Merger Mania Reshapes Indian Airlines

With losses piling up, India's commercial aviation industry is set for a major consolidation that could cut out quite a few players

India is an expanding economy with rising incomes and a large population of young people eager to travel. That has made India the world's fastest-growing and most competitive aviation market. Domestic passenger traffic is expected to double to 60 million by 2010 and reach 200 million by 2020.

That's sweet news for airplane manufacturers such as Boeing (BA), Airbus, and Brazil's Embraer (ERJ)—and a pack of Indian carriers that have entered the fray in recent years. However, the price competition is brutal and already a major consolidation wave is reshaping the contours of India's commercial aviation sector.

Consider the frenetic round of deal-making this year as Indian players aim to scale up to lower their cost base and gain access to the kind of financing they need for major buildouts of their air fleets. On May 31, India's Kingfisher Airlines announced it was picking up a 26% stake in Air Deccan, the country's first low-cost carrier, for $121 million. That follows a deal in April in which the country's biggest privately owned airline, Jet Airways, snapped up full-service airline Air Sahara for $354 million.

Stopping the Bleeding

After years of discussions, the long-awaited merger of the state-run domestic and international carriers—Indian Airlines and Air India—is expected to be complete in two years. Meanwhile, there is market speculation that Chennai-based business carrier Paramount Airways will acquire a substantial stake in GoAir, another no-frills budget carrier.

"Consolidation has been the single most critical issue in the aviation sector," says Venkat Ramaswamy, executive director at Edelweiss Capital, which brokered the Kingfisher-Air Deccan deal. He says his bank had drawn up a host of options to raise capital for a bleeding Air Deccan including debt and private equity. But the Kingfisher deal seemed appropriate as "There were back-end synergies which could be leveraged to reduce costs."

The betting is that it's only a matter of time before the urge to merge sways the more than dozen other Indian carriers now operating, and eventually leads to a dramatic downsizing of players. Kapil Kaul, the Delhi-based consultant with the Center for Asia Pacific Aviation, reckons that just 8 to 10 players will be left in the next three years, down from over a dozen now. "Indian aviation couldn't have been fragmented for long. Consolidation is the by-product of the environment," he says.

Elbowing for Orders

In fact, industry consolidation was a given, ever since a crop of eight new airlines hit the Indian skies in the last three years. Most were budget carriers set up by entrepreneurs who quickly placed tremendous downward pressure on fare prices. They all have been chasing the estimated 300 million middle-class Indians who have been enjoying rising disposable incomes and now have the financial wherewithal to travel at home and abroad.

Today, some 650 flights take off daily from India's 95 operational airports vs. only about 200 three years ago. That figure is likely to nearly double to 1,200 by 2010.

And major international aircraft manufacturers such as Boeing, Airbus, ATR, and Brazil's Embraer are knocking each over to win orders. According to Dinesh Keskar, vice-president of sales with Boeing Commercial Airplanes, his 125-aircraft fleet currently in India will double by 2011. If so, that would mean about a $20 billion revenue haul for Boeing.

With more than 100 Airbus planes operating in India, the European concern's new orders have come from startup airlines such as Air Deccan, Kingfisher, Spice Jet, and GoAir. Last year, Kiran Rao, an executive vice-president with Airbus, said, "We hold 73% of all future orders and options in India, valued at $22 billion."

Needed: More Airports

Among India's passenger carriers, however, the outlook is challenging as long as the fare wars continue. Discounted tickets represent 20% of total fares in India vs. a global average about 10% to 15%. On top of that, the scarcity of airports in India has meant higher landing and maintenance fees, another drag on profits.

Indian skies are so congested that it's not unusual for passenger jets to spend an hour circling around an airport and waiting for a landing slot, which drives up the fuel costs even on short-haul trips and adds up to 10% in additional costs, according to Navin Wadhwani, a director at investment bank NM Rothschild.

Take the cash-strapped Air Deccan. Managing Director GR Gopinath had said his carrier would break even by the end of 2006. Instead, the company lost $49 million during the first quarter of this year. That kind of profit pressure broke earlier resistance by Air Deccan executives to a tie-up with Kingfisher.

"Consolidation will definitely help rationalize capacities and reduce costs," says Saroj Dutta, executive director of Jet Airways, referring to such needs as engineering, maintenance and repair, ground services, and route networking and planning. Newly merged airlines also will have the financial muscle to fly to new destinations.

Foreign Airliners Revving Up

Adds M Thiagarajan, managing director of Chennai-based Paramount Airways, which operates a business airline in south India, "An acquisition can help you grow quicker." Some sort of tie-up is probably crucial for Paramount if it hopes to realize its aim to be a national player by 2011 and enlarge its five-Embraer fleet to 55.

Already, the three consolidated groups—Air India, Jet Airways, and Kingfisher—dominate the Indian skies with an 85% market share. Other low-cost carriers could be in play soon, experts envision. "It will make them the ideal takeover targets," says Bundeep Singh Rangar, chairman of the British Indusview Advisors. The growing competition from foreign airliners provides another reason to scale up.

In late 2006, Delta Airlines (DAL) inaugurated its Mumbai-New York direct flights. The route has been in such high demand that the U.S. carrier plans to fly into other cities like New Delhi and Bangalore. British Airways has regular flights from three Indian cities—Delhi, Bangalore, and Mumbai. And a host of global budget airlines are waiting to put India on their itinerary.