The Jet-Etihad deal is almost here and I stick my neck out that a battered Maharaja, living on doles from North Block, is consigned to die.

This isn’t to mourn for the inefficient. My despair is on behalf of tax payers in general and those of us who squirm each time a premier brand identified with India is the butt of jokes.

Therefore, this column isn’t one bit to suggest to finance minister P Chidambaram and civil aviation minister Ajit Singh that they must nix Etihad FDI. The argument, instead, is for decisive counter-steps that create a strategic direction for the money being pumped into Air India.
For those interested in a deeper dive, two brand-new reports by the Centre for Asia Pacific Aviation (CAPA), an aviation advisory body, are commended. The first, on Jet-Etihad [attached below], came out about 10 days back. It explains the business case for those invested in the Jet stock.

From GN archives:

Broken wing: How Air India is being run to the ground
Broken Wing: Hungry Kya - Where is AI's appetite for success?

“Jet’s share has been depressed by current structural weakness across the aviation sector – so, from a long-term perspective Etihad is counter-cyclically acquiring an important strategic asset at a very attractive level. More importantly, the sum of the parts here will by no means represent the real upside. Combining the almost symmetrically complementary operations of the two airlines promises a much more powerful overall entity.”

But the deepest parts in the report are the part-poser, part-warning, where Kapil Kaul, CAPA South Asia CEO, states: “One positive outcome is that this (the Jet-Etihad deal) could – at last –  act as the trigger for a decision on Air India’s future.”

Naresh Goyal triggering Air India’s future! “Well said, Mr Kaul…what’s new about that,” I had asked.

To my glib question, Kaul has now reverted with a thoughtful reply. It’s a detailed fast forward on Air India. The message in this report [also attached below] isn’t confined to Goyal’s considerable aero-political clasp, but the ruin being presided over by the grand puppeteers. Let’s flag just a few:

1. Deep structural issues remain: From FY08 to FY12 inclusive Air India accumulated losses of close to $5.25 billion, a figure which is estimated to increase by a further $950 million or more by the end of FY13. Of the 189 routes that the Maharaja operates, only 12 meet total costs. A further 82 cover their cash costs but not their total costs and 95 routes, or just over half, do not even meet their cash costs. International routes are bleeding particularly badly and account for 80-90% of losses.

2. Piecemeal recapitalisation have weakened turnaround efforts: The government has committed to fund the Maharaja’s turnaround plan. However, rather than infusing capital on a one-time basis, it is drip-fed in an uncertain schedule. When each small tranche is received it is largely absorbed by overdue of vendor and salary payments rather than being utilised to implement turnaround initiatives. As a result the recapitalisation efforts are not providing the strategic stability required.

3. Debt level imposes huge interest burden: Air India’s debt is approximately twice that of all the other carriers combined. Bank loans and aircraft-related debt total approximately $9 billion, in addition to which there are vendor-related liabilities, e.g., to fuel suppliers and airport operators, in excess of $1 billion.

4. Sub-optimal aircraft utilisation: Air India’s fleet utilisation is very poor with only around 100 operational aircraft out of a total registered fleet of 127 aircraft (including Air India Express). Even those aircraft in service have daily utilisation rates below the industry average.

5. Recovery hampered by labour productivity: The productivity of Air India’s bloated workforce continues to be a major challenge. The Maharaja carries the historical baggage of unresolved issues related to the integration of employees during the merger of Air India and the former Indian Airlines in 2007.

6. Fleet issues impose strategic limitations: Air India faces significant current and forward challenges with its fleet structure across its domestic and international operations:

a) The B777-200LR, B747-400 and the A319 aircraft are poorly matched with the mission requirements of its international and domestic routes;
b) The grounding of the B787, which was a cornerstone of the airline’s turnaround strategy, is a major setback, especially as there is no clear timeline for the resumption of services;
c) The absence of a long-term fleet strategy, with no pending narrow body orders and no long-haul aircraft commitments beyond 2015, limits the future business case.

7. Business model needs to be reworked: Air India requires a comprehensive review of its business model. At present there are fundamental weaknesses in each of its key domains. On its long-haul routes, for example, it does not have the commercial strength to drive the necessary yields and premium traffic volumes. In the regional international market it is focusing on routes to/from Kerala but neglecting the significant opportunities elsewhere.

While on the domestic front it faces a significant capacity crunch due to a limited fleet, which itself is dominated by an aircraft type that is not competitive on most of the routes which it operates. The absence of a domestic low-cost operation or a clear regional strategy means that it is not participating in the fastest growing segments of the market.

8. Government intervention: In addition to these huge challenges, the management of Air India has to deal with excessive intervention by the ministry of civil aviation and other ministries in the carrier’s turnaround. This leaves little time or space to pursue strategic activities.

Along with these internal challenges, there is a fast-changing external environment to contend with.

