Divestment of Air India

1
Divestment of Air India

• Ashish Parikh
• Manavendra Singh Sial
• Nikolay Nazarov
• Pallav Jain

2
Agenda

• Case Introduction
• Background Duke Air
• Background India
• Background Air India
• Transaction
• Issues
• Our Analysis
• Our Valuation
• Case Update

3
Case Introduction

• Synopsis
• Duke Air is considering an investment in Air
  India
• Learning Objectives
• Cost of capital considerations
• Comprehensive DCF Modeling

4
Background Duke Air

• Finlands leading airline
• Most profitable European airline in 2000
• European revenues make majority of total revenues
• Interested to diversify into other markets

5
Background India

• Largest Democracy
• Second largest country - population
• Per capita GDP 471
• Huge income disparity
• In the midst of economic liberalization
• Severe corruption

6
India Key Economic Indicators
7
Background Privatization

• Learning from our experience, especially over
  the last decade, it is evident that disinvestment
  in public sector enterprises is no longer a
  matter of choice, but an imperative
• Address by the President to
• Parliament in the Budget Session

8
Background Privatization Process
9
Background Air India

• Founded in 1932 as Tata Airlines
• Nationalized in 1946 and turned into Air India
• 1999 Revenues - 1B (Rs 44B)
• 1999 Assets - 834M (Rs 36B)
• 18,000 employees
• 200 world-wide destinations
• 3.37 million passengers annually

10
Background Air India

• 100 Government owned
• Strong Brand image
• Strong Operational Capabilities
• Strategic partner would increase operational
  efficiencies
• Competitive disadvantage due to small fleet size

11
Transaction

• Acquire a 40 equity stake in Air India
• Requirement of an Indian partner
• Foreign partner can not have more than 26 stake
• Additional 20 to be sold to Indian institutional
  investors
• All cash transaction
• Possibility of Indian Airlines divestment

12
Option to buy Indian Airlines

• Probability of IA divestment by 2005 40
• Probability of acquiring IA after acquiring Air
  India 50
• Expected synergies from such a transaction 15
  of Air Indias operating cash flows

13
Air India operating details

• Air India travel market share of 21 (air traffic
  in India)
• Indian Airlines travel market share of 11
• Major markets
• India/U.S.
• India/U.K.
• India/Europe
• India/South East Asia

14
Air India operating details

• Other sources of revenue (MM USD)

Year Cargo Mail Charter
1995-96 87 2 18
1996-97 77 2 19
1997-98 74 2 41
1998-99 77 3 47
1999-00 82 4 21
15
Air India operating details

• Fleet size

16
Air India projections

• Revenue growth of 10
• Major costs aircrafts and fuels tied to US
  dollars
• Fuel costs based on a stable oil price of 27.5
  USD/barrel
• High capital expenditure in 2003-2004 and
  2006-2007 for fleet augmentation
• Prices consistent with competitive carriers
• Debt refinancing assumed to maintain high D/E
  ratio

17
Air India projections
18
Issues to consider

• Adjustment to operating cash flows
• Adjustments to cost of capital
• Other adjustments
• Incorporating Indian Airlines option (probability
  of 0.4 and 0.5)
• Other qualitative issues

19
Our Analysis
20
Analysis Risks
Entry and Market Risk Competition IA, regional airlines Lack of similar deals - little learning
Operational Risk Little resource risk AI has great infrastructure Fuel Prices Labor unions long term contracts risky Operational control
Sovereign Risk Currency Expropriation risk Creeping expropriation risk Political instability Indo-Pak Conflict
Financial Risk High Leverage but reduced due to involvement of GOI Need for an Indian partner risk factored by Duke Air
21
Analysis Mitigants
Entry and Market Risk No timing or pre-completion risk
Operational Risk AI has great infrastructure VRS scheme Potential to obtain operating control
Sovereign Risk Revenues consistent with competitors Low expropriation risk due to high D/E ratio High creeping expropriation risk (low corporate tax) Project impacts other divestments
Financial Risk High Leverage but reduced risk due to involvement of GOI Various business houses interested to venture into Indian air market
22
Analysis Cost of Equity

• ICCRC India
• Assumptions
• Risk Free Rate 4
• US Market Risk Premium 3
• Anchored to US
• ICCRC Cost of Capital for India
• Cost of Equity (ICCRC) 19.5

23
Analysis Cost of Equity
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Analysis Use of Multiples

• Acquisition Multiples
• Not meaningful, due to regional and other
  differences
• Trading Multiples
• P/E Regional differences, AI negative earnings
• EBITDAR Best multiple for industry, but also
  problematic due to high leverage and lack of
  comparables

25
AnalysisChanges in Valuation

• DCF approach - Free Cash Flow to Common Equity
  (FCFCE).
• Operating Cash Flows were adjusted down by 5 to
  reflect resource risk and operational
  inefficiencies.
• Risk adjustments reduced the cost of equity
  capital from 19.5 to 19.03

26
Analysis Changes in Valuation

• Scenario wrt. equity investment in Indian
  Airlines (real option)
• Terminal Value growth rate 2
• Exchange rate is determined from the Purchasing
  Power Parity
• - Assumptions
• - US inflation rate 2
• - Indian inflation rate 5

27
Our Valuation
28
DCF Model

• FCFCE projections for the next 13 years
• Main Issues
• Revenue Projections (10 growth rate over the
  next 10 years)
• Alliance/Consolidation Benefits
• Fuel Costs
• Debt Pay down

29
Valuation

• Monte Carlo Simulation
• Jet fuel price is modeled as a function of oil
  price.
• Simulation of oil price as random walk with a
  drift.
• Embedded parameters in oil price simulation are
  conservative.
• Since jet fuel is a part of COGS,
• after-tax effect is imputed.

30
Expected Value AI
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AI Value with IA option
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DCF Present Value

• For AI only
• Expected PV US 75.16 million
• Likelihood of positive NPV 80.76
• For AI considering the synergistic benefits from
  acquiring IA
• Expected PV (median) US 115.96 million

33
Valuing AI with real option

• Probability of IA divestment 40
• Probability of acquiring IA by
• Air India 50
• Decision tree framework expected value for Air
  India

34
Decision tree
35
Multiples Valuation (regional airlines)
36
Valuation Bid Value

• Bid - 77 MM USD
• AI great strategic fit

37
Case Update

• Duke Air did not win the bid
• Political issues surrounded the privatization
  process
• Trade unions raise concerns over divestment
• Government defers divestment of Air India

38
Questions?
39
Air India References

• Information memorandum and valuation model from a
  leading Investment Bank
• Other Emerging Market cases
• Presentation by HSBC on divestment in India
• Discussions with Ministry of Civil Aviation
• Some of the case facts, cash flow projections and
  probabilities have been modified for
  simplification