Employees and stakeholders are patiently waiting for the bid process of the grounded
Jet Airways to conclude on May 10. Each passing day brings forth another news item that impacts the value of the airline.
Given that the successful bid will be a “binding bid” any investor needs to value the airline and assess the opportunity costs. But the traditional valuations methods simply won’t do. Because given the complexities of the situation the asset base, loan quality, liability structures, liquidity, capital structure, inter-corporate agreements and unencumbered assets – all are in question. So how does one value Jet?
Traditional measures of financial value are invalid when an airline is not flying
The financial value of any asset derives from the expected cash-flows that the asset will produce. Discount this back adjusting for risk and one arrives at a valuation. Jet at this point is not generating any cash.
And owing to a string of disconcerting events — lessors’ repossession of aircraft, defaults including breach of debt covenants and multiple resignations — the airline is a shadow of what it used to be. Thus one can neither use current numbers nor historical ones to predict future cash flows.Any party forcing a discounted cash-flow essentially will have to make multivariate forecasts and then adjust the presumed cash-flows for risks, complexities and contingencies. Such a valuation based on forecasts is best summed up in the words of Warren Buffet who stated:
Forecasts may tell you a great deal about the forecaster; they tell you nothing about the future.
Similarly, a multiples-based approach cannot be used because the only listed competitors are SpiceJet and IndiGo, both of whom have a different business model. And remember Jet is not comparable in its current form to competitors. If one forces such a valuation, it will be misleading at best. Ironically because competitor multiples have witnessed an expansion due to the situation at Jet.
Finally one may consider a net asset valuation. However, since Jet’s debt is higher than the assets this also becomes meaningless.
The valuation must also consider opportunity cost
Every investment comes with an opportunity cost. That is, for any investor to go ahead the investment case must be strong enough where other options are disregarded. Any assessment of opportunity cost must measure the investment against alternatives, these being: making an alternate investment; making no investment at all; or waiting for the next opportunity.
The opportunity cost here is driven by the India market potential (300 million middle class, low air travel penetration and increasing propensity to spend) coupled with the constrained airport infrastructure (lack of adequate slots and parking and the inability of airport capacity to keep up with demand). These two combined create a moat for an investor that comes in – a moat that may not be available in the future when the market matures and airport capacity starts to catch up.
In the case of Jet, it is no wonder that there has been so much discussion on slots because these represent a significant opportunity cost.
Complexity adds to cost and leads to erosion of value
Over the last few weeks, Jet has seen a continuous erosion of value. This started with the
promoter unwilling to cede control and then with a gradual grounding of the fleet. The grounding had impact on schedules and forward sales both of which added to contingent liabilities. Aircraft repossessions followed and each airplane taken back meant a lesser ability to generate cash-flows.
The lack of cash led to the eventual suspension of Jet operations on April 17, 2019. Post the suspension, Jet’s most valuable assets namely slots were re-allocated (albeit temporarily). If that wasn’t enough there are also allegations of tax evasion.
All of the above actions have increased the complexity of the investment. An investor that comes in essentially has to appoint a new management team to unravel these and resolve these in a time-bound fashion.
Unfortunately, this plays into the erosion of value.
The only way to ascertain value is a building blocks approach
With traditional approaches being invalid and the ongoing erosion of value, the only way to value Jet Airways at this time is to use a building blocks approach. That is, take apart the assets and liabilities ascribe a value to each -- in terms of time and money and risk appetite.
Also Read: Tepid interest in Jet Airways and Air India: Why investors must take a second look at how Indian airlines are valued
The assets include a mix of tangible and intangible assets such as the airline operating certificates, unencumbered aircraft, trained talent, aircraft order, slots, bilaterals and the Jet privilege programme (inextricably linked to the airline operation). Valuation of these is a topic in and of itself.
Interestingly, the valuation of the liabilities is easier (with the exception of contingent liabilities). Jet is staring at a debt of Rs 8,500 crore, a working capital requirement of Rs 2,000–3,000 crore, and contingent liabilities estimated at another Rs 3,000–5,000 crore. With proper management expertise, these can be structured in a manner that is acceptable to investors and banks using triggers, milestones and contingent provisions.
Unfortunately, because the building blocks approach aggregates the value of parts, it is also why there have been rumours that some investors will only look at Jet post it being referred to the National Company Law Tribunal (NCLT). The NCLT scenario ironically gives investors more certainty (due to the moratorium on lawsuits, the priority on payments and the decision being binding on all parties).
Total value = financial value + opportunity cost + strategic gain
With an assessment of the financial value and opportunity cost, one has to concurrently start layering in the strategic gain that will accrue to an airline investor or to a third party in the event of a secondary buyout or a trade sale. To understand this gain though requires a clear compelling strategy, market expertise and an unbiased view of the situation.This view is hard to come by because most stakeholders are entrenched. Banks want a bid to come through so the loans don’t go bad; consultants and lawyers that help with the bid may also be the folks who then work on the restructuring; vendors and employees are keen to see the airline resurrect while also waiting for pending dues. All of this makes for an extremely complex case and has parties pushing outcomes that by their very nature are misaligned.
Show me the incentive and I will show you the outcome.
– Charlie Munger
The valuation of an airline that is not flying requires multiple perspectives all to be layered in at the same time. This includes factoring in non-measurable parameters such as time, access, talent, tradition and technology. Pure financial models simply won’t do and investors have to search for value in non-traditional sources.
And once the value arrives the next step is the price the investor is willing to pay.
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. Has also provided policy inputs and suggestions. A certified pilot, he is an alumnus of the London Business School.