Kingfisher: On a wing and a prayer

In the last week of October,Mallya met civil aviation minister Vayalar Ravi. What was unusual on that day was his patience. He waited at the minister’s office for nearly an hour before he could have an audience with him for 20 minutes. Later,he waited in the ministry for another hour to meet secretary Nasim Zaidi.

“Yes,he had come to see me,” Ravi had told The Indian Express. “He wanted help with bankers on loans.” Ravi asked him to submit a proposal to his ministry,which they could take up with the finance ministry.

The airline that Mallya built over the past six years is burning cash rapidly in a business that requires capital perpetually; its losses are mounting; experts say it has no pricing power given six carriers are fighting over the major hubs in India; it is dependent on the vagaries of oil prices and the largesse of state-run banks; and its parent UB has run out of financial room to accommodate the needs of this capital-starved child. Its auditors have “qualified” reported financials of Kingfisher on many occasions,referencing accounting policy changes and expressing disagreement with the management’s interpretation of Indian accounting standards. After a bailout of sorts in the form of loan restructuring by banks earlier this year,Mallya still needs funds desperately—a working capital of Rs 700-800 crore. The airline has shut its no-frills segment due to heavy losses.

The halo of an airline

Why did Mallya start an airline? Many believed it was to take his flamboyance to the next level. But his lieutenants say the owner of the second-largest spirits company in the world entered the aviation sector as he saw latency of demand and business opportunity around the growing need for connectivity. “He already had enough flamboyance,and he did not need to start an airline to get any mileage on that,” says Ravi Nedungadi,president and CFO of UB group.

But Mallya,who took his spirits business to new heights through expansion and takeovers,including the $1.2 billion acquisition of Scottish distiller Whyte and Mackay in 2007,carried his flamboyant persona into his aviation business. When he launched the airline in May 2005,he said he wouldn’t have any economy or business class,but his own K class. “The name Kingfisher has an imagery and the product has been crafted to match that imagery,” says Nedungadi.

Kingfisher,named after UB’s best-selling beer,also best represented its promoter who is well known for his style and expensive hobbies (he owns an IPL team and co-owns a Formula One team). Thus,Kingfisher certainly had to be different and a few shades better than what other carriers offered at that time. And who could have been a better ambassador of the product than Mallya himself.

“Kingfisher by necessity and branding represents affluent and aspirational qualities and therefore we went in with inflight entertainment,luxurious seating and the full-service model,” says Nedungadi on the business model chosen by Mallya.

So is Mallya just a showman who inherited his father’s wealth and is interested only in IPL matches,Formula One cars,horse racing and yachting?

“Mallya is really a private individual,and the flamboyant lifestyle is an image,” says Nedungadi. “As a brand ambassador,he has the imagery but at the heart he is a seriously dedicated business person. He works harder than all of us put together.” Before he started the airline,Mallya had said to one of his confidantes,“I will make comfortable and cheerful the entire process and timeframe from the point of the flyer’s departure from the airport all the way till he gets into his vehicle at the arrival airport.” This plan has gone haywire now.

Though the airline never made profit,things went on fine for a couple of years and Mallya was hailed by consumers and his admirers as one who changed the way people flew.

So what went wrong?

One may argue that if the positioning was premium and if he consciously stayed away from the more competitive low-cost segment,what went wrong for Mallya? From the soaring prices of fuel to cut-throat competition to the mistake of taking over Air Deccan—everything went against him.

Nedungadi says Mallya entered with optimism and expected the government would bring in reforms as time passed but things did not shape up the way he thought. “We anticipated that the environment would respond faster,open up the old regulatory framework in which the industry existed,” says a UB group insider. “We expected that it will open faster. Things like overtaxing such an essential service is something that we had hoped would go.”

Industry experts too feel that a lot has to be blamed on structural issues. “ATF prices are up and on top of it there is a depreciating rupee,” says Dhiraj Mathur,ED,Pricewaterhouse Coopers. “Then,there are taxes on ATF which are between 20 and 30 per cent,and there is a high interest rate environment. This industry is a high fixed-cost industry and if the fuel cost accounts to 50 per cent and manpower cost is around 10 per cent,there is no elbow room or scope for operational efficiencies and cost cutting and so on.”

Senior civil aviation officials say apart from high taxation on fuel,what is killing the industry is the predatory pricing. “The pricing has been driven downward on account of the low-fare regime caused by one or two carriers,” says an official. “Predatory pricing is unhealthy. They should compete on the basis of efficiencies.”

“We had raised red flags when airlines placed proposals for aircraft acquisition,trying to outpace each other,” says another ministry official. “But no one wanted to listen to us. They came with inflated traffic projections on overseas routes,with the result that most of them are in the red now.” In the last one year, airlines have been reducing head count,easing out staff and delaying salaries.

