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BW Businessworld

In Critical Care

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DAY: 15 November. The two biggest airlines in India called for meetings, both coincidentally in Mumbai and around the same time. Kingfisher Airlines (KFA), India's second-biggest airline even till that day — it has since slipped to third position — had called a press conference in Mumbai's Hyatt Regency to explain its parlous situation. At the conference, Vijay Mallya, chairman of the beleaguered airline, and Sanjay Aggarwal, its CEO, tried their best to explain why the airline suddenly needed to cancel scores of flights, why it was looking desperately for a cash infusion and a restructuring of its debt, and why it was the duty of the government to help it out.

The Jet Airways meeting was being held in its new headquarters at Siroya Centre, a stone's throw from Kingfisher's press briefing. This one was an internal management committee meeting. And the CEO of India's biggest airline by market share, Nikos Kardassis, was breaking bad news to the pilots. He had a simple point to make. Jet was also in deep trouble and things were not getting any better. Deep cost cuts would be needed so that the airline could avoid slipping into the same mess that Kingfisher was in.

The Jet pilots listened with disbelief. Sure, they all knew that Jet was losing money. But the airline had continued to hire more expensive expatriate and SpiceJet pilots. They were hoping to wrest a salary hike from the management, but Kardassis was suggesting the opposite.

In the Ministry of Civil Aviation in New Delhi, senior bureaucrats were trying to figure out if there was a way out of the sludge that the entire sector is in. The director general of civil aviation, Bharat Bhushan, was trying to figure out how many slots Kingfisher was using and how many it was cancelling, and whether the airline was carrying out the required safety checks before flying. Financial crunch or not, safety remains core.

The bureaucrats have other worries too. Air India, the national carrier, is virtually a "basket case", with losses several times higher than Jet's and KFA's put together. It needs huge infusions of cash from the government to keep flying.

Low-cost airline SpiceJet, now owned by the Marans of Chennai, is losing money too. Mumbai-headquartered Go Air, promoted by the Wadias of Bombay Dyeing, is haemorrhaging as usual. Airline industry sources say that it has never made money since the day it started, though confirmation is hard to get because it is an unlisted firm and its management does not want to talk. Meanwhile, two airlines — MDLR and Paramount — have folded up in the recent past. There seems to be just one airline in the entire country that is doing reasonably well — low-cost carrier IndiGo.

A Lousy Business
Aviation is a tough business globally. Margins are low and only the most-efficient make any money. This year, with global crude prices rising, even some of the profitable airlines of last year are expecting to make losses. The International Air Transport Association (IATA) recently revised its profit numbers for the year downwards.

But in India, it is a nightmare. Overcapacity, poor management and bizarre competition have led to a situation where almost no airline can hope to make money consistently. And few can hope to make money at all.

There are two problems unique to India. One, Air India — which enjoys government support — cuts fares to fill aircraft and sparks off a price war every few months even though its losses keep mounting. This year in January, it cut fares sharply and everyone had to follow. In April, Jet Airways — aware that this would lead to blood on its balance sheet — tried to raise fares marginally, but failed. Its loads fell sharply and it had to cut fares again. In the quarter ending 30 September, all airlines in India saw fares decline by 15 per cent while costs rose by 25-30 per cent, largely because of fuel price hikes. The result: combined losses of close to Rs 2,000 crore in a single quarter.

The second problem unique to India is that the aviation turbine fuel (ATF) sales tax (which varies across states) is among the highest in the world. "No one can make money in India unless these taxes are rationalised," says Kapil Kaul, CEO for South Asia at Centre for Aviation (Capa). Jet's Kardassis says the airline would turn profitable "instantly" if these taxes were removed (see interview on page 32). He would not speak for Air India and Kingfisher, but says he is certain that SpiceJet would turn profitable and IndiGo even more so. But even if the government did slash ATF prices, would that solve Kingfisher's problems?

