INVESTMENT OPTIONS OF LOW COST AIRLINES- THE CASE OF SPICEJET AND ROSS FUNDING
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Padma Srinivasan
Case Study
INVESTMENT OPTIONS OF LOW COST
AIRLINES- THE CASE OF SPICEJET AND
ROSS FUNDING
Padma Srinivasan 1
Abstract Introduction
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SpiceJet completed three successful years
The Airline Industry provides air transport facilities
in the low cost airline industry in India. It
has become airline of choice to most of to the public and also used for freight. Their
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the satisfied customers and frequent fliers. operations are certified or licensed by the
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The efforts for continual improvement in regulatory authority like the Civil Aviation
reducing the cost in operations were fruitful
and it continues to do so. The major Authority in India. German DELAG was the first
current hurdle for the SpiceJet that it needs airlines started in November 16, 1909.
to manage, through the soaring oil prices,
is the working capital resulting in financial
crunch.
The airline services can be categorized as: - 1)
Domestic and 2) International
The cash strapped SpiceJet appointed
Rothschild, a merchant banker, who The demand for airlines is increasing day by day
consulted various measures for investment
options and out of that W L Ross stepped which is the result of the differential services
forward with the positive decision. The rendered by the industry targeting differential
investment was through the stake customers. India's airline sector is headed in for
divestment and the likely seller were the
UK based resident Kansagra family and
turbulent times created by a surge in global fuel
Dubai based investment firm Istithmar. The prices that have forced it to hike fares, and resulted
deal is worth $ 80 million (Rs 340 crore) in the slowing of passenger growth. Its woes
and is in the process of closing. It would pushed airlines to a combined loss of $938 billion
be favorable for the SpiceJet to accept the
deal with W L Ross comparable to other in the fiscal year to March 2008, and aviation
potential investors and their implications. secretary Ashok Chawla opines that the figure
This research case is descriptive of the could double this year if oil prices remain at
challenge in hand and the possible solution
subject to case constraints, as analyzed and
current levels 1. The forecast represents almost a
concluded. The Indian economy is going third of the total global losses of $6.1 billion
through fast paced manifestations due to projected by the International Air Transport
its liberalization, privatization and Association (IATA) a week ago, in case oil stays
globalization zeal.
around $135 per barrel till year-end 2.
Keywords: SpiceJet, Ross Funding,
Financial management, Low Cost Airlines 2. Indian Low Cost Airlines Industry
in India Low cost airlines are air transport companies
offering services at low rates to the customers
1. Faculty, Icfai Business School, Bangalore, especially targeting middle class people. The low
Karnataka.
124Pranjana ? Vol 12, No 1, Jan-June, 2009
cost of the air fare is due to the implementation of low cost operations in the services like
reducing the in flight passenger services etc. The structure of the Low Cost Carrier and its
features are:
1.) Class Type – Single Passenger.
2.) Aircraft Type – Low maintenance and servicing cost.
3.) Avoids traffic delay.
4.) Emphasis on low landing cost and less congested airports.
5.) Direct sales of tickets to the customer. Example: Internet.
Some of the low cost airlines operating in India:- Air Deccan, Go Air , IndiGo, Indus
Airways, Jagson Airlines, JetLite, MDLR Airlines and SpiceJet
3. Research Objectives
To know and analyze
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1. The scenario behind the cash strapped discount airline SpiceJet Ltd. considering in
stake divestment to foreign investor and
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2. The implications of financial crunch and funding agreements.
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The estimated airline losses for 2008 – 09 are close to $2 billion and the low cost carrier
(LCC) valuations have been reduced by 50% since the beginning of 2008 that causes an
industrial pressure. This situation is expected to continue for the next 12 months and
capacity reductions and cancellation of orders and fleet plan reductions etc may cause
havoc on the industry performance. There will be fundamental changes in size, shape
and character of the industry if fuel prices continue to rise which may lead to further
consolidation and the working capital may not be well managed and cash is expected to
dry up 3.
4. SpiceJet – Company Details
SpiceJet airlines started in May 2005. It is a low cost airline and the promoters are Mr.
