Going gets tough for airlines as input cost rises
The result is a fall in return on capital and strategic investors are steering clear of taking an equity exposure to the business. Say it with gifts this Diwali
By Cuckoo Paul & Anto T Joseph, TNN |
MUMBAI: Dark clouds seem to be looming large for domestic airlines as equity funding becomes difficult to find. Input costs are mounting, even as the airlines try to expand and consolidate at the same time.
The result is a fall in return on capital, and it is not surprising that private equity players and strategic investors are steering clear of taking an equity exposure to the business. Industry officials said most carriers operating domestically are still in need of funds to pay for increasing working capital requirements.
Fleet expansion is being financed largely through credit from export credit agencies like the US Exim. Sources told ET that Kingfisher and SpiceJet are among those currently in the market trying to offload equity to prospective investors, but their airline promoters have denied any such move.
Investment bankers say there is a significant mismatch between expectations and the valuations being offered in the market. Many airlines, including big names such as Jet Airways, have deferred plans to raise funds, preferring to wait till conditions change. The last two quarters of the year are traditionally better for airlines and profits are expected to look up in this period.
For over a year now, private equity players, hedge funds and commercial banks have been chary, as the airlines struggle to make profits. Despite attempts by most of the players at fund raising in the industry by selling equity, there has been no successful transaction so far this year.
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The last big deal was in December last year when low-cost carrier SpiceJet raised about $80 million from a clutch of investors led by Isthithmar, Goldman Sachs and the Tata group. Two carriers, Air Sahara and Air Deccan, that were among those who made maximum losses last year, were bought out this year, by Jet and Kingfisher, respectively. Both acquirers are now struggling to turn around the airlines by finding synergies with their own operations.Commenting on the situation, director of transaction advisory services at Ernst and Young, Jayesh Desai, says, “There is clearly a value-expectation mismatch in the industry.” Though several players are looking to raise equity funding, they have not been successful in completing their transactions, he said.
A leading PE player said the return on capital employed in the sector is only around 7-8%, far below the figures expected by investors. “Lack of aviation infrastructure in India and increasing input prices such as oil and salaries are driving away prospective investors. Almost every player has tried to raise private equity, but only a few were successful,” he said.
A senior official at Edelweiss Capital, however, countered the argument claiming that there are still takers for equity in the sector. “We raised equity for Air Deccan and SpiceJet without any hassles,” said the official. The Mumbai-based merchant banker was the adviser to the UB Group’s takeover of Deccan Aviation as well as the recent open offer for the operator of India’s first low-cost carrier.
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Edelweiss is also believed to be scouting for an investor in UB group’s aviation business, which includes Kingfisher and a near-majority stake in Deccan Aviation. Sources said the merchant banker has not met with any success even after long parleys with PE investors.Jet Airways chairman Naresh Goyal said at the company’s annual general meeting that the airline has deferred its rights issue till conditions improve. It may approach the market by December or January 2008, he said. Go Air managing director Jeh Wadia has been talking to investors for over a year, but is yet to close a deal to bring in an investor Airline sources say funding for aircraft is being done through debt.
Air India, for instance, has just raised about $1.5 billion in debt, at rates below Libor, mainly through US Exim loans. Most airlines are still losing money and have already wiped off most of their net worth.
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