Manu Kaushik August 5, 2019
In the third week of July, IndiGo reported its highest-ever quarterly profit of Rs 1,203 crore, a staggering 4,230 per cent jump over the first quarter of last year. The strong performance came in the backdrop of the slowdown in the aviation sector as passenger growth plummeted to a multi-year low in the first six months of 2019. The airline also reported its highest ever market share of 49 per cent in quarter-ended June. All this called for a grand celebration at the Gurgaon-headquartered carrier that has grown from a single aircraft to over 238 in just over a dozen years. But the euphoria was clouded by the bitter fight between the friends-turned-foes co-founders - Rakesh Gangwal and Rahul Bhatia - mainly over the latter's unequal rights and powers and the controversial related party transactions between Bhatia's private firm InterGlobe Enterprises (IGE Group) and IndiGo.
The first salvo was fired by Gangwal who, in a letter to market regulator Sebi's top brass in early July, objected to the "unusual" rights given to the Bhatia-controlled IGE Group and his alleged abuse of these rights to serve his vested interests. The IGE Group responded by saying "the parties went into the venture with their eyes open? the deal was struck between seasoned business people who made their own assessment of risks, their rights, and their obligations." Experts say the rights are, indeed, one-sided, considering that both the founders hold an almost equal stake. "It's difficult to say why they signed such a one-sided agreement. I think nobody had imagined that IndiGo would become so big in a short time," says Amit Sinha, Partner at Bain & Co. The terms survived even during the IndiGo's initial public offering in 2015, when the shareholders' agreement (SHA) was heavily renegotiated twice.
However, after weeks of uncertainty that hit the IndiGo stock and threatened the future of India's longest-running profitable airline, reports suggest that the co-founders have agreed to a settlement, brokered by the airline's Chairman, M. Damodaran. As per the reports, the co-founders have agreed to increase the board strength to 10 - adding four independent directors, including a woman (as mandated by Sebi rules). Also, external advice will be sought for related party transactions over Rs 2 crore, and bidding will be mandatory for such contracts. In addition, changes in related party transactions will have to be unanimously approved by the airline's independent directors.
Though the settlement will assure investors for the time being, the truce is, in all likelihood, temporary. Just a few days after the reported agreement, Gangwal, referring to Bhatia's claims on related party transactions, was quoted in the media as saying: "I wish people had the conviction to be quoted and not hide behind the veil of so-called unnamed 'sources' to spread a false narrative in the media." This was expected. After all, even under the reported truce agreement, the Bhatia group will have the authority to nominate five of the 10 directors. Also, although some provisions of the SHA are expiring in October, many rights given to the Bhatia camp will survive as they are part of the articles of association (AoA), which cannot be changed without Bhatia's approval. Apart from this, there's no word on dilution of rights by the Bhatia group, the main bone of contention. "Listed companies generally don't have such specific clauses. Earlier, stock exchanges would advise companies to remove clauses giving preferential rights to one partner before listing. As such, these clauses are, per se, against good governance practices. If one shareholder has the right to appoint the CEO, what's the independence of the board? Now, they are talking about increasing the board strength. If preferential treatment is given to certain promoters, the independence is always compromised," says Ankit Singhi, Executive Director, Corporate Professionals - a New Delhi-based corporate law advisory firm.
Game of Thrones - And More
The clauses in the SHA and related party transactions have been there for years. Yet, Gangwal never cried foul. Until recently, the partners agreed on almost every big decision - management appointments, international strategy (though there are reports emerging that the partners differ on the choice of aircraft for long-haul international operations), and even relieving IndiGo's longest-serving president Aditya Ghosh, last year. So, what pushed Gangwal to wage a war against his long-time friend, putting IndiGo's reputation at stake?
The explanation lies in roles both promoters had demarcated for themselves while starting the airline. Before a plunge in the Indian aviation space in 2004, Gangwal had worked in the US aviation industry for over two decades. The story goes that he was not convinced initially (to start IndiGo) because of the high failure rate in the sector, but Bhatia, who had already built a bunch of businesses around aviation, was keen. His strong ticketing business gave him insights into the workings of the market. InterGlobe had suffered a shock after the dip in air travel post 9/11 and saw diversification as the best way to survive. Bhatia managed to get the licence for IndiGo at a time when policies favoured the politically connected. The airline took off.
Over the next few years, Bhatia's private entities signed dozens of deals with IndiGo that Gangwal now says are questionable. "Related party transactions are mostly favourable to promoters. Promoters typically make money by way of remuneration and dividends. Since both of them don't have executive roles, Bhatia is making money from IndiGo indirectly through his other companies," says a company law expert, adding that India's biggest pharmaceutical company, Sun Pharma, was caught in a related party transaction controversy last year after it was discovered that its main distributor, Aditya Medisales, was owned by Sun promoter Dilip Shanghvi.
