iima consult club newsletter - oct 2010

8/8/2019 IIMA Consult Club Newsletter - Oct 2010

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After two decades which saw both

unprecedented growth and stagnation,the Indian Civil Aviation sector isentering a new phase of development.Despite tremendous growth in recent years, less than 2% of Indians travel byair each year indicating that muchremains to be explored within the sector.

A Brief History:

1912 Domestic air route betweenKarachi and Delhi becomeso p e r a t i o n a l , i n i t i a t e d b ycollaboration between IndianState Air Services and Imperial Airways UK. In reality just an

extension of the London-Karachiflight operated by ImperialAirways.

1932 .R.D Tata himself flies a DeHavil land Puss Moth fromKarachi to Bombay, carryingpostal mail of Imperial Airlines.This marks the instigation of theIndian Aviation Industry in theform of Tata Airline.

Tata Airline was transformed intoAir India in 1946. At the dawn oindependence, India operatednine air transport companiesprovid ing both cargo andpassenger services.

1953 All airline assets were nationalised

and Indian Airline Corporationand Air India Corporation wereformed f or domes t i c andinternational services respectively.

1991 T h e s e t w o c o m p a n i e scommanded a monopoly in Indiauntil 1991. In this year, privateairlines were allowed to operatenon-scheduled services andchartered flights under the airtaxi scheme to uplift Indiantourism. In 1994, resulting from arepeal of the air corporation act,pr ivate a ir l ines companiesobtained permission to function

scheduled air services.

2003 2003 proved a landmark year inIndian Aviation being marked bythe entry of the low-cost carrier Air Deccan, which slashed pricesup to 17% of existing fares. Sincethen the Indian aviation landscapehas witnessed the entry of morethan 12 low cost players, whichnow dominate the aviationlandscape. Such players nowinclude Spice Jet, Go Airways andKingfisher Air.

Current Outlook

The Airlines Industry in India hasdisplayed explosive growth since 2003,with average year-on-year growth inpassenger traffic between 2003 and nowtouching 20%.

Indias eight domestic airlines carried atotal of 4.08 million passengers in Julythis year, compared with 3.59 million a year earlier. The average number offlights per person per year for the 1.1billion Indian population is 0.03

compared to 1.6 in the United States.This indicates that there is huge room forfurther penetration. There are currently136 airports in India, compared to over400 in the United States, one of the mostdeveloped markets for air-travel.

Due to the global meltdown in2007-2008, for the Indian AirlinesIndustry and even worldwide the growthtrend in the aviation sector, displayedsince the entry of low cost barriers wasreversed. Following the fuel-price hike inmid 2008, airlines were forced to raisefares and the 12 months proceeding July

2009, saw consecutive year on yeardeclines in passenger traffic.

The airlines industry worldwide, however,is showing distinct signs of recovery. Theglobal aviation market is expected togrow at a CAGR of 5.9% over the next

Overview of the Airline Industry

PanoramaOCTOBER ISSUE FOUR


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five years, as estimated by GlobalInformation Inc. While the market shareof the more mature markets such as theUS and Europe has witnessed a fall to thepresent proportion of 52%, emergingmarkets offer tremendous growthpotential. According to Kapil Kaul, CEOIndia & Middle East, Centre for AsiaPacific Aviation (CAPA), India's civilaviation passenger growth is among the

highest in the world. The sector is slatedto cruise far ahead of other Asian giantslike China or even strong economies likeFrance and Australia. The number ofpassengers who will be airborne by 2020is a whopping 400 million. This in turn

implies much room for growth within thein Indian Aviation Sector.

Airport Infrastructure

The present number of airports in Indiais 136, of which the Airports Authority ofIndia (AAI) owns 94. Of these 136

airports, 82 are used for scheduledservices. Wide-scale modernisation ofairports across the country has takenplace recently, with the HyderabadInternational Airport being rankedamongst the world's top five in the annualAirport Service Quality (ASQ) passengersurvey along with airportsat Seoul, Singapore, HongKong and Beijing. TheAirports Authority of India(AAI) has planned to spendover US$ 1.02 billion in2 0 1 0 , t o w a r d smodernisation of non-metro airports. The city-side development of 24airports is being planned,i n c l u d i n g t h o s e a tAhmedabad and Amritsar.Moreover, 11 Greenfielda i r p o r t s h a v e b e e nidentified to reduce theload on existing airports.

