mergers.Often it is necessary to protect a key source of supply from a competitor which can

be done through mergers.

Empirical Studies Regarding Post Merger Performances

Several researchers have tried to study the performances of acquiring firms post

the merger. However, there has been no concrete conclusion or consensus

regarding the same. The most popular forms of empirical studies are event studies,

accounting studies, clinical studies and executive surveys.

From most of the studies conducted till date, it only appears that mergers do not

improve the financial performance of the acquirers.


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Event studies and accounting studies as such point to the fact that these gains are

either small or nonexistent. However, it must also be noted that there have been

studies conducted that show that post merger performance also largely depends on

the industry or sector and cannot be generalized.

Accounting Studies

This method involves the study of financial statements and ratios to compare the

pre merger and post merger financial performance of the acquiring company. It is

also used to study whether the acquirers outperformed the non acquirers .Various

ratios like return on equity or assets; EPS, liquidity, etc are studied. Whether a

merger actually improves the operating performance of the acquiring company is

uncertain, but mostly leads to a conclusion that mergers do not really benefit in

improving operating performances. A research conducted on Indian companies

also showed no real signs of better post merger operating performance of the

acquiring company.

Causes of Failures

There could be many causes of failed mergers and acquisitions. It is most likely

that a failed merger would be a result of poor management decisions and

overconfidence. There could be personal reasons considering which managers tend

to enter into such activities and hence tend to ignore the primary motive of

mergers, creating shareholder value. Sometimes however, good decisions may also

backfire due to pure business reasons. These factors can be summarized by the

following points.


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Overpayment

A very common cause of failed mergers is overpayment. This situation arises

essentially due to overconfidence or the urge for expansion. Overpayment often

has disastrous consequences. Overpayment leads to expectations of higher

profitability which is often not possible. Excessive goodwill as a result of

overpaying needs to be written off which reduces the profitability of the firm.

Integration issues

It is rightly said that Few business marriages are made in heaven (Sadler,

2003)[25].Both merging companies need to be compatible with each other. Business

cultures, traditions, work ethics, etc. need to be flexible and adaptable.

Inefficiencies or administrative problems are a very common occurrence in a

merger which often nullifies the advantages of the merger (Straub, 2007)[26]

. Often

it is necessary to identify the people needed in the future to see the merger through.

There must be some urgency between the parties and good communicationbetween them. Due to lack of these qualities, mergers often do not produce the

desired results (Sadler, 2003)[25].

Personal Motives of Executives

Managers often enter into mergers to satisfy their own personal motives like

empire building, fame, higher managerial compensation, etc. As a result, they often

lose focus on the fact that they need to look at the strategic benefits of the merger.

As a result, mergers that do not necessarily benefit the organisation are entered

into. These executives enter into these mergers for the purpose of seeking glory

and satisfying their executive ego, leading to failure of mergers.


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Selecting the target

Selecting the appropriate target firm is an extremely important stage in the merger

process. Executives must be able to select the target that suits the organizations

strategic and financial motives and needs. Often the incapability or lack of

motivation and interest on the part of executives leads to incorrect target selection.

Lubatkin (1983)[50] very appropriately said that selecting a merger candidate may

be more of an art than a science (Straub, 2007)[26].

Strategic Issues

Strategic benefits should ideally be the primary motive of any merger activity.

However, managers sometimes tend to overlook this aspect. Faulty strategic

planning and unskilled execution often leads to problems. Over expectation of

strategic benefits is another area of concern surrounding mergers. (Schuler,

Jackson, Luo, 2004)[27]. These issues which form the core of all merger activities

are not addressed adequately leading to failures of mergers.


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PROBLEM STATEMENT

It is said that a problem which is well defined is half solved. The main problem

area which the research is testing related to the subject of mergers and acquisitions.

In this, we want to investigate whether mergers and acquisitions have an impact on

the operating performance of the acquiring firm and does it create wealth for the

shareholders.

This problem stems from the fact that there have been mergers and acquisitions

which have created wealth only for the acquiring firms and few have created

wealth for only the target firms.

Likewise mergers and acquisitions have sometimes benefitted the shareholders of

only the target company and vice versa. We are trying to find out whether mergersand acquisitions impact the operating performance of the acquiring firm and

enhance shareholder wealth.

Aim of the Research

The main aim of the research is to analyze the feasibility and the impact of

mergers and acquisitions on the operating performance of the firm.