Industry sources say Bhatia compensated Gangwal by giving him the power to take calls on large engine and aircraft deals. Gangwal had done a lot of aircraft leasing and purchase for United Airlines and US Airways. In US Airways, for instance, he had ordered for 400 A320-family planes and 30 A330 widebodies from Airbus, creating a huge leverage for himself that he would encash at IndiGo.
Following an Indian Airlines accident in 1990, involving an Airbus plane, the French aircraft maker's India order book had dried up. With Boeing capturing nearly 90 per cent of the market as a result, Airbus was eagerly looking to make a comeback. A protege of US aviation veteran and his boss at US Airways, Stephen Wolf, Gangwal knew this well. Despite being from a start-up airline, he managed to crack a highly-profitable 100-aircraft deal with Airbus, which brought the airline $4-5 million profit per aircraft in years to come. Gangwal also spearheaded the subsequent orders for 430 Airbus planes and Pratt & Whitney (P&W) engines.
So far so good. The cracks appeared when Bhatia presided over negotiations for a $20-billion deal to replace P&W (which were creating problems for the airline) with CFM International engines to power the 280 Airbus A320neo and A321neo aircraft in IndiGo's fleet. Bhatia reportedly got a highly-lucrative deal with CFM, and even engaged former Airbus India chief Kiran Rao to assist him in the deal - all in the absence of Gangwal. In a give-and-take type of arrangement between the two, it was perhaps seen as a transgression by Rakesh Gangwal's RG Group.
"With all these events taking place one after the other, there has to be some correlation. A contract that would have been negotiated by Gangwal out of his past expertise was given to some other party. Related party transactions and unusual rights are not new. Why has Gangwal suddenly realised these things are not right? There would be some linkages," says an aviation expert who didn't wish to be quoted.
War of Words
The fight started early last year when, according to Bhatia, Gangwal asked him to expand the board. Bhatia said he was fine with this as long as his board representation remained intact, which meant 50 per cent IGE Group nominees. This seemed to have irked Gangwal, who stopped participating in aircraft and related acquisition activities, which Bhatia said was the principal reason for him to take Gangwal on board. The rift kept growing until last October, when Gangwal wrote two back-to-back letters to the chairman seeking board approval to amend the policies for related party transactions between the airline and Bhatia's IGE Group. This was followed by two letters from the Bhatia camp challenging the objections raised by the Gangwal camp. The Bhatia camp also asked for an independent review of related party transactions between IndiGo and IGE Group. Damodaran asked the airline to engage audit firm EY for this. Later on the basis of the EY report, he found procedural irregularities in related party transactions and asked for an examination by an internal committee.
The spat took an ugly turn early this year when Bhatia wrote to the board, saying the objective of the RG Group was not to investigate related party transactions but to malign the image of the IGE Group, destabilise the management and grab management rights. "The script of the play stands exposed even more starkly as Gangwal makes innocent fig leaf statements of standing by and honouring the SHA and being a crusader of corporate governance," Bhatia said to the board in June this year. Bhatia added that "the hurt ego of Gangwal on realising that upon his refusal to lend his hand in the company's ongoing negotiations with original equipment manufacturers (OEMs), the company had proceeded to make alternative arrangements for the purpose... the company will remain eternally grateful to Gangwal for having attempted to hold the business to ransom by purposely delaying the ongoing negotiations with OEMs," reportedly referring to IndiGo's discussion with CFM International for new engines.
Despite strong speculations, Gangwal has so far denied reports of exiting the airline or intending to take control. Since the current SHA and AoA don't allow Bhatia or Gangwal to sell stakes to a third party - either privately or through stock exchanges - it effectively means that they can sell their stake only to each other.
With his enormous rights, Bhatia seems to be on a good wicket compared to Gangwal even as both hold roughly similar stakes - the Bhatia camp 37.9 per cent and the Gangwal camp 36.99 per cent. Just two years before the IPO, the difference was bigger - the Bhatia camp owned 51.15 per cent and the Gangwal camp 48.84 per cent. Bhatia claims they have equal ownership despite the IGE Group taking on financial exposure of over Rs 1,100 crore in the initial years as against Gangwal's Rs 15 crore financial risk. "Gangwal was aware of what it would take to run an airline and based on global empirical evidence the real risk of failure... Gangwal says that he made a mistake in agreeing to the rights of the IGE Group and that 'times, circumstances and behaviour of promoters' has changed since 2015... Is there sanctity in agreements entered into by business people freely and at their own will?" says an IGE Group statement.
