Why the Air India disinvestment will likely be a sale of parts

Legendary investor Charlie Munger, when asked about analysing companies, famously stated, “Invert. Always invert.” His contention is that inverting an issue is one of the best ways to understand it fully. This derives from the work of mathematician Carl Jacobi. And such an approach indeed throws up interesting angles for companies being analysed. In the case of Air India such an approach not only helps understand where the issues lie but also where the pockets of value are.

Traditional analysis of Air India has been a top-down view. And indeed, the numbers paint a stark picture. Consider the FY19 loss of Rs 7,635 crore and consolidated debts of Rs 58,351 crore. This during a year where there were several opportunities to exploit competitor challenges and weaknesses. Yet consolidated numbers do not give a fair picture. The true value of the airline can only be established by examining the parts as stand-alone entities.

Profitability profiles of different subsidiaries are in stark contrast. Consider the regional airline arm that bled Rs 263 crore for the last available financial year (FY18) while Air India Express delivered a net profit of the same amount. Or The Hotel Corporation of India Limited consisting of two hotels and two flight catering units which lost Rs 55 crore compared to the net profit of the ground handling arm for the same period.

The biggest challenge is the core airline which has been bleeding cash. For a period to FY15 - 18 the cash losses have exceeded Rs 29,000 crore – an amount enough to capitalise global international airline. And a path to profitability is nowhere in sight.

Strategic investors looking to assets such as slots, bi-lateral rights, maintenance facilities and other assets, face huge challenge. This is because the government has indicated that the assets will not be sold in a piece-meal fashion. Essentially, this means buying the entire entity or subsidiary and then stripping out the costs towards profitability. Concurrently, integrating parts that make strategic sense while selling off non-core and non-strategic assets. The only challenge: the liabilities are not ring-fenced.

Without ring-fencing of liabilities, it is almost impossible to determine the full-extent of the costs. Of particular concern are the contingent liabilities. Take for instance the core airline. Of a total of 49 wide-body jets, 6 are grounded owing to payment due to the vendors. The assessment of costs towards getting these aircraft flying again are varied and there is no guarantee against contingent claims from any of the parties affected. As such, it is a deterrent for any potential investor.

It is inevitable that the government will have to ring-fence the liabilities in one way or another – but this has not yet been communicated.

The government created a special purpose vehicle named Air India Asset Holding Ltd (AIAHL) as part of financial restructuring. The aim is to transfer Rs 29,464 crore to this SPV which will then be paid out with the money accrued from asset sales. The asset sales include non-core assets and non-operational assets. But the SPV is a double-edged sword. Firstly, with a total debt of Rs 58,351 crore, this still leaves the airline and subsidiaries with

Rs 28,887 crore of debt. And a debt level that high or even fifty percent of that amount is far too high to attract any buyers. Secondly, given that the lending to aviation is highly constrained, in several cases the value extraction or value accretion for a bidder would likely come from the non-core assets. With these hived off, the attractiveness of the sale actually decreases.

Finally, the challenge of asset sales are further compounded by the general economic climate. For instance, the land banks were to be particularly cash-generative. Yet the indications are not positive. The very reasonable target of Rs 500 crore that was to be raised through the sale of land assets in FY19 was missed. FY20s target will likely be more aggressive against a backdrop of falling real-estate demand and developers facing a liquidity crunch.

In what could be a case study of intent versus impact, the SPV and the method of reducing liabilities via non-core asset sales may actually become counter-productive to the overall effort.

A national carrier with established route structures and sizeable assets in the fastest growing aviation market in the world.  But investors are still wary – not only for Air India but for Indian aviation as a whole. (Read more here.) If the last round was any indication, the signs are not good. While the last round had bid-parameters that itself deterred buyers, the bid parameters have now been re-done.  But against that backdrop, the Tata’s (assumed to be a lead contender) already announced that they will not be engaging in any large purchases in the near future. Amongst other competing airlines, only Indigo and SpiceJet will have the wherewithal to make such an acquisition. Even there, Indigo has clearly indicated that it is only interested in certain parts of Air India. They are only looking at key assets that are value accretive. Specifically: hangars, training facilities and the jewel in the crown: Air India Express. Foreign airlines or funds will require an Indian partner and it is almost certain that issues of substantial ownership and effective control will be brought up. If the courts get involved, any buyer is left navigating the legal maze which is both time consuming and expensive.

Yet, for the government there are few options that remain. The indications have been clear that the status quo will not continue with Air India and continued funding of losses is unsustainable. Without any determined path to profitability coupled with limited interest from potential buyers, the government will likely have to reconsider the sale of the complete entity to one that involves a sale of parts.

In considering a sale of parts, and if examined in terms of profits and stability of cash-flows, two extremely valuable subsidiaries emerge. Namely, Air India Express – the low-cost international arm, and Air India Air Transport Services Limited (AIATSL) – the ground handling arm. Both are well positioned within their segments and do not carry the same debt burden like their counterparts. AIATSL though does have some personnel issues that will need to be addressed. Most importantly both are well managed and have been profitable on a net level for the last five years.

Indeed competing airlines such as Indigo or SpiceJet will likely be examining these subsidiaries closely, because these are value accretive and cash-flow accretive and accelerate growth plans. They also are easier to integrate with operations as opposed to a consolidated entity. On the valuation front, considering current valuation multiples, the government can easily expect an amount of Rs 5000-7000 crore for these entities combined.

Overall, the contention is that given the above challenges the government will be forced to consider a sale of Air India by parts. Failing that it seems there are no other options.

Satyendra Pandey is the former head of strategy at a fast growing airline. Previously, he was with the Centre for Aviation (CAPA) where he led the advisory and research teams. Satyendra has been involved in restructuring, scaling and turnarounds.