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DATA & ANALYSIS

The Indian airline industry underwent liberalization in the year 1990 when the

private sector companies were allowed to start its business. Many companies like

Damania, East-West, Air Sahara and NEPC entered the market but after nearly a

decade none of them survived. However in todays scenario there have been

number of private airline companies operating in this sector with players like Air

Deccan, Kingfisher, Jet Air, Go Air, Spice Jet and many other players. The Indian

aviation has only two Government controlled airline companies i.e. Air India and

Indian Airlines. Sahara Airlines is one of the oldest private sector airline

companies in India which commenced business in 1991 and then was rebranded as

Air Sahara in 2000. Similarly the government owned domestic airline company

Indian Airlines was rebranded as Indian under its plan to revamp the position in

the airline industry. Later the government announced the merger of Air India and

Indian which would build an airline giant in India. Jet Airways is one privateplayer which operated both on domestic and international routes in India and holds

a major share in the aviation industry in India. Spice Jet, Go Air and Air Deccan

are the low cost no frill airline companies in India. Kingfisher airlines was being

considered as the closest competitor to private players and it operates in both

domestic and international routes.

Strategic alliance and mergers have been one of the buzz words in the airline

industry. According to Oum, Park and Zhang (2000)[28] for the airline industry

strategic alliances refer to a long term commitment and partnership with two or

more companies who attempt to gain competitive advantage collectively by

fighting their competitors by sharing resources, cutting costs and improving

profitability.


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The following is the market share of different airline companies in the year 2008.

KINGFISHER AIRLINES AND AIR DECCAN MERGER

One of the significant moves in the airline industry was the merger between Air

Deccan, the first low cost carrier in India and Kingfisher Airlines. Air Deccan has

created waves in the airline industry by offering people the lowest cost flyingexperience and shifted rail travelers to airline travelers.

However Air Deccan and Kingfisher Airlines have now merged and known as

Kingfisher Aviation. The merger started when Kingfisher Airlines owner Dr. Vijay

Mallya bought 26% controlling stake in Air Deccan.

Jet

24%

Jet Lite

9%

K Red

10%Kingfisher

15%

Spice Jet

9%

Paramount

2%

Go Air

3%

Indigo

10%

Indian

18% Jet

Jet Lite

K Red

Kingfisher

Spice Jet

Paramount

Go Air

Indigo

Indian


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Synergy

The combined entity now has a fleet size of 71 aircrafts covering 70 destinations

and more than 550 flights in a single day. The merger would benefit the entity by

offering operational synergies like inventory management, maintenance,

engineering and overhaul which would reduce the overall cost by 4% to 5% i.e.

around 300 million (Financial Express, 2007)[29]. Further the company would be

able to rationalize its routes in a better way by changing its fare structure which

will attract more passengers (Business Standard, 2007)[30]. The merged entity

would also have clear business model with reaching wider domestic base with Air

Deccan capabilities and Kingfisher Airlines would reach international destinations.

Synergies can be seen in two directions, financial and operational. On operational

grounds this merger would help Kingfisher expand its international base as it

finishes 5 year mandatory period to fly domestic before getting an internationallicense. Secondly on financial grounds it would mean a lot to Kingfisher because

of savings on operation cost. With the growth expected in the industry, the

combined entity would make better profits in the coming years. Other reasons for

merger with Air Deccan was totally logistical like both the companies have the

same maintenance contract with Lufthansa Tecknik, both the companies have

Airbus fleet and same types of engines and brakes.


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Financial Analysis

The merger between Kingfisher Airlines and Air Deccan took place in the year

2006. Hence below analysis has been done two years prior to the merger i.e. during

2004-05 and 2005-06 and two years after the merger i.e. 2007-08 and 2008-09

respectively.

Kingfisher Airlines 2004-05 2005-06 2006-07 2007-08 2008-09

Operating Profit Margin 10.2% -1.3% -21.9% -51.5% -26.5%

Gross Operating Margin -4% -24.6% -21% -47.8% -33.9%

Net Profit Margin -6.4% -27.5% -23.6% -13.1% -30.5%

Return on Capital Employed 15.4% -9.8% 7.5% -19.6% -24.4%

Return on Net Worth -143% -347.5% -287.4% -129.8% -809%

Debt-Equity Ratio 20.8 4.6 6.3 6.4 4.7

EPS -63.0 -347.5 -31.0 -13.9 -118.5

P/E -1.9 -0.3 -4.6 -9.6 -0.4

From the above ratios it can seen that before 2008 (Pre- merger) operating profit

margin has increased to 14.57 % from 10.23 % .The operating profit has increased

to 22.33 % , so we called it a successful merger. However, due to recession it has

decreased to 10.50 %. From the above ratios it can be seen that before 2008 (Pre-

merger) Net profit margin has decreased over a period of time. We called it a

successful merger. Because net loss margin has decreased .However, due torecession Net loss margin increased to (30.53) %. The figure of net worth has

increased to 384.7 crores which was decreased after merger and due to the

recession time it has decreased to (2125.34) crores and debt to equity ratio has

come closer to 2.66:1 which is near to ideal ratios. To sum up, It was indeed a

good deal Here, no of shares has increased which directly affected the EPS of the


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company which resulted in to loss of the company in terms of per share `Of

(72.33).

