Airindia Limited Debt Trap

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Introduction        

Air India is the flag carrier airline of India headquartered at New Delhi. It is owned by Air India Limited, a government-owned enterprise, and operates a fleet of Airbus and Boeing aircraft serving 94 domestic and international destinations. The airline has its hub at Indira Gandhi International Airport, New Delhi, alongside several focus cities across India. Air India is the largest international carrier out of India with an 18.6% market share. Over 60 international destinations are served by Air India across four continents. Additionally, the carrier is the third largest domestic airline in India in terms of passengers carried (after IndiGo and Jet Airways) with a market share of 13.5% as of July 2017.

In 2007, Air India and Indian Airlines were merged under Air India Limited and the airline took delivery of its first Boeing 777 aircraft. The airline was invited to be a part of the Star Alliance in 2007.

The combined losses for Air India and Indian Airlines in 2006–07 were ₹7.7 billion (US$110 million) and after the merger, it went up to ₹72 billion (US$1.0 billion) by March 2009. In July 2009, State Bank of India was appointed to prepare a road map for the recovery of the airline. The carrier sold three Airbus A300 and one Boeing 747-300M in March 2009 for $18.75 million to finance the debt. By March 2011, Air India had accumulated a debt of ₹426 billion (US$5.9 billion) and an operating loss of ₹220 billion (US$3.1 billion) and was seeking ₹429 billion (US$6.0 billion) from the government. A report by the Comptroller and Auditor General blamed the decision to buy 111 new aircraft and the ill-timed merger with Indian Airlines for the poor financial situation. In August 2011, the invitation to join Star Alliance was suspended as a result of its failure to meet the minimum standards for the membership. The government pumped ₹32 billion (US$450 million) into Air India in March 2012.

Turn-around strategy

To facilitate the revival of Air India, Ashwani Lohani, known as the “turnaround man”, was appointed Chairman and Managing Director (CMD) of Air India. With a reputation for being very practical, Lohani was aware of the multitude of problems staring him in the face. Though he believed that the money-losing airline’s problems were not insurmountable, he knew they were serious enough. The most important challenge was the huge debt burden that was weighing the Maharaja down.

The government was pushing for the self-sufficiency of its undertakings and was scouting for ways to bring down its stake in Air India to less than 51%. One of the options it had considered was to get the Life Insurance Corporation of India (LIC) to shoulder some of the debt burden. Another option was to ask the lender banks to convert a part of the debt into equity. However, divesting in Air India in its present health would be difficult as it was unlikely to get too many buyers. Thus, restructuring of the working capital portion of its debt was an option that would help cut its interest burden. Further, to cut down on the aircraft loan, Air India could sell aircraft that it owned and then take them back on  lease.

There seemed to be three options for restructuring the loans.

• One was to get banks to convert a part of the loans into equity.
• The second was to swap the “high-cost debt” with non-convertible debentures, which would cost 7-8%, resulting in annual savings of around INR 2 billion.
• The third option was that banks could be issued preferential capital with a fixed rate of dividend payable.

Debt: Sustainable or not?

RBI’s Scheme for Sustainable Structuring of Stressed Assets (S4A) allowed for the restructuring of bigger loans. Under this scheme, lenders were required to separate the sustainable loan, or the portion of the loan where timely repayment was possible, from the unsustainable portion. The bank would convert the unsustainable debt into equity or equity related instruments. This would lower the debt burden of the borrower, while the bank, as a shareholder, would gain from the improved valuation should a turnaround at the company happen.

Out of a total debt for INR 200 Billion to cover the working capital of the company, below is breakup which reflect the sustainable aspects of the debt -

• Sustainable Debt – INR 100 Billion
• Unsustainable debt (to be converted to equity) - INR 100 Billion

Out of the 3 available options, Option-1 is recommended for the re-structuring of loans i.e banks to convert a part of loan into equity.  This removes a lot of debt burden from Air India and lets it focus on its core business of flying airplanes instead of having a management that is constantly struggling to meet interest payments and is always on the verge of bankruptcy.  Option 1 is not without challenges. The fair value of Air India would have to be calculated as it wasn’t listed. This would have to come up to a number that made sense for both equity and debt holders. Then a good conversion ratio would have to be figured out for the debt to equity. This was again a humongous task which would require bringing a lot of different parties on board. Also the banks were themselves facing challenges of rising NPAs in the system. They would have to tread carefully when it came to Air India’s debt.

Valuing Air India

Some financial data has been provided for the firm which can be projected into the future to calculate the Enterprise value of the firm. Discounted Cash Flow has been used to value Air India.

For Air India’s valuation, the following assumptions have been taken:

• The revenue growth would be at 10% per annum. This is as per industry norms
• Operating ratio would come closer to industry averages of around 87% and not the present 98%.
• Depreciation is assumed to be 5% in Net Assets
• Long term growth rate is assumed to be 10%. This is taken because the inflation in India is around 4 to 5% and the growth rate would be around 7% in real terms. Hence 10% is a conservative estimate.
• The capital expenditure would be fixed at the amount of depreciation, i.e. capital would only be spent to maintain fleet and not increase it
• Dividends would not be paid. This is to ensure that all the money is plowed back into making the company stable and profitable.
• The current liabilities would be maintained at original levels.
• Current assets are maintained at 2017 levels
• Unlevered beta of a comparable company Jet Airways will be used. This is because it’s a comparable company with exposure to both domestic and international markets, thus making it a suitable firm to take beta from. The value is around 0.35 on average
• D/E is maintained constant
• Debt is restructured to reduce interest rate to 8%
•  Tax rate is constant at 35%
• The market risk premium is taken to be 8%
• The risk free rate is around 7%. This is the average return on long term government of India bonds.

Exhibit 1 shows the valuation of Air India. For the purposes of calculating WACC separate calculations have been shown in Exhibit 2. The revenue of Financial Year 2017 have been projected for the next 3 years and then terminal value have been calculated. This gives a EV of around 428000 million INR. For this a major factor is Air India’s huge asset base which bolsters its high valuations.

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