Ajay Singh (Kansangra family) and Mr. Sanjay Malhotra. Their mission is to make the
airline affordable for every individual. They call SpiceJet as “Economic Airline”. SpiceJet
flights are mainly from these destinations: Ahmedabad, Bagdogra, Bangalore, Chennai,
Coimbatore, Delhi, Goa, Guwahati, Hyderabad, Jaipur, Jammu, Kolkata, Mumbai, Pune,
Srinagar, Varanasi and Vizag. They recently launched hotels in some of these destinations.
SpiceJet has a single aircraft type fleet. It cut the cost and gives better efficiency. It has
Boeing 737 flight having 189 seats in single class configuration which suits for short
distance traveling. Recently, SpiceJet is largely affected by the rise in the Aviation Turbine
Fuel price that affected its operations cost. So the company is looking for funding from
external investors. At this moment it hired Rothschild as a Financial Consultant to invest
in the company. In the process W L Ross step forward for funding SpiceJet.
1. www.domain-b.com/aero/airlines/20080611_airline_losses.html-12k
2. ibid
3. http://www.domain-b.com/aero/aero_general/20080611_massive_growth.html
125Padma Srinivasan
4. W L Ross – The Investment Option
Wilbur L Ross has the enthusiasm and expertise to steer failed companies across sectors
in America. He was ranked 346 in the list of 400 richest Americans in 2005 by Forbes
magazine. Initially, he worked with the US private equity company, Rothschild Investment
and later in 2000, he opened W L Ross & Co. in New York with $440 million.
Currently, it is a part of Invesco Ltd. Today, his company has an asset of US $7.9 billion.
The investment company funds those companies that are not performing for the years
and wherein they need capital to sustain the business. They had provided private equity
funds and hedge funds to the companies in several countries like India, U.S., U.K.,
Germany, China, Mexico, Brazil, Japan, Korea, Vietnam, Nicaragua, Canada, France
and Bermuda. In October 2005, W L Ross came to India with an agreement with HDFC
(Housing Development and Financing Corporation) Ltd. for opportunities in India. In
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Mumbai, they established W L Ross Private Limited as a sub-advisor to India Asset
Recovery Management Limited and in February 2007, they acquired OCM, the suit maker.
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5. The Case Analysis
On May 23, 2008, the Low Cost Carrier, SpiceJet completed three years successfully.
SpiceJet, with technicalities in its operations delivered performance to its customers that
were reliable and on time. As a result the airline became preferable choice for all. Efforts
were delivered towards controlling the cost without compromising on quality and service
standards. With this SpiceJet was inspirational in keeping the cost per available seat
kilometer at Rs. 2.65. This reflected in the market when the share price of the company
rose to Rs. 104.80 as on 8th January, 2008 and is recognized as one of the best low cost
airlines in the world. The airline is promoted by various investors as mentioned below:
1. Kansagra family holds 12.91% stake.
2. Istithmar, a Dubai based investment firm holds 13.42% stake.
3. The Tata group, holding 6% stake.
4. The Director of the company Mr. Ajay Singh holding 4.16% stake etc.
The positive trend of growth never lasted from 8th January 2008. It showed a negative
trend where the market share price plummeted from Rs. 104.80 to Rs. 22.15 as on 1st of
July 2008. The show started from the highest market price that was largely hit by the
soaring prices of the Aviation Turbine Fuel (ATF). This impacted the operation of the firm
where there was lack in the working capital. It was further impacted with customers
stepping back from the air transport.
This was articulated in the financial year ending March 2008 where the operation revenue
grew by 72% to 12.95 billion rupees and the net loss widened to 1.34 billion rupees
compared to the net loss of 721 million rupees in the previous year. So the highlight of the
downward trend is due the soaring fuel prices that eroded the margins. The figure 1 shows
the trend of the market share price of the SpiceJet.
126Pranjana ? Vol 12, No 1, Jan-June, 2009
Figure 1
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In order to restructure the firm from ongoing loss, it was looking at an investment of at
least $ 100 million or even an option of merger to meet the immediate fund requirements
and also to expand as there is immense potential for the air travel industry. The current
market share of the company is over 10 percent.