"Whether Bhatia made money through related party transactions is a different question. He took financial risk and they both agreed on some terms. Gangwal didn't share financial risk, his was sweat equity. If you look at it, Gangwal's 37 per cent stake is almost powerless. The matter largely revolves around his ownership and whether this is a precursor to his exit from the airline," says Devesh Agarwal, an aviation analyst.
The Bhatia camp has been fending off the RG Group demand for an extraordinary general meeting (EGM) to sort out these issues for over six months. On June 7, it consulted a former Supreme Court judge for legal opinion whether there's a need for an EGM. The judge advised against it.
Much to Gangwal's annoyance, the details of the opinion were disclosed six minutes prior to the proposed EGM on June 12. This worked like a match in the powder barrel, and within four weeks, Gangwal decided to take his fight public. "All these incidents could be a pressure-building mechanism from the Bhatia camp to force Gangwal to sell his stake. Bhatia camp has literally closed all the avenues for him. Gangwal has tried to bring his brawl to everyone's notice, including prime minister, finance minister and others. He seems to be unnerved by Bhatia's next move," says an aviation expert. In his letter, Gangwal has mentioned that there are powerful people in the airline who would use their position to influence the outcome of his campaign.
Holding the Nozzle
Gangwal has raised concerns over the EY audit of related party transactions and asked why it didn't reach out to him. He says the report has not been shared with the audit committee and the board. IndiGo recently submitted the report to Sebi. It's surprising that parts of the EY report were selectively leaked to the media recently, an issue raised by Avinash Vazirani of Jupiter India Fund, an IndiGo shareholder, in the recent quarterly earnings call. "We very much respect what you just said. We are taking it on the advisement...thank you for this input, it is very valuable and we will take action," IndiGo CEO Ronojoy Dutta replied to Jupiter India in an assuring voice.
More than a CEO, of late, Dutta's job has been that of a firefighter inside a burning house. Ever since the fight became public in May, he has been brushing it off, saying the difference is over just "one issue". Dutta learnt crisis management during his stint at United Airlines where he was president during the 9/11 terror attack. Two United planes were involved in the attacks, and for the next one year - till the time the airline filed for bankruptcy - Dutta had to manage the worst nightmare in the history of the aviation industry. Now, he is doing everything to make things look normal at IndiGo.
Following Gangwal's letter, the IndiGo stock tanked as much as 13.5 per cent in two days, prompting the IGE Group to assuage investors' worries. It has since then engaged in shaping up the narrative in favour of Bhatia, while simultaneously trying to bring things under control. Gangwal, on the other hand, has been talking sparsely, though the stock has recovered after the reported truce.
The friendship between Bhatia and Gangwal dates back to 1985, when the two first met at the Chicago headquarters of United Airways where Gangwal worked for 10 years - even working alongside IndiGo's current CEO Dutta who, Gangwal says, is Bhatia's man - before moving on to other assignments in Air France and US Airways Group (where he was chief executive and chairman). In 1994, the IGE Group got its first big break when it became the local agent of Galileo International's global distribution systems (GDS), a ticketing platform owned by United (during that period), where Gangwal was working at a senior position.
Both have different personalities. Gangwal pays attention to details and is obsessed with cutting costs, which has helped IndiGo stay profitable. An otherwise quiet Gangwal is aggressive in negotiations. Bhatia also prefers a low profile, but has a strong grip over commercial and regulatory aspects of the airline business.
Unlike promoters such as Jet Airways' Naresh Goyal, who were allegedly influential in framing of the restrictive 5/20 rule and capping of foreign direct investment in the sector, Bhatia is understood to have risen without influencing government policies. Even if Bhatia has overwhelming rights and doesn't have to dilute those in favour of Gangwal, experts say the entire matter is under government scrutiny, which may have forced the partners to reach a settlement, even if it's temporary and meant for optics. "It will be a big reputation loss for IndiGo if the government decides to probe it further. The mindset of government agencies is to catch the tiniest of faults. No promoter would want to go down that road," says Singhi.
It's unlikely that the two of them - who once holidayed together - will ever sit under the same roof again or break bread to sort out their differences, given the nature of the unpleasant things both have said about each other.
IGE Group claims that related party transactions account for just 0.53 per cent revenues of IndiGo and the airline has received more favourable treatment from IGE Group entities as compared to their other customers. Related party transactions with Bhatia's private entities can be a small part of IndiGo's overall revenues, but experts argue it may not be the case with the IGE Group. Among the four areas of related party transactions, simulator training to IndiGo's pilots contributed the highest - Rs 96.48 crore - to the IGE Group's revenues in 2018/19, followed by crew accommodation at hotels (part of a joint venture between Accor Hotels and IGE Group), general sales agent services and real estate properties leased out to IndiGo.
