Case 14


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Case 14

  1. 1. AsiaCase.comthe Asian Business Case Centre KINGFISHER AIRLINES–ACQUISITION OF AIR DECCAN: INDIA’SFIRSTLOW-COST CARRIER Mahmud Hossain and D. G. Allampalli Publication No:ABCC-2009-004 Print copy version: 12 Nov 2009 Associate Professor Mahmud Hossain and D G Allampalli prepared this case based on public sources. As the case is not intended to illustrate either effective or ineffective practices or policies, the information presented reflects the authors’interpretationofeventsandservesmerelytoprovideopportunitiesforclassroom discussions. COPYRIGHT © 2009 Nanyang Technological University, Singapore. All rights reserved. Not to be reproduced, stored, transmitted or altered in any way without the written consent of Nanyang Technological University. For copies, please write to The Asian Business Case Centre, Nanyang Business School, Nanyang Technological University, Nanyang Avenue, Singapore 639798 Phone: +65-6790-4864/5706, Fax: +65-6791-6207, E-mail: In 2005, Vijay Mallya, Chairman of United Breweries Holdings Limited, founded Kingfisher Airlines (Kingfisher), a premium Full-Service Carrier (FSC) aiming to be a market leader by 2010. Two incumbents, Air Sahara, a FSC and Air Deccan, a Low-Cost Carrier (LCC)offered low fares and were giving Kingfisher tough competition. By 2006, as some FSCs and most LCCs incurred losses, the Indian aviation industry was headed for consolidation. InMarch2007,AirDeccan,India’sfirstLCCpromotedbyCaptainG.R.Gopinath,whichoffered low fares for early birds, had garnered more than 20 percent market share and was looking for strategicinvestors.AsAirDeccan’sfaresandcompetitionhadhurtallFSCsincludingKingfisher, Mallya was looking for opportunities to acquire it. With negative earnings before interest, taxes, depreciation, amortisation and aircraft rentals, and no financial or stock-market comparables to value the loss-making LCC, Mallya came up with an offer of Rs. 5,500 million for a 26 percent stake in May 2007. As Kingfisher and Air Deccan inherited different business models, brands, management andleadership styles, and organisational culture, industry analysts and aviation experts weredividedonthevaluationandofferofKingfisher,andthealignmentofthetwofounders’ leadership style and vision. AuthorizedforuseonlybyMudrahirRahamaninFinancialCaseAnalysisatUniversityofDhakafromMar01,2014toOct31,2014. Useoutsidetheseparametersisacopyrightviolation.
  2. 2. Page 2 ABCC-2009-004 the Asian Business Case Centre KINGFISHER BUYS STAKE IN AIR DECCAN At end-May 2007, Vijay Mallya, Chairman of UB Holdings Limited (UBH) agreed to buy a 26 percent stake in Deccan Aviation Limited, Bangalore (DAL) from theownersofIndia’sfirstLCC,AirDeccan. Mallya made an open offer to acquire an additional 20 percent stake from the open market. The new stake would make UBH the largest shareholder in DAL. Further, the combined 32 percent market share of UBH-promoted Kingfisher and Air Deccan would enable it to surpass the 31 percent share held by Jet Airways and Air Sahara, and become the market leader. David Huttner, a Belgium-based international aviation analyst, commented: Common shareholding in itself is not likely to change much. We have the same capacity chasing the same market, just under bigger umbrellas, therefore, its hard to see fares rising in the short term.They need to put together a coordinated and well thought out strategy as to how they will allocate their assets, improve efficiencies and lower their costs, all the while enhancing revenue.1 UNITED BREWERIES HOLDINGS LIMITED Mallya began his career with Hoechst (nowAventis), an American corporation and worked in the United States and United Kingdom before joining his father at the Bangalore-based United Breweries Limited in 1980. Three years later, after the demise of his father, he took over chairmanship of UBH, a group of companies with core business interests in liquor and spirits, which had diversified into pharmaceuticals, paints, agrochemicals, polymers and food products. Withintwodecades,UBH’sspiritsbusinessbecame the fifth largest beverage alcohol group after Diageo, Pernod Richard,Allied Domecq Spirits and Wine Ltd, and Bacardi by sales. Further, its spirits business had seven millionaire brands and 36 percent share in the Indian beer market, and its flagship brand ‘Kingfisher’wassoldin32countries.2 1 Mallya buys 26 pc in Deccan for Rs 550 crore. (2007, May 31). Hindustan Times, India. 2 VijayMallya:beyondthe“liquorbaron.”Sify Finance. Retrieved 31 March 2008 from fullstory.php?id=13221490 3 Leahy, J. (2007, October 26). Vijay Mallya FT.Com. 4 ibid. 5 A millionaire brand: Beverages that accounts for sale of one million cases or more. (SWC adds 6 millionaire brands to UB Group.) (2005, Mar 26). The Financial Express, India. Founder to Brand Icon At the age of 28, Mallya took over the family business. His lavish lifestyle brought him into the corporate limelight at an early age. On corporate India then, he said: But of course India in those days, particularly, corporate India was far more conservative. So obviously my lifestyle attracted a lot of attention and [my career] began with a lot of adverse comments, that my lifestyle would drive UB down the tube.3 In 1992, Mallya decided to deploy his youth and popularitytoboostUBGroup’sbrandsandcoined the“KingofGoodTimes”sloganforthecompany’s beer. However, good times arrived for Mallya outside India when he made a US$66 million profit after buying and selling the UK-headquartered Berger Paints which he spent on fast cars, yachts and maintaining his 40-odd international homes. On his transformation from chairman of the UB Group to its brand icon, he said: My own lifestyle got intertwined with the brand personality and so without really planning it that way I became almost my ownbrandambassadorandthat’sjust thewayit’skeptondeveloping.4 By 2006, UB Group had grown into a Rs 6.82 billion business conglomerate and the liquor business had created 15 millionaire brands.5 KINGFISHER AIRLINES LIMITED Startup In 2005, UBH decided to enter the aviation industry, byleveraging on its unique strengths acquired through the spirits and beer business over the past two decades.Thesewereunderstanding theevolvingIndian consumer, creating premium products, building brand equity and market leadership while operating in a AuthorizedforuseonlybyMudrahirRahamaninFinancialCaseAnalysisatUniversityofDhakafromMar01,2014toOct31,2014. Useoutsidetheseparametersisacopyrightviolation.
