The government continues to focus on the Air India disinvestment. This topic came up in a recent interview with Chairman of Tata Sons N Chandrasekaran. When asked about Air India and if the Tatas were open to the opportunity, he indicated, “as long as it can add value to our airline portfolio, then we will take a look.” He further stated that it would be a “calculated call” keeping in mind the complexity of the decision. Any discussion would be centred on three pillars. Specifically: If an acquisition added to the portfolio; what it adds; and finally what are the pain points.
The response has the industry abuzz with speculation that the Tata Group will likely bid for Air India. Indeed, Air India is a more attractive proposition this time around. Debt levels are significantly reduced. A 100 percent stake sale (as opposed to 76 percent the last time) gives the buyer total control. And the liabilities are likely to be ring-fenced. Add to that a valuable slot-portfolio, a captive Maintenance Repair and Overhaul setup (MRO), lucrative bilateral rights, membership in the Star Alliance and the Maharaja brand. Yet the question remains: Does such an acquisition make sense?
The Tata Group’s current airline portfolio is bleeding cash
The Tata Group’s current airline portfolio includes Vistara and AirAsia India. Both are 51:49 joint ventures– Vistara between Tata Sons and Singapore Airlines and AirAsia India between Tata Sons and AirAsia Berhad. Combined these airlines command a market share of 12.1 percent with a fleet of 59 aircraft flying to 34 domestic destinations and 3 international destinations. AirAsia India is geared towards the leisure market focused on offering the lowest fares and Vistara is a more premium offering based around customer experience. Since inception, both have been forced to change strategy to align with the changing nature of the Indian market.
The challenges for Vistara and AirAsia India can be traced back to two key items: The cost-base and the network. To set this right, both airlines need to scale up which in turn will drive efficiency, help amortise costs and provide a better offering. But that effort is challenging due to airport constraints and competitive intensity. The impacts of this are seen in the financials. Combined Vistara and AirAsia India posted a loss of Rs 1500 crore in FY19. The losses are forecast to continue for a while. As Tata Sons chairman indicated, “…we are not going to see those companies generating profits or cash at least until 2025.”
Air India is value-accretive to the airline portfolio but requires patient capital
For a portfolio that is bleeding cash, prima facie an acquisition of Air India does not make sense. Because it adds debt to the balance sheet, complexity to the operation and continued cash losses. That is until you separate out the parts.
Air India on a consolidated basis registered a net loss of Rs 8,400 crore in FY19. Yet, looking at the parts separately is what is likely to inform the strategy of integration. Air India Express continued its profitability streak generating Rs 169 crore (actual profitability is much higher as it pays royalties to the parent company) and the ground handling arm will also report a net profit in excess of Rs 100 crore. Both subsidiaries are profitable and with good fundamentals. As such, both these arms will continue to churn cash in the future. The regional arm is a cash-drain with losses estimated to be in excess of Rs 250 crore and will have to be sold. Air India domestic and Air India international are the two segments that will have to be rationalised.
With an acquisition of Air India, the Tata group airline portfolio reaches a 25 percent market share with a fleet of 220+ aircraft and a combined network of 100 destinations (domestic plus international) effectively positioning it as #2 player in the industry. It also enables Vistara and AirAsia India to address structural challenges in the network, giving both airlines a boost.
Further, such an acquisition enables the Tatas to compete on multiple segments. The low-cost segment via AirAsia India, the premium segment via the Vistara-Air India combination, the low-cost international segment via Air India Express and on ground-handling and MRO via the other subsidiaries. On the full-service segment the Tata Airline portfolio will command a complete monopoly. On long-haul flights - such as the flights to Europe and the USA - with the right investment in product (estimated at Rs 700 crore) - it can realistically compete with foreign carriers.