I n 2 0 0 7 0 8 , t h einternat ional a irport stogether handled about 80per cen t of a irc raf tmovement, 88 per cent of

passenger traffic and 97per cent of freight traffic.

I n d u s t r y C h a r a c t e r i s t i c s

The airline industry business is cyclical,and the major factors that affect theearnings are economic conditions, excesscapacity and oil prices. Thus, investmentin this industry is prone to higher risk butlower profitabili ty, compared toinvestments in other industries.Inaddition, the airlines industry is extremely

captital intensive requiring a range ofexpensive equipment and facilitiesranging from airplanes to flightsimulators to maintenance hangars.

Additionally, the industry typicallyrecords high positive cash flows and is

labour intensive, employing a virtualarmy of pilots, flight attendant,mechanics, baggage handlers,reservation agents and the like.

Cost Drivers:

The biggest cost driver in airlines is

typically power and fuel followed bymaintenance and employee costs.The latter includes the salaries ofpilots as well as costs assosciated withaircraft and traffic service such as thesalaries of baggage handlers,dispatchers and airlines gate agentsand passenger service. In additiongiven the capital intensive nature of

the industry, depreciation is a criticalexpense for all airlines companies. Theamount of depreciation varies acrosscompanies, as some buy aircrafts, othersdecide to lease and there are some whodepend on 2nd hand aircrafts.

Revenue Drivers:

The primary revenue drivers in Civil Aviation are Ticket sales. Ancilliaryrevenue comes in the form of excessbaggage charges, commissions throughhotel accomodation, travel insurance and

car rentals as also revenue from sales offood and beverages. Ancilliary revenuehas become increasingly important lately,given that the Low Cost Carriers derivemuch of their income from the same.

Segmentation

With regard to segmentation, the industrymaybe broadly segmented into twocategories based on the airline unit costs

and average fares

1. Low Cost carriers (LCC)

Among the various carriers, the LCCprovide the lowest fares and operate atthe lowest costs. They offer no-frills one-class service. The entry of LCC intoIndia was marked by Air Deccan in 2003and today this category includes playerssuch as JetLite, Kingfisher Red, Spicejetand Indigo amongst others.

2. Full Service carriers (FSC)

A Full Service Carrier provides in-flightmeals , enter ta inment and othercomplementary services. Hence, FSCfares are typically higher than LCC fares.It also offers a variety of air travel classessuch as first (F), business (C) and economy(E) classes. FSCs in India include JetAirways and Indian Airlines.

With intense competition however, thegap between these two categories appearsto be diminishing. One the one hand, Jet Airways and Kingfisher have movedmore than 60% their passenger capacities

to no-frills and all economy services. Onthe other hand, LCCs are offeringservices and discounts- traditionallyoffered only by the FSCs. While Spice Jethas introduced online check-in andf a c i l i t i e s f o r s u p e r v i s i o n o f unaccompanied minors, GoAir offers

Airports NumberI n t e r n a t i o n a lairports, includingo i n t v e n t u r e

airports

17

Domestic airports 79Customs airports 8Civil enclaves 24Others 8


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complimentary beverages at selectairports and Indigo informs passengers oftheir flight status through texts messageson their mobiles.

International vs. DomesticPlayers:

The industry can also be segmentedas international carriers and domesticcarriers. The major players in the

international segment along with theircapacity contribution are NACIL and Jet Airways. Kingfisher has recently enteredthis segment. All other players haveoperations in the domestic segment. Interms of passenger traffic, 18.5% iscontributed by the international segmentat present and the rest is contributed bythe domestic segment.

The parameters for judging airlineperformance are varied and may be asfollows:

Aircraft Utilization: The most basicmetric for an airline is aircraftutilization. This measures the averagenumber of hours that each aircraft isflying in each 24 hour period.

The basic idea is that planes that are inuse are probably making money.Utilization is a statistic that varies fromcarrier to carrier and is normallyconsidered a closely guarded corporatetrade secret and is not tracked bygovernment. Part of the "art" inrunning an airline is keeping utilizationhigh.