  3. 3. Page 3 ABCC-2009-004 the Asian Business Case Centre regulated market (see Exhibit 1), and exploiting the growth potential offered bythe Indian aviation industry. On 9 May 2005, UB Group set up Kingfisher as a 100-percent owned subsidiary (see Exhibit 2). The management of Kingfisher hoped to provide superior experience in air travel to its customers by being ahead of the competition in product and service offerings. It deployed brand new aircraft and chose a five element product concept: highest seat pitch, personalized entertainment, hot meals, home delivery of tickets and valet service at the airport (see Exhibit 3).6 Further, it considered the travellers on Kingfisher not as passengers or customers but asserted that theywereits“guests”. To reduce boredom on the ground and onboard, the carrier provided X-box games in its lounge and installed state-of-the-art in-flight entertainment systems including video-on-demand, live television7 and WiFi services, raising the bar for rival carriers. Further,should a guest spill coffee or tea on their attire, the carrier would gift a brand new white Arrow shirt.8 With excellent service and punctuality, the carrier won the hearts of corporate travellers as well as market share from its competitor, Jet Airways. Kingfisher began with four flights per dayand spread its domestic network to 104 flights per day to 16 cities by inducting 17 aircraft in one year. Also, it set the world record for fastest aircraft induction in the year 2005-06.9 Organic Growth: To expand domestic routes and enter international routes, Kingfisher decided to increase its fleet and placed orders for many wide-bodiedA340- 500s,A330s, andA350s, and became the first carrier to sign-up for A380 type aircraft in April 2007. Mallya said,“KingfisherAirlinesneedsmorewide-bodiesfor 2009-10,partlybecauseofdelayintheA380”.10 Also, he was very optimistic that the Ministry of CivilAviation (MCA) would waive the five-year operations eligibility rule to grant Kingfisher the rights to fly international routes before May 2010.11 By 2007, the carrier expanded its route network to 34 cities and its fleet to 34 aircraft, while doubling the frequency to 208 flights per day.Also, it introduced Kingfisher first to increase yield and also explored the opportunities to acquire existing airlines. From 2005 to 2007, the market share of Kingfisher increased from two percent to 13 percent and the market share of its competitor, Jet Airways, dropped from 45 percent to 22.7 percent.12 By providing safe and true value air travel, Kingfisher hoped to attain market leadership by 2010 (see Exhibit 4).13 Although Kingfisher was not required to report its financials publicly, its management occasionally shared financial data during corporate presentations. For financialyear2006,thecarrier’slossbeforetaxwas Rs 1,908 million (see Exhibit 5). Although Kingfisher experienced high traffic on the metrpolitan city routes like Bangalore, Mumbai, New Delhi, Kolkata and Chennai, congested airport infrastructure in these state capitals limited its organic growth. With airport modernization in these cities set to be completed14 between 2008 and 2010, and tough competition from a large number of new entrants and LCCsofferinglowfares,thecarrier’sfuturegrowthin the domestic market depended on the ways it increased its market share.15 Inorganic Growth: In 2005-2006, the clouds of consolidation began to appear due to a large number of new entrants, creation of excess capacity due to a large number of new aircraft, fierce competition and unrealistic pricing by LCCs which led to industry-wide losses and created opportunities for mergers and acquisitions. Both Kingfisher and Jet Airways were exploring potential markets to expand their operations. In late 2005, they bid for the acquisition of Air Sahara, whose valuation by Ernst & Young caused a furor in the market. In response, Mallya said: We will put in an indicative offer, which will show the price valuation range that 6 UB Group Presentation. (2006, September). Retrieved 27 May 2008 from 7 Emirates and JetBlue were the other carriers to provide such in-flight services 8 Mehra, P. (2007). Flying colours. Businessworld, India. 9 United Breweries Holdings Limited. (2005-2006). Annual Report. 10 Ionides, N. (2007, June 12-18). Kingfisher makes swoop for additional widebodies, Flight International. 11 ibid. 12 Mehra, P. (2007). Flying colours. Businessworld, India. 13 UB Group Presentation. (2006, September). Retrieved 27 May 2008 from 14 2008–Bangaluru&Hyderabad;2010–NewDelhi,Kolkata,Mumbai&Chennai;and2012–NaviMumbai14Allirajan,M.(16Nov 2007). Flight or Fancy. Businessworld, India. 15 Allirajan, M. (2007, November 16). Flight or Fancy. Businessworld, India. AuthorizedforuseonlybyMudrahirRahamaninFinancialCaseAnalysisatUniversityofDhakafromMar01,2014toOct31,2014. Useoutsidetheseparametersisacopyrightviolation.
