Derek Sadubin, Centre for Asia Pacific AviationDerek Sadubin, general manager of the Centre for Asia Pacific Aviation, examines the failure of the proposed takeover of Air Sahara by Jet Airways and looks at their prospects given the rapid rise of low-cost carriers in the dynamic Indian market.
The dissolution of the Jet Airways takeover of Air Sahara is typical of the growing pains that emerging markets go through.

The match appeared made in heaven just six months ago, providing Jet with aircraft and human resources plus a roughly 10 percentage point boost to its domestic travel share, to help it defend its market position in the face of rising competition. But airline valuations in India have plummeted about 40% this year, despite rapid market growth, which made Jet’s $500 million deal for Air Sahara, announced back in January 2006, look too expensive. 

The correction in investor sentiment for Indian airline companies followed last year’s rush of capital into the sector, when start-up valuations reached unrealistic levels, touching almost $200 million. It also became clear that Jet would be required to make continuous investments, estimated as high as $200 million, to turn around Air Sahara.

In the end, Jet said its withdrawal was driven by “commercial considerations”, as delayed government clearances were not available by the deadline. Overall, this may reflect a strategic miscalculation by Jet, which could prove damaging, particularly if the legal battle becomes drawn-out.

Air Sahara is reportedly planning to sue for damages of up to $450 million. The financial implications for Jet are likely to be serious as it tries to make an out-of-court settlement with Sahara. Jet also faces the capital-intensive route of growing its business organically, rather than expanding via acquisition.

The aborted deal leaves Air Sahara vulnerable, with only a 9.7% share of a highly competitive market and the difficult prospect of rebuilding its airline (12 aircraft are currently grounded) and organisation structure quickly. The carrier aims to hire about 700 employees – mainly pilots and cabin crew – in the next six months to meet its immediate needs, but this will come at significant cost in a tight labour market. Fresh management and restructuring expertise is also critical to the airline’s survival.

Both Jet and Air Sahara are left with the immediate prospect of urgently needing fresh funds, but they have fewer options at their disposal following the Indian stock market tumble in May and June. Jet Airways is reportedly in talks with local Indian banks to raise $400 million in short-term loans to finance aircraft pre-delivery payments, following the delay in its proposed issue of $500 million in foreign currency convertible bonds. Air Sahara is yet to announce its immediate funding plans, but further bank debt is likely.

Trailblazers such as Air Deccan, Go Air and Spicejet are capturing a significant proportion of the market, at the expense of full-service carriers. Back in October 2005, full-service carriers – including Kingfisher for the purposes of analysis – commanded 84% of the market, including 35% by Jet and 12% by Air Sahara. By May 2006, the full-service-carrier share had dropped to 73%, including 34% by Jet and 9% by Air Sahara. 

Reviewing the past eight months, full-service carriers are, on average, bleeding 1.5 percentage points of market share a month to no-frills carriers. We do not expect this rate to slow in the short term, given the profile of current fleet orders. Low-cost carriers could therefore control more than 35% of the domestic market by the end of 2006 and pass 50% some time in the second half of 2007. By 2010, the low-cost carrier share could be as high as 70%.

On the other hand, business travel – the bread and butter for Jet and Air Sahara – is expected to increase only a little above GDP growth levels for the next five years. The spectacular rise in demand in India since 2004 has been at the leisure end of the market. It is the emerging untapped leisure sector that will drive the domestic market to more than double over the next five years (growing at 25% a year) to about 60 million passengers by 2010. This leisure growth will mainly be captured by the new breed of low-cost carriers entering the market.

Investment opportunities
These forecasts carry massive implications for airline strategy and financing in India. The recent stock market correction, coupled with the state of the airline industry’s financials, has resulted in more sensible valuations in the market. Nervous investors will be looking at other investment opportunities – such as cargo, maintenance companies and airports – which offer more reliable revenue streams and better long-term returns. Investors will also weigh up the merits of full-service versus low-cost carrier prospects, and will back those that demonstrate efficiency, productivity and stable yields.

Air Sahara, in particular, will need to decide which market segment it aims to serve over the long term, although successfully transitioning from a full-service to low-cost operating model has met with almost universal failure in other markets. For those that survive the current turmoil, the spoils could be significant. But bouts of upheaval and investor nervousness are inevitable in fast-growing markets like India. The bulls will return eventually – India’s aviation future is too bright to keep them away for long.

Source: Airline Business