AirAsia, Tatas and Amit Bhatia seek approval to start airline in India. Is SpiceJet the target?

by Devesh Agarwal

Malaysian low cost carrier AirAsia Berhad (Ltd.) through its investment arm, AirAsia Investment Ltd. (AAIL) has submitted an application to the Indian Foreign Investment Promotion Board (FIPB) seeking approval for AAIL to invest 49% into a proposed Indian joint venture together with Tata Sons Limited and Mr. Arun Bhatia of Telestra Tradeplace Pvt. Ltd. The expected holding in the JV is AirAsia 49%, Tatas 30%, and Arun Bhatia 21%.

Photo: Devesh Agarwal

This move comes amidst the backdrop of the September 2012 decision by the Government of India to open up the aviation sector to Foreign Direct Investment from foreign carriers.

AirAsia is one of the most successful low cost carriers in the world, and has created regional AirAsia airlines in Thailand, Indonesia, Philippines, and Japan in similar joint ventures like the one proposed for India.

The Tatas are a $100 billion conglomerate highly respected for their business values, and who used to own, then operate Air India prior to the government taking it over in the 1970s. The Tatas used to own close to 6% in Indian LCC SpiceJet Ltd., owned by the political heavyweight Marans who are related to DMK supremo Karunanidhi of Tamil Nadu. However, the Tatas claim their investment in SpiceJet is purely financial on with the two rounds of equity dilution at the airline, their stake is now down to less than 0.5%.

Mr. Arun Bhatia's son Amit Bhatia, is the son-in-law of one the richest men in the world, Mr. L.N. Mittal and serves serves on the Board of Directors at Queens Park Rangers Football Club in the United Kingdom alongside Tony Fernandes, the founder of AirAsia.

Subject to FIPB approval, the proposed joint venture company will make an application to Indian aviation regulators for the Air Operators Permit. The parties have signed a Memorandum of Agreement that details high-level terms with regards to the proposed partnership.

The airline, if formed, will be based out of Chennai, which will allow domestic connectivity to AirAsia's international operations.

This foray will mark a return of the Tatas to the airline and airport sector after almost 25 years. In the 1980s and 1990s, the Tatas had proposed a collaboration with Singapore Airlines to operate a domestic carrier and also to take over Air India. The Tatas had also collaborated with Changi Airport to develop the greenfield airport at Bangalore, which is now BIA. All efforts were thwarted by political opposition.

Our analysis

We are not sure how well this proposal will be received. India's civil aviation minister is on record with the Business Standard newspaper

“We are not giving licences for greenfield airlines. As of now, FDI (foreign direct investment) in aviation can come only through existing airlines."

Based on this premise, for the past few months, Jet Airways has been negotiating with Abu Dhabi based Etihad to sell a 24% stake in Jet for about $300 million. The Chairman of Etihad Sheikh Hamed bin Zayed al-Nahyan has already delayed the deal citing concerns on policy flip-flops. An approval to AirAsia will prove the Sheikh's point, and almost certainly scuttle the FDI initiative, announced by the government last year, which is essentially meant for rescuing India's debt-laden airlines and the banks who have already lent massive amounts to them.

We expect there will be strong, if not, insurmountable opposition especially with regards to existing Indian carriers like Jet Airways, SpiceJet and IndiGo, each of whom should not be discounted for their strong political connections.

So knowing all of this, why has this JV application been submitted? What do the Tatas, Bhatias, and Tony Fernandes know, that is not apparent?

Photo: Devesh Agarwal

If one was to go in to a conspiracy theory mode, the common point is SpiceJet.

From one side, the Tatas own a stake in the the airline. From the other side, Anthony Francis "Tony" Fernandes is in the very top Malaysian business tycoons circle, along with Mr. Ananda Krishnan, the Chairman of Maxis and Astro, both of which have been linked to the Maran brothers Dayanidhi and Kalanithi respectively, and Kalanithi Maran is the owner of SpiceJet, which has a need of funds for expansion.

Quoting from our Indian Aviation Review from earlier this year

Q400 operation is certainly a strong performer in SpiceJet’s tepid overall finances. The full order of 15 Q400s is now complete, and while SpiceJet has options to purchase 15 more from Bombardier, unfortunately it cannot find financing for the next 15 deliveries, which it desperately needs to expand the regional operation

May be Mr. Maran is wanting to exit the airline business?

