Kingfisher Airlines

Acquires

a stake in Air Deccan: The Indian Aviation

Sector Moves towards Consolidation On May 31, 2007, United Breweries Holdings Limited (UBH), the parent company of Kingfisher Airlines (Kingfisher), a 'value carrier' 1 based in Bangalore, acquired a 26 percent stake in Deccan Aviation Private Limited (DAP), which owned Air Deccan (Deccan), the pioneer of low-cost airline in India, also based in Bangalore. UBH paid Rs. 5.5 billion2 to acquire the stake, which made it the largest shareholder in DAP. 3 UBH said that it would subsequently make an open offer to all the shareholders of DAP, for an additional 20 percent stake.4 Vijay Mallya (Mallya), the Chairman of UBH (and Kingfisher) who became the ViceChairman of Deccan after the acquisition (Ramki Sundaram became the CEO and Capt. G. R. Gopinath - formerly the Managing Director of Deccan - became the Executive Chairman of Deccan after the acquisition), said that the KingfisherDeccan combine would cover both low and premium fare segments. It was announced soon after the acquisition that Deccan would continue with its low-cost business model.5 The airline would also focus mostly on Tier II and III city routes, while Kingfisher would operate on the high density metro routes. 6

The Kingfisher-Deccan combine became the largest domestic airline in India in terms of fleet size, with 71 aircraft.7 The combined entity offered 537 flights to 69 cities daily.8 In addition to this, the combined market share of KingfisherDeccan was estimated to be about 30 percent, positioning them in the second place after Jet Airways, a full service private airline, whose market share was estimated to be about 34 percent in mid 2007.9

After the acquisition, both the airlines formed a team to study their operations and suggest areas in which costs could be pruned. The team would also suggest how the two airlines could share each other's infrastructure to achieve maximum synergies.10 Mallya said that Kingfisher and Deccan expected to save Rs. 3 billion, through

combined operations, in the first year. 11 He said that Deccan's network was a key asset that could be leveraged. Synergies were expected to arise in the areas of ground staff, aircraft, operation and maintenance, ground handling, baggage handling, increased connectivity, feeder services, and distribution penetration. Mallya indicated that the airlines could achieve savings by sharing reservation services, engineering services, service stations, spares, pilots, other crew, and parking bays at airports. Also, both Kingfisher and Deccan operated identical aircraft (the Airbus A-320 family and ATR-72-500). This was expected to save engineering and maintenance costs for both the airlines. Earlier, Deccan had posted a loss of Rs. 2.13 billion during the quarter ending March 31, 2007.12 Kingfisher was also reportedly losing an average of Rs. 120 million, on average revenues of about Rs. 22 billion, every month.13 It was expected that the synergies achieved through combined operations would improve the financial health of both the airlines. The alliance was also expected to allow Kingfisher to achieve its goal of operating flights on international routes. As of mid 2007, the Indian government issued international operations permits only to those airlines that had completed five years of domestic operations. As Kingfisher was only two years old (it started operations in May 2005), it would have had to wait for three more years to fly on international routes. But acquiring a stake in Deccan, which would reach the stipulated condition of five year of operations in 2008 (Deccan started its operations in August 2003), could allow Kingfisher to fly to international destinations starting in the second part of 2008. Mallya said that he would have an internal arrangement to lease out Kingfisher aircraft to Deccan 'to maximize the benefit of overseas routes'.14

In a report released in March 2007, the Center for Asia Pacific Aviation (CAPA), an airline industry consultancy based in Sydney, had predicted that increasing losses and excess capacity would result in consolidation in the Indian aviation sector. 15 The Kingfisher-Deccan deal was the third alliance in the Indian aviation sector, since

the beginning of 2007. The year saw the merger of Jet Airways and Sahara Airlines (in April 2007), and Air India and Indian Airlines (in early May 2007). Talking about the trend of consolidation in Indian aviation sector, Mallya said that intense competition and the increasing number of budget carriers had led to under-pricing of tickets, which resulted in losses to the budget carriers as well as to the entire aviation sector. He felt that consolidation among the airlines would lead to less competition and stable fares. Kapil Kaul (Kaul), the CEO of CAPA (Indian subcontinent and Middle East), said that in spite of the encouraging traffic growth projections, it was "extremely difficult for a market to absorb so many new entrants in a short space of time." 16 Kaul said that airport infrastructure and manpower shortages would result in increasing costs, and reduced efficiency and flexibility for the Indian aviation sector. 17 There were 13 scheduled carriers in the fragmented Indian domestic aviation sector, as of early 2007.18 Kaul estimated that this number would fall to 8-10 by 2010. Analysts felt that the new entrants into the aviation sector had overestimated the number of prospective air travelers. They felt that the cost structure of airline operations was a key cause of the problems affecting domestic airlines. In the cost structure of airline operations, fixed costs like aircraft lease rentals, depreciation, and staff costs could be as high as 50 per cent of sales. And even a slight decline in traffic volume, or a nominal addition to the industry capacity due to the entry of new players, could adversely affect the existing operators. Analysts also felt that the operating cost for airlines was high in India because of high fuel prices, inadequate airport infrastructure, and lack of trained manpower. 19

The stabilizing of airfares due to mergers and alliances was expected to provide respite to small airlines which had been forced to reduce their fares drastically to gain market share, but were facing losses as a result. Bundeep Singh Rangar, the Chairman of Indusview Advisors of Britain, a business advisory consultancy, said that the remaining low cost airlines in India could also become takeover targets in future.20 Kaul also predicted consolidation in the Indian aviation sector in the form of strategic alliances, market exits, and buyouts of smaller airlines." 21

Additional Readings and References 1. "Now, Three-Year-Old Airlines Can Fly Abroad,"The Economic Times, http://ibef.org, December 14, 2006. 2. "Aviation Consolidation Looming in India: Outlook 2007 Report Released,"www.centreforaviation.com, March 7, 2007. 3. "Kingfisher Airlines Buys 26 Pct Stake in Air Deccan for 5.5 Bln Rupees,"www.abcmoney.co.uk, May 31, 2007. 4. "Kingfisher Flies with Air Deccan,"The Indian Express, June 01, 2007. 5. "Air Deccan Fares to Go up: Mallya,"www.expressindia.com, June 01, 2007. 6. "Vijay Mallya Lands 26% Stake in Deccan Aviation,"The Hindu Business Line, June 01, 2007. 7. "Kingfisher-Air Deccan: Different, Yet Similar,"The Hindu Business Line, June 01, 2007. 8. C.H.Unnikrishnan, "'Air Deccan Helps Our Overseas Plans',"www.livemint.com, June 04, 2007 9. Nandini Lakshman "Merger Mania Reshapes Indian Airlines,"BusinessWeek, June 11, 2007. 10. Virendra Parekh, "Indian Aviation Sector Expects M&A among Low Budget Carriers,"Khaleej Times, June 11, 2007. 11. "India's Airline Industry Faces More Consolidation,"www.livemint.com, June 14, 2007 12. Rabin Ghosh "' Kingfisher-Air Deccan Merger Best Fit',"www.dnaindia.com, July 25, 2007.