  4. 4. Page 4 ABCC-2009-004 the Asian Business Case Centre we are willing to offer before the deadline expires. However, the US$750 million - US$1 billion initial estimates are way too high in relation to earnings.16 In October 2005, Mallya conducted an independent due diligence of Air Sahara and stated that he had offered“substantiallyless”thanwhatAirSahara expected for the sale of its 100-percent stake.17 Upon scrutinizing the bids, the management of Air Sahara foundthatKingfisher’sUS$600millionofferwasspread overthreeinstallmentswhileJetAirways’offerwas allincashbutslightlylowerthanKingfisherAirlines’ at US$500 million. As such, Kingfisher lost the opportunity to acquire Air Sahara and was on the lookout for new airlines to acquire or fly on international routes (see Exhibit 6). DECCAN AVIATION LIMITED In December 2006, Mallya and Captain G. R. Gopinath, Chief Executive Officer (CEO) of DAL met in Mumbai to explore the possibility of a merger betweenKingfisherandAirDeccan,India’sfirstLCC set up in August 2003. Air Deccan began scheduled flights with a single ATR turbroprop aircraft to fly passengers from Bangalore to Hubli, an industrial town in Karnataka. It envisioned the provision of a cost- effective and commercially successful alternative to the traditional ways for domestic travel used by the Indian mass consumer market. Business Model: Low-Cost Carrier The management of Air Deccan emulated the LCC modelsfromthewesttocreatea“no-frills,low-cost” business model for India. Some of the elements consideredinAirDeccan’sstrategywereofferinglow fares on new routes to stimulate demand from untapped markets, and reducing costs by higher aircraft utilisation and standardisation in its fleet. From mid-2005 to early 2007, Air Deccan offered a large number (10,000 to 200,000) of low-fare tickets in the price range of Rs.1, Rs.2, Rs.3, Rs.5, Rs.6,Rs. 499 (inclusive of taxes) and Rs. 999 (inclusive of taxes)tocelebratethecarrier’sanniversaries, Christmas, and events likeAir Deccan attaining 21.2 percent market share in June 2006, when it became India’ssecondlargestairline.18 It used Internet services and other unconventionalsales channels such as Call Centre, SMS and GPRS technologies to distribute air tickets. To better serve the metropolitan and regional air travel markets of India, the management of Air Deccan adopted a two-type aircraft fleet strategy: - 11 Airbus A320 jets for the trunk routes connecting the six largest cities of India. - 18 ATR turboprops to serve the regional cities. It noticed high demand for point-to-point travel from small towns/cities to urban cities and feed traffic to metropolitan cities which were hubs. Creating this connectivity enabled Air Deccan to create new markets and expand the size of the aviation market by attracting several first-time air travelers. It believed thatATR turboprops were best suited for such routes. Of 29 such aircraft, 26 were on operating lease19 in March 2006 (see Exhibit 7). Operations and Performance Tapping into the demand generated by low fares,Air Deccan grew its operations. The routes flown by the carrier grew from 14 routes in 12 airports in 2004 to 85 routes in 52 airports by late November 2005. During the same period, the passenger load factor (ratio of the number of available seats to the number of passengers flown) improved from 62.6 percent in March 2004 to 76.4 percent in March 2005. From April to November 2005, the number of passengers flown reached nearly 16 million and the load factor remainedaround73percent.AirDeccan’sincome rose from Rs. 314.18 million in 2004 to Rs. 2,669.46 million in 2005, and for the first eight months of 2005, its income touched Rs. 4,458.98 million (see Exhibit 8).20 Despite the sales growth, Air Deccan incurred net losses (after all adjustments) during FY2004, FY2005 and the first eight months of 2005 amounting to Rs. 117.10 million (March 31, 2004), Rs. 352.32 million (March 31, 2005) and Rs. 1,179.36 million (eight months ended Nov 30, 2005), respectively.21 Its net worth had turned negative to Rs. 123.73 million 16 Mallyatoputin‘indicateoffer’forAirSaharastake.(2005,October30)Business Line, India. Retrieved July 27, 2006, from http:/ / 17 Mallya offers less than US$750 million for Air Sahara. (2005, November 30). The Financial Express, India. 18 Air Deccan. (2005-2006). Media Releases. 19 A type of ownership when in an airline leases an aircraft from its owner in exchange for rental payment 20 Deccan Aviation Limited. (2006, April 28). IPO Prospectus, .pp8-9. 21 ibid. AuthorizedforuseonlybyMudrahirRahamaninFinancialCaseAnalysisatUniversityofDhakafromMar01,2014toOct31,2014. Useoutsidetheseparametersisacopyrightviolation.
  5. 5. Page 5 ABCC-2009-004 the Asian Business Case Centre by March 2005 and further increased to Rs. 1,141.48 million by November 2005. The carrier met part of the losses by increasing its share capital which rose from Rs. 161.99 million to Rs. 462.57 million and the increased loss of Rs. 1,017.75 million was funded using a mix of secured loans, unsecured loans and current liabilities (see Exhibit 8). The management of Air Deccan attributed its poor performance tonon-availabilityof aviationinfrastructure at key airports in cities which provided efficient point- to-point connectivity, traffic density and parking space to maximise passenger yield. Further, the losses were partly attributed to delays in the allotment of aircraft parking lots in Mumbai where its competitors had more aircraft parking lots and were able to mount more flights. Commenting on the fare tactics adopted by some dominant incumbents, Gopinath recollected: You know what Jet, Sahara and Indian Airlines did in those days? If I [Air Deccan] had one flight at 1000 hrs, they had 10 flights a day. They would put a flight at 0930 hrs and slash the fare below mine and increase it on all the other flights.That’sthereasonwehadto expand the way we expanded.22 With no hangars at these key airports, Air Deccan expanded on low-density traffic routes and suffered poor turnaround of aircraft. Furthermore, several bird hits to aircraft, resulting in reduced availabilityof such aircraft and cost of repairing blades and engines, as well as lower fares contributed to the losses. Financing Growth: Private Equity and IPO As internal cash generation was insufficient to fund its expansion and growth,Air Deccan was dependent on injection of external capital for financing operations and growth. By 2004, the management raised Rs. 1,840 million (US$40 million) by placing private equity with ICICI Ventures (India) and Capital International (USA)23 to fund the purchase of 60 aircraft (30 ATRs and 30 AB320s) over the next five years using a mix of buying and leasing.24 Next, it raised capital from the market through an initial public offering (IPO) by offering 24,546,000 equity shares of Rs. 10 each through the book-building process in the price band of Rs. 150 to Rs. 175 and hoped to raise Rs. 3,800 million or Rs. 4,440 million, respectively. It hoped to deploy these funds to set up a training centre (Rs. 656.69 million), hangar and maintenance facility (Rs. 400.20 million), infrastructure at airports (Rs. 170.83 million), market development initiatives (Rs. 452.20 million) and debt payment (Rs. 1,327.50 million).25 OntheAirDeccanIPO,ananalystsaid,“Theloss- making company would breakeven only after two years. So the investors were a bit bearish since the first day of the issue. The carnage in the market aggravatedtheirfears.”26 Also, some analysts felt that the leading merchant bankers such as ABN Amro, JP Morgan and State Bank of India (SBI), who were involved in the preliminary discussions, were dropped in the management of the final issue because these merchant bankers did not agree to the valuations proposed by the management.27 Another analyst, said: SinceAirDeccanisn’tmakinganyprofit yet,aP/Ecomparisonisn’tpossible.Air Deccan’sissuesizeisRs430crore28 at the higher end of the price band for 25% of the post-issue equity - the valuation of the company works out to Rs 1,718 crore. The other listed players in the aviation business - Jet Airways and SpiceJet–commandvaluationsof Rs 8,281 crore and Rs 1,315 crore respectively. While JetAirways is a larger airline with a fleet of over 50 aircraft, SpiceJet has a fleet of less than 10 aircraft.29 In an interview with an online portal for aviation industry, Gopinath responded: 22 Bhargava, A. (25 September 2006). Captain Gopi Defends Himself. Businessworld, India. 23 Mahalingam, T.V., & Mitra, K. (2007, June 3). On a wing and a prayer. Business Today, India. 24 Air Deccan inks US$40 million with ICICI Ventures. (2004,December 15). The Financial Express, India. 25 Deccan Aviation Limited. (2006, April 28). IPO Prospectus, pp.30. 26 Air Deccan extends IPO, cuts price. (2006, May 24). Retrieved 4 June 2008 from may/24deccan.htm 27 Dalal, S. (2006, May 28). Succinct Analysis. Indian Express, India. Retrieved 8 June 2008 from sunday/story/5315.html 28 Crore–Tenmillionrupeesmakeacrore 29 Vijay, P.N. (2006, May15). Your Money IPO Update. Retrieved 8 June 2008 from Deccan%20final%20report.pdf AuthorizedforuseonlybyMudrahirRahamaninFinancialCaseAnalysisatUniversityofDhakafromMar01,2014toOct31,2014. Useoutsidetheseparametersisacopyrightviolation.
