The Maharajah of debt

The Maharajah of debt

Air India mess: Many countries had to also divest their flag carriers after attempts to rescue them failed.

The Maharajah of debt

This is not the first time that Air India (AI) has been the subject of uncomfortable conversations. The national airline has accumulated losses of over Rs 55,000 crore and debt of Rs 52,000 crore with no end in sight for its troubles. A quick comparison of AI’s performance in FY16 with its competitors drives the point home.

In spite of low oil prices, AI has struggled to break even operationally. Repeated bailouts in the past failed to cure AI of its ills. If anything, government support is only harmful to the aviation industry in India as funding AI with taxpayer’s money distorts price discovery in an otherwise free market.

Experiences from across the world tell us that these problems are not unique to AI. Consumer-facing businesses in a competitive market cannot be run with restrictions and obligations that come with being a public sector company. Overregulation, union issues, poor management and political interference are a common theme across these companies.

We need not look far for examples of such companies. BSNL could not adjust to growing competition in the telecom space. From profits of Rs 8,900 crore in FY 06, the company made losses of Rs 3,900 crore in FY 16, in the face of intense competition. In aviation itself, a number of countries had to divest their flag carriers after repeated attempts to rescue them. A typical example being the national carrier of Switzerland, which was grounded in 2001 as a result of continuing losses, complex structure and heavy debt. The Swiss government liquidated the carrier and encouraged the creation of a successor airline taking over most of the routes, aircraft and staff.

The successor airline was then sold off to a leading European airline and is among its most profitable divisions today. The “public good” benefits of AI, such as remote connectivity, can be achieved by the government using more economically efficient means. The first round of Regional Connectivity Scheme is being supported by a paltry viability gap funding or Rs 205 crore per year. The key to successful divestment is ensuring a transformational change in the organisation once it is sold. While partial divestment, if successful, can lead to a higher value to the government later, the chance of success falls drastically if the new owner does not have full control of the company. Case in point: a key airline in Italy is once again in dire financial straits less than three years after it was rescued by a Gulf-based airline major, which bought 49% stake in the ailing carrier in 2014. But persisting labour issues and carrying over legacy culture pushed the carrier back into the red.

To realise the most value out of divesting AI, in addition to looking at selling it as a whole, the government should consider selling AI's domestic and international operations separately. Different players in the market value one or the other more. For instance, international operations of AI can be very valuable to many domestic players which are looking to expand internationally. Air India’s international landing and parking slots across the world will fetch a premium from potential buyers. Recently a pair of slots in Heathrow was bought for $75 million. Air India’s domestic operations, however, may not be very attractive to domestic carriers. On the other hand, many Gulf carriers are looking to get a slice of the fast-growing domestic aviation market in India. Acquiring AI’s domestic operations can allow them a good market position along with preferred domestic slots as well as other facilities at airports.

Air India’s interests in other profit-making entities like AI Transport Services, AI-SATS should be sold off separately and the proceeds can be used to reduce the debt burden. Similarly, real estate should be hived off into a different company and sold off, with proceeds used to reduce debt.

Right time
There are a number of favourable factors that make this the right time to divest. Fuel prices are low and are expected to remain flat for foreseeable future, making airlines an attractive business. Airport infrastructure across India is lagging behind air travel growth. Mumbai and Delhi, accounting for over 36% of total domestic traffic, are already facing constraints on giving out new slots to airlines. This leads to higher ticket price realisation and higher passenger loads, further contributing to airline profitability. Passenger load factor in India increased from 68% in 2006 to 82% in 2016. Air India’s landing and parking slots will be prized in this environment.  Internationally, airlines are increasingly favouring point-to-point service due to improvement in fuel efficiencies of aircraft. Air India, with slots across countries, is well suited for it.

The government must first reduce the gigantic debt burden on AI before divesting. Out of Rs 52,000 crore debt, about Rs 22,000 crore is used for financing aircraft purchases while the remaining is for working capital. The working capital debt must be taken over by the government before divesting while debt used for financing aircraft should be passed on to the buyers. The government should also take steps to ensure that the interests of AI employees are protected. When Mumbai and Delhi airports were privatised, the new owners had to make employment offers to at least 60% of the existing workforce.

A similar arrangement could be made in this case, too, with the remaining employees offered voluntary retirement. The time is right for divesting AI. The government must act decisively and divest it completely while ensuring its employees get a fair deal. The sum of parts of AI may be greater than the whole.

The government should consider selling international and domestic operations separately. Selling real estate and other profitable businesses separately can help the government in reducing the working capital debt before taking it over. If it’s done right, this will strengthen the reformist image of the government and set a precedent for dealing with other loss making government companies. It will also prevent further wastage of valuable tax money and ensure that this will be the last time we will have this unpleasant conversation.

(The writer is partner at Strategy&, part of PwC Network)

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