SpiceJet hired N M Rothschild and Sons (India) Pvt. Ltd, a merchant banker to scout for
potential investors in the company. The banker opened up various measures such as
stand-alone shareholders, hedge funds, VCs (venture capital firms) and merger. The broker
also came up with the potential investors who were also interested in the merger option.
The potential investors were:-
1. Anil Ambani of Reliance
2. Vijay Mallya of Kingfisher.
3. Jet Airways
4. W L Ross.
5. Goldman Sachs.
Hitherto, Istithmar, a Dubai government’s private equity arm, holds 13.42% stake in
SpiceJet in the form of FCCBs*(Foreign Currency Convertible Bonds) amounting to 80
million Dollars which they issued in December 2005 with the coupon rate of 8% and
premium of Rs. 89.3 per share. Using these amounts SpiceJet ordered 20 Boeing aircraft.
Due to the cash trap, the company lease backed the aircraft where in return the Boeing
deposited the amount Rs. 320 crore into an escrow* amount in a US bank. This amount
would be recovered only when the Istithmar converts the bond into equity and was
against the interest of the private equity arm. The private equity arm wanted to lower the
price of the share to which SpiceJet resisted. The strategy was to hold the maximum
stake in SpiceJet.
127Padma Srinivasan
So this FCCBs* was willing to be exchanged as the amount to be funded by the W L
Ross. The other investor who is willing to sell is the UK based resident Kansagra family.
Together would be divested to W L Ross. The equity investment firm took the deal as it is
the efficient low cost model in India and with the long term perspective.
5. 1. Financial Stake That W L Ross Can Acquire In Spice Jet:
According to Indian Civil Aviation laws, any foreign investors can hold around 49% of
stakes in any of the Indian firms but not more than the mentioned number. But in the
case of SpiceJet around 38.35% of the holdings were already vested with foreign companies
like Dubai investment firm, Istithmar (13%) and London based Bhupendra Kansagra
(12.91%) etc. there were around 10% stakes were left for W.L.ROSS to invest. (The Ross
investment firm mainly extend their investment in such companies to finance that are not
performing well and it supports them to perform better)
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5.2 General problems faced by SpiceJet Airlines other than high fuel prices:
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The other problems faced by SpiceJet are as follows:
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1. Airport infrastructural problems: Actually there were no slots available for the
spice jet for its new airlines in the major airports of India. This is the one of the
biggest problem the spice jet faced while launching new air services.
2. Massive pilot shortages: Recently the spice jet airlines is facing problem of skilled
pilots.
3. Stringent civil aviation laws and regulations:
4. More Supply than demand: The SpiceJet airline is offering more number of
passengers than demand.
5.3 Potential other investors who are interested in buying stakes of Spice Jet:
These are the giant investors who want to buy stakes in Spice Jet:
1. Anil Ambani’s ADAG group: The ADAG of Anil Ambani planned to buy stakes
in SpiceJet, through this he wanted to enter civil aviation industry in India.
Unfortunately, that did not work due to various reasons.
2. Vijay Mallya’s Kingfisher Airlines: Vijay Mallya, the chairman of Kingfisher
Airline was also looking for SpiceJet (Initially he merged his Kingfisher with the
Deccan Airlines and a notion that by buying SpiceJet stakes or by merger with
SpiceJet, it would have made Mallya as King of Indian Low Cost Airlines.
3. Jet Airways:
Even the Jet Airways was also on the thought of buying stakes in SpiceJet airlines.
4. Tata Group:
Ratan Tata of Tata group holds 6% of stakes in SpiceJet and was planning to
double the hold to around 15%. But unfortunately it did not work.
128Pranjana ? Vol 12, No 1, Jan-June, 2009
6. Findings and Recommendations
SpiceJet wanted fund for carrying out its day to day operations and executing its fleet
expansion plan. Some of the options along with our recommendations are mentioned
below:-
1) Option Of Raising Money Through FPO:-
One of the options with SpiceJet is that it can go for Follow-On Public Offering (FPO*).
But the problem is that the company is already undergoing losses and chances of growth
in the near future are very less, so public would be reluctant in investing in their company
and therefore it won’t be able to raise enough money as per requirements. So it is not
recommended that the company to go on for a FPO.