Load Factor: This measures the

percentage of available seats that arefilled during a specific period. Thepassenger load factor for the aviationsector in India as a whole towards theend of 2009 was estimated at about75%.

Available Seat Kilometres(ASKM): ASKM is equal to thenumber of available seats times thenumber of kilometres flown. The ASKM metric is used to track seatsupply among airlines.

Revenue Passenger Kilometres(RPKM): RPKM measures the

number of seat kilometres flown forwhich the company earned revenues.That is, RPKM equals the number offilled seats times the number ofkilometres flown.

Yield: The amount of revenue earnedper RPKM is known as the airline's yield. This metric is generallyexpressed in cents and ranged from9.8-13.1 cents for the major airlines inthe first half of 2007].

Fuel Costs: Most factors that affectthe profitability of airlines are fairlystable, except for fuel costs. Fuel costs

are facing extreme risk from the threatof Peak Oil.

Unit Cost: It is the ratio of operatingexpenses to ASKM, an indicator ofunit costs.

Daily Aircraft Utilization/hr:Ratio of the number of aircraftsutilized to the number of operatinghours- indicator of the effectiveness offleet utilization by the airline.

Break Even Seat Factor: Ratio ofUnit Cost to Yield. It signifies theaverage number of seats an airlineneeds to sell to cover its operating costs,

indicator of operating margins.

Financial Standing and FutureTrends

In the aftermath of the financial crisis,Indians reported a sharp drop in airtravel. Fuel prices were on the rise and sowere costs. All together, Indian airlineslost an estimated $2 bn in the 2009financial year. Kingfisher and Jetpostponed the delivery of new planes andleased out or sold off surplus planes.

But things have changeD since.

Indian carriers are now regainingaltitude. This year, barring February,traffic has grown at an average of 20%year-or-year in 2010 so far. In July 2010the year on year growth in domestic airpassenger t ra ffic growth s lowedmarginally to 13.64%, following the endof the peak travel season.

Passenger loads are at a healthy 78 percent, from 65 per cent during the crisis.Low-cost carriers are doing even better,with passenger load factors rangingbetween 85 to 90%. At industry level,both the ASKM and RPKM have been

on the rise.

While most airlines were suffering lossesthrough 2009, things are now starting tolook up. While Kingfisher narrowed itsfirst quarter losses to Rs. 1.87bn from Rs.2.37bn last year, Jet Airways evenreported a small profit of Rs.35.2m in thefirst quarter of the current financial year,compared to a loss of Rs.2.25bn at thesame time last year. For Jet, domesticoperations accounted for 44% of totalrevenues (or USD 285.1 million) andgrew by 23.8% year-on-year in thequarter.Both Jet airways and Jet connecthave now broken even on seat factor andpassenger load factor. Even SpiceJets firstquarter net profit more than doubled toUS 11.8 million in the three monthsended Jun-2010.

If the expected projection by Boeing of afuture average growth rate of 8.4% forSouth Asias Aviation Market for the nextdecade materialises, it would translateinto a $ 130bn market for around 1150planes for the next decade. With suchoptimistic projections, expansion plans ofseveral airlines are in place. While JetsChairman, Naresh Goyal, recentlyannounced that Jet plans to expand itscapacity by 10-15% by adding another 5planes to its fleet, SpiceJet announcedthat it has ordered 30 Boeing planes fordelivery from 2014 for $2.7bn.

Growth drivers

The factors contributing to the air trafficgrowth may be broadly classified intoeconomic and policy factors. Entry oflow cost carriers, rise in disposableincome--expected to increase at anaverage of 8.5% p.a. till 2015, the 300mstrong middle class, increased FDIinflows, surging tourist inflow, increased

cargo movement, strong business growthand supporting government policies arethe major drivers for the growth ofaviation sector in India.