1. Indian market dynamics: The market dynamics in India are being reshaped as a result of foreign airline investment. With up to three Indian carriers expected to secure strategic partners in early 2013, Air India will be faced with an increasingly strengthened set of competitors on domestic, regional international and long-haul routes.

2 Shifting sands of global aviation: The international aviation industry is adjusting to the impact of a number of emerging phenomena such as the growth of low-cost carriers (LCCs) and the unfettered global ambitions of Middle East carriers. For example, the three major Gulf carriers alone – Emirates, Etihad and Qatar Airways – already have 311 wide-body aircraft (that is, aircraft with more than one aisle) in service and a massive 418 on order. Recent developments (e.g., the Emirates/Qantas partnership, Etihad’s network of equity investments and code-share arrangements and Oneworld’s invitation to Qatar Airways to join the alliance) have also shaken the foundations of the global alliance structure. What were intended to be clearly distinct airline groupings have now become blurred. Airlines now cooperate with and invest in carriers across alliances. A new web of partnerships, deep code-shares and joint ventures is being created.

3. Constant shocks: And as always the aviation industry remains susceptible to “constant shocks” which range from economic downturns to fuel price spikes, health pandemics, natural disasters and terrorism.

Indeed, the pace of change is so rapid that it puts into question the validity of the turnaround plan that has been developed for Air India.
Meanwhile, there are certain environmental features that are not changing fast enough, most notably the numerous structural challenges in Indian aviation which impact the overall viability of the sector. These include:

• Uncertain and unpredictable policy environment compounded by arbitrary distortions such as the five-year/20 aircraft rule for international operations, route dispersal guidelines, and the regional airline policy which are not achieving their objectives;
• Weak regulatory framework
• Micro-intervention by the regulator on commercial issues
•  Negative fiscal regime, particularly high sales taxation on fuel
•  Low productivity of airports and airspace
•  Shortage of skills and expertise
•  Absence of long-term vision for the sector

An issue that CAPA identifies for Air India’s long-haul operations, with Etihad almost in the backyard, are how cash from the deal will accelerate Jet Airways’ domestic and international expansion plans. Jet Airways currently has a wide-body fleet of 23 aircraft (13 A330s and 10 B777-300ER) of which five B777s have been sub¬leased to Thai Airways, leaving an operational fleet of 18 aircraft. Over the next 12-18 months the wide-body fleet is expected to increase from 18 operational aircraft to at least 30 aircraft, although this is largely dependent upon the new network plan to be developed upon conclusion of the Etihad transaction. This growth will be achieved as a result of:

• Retaining at least two of the five sub-leased aircraft when they are returned at the end of their lease term later this year, with the balance three to possibly be re-leased;
• Taking delivery of six new A330-300s (out of a total of 10 to be taken on lease, of which four have already been inducted);
• Induction of five or six B777-300ERs in 2014/15.

Meanwhile, the carrier is likely to defer its order for 10 B787-800s (with 10 options) until after 2016 and possibly switch to the -900 variant. Jet Airways is also expected to evaluate the A350 as an option. The carrier will likely review its long-haul fleet strategy after developing a coordinated network plan in conjunction with Etihad.

Jet’s international operations have stabilised financially, however the route network continues to evolve. In 2012 for example the carrier exited loss-making routes, e.g., services to Johannesburg, Milan, New York JFK and Kuala Lumpur. Further changes can be expected in the short-term and a new network will emerge following the deal with Etihad, especially as the two carriers compete on westbound routes from India.

For Etihad, a key rationale of the proposed investment is to provide greater feed from the Indian market to support its intercontinental services to Europe and the Americas which involves the development of Abu Dhabi as a hub. Jet Airways may in turn be used to develop Canada and other markets where Etihad faces challenges to securing bilateral entitlements.

If this wasn’t enough bad news, CAPA expects the government to liberalise bilateral agreements with key markets. One of the critical impacts of the Jet-Etihad deal is likely to be a liberalisation of the India-UAE bilateral. This will benefit not only these two carriers, but also Emirates, FlyDubai and Air Arabia. Meanwhile, Qatar Airways, Turkish Airlines and Singapore Airlines are all waiting in the wings seeking an expansion of bilaterals as they have exhausted their current entitlements.

Most of the airlines seeking additional rights are sixth freedom carriers which will place further competitive pressure on Air India’s key routes. The historical weakness of international services by Indian carriers means that close to 40% of Indian international traffic travels to its final destination via an intermediate offshore airport, with Middle East hubs capturing just over half of such flows.
Meanwhile, Air India’s long-haul operations remain compromised by wide-body fleet issues.
The wide-body fleet of 33 aircraft, with a further 21 (all B787s) on order is stretched across five different aircraft types adding complexity and cost.

And two of these types – representing 13 aircraft (eight B777-200LRs and five B747-400s) – do not have a good strategic fit with Air India’s operations. The airline has not been able to generate the necessary traffic volumes and yields – particularly in premium cabins – to support the high trip costs of these large aircraft.

As a result, aircraft which are ideally suited to long-range missions are instead being sub-optimally deployed on medium-haul routes with relatively low utilisation. The airline has been trying to sell at least five of its B777-200LRs – and possibly all eight – but has not been successful to date. The B747-400s may be reconfigured for VIP operations and sold to the government of India.

Until recently this left Air India with just the 12 B777-300ERs, supplemented by a couple of A330s, as the only wide-body aircraft suited to its mission requirements.

For this reason the right-sized B787 with its superior seat mile costs was eagerly awaited and the aircraft was a cornerstone of Air India’s turnaround plan. The strategy was proving effective with routes such as Delhi-Frankfurt turning to an operating profit within just a few weeks of deploying B787s.

But with the grounding of the Dreamliner and no clear timeline for the resumption of services, Air India will have to increasingly deploy its B777-200LRs which are poorly matched with the demand profile on its key long-haul routes.

Beyond 2015 Air India has no committed fleet expansion which together with its commercial weakness, the opening up of bilaterals and the strengthened competition it will face from Indian and foreign carriers, LCCs and sixth freedom behemoths, imposes a structural limitation on its long term business plan. Air India is already bleeding badly on international routes which account for 80-90% of its total losses, and these developments will significantly weaken the business case.

Air India currently operates a domestic fleet of approximately 40 aircraft with no further equipment on order. However, around 60% of the fleet comprises A319s which have limitations in that they are not competitive against larger narrow-bodies such as A320s and B737NGs as used by most Indian carriers, but are too large for regional routes.

In contrast, Jet Airways is expected to place an order in the coming months for up to 100 narrow-bodies, which may consist of a mix of B737 MAXs for the full service operation and A320neos for JetKonnect. Meanwhile, 46 B737-800s from an earlier order are still to be delivered.

Following the conclusion of the Etihad transaction, Jet Airways is also expected to have the capital to implement a clearer market segmentation strategy, in particular the establishment of a strong hybrid model under the JetKonnect brand.

IndiGo has around 30 A320s from its 2005 order still to be delivered of which some will be used for replacement. However, from 2016-17 it will start to take delivery of the first of its 150 A320neos, as well as a further 30 A320s. As a launch customer placing what was at the time the largest civilian order by number of aircraft, IndiGo will have obtained very attractive pricing on its aircraft (as it did when it placed its original 100 aircraft order in 2005) providing it with a competitive cost base. IndiGo is also evaluating the possibility of placing an ATR order to establish a regional subsidiary.

SpiceJet has 30 B737-800s on order with deliveries set to commence from next year. A further narrow-body order may be finalised by early April 2013 after a new investor comes on board. The B737 MAX is the most likely equipment, particularly as there are no available A320neo delivery slots within the required timeframe. SpiceJet remains undecided on whether to exercise its options for a further 15 Q400s, however CAPA expects that the carrier will increase its regional fleet in due course.

GoAir will see its fleet size increase from 13 to around 20 aircraft over the next couple of years, to be followed by the first of its 72 A320neos on order from 2017. The airline is also considering inducting turboprops to serve tier-2 and tier-3 cities.

So, between them, Air India’s competitors could have 500 narrow-bodies on order by the end of this year (over 360 narrow-bodies currently on order, with up to a further 140 aircraft to possibly be ordered in the coming months).

So, what does CAPA suggest? Unthinkable funding requirements: fleet modernisation that could require $12-14 billion over ten years, let alone operating losses, with the money going into:

• 40-50 turboprops or regional jets,
• 100-120 narrow-body aircraft for domestic operations,
• 50-60 narrow-body aircraft for regional international operations,
• 50 wide-body aircraft for long-haul operations.

A scandal-ridden government neither has the money nor the guts to take this challenge.
Not that this hasn’t been done elsewhere. CAPA cites the case of Japan Airlines’ bankruptcy in 2009, where too it was clear that incremental changes to the business would not deliver results and that radical surgery was required. The carrier took the following measures:

• Retired 103 aircraft out of a total fleet size of 258 aircraft,
•  Terminated more than 20% of its domestic and international routes,
• Secured a debt waiver of $6 billion and received an infusion of $3 billion,
• Retrenched 16,000 employees representing 30% of its workforce,
• Aggressively reviewed its business processes to improve efficiencies,
• Upgraded its IT infrastructure to support process improvements,
• Agreed to establish a low-cost subsidiary in a joint venture with Jetstar.
Retrenching 1/3rd of the work force. Hmmm…!
 
Tailpiece: “Government is of course free to pursue any policy however damaging it may be to the air transport industry, but I wish they would spare us, at the same time, obviously unrealisable assurances that they do not wish airlines to suffer losses,” JRD Tata, in September 1949 (Source quoted by CAPA is ‘Beyond the Last Blue Mountain, R.D. Lala’).
Mr Tata could have said this in 2013, 64 years later!