Empty Coffers
Kingfisher refused to participate in this story. Despite repeated calls and emails, neither the senior management of the airline nor its corporate communication department or public relations firm responded to Businessworld's queries. But industry sources — those employed by KFA rivals as well as its vendors — say that the airline was on cash-and-carry for most items. Moreover, with rising fuel prices, what the airline earned daily kept falling and its losses mounted. Finally, KFA found that it just could not afford to keep its planes flying.
So it started cancelling flights, not because it had decided to move out of the low-cost segment and was pulling out aircraft to reconfigure its routes — as it has claimed — but primarily because it had no funds. One week after the press conference, the airline was not operating 147 of the 418 time slots it had been allotted. Only 25 A320s and 15 ATRs out of its total fleet of 66 aircraft were flying. Bhushan from the Directorate General of Civil Aviation (DGCA) told BW that he may cancel KFA's unused time slots and give them to other airlines.

"Why none of us believe Kingfisher's claim is for two reasons. One, the crew and ground staff were taken as much by surprise by the cancellations as the passengers. There was nothing planned about it. Two, many airlines withdraw aircraft to reconfigure, but this is done in a planned manner. A while back, Jet Airways reconfigured almost 72 per cent of its fleet (to JetKonnect). It cancelled maybe one odd flight," says a Mumbai-based aviation analyst, who refused to be named as his firm works with all major carriers.

On 15 November, for instance, only two of Kingfisher's 26 counters at Delhi's T3 terminal were operating. The rest were deserted. "Flights were cancelled left, right and centre. There was no planned withdrawal. Things had spun out of control," says a Delhi airport official.

Civil aviation ministry sources agree. "No one creates such mayhem for a planned reconfiguration. They stopped flying because they were broke. Most vendors have put them on cash-and-carry. No cash, no carry," says a civil aviation ministry official, adding that KFA has "over-extended" itself.

No one believes the airline's second claim either — that they are moving out of the segment because there is no such thing as "low cost, only low fare". A KPMG aviation analyst says that KFA CEO Aggarwal was primarily a low-cost airline professional. "The only airline in India making money is in the low-cost segment. And they (Kingfisher) claim there is no such thing. He (Aggarwal) was most unconvincing. And Mallya clearly cannot make up his mind. He has flip-flopped between the two models from the very start," he says.

Also, it was only recently that the airline got a full-time CEO. "You need a hands-on, full-time CEO and management team. This is not a business to be run by remote control or from on board aircraft," says a former aviation secretary.

Critics also say Mallya never had a handle on costs. "You remember the time when they were serving lobster on board. Then, they had (Kingfisher) Red — a low-cost airline — but they wanted to serve food on board. Then, they decided not to serve food on Kingfisher Red. At one point, they swung to serving only vegetarian fare on all domestic sectors. There has been no control on costs, and sharp swerves in what they offer," says an industry source.

Unfortunately for Mallya and Co., the problem could worsen. Many of their aircraft leases will end soon (in 1-2 years). The airline was already struggling to pay the rentals, and cannot afford renewals. If it is not able to pay, the leases could get cancelled and airplanes repossessed.

In some cases, the lessors are unwilling to renew the leases. UK-based leasing company Investec has offered some of Kingfisher's grounded ATRs to Jet Airways "for a song" (Jet is considering taking 8-10 aircraft). In the case of these 12 ATRs, Kingfisher has been unable to make the lease payments.

This would mean that in the coming year or so, Kingfisher's fleet is likely to shrink. "In such a situation, one has to choose which segment to focus on, and that is precisely what they have done," says a senior DGCA official.

Most analysts and rivals feel Mallya is likely to pull through the current crisis — he can bring in funds from other businesses — but the airline would "shrink" in the process. "One will see a smaller and, hopefully, tighter ship," says a Jet executive, who was earlier with Kingfisher. He adds that no one in the airline understands the meaning of "tight"; and it is not in Mallya's DNA.