2) Going For The Offer Given By Vijay Mallya’s U.B Group:-
When SpiceJet was looking for funds, Vijay Mallya showed his interest in buying SpiceJet.
But SpiceJet rejected to its offer as the promoters were against this deal. They had the
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fear of losing their individuality as an independent brand, as Air Deccan lost after its
merger with Kingfisher Airlines.
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3) W L Ross offer to SpiceJet for buying FCCBs* held by Istithmar:-
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W L Ross is ready to pay $ 80 million to SpiceJet in exchange of FCCB held by Istithmar.
By doing so, SpiceJet will get enough money for their activities and to achieve their
expansion plan of increasing their fleet size and thereby increasing their market share. By
doing so they won’t loose their identity in civil aviation industry. So this option looks
favorable to SpiceJet to raise its funds.
SpiceJet should go ahead with the W.L. ROSS deal. The $ 80 million fund would recover
its financial position and would meet its operational activities and rising ATF (Aviation
Turbine Fuel) prices. The money that was raised through the leaseback of the Boeing
aircrafts became a barrier as it was in the U.S. bank in an escrow account. The money
will only be available to the SpiceJet if Istithmar is ready to convert the FCCBs (Foreign
Currency Convertible Bonds) into equity but was against the same. The other alternative
to SpiceJet was to merger with Kingfisher airlines or ADAG (Anil Dhirubhai Ambani
Group) or funding by TATA’s. Among all the possible options the best one is to go for the
W.L Ross deal and stabilize its position in the airline industry.
References
1. www.civilaviation.nic.in
2. www.investopedia.com
3. www.spicejet.com
4. www.livemint.com
5. www.hindustantimes.com
6. www.4to40.com
7. www.businessline.com
8. www.businessstandard.com
9. www.financialexpress.com
10. http://www.domain-b.com/aero/airlines/20080611_airline_losses.html
11. www.centreforaviation.com/aviation/Info_Services_News/Aviation_News/
HSBC_Wins_Mandate.../index.php
129Padma Srinivasan
Appendix: 1 Glossary
1. Leveraged Buyouts:
Take over of a company or controlling interest in a company, using a significant amount
of borrowed money. The target company’s assets are used as the collateral security for
the borrowing*.
Source: - www.ivc-online.com/glossary.asp-40k
2. Bottom Fisher:-
An investor who bargains among stocks whose prices have dropped dramatically. The
investor believes that the recent price drop is temporary and a recovery is soon to follow*.
Source: - www.answers.com/topic/bottom-fisher-33k
3. Foreign Currency Convertible Bonds:-
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A type of convertible bond issued in a currency different than the issuer’s domestic
currency*. In other words, the money being raised by the issuing company is in the form
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of a foreign currency. A convertible bond is a mix between a debt and equity instrument.
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It acts like a bond by making regular coupon and principal payments, but these bonds
also give the bondholder the option to convert the bond into stock**.
These types of bonds are attractive to both investors and issuers. The investors receive the
safety of guaranteed payments on the bond and are also able to take advantage of any
large price appreciation in the company’s stock. Due to the equity side of the bond, which
adds value, the coupon payments on the bond are lower for the company, thereby reducing
its debt-financing costs.
Source: - *www.icai.org/resource_file/10351703-708.pdf
**www.thehindubusinessline.com/2007/09/12/stories/2007091252160600.htm-22k
***http://in.ibtimes.com/articles/.../spicejet-airlines-kansagra-wilbur-ross-investor-private-
equity-buyout-acquisition-stake-aviation-g-34k
****http://rktcmcaagaaz.com/yahoo_site_admin/assets/docs/FCCB.176221707.rtf
4. Escrow:-
A financial instrument held by a third party on behalf of the other two parties in a
transaction*. The funds are held by the escrow service until it receives the appropriate
written or oral instructions or until obligations have been fulfilled.
Source: - *http://rktcmcaagaaz.com/yahoo_site_admin/assets/docs/FCCB.176221707.rtf
**www.answers.com/topic/escrow-67k
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