  6. 6. Page 6 ABCC-2009-004 the Asian Business Case Centre Many times, the bullishness or bearishness of a stock market is not the true reflection of the condition of a country’seconomyoracompany.What I mean is that when the market is on an upswing, stock prices gallop, and a company’svaluegoesup.Andthe conversehappenswhenitcrashes.…As far as our own valuation is concerned, we had wanted the issue price to be Rs 150-175 but because the market crashed, we lowered the allotment price to Rs 148. In my view, this may not be the true value for my company or for any airline.30 AsAirDeccan’sIPOfailedtoevokeinvestorresponse and achieve full subscription before the closing date of 23 May 2006, the management extended the deadline and also pared the lower price-band by four rupees. It hoped the extension would provide opportunities for investors whose finances were locked up in the stock market. Thus, Air Deccan just managed to raise the targeted amount. By June 2006, Air Deccan losses had touched Rs. 3,400 million for the last 15 months of operations and it faced a tight cash-flow situation. In October 2006, Air Deccan sought US$100 million (approx: Rs. 4,500 million) funding from Southwest Trading Limited (funded by two European Banks: Investec bank, UK and HSH Nord Bank AG, Germany) to pay for the 96 aircraft order which would be completed by 2013 (see Exhibit 9).31 As debt would create additional burden on the cash flow of the carrier, the managementchosea‘uniquefinancialstructuring’ route. The disbursement of US$30 million of the US$100 million, helped the carrier to show a modest profit of Rs. 96.40 million on sales of Rs.6,370 million for the second quarter of 2006-2007 compared to a loss of Rs. 429.4 million in the previous quarter.32 Describing the achievement, Gopinath commented: One way to look at it is that we have a long way to go as we need to make absolute profits (operating profits). But then we have started turning around now….IftheairlineisabletomakeRs 4,900 per ticket at 80 percent seat factor, it can turn profitable straightaway. However, it manages to make Rs 4,400 perticketnow.…Wehavetofindaway to make an extra Rs. 400-500 per ticket and we could sail through. Three years ago, only about 13 million passengers flew and today it has gone up to 30 million with Air Deccan alone flying 8 million passengers.33 CommentingonIndia’sdomesticairtravelmarket potential,hesaid,“Weneedtolookatthebigpicture. We need to make 150 million-200 million middle class tomakeflyingtheirpartoflifestyleorworkculture.”34 Analysing the Q2 2006-07 performance and future growth in fleet, Mohan Kumar, Chief Financial Officer, said: Our second quarter [Q2 of 2006-2007] revenues have increased by 19 percent. This has been possible mainly on account of being able to control our costs. Our cost per seat km is Rs 3.18, which is among the lowest in the country. Our average yield per passenger is Rs 2,615 this quarter compared with Rs 2,512 in the quarter ended December 2005 despite a significant increase in seat capacity.35 During the quarter,Air Deccan inducted fourA-320s. It has added 24 new routes, 38 new flights and six new destinations including three monopoly sectors to its network. The airline carried 1,645,362 passengers and launched its eighth aircraft base at Ahmedabad in November. It had on order 81 new aircraft to be delivered over the next six years.36 However,Air Deccan could not sustain its performance in the third quarter of 2006-2007 when it incurred a loss of Rs 2,130 million on sales of Rs.4,574.5 million. The airline clarified that the modest profit of the second quarter of 2006-2007 was due to the structured funding, and cited rising costs, including fuel, for the huge loss in the third quarter of 2006-07.37 Also, the 30 Gopinath, G. (2006, July 4). Our IPO got caught in a tsunami. Retrieved 4 June 2008 from deccan/page/4/ 31 Deccan Aviation in deal with 2 European Banks. (2006, October 14). Business Line, India. 32 Deccan Aviation Q2 net profit at Rs. 9.6 crore. (2007, January 27). Business Line, India. 33 ibid. 34 ibid. 35 ibid. 36 ibid. 37 Dey,S.&Jha,U.(2007,May31).SBIextendsdeadlineforAirDeccan’sloanrepayment.The Economic Times, India. AuthorizedforuseonlybyMudrahirRahamaninFinancialCaseAnalysisatUniversityofDhakafromMar01,2014toOct31,2014. Useoutsidetheseparametersisacopyrightviolation.
