Is Indigo's Negative Networth the Main Concern?

Oct 20, 2015

In this issue:
» Rajan criticizes IMF
»  Valuations of startup firms up by 167%
»  ...and more!

 Chart of the day
It would be difficult to miss the story surrounding Indigo and its negative networth making rounds in business dailies today. For those who have no clue what we are talking about, it seems that the company's promoters have been receiving flak for paying out a dividend that has turned the company's networth negative for the quarter ended June 2015. Three months prior, the company's networth was positive. As such, it paid out more than what it earned in the quarter. And that just before the IPO hits the market!

From what we have gathered, the promoters are of the view that the company will keep its business model lean and thus will not need much cash. Indigo's low operating costs (through its standardisation and leasing model), young fleet (allowing it to have fuel cost efficiencies), and minimal ancillary costs differentiate it from its peers.

In fact, Indigo is one of the lowest cost airlines in the world. Through different measures (such as entering into contracts with original equipment manufacturers), it has been able to keep its costs low and show profits. In short, its capital requirements remain low.

But then...that raises the question: Why raise capital in the first place?

Well...turns out that about 60% of the issue size is an offer for sale. That is, the promoters are putting their shares on the block. Only the balance of 40% will be utilised internally.

So Indigo has some clear strong points in its favour but also raises some red flags.

But...should investors concern themselves with these aspects? Perhaps it would be better to look at the bigger picture in this case...

Yes, the opportunity in the aviation industry remains massive. But the sector's worldwide historical performance has been weak. Strong headwinds - regulatory hurdles coupled with volatile fuel prices as well as high competition and its effect on pricing power - have kept industry players from truly flourishing over time.

With these factors holding true in India as well, investors would do well to consider the big picture rather than worry about these relatively trivial controversies before investing in this sector.

The following chart puts this in perspective...

Aviation industry: one tough sector

As you can see, the return ratios of the two large aviation players have been anything but decent ('L' indicates latest year, 'L-1' indicates one year before latest, and so on).

Please note that we are not saying that Indigo's performance will necessarily resemble that of its peers. After all, it has proved to standout from the crowd.

But the fact is that certain industries have relatively dull economics compared to others. And investors would do well to keep this in mind, particularly in the case of aviation.

What should investors be more worried about - the controversy surrounding Indigo's promoters or the poor dynamics of the aviation industry? Let us know your comments or share your views in the Equitymaster Club.

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Time and again, we have praised the Reserve Bank of India and Raghuram Rajan in particular. For good reasons too. The RBI is a model central bank in many ways. It has a long track record of standing up to political pressure.

Governor Rajan has earned praise the world over for his inflation fighting credentials. We take comfort in the fact that he calls out risks in his public statements along with the opportunities. Thus, it came as no surprise to us that he chided his former employer, the IMF.

The International Monetary Fund is not supposed to be a cheerleader for global central banks. Sadly, it has not been critical of the easy money policies of developed world. As per Rajan, the least that the IMF can do is to question the success of these policies.

We are thankful that India has such folks heading key institutions. As a former chief economist at the IMF, Rajan is perfectly entitled to question its stance. There is almost no one to question the long-term damage that such easy money policies may cause.

Those who are skeptical of Rajan's comments need to only remember the last time he called out the risks facing the global economy. In 2005, he had warned of the same dangers and was proved right in 2008. He may well be right again.

Valuations in India's e-commerce space have clearly reached bubble territory. We have heard of all kinds of start-ups raising big money from venture capitalists (VCs). But the e-commerce firms are head and shoulders above them all. As per an article in the Business Standard, the valuations of these firms have increased by 167% over the last five years! To put things in perspective, this is the same as a listed stock's P/E ratio rising from 10 to 26.7. And e-commerce firms aren't even making profits yet. Venture capitalists are no fools. They have invested in these firms with the expectations that growth will lead to profitability. The VCs would obviously look to exit at that stage. However, things haven't turned out that way yet. These firms are nowhere near the breakeven points. And if their recent advertising blitz that we have seen is anything to go by, profits may be a distant dream.

