Why Air India’s global business sold separately means gold for IndiGo

Just a day after the Union Cabinet cleared a proposal to allow the sale of government stake in Air India, IndiGo Chief Executive Aditya Ghosh wrote to the aviation ministry expressing his airline’s interest in Air India, primarily its international business.

However, the market did not take it well. After the piece of news pummelled the stock prices of InterGlobe Aviation, the company that owns IndiGo, the promoters were last week forced to organise an investors’ call.

In the hour-long call co-founder Rakesh Gangwal explained that the airline was planning to enter the long-haul international market on a low-cost model, with or without Air India. Surely, however, buying out Air India — provided it is viable — would help IndiGo grow the business faster.

There are many reasons why IndiGo should want to split the airline into two parts, or even more as Gangwal said. But aviation analysts are divided on the merit of such a move; many believe a spin-off would reduce the number of suitors for Air India and not fetch the government the best value for its stake.

What are the key arguments? For one, Air India’s international business has tremendous value; if it is sold off separately, there might not be much incentive for suitors to go for just the domestic business. According to some estimates, its international business accounts for 60 per cent of Air India’s revenues, and about 63 per cent of the available seat kilometres (ASKM), or seats multiplied by the number of kilometres a plane flies while deployed in international skies.

Also, unlike Alliance Air, the domestic airline that flies to smaller cities and is losing money, Air India Express, flying mainly on international routes is highly profitable. And, it is this business that IndiGo has shown its interest in.

In 2015-16, Air India Express had a net profit of ~361 crore on a turnover of ~2,909 crore, and an attractive operating margin of 24 per cent.

It is true that an internal data analysed by the Comptroller and Auditor General (CAG) shows that Air India’s international business is losing more money than domestic. But that is because of inefficiencies in running the business — poor utilisation of aircraft, for instance — which can be fixed by a new operator.

The deficit on international routes over the total cost (fixed and variable) in 2015-16 was ~3,755 crore, against ~1,759 crore for the domestic market.

Another inherent advantage that analysts point out is that the utilisation of aircraft on international flights is much higher than that on domestic flights. That, of course, has a bearing on cost and margins. Based on Air India’s own internal targets on wide-bodied international routes, the targeted flying time is between 13 hours and 15 hours on international routes, while it is an average 12 hours for flights in domestic skies. These targets for 2015-16, according to CAG, were not met by the airlines.

There is also a huge value in international slots, which are either very expensive — a slot was sold at $75 million at Heathrow — or just not available, like in London and New York. Air India has slots at 18 level-three airports (cities where there is a huge shortage of infrastructure and availability). That is one point that even Gangwal acknowledges when he says IndiGo’s growth will be much slower if its goes there alone.

Experts also say that bilateral agreements, unlike domestic skies, ensure that the number of flights or competitors on the route are limited by government permissions. So, there is limited competition. By comparison, there is no such restriction on domestic routes, except in the case of shortage of slots in some metros.

Air India, despite all odds, still remains the largest international airline in the country, with a combined market share (including Air India Express) of 16.9 per cent. The closest competitor is Jet airways, which controls 14.5 per cent of the market.

According to experts, the government cannot get the full value by selling Air India in parts. Captain G R Gopinath, the promoter of the erstwhile Air Deccan who is credit with bringing the low-cost carrier (LCC) model to India, says: “You cannot separate the lungs from the heart and run the business. You will get value when you sell it in one piece.”

The reason is simple: Both domestic and international businesses feed on each other. For an international business to grow, there needs to be a strong domestic network in many cities and towns to bring passengers to international flights. The opposite, similarly, is also true, as passengers travelling internationally need a well spread out domestic network to take them to smaller cities and towns beyond the few metros.

For IndiGo, with over 40 per cent share of the domestic market and nearly one new fleet to be delivered every week from next year, there is no need to acquire a domestic business. It can increase its share on its own through its planned capacity increase. It does not make much sense for it to pick up a domestic business with all its problems — all for less than a 13 per cent market share.

However, for the Tatas, on the other hand, it may be logical to pick up the entire business, say experts. Through Vistara, its JV with Singapore Airlines, the group clearly wants to be in the global market, and be a substantial player domestically, too. But it has only about 3 per cent share of the domestic market at present, and its international foray is expected only next year.

So, Vistara for one needs both the domestic and international business to support each other. And if SIA is roped in, it could leverage the international business even better on the back of a substantial domestic passenger and network base.

If a west Asian airline was interested, it would have paid a bigger value for both of Air India’s businesses auctioned together. It could use Air India’s bilateral rights to put in more flights, from more Indian cities to its hub – that is limited currently because the government limits flights, passengers and cities from where such carriers can fly. But such a player will also need a strong domestic business to feed the extra flights. At the moment, there is a dependence on code sharing with others.

There also, meanwhile, are others like Jitender Bhargava, former executive director of Air India, who say the standalone domestic business of the airline could be attractive to some companies like SpiceJet, which could double its market share and become the second-largest player in one go.

Bhargava agrees that some substantial restructuring will be needed because SpiceJet runs on the LCC model and will need to completely overhaul the confliguration of seats in the planes of Air India, which runs as a full-service carrier. Considering the Indian market has dramatically shifted to LCC, no bidder would like to continue running it separately as full-service carrier.

As far as IndiGo is concerned, it is not difficult to understand its interest in international skies. With a 3.9 per cent share of the international market, it has been a very cautious player, especially after its aggressive move in Singapore led to a price war with Singapore Airlines. As a result, IndiGo had to reduce its flights to the city.

Air India’s international business can catapult IndiGo in the top league, with a market share of around 21 per cent — more than Jet Airways. Also, it will make its entry into long-haul flights quite smooth, with all the valuable routes and slots already available across markets. Of course, for the LCC model, it will still need to make some investments in tweaking the seat configuration.