But such integration requires capital. And patient capital at that. Looking at corporate houses in India, the Tatas are the only one that come to mind. Because whether it is their acquisition of Tetley Tea (that broke even after 11 years) or their patience with the integration and turnaround of Corus Group plc as a part of the overall steel business or the turnaround with JLR and the continued patience with its international operations - the group has demonstrated that once it has committed to an investment, it has the wherewithal to see it through. The stellar credit rating, availability of talent well versed with complexity, and the ability to borrow at very competitive rates further helps.
Managing the airline portfolio and realising synergy benefits
While the term “synergy” is thrown around, realising these gains will be an uphill task. Especially given the House of Brands that will emerge with all three airlines - Vistara, AirAsia India and Air India - having strong brands. Simply looking at operational metrics one sees large variation amongst the three. Consider the most recent parameters where there was a 30 percent spread between the aircraft utilisation figures, 10 percent spread between adjusted stage lengths and very different yield management and pricing strategies with a load-factor difference of 7 percentage points. All of these will have to be addressed – separately and collectively.
Managing the airline portfolio will also include carving out distinct market segments, targeting those segments, driving yield, driving efficiency and revisiting the overall strategy. Decisions will include where to compete and where not to compete, commercial agreements, procurement, technology and talent. This includes the frequent flyer programme, national flag carrier status, the captive MRO, OEM agreements and staff redundancies – to name a few. The complete list is fairly exhaustive.
The overall synergies gained though can be significant. The value of being in the right market at the right time cannot be overstated. Add to the fact that other airlines in the South Asia region are facing their own set of challenges and looking to sell as well.
For the Tatas, this presents a unique opportunity and with the right strategy, discipline and execution the portfolio can be EBITDA positive within three years and depending on the financing structures and cost of capital breakeven soon thereafter.
An acquisition is not without pain points
While an Air India acquisition is value-accretive in the long term, it is not without challenges. First there is the issue of attacking the cost base and driving efficiency. This is not limited to Air India but for the airline portfolio. As such it is an extensive and painful effort. The cost base has to be addressed. A fleet of 8 aircraft types and 4 engine types will have to be rationalised. A new fleet order towards replacement capacity to be negotiated. Thirteen unions and contingent liabilities dealt with. Add to that political pressure, likely PILs and other cases.
At the same time, competitors are expanding rapidly. With voluminous fleet orders and continued expansion of operations, everyone wants to lay claim to the 200+ million passengers flying in and out of India (forecast to grow to 500+ million passengers). It is expected that competitors will take a position that slots and bilateral rights are national assets and cannot be reshuffled within the airline portfolio. The precursor to this was how airlines veered away from a single fleet type just to be able to get these assets.
And finally the issue of cash. When examined in terms of EBITDA, capex and debt the acquisition requires a fair amount of cash. And in the near term this can be significant: estimated to be in the range of Rs 5000 – 7000 crore. This following an infusion of more than Rs 5000 crore by the Tata Group till date into Vistara and AirAsia India.
The decision to bid or to expand organically
As the government continues to signal its intent for the privatisation of Air India, any potential bid from the Tatas will undoubtedly come with extensive due diligence. Just recently news reports indicated that Air India invited bids for legal firms to assess the contractual obligations, labour issues and potential liabilities. This is an action that should have been carried out months ago. A forensic audit is also the need of the hour.
Selling a much-improved Air India would have delivered better gains for the government. Unfortunately, the cash-strapped airline in its current form simply does not have the resources, will or the leadership to affect a turnaround. Profitability remains elusive and even now a sale of parts is likely to be the most reasonable option.
While the Tata Group is the best suitor for Air India, for the Tatas the decision is even more complex given that they have the option to expand organically with their current airlines. This not only gives them a clean slate, it also helps identify marketplace weaknesses and wait out a possible consolidation, exits or further policy changes.
JRD Tata famously stated, “Nothing worthwhile is ever achieved without deep thought and hard work.” If the Tata Group does indeed bid for Air India this line will essentially have to be the guiding mantra.
Satyendra Pandey has held a variety of assignments in aviation. He 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.
Read his columns here.
First Published: IST