Above ratios depicts that there is direct relationship between market price and EPS

as both figures were decreasing which resulted in to negative price to earnings

ratio. Return on net worth has increased to 75.7 % which attracts the investors to

continue with the company and new investors to put their money in companys

equity. From the above ration efficiency and profitability of a company's capital

investments has determined which is fluctuated over a period of time. It was 10.62

% in June 2006 which comes to 63.54 %. So , there is overall increased in return

on capital employed .ROCE as currently defined is erroneous and capable of

misleading investors and other interested parties on the performance of an

enterprise


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JET AIRWAYS & AIR SAHARA MERGER

Jet Airways started its business operations in 1993 and is now the largest company

in the airline industry in terms of market share. The company has a fleet size of 88

aircraft and flies over 60 destinations worldwide with over 360 flights scheduled

for a single day.

Synergy

Fleet Jet Airways Air Sahara Merged Entity

B737-300 - 2 2

B737-400 6 3 9

B737-700 13 7 20

B737-800 28 7 35

B737-900 2 - 2

CRJ-200 - 7 7

ATR-72 8 - 8

A330-200 2 - 2

A340-300 3 - 3

TOTAL 62 26 88

The major efficiency and synergy comes because both the companies use B737 as

their domestic fleet efficiencies. Air Sahara has B737s which are more than 10

years old and CRJ-200 which were taken on lease for higher rentals. Jet Airways

will have to rationalize the cost aspect of operating and maintaining the fleet size.

Since Jet Airways does not have a proper mix of aircrafts this would lead to higher

maintenance cost for merged entity.


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Financial Analysis

The acquisition between Jet Airways and Air Sahara took place in the year 2006.

Hence below analysis has been done two years prior to the merger i.e. during

2004-05 and 2005-06 and two years after the merger i.e. 2007-08 and 2008-09

respectively.

Jet Airways 2004-05 2005-06 2006-07 2007-08 2008-09

Operating Profit Margin 33.2% 24.8% 14.7% 8.6% 5.2%

Gross Operating Margin 24% 19.8% 6.6% 4.1% -6.4%

Net Profit Margin 9% 7.9% 0.4% -2.9% -3.5%

Return on Capital Employed 31.6% 21.2% 13.8% 6.3% 4%

Return on Net Worth 22.4% 21.1% 1.3% -13.7% -31.1%

Debt-Equity Ratio 1.7 2.3 2.9 6.5 12.6

EPS 45.4 52.4 3.2 -29.3 -46.6

P/E 27.6 18.5 195.8 -17.7 -3.3

On carefully looking at the above figures it can be seen that the operating margins

of Jet Airways were very strong in the year 2004-05. Later the operating margins

started slowing down in the coming years. Post merger the operating margins of Jet


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Airways had gone down to 5.2% from an earlier five year high of 33.2%. Gross

Profit margin was very strong at 24% in 2004-05 however post merger it has

moved into a negative territory of (6.4%). Return on capital employed proves the

efficiency with which the business is maintained. Looking at the post merger

results the shareholders who act as owners would surely be disappointed with only

4% return compared to 31.6% in 2004-05. Similarly the return on Net Worth for

the company has also gone negative and post merger it has not added any

significant value for shareholders. The debt-equity ration of the firm at the current

level is around 10 times higher than in the year 2004-05 which shows the level of

leverage which the company wants to drive on. The EPS which is the crude factor

for any shareholder has seen a dip of -46.6%. Looking at the P/E ratio clearly

shows that the stock has been highly undervalued and shareholders wealth has

been deteriorated.

Overall it can be seen that Jet Airways has been able to post positive operating

margins post mergers however Kingfisher Airlines have failed to do that.

Kingfisher Airlines also has a negative return on capital employed compared to Jet

Airways. But on other parameters like EPS, Return on Net Worth and Net Profit

Margin have been negative for both the companies. It can be thus inferred that

mergers and acquisitions have not created enough shareholder wealth post merger.


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CONCLUSION

In 2007 alone, Indian aviation saw three mergers -- Kingfisher Airlines acquiring

Air Deccan at Rs 550 crore (Rs 5.5 billion) and Jet Airways acquiring Air Sahara

at Rs 1,450 crore (Rs 14.5 billion) besides the forced merger of national carriers

Air India and Indian Airlines. Industry analysts say Kingfisher's merger with Air

Deccan gave the merged entity rights to fly international.