In the meantime, things will get worse before they get better. The airline has 7,000-odd staffers. "Every department has been asked to look at each and every position with a microscope and weed out what is not needed," says a Kingfisher executive. "We will operate with the basic minimum henceforth."

An industry analyst says that in any other jurisdiction, the government would have started an unwinding of the business and asked for an orderly closing. "They are bankrupt and relying on supplier credit. It is unviable."
Foreign Support
One of the things Mallya wants is foreign airline equity to be permitted in airlines flying in India. He has been exhorting the government to allow this for a couple of years now. Go Air is supposed to hold similar views. But not everyone is convinced that this will help KFA.

First, points out one airline boss, why would a foreign airline want to take 25 per cent stake in any Indian airline given that it will not give the investor any substantial say in the running of the company. More importantly, even if a bigger stake is allowed, why would anyone choose Kingfisher with its accumulated losses and debt when there are better targets available?

"Wouldn't I choose the airline where I see a best fit and the highest returns?" says an analyst, arguing that Mallya's hard work may actually benefit his rivals more.

Moreover, even if Kingfisher got an investor, it would at best, even with a premium attached, fetch it $100 million at current valuations. The airline does not own most of its assets. "What is $100 million? It won't even reach the bank. The airline's creditors will grab it before it does. One year down the line, Kingfisher will be back where it started," says a source from IndusInd Bank.  

Jet's Kardassis says bringing in a foreign airline that can invest 25 per cent cash and offer some expertise will help only marginally. "It may increase the prices of shares for now. But at the end of the day, you have to set your own house in order."

Meanwhile, most other airlines are opposing the move to allow foreign equity. "Jet Airways, IndiGo, SpiceJet — none of the three are pushing for this and, in fact, some are lobbying against this," says an aviation ministry official. Air India, too, is not keen on allowing a foreign player as it thinks that a foreign airline combined with one of the stronger domestic players could wipe out whatever little advantage it has.

As a result, Mallya only has Jeh Wadia's feather-weight backing him on this one. "Let me put it this way. Naresh Goyal will not miss a heartbeat if Kingfisher dies. Right now, he has his own problems," says a Jet insider. He says Goyal has simply told his management to set things in order, and not bank on Kingfisher's fall. "Would Goyal like the FDI issue to be put on the backburner? Of course, he would. The longer that Kingfisher lasts, more will be Goyal's troubles."

Ministry officials say the lobbying against foreign airline equity is also not very convincing. "If Kingfisher sinks, you may find the opposition has also died down," says one official.

If the government moves at its typical snail-like pace, it may be too late for Mallya. "He needs the money and he needs it now," says Capa's Kaul, adding that KFA needs Rs 1,000 crore as of yesterday to survive the next few months.

That the airline is looking for cash desperately is evident in its latest moves. For the 1-15 December fortnight, it is collecting advance payments from travel agents for tickets that have not yet been sold. The airline has also turned "net debtor" on the bank settlement plan in November, which it finally paid up (see ‘Teetering On the Edge', BW, 28 November).

The King Has Company
Mallya could take solace from the fact that his two biggest rivals — Jet Airways and Air India also have their own set of woes. Jet insiders feel that their airline has expanded faster than was warranted.

With half-year losses at Rs 1,000 crore, debts of Rs 14,000 crore and a "confused model" (Jet Airways, JetKonnect and JetLite), fans of Jet in the Mumbai's financial circles are fast dwindling. Jet's biggest mistake since inception — its buy-out of Sahara Airlines — continues to be a thorn by its side. JetLite's losses exceed those of Jet Airways.

Go Air and SpiceJet are also in trouble, but their troubles are smaller in magnitude as the airlines are smaller. Both reported losses for the "dreaded" quarter of July-September 2011. Of the two, however, Go Air is said to have higher losses and debt — SpiceJet's interest cost as a percentage of sales is just 1.2 per cent.