"There's a fine line as far as ethics is concerned. In case of related party transactions, the beneficiaries believe it's a small thing. Should the quantum matter or the practice?," asks Jitender Bhargava, former executive director at Air India.
Not much is known about Gangwal's other sources of income, but Bhatia's IGE Group has been fairly active in different lines of business. In fact, it sold its IT and back-office arm (InterGlobe Technologies) to AION Capital for about Rs 1,600 crore early this year.
Oddly enough, IGE registered net losses in 2016/17 and 2017/18, even as the investee airline IndiGo did brisk business during the period. For instance, the company posted a net loss of Rs 11.1 crore on a revenue of Rs 276.1 crore in 2017/18. IndiGo made a net profit of Rs 2,242.37 crore in the same year.
"Bhatia doesn't have a good track record of maintaining long-term partnerships - starting from the days of Delhi Express [a travel agency started by Rahul's father Kapil Bhatia] in the 1980s to his partnership with Accor, which went through a difficult phase a few years ago," says the promoter of a rival business group.
At present, IGE Group has a portfolio of 16 ibis Budget hotels across the country, while five more hotels are under construction. IGE Group's GSA business - InterGlobe Technology Quotient (ITQ) - has been under fire of late. Last October, ITQ, the official distributor of central reservation system Travelport in six markets, won the contract to manage Air India's (AI's) reservation content. This was strongly opposed by travel agents and some of Air India's senior management given the exclusive nature of the deal. A PIL was filed in the Bombay High Court challenging the AI's decision, and aviation sector veteran G.R. Gopinath termed AI's move to shift its data to the rival IndiGo's group company as "the sheep choosing the wolf's den for residence".
According to travel sector consultants, ITQ's share in the domestic GDS market has jumped from about 35 per cent to 52 per cent on back of the AI deal. This has affected players like Amadeus, Sabre and Abacus in a major way.
BT's questions to Gangwal's lawyers at Khaitan & Co and IGE Group spokesperson went unanswered.
The Spillover Effect?
So far, the fight at the promoter level seems to have had no effect on the airline's operational performance, though there's been a bit of a blow to the employees' morale. IndiGo's OTP (on-time performance) has lagged that of its private sector rivals for almost a year. IndiGo is no longer an airline known for affordable fares, quick turnaround and low operational complexities.
"People are talking a lot of things. IndiGo's OTP has come down at times. It's not perhaps because of the feud at the shareholder level, but the airline has itself become big and complex," says Bain & Co's Sinha. Old timers recall that for a long time, IndiGo followed the Southwest Airlines' single-type aircraft fleet model. The promoters took pride in being equated with strong legacy carriers like Southwest and Ryanair. Now, it operates three types of aircraft (A320s, A321s and ATRs), and considering its international long-haul aspirations, may add wide-bodied aircraft as well by the end of the current financial year.
In a meeting with BT last year, IndiGo CFO Rohit Philip had said that the aim of adding ATRs was to tap demand in small towns. "There are 30-35 airports in small cities where narrow-bodied aircraft cannot land. We will connect these cities to our domestic network through ATRs. Similarly, we feel there's unmet need for a traveller out of India flying in an Indian airline. The problem is that bilateral routes and slots in the international segment are not easy to get," he said.
When AI decided to divest stake in 2017, IndiGo was quick on the draw to express interest in acquiring its international operations. But the deal never happened because AI wasn't willing to sell its international business separately. For now, it's hoping that Jet's fall will get it more international slots. So far, IndiGo has been awarded 12 departures in a day on international routes, far less than what Jet had been flying. At Delhi and Mumbai, it has snapped up 30 per cent of about 200 slots that once belonged to Jet.
A part of IndiGo's success can be attributed to the failure of others - first Kingfisher Airlines in 2012 and now Jet. IndiGo's unit revenues grew 2-3 per cent and profits were positively impacted due to cessation of Jet services, CEO Dutta said in a recent earnings call.
Aviation experts say airlines like IndiGo, SpiceJet, Vistara and GoAir would benefit over the next one year since the large capacity vacuum left by Jet would take time to be filled. "If the CEO is able to provide leadership, some of the noise at the shareholder level can be easily managed, and IndiGo can continue to benefit from Jet's situation," says a consultant.
IndiGo earned much of its glory for being safe and consistent. The bickering at the top could take away these hard-earned medals and potentially send the airline into a tailspin for reasons generally not associated with the downfall of a carrier.