After considering the state of Jet Airways and Air Sahara along with the scenario

of the Indian Aviation Industry this acquisition was a good decision taken at the

right time. This move further strengthened the position of Jet Airways and helped

it fight with the other competitors and maintain its market leadership. Also Air

Sahara found an easy bailout option to clear its debts. Thus this deal was beneficial

for both Jet Airways and Air Sahara.

Jet-Sahara or Kingfisher-Deccan and Air India-Indian Airlines had different

corporate cultures. This makes a merger process difficult. Fortunately, Jet Airways

has kept JetLite as a subsidiary. "Otherwise they would have killed the airline."

However, some feel that apart from the reasons cited above, external factors like

slowdown in the Indian aviation market because of recession have contributed to

the failure of the merger.

Post merger the operating margins of Jet Airways had gone down to 5.2% from an

earlier five year high of 33.2%. Gross Profit margin was at a very strong 24% in

2004-05 however post merger it has moved into a negative territory of (6.4%).

Return on capital employed proves the efficiency with which the business is

maintained. Looking at the post merger results the shareholders who act as owners


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would surely be disappointed with only 4% return compared to 31.6% in 2004-05.

Similarly the Return on Net worth for the company has also gone negative and post

merger it has not added any significant value for the shareholders.

Shareholders wealth of Kingfisher airlines has deteriorated significantly post

merger with Air Deccan. The P/E ratio of the firm also states that the stock has

been undervalued over the years and does not look that an immediate upward

movement in share price or EPS basis which the P/E will go up.

Overall it can be seen that Jet Airways has been able to post positive operating

margins post merger however Kingfisher Airlines have failed to do that Kingfisher

Airlines also has a negative return on capital employed compared to Jet Airways.

But on the other parameters like Earnings per share, Return on Net Worth and Net

Profit Margin have been negative for both the companies. It can thus be inferred

that mergers and acquisitions have not created enough shareholder wealth postmerger.


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Appendix 1:

KINGFISHER

AIRLINES

INCRORE 2004-05 June 2006 June 2007 March

20008

March

20009

Operating

Profit Margin

Operating

profit

31.28 -113.44 -262.4 -325.18 -553.2

Net Sales 305.55 1285.42 1800.21 1456.28 5269.17

Net Profit

Margin

Net Profit -19.53 -340.55 -419.58 -188.14 -1608.83

Net Sales 305.55 1285.42 1800.21 1456.28 5269.17

Return On

capital

Employed

EBIT 20.11 -150.97 -290.91 155.16 174.37

Capital

Employed

189.37 241.75 852.25 445.95 -274.42

Return On Net

Worth

Net Profit -19.53 -340.55 -419.55 -188.14 -1608.83

Net Worth 13.66 224.13 384.7 198.88 -2125.34

Debt-Equity

Ratio

Debt 284.48 451.66 916.71 934.38 5665.56

Equity 13.66 224.13 384.7 198.88 -2125.34

EPS PAT -19.53 -340.55 -419.58 -188.14 -1608.83

No. EquityShare

1,553,226 49,904,959 99,326,445 135,668,051 222,434,428

PE MPS 85.85 137.65 122.05 33.25

EPS -68.23 -42.24 -13.87 -72.33


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Appendix 2:

JET AIRWAYS INCRORE 2004-05 2005-06 2006-07 2007-08 2008-09

Operating Profit

Margin

Operating

profit

1461.39 1431.64 1037.12 755.1 601.83

Net Sales 4338.01 5693.73 7057.78 8811.1 11,571.15

Net Profit Margin Net Profit 391.99 452.04 27.94 -253.06 -402.34

Net Sales 4338.01 5693.7 7057.78 8811.1 11,571.15

Return On capital

Employed

EBIT 1212.68 1071.08 873.1 734.71 310.29

Capital

Employed

3895.11 5801.42 6072 12394.15 16198.98

Return On Net Worth Net Profit 391.99 452.04 27.94 -251.86 -402.34

Net Worth 1750.89 2143.86 2104.81 1851.75 1294.65

Debt-Equity

Ratio(lakh)

Debt 2,964.84 4,895.6 6,056.3 12,015.04 16,323.53

Equity 1,750.84 2,143.86 2,104.81 1,851.75 1,294.65

EPS PAT 391.99 452.04 27.95 -251.86 -402.34

No. EquityShare

7.298 8.633 8.633 8.633 8.633

PE MPS 1210.05 933.4 647.75 557.5 172.9

EPS 45.78 52.1 3.23 -29.31 -46.4

a study of mergers in aviation industry

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