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Kingfisher Airlines: Airline in acute distress - Outside View by Luke Verghese

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Kingfisher Airlines: Airline in acute distress
Nov 15, 2012

A double whammy comes a cropper

Dr Vijay Mallya's brilliant 'intuitive vision' of pitch forking the Kingfisher beer brand on to a domestic airline to earn a double whammy for the brand has come a cropper-unless the fairy god mother bails him out. The beer business is increasingly facing acute competition, including from top notch foreign brands (Carlsberg, Budweiser, Heineken, Tuborg, Fosters) which are muscling in, and, all the domestic airlines barring none are in some sort of suspended animation. It is also difficult to see how the recently liberalised investment regime for the domestic aviation sector is going to help pull Kingfisher Airlines (KFA) out from what looks like a very hopeless situation-if that is the right term. It was Mallya's unfailing pressure on the govt to allow Foreign Direct Investment (FDI) in aviation that led to the opening of the aviation sector to foreign investment. The previous aviation regulator was moved out without any prior notice as he was about to shut down the airline.

Vulture investors run for cover

A dekko at the latest annual report of Kingfisher is enough to send even a vulture investor scurrying for cover. Against a paid up capital of Rs 11.3 bn (consisting of preference capital of Rs 5.5 bn and equity capital of Rs 5.8 bn) the reserves and surplus are in the red to the tune of Rs 62.13 bn, leading to a negative net worth of Rs 51 bn. The additional capital infusion during the year for the matter of record was Rