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Fighting the bad times

K. R. Balasubramanyam and Kushan Mitra     November 27, 2008
“We have done our homework. I have done 10 months of meticulous planning for this venture. Today it has become fashionable to launch an airline. But we have a huge brand pull because of the Kingfisher brand. Half of my marketing problems are taken care of”

Vijay Mallya, in Business Today dated April 10, 2005, roughly a month before he launched Kingfisher Airlines

“Aviation is a business in which cheques fly faster than planes” Captain G.R. Gopinath, MD, Air Deccan, in the same story

Vijay Mallya
Hindsight is a wonderful thing, more so perhaps for smug business writers. However, the point of digging into our archives and pulling out these two gems is not to say “we told you so” or to make UB Group supremo Vijay Mallya look silly. Rather, it’s an attempt to highlight the hazards of the airlines business, which can upset the applecart of the most seasoned entrepreneurs and make their best intentions and grandest ambitions appear extravagant. Three years ago, Jet Airways was king of the hill, Captain G.R. Gopinath was the much-heralded pioneer of the lowcost format, and Mallya was looking at breaking even in a year. Today, Jet Airways and Kingfisher are preparing to work together to ensure they don’t cannibalise each other; Gopinath is now Non-Executive Vice Chairman of Kingfisher Airlines (after Air Deccan was merged into Kingfisher); and Mallya is at the helm of an airline that’s reeling under piled-up losses of Rs 2,500 crore and an estimated debt heap of Rs 4,000 crore.

Mallya’s current task is clearcut: He has got to prevent Kingfisher from going under. He has got to do it solo, as policy norms don’t allow him to bring in an overseas airline as a partner. High levels of sales tax at the state level, which Mallya terms “punitive” and “like a guillotine”, aren’t doing him any favours. All expansion plans have been put on hold for now, with delivery of some 80 aircraft (between Kingfisher and Deccan) being deferred. Kingfisher has to first wipe out its accumulated losses, which Mallya expects to do in the next three years.

“The airline business is such that you have to be prepared for losses and stay invested. A full-service carrier will take anywhere between five and eight years to break even,’’ says Mark Martin, Senior Advisor with consulting firm KPMG India.

A grim picture

Mallya has a Herculean task on his hands.

  • Losses of Kingfisher for the first six months of 2008-09 Rs 641 crore
  • Accumulated losses of Kingfisher Airlines Rs 2,500 crore+
  • Estimated operating losses of Kingfisher for 2008-09 Rs 499 crore
  • Analysts’ estimates for Kingfisher’s net losses for 2008-09 Rs 1,500 crore
  • Estimated profits of listed group companies for 2008-09* Rs 600 crore
  • Debt on Kingfisher balance sheet Rs 4,000 crore
  • Number of new aircraft whose delivery has been rescheduled 80(60 from Deccan and 20 from KF)
  • Number of new aircraft whose delivery will be taken in 2009 Zero**

+ Including losses of Deccan Aviation, which was merged into Kingfisher
* Includes USL, UBL and UB Engg
** Mallya might take up some A320 or ATR deliveries in late 2009 if conditions improve



Over the past six months, during which prices of aviation turbine fuel (ATF) rode a rollercoaster, Gopinath’s truism that cheques fly faster than planes has come home to haunt Mallya. Last fortnight, he finally cleared part of dues—Rs 167 crore of Rs 967 crore to oil companies, and Rs 50 crore of Rs 220 crore to Airports Authority of India (AAI). “We have time till March 31 to clear the balance to oil companies and have worked out a settlement plan with AAI,” clarifies A. Raghunathan, Chief Financial Officer (CFO), Kingfisher Airlines. Apparent defaults on payments to General Electric’s aircraft leasing company have also prompted Mallya to return two of four disputed aircraft; a third was on its way back at the time of writing, the fourth will also be handed back (Kingfisher isn’t the only airline returning aircraft to lessors; other airlines have, too).

Kingfisher maintains that no payments were pending, but the fact remains that Mallya’s expenditure in running the airline was higher than the monthly collections in sales in the April-September period. The losses, as a result, kept mounting— from Rs 157.86 crore in the April-June 2008 quarter to Rs 483.25 crore at the end of the following three-month period, on revenues of around Rs 1,350 crore in each quarter. In the first half of this fiscal, the airline has paid Rs 246 crore in interest.

There’s a feeling that the group might be under-reporting the airline’s losses, having switched to a new accounting procedure. “The actual loss may appear much higher at Rs 1,119.71 crore for the April-September period if you also factor in deferred taxes of Rs 275.59 crore, and maintenance rent of Rs 203 crore payable to lessor aircraft. The company has shifted maintenance rent out from revenue expenditure under a new accounting practice,’’ points out R. Ramakrishnan, Partner with chartered accountancy firm R. Ramakrishnan & Co., in Bangalore. Mallya insists maintenance reserve cannot be counted as expense until the expenditure is actually incurred, and that’s the standard global practice.

A. Raghunathan Chief Financial Officer, Kingfisher Airlines
A. Raghunathan
Mallya claims that neither is he under any financial stress nor is he scouting for money. “If the conclusion is that I require huge sums of money, I disagree with that. We have a very healthy cash flow due to healthy sales. We are collecting Rs 475 crore a month in our sales,’’ he told BT. He is relieved that the monthly expenditure has dipped to Rs 480 crore on the back of a drop in the prices of crude oil, from a peak of Rs 540 crore in August. But, on the other hand, a sharp depreciation in rupee has played spoilsport with Kingfisher’s dollar expenses like costs on lease rentals and maintenance. The high-profile billionaire is hunting for a “strategic investor” who would value his airline for its long-term potential; for this he is pushing hard for foreign direct investment (FDI) from a foreign airline, which current policies don’t allow. He would want to fly jointly with a foreign airline with which he can strike out an operational alliance, too.

Investment bankers are not as gung-ho as Mallya about a potential partner being willing to ignore current market realities and focus on long-term prospects. Says K. Ramakrishnan, Executive Director & Head-Investment Banking, Spark Capital Advisors, Chennai: “I am a little sceptical about Mallya getting an “acceptable” value for his aviation business in these conditions. Today, there is a more pronounced disconnect between expectations in the minds of the sellers and readiness to pay in the minds of buyers. You cannot brush off current low stock market valuations as “unrealistic”. It is a reflection of the sentiment and is a discounting of immediate foreseeable potential.” Ramakrishnan adds that the possibility of somebody willing to pay a more acceptable value is higher in the liquor business, which enjoys superior profitability and leadership than in aviation.
So, how big an albatross is KF around the Rs 13,600 crore UB Group’s neck? “We find the balance sheet of the parent company, UB (Holdings)—which owns 55.5 per cent of KF—slightly stretched. It is difficult to raise funds on KF’s balance sheet because of its negative net worth,” says Nikhil Vora, Managing Director, IDFC SSKI Securities. “While operational businesses of the UB Group (United Spirits, United Breweries and UB Engineering) are estimated to make a profit of Rs 600 crore for 2008-09, we believe that Kingfisher’s losses for the current year could be around Rs 1,500 crore. The biggest challenge for the UB Group is to address investor concerns with regard to fund-raising for Kingfisher Airlines. Hopefully, the recent sharp correction in ATF prices will provide relief for the aviation business,’’ adds Vora, who tracks the group.

The UB Group maintains that the airline does not get funds from any other group companies, except the holding company (see The UB Empire). “Not a single penny moves from either the breweries or spirits business to the airline. We operate in three completely independent silos. None of the businesses funds each other. Any funding support comes only from UB (Holdings),’’ says Ravi Nedungadi, Chief Financial Officer, UB Group. This means Mallya has to leverage only the balance sheet of UB (Holdings) to raise funds and stay invested in his airline business. UB (Holdings) grew 74 per cent sequentially to report a net profit of Rs 15.36 crore in the second quarter, and owns, among other assets, 9.50 lakh sq. feet of prime real estate in UB City in Bangalore, in a joint venture with Prestige Group.

Kingfisher Airline’s yet-to-be revealed balance sheet may be weak, but there have been enough developments in recent days to help improve sentiment. The reduction in ATF prices and abolition of import duty of 5 per cent on the fuel will, indeed, help in stemming the losses. “If the sales tax on ATF is reduced to 4 per cent, Kingfisher will not have any loss in December for the month. There will be no cash burn and we will save between Rs 300 crore and Rs 400 crore a year on account of saving in taxes, which is 25 per cent on an average now,’’ says Raghunathan. Aware that he cannot get states to slash sales tax rates on ATF to 4 per cent, Mallya has stepped up the campaign to get the Centre to bring ATF under declared goods category (See Heavy, Heavy Fuel) so that it becomes taxable at 4 per cent. He has dangled a carrot, too: “If they cut taxes, I will cut fares.’’

It’s not as if the entire industry is clamouring for lower taxes. “Reducing taxes on fuel is not the solution, because what happens when the base price of fuel climbs again like it did earlier this year? The solution, I believe, is that airlines will have to seriously think about their business models. And also get the right-sized aircraft for the right route. What is the point of flying a 180-seat Airbus with only 70 passengers in off-peak hours. A plane has to make money through the day, not just at peak hours,” says M. Thiagarajan, MD, Paramount Airways. Paramount operates only 70-seat Embraer E170 jets. Mallya, for his part, says the large scale of the operations of Jet and Kingfisher, which fly some 170 aircraft between them, is not comparable with the rest of the private sector pack.

Ravi Nedungadi Chief Financial Officer, UB Group
Ravi Nedungadi

Yet, government sops are unlikely to make a dramatic difference to Kingfisher’s finances in the near term. An alliance with Jet and the announcement that Kingfisher will not cut fares will translate into better sales revenues only if passenger volume rises. “It is a positive sign that Kingfisher and Jet have decided not to reduce fares, but whether that will increase profitability is hard to predict now,’’ says Hitesh Agrawal, Head of Research at Angel Broking. One-time rival and now Kingfisher Non-Executive Vice-Chairman, G.R. Gopinath, says that just relying on government sops isn’t the way to go for the industry. “The way forward is for airlines to control costs and stimulate demand. The government must also participate in this endeavour by ensuring that various service providers to the airline industry offer their services at competitive prices. The combined efforts of government and the airlines will improve profitability. The airlines, too, on their part, must shift their focus from doles and raising money to getting themselves to profitability by controlling costs,” says the Founder of Deccan Aviation.

 To divest in a downturn or not

Mallya’s options for unlocking value.

  • Strategic sale in Kingfisher: Mallya feels he will get a far more attractive valuation from a strategic investor than from a financial investor.
  • Strategic sale in United Spirits: Negotiations are underway with Diageo, although both companies have clarified these are just ‘exploratory talks.’
  • Offloading equity in Bangalore Royal Challengers (IPL team): Mallya can leverage the long-term potential of his IPL team, although Mallya claims he has no such plans.
  • UB City: The company, which is a JV with the Prestige Group, owns 9.50 lakh sq. ft of commercial space, valued at an estimated Rs 1,425 crore at today’s prices.
  • A 10 per cent stake in Aventis Pharma: Valued at Rs 190 crore in a bear market.


The Kingfisher brass is quick to point to the benefits of the integration with Deccan, now christened Kingfisher Red, which have begun kicking in. They point to Sports—a subsidiary of United Spirits Ltd (USL). And, of course, there’s the flagship liquor enterprise, United Spirits, in which Diageo has expressed a keenness to buy. “There is clearly pressure on the financials of the entire group. But there is still enough potential for value unlocking in a lot of the group companies like USL, where they have treasury stocks, and Whyte & Mackay (which was acquired last year for $ 1.18 billion or Rs 4,720 crore) to latch on to. They can sell part of IPL to private equity investors. I think the UB Group will do something in the next 12 months,” says Vora of IDFC SSKI Securities. Mallya, for his part, says he’s not keen on unlocking value in the IPL team, which analysts value at some Rs 700 crore. According to a UB Group presentation, the IPL team has received unsolicited expressions of interest for participating in the equity of Royal Challengers Sports at a significant premium.

There’s another option, however unlikely it may seem, to unlock value. Gopinath has made an offer to buy back the erstwhile Air Deccan. “I offered to explore buying out Air Deccan if Mallya was willing to sell. I am sure there are people to invest in a low-cost carrier,” says Gopinath. Mallya is, of course, in no mood to take the offer seriously. “He has to buy the whole of Kingfisher. Deccan does not exist,” he quips.

Apurv Nagpal, Marketing Director, SABMiller India
Apurv Nagpal
Liquor is quicker
Mallya’s core businesses of liquor and beer are his mainstays, although the latter could give him a few headaches.

Our core businesses are doing excellently,” Mallya booms before starting his interview with BT. Little wonder then that the world’s largest spirits firm Diageo has expressed an interest in buying a strategic stake in USL, which also has Whyte & Mackay and Shaw Wallace in its stable. Both USL and Diageo maintain these are just “exploratory” talks.