Regulatory Trends

At present, the domestic air transportpolicy debars foreign airlines from equityparticipation in the companies formed fordomestic air transportation. The policya l lows par t i c ipa t ion o f f o re ignindividual/companies up to 40 per centand the participation of Non-ResidentIndians (NRIs) / Overseas CorporateBodies (OCBs) up to 100 per cent in thedomestic air transport services. The issuerelating to permitting foreign airlinesequity investment in companies formedfor domestic operations is beingreconsidered by the Government at thebehest of both international and Indianplayers interested in strategic alliances.Moreover, overall increase in the foreignequity limit in domestic airlinesoperations may also be considered with a view to attracting new technology andmanagement expertise.The foreign equity l imit in theinternational services is 26 per cent. In

order to attract investment in this sector,the possibility of increase in foreignequity participation may also beconsidered.

The Government approved the FDIlimits in the civil aviation sector which areexpected to bring in more foreigninvestments to the sector. This includesupto 49% on automatic route and upto100% for NRI in air transport servicessubject to no direct or indirectparticipation by foreign airlines; upto74% on automatic route for non-scheduled airlines, chartered airlines and

cargo airlines and up to 100% for NRIssubject to no direct or indirectparticipation by foreign airlines in non-scheduled and chartered airlines; upto74% for ground handling services and up

to 100% for NRIs on automatic route

subject to sectoral regulations andsecurity clearance; and upto 100% onautomatic route for maintenance andrepair organisations,flying traininginstitutes, technical training institutionsand helicopter/seaplane services.

Current regulations also requiredomestic airlines to operate for at least 5years and operate a minimum fleet size of20 aircraft before being permitted tooperate on international routes.


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The government, considering thestrained liquidity positions of theairlines, has providedflexibility in clearing dues of oilcompanies. Further, custom duties on ATF have been reduced from 5% to0%. There is substantial competitionin both domestic and internationalsegments. The airlines are allowed tooperate any domestic routes with no

restrictions on pricing. The Indiangovernment has pushed for bilateralair service agreements with overseasmarkets, engendering greater access toforeign carriers.

A bill to establish the AviationEconomic Regulatory Authority(AERA) was passed in Oct'08 withresponsibility for regulation ofaeronautical changes and to safeguardthe interest of stakeholders at Indianairports. The Government may issuefresh licenses for airlines planning to

The Indian Airspace has undergonetremendous changes since its monopolydays and today several players exist in themarket offering diversified services and arange of fares. Jet Airways has thehighest market share among the domesticcarriers. Jet Airways together with itsbudget arm Jetlite commands 27% of themarket share among domestic Indian

carriers. Kingfisher comes in second, with20% of market share. They are followedby Air India, with a market share of18.3% and IndiGo with a market share of16.4%.

Jet Airways:

Widely regarded as Indias biggest andbest airline, Jet Airways is a privatelyowned full service airlines which was firstincorporated as an Air Taxi on April 1st,1992. In January 2006, Jet Airwayslaunched a $500 million, all-cash deal totake over Air Sahara, which was then the

second biggest private operator in thedomestic market. After a protractedacquisition saga, Jet finally completed thetakeover on 12th April 2007 for $340million. It rebranded Air Sahara as JetLite and operates it in the VBCsegment. In May 2009, Jet launched JetKonnect, its own LCC.

It currently commands 27% in theIndian Aviation Market and has a fleet of90 and an average fleet age of 4.82 years,significantly lower than industry average. Jet operates 330 daily flights to 50destinations across the country and 6

overseas flights.

Jet has been increasing its focus oninternational operations, with itsinternational air traffic increasing by20.1% in the year ended March 2010, as

opposed to the 4.2% increase in domesticair traffic. It now serves 23 internationaland 44 domestic locations

The ASKMs reduced to to 29.2 millionin 2009-2010 from 31.6 million in2008-2009. Passenger Load factor on theother hand increase from 67.4% in2008-2009 to 77.4% in 2009-2010

Jet Airways is renowned for its excellentin-flight service, punctuality and food. Itsprimary strengths l ie in stronggovernment networks, its young fleet anda diversified presence across the globe.However, there is uncertainty about the

way Jet Airways has positioned itself.Traditionally it has been seen as a FSCprovider. It has recently launched intoLLC services, with the launch of JetConnect. Then there is also JetLite whichis a Value-based provider. There is thusconfusion about its positioning bothwithin the organisation and outside.