When BW met Jet's CEO Kardassis in Mumbai, he was looking obsessively at cutting costs (just like in 2008). He had just finished an exercise by which he says he will be able to cut costs by about $170-180 million by reducing "a little bit of everything". "We can close some stations, reduce the number of counters at airports, cut on catering… We are renegotiating any contract we can. We are looking at renegotiating with hotels (we spend $20 million on this every year). We are looking at cutting staff transport from Rs 60 crore a year to Rs 20 crore. There is a list of $2 million here, $3 million there…," he goes on.

The airline has no dues with oil vendors beyond the normal credit period but it is exploring whether it can pay right on the due date and secure a discount of 1-1.5 per cent on its total bill.
When BW mentioned this to some Jet pilots, they said that if the airline wants to cut costs by $170 million, they "may as well shut shop". The pilots allege that while Jet Airways has steadily got poorer, its promoters have steadily got richer. They even claim that money from cargo operations has been "siphoned" out, and that they are fed up of being told the airline is broke.

The airline is also looking at sale and lease-back of some its B737s to retire some of its expensive rupee debt. Each sale and lease-back will fetch it around $20 million per aircraft.

A Kingfisher insider said they too had embarked on a similar exercise. "Cut, cut, cut — that is all we have been told to do," he says. But everyone in the industry remains open-mouthed at IndiGo and its performance.

Go IndiGo
The industry is calling it "IndiGo's magic wand". What does this airline have that allows it to make money (according to IndiGo sources, it will make a profit of Rs 350-400 crore this financial year) when all the others are in the red?

The answer lies in a combination of factors. One, Rahul Bhatia, the airline's low-profile owner, got into the business for the right reasons — to make money, and not for power, glamour, status or a heady combination of these.

ON A WING AND A PRAYER: Of Kingfisher Airlines' fleet of 66, only about 40 aircraft are in operation now (AP)

Two, the airline got two things right — its contracts, and cost structure and operations.

Bhatia's American partner Rakesh Gangwal  (who is said to have a share of the airline) negotiated well on IndiGo's behalf on the purchase price of bulk order aircraft (rumour has it that Bhatia got each aircraft $1-2 million cheaper than, say, KFA). IndiGo's contracts for maintenance and other supplies have also been expertly negotiated. The airline initially worked out leases in which the aircraft were returned and replaced with new ones as soon as they turned five years old. That itself meant lower expenses on spares and maintenance.

Bruce Ashby, IndiGo's former CEO, put in place well-tuned cost structures and operations. The airline's cost per ASK (available seat kilometre) was as low as Rs 2.2-2.5 in the earlier days. Industry sources say that even now it is not above Rs 3. IndiGo manages to make money despite high fuel taxes and fares that are sometimes below cost.

Also, the airline has not wavered from its basic model; it has "stuck to the knitting". "It is a perfect example of someone who knew his mind and knew how to go about getting what he wanted," says a former civil aviation secretary.

IndiGo has been planning a public issue, but has delayed it till it feels it can get the "best value". Bhatia is not in a hurry to tap the market because he does not need the money as of now.

Will Things Get Better?
And Bhatia is certainly the only player in the industry who can make that claim. Jet — despite trying for the past 5-6 years — has not managed to raise funds. But its auditors have asked the airline to somehow raise cash. Industry rumours are that Mukesh Ambani has in the past given cash at different times to Goyal to save the airline.

Air India is becoming a bottomless pit for the Indian government. Go Air has also been trying without success to raise funds for the past 3-4 years. "Unless the Indian environment changes, I do not see any investor putting in money in any airline in India," says Jet's Kardassis.

In fact, if the aviation sector's fundamental problems — unviable fares and high sales tax on ATF — are not resolved by the government, it is unlikely that many of the Indian players will make any money in the near future. And then too, it will only be those who have set their houses firmly in order. Aviation is undoubtedly a tough business.


(This story was published in Businessworld Issue Dated 05-12-2011)