Air Deccan - Cutting Costs, Not Corners
The Story of India’s First Low Cost Airline
Fin 456-Team 9: Ruchika Chinda, Ruibin Chen, Rishi Gupta, Anuj Sharma
Case Outline
• Air Deccan’s first flight took-off from Bangalore to Mangalore on Aug.
25, 2003
• Stunned the market by offering tickets at 10% of the regular rate, at an
average price at 50% less than full service airlines
• Achieved a market share of 11%, two years after its debut, making it the
second largest privately owned airline in India
• Plans to go IPO in 2006 with a goal to be the leading aircraft company
in India providing a wide gamut of airborne services throughout the
country
Questions to Ask
• With the increase in competition in the Indian aviation industry, is this
low cost model sustainable?
• Why IPO and why now?
• What’s the road-map for expansion after IPO?
• What is the optimal price of the offering?
Agenda
• Air Deccan’s business
• The aviation industry in India
• Major risk factors
• Suggested solution for the IPO
Air Deccan’s Business
• Positioning as a “low cost carrier”
• Offers no in-flight service
• Single class aircraft configuration
• Internet booking and cheap fares
• Two aircraft strategy – Airbus and ATR
• Offering non-trunk short-haul routes and attracting high-end railway
traffic through comparable fares
• Target market: Upper middle class in short term and lower middle class
aggressively in long term
Air Deccan’s Business
• Target to expand fleet to 124 aircraft by 2013
• The Indian aviation market expected to grow at 20% annually for the
next ten years. Air Deccan is targeting 18% market share by 2013
• Passenger load factors anticipated at 70%
• Revenues per customer to increase at 5% in the long run
• Targets to decease fuel expense as a percentage of total revenues from
30% to 26%, operating expense from 23% to 16% in 8 years
The Aviation Industry in India
• High growth potential due to economic boom and highly under penetration
market
• 0.02 trips per capita per annum
• Long-term GPD growth at 8% annually
• It is forecast that India would be the second fastest growing travel and tourism
economy in the world
• ATF (Aviation Turbine Fuel) prices and airport charges in India are among the
highest in the world
• Regulatory and infrastructure bottlenecks have prevented accelerated growth in
the industry
• The government is proactively looking to address the bottlenecks
The Aviation Industry in India
• Five-force analysis
• Rivalry: Increased competitive pressures due to new entrants
• Barriers to Entry: Easy entry but execution doubtful
• Resource & Supply: Inadequate airport infrastructure, shortage of pilots,
high fuel costs
• Customers: Business travelers sector intensified by GDP growth, leisure
customer market too a huge growth opportunity
• Substitutes: Railways, high price elasticity of common mans
Major Risks
• Increase in Competition
• Excess capacity could lead to price wars
• Oil Price
• Extremely vulnerable to oil price fluctuations due to government
regulations on price hedging
• Regulatory risk
• A collapse of the current coalition government could trigger significant
changes in India’s economic liberalization and deregulation policies
Questions Recap
• With the increase in competition in the Indian aviation Industry, is this
low cost model sustainable?
• Why IPO and why now?
• What’s the road-map for expansion after IPO?
• What is the optimal price of the offering?
Q&A
How sustainable? Why IPO?
What to do after IPO? At what price to IPO?
Suggested Solutions
• How sustainable?
• High growth potential market
• The second fastest growing travel and tourism economy in the world
• Airport infrastructure improvement opening up new sectors
• The firm achieved break-even in its first year of operations, through a
combination of high load factors and low-cost operating economics.
Suggested Solutions
• Why IPO? Air Deccan wanted:
• to expand its fleet and enhance engineering and operational capabilities
• to establish a relationship with capital markets
• to have additional finance flexibility and ensure its long-term growth
• to enhance Deccan’s brand among common man
Suggested Solutions
• Risk Analysis &
Cost of Capital
Calculation
Risk Premium Calculation
Inputs
4.50
3.00
92.50
57.00
Output Category
U.S. risk free in %
U.S. risk premium in %
Current U.S. Credit Rating
Institutional Investor country credit rating (0-100)
16.07 Anchored Cost of Equity Capital for project of average risk in country (ICCRC)
8.57 Country Risk Premium
Industry Adjustment
1.10
Beta (Industry)
0.30 Sector adjustment
Project Risk Mitigation
(-10 to 10; where 10=risk completely eliminated, 0=average for country)
Impact on
Country
Premium
Weights Score
Sovereign
0.40
-2.00
0.69 Currency (direct, e.g. convertibility)
0.10
7.00
-0.60 Currency (indirect, e.g. political risk caused by crisis)
0.15
-2.00
0.26 Expropriation (direct, diversion, creeping)
0.05
-1.00
0.04 Commercial International partners
0.05
-1.00
0.04 Involvement of Multilateral Agencies
0.05
-3.00
0.13 Sensitivity of Project to wars, strikes, terrorism
0.05
0.00
0.00 Sensitivity of Project to natural disasters
.