Kingfisher Red

Founded on 25th August 2003, KingfisherRed (formerly Air Deccan) has thedistinction of being Indias first low-costairline. It is reputed as having brought air

Player profiles


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travel within the reach of the commonman, connecting second-rung cities suchas Hubli and Madurai to metros likeBangalore.

Since Kingfisher Airlines took over AirDeccan in 2007, the latter underwentmassive rebranding first being renamedSimplifly Deccan and Kingfisher Red in2008.

Kingfisher has a young air fleet, with afleet size of 66 and an average fleet age ofaround 3.7 years. Kingfisher has seen a12 percentage points increase in loadfactors to 81% from 69%, and a 5%improvement in yields between Q1 2009and Q1 2010. It currently has a seatfactor of 80.6%. Kingfisher Airlinesserves 63 domestic destinations and 8international destinations in 8 countriesacross Asia and Europe.Kingfisher is known for excellent service.It is one of the 6 airlines in the world tohave a 5 star rating from Skytrax, a UKbased consulting agency. It is reputed tobe the best in the industry with respect totimely delivery of baggage as well as itsin-flight services. It has built an image asa passenger-friendly airline, and presentlyKingfisher Red is the only low-costIndian airline to provide complimentaryin-flight meals and bottled water to itspassengers.

Air India

Indias national carrier, Air India wasfounded in 1932, as Tata Airlines by J.R.D. Tata. Soon after independence,49% of the airlines was taken over by theGovernment of India. Tata Airlinesbecame a publicly listed company in1946, under the name Air India. AirIndia continued to expand in thefollowing years and today it is the 16thlargest airline in Asia. In 2007, Air Indiamerger with Indian Airlines and as a partof the process, a new company calledtheNational Aviation Company of IndiaLimited(NACIL) was established.

Air India has a total fleet of 135 of whichit owns 108. The average fleet age isabout 9.5 years.In July 2010, Air India carried 7.08 lakhpassengers on its domestic network. Theair-carrier clocked a robust 43.1 per centgrowth in revenue on domestic operationsduring this period compared to theprevious year. On the other hand, therevenue from international operations

increased by 16.2%.

Simultaneously, the country's flagshipcarrier also recorded s ignificantimprovements in its seat factor and yieldsacross its domestic and internationaloperations. The seat factor on thedomestic routes rose to 71.4% in the April-July period as compared to 63.8%last year, the seat factor on internationalroutes rose to 68.1% from 62.2%," thesource said. At the same time, the yieldper revenue passenger kilometer (RPK)on domestic operations registered a 14.8per cent growth as it stood at Rs 5.45during the period from Rs 4.74 last year.

The loss-making airline, having a debt ofRs 40,000 crore mainly on account ofaircraft acquisitions, has embarked on aturnaround plan, which envisages bothrevenue enhancement and cost reduction.

Air Indias brand has been weaker thancompeting airlines, despite it oftenoffering better connectivity, better planesand more timely service. However, whatis remembered by the customers is theapathetic nature of the crew, and any

shortfall on the part of airline isconvenient attributed to slow and corruptstate of affairs in government runorganisations. Questions are also oftenraised about Air Indias disastermanagement practises. However, theairline has been taking active measurestowards building a stronger brand andthe results are likely to emerge favourable.

Low Cost Carriers:

Apart from the three players listed above,the Indian Air space has players likeIndiGo, SpiceJet and Go Air, all of which

are low cost carriers. While the seat factorfor SpiceJet is currently at 70.3%, thesame is 74.6% for IndiGo.

Each of these airlines historically gainedmarket share by bringing prices down toall-time lows. Air Deccan initially offeredprice at par with high-end rail ticketprices, and other airlines followed suit.SpiceJet gained market share by adopting

means such as offering free services andconcessional fares to students.

The LCC Carriers attempted to reduceexpenses by cutting down on ground-staffas well as in-flight crew members,reducing in-flight services, adheringstrictly to on-line booking and bypassingtravel agents. These measures weresimilar to those adopted by InternationalLCCs. However Indian LCCs failed toreplic ate the profitabi lity of their

international counterparts. A part of thereason was that India does not have any

secondary airports for LCCs and theIndian LCCs had to she l l outcomparatively higher airport chargesthan their international peers. Moreover,the under-developed commodity hedgingmarket also put a stumbling block onthese companies to hedge againstfluctuating prices of air fuel, unlike theirinternational counterparts.

