Getting bids for Air India was a tall order to start with. Apart from the airline’s heavy debt and high losses, potential bidders had to grapple with uncertainty about the government’s demands on employee retention, or any other downside from its decision to retain a 24% stake. Besides, there were peculiar clauses such as one that required buyers to retain the Air India brand for a specified period. The list of queries submitted by potential bidders gives a fair indication of the factors that most irked them.
With all these hurdles, the Maharajah was at best an ambitious target for an adventurous buyer who thought there was significant value to be extracted through operational improvements. But within weeks of the invitation from the government for expressions of interest (EoIs), Air India moved from being an ambitious target to an irrational one.
Crude oil prices have risen 14% in the past two months, taking the total increase in the past year to around 50%. With no signs of a correction anytime soon, airline stocks have fallen. Shares of Jet Airways (India) Ltd, the closest comparable for Air India, have halved this year, and have fallen by about a third since the government invited EoIs. Last year, fuel accounted for 29% of total cost for Jet Airways, a full service airline; and 39% of total costs for IndiGo, a low-cost airline.
According to news reports, the higher costs are resulting in a crunch—a domestic airline has delayed salary payments, while another is raising tariffs to make ends meet. Needless to say, higher tariffs will hit load factors or capacity utilization. In such a backdrop, the last thing on anyone’s mind would be to add significant capacity by making a large acquisition. To that extent, the sale was ill-timed.
But as pointed out earlier in this column, even with lower assumptions of crude oil prices, the government can’t really expect much from its sale of Air India. Analysts at Kotak Institutional Equities estimate that the asset is being valued at over 10 times FY17 earnings on an EV to Ebitdar basis, even without ascribing any equity value. This was when other airlines were valued at 7-8 times FY17 earnings. Ebitdar stands for earnings before interest, tax, depreciation, amortization and lease rentals. EV, or enterprise value, includes the present value of future rentals, using a capitalization factor of seven times FY17 rentals.
With airline valuations having corrected further, bidders need to factor in far higher levels of operational improvement to justify even a nominal bid for the asset. It’s little wonder everyone has stayed away from this flight. The all-important question now is, as Adam Smith Institute’s Tim Worstall suggested in Forbes a year ago, “If no one wants to buy Air India, should Air India exist?"