0.05
0.03
-3.00
7.00
0.05
0.03
-3.00
0.00
Operating
0.13 Resource risk
-0.15 Technology risk
Financial
0.13 Probability of Default
0.00 Political Risk Insurance
1.00
Project Cost of Capital
Sum of weights (make sure = 1.00)
17.03
Suggested Solutions
• Revenue Projection
Suggested Solutions
• Expense Projections
Air Deccan Expense Projections (1)
Actual
Aircraft fuel expenses
Aircraft/engine repairs
and maintenance
Aircraft/engine lease
rentals
Other direct operating
expenses
Employee remuneration
and benefits
Administrative and
general expenses
Employee stock
compensation cost
Advertisement and
business promotion
expenses
Finance and banking
charges
Amortisation
Depreciation
Total Expenditure
Projected
Year ended March 31,
2006
2007
2008
30.00%
31.00%
30.00%
14.00%
14.00%
14.00%
2003
5.34%
1.32%
2004
13.72%
13.13%
2005
29.03%
15.39%
24.36%
15.80%
14.09%
14.00%
12.00%
24.74%
24.89%
23.00%
22.00%
11.24%
10.61%
9.92%
14.71%
11.22%
6.34%
-
-
-
2009
29.00%
14.00%
2010
28.00%
14.00%
2011
28.00%
14.00%
2012
27.00%
14.00%
2013
26.00%
14.00%
10.00%
9.00%
8.00%
8.00%
8.00%
8.00%
20.00%
19.00%
17.00%
16.00%
16.00%
16.00%
16.00%
10.00%
10.00%
9.00%
9.00%
8.00%
8.00%
8.00%
8.00%
7.00%
8.00%
9.00%
9.00%
9.00%
9.00%
9.00%
9.00%
-
-
-
-
-
2.30%
0.47%
1.97%
2.00%
3.00%
4.00%
4.00%
4.00%
4.00%
4.00%
4.00%
6.46%
5.74%
3.19%
6.00%
8.00%
9.00%
9.00%
9.00%
9.00%
9.00%
9.00%
3.35%
1.39%
95.21%
1.47%
1.66%
98.71%
1.79%
0.96%
105.68%
2.00%
3.00%
110.00%
1.00%
7.00%
114.00%
1.00%
10.00%
115.00%
0.00%
8.00%
108.00%
Note:
(1) All numbers are a percentage of revenue.
0.00%
0.00%
0.00%
0.00%
7.00%
7.00%
7.00%
7.00%
103.00% 103.00% 102.00% 101.00%
Suggested Solutions
• DCF Valuation
Air Deccan Discounted Cash Flow- (Rs in million)
Actual
INCOME
Total Income
EXPENDITURE
Preliminary expenses written off
Total Expenditure
Profit/(Loss) before taxation and prior period items
EBITDA
EBITDA Margin
EBITDAR
EBITDAR Margin
EBIT
Tax
EBIT (1-t)
Depreciation
Amortization
Capital Expenditures as a % of Sales
Capital Expenditures
Changes in Working Capital
FCF
WACC
PV of FCF's
Sum of FCF's
Terminal Value
PV of Terminal Value
Enterprise Value
Less Net Debt
Equity Value
No of shares outstanding
Implied price per share
Projected
2001
2004
2005
2006
147
314
2,669
6,557
-
-
-
-
Year Ended March 31,
2007
2008
11,356
-
16,921
-
2009
2010
2011
2012
2013
22,276
28,728
34,388
40,801
47,982
-
-
-
-
-
139
665
3,384
6,669
11,806
17,314
21,595
26,234
31,453
36,528
42,566
8
15
9.85%
(351)
(291)
(92.62%)
(715)
(525)
(19.65%)
(112)
610
9.30%
(450)
1,367
12.04%
(392)
2,992
17.68%
681
4,468
20.06%
2,494
7,091
24.68%
2,935
8,437
24.53%
4,273
10,801
26.47%
5,416
13,093
27.29%
62
42.42%
(185)
(58.74%)
(73)
(2.75%)
1,528
23.30%
2,730
24.04%
4,684
27.68%
6,473
29.06%
9,389
32.68%
11,188
32.53%
14,066
34.47%
16,932
35.29%
11
(312)
(612)
282
33.6%
187
197
131
20.0%
(1,311)
0
459
33.6%
304
795
114
30.0%
(3,407)
0
1,130
33.6%
751
1,692
169
40.0%
(6,769)
0
2,686
33.6%
1,784
1,782
0
37.0%
(8,242)
0
5,080
33.6%
3,373
2,011
0
27.0%
(7,757)
0
6,030
33.6%
4,004
2,407
0
17.0%
(5,846)
0
7,945
33.6%
5,276
2,856
0
7.0%
(2,856)
0
9,735
33.6%
6,464
3,359
0
7.0%
(3,359)
0
(797)
15.0%
(693)
(2,194)
14.4%
(1,676)
(4,157)
13.9%
(2,811)
(4,677)
13.3%
(2,838)
(2,373)
12.8%
(1,298)
565
12.4%
281
5,276
11.9%
2,400
6,464
11.1%
2,780
(3,856)
148,840
64,007
60,151
4,179
55,972
98.18
570.08
Suggested Solutions
• Comparable Valuation
Comparable Company Analysis
Comaparable EV/EBITDAR multiple
Air Deccan 2008E EBITDAR
EV
Less Net Debt
Equity Value
No of shares outstanding
Implied price per share
7.40
4,684
34,662
4,179
30,483
98
310.47
12.4
4,684
58,282
4,179
54,103
98
551.05
Thanks
“If it’s on the map, we will get you there”---Air Deccan