  7. 7. Page 7 ABCC-2009-004 the Asian Business Case Centre carrier needed funds to repay the State Bank of India (SBI) the two tranches of Rs. 1,000 million it borrowed by providing its cash flow as collateral before June 2007. The management revealed that although SBI extended the original payment deadline, the bank did not indicate any period for such extension and the time-frame for the repayment of the Rs.1,000 million loan.38 Valuation In order to shore up depleted finances and meet Air Deccan’scashflowneeds,itsmanagementdecided todivestpartofthepromoters’22.13percentstake39 to a strategic investor. In early 2007, it appointed Edelweiss Capital, a Mumbai-based investment banker to advise the company on the deal.40 In mid- 2006, though Mallya had evinced interest to invest in Air Deccan, Gopinath was reluctant to sell the entire stake in the carrier which he had built with passion. The Target Mallya felt that Air Deccan was an ideal target for Kingfisher. Compared toAir Sahara, he observed that AirDeccan’sfleet,engines,brakes,avionicsand rotables41 including the vendor for maintenance, Lufthansa Technik, were common to Kingfisher. Drawing parallels with KLM-Air France and Qantas- JetStar, Mallya felt that the combined carrier would be able to mount 537 flights per day, connect to 69 destinations and be a market leader.42 Further he had seen the total passenger traffic in India grow from 15.68 million in 2003-04 to 25.20 million in 2005-06 at a compound annual growth rate (CAGR) of around 20 percent but the domestic passenger traffic had grown at a higher CAGR of 22 percent.43 However, the Indian airline industry performance was mixed. In line with the rise in passenger traffic, the operating performance of private scheduled carriers (PSC) was better than the national scheduled carriers (Indian Airlines and Air India), which incurred a combined loss of Rs.3.63 billion in 2005-06 (see Exhibit 10). The PSC made profits in 2003-04 and 2004-05 but incurred a loss in 2005-06 due to overcapacity, overcrowded market and competition from the budget carriers, and their lower fares. The total operating revenue of all scheduled carriers declined from Rs. 274.3 billion to Rs. 198.9 billion and then rose to Rs. 255 billion during 2003-04, 2004- 05 and 2005-06, respectively. Industry consolidation became necessary to attain operational scale and economies for the domestic carriers. Further, analysts felt that acquiring Air Deccan would enable Kingfisher to launch international flights in 2008 because it completed the ‘five-years-in-operation’requirementforflyingon international routes. However, in 2007, industryexperts hoped that the Ministry of Civil Aviation would relax the eligibility to three years.44 During this period,India’sgrossdomesticproductgrewbetween 6 to 8 percent and it was likely to sustain the same pace of growth in the future and thereby boost the demand for domestic air travel. The Deal and Valuation After the IPO of Air Deccan in May 2006, the shareholding was widely held with promoters owning 22 percent (Gopinath - 11 percent, and the rest by Captain K. J. Samuel and Vishnu Raval). The remaining 78 percent was held by the public including four bulk owners who held between 7.5 to 13.5 percent stakes and were waiting for a right price to cash out.45 In the last week of May 2007, Mallya sprang a surprise and made another offer forAir Deccan at Rs. 155 per share for a 26 percent stake but assured continued involvementofGopinathinthecarrier’smanagement. Further,Mallya’sofferwashigherthantheIPOlower- bandpriceaswellastheclosestcontender’s, Reliance-Anil Dhirubhai Ambani Group, which apparently had offered Rs. 140 per share. From Mallya’snewoffer,GopinathfeltthattheAirDeccan brandanditsLCCmodelwouldcontinue.Mallya’s bid at Rs. 155 per share put the stake valuation at Rs. 5,500 million. 38 Dey,S.&Jha,U.(2007,May31).SBIextendsdeadlineforAirDeccan’sloanrepayment.The Economic Times, India. 39 Public–33percent,UK-basedInvestecbank–1.96percentandCorporateInvestors–45percent) 40 Anil eyes 26 percent in Air Deccan, leads race. (2007,April 19). Retrieved 3 April 2008 from newsdet.aspx?q=3089&q1=4/20/2007 41 Component or inventory item that can be repeatedly and economically restored to a fully serviceable condition. (Source: BusinessDictionary.Com. Retrieved 24 April 2009 from 42 Bhargava, A. (2007, June 18). Sultan of the skies. Businessworld, India. 43 Air Transport Statistics. (2005-2006). Director General for Civil Aviation, India. Retrieved 12 January 2009 from reports/stat-ind.htm 44 Mahalingam, T.V. & Mitra, K. (2007, June 3). On a wing and a prayer. Business Today, India. 45 ibid. AuthorizedforuseonlybyMudrahirRahamaninFinancialCaseAnalysisatUniversityofDhakafromMar01,2014toOct31,2014. Useoutsidetheseparametersisacopyrightviolation.
  8. 8. Page 8 ABCC-2009-004 the Asian Business Case Centre Keeping in mind the concerns and expectations of the two leaders, Edelweiss Capital prepared a revised proposal after the duo negotiated the share price (Rs.160 versus Rs. 155) and number of directors (4 versus 3) and closed the deal. An agreement was prepared, both the parties signed and Rs. 1,500 million was deposited by Kingfisher in an escrow account.46 To complete the acquisition, DAL would need to issue 35.20 million new equity shares to the UB Group at Rs. 155 per share (a premium of Rs. 8.80 over the closingpriceofDAL’sshareat146.20).47 Gopinath clarifiedthattherewasnosaleofpromoter’sholdings: The entire Rs. 550 crores will come throughpreferentialshares…Therehas been no sale of individual shares. None of us have sold shares. We (Air Deccan) will continue to be an independent identity and pursue our low-cost business model. Our combined market share will go up to33percent–AirDeccan22percent and Kingfisher 11 percent.48 Although industry analysts welcomed the consolidation, investment bankers were divided over the price paid by Mallya. Covering the event, Rediff, an online portal reported the response of an investment banker: This is a crazy valuation. Mallya has paid substantial premium to Air Deccan for no reason. Kingfisher Airlines, which is making Rs. 500 million a month, has joined hands with Air Deccan which is making huge losses.49 However, Ravi Nedungadi, Chief Financial Officer of UB Group defended the arrangement and said: It is a good deal. We are paying the right price for Air Deccan. It would make better sense to pay Rs. 5,500 million for Air Deccan, which has 23 percent market share rather than acquiring Air Sahara with a market share of less than 8 percent.50 Another business analyst, reporting for the business segment of a weekly magazine, observed that the valuation of airlines in India was tricky as they were valued high despite negative earnings before interest, taxes, depreciation, amortisation and aircraft rentals (EBITDAR). As most airlines were making losses, the EBITDAR was negative and valuation techniques failed to estimate the true value of the carrier. For example, the valuation of Air Sahara by Jet Airways, in which Mallya also participated, was found to be excessively high and Jet Airways needed to renegotiate the agreed enterprise value. In the case of Air Deccan, a business analyst estimated that the enterprise value was Rs. 21,150 million (on the basis of Rs. 5,500 million for 26 percent stake) as against the current market capitalization, a proxy for enterprise value, which was Rs. 14,540 million.51 ACQUISITION AND MERGER As soon as UB Group bought 26 percent equity in DAL, the management of Kingfisher took control of Air Deccan. While Gopinath was made the Executive Chairman of DAL, Mallya became its Vice-Chairman. The Boards of DAL and UB appointed KPMG as consultants and Dalal & Shah as chartered accountants to develop the merger structure for the twocarriers.ThecontinuationofAirDeccan’sChief Operating Officer, Warwick Brady, was dependent on the terms offered by the new management. Already rumours abounded that Brady would leave the airline andAir Deccan had appointed Spencer Stuart to hire a CEO for the carrier. Moving forward, the two management set up an integration team and deliberated upon the issues that the two airlines would face in aligning their mission and vision. Brands The Board of DAL rechristened Air Deccan as “Deccan”anditscorporatetagline‘Simplifly’became ‘SimpliflyDeccan.’DeccanoperatedasaLCCbut its logo was replaced by the red Kingfisher image. Brand management experts felt that it was brand extensionwithoutthename‘Kingfisher’andwondered how it would drive sales and improve the profitability 46 Bhargava, A. (2007, June 18). Sultan of the skies. Businessworld, India. 47 26% makes Mallya Air Deccan co-pilot. (2007, June 1). The Financial Express, India. 48 ibid. 49 Sanjai, P. R. (2007, June 1). Did Mallya pay more for Deccan pie? Rediff.Com. Retrieved 12 March 2008 from //money/2007/jun/01deccan.htm 50 ibid. 51 Kaul, P. Prasad, A. (2007, July 5). When the clouds clear? Outlook, Business, India. AuthorizedforuseonlybyMudrahirRahamaninFinancialCaseAnalysisatUniversityofDhakafromMar01,2014toOct31,2014. Useoutsidetheseparametersisacopyrightviolation.
