How the IndiGo IPO leads us to the question of ‘right’ foreign investments in the aviation industry

Steven Philip Warner | The Dollar Business

 For those hopefully expecting an Indigo Airlines IPO in the last few days of this month, here’s an insider leak – the IPO won’t be out until late-July. Last fourteen days of July 2015 is when the window has been decided. The IndiGo management for now isn’t sure of the date either. Whatever the uncertainties over India’s largest carrier going public, one thing’s for sure – the market definitely expects IndiGo to get this one right too! We’re not just talking of the euphoria over a ‘healthy airline’ (much of an oxymoron these days in India) being listed. Speculations are rife about what IndiGo will do to get engaged with foreign investors – be it the pure chair-warming lot or even scheduled foreign carriers. There are suitors aplenty – some have gone vocal while some have remained tight-lipped. The tones of conversations about FIIs investing in IndiGo is different from those of the yesteryear, when the Indian partner was either a Kingfisher or an Air India. Far more positive is what it is today. [Given that Kingfisher mixed alcohol with flying, Air India drowned deeper each day with lack of professional management and constipated by survival kits funded by Indian taxpayers, and SpiceJet actually paid for just a mirage of greater market share, most wouldn’t have given a second thought to whether these three were even worth considering for a foreign carrier to invest in; forget investors looking for pure profit-making handshakes.] To give you an example, back in 2011, Gordon Bevan, Senior VP of UBM Aviation was of the opinion that whether or not the Indian government increased the FII/FDI limits in Indian airlines, the-then lot of carriers wouldn’t have found credible suitors. He was right. Kingfisher is in a coma and Air India only breathes because India is still an economy that is half clothed in the socialist fabric. But Bevan is upbeat today. He talks about IndiGo as being the start to a new chapter for Indian aviation when it comes to foreign investments (through the FDI-FII routes) in the business of scheduled airlines in the country. Some questions need to be asked here. Will investments by non-airline foreign investors help scheduled Indian airlines in the present day? Which is better – the non-airline group or carriers as buyers? And should FDI cap in scheduled Indian carriers be raised to 74%? To answer the first two questions first, we’d need to take a look at the Jet Airways-Ethiad Airways deal signed in 2013. Ethiad purchased a 24% minority stake in Jet for close to $400 million. That not only helped reduce Jet’s debt but also made operations slightly more cost-effective due to asset sharing and gave Jet indirect access to many of Ethiad’s overseas destinations. So going by this particular purchase by an airline entity, that investments by foreign carriers is a most positive development for Indian carriers is a given. Speaking about benefits to Jet from the Ethiad buy in it, to The Dollar Business, Binit Somaia, Regional Director – South Asia, Centre for Asia Pacific Aviation (CAPA), opines, “As a result of the investment by Etihad, Jet Airways has benefited from access to a powerful hub in Abu Dhabi and Etihad’s global network. In addition it has been able to refinance its debt through lower cost funding. It also benefits from scale economies in procurement right across the board.” Of course, for natural reasons, Indian carriers need to look to shake hands with foreign carriers class – even if that means overlooking non-carrier investors’ lucrative offers that may come on a premium of 10-20%. Adding detail to this argument in terms of choice of airline partners, John Siddharth, Defence & Aerospace Expert, Markets&Markets, tells The Dollar Business, “An Indian airline would consider selling stake to an airline from either South-East Asia or the Middle East depending on its future route planning. The advantage of stake sale to airline buyers is a common pool of resources and optimal asset utilization. From a passenger perspective it is all about connectivity and ease of travel.” But a choice of foreign buyer isn’t as simple as these few lines make it sound. One, buyers are hard to come when the sector-specific climate is as such as in India. Two, proper care has to be taken to ensure that neither is there a duplication of costs nor an overlapping of routes. (One reason why the merger between Air India and Indian Airlines (Feb 2011), and United and Continental Airlines (Oct 2010) got costly was because of the difference in fleet types that created duplicated maintenance costs and weighed heavy on operating margins of the merged entity!) Also it’s no big challenge for foreign carriers that have large exposure to the Indian market to bring traffic into the Indian sub-continent without local airline investment. (Look at FinnAir, Lufthansa and Emirates as examples.) Each foreign airline can talk though its own sweet deal with an Indian carrier (especially those in trouble and on the lookout for more business like SpiceJet) to secure connecting traffic in India. As far as duplication of routes is concerned, there will be little sense in say, a Lufthansa acquiring a minority stake in Jet. Why? What would Lufthansa do with Jet’s services to US? It will be difficult to allow the Indian carrier to route via Frankfurt or Munich because that would mean killing its own hub! So in this case, a stake purchase by Qantas in either Jet or Air India makes most sense because it would allow these brands to fly to Australia without actually flying their aircraft (which the two are reluctantly doing so at present). Talking about IndiGo in particular – if the airline is looking to welcome a foreign carrier aboard, it could divide the 49% FDI chunk into two exact pieces and give one to each carrier from US/Europe (like a Virgin, Lufthansa, British Airways, KLM, Air Canada, etc.) and either the Middle East or South Asia (Emirates, Singapore Airlines, Cathay Pacific, Emirates, Qatar, etc.). These will help fuel IndiGo’s expansion to foreign markets. [In fact for the past nine months, since FIPB approved a proposal from InterGlobe Aviation, to reclassify the 49% stake of promoter Rakesh Gangwal in IndiGo as NRI stake from FDI, Qatar Airways has been requesting IndiGo for permission to buy 49% in the airline, which IndiGo has been royally ignoring!] Here we come to the third big question. That of the Indian government’s Ministry of Civil Aviation (MoCA) allowing foreign investors to buy up to 74% stake in Indian carriers. About two years back, a logical request by the Department of Industrial Policy and Promotion (DIPP) to increase FDI cap in scheduled Indian airlines to 74% was brushed aside by the MoCA. Obviously the MoCA didn’t have to worry about FDI in Air India (the tax payers are always there, right?). Or they were perhaps too worried about the rule under international bilateral air services agreements that doesn’t allow airlines operating on foreign routes to have foreign majority stake ownership. [So if an Indian international carrier was 74% owned by an American airlines, it would no longer remain an Indian. Logical.] But how about airlines that were destined to remain within India by character and not out of will. Given a choice, Kingfisher Airlines’ CEO would have agreed to keep his carrier “only-national” for a 74% stake purchase by a foreign investor. Or a SpiceJet would have chosen to save some embarrassment by opting to stay limited to Indian boundaries. But because there was no facility for a majority stake in India’s domestic airlines, foreign buyers weren’t interested to rescue many ailing Indian carriers like Kingfisher Airlines and SpiceJet. The only thing real “foreign” about these many airlines remained their expat CEOs who knew little about the Indian daily flier! So there could be a reason for the MoCA to make a correction to its stance for logical reasons. Coming back to IndiGo’s IPO, it has “probably” been the only Indian airline to make profits every year for the past seven years. “Probably” because it may not be the only (Can you imagine Jet Airways making losses in the past eight years at a stretch to the tune of many thousands of crores and still continuing without working capital woes?), and because it may not be making profits in the first place (because it’s still not listed for reasons best known to its promoters and management). [We’ll keep speculation about how UK-based and Jet Airways’ promoter-owned Tail Winds Ltd. supplies aircraft to Jet Airways and how the airline makes losses due to the heavy outflow that happens as lease payments, for another day.] But all said and done, that IndiGo is up for hitting the primary market soon is fantastic news for the airlines and the Indian aviation sector alike. It has to be careful about its choice of foreign partner though. Come July and we will hear the opening bell for IndiGo.  

“India’s airline industry scenario is like a pressure cooker, without an outlet for the pressure. Increasing FDI cap is only a knee-jerk reaction… ”Binit Somaia, Regional Director – South Asia, Centre for Asia Pacific Aviation (CAPA) and John Siddharth, Defence & Aerospace Expert, Markets & Markets, speak to The Dollar Business on the IndiGo Airlines’ IPO, benefits to Indian carriers from foreign investments and on the proposed increase in FDI cap in scheduled airlines to 74%. How do investments made by non-airline foreign investors FIIs help scheduled commercial airlines in India? And how is that different from foreign carriers buying stakes? Which is a better alternative for scheduled Indian carriers?

Binit Somaia, Regional Director – South Asia, Centre for Asia Pacific Aviation (CAPA)

Binit Somaia (BS): Foreign airlines are in a position to bring strategic synergies as well as management and operational expertise over and above the capital itself, which generally makes them a better investor class for Indian carriers. John Siddharth (JS): FII or FDI route of investment opens up cash flow of the airline. The option of the alternative depends on the long term objective. An airline would consider selling stake to an airline in South East Asia or in Middle East depending on their future route planning. The advantages of stake sale are – a common pool of resources and an optimal asset utilization. From a passenger perspective it is all about connectivity and ease of travel. Has Jet Airways benefitted from the 24% minority stake purchase made by Ethiad in end-2013? BS: Foreign airlines are in a position to bring strategic synergies as well as management and operational expertise over and above the capital itself, which generally makes them a better investor class for Indian carriers. As a result of the investment by Etihad, Jet Airways has benefited from access to a powerful hub in Abu Dhabi and Etihad’s global network. In addition it has been able to refinance its debt through lower cost funding. It also benefits from scale economies in procurement right across the board.

] John Siddharth, Defence & Aerospace Expert, Markets & Markets

JS: Jet Airways has definitely benefited from the deal. The deal helped Jet to infuse cash $750 million, which helped cut its debt. As discussed earlier, the other major benefits are cyclical in nature, wherein Jet gets indirect access to the destinations served by Ethiad and vice versa, apart from cost effective operations due to asset sharing. IndiGo currently claims to be the only airline in India making profits quarter-after-quarter. Is that completely true? BS: I am not in a position to state whether IndiGo is profitable every quarter, however on an annual basis it has been consistently profitable for the last seven years, and it is the only carrier in India to have achieved this. JS: Indigo is definitely making profits due to its unique sale and lease back model. The airline makes about $4.5-5 million per aircraft due to this model. The cost of maintenance is also curbed due to the six-seven year service period of the aircraft. The unique sale and lease back model has helped Indigo to maintain consistency. IndiGo is gunning for a Rs.2,500 crore IPO. What are your expectations from it? What kind of interest will FIIs show, especially considering that the shareholding of promoter Rakesh Gangwal has now been reclassified as NRI holding from FDI and that Qatar Airways has for long been wanting to buy a 49% stake in IndiGo? BS: I am not in a position to comment on IndiGo’s IPO. JS: The valuation of Indigo is at about $1.6 billion, approximately Rs.10,000 crore. Indigo plans to raise about $400 million in exchange of 25% stake through an IPO. The current valuation is double of its closest competitor. Qatar Airways has been showing interest to buy into Indigo for the past few years, however Indigo has not been keen on the deal. The Indian aviation market is opening up with expected growth in travel numbers estimated at about 10% for the next decade. Almost two years back, a proposal was made by the Department of Industrial Policy and Promotion (DIPP) to increase FDI cap in scheduled airlines to 74%, therefore allowing cash rich foreign carrier to buy controlling stakes in scheduled Indian carriers. Should the hike be introduced to attract more FDI/FII? How will ailing carriers like SpiceJet, AI, maybe even Kingfisher which is practically dead, benefit from the move? BS: There is no strong interest that we are aware of in increasing the FDI cap to 74%, either from Indian or foreign airlines. If an airline wishes to operate on international routes, it does so in line with the entitlements granted under bilateral air services agreements between the governments of the countries between which it wishes to fly. The standard condition under international bilateral air services agreements is that airlines must be majority-owned by the nationals of that country to qualify for seat entitlements. Most countries in the world therefore cap FDI in airlines at 49%, and in the few cases where they permit higher equity e.g. Australia, it is for domestic airlines only. JS: India’s airline industry scenario is like a pressure cooker, without an outlet for the pressure. Increasing the FDI cap is only a knee-jerk reaction. The major killers in the sector are ATF taxes, airport development fee and 5/20 rule. Other pitfalls include bilateral agreements without a forward outlook – these agreements have enabled international carriers to fly to Tier 2 cities and cannibalise the ambitious plans of airlines in India to go international. The problem lies within. This sector is in a growth phase and needs support. And an earlier solution to these issues could have saved most of the airlines which are today in the death bed. Would new Indian carriers like AirAsia India and Vistara be interested in allowing foreign carriers/investors to own greater stakes in them, beyond the 49%-mark? BS: AirAsia India and Vistara both already have foreign airline equity partners. AirAsia Malaysia holds 49% in AirAsia India and Singapore Airlines holds 49% in Vistara. But since 49% is the maximum permitted under the regulations, they cannot offer any additional equity to foreign airlines without the current airlines reducing their holding. JS: 49% of the stake of Vistara is with Singapore Airlines which was approved by FIPB in October 2013. The same is the case with Air Asia India wherein 49% of the stake is with Air Asia Berhad and about 30% is with TATA. The rules were relaxed in 2012, the only eligibility is that three quarters of the directors need to be Indians.

May 29, 2015 | 3:53 pm IST.