In beer, leader Kingfisher finds itself getting crowded out by a host of foreign competitors, right from SABMiller, Asia Pacific Breweries (APB) (in which Heineken has a large stake) to Belgian brewer InBev, which recently acquired Anheuser-Busch. “We are extremely strong in the strong-beer segment (which makes up 70 per cent of the entire beer market) and lead the market vis-à-vis UB in this segment. We will be expanding to provide consumers with a genuine alternative to UB products,’’ says Apurv Nagpal, Marketing Director, SABMiller India. SABMiller, according to him, commands 35 per cent of the Indian beer market. UB has some 45 per cent.

UB’s spat with Dutch brewing giant Heineken B.V is still unresolved. The Dutch brewer inherited a 37.5 per cent stake in UB when it along with Carlsberg of Denmark bought out British brewer Scottish & Newcastle (S&N), which is Mallya’s joint venture partner in UB (with each owning 37.5 per cent). The bone of contention between the two is Heineken directly competes with UB’s Kingfisher through APB’s brands such as Tiger and Baron. UB had, as per its earlier agreement, granted certain special privileges to S&N. The same, it now argues, do not automatically pass on to Heineken. “The earlier shareholder agreement was specifically restricted to the parties in that agreement. It has to be redrafted now. We want to give time to Heineken to resolve matters internally,’’ says Ravi Nedungadi, CFO, UB Group.

Mallya’s team in the Indian Premier League, the Bangalore Royal Challengers—a wholly-owned subsidiary of USL and for whose franchise rights Mallya paid Rs 446 crore—is estimated by analysts to be valued at Rs 700 crore. Mallya says he is in no hurry to unlock value. “The team will have a far better second season than the first.”

Heavy, heavy fuel
Are punitive state taxes on ATF killing the industry?

When Maharashtra Chief Minister Vilasrao Deshmukh suggested to Vijay Mallya a few months ago, that he operate flights to Tier-II cities in Maharashtra, the aviation baron politely declined. Mallya clearly wasn’t inclined to oblige governments unless they bailed out the aviation sector from state levies—that average 25 per cent—he calls “punitive”. It’s these levies that are breaking the back of the Indian aviation industry, argues Mallya. According to some estimates, India’s airlines are expected to end the year with combined losses of about Rs 10,000 crore (approx. $2 billion), up from $1 billion a year ago.

In the recent past, global crude prices have slid from a high of $147 a barrel in July to $50 currently. Whilst that’s solace for the industry, it doesn’t mean that the airlines are in clover. For one, the rupee itself has fallen to Rs 50, making imports costlier.

As import duty on ATF has been abolished from November 1, airlines pay an excise duty of 8 per cent. On top of this, states collect levies between 25 and 33 per cent on ATF. Only Kerala and Andhra Pradesh have sales tax rates of 4 per cent on ATF, effective April 1, 2008. Maharashtra, too, has extended a similar relief, but outside Mumbai and Pune. So, effectively it means nothing to airlines as over 90 per cent of flights in that state take off from these two centres.

Civil Aviation Minister Praful Patel has been arguing the aviation sector’s case and had said ATF prices in India are 70 per cent higher than the international benchmark. The Centre is seeing if it can bring ATF under declared goods. Once the Centre notifies a commodity as declared goods, the maximum sales tax or valueadded tax that a state can levy is 4 per cent. The Centre notifies a commodity as declared goods if it is found to be of special importance in inter-state trade or commerce. For instance, ATF used in aircraft with a maximum take-off mass of less than 40,000 kg, operated by scheduled airlines, was recently notified as declared goods as these aircraft are doing a service in connecting distant parts of India.

A commercial taxes official in Bangalore, not willing to be identified, says they have strong reasons not to agree with the demand for a 4 per cent uniform sales tax. The government cannot cut taxes on ATF when others continue to pay an effective tax of 26 per cent on diesel. “How can we subsidise air travellers when people who use buses are absorbing high taxes on diesel,” wonders the official.

But Karnataka Home Minister V.S. Acharya, who represents the state on the Empowered Committee of State Finance Ministers, believes cut in levies will stimulate growth in traffic volumes as air schedules have drastically come down in the last few months. He, however, adds that Karnataka is sticking to the present rate as it does not want to deviate from the suggested rate. That’s not good news for Mallya and other operators of Airbus and Boeing aircraft.

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