Hence, LCCs in India were faced withmounting losses and started to hike fares. As a result of the losses, in 2007, AirDeccan merged with Kingfisher Airlinesand GoAir moved out of the LCC model,

adding a business class to its aircrafts. Ofthe LCCs that remain, ancillary sourcesof revenue have become an increasinglyimportant means for sustainability- forinstance IndiGo uses the in-flightmagazine and booking of additionalbaggage to generate revenue.

Airline Debt RestructuringThe Indian airlines industry exhibited

explosive growth in the period from 2003

to 2007. Thousands of passengers started

flying for the first time, drawn by new

airlines offering bargain flights around

the country. However, the industry was

hard hit by the economic crisis in

2007-08. Passenger growth, which wastouching 40% at the onset of 2007, went

into reverse. Soaring fuel prices in 2008

pushed up ticket prices, which further

reduced demand.

The three major players in the aviation

sector in India - Jet Airways (India) Ltd,

Kingfisher Airlines Ltd and National

Aviation Co. of India Ltd (NACIL)

which collectively control 65% of

domestic passenger traffic, were the worst

affected. The three airlines currently have

a combined debt of $13.5 billion(Rs63,315 crore). State-owned NACIL

runs Air India. Other than the exogenous

factors, poor managerial decisions

including predatory pricing by the larger

players and underutilization of capacity

were prime contributors to the huge debt.

Factors Leading to the Debt

Kingfisher Airlines is labouring under adebt burden of Rs 7,413-crore (as onDecember 2009). Out of this, Rs 2,099

crore is short-term debt; the remaininga m o u n t b e i n g l o n g - t e r m d e b t .Subsequent to its launch in 2005, the first year and a half went quite smoothly forthe airline. A lot of Jet passengers shifted


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allegiance and joined Kingfisher and thecompany registered rising profits.However, it spent money like water ononboard service and brand building;neglecting costs altogether. Things beganto go downhill soon after the airlinesbought a stake in Air Deccan in June,2007. Not having a CEO furtherexacerbated the airlines problems.

2008 proved to be the final straw in itsoperations, and as oil prices hit newhighs, so did the merged entitysproblems. By end March 2009, theairlines debts had touched over a billiondollars. Senior executives were also atloggerheads with oil companies, vendorsand the Airports Authority of India.

Jet Airways is slightly better off than itsrival. Although it has a debt of Rs. 14000crore; short term debts constitute only asmall portion of that amount. In 2009,Jets domestic revenues were 37% higherand profitability was superior toKingfisher due to a higher share of full-service carrier operations, while thehigher proportion of low-cost operationsin Kingfishers operations dragged itdown.

Furthermore, aircraft ownership is a keydifference between the two airlinecompanies. Jet owns 39 aircraft against21 owned by Kingfisher Airlines.Difference in fleet ownership is reflectedin Jets higher debt levels. As per Jetsmanagement, 85-90% of the debt istowards purchase of aircraft at long terminterest rates of 5-7%.

In an effort to minimize losses, Jet enteredinto sale-and-lease-back of its aircraft, orthe ability to sell off the aircraft itpurchased and continue using them for arental fee.

State-run Air India, which enjoyed amonopoly in the country till thederegulation of the aviation sector in1991, is besieged by a debt of Rs. 40000crore. One of the major factors for thiscolossal figure is over employment oflabour. The airline has a workforce of31,000; which translates into 230employees per aircraft. According to

international standards, the numbershould be 100-150 employees for everyaircraft.

Another major reason for the spiralingdebt are the massive aircraft ordersplaced by the beleaguered firm withaircraft makers 68 with Boeing and 43with Airbus. The orders were placedwhen the country was beginning towitness an aviation boom, but the figureswere overestimated even according to theheydays. The orders cannot be cancellednow; since cancellation entails a heftypenalty, which the airline is ill situated to

bear. Poor capacity utilization is anothermajor issue for the national carrier, withover 40% of seats going unoccupied in2009.