However,even though there is no denying that there are many structural problems with the sector,there are issues that are exclusive to Kingfisher. Rising competition from low-cost carriers and Mallya’s inability to fly international routes until he completed five years of operation led him to buy Air Deccan in 2007,which experts call his biggest mistake. Not only did he deviate from his initial plan of serving only the top end,he also paid a lot of money for the acquisition.

“While he did that in order to get an entry into international routes,I think Kingfisher made a commercially and strategically improper decision,” says a leading aviation expert who did not wish to be named. “They paid a lot for Air Deccan which was not in a very good shape at the time they bought it. And also the mindset for running a low-cost and a full-service operation are different,” he says.

Mallya has maintained that he does not regret having bought Air Deccan. But now his decision to exit the low-cost business and once again focus only on the top end only reaffirms what experts have been saying.

Bad financial health

While the company has not made profits in any of the past five financial years,it announced that its losses for the quarter ended September 2011 doubled at Rs 468 crore,primarily driven by a 70 per cent jump in its fuel cost at Rs 816 crore,from Rs 480 crore in the corresponding quarter last year.

According to research firm Veritas,for the three fiscal periods ending financial year 2010-11,Kingfisher’s cumulative losses were Rs 6,624.6 crore . “Reported losses are understated on account of accounting policy changes related to engine overhaul expenses,” says the research firm. “As per its 2011 annual report,Kingfisher reported book equity of Rs 2,397.2 crore compared to a deferred tax asset of Rs 2,927.7 crore. On that basis,we estimate that since inception,the airline has accumulated losses of approximately Rs 8,176 crore.”

Veritas also talks about the pressure of Kingfisher on the books of UB. The market value of UB holdings is only Rs 4,713.4 crore compared to debt on its books of Rs 2,331.6 crore,in addition to debt guarantees and collateral provided on behalf of Kingfisher of Rs 16,852.9 crore as per its 2010-11 annual report. “That could mean only one thing: both UB and Kingfisher are at the mercy of Indian financial institutions,” it says.

Burdened with a high-cost debt in excess of Rs 7,000 crore,the ‘king of good times’ is in dire need of at least Rs 800 crore for his working capital requirements and another considerations from banks to help him reduce the interest cost of the ailing airline. The company’s interest cost stood at Rs 334 crore during the latest quarter. “The interest cost for the company has gone up from 11 per cent at the time of debt recast package to 14 per cent now and we have asked banks to help us reduce the interest cost,” Mallya has said.

A bigger concern is the frequency at which Kingfisher Airlines needs financial aid. Earlier,towards the beginning of this calendar year,a consortium of 14 banks had restructured its loans through a master debt recast package but the financial health has not improved.

After asking the government for change in the FDI policy for strategic investors,cutting taxes on fuel and allowing direct import of fuel,Mallya denied that he asked for any bailout from the government or banks. “I haven’t asked for bailout from the banks or government,” he said. “We haven’t asked the government to dip into taxpayer’s money. We have never done it,we will never do it.”

Will Kingfisher fly high again?

About two weeks ago,a desperate Mallya wrote to the civil aviation ministry,requesting it to persuade state-owned oil marketing companies to extend its credit period for three months. “He hoped that in the meantime,he will be able to strike an arrangement with his bankers on the much-needed working capital for his company,” says a senior civil aviation ministry official.

Mallya also says a large business house has approached him for strategic investment in the airline,but he’s not ready to reveal more about it.

His wings may have been clipped for now,but Mallya is hopeful and says while the business remains,given the huge opportunity in the sector,government reform actions would help. He didn’t forget to thank Prime Minister Manmohan Singh for his helpful comments. “He is an economist by profession. He understands,” he said.

But political parties such as the BJP and those from the Left had already opposed foreign direct investment by foreign airlines in Indian airlines. “From all the statements that are now coming from the government,there is certainly an appreciation that aviation is a force accelerator for economic development and connectivity is vital,” says Nedungadi. “We hope that with that thought process,policies will also evolve along those lines.”

While some of the issues plaguing Kingfisher,such as fuel cost,are also affecting the industry,the more critical ones such as allowing foreign airlines to pick stakes in domestic airlines,have divided the industry. In a representation to the ministry,the Federation of Indian Airlines,which represents all domestic airlines,has asked for several safeguards before opening up the sector to FDI. Maintaining a balance between two key airlines—Kingfisher and Jet Airways,which have fiercely opposite views on the issue—the association has said that the FDI liberalisation should be on a reciprocal basis,so that foreign-owned carriers do not “kill” domestic airlines by predatory pricing. Industry experts say the players would have to avoid getting into price wars. “All airlines need to get out of the price war as it is a recipe for disaster,” says Mathur of Pricewaterhouse Coopers. “There are already so many structural issues that there is no scope for this price war.”

However,such is the outrage in political circles against any suggestion of bailout,that the BJP,the main Opposition party,has said that “it (Kingfisher) should find its own way.”

Will Mallya find his way in the rough skies while his once-flashy airline is tumbling down?