The vulnerability of the industry

Looking at the annual report of SpiceJet one wonders what it is that spurs entrepreneurs to kick start aviation companies. Is it the self perceived glamour quotient, or is it the adrenalin pumping razzmatazz of owning a set of wheels which operates at 30,000 feet above ground level, or, some such equivalent lunacy? It has got to be, as the aviation industry is characterized by high capital costs, high operating costs, acute competition, and high vulnerability. Till a decade ago it was every other nation’s pride to own a state owned airline of sorts. If they subsisted for long it was due to lack of competition from within and without, and not due to any level of efficiency in operations. All state airlines became croppers when the markets were opened up to competition. After the attack on the World Trade Centre, the first industry to reel from the aftermath of the full blast of the shockwaves, and go six feet under was a string of aviation companies. But entrepreneurs never learn from the mistakes of others, and consequently, history has a way of repeating itself.

From bad to worse

SpiceJet is in deep trouble and it should thank the gods that it has found a benefactor in the promoter of the Sun TV group. SpiceJet itself is a spinoff of another aviation disaster which went by the name of ModiLuft, promoted by S K Modi of the Delhi based Modi group. What miracles Kalnanithi Maran can conjure up will be most interesting to see. SpiceJets’ singular problem is that no lender will touch it even with a bargepole. What Maran will most definitely have to do is to bring in oodles of additional cash as capital, and utilize it very judiciously, but for which the company is well and truly sunk. Minor miracles are not known to visit the aviation industry.

After five years of operations of the new avatar under the Kansagras, all that the company has to show for its efforts is an accumulated book loss of Rs 8.2 bn. If the unabsorbed depreciation and other liabilities, which are not quite easily discernable, are also factored in, then the book losses will be way higher. Needless to add its total liabilities as it stands, exceeds its total assets by a mile, and which is another way of saying that its net worth is negative. Its net working capital position at year end, inspite of the book profits, was strictly in negative territory.

Enter the tooth fairy

If SpiceJet was able to show some modicum of respectability in its operations in the year just past, it was because of the excessive interest shown in the industry’s welfare by the aviation ministry. The latter used its good offices to slash aviation turbine fuel prices to the bone, and get PSU oil marketers to go slow on collecting receivables. With so much capital already locked up in the beleaguered industry, and its numerous spinoffs, the government was caught in a veritable Catch 22 situation, so to speak, and had perforce to act.

Seeing the writing on the wall, the current management chose to cut their losses, and bring in the fat cats. If the company has not signed off already, it was only due to some good fortune coming its way. (This is inspite of the latest annual report crying itself hoarse, with the aid of a number of pie charts and graphs to buttress its statements, that the Indian air passenger traffic is going to boom, that it is the most efficiently run aviation company, and of it steadily gaining market share. These protestations are nothing more than a last gasp before the final denouement).

The funding nightmare

It was the well thought out manner in which the long term funding for acquisition of aircraft was tied up. This deal did not enforce any interest burden on its already tottering cash flow. The company issued zero coupon FCCBs (Foreign Currency Convertible Bonds) in excess of Rs 4 bn to be converted into equity shares at future dates at a premium to the face value. The caveat here was that if the holders do not exercise their rights to the issue of equity shares by November 2010, then the company has to redeem the debentures at a premium. With the deadline fast approaching and with Rs 3.6 bn still outstanding (excluding premium on redemption of Rs 1.4 bn) there was no way out for the promoters but to exit in a hurry. These loans materialized as a part of a package to induct 7 new aircraft in FY11.

That is only a part of the overall story. It has perforce to fund capital works in progress of Rs 3.3 bn, and the estimated amount of contracts to be executed on capital account and not provided for runs into a gargantuan Rs 25.9 bn. Quite simply stated, it requires the services of the tooth fairy to fund this extravaganza.

Selling its family silver

How ironic the reality is. Currently the company is actually selling aircraft apparently just to remain afloat. At least this is what the accounts reveal. It realized a profit of Rs 617 m in FY10 on the sale of aircraft, and a profit of Rs 35 m in the latest year. But the fixed assets schedule does not show any appreciable deletion from the gross block table in this respect. How can this be? The accounts also show that it had received advances of Rs 3.1 bn at year end (Rs 1.8 bn in the preceding year) in its books against agreement to sell aircraft. As a matter of fact its tangible gross block is a telltale sign of the state of affairs. On a gross block of a mere Rs 833 m (20 aircraft on its rolls!) it was able to drum up revenues of Rs 21.8 bn. This is equivalent to a magician pulling a rabbit out of the hat. The trick here is that the aircraft are now on lease, judging from the revenue outflow on lease rentals in the P&L account.

The new setup

One has to see what call the new management will take on the company’s commitment to acquire new aircraft. Or by how much it can cut revenue expenditure. The big ticket costs are really not negotiable. Lease rentals, the fuel bill, landing rights, salaries, and insurance costs. Not negotiable on the revenue income side is the pricing of the ticket sales, as all the airlines are busy chasing the ever growing flyer base to get a higher load factor. The latter factor is a double irony. The new owners may even seek to merge the company with the Sun TV group and take advantage of the tax benefits that accrue. Whether the company will affect a name change is also a moot point. However this is unlikely to earn the company any brownie points.

All in all, a very interesting situation in the making as the days goes by.

Disclosure: Please note that I am not a shareholder of this company

This column Cool Hand Luke is written by Luke Verghese. Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.

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