In the meanwhile, Indian stock markets continued to trade near the dotted line after opening the day on a flat note. At the time of writing, the BSE-Sensex was trading up by around 55 points (+0.2%). Gains were led by power and auto stocks. Mid and smallcap stocks were trading firm as well, with their respective indices trading higher by about 0.6% and 0.7% respectively at the time of writing.

 Today's investing mantra
"Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Devanshu Sampat (Research Analyst).

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4 Responses to "Is Indigo's Negative Networth the Main Concern?"

Gautam M

Oct 27, 2015

While for a minority shareholder this definitely looks a bad deal, just think from the promoter perspective. The fact that they were into a difficult business and they managed it well turning this into a leader in their business. Of course they are entitled to reap the fruits of their labor and hard work, so there is nothing wrong they have done and all this is very much open and not hidden to anyone. So in my view promoters has done nothing wrong in claiming their due share of moolah which everyone does now a days (do not forget the khans of Bollywood and their riches story). Now for a minority shareholder it is a risk reward scenario and the promoters have only increased the risk portion in this deal. If the good going in terms of low oil price and high passenger volumes last for 2 or 3 years then minority shareholders will reap double the share price to what they are investing now. Conversely if things go wrong they might also loose half of what they are investing now. It is solely ones risk appetite as to what they want



Oct 20, 2015

Only a lotus flower can bloom in brackish water ! Even it's leaf is smooth water does not stick to it !! From what has been written / reported it is doubtful if the company / its management cum ownership is a Lotus !!!


Shankar S

Oct 20, 2015

Why you will be well advised not to be taken in by the numbers posted by Indigo and get lured into investing in their IPO. Read the following post by Prashanth Krishna and be informed before embarking on any investments

FWD: A look at the Indigo (Interglobe Aviation) RHP reveals how promoters have (and propose to) milked the airline.
In the last 5.25 years since Apr 2010, the airline has made a cumulative PAT of Rs3914crs. Since the PAT has MAT credit of Rs473crs, the real profits are Rs3441crs.

Now the milking part - the airline has paid a cumulative dividend of Rs3700crs to the promoters. Therefore, the promoters pulled out Rs260crs more than what was due to them in this period.

The airline dipped into its reserves to do just that. Plus a dividend tax outgo of Rs423crs meant the networth has turned negative with the commencement of the IPO.

Further, its world-record aircraft orders on Airbus has meant that they have received incentives from the Toulouse based company. That amount has been Rs1654crs in the same 5.25 years. The B/S sheet shows another similar amount of Rs1646crs is still receivable.

Ordering a humungous amount of aircrafts is no particular skill of the promoters. Excluding those incentive-linked profits, the promoters have really squeezed the airline dry.

A risk on the yet-to-be recieved incentives is that the incentive amount can only be claimed by the buyer if he gaurantees Airbus a higher resale price during its period of lease. Airbus, by this mechanism, ensures that a large buyer does not dump the aircrafts in the general market at low prices under any financial distress spoiling their ability to charge a higher price for a fresh of-the-line aircraft. That gaurantee by a buyer also means that the lessor (financing bank) implicitly get the difference if the actual market-determined resale price is lower at the time of expiry of lease when the airline comes to them for a fresh round of financing. This risk is amply highlighted when a closer look at the 1QF16 cashflow shows that the incentive recievable is lowered by Rs102crs (however, quick calculations show that as it may be) a phenomenon hitherto unseen for 5 years.

As for the IPO and its pricing (Rs700-756 per share); the valuations are a tad expensive at FY15 based Adj EV/EBITDAR between 10.25x-10.75x.

Is it worth applying? Well, with a free-float of mere 12%, curious buyers, outnumbering the saner ones, will manage to keep the stock price afloat. Not to mention that the promoters got a dividend of Rs1135crs just a few months ago and therefore have the ability to keep valuations afloat if the need so arises.

And, did I forget to add that the OFS portion ensures that the promoters get another Rs1900crs or so over the Rs3700crs they recieved all these 5.25 years.




Oct 20, 2015

It is unethical practice of stripping of cash reserves as dividend pay outs to the promoters, a few months before coming "Public". Now it has negative networth. The company will build reserves on the premium from the IPO and the same will be distributed to the shareholders in the next decade. Certainly a bad practice and SEBI has closed their eyes.

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