AIR INDIA PRIVATISATION

Date: 4/10/2017

Airline industry is going through a good phase—lower crude oil prices, lower interest rates, a prominent lessor
community and favourable currency. This phase has the capability of turnaround a loss making airline business
into profitable like we have seen in the case of Jet Airways and spice jet.

Air India, also, at least would surely be able to do the same at an EBITDAR (Earnings before Interest, Taxes,
Depreciation, Amortization or Rent Cost) level. Hence, it is not as much an operational challenge as perceived
by many to manage Air India, but more of a one-time restructuring which should involve necessary
monetization of assets and requisite write down of debt.

Valuation of Air India would be driven by possible EBITDAR margins of 15-18% and value of land and aircraft
on books are the main drivers. The bilateral rights, international slots and the intangible institutional expertise
will lend valuation premium.

Like other airlines, Air India would also record significant improvement in operational earnings in FY16/17. Air
India would record significant improvement in earnings between FY15-FY17 as has been the case with other
airlines. Reports suggest that the standalone EBITDAR is likely to improve from Rs4.5bn in FY15 to ~Rs35bn in
FY16/17E. This is purely on the back of lower crude and other cost control exercises as a part of the
turnaround plan of the company initiated in 2012.

Operation Cost Has Already Seen a Turnaround

The operational cost structure of Air India (ex-debt servicing and depreciation) has already seen a turnaround,
while there is significant scope remaining to improve, especially on items like landing charges, maintenance
and other expenses. A lot of these costs emanate from sub optimal route network and sub optimal fleet
deployment. Further operational efficiencies can be achieved from improving PLF (passenger Load factor—
this measures the capacity utilization) and OTP (On time performance) (both lowest among big airlines).

Companies Showing Interest

IndiGo is the first airline to express interest in Air India. IndiGo has evinced primary interest in the international
operations of Air India, though also expressing alternative interest to acquire all of the airline operations of Air
India as well. IndiGo currently does not have any meaningful international presence and Air India can fill that
gap. The international operations of Air India will come along with a host of bilateral rights and international
hubs which IndiGo would be able to use.

There is only an expression of interest at this point of time, the IndiGo management has also said that if IndiGo
were to acquire Air India, there would be considerable restructuring required and the company will not take
any debt or liability that cannot be supported by the restructured operations. However, the candidature of
IndiGo will have the concerns of competition commission, especially the domestic business as if IndiGo were
to acquire Air India, the combined market share would be ~55% in the domestic segment and ~25% in the
international segment.

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Can Foreign Airlines Buy Air India??

The Centre will not allow foreign airline to pick a stake in Air India, going by the Consolidated Foreign Direct
Investment policy released recently.

The policy says that while foreign airlines are allowed to invest in the capital of Indian companies operating
scheduled and non-scheduled air transport services up to the limit of 49 per cent of their paid-up capital, “this
policy will not apply to Air India.” In effect, this rules out the participation of any foreign airline in the proposed
Air India divestment. Interestingly, in June, when the Centre moved a Cabinet note on the disinvestment of Air
India, the Prime Minister’s Office is said to have insisted that no foreign investor be allowed to buy a stake in
Air India.

The Centre is not keen to pump in any more funds into the state-owned airline, which has a debt burden of
around INR 500bn. NITI Aayog, the Centre’s think tank, also examined Air India’s finances and suggested
divestment as one of the options. On June 28 the Union Cabinet gave its in-principle approval for the
divestment and set up an Alternative

Mechanism overseen by the Finance Minister to look into the strategic divestment. According to existing
government regulations, domestic airlines can accept foreign direct investments of up to 49% from a foreign
airline. Singapore Airlines thus has a 49 per cent stake in Vistara, in which Tata Sons holds the remaining
51%. Similarly, Malaysia-based Air Asia Berhad is invested in Air Asia India. Tata Sons has a take in this low-
cost airline, also.

What could be the possible hurdles in the Divestment??

While the banks have done a good job drumming up excitement for the privatization of Air India, there are
some hurdles, namely it’s crippling debt and dreadful operational performance.

That answers one part of the problem, as the debt will have to be handled differently. Initially, the expectation
was that if parts of Air India were sold, the company could attract more buyers and reduce the debt of the
parent company.

However, it looks like things will go a bit further. The Indian government will move Air India’s debt into a special
purpose vehicle (SPV) before selling the carrier. The government will transfer all debt and assets of Air India
into an SPV, leaving the airline with only with aircraft debt on its books.

Recent news reports suggest that our of the total debt of Rs.52000crs about Rs.33000 crs will be transferred
to a special purpose vehicles.

This will allow the airline to clean up the books and make itself much more appealing to buyers and also
increases the valuation.

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What Is The Market Value of Air India??

Jet Airways (India) Ltd, an airline with similar revenues as Air India but comparatively better profitability,
has an enterprise value, or EV (market capitalization plus net debt) of only Rs13,400 crore. Even if investors
assign a small equity value to Air India, its EV would be about 50% more than that of Jet Airways.

Does Air India deserve such a significant premium over Jet Airways? A new owner may be able to pluck some
low-hanging fruit that can help improve Air India’s financials. One area is making better use of the airline’s
slots.

According to some analyst, Air India is better off on the slots front and could prove to be more profitable
compared to Jet Airways, if managed well. If Air India reduces fares on the long-haul international routes, there
could be more underlying demand, which in turn may boost load factors, reports have highlighted. But how
these pan out remains to be seen and it can prove an uphill task. Sure, lower debt will offer relief on interest
costs, which were as high as about Rs4,700 crore for fiscal year 2016 (FY16).

Even then, the remaining Rs19,000 crore of debt needs to be serviced. Moreover, the transfer of debt to the
SPV may be accompanied by transfer of non-core assets as well.

Air India’s consolidated financials show that lower fuel costs aided operating profitability in FY16. For instance,
it earned an EBIDTA of Rs2,246 crore compared to an EBIDTA loss worth Rs325 crore in FY15. However, higher
interest costs ate into profits, with the company reporting a pre-tax and exceptional item loss of Rs4,321 crore
on revenue of Rs23,302 crore. EBIDTA is short for earnings before interest, tax, depreciation and amortization.

For comparison, Jet Airways’ consolidated revenues, EBIDTA, and pre-tax and exceptional profit for FY16 were
Rs22,207 crore, Rs2,236 crore and Rs1,054 crore, respectively. Debt of Rs19,000 crore would mean annual
interest costs worth Rs1,700 crore at a similar effective interest rate, which Air India’s FY16 EBIDTA could cover.
But note that Jet Airways’ EBIDTA declined to Rs1,153 crore in FY17 primarily owing to higher fuel costs. Air
India’s FY17 earnings are also likely to show similar trends.

Impact on the Industry

In the interim till Air India privatization kicks off, the lessor market will be more sceptical to lease aircraft to
Air India and may do so with higher guarantees and other recourse structures. The competitors will actually
benefit if there is a temporary suspension of the expansion plans of Air India which was supposed to induct
~15-20 aircraft in FY18.

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