The Air India sale has been code-named Project Royal, although the plain truth is that the national airline isn’t the king of Indian aviation. The company has run losses for years and is laden with debt. Even so, like its affable mascot Maharajah, there are things Air India brings to the table that will attract some buying interest.

More importantly, the government has decided to take over roughly 50% of the company’s debt on its own books, along with a smattering of non-core assets such as Air India’s regional airline operations, maintenance and repair, and parts of its ground handling operations.

With half of the debt load off its back, the new look Air India may well start generating cash profits soon after its new owner takes over. In fiscal year 2017 (FY17), profit before depreciation and tax, a rough proxy for cash profit, stood at a negative Rs1,420 crore. Assuming 50% savings on interest costs, annual cash profit would have been Rs830 crore in that year.

Along with the company’s domestic and international operations under the Air India and Air India Express brands, the buyer will also take home a 50% stake in a joint venture with SATS Ltd. The venture provides ground handling and cargo handling services at five airports, including three metros, and is profitable.

“The national carrier has the benefit of possessing more wide-bodied aircraft and a network that has rights on superior time slots and routes in the international sector, compared to peers such as Jet Airways Ltd," says Mahantesh Sabarad, deputy vice president at SBICap Securities Ltd. Still, it’s not all rosy for prospective buyers. “Air India’s advantages are somewhat offset by other factors such as a high cost structure and the burden of flying some unviable routes," adds Sabarad.

Some analysts also worry about the possibility of continued interference from the government, which has decided to retain a 24% stake in the company. Besides, companies and consortiums considering bids need to factor in challenges such as employee unions and the work culture associated with government-owned firms.

Given this backdrop, a moot question is whether the government can expect a significant valuation for the Air India asset. InterGlobe Aviation Ltd, which runs IndiGo airline, has an enterprise value (EV) of around Rs72,000 crore, including the present value of lease rentals. But the two airlines are hardly comparable—both in terms of operational efficiency and the nature of business. IndiGo gets most of its revenues from domestic operations, while Air India gets the majority of its revenues from international routes.

Jet Airways isn’t strictly comparable either, says Sabarad, despite the fact that it gets a large chunk of revenues from international routes. Even so, he says that since Air India’s advantages over Jet Airways are more or less offset by some negative factors, it wouldn’t be off the mark to ascribe similar valuation multiples to the two airlines. The two airlines are also fairly similar in terms of revenue and cost metrics.

As the table alongside shows, Jet Airways trades at an EV to Ebitdar multiple of 9.6 times, using FY17 earnings. Ebitdar stands for earnings before interest, tax, depreciation and lease rentals. EV includes the present value of future rentals (bit.ly/1WlrTlm), using a rough capitalization factor of eight times current rentals.

Applying the same multiple for Air India results in an EV of Rs45,000 crore, most of which will be offset by the remaining debt on its books (roughly Rs25,000 crore) and the capitalized value of lease rentals. As such, the government may end up with only Rs5,000 crore or so, which may well lead to criticism that the national airline is being sold for a song.

Some companies may also factor in gains from cost-cutting and improved efficiencies, which may result in higher valuations. But on the other hand, note that Jet Airways’ pre-tax profit has fallen over 60% in the first three quarters of this year, partly because of the rise in crude oil prices. As such, the rosy numbers reflected in FY17 financials are no longer a reality.

In this backdrop, the only hope for the government is that buyers get into a bidding war for the asset, and prop up valuations. Needless to say, they will also be setting themselves up for failure, in the process.

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