Braving the Storm

In June this year, SBI had approachedRBI with a proposal to restructure morethan Rs2000 crore of Kingfishers debt.RBI declined to clear that proposal as itwas not comfortable with the idea ofgiving any special concessions to anyparticular aviation company. In an 18 June meeting with bank executives, the

central bank noted it would be a moralhazard for RBI to give any regulatoryforbearance for any specific company. Itwas made clear that any regulatoryconsideration of banks requestsregarding restructuring guidelines couldonly be for the aviation sectorand notfor any airlines in isolationin view ofthe difficulties faced; and provided thebanks came together in a consortiumarrangement and took a long-term andholistic view on the restructuring.

This prompted the bank to put forwardthe case of the entire airline industry

rather than that of a particular firm,which was approved by the RBI inSeptember. The proposal asks forconversion of the short-term loans intolong-term ones and then extending therepayment schedule to nine years, with aone to two-year moratorium. SBIsinvestment banking arm, SBI CapitalMarkets Ltd (SBICaps) is working on thedebt recast plan, leading a consortium of13 banks.

The most significant beneficiary of therecast would be Kingfisher Airlines, andwill get a much needed respite from the

payment demands of various lendersincluding oil companies and airports.With the restructuring, more time wouldbecome available for repayment of loansand its operations would not beencumbered by the cash crunch. Otheroptions like raising money overseas ordiluting equity to raise cash could also beexplored. In the fiscal ended March, theairline also reduced its losses to almosthalf of those posted in the previous fiscal.This improved performance was achievedthrough better seat occupancy and costreductions.

While the airlines are talking about cost-

cuts and route rationalizations to turnthings around, Jet Airways posted a profitin the current fiscal year through anumber of innovative strategies. Theseinclude improving aircraft utilizationefficiency, increasing flights on existingand new routes without adding newaircraft, reducing the weight of flights toscale back fuel expenses, and launching asecond low-cost carrier; by convertingsome of its full-scale flights into a no-frillsall-economy service under the brandname of Jet Konnect. Jet Airways hasalso sought approval from the ForeignInvestment Promotion Board (FIPB tora ise $400 mi l l ion via qual ifiedinstitutional placement (QIP) to repaydebt andaugmentcapacity.

Air Indias debt of Rs. 40000 crore is adifferent story altogether. More than anyproposed debt restructuring, measurestaken by the government in terms ofequity infusion and guaranteed loanswould have a larger impact on the publicsector carrier. However, the governmenthas hinted that the airline shouldgenerate more funds through betterpassenger yields and cost-cutting, instead

of expecting further bailouts.

Is the Restructuring Justified?

In the past, the government has extendedsupport to crisis hit sectors such as realestate and steel on previous occasions,and there is no reason not to provide thesame to the domestic airlines.However, the debt recast should comewith certain riders. A major cause for theheavy losses was the overcapacityinducted by the airlines and theundercutting that followed.They should commit to keeping costsunder leash and run their operations withmaximum efficiency.The debt restructuring also makes sensefrom the banks point of view. Bigplayers like SBI have an exposure of overRs. 3500 crore to the industry. RBIsmove would help provide relief to banksas they would not have to classify airline-sector loans as non-performing assets(NPAs), giving them an opportunity tocontain the growth of NPAs, whileairlines would get some breathing spaceto repay their loans and would not becompelled to raise costly debt to continue

operations.


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Overview of the groupThe Vedanta group is a

diversified metals and mining

company, and is the first Indian

manufacturing company to be

listed on the London Stock

Exchange.

As is clear from the graphic, thegroup is highly diversified, andits business can be divided intofive principal verticals - copper,zinc, aluminium, iron-ore andpower generation business. Theimportant members of theconsolidated group are:

Copper Business Sterlite Industries (India)

Ltd. Konkola Copper Mines.

C o p p e r M i n e s o f Tasmania Pty Ltd.

Zinc Business Hindustan Zinc Limited.

Aluminium Business Bharat Aluminium Company

Ltd. Vedanta Aluminium Ltd.

Iron-ore Business Sesa Goa Limited.