  9. 9. Page 9 ABCC-2009-004 the Asian Business Case Centre of Deccan.52 They also pondered on the issue of what Kingfisher had bought: a brand or business? Several first-time flyers from the new cities which Air Deccan flew had made Gopinath synonymous with lower fares and air travel.53 Some industry experts backed Gopinath as a brand ambassador for the low- cost airline industry and Deccan. They were not sure whether Deccan would become a drag and Kingfisher a driver or vice-versa.Also, they noted that the value attrributes of the two carriers were different and wondered how these two companies could build both brands in the future. Although these decisions impacted future brand building and marketing plans, theintegrationteam’sprimarytaskwastotapthe synergies and achieve cost savings. Operations The team realised that streamlining the routes and operations of both carriers was not easy, due to infrastructure bottlenecks on the metro routes that provided high traffic density and load factors. Firstly, the team needed to strike a balance between the metro and regional routes or profitable high traffic density routes versus the low traffic density regional routes.Secondly,whileKingfisher’simmediate priorities were profitable route operations and growth, the priority for Deccan was cost control and to raise revenues to improve yield. Deccan’sstrategywastounlockvaluefortheIPO investors by setting up maintenance, repair and overhaul organisation and eventually, spawning these into new businesses. While Gopinath focused on domestic network growth and low fares, Mallya was keen to mount international flights.As Deccan began operationsin2003,itwasabouttoreachthe‘five- years-in-operation’conditiontoflyoverseas,which meant that Deccan would have to remain standalone. The team also had to deal with aircraft orders placed by Deccan and Kingfisher which included AB320s and A380s. Synergies To tap the anticipated synergies, the integration team conducted a review of operations, manpower and back-office processes, Maintenance, Repair and Overhaul (MRO), purchasing and Frequent Flyer Programme (FFP), and sales and marketing. They estimated that for the first year alone, the cost synergies would be Rs. 3,000 million.54 The team believed that there was a good operational fit and fleet alignment between the two carriers. Gopinath stated: We both have Airbuses, we both have ATRs, the combined fleet will be now 71 aircraft. So, negotiating with any vendor, any supplier globally, is going to give us a tremendous leverage in bringing down our acquisition costs, in bringing down our contract costs and bringing down the costs for both airlines tremendously.55 In addition, there was potential for sharing common costs for security, ground handling, engineering, and inventoryof spare engines and other materials among the two carriers. Business Model The team noted that the management of both companies had the option of merging the two carriers under one brand or running them as separate carriers with independent brands, which industry experts calledthe‘hybridmodel.’ For example, after the merger of Air Sahara with Jet Airways, the LCC was renamed as JetLite, and the same group ran both the LCC and FSC, emulating the successful hybrid model of Qantas and JetStar. Jet Airways separated certain aspects of marketing and customer service, and tapped synergies between the two airlines in the area of back-office operations, purchasing and FFPs. Although, globally, value-based carrier (VBC) operations by large network airlines had failed, the team needed to customize and recommend to the management of Kingfisher and Air Deccan a new hybrid model.56 Despite the business fit, Gopinath was not optimistic that the merger of the two carriers would work. He felt that the high cost FSC and low-cost LCC model 52 Bhat, S. (2007, December 25-31). Deccan Plateau for Kingfisher. Businessworld, India. 53 Mahalingam, T. V & Mitra, K. (2007, June 3). Business Today, India. 54 Bhargava, A. (2007, June 18). Sultan of the skies. Businessworld, India. 55 ItoldMallyaamergerwon’twork:Gopinath.(2007,June1).Moneycontrol.Com. Retrieved on 5 June 2008 from http:// 56 Mahalingam, T. V & Mitra, K. (2007, June 3 ). On A Wing and A Prayer. Business Today, India. AuthorizedforuseonlybyMudrahirRahamaninFinancialCaseAnalysisatUniversityofDhakafromMar01,2014toOct31,2014. Useoutsidetheseparametersisacopyrightviolation.
  10. 10. Page 10 ABCC-2009-004 the Asian Business Case Centre could not coexist, as employees of Kingfisher stayed infive-starhotelswhileAirDeccan’s employees stayed in guest houses.Air Deccan also did not offer cars to air hostesses. Due to these differences, Gopinath did not believe in the merger of the two airlines.57 Management and Culture To the general public, both Mallya and Gopinath seemed to be in control of the management. The team felt that senior industry executives were not sure who was in control.Atop executive of a rival airline stated: After having burned so much money, and gamblingAirDeccan’sfutureexpansion for cash upfront, it will be extremely surprising if someone lets Gopinath retain a say in the management of the airline.58 The team learnt that depending on the way the deal was structured, the holdings of Gopinath and his associate would go down from 22 percent to 16 percent.59 At the same time, however, it found out from Gopinath that he could muster support of 35 percent of the shares through his associates. In a response to Fortune magazine, Mallya explained: Withmajoritystake,that’spretty inevitable,isn’tit?Thereisnoquestion ofcutpricescontinuinginIndia– everyone wants to raise fares. Deccan is widely regarded as a market spoiler, and that will stop.60 Further, the team saw that the differences in business focus between Mallya and Gopinath were made known to the public when the two leaders openly shared their goals. While Gopinath focused on network growth, load factors and lower cost, Mallya focused on revenue management: Earlier the focus was more on increase in the volumes being synonymous with profits. We are now giving serious attention to revenue management. The results are already showing. The financial collection of Air Deccan have jumped from Rs. 40 to 45 million per day to Rs. 50 to 60 million per day. 61 As LCCs and VBCs accounted for over 80 percent of narrow-bodied aircraft orders fromAirbus and Boeing, Gary Kingshott, the CEO of JetLite felt they would capture a significant share of the domestic market.62 FUTURE OUTLOOK Despite the infrastructural and operational challenges, the senior management teams of Deccan and Kingfisher were convinced that a speedyconsolidation in the aviation industry would lead to profitable growth. The hitherto highly fragmented Indian aviation market had become an oligopoly with three dominant players: Kingfisher-Deccan, JetAirways-Sahara andAir India- Indian. The integration team was optimistic that turning profitable to ride on the air traffic boom of the country wouldalignthetwoleaders’vision,buildawin-win partnership and cement their differences. Byforegoing due diligence, closing the deal promptly and paying a substantial premium to the stock price, Mallya had won the trust of Gopinath although he did not believe in low-fare operations (see Exhibit 11). Commenting on the expectations from the merger, Mallya elaborated: Istilldon’tbelieveinthelow-costmodel because there is nothing low cost about operatinganairlineinIndia.WhatIdon’t believe in is the low-fare model and the high costs associated with operating in India. But two things are happening here. With synergy between Deccan and Kingfisher, a lot of our joint costs will come down dramatically. So, we can offer the cheapest fares to most expensive 57 ItoldMallyaamergerwon’twork:Gopinath.(2007,June1).Moneycontrol.Com. Retrieved 6 may 2008 from http:// 58 Mahalingam, T. V & Mitra, K. (2007, June 3). On A Wing and A Prayer. Business Today, India. 59 Bhargava, A. (2007, June 11). Gone for 550 crore. Businessworld, India. 60 Elliot, J. (2007, June 25). Fortune. 61 Bhargava, A. (2007, June 11). Gone for 550 crore. Businessworld, India. 62 Ibid. AuthorizedforuseonlybyMudrahirRahamaninFinancialCaseAnalysisatUniversityofDhakafromMar01,2014toOct31,2014. Useoutsidetheseparametersisacopyrightviolation.
  11. 11. Page 11 ABCC-2009-004 the Asian Business Case Centre fares…Two,thiswillconsolidatethe industry, which will end this bloodbath of airfares, which is due to overcapacity in the market.63 Accounting and tax analysts noticed that Kingfisher had carried forward a loss of Rs. 12,000 million (as of January 2008) and Deccan had accumulated losses of Rs. 8,000 million (as of January 2008) and that it would be advantageous to keep the two carriers separate to set off the loss against future profits.64 Going forward, there were many challenging tasks onthehandsoftheteam:toprovethatMallya’s valuation of Air Deccan was justified, realise the synergies identified by the two leaders, and balance the strong brands and leadership styles of the two leaders. 63 Bhargava, A. (18 June 2007). Sultan of the skies. Businessworld, India. 64 Kingfisher to wet lease 4 new Airbus to Air India. (12 January 2008). The Financial Express, India. AuthorizedforuseonlybyMudrahirRahamaninFinancialCaseAnalysisatUniversityofDhakafromMar01,2014toOct31,2014. Useoutsidetheseparametersisacopyrightviolation.
  12. 12. Page 12 ABCC-2009-004 the Asian Business Case Centre Source: UB Group Finance Presentations. (September 2006). Retrieved 27 May 2008 from http:// •UBGroup,havingachieveddominanceinitscorebeveragebusiness,waslookingtoleverageitsunique strengths in a) Understanding the needs of the evolving Indian consumer b) Creating premium products at true value c) Operating in a highly regulated environment d) Leveraging brand equity •Aviationoffersextraordinarygrowthpotential •Successbasedonthreecorestrengths a) Ability to tightly manage cost b) Ability to manage scale up c) Ability to deliver a unique experience while remaining competitive •UBGroupiscommittedtothesuccessofKFAthroughfinancial,management,brandandmarketing support EXHIBIT 1 AuthorizedforuseonlybyMudrahirRahamaninFinancialCaseAnalysisatUniversityofDhakafromMar01,2014toOct31,2014. Useoutsidetheseparametersisacopyrightviolation.
  13. 13. Page 13 ABCC-2009-004 the Asian Business Case Centre Source: UB Group Finance Presentations. (September 2006). Retrieved 27 May 2008 from http:// THE UB GROUP AND AVIATION EXHIBIT 2 AuthorizedforuseonlybyMudrahirRahamaninFinancialCaseAnalysisatUniversityofDhakafromMar01,2014toOct31,2014. Useoutsidetheseparametersisacopyrightviolation.
  14. 14. Page 14 ABCC-2009-004 the Asian Business Case Centre EXHIBIT 4 KINGFISHERAIRLINES–MISSION&VISION UB GROUP STRUCTURE EXHIBIT 3 CONCEPT OF KINGFISHER AIRLINES •SuperiorExperience– •Highestseatpitch •Personalizedin-flightaudio&video •Hotmeals •Homedeliveryoftickets •Valetserviceattheairport •StandardAircrafttyperesultinginhighaircraftutilization •AllBrandnewaircraftoperatedbyInternationalclasscabincrew Source: UB Group Finance Presentation. (September 2006). Retrieved 27 May 2008 from http:// VISION: •The KingfisherAirline family will consistently delvier a safe, value based and enjoyable travel experience to all our guests VALUE: •Safety, Service, Happiness, Teamwork and Accountability MISSION: •Be the most successful Full Service, True Value airlline operating in India •Createafollowingof‘fans’andnotjustloyalists. •Drive‘Addiction’toKingfisherClassandKingfisherfirst. •To be the Market Leader by 2010. Source: UB Group Finance Presentation. (September 2006). Retrieved 27 May 2008 from http:// AuthorizedforuseonlybyMudrahirRahamaninFinancialCaseAnalysisatUniversityofDhakafromMar01,2014toOct31,2014. Useoutsidetheseparametersisacopyrightviolation.
  15. 15. Page 15 ABCC-2009-004 the Asian Business Case Centre Source: UB Group Finance Presentations. (September 2006). Retrieved 27 May 2008 from http:// EXHIBIT 5 KFA-INCOME STATEMENT (FY2005-2006) FINANCIALS - UNAUDITED - FY06 Revenue Statement - Major Items Rs. Mio Rs, Mio Income 5,845.00 Fuel Cost 2,356.00 Total Operating Cost 6,806.00 Other Cost 760.00 EBIDTA (1,721.00) PBT (1,908.00) EXHIBIT 6 KFA–INTERNATIONAL ROUTE STRATEGY International traffic expected to grow between 18-20% per annum. Current Governemt policy requiring 5 years of domestic operations prior to flying overseas likely to be reduced. AsacontingencyplanKFAhasworkedout“damp”leasearrangementwithforeigncarrierstooperateKFA aircraftoninternationalsectors.India–US–Indianonstopflightspresentthemostuniqueopportunityand reduced competition. KFA will concentrate mainly on this opportunity and has ordered specific aircrafy types to undertake this mission. KFAwill commence nonstop flights withAirbusA340-500 between Bangalore and San Francisco and Bombay and New York in Q1 2008. KFA will commence nonstop flights with Airbus A330-200 between Bombay and London and Bombay and Hong Kong in Q1 2008.All KFAaircraft will be configured in a class 3 layout, offering Super First Class, Ultra Business Class and Kingfisher Class. Source: UB Group Finance Presentation. (September 2006). Retrieved 27 May 2008 from finance_presentations.aspx AuthorizedforuseonlybyMudrahirRahamaninFinancialCaseAnalysisatUniversityofDhakafromMar01,2014toOct31,2014. Useoutsidetheseparametersisacopyrightviolation.
  16. 16. Page 16 ABCC-2009-004 the Asian Business Case Centre EXHIBIT 8 AIRDECCAN–BALANCESHEET&INCOMESTATEMENT FROM 2001 TO 2005 Source: Deccan Aviation Limited. (18 April 2006). IPO Prospectus, pp.57. Source: Deccan Aviation Limited. (18 April 2006). IPO Prospectus, pp.7-9 Rs. in million EXHIBIT 7 PROFILE OF AIR DECCAN FLEET (MARCH 2006) Aircraft Type No. of Passenger Seats Model No. of Aircraft Average Age (years) ATR 48 42-320 5 12 48 42-500 9 8.56 72 72-500 4 3 Airbus 180 A320-200 11 3 AuthorizedforuseonlybyMudrahirRahamaninFinancialCaseAnalysisatUniversityofDhakafromMar01,2014toOct31,2014. Useoutsidetheseparametersisacopyrightviolation.
  17. 17. Page 17 ABCC-2009-004 the Asian Business Case Centre EXHIBIT 8 AIRDECCAN–BALANCESHEET&INCOMESTATEMENT FROM 2001 TO 2005 (CONTINUED) Source: Deccan Aviation Limited. (2 April 2006). IPO Prospectus, pp.7-9 Rs. in million AuthorizedforuseonlybyMudrahirRahamaninFinancialCaseAnalysisatUniversityofDhakafromMar01,2014toOct31,2014. Useoutsidetheseparametersisacopyrightviolation.
  18. 18. Page 18 ABCC-2009-004 the Asian Business Case Centre Source: Deccan Aviation Limited. (18 April 2006). IPO Prospectus, pp.61. EXHIBIT 9 PROFILE OF AIR DECCAN NEW FLEET (2007-2013) AuthorizedforuseonlybyMudrahirRahamaninFinancialCaseAnalysisatUniversityofDhakafromMar01,2014toOct31,2014. Useoutsidetheseparametersisacopyrightviolation.
  19. 19. Page 19 ABCC-2009-004 the Asian Business Case Centre Year Passenger Growth rates in Operating Operating Carried1 Passenger Traffic (%)2 Revenues3 Result4 Domestic International NSC PSC NSC PSC 2003-04 15,677,000 12.4 6.9 112.9 161.4 0.12 4.5 2004-05 19,445,000 24.0 18.6 134.5 64.5 (1.40) 8.9 2005-06 25,205,000 29.6 22.9 155.8 99.3 (3.63) (2.0) 1 Passengers flown - Table 4.7 of respective years 2 Growthratesinpercentage–Table4.2ofrespectiveyears 3 Operatingrevenuesinbillionrupees–Table4.23ofrespectiveyears 4 Operatingresultinbillionrupees–Table4.23ofrespectiveyears Sources: Financial Results of Scheduled Carriers. (2003-04; 2004-05; & 2005-06). Directorate General of Civil Aviation, India. Retrieved 12 January 2009 from EXHIBIT 10 GROWTH AND PERFORMANCE OF SCHEDULED DOMESTIC CARRIERS Source: UB Group Finance Presentation. (September 2006). Retrieved 27 May 2008 from http:// EXHIBIT 11 CONCEPT OF KINGFISHER AIRLINES WHY FULL SERVICE & NOT LOW COST ? •Over60%ofvariablecostsarecommonforanyairline.Thisincludes •Fuel–37% •Mainetenance–10% •LandingandParkingCharges–7% 60 % •LeaseRentals–6% •Cost such as salaries of Pilots, Engineers etc, are standard and do nto differ between LCC and a full service carrier •In India , there is no cost differential to jusitfy low pricing as in an LCC AuthorizedforuseonlybyMudrahirRahamaninFinancialCaseAnalysisatUniversityofDhakafromMar01,2014toOct31,2014. Useoutsidetheseparametersisacopyrightviolation.