Divestment of Air India
Ashish Parikh
Manavendra Singh Sial
Nikolay Nazarov
Pallav Jain
Agenda
 Case Introduction
 Background Duke Air
 Background India
 Background Air India
 Transaction
 Issues
 Our Analysis
 Our Valuation
 Case Update
Case Introduction
Synopsis
 Duke Air is considering an investment
in Air India
Learning Objectives
 Cost of capital considerations
 Comprehensive DCF Modeling
Background: Duke Air
 Finland’s leading airline
 Most profitable European airline in
2000
 European revenues make majority of
total revenues
 Interested to diversify into other
markets
Background: India






Largest Democracy
Second largest country - population
Per capita GDP $471
Huge income disparity
In the midst of economic liberalization
Severe corruption
India: Key Economic Indicators
Country
GDP (US$ bn)
GDP per capita (US$)
GDP per capita (US$ at PPP)
Consumer price inflation
(avg. %)
Current-account balance
(US$ bn)
% of GDP
Exports of goods fob (US$
bn)
Imports of goods fob (US$
bn)
External debt (US$ bn)
Debt-service ratio, paid (%)
India
485.2
471
2,489
3.7
China
1180.1
928
5,575
0.7
-3
20.1
-0.6
44.8
1.7
264.1
-54.9
-232.6
101.5
13.3
146
6.3
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
Background: Privatization Process
Selection of PSU by MODI
Approval by CCD
Formation of IMG & Selection of Global Advisors
2-3 months
Submission of Expression of Interest
Submission of Initial Technical Proposal
Due Diligence / Commercial negotiations
3-6 months
Finalise Shareholders Agreement (SHA)
& Share Purchase Agreement (SPA)
Financial bids
1 week
Selection of strategic partner & signing
of SHA & SPA
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
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




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
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 India’s
operating cash flows
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
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
Air India operating details
 Fleet size
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
Air India projections
Year
OB
2000/01
2001/02
2002/03
2003/04
2004/05
2005/06
2006/07
2007/08
2008/09
2009/10
2010/11
2011/12
2012/13
Operating
Revenues
Operating
cash flows
Capital
Expenditure
46,654.50
51,761.00
56,699.86
68,374.85
74,868.33
83,944.13
93,875.34
101,498.56
113,089.34
123,931.21
141,094.54
144,720.28
148,472.21
5,145.27
2,491.12
10,583.78
9,569.22
11,297.17
15,068.54
20,081.03
24,039.45
22,793.14
25,691.63
30,464.62
32,396.67
33,130.44
4,033.70
1,698.33
5,180.55
52,765.75
18,916.41
32,523.40
46,199.02
33,985.30
31,357.95
26,875.09
38,459.08
23,791.04
23,717.18
Cash flow
from
financing
-237.38
-792.79
-5,403.23
43,196.53
7,619.24
17,454.86
26,117.99
9,945.85
8,564.81
2,311.14
9,861.79
-2,662.00
8,557.72
Dividend
payout in Cash
flow from
financing
Fuel costs
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
1,127.67
6,867.32
14,943.63
27,370.99
9,981.50
9,619.87
8,885.85
9,497.99
9,974.14
10,815.80
11,898.22
12,436.02
13,766.89
15,106.79
17,197.83
17,703.65
18,224.35
Interest
Expense
2,581.70
2,016.00
1,074.93
4,164.74
4,661.96
5,885.17
7,724.70
8,325.15
8,449.22
8,416.29
8,844.53
7,242.48
5,593.31
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




Our Analysis
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

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

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%
Analysis: Cost of Equity
2.00
IMPACT OF RISK MITIGATION ON COST OF CAPITAL
Industry Adjustment
Beta (Industry)
3.50 Sector adjustment
Project Risk Mitigation
(-10 to 10; where 10=risk completely eliminated, 0=average for country)
Impact
Weights Score
Sovereign
0.40
4.00
-1.92 Currency (convertibility)
0.15
5.00
-0.90 Expropriation (direct, diversion, creeping)
0.05
0.00
0.00 Commercial International partners
0.05
0.00
0.00 Involvement of Multilateral Agencies
0.05
-2.00
0.12 Sensitivity of Project to wars, strikes, terrorism
0.05
0.00
0.00 Sensitivity of Project to natural disasters
Operating
0.05
5.00
-0.30 Resource risk
0.03
8.00
-0.24 Technology risk
Financial
0.05
5.00
-0.30 Probability of Default
0.03
0.00
0.00 Political Risk Insurance
Real Options (some handled through cash flows)
0.05
7.00
-0.42 Project impacts other projects
0.05
0.00
0.00 Other options that are difficult to value
1.00
Sum of weights (make sure = 1.00)
Project Cost of Capital
19.03
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
Analysis:Changes 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%
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%
Our Valuation
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
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.
Expected Value AI
Forecast: 26% share of Duke Air
2,500 Trials
Cumulativ e Chart
2,437 Displayed
1.000
2500
.750
.500
.250
625
.000
0
($225.77)
($105.95)
$13.86
Certainty i s 80.76% from $0.00 to +Infinity Doll ars
$133.68
$253.49
AI Value with IA option
Ov erlay Chart
Frequency Comparison
.034
26% share of Duke Ai r (IA Synergy)
.026
.017
.009
26% share of Duke Ai r
.000
($250.00)
($100.00)
$50.00
$200.00
$350.00
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
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
Decision tree
Expected Value of
Duke Air's 26% equity
0.5
Duke Air gets Indian Airlines
0.4
Indian Airlines Divested
0
$95.56
$115.96
$115.96
$115.96
0.5
Duke Air does not get Indian Airlines
$75.16
$75.16
$75.16
$83.32
0.6
Indian Airlines not Divested
$75.16
$75.16
$75.16
Multiples Valuation (regional airlines)
Air India
EBITDAR
Rupees
6346.130241
-100.8697591
(525)
46654.5
129.38
(2.06)
(10.70)
951.13
EV/EBITDAR
7.2
6.4
5.3
5.4
5.8
6
129.38
$
931.51
$
657.50
P/E
12.7x
14.2x
9.0x
3.8x
16.2x
11.2x
EBIT
Profit After Tax
Sales
China Airlines
China Eastern
China Southern
Korean Air
Singapore Air
Universe Averages
Metric US$
Implied EV (US$ MM)
- Net Debt (US$ MM)
Implied Equity Value (US$
MM)
Implied Duke Air Value of
26% of AI
Dollars
$
$
274.02
71.24
n/a
Valuation: Bid Value
 Bid - 77 MM
USD
 AI great
strategic fit
Bid
90
80
70
60
50
40
30
20
10
0
DCF
EV/EBITDAR
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
Questions?
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