Power Generation Business

Sterlite Energy Limited. Madras Aluminium Company Ltd

Acquisitions Prior to the Cairn

Deal

Acquisitions and diversification havealways been a central theme in thegroups growth, which shot into thelimelight about a decade ago by buyingmajority stakes in BALCO for Rs 551crore in 2001 and Hindustan Zinc forover Rs 750 crore in 2002. It transformedthe loss-making PSUs into cash richcompanies. Hindustan Zinc (HZL), saw a

400 per cent jump in capacity in seven years under Agarwals leadership toemerge as the largest zinc maker in thecountry with the highest margins. Thegroup spread its roots to the Africancontinent by acquiring majority stake inKonkola Copper Mines in 2004. Later, itbought Copper Mines of Tasmania tofurther augment its position in the copperindustry.

The group entered the iron ore businessin 2007 when it acquired Sesa Goa from Japan's Mitsui for about USD 1 billion.The move had surprised shareholders,

investors and analysts as they dubbed it arandom buyout by a base metal company.They felt that by entering into the ferrousmetals industry, the group was movingaway from its core non-ferrous business of

making zinc, copper and aluminium. In just two years, Sesa Goa is a hugelyprofitable entity, with an operatingmargin of 60%.

In response to critics, Vedanta Resourcesacquired mining assets of another Goa-based mining firm V S Dempo last yearfor Rs 1,750 crore. In May last year,Vedanta also bought zinc assets of globalrival Anglo American for USD 1.34billion.

The Four Box Strategy

Anil Agrawal, the groups chairman, is afirm proponent of the Four Box strategy a strategy to create a diversifiedportfolio that can generate enough cashto fund complex and large projects incyclical businesses. The strategy consistsof making use of existing assets to

become a low cost producer, investing thecash flows obtained in greenfield andlarge scale brownfield expansions andtaking advantage of any external blue skyopportunities which may arise (referexhibit for explanation of terms).

This approach is based on the 2x2 matrixapproach developed by the BostonConsulting Group, which divides theStrategic Business Units in a companysportfolio into four broad areas:

Stars - Stars are high growth businesses

or products competing in markets wherethey are relatively strong compared withthe competition. They require heavyinvestment to sustain growth, which willeventually slow down.

Cash Cows - Cash cows are low-growthbusinesses or products with a relativelyhigh market share. They have relativelylittle need for investment and need to bemanaged for continued profit.

Question marks - Question marks arebusinesses or products with low marketshare but which operate in higher growthmarkets. They have potential for growth,but may require substantial investment.

Dogs The term "dogs" refers tobusinesses or products that have lowrelative share in unattractive, low-growthmarkets. They are rarely worth investingin.

The Cairn Deal

Last month, Vedanta Resources Plc

announced its plans to acquire a majority

stake in Cairn India Limited, a unit ofCairn Energy plc. The Vedanta Group

will pick up 51% stake in Cairn India

from Cairn Energy at Rs405/share. This

includes Rs50/share (i.e., $1bn) as non-

compete fee (Cairn Energy will not

compete in India, Bhutan, Sri Lanka and

Pakistan or poach senior management for

three years). The transaction, which

would be a reverse takeover, is expected

to close by the first quarter of 2011.

Cairn India currently produces about

125,000 barrels of crude oil per day.

According to Vedanta, there is thepotential to more than double this level to

around 240,000 barrels per day,

represent ing about 25% of India's

production. Industry experts have

Vedantas Cairn Deal


8/8

expressed surprise at Anil Agrawals

decision to invest in the Indian oil

exploration sector when most global

majors or domestic players are either

scaling down their Indian operations or

going overseas.

However, the journey from bulk

commodities to energy (coal, power and

now oil) is a natural progression. Thegroup is already involved in commercial

power generation, so picking up stakes in

gas blocks could be backward integration

to fuel its power projects. Furthermore,

having stakes in metals and oil could pay

off as the cyclical nature of the two

industries is complementary. The Cairn

acquisition is also in consonance with

Agarwals Four Box strategy he is

channelizing funds to the tune of USD 3

billion from the cash cow Sesa Goa to

finance the Cairn deal.

The deal has been criticized for being

solely an exercise in empire building -

good for the dominant shareholder but

not necessarily for minority shareholders;which in this case are the Sesa

shareholders.

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iima consult club newsletter - oct 2010

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