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Financial Analysis of SpiceJet's Q1 Financial Results

Earlier this month, all 3 of India's publicly traded carriers announced their results for the first quarter of Fiscal Year 2012. Devesh has already taken a look at the operating parameters for the quarter, so I'll be digging into the raw data itself.


The three carriers to be studied are; Jet Airways Group; composed of full service carrier Jet Airways and its low cost subsidiary JetLite, (their second low fare service Jet Airways Konnect's numbers are rolled in to those of Jet Airways), fellow full service carrier Kingfisher which includes its low fare Kingfisher Red service in the mainline numbers, and low cost carrier (LCC) SpiceJet.

First up is SpiceJet.

The Gurugaon based carrier swung sharply to a net loss of 719.6 million rupees in the first quarter of FY2012 (ended 30th, June 2011), versus a net profit of 552.2 million rupees in the comparable quarter of FY2011.

The airline did, however, indicate that some of its performance metrics improved year over year.

• Revenue was up sharply to Rs. 9456.4 Crore, up 31.9% from Rs. 7168.6 Crore in Q1 2011
• SpiceJet carried 2.58 million passengers, with its growth rate of 25% outpacing the overall industry growth of ~15%
• Passenger yield was up 5.5% to Rs. 3,663
• Absolute non-fuel costs grew 29.8%, while absolute fuel costs grew 94.9%; all on capacity growth of 36.7%, an increase of 40% in the number of departure, and 28.0% increase in block hours
• Seat-kilometer revenues declined 3.5%, while seat-kilometer costs rose almost 14%; seat-kilometer costs excluding fuel decreased 5%.
  
• Interest payments increased 352.8% to Rs. 59.9 million, greater than the entire interest payments of FY11; Rs. 48.3 million; however this total is miniscule in comparison to other Indian carriers
  
• Total maintenance cost was up 33.6% on fleet growth of around 39.1%

Observations:

Fuel cost was obviously the biggest driver of SpiceJet's performance this quarter. With fuel prices paid by SpiceJet up more than 42.5% YOY; it would have been hard for SpiceJet to make a profit in the best of revenue environments.

Despite Q1 traditionally being a period of peak demand (April and May are peak summer travel months), the lack of capacity discipline hurt SpiceJet's ability to improve yields. As SpiceJet CEO Neil Mills put it:

"However, yields remained under severe pressure due to an irrational pricing environment that prevailed in the market, thereby undermining the airline’s ability to pass on the impact of the higher fuel price to the passenger in a growing market."

Passenger yield did grow 5.5%, but this lags far behind the regular 15%+ growth figures displayed by SpiceJet; this in spite of 15% growth in demand.

Part of SpiceJet's problem stems from the fact that its network is metro-heavy; the majority of its flights are in large cities; especially in the North. While Delhi is certainly a strong base for the carrier, having your largest bases in Mumbai and Delhi leaves a carrier vulnerable to fare wars. With margins on metro routes razor-thin due to competition amongst carriers, any increase in fuel prices is going to have a disproportionate effect on SpiceJet.

Thus, the new Q400 operation should help SpiceJet by balancing its route network with more smaller cities in the South (and later the North as well). Both Jet Airways and Kingfisher already have decent sized turboprop networks; these have higher passenger yield, less competition, and lower fuel costs. Look for SpiceJet's results to reflect these benefits starting in Q3 and Q4 (as the operation really kicks into gear).

In spite of these issues, SpiceJet did manage to grow at a significant clip; with market-share up from 13% to 14%. As the carrier continues to grow its fleet and increase its flight offerings, it should be able to capture an ever-increasing share.

International growth looks to be more stagnant. SpiceJet has not yet expanded beyond its initial two destinations of Colombo and Kathmandu, even though it has rights to operate to Dhaka and Male. This blog speculated in 2010 that the Maran take-over would drive an increase in international presence; especially to ASEAN nations. As of today, no such expansion has occurred, and with the focus shifting to the Q400 operation, serious international growth may be pushed deeper into the future.

Cost performance excluding fuel was positive, despite a drop in aircraft utilization from 12.45 hours per day to 11.43 hours per day. However, utilization may have dropped due to an increase in the number of bases from which flights are operated. Utilization figure analysis must always be tempered with a consideration of revenues; if such an approach yields revenue growth; then SpiceJet can get away with flying their aircraft for less time each day.

Longer term, the only major concern I see for SpiceJet that is independent of the broader market, is aircraft related costs. Assuming that lease rates for the 737NG remain roughly stable over time (a valid assumption given that the A320neo and possibly 737-7/8/9 are on the horizon to drive down lease rates on current generation aircraft), SpiceJet will have to deal with increasing depreciation and maintenance costs. With an average fleet age of just 4.4 years in May of 2011, SpiceJet has thus far escaped the worst of these fleet related costs. Depreciation and maintenance costs increase exponentially as aircraft age, so longer term cost performance will be trending upwards.

-Vinay Bhaskara

Twitter: @TheABVinay

Contact me at vinay@bangaloreaviation.com

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Kalanithi Maran's takeover will make SpiceJet a game changer in Indian aviation

After six months of discussions, it is finally official. Media baron and political heavyweight, Kalanithi Maran will acquire a majority stake in low fare carrier SpiceJet.

Mr. Maran in his individual capacity and via his aviation company KAL Airways jointly owned with wife Kaveri, will initially acquire the 37.73% stake of the Kansagara family promoted Royal Holding Services Ltd., Wilbur Ross and his investment company WL Ross. To ensure this transaction does not breach the 49% foreign ownership rules of the Indian government, the transfer will be done in tranches. Mr. Maran will initially buy 24% from Kansagara and Ross and then another 13% from Ross in December.

In parallel, as per rules of the Indian securities market, Mr. Maran and KAL have today announced an open market offer to acquire an additional 20% stake in SpiceJet. The offer at Rs. 57.76 per share represents a three percent premium over last Friday's closing price of SpiceJet of Rs. 56.05. The offer will open on August 6th and close on 25th. Maran is expected to pick-up enough shares to ensure his control on the airline.

Consolidation
SpiceJet completed the mandated five years of operation and has crossed the 20 aircraft fleet requirement making it eligible to commence international operations.

Till now, SpiceJet's ownership has been extremely fragmented, which has resulted in many a delay on critical decisions. The airline has been grappling with attempts to raise $75~$80 million for its much needed expansion. Mr. Maran's takeover will consolidate the ownership and his deep pockets will provide the funds needed to add more aircraft and an impetus to quick growth.

Clout
The Marans are a force to be reckoned with, both financially and politically. The Maran family is a core part of the DMK party, currently in power in Tamil Nadu state, as well as at New Delhi, as part of the UPA coalition government. Kalanithi's elder brother Dayanidhi Maran is a union cabinet minister. The Marans do not lack on the financial front either. Apart from their flagship Sun media powerhouse, the Marans have widespread business interests across the south, and have come to dominate the businesses they are in.

In an area that requires both money and behind the scenes politicking, the Marans can be expected to use their clout to ensure quick and decisive actions which will make SpiceJet a game changer in Indian aviation.

SpiceJet has been already been given permission to operate to Colombo, a much desired destination that was previously refused by the Ministry of Civil Aviation before Maran launched his takeover.

The ASEAN region, especially Malaysia and Singapore have very strong cultural, and commercial ties with south India, and Tamil Nadu in particular. Tamil is in fact one of the four official languages of Singapore. A strong SpiceJet will compete far more effectively with ASEAN low fare behemoths AirAsia and Tiger Airways.

Management and Operations
Without doubt SpiceJet will increase its focus on the south, especially Chennai, and this is good. The south by and large has not received its due share of market focus by most Indian carriers. No Indian airline, with the exception of the single plane Paramount, claims any of the southern airports as its hub.

To the fears the Marans may shift the entire head-quarters of SpiceJet from Gurgaon near Delhi to Chennai, I offer a small saying by my uncle "In the south [part of India] man fears god, in the north its the other way around".

There is also a fear that SpiceJet CEO Sanjay Aggarwal who was brought in soon after Wilbur Ross acquired a stake in SpiceJet may be replaced. This in my humble opinion will be a bad move. Aggarwal brings a great blend of hospitality and transportation experience and many SpiceJet initiatives showcase his learning from both industries. He is an asset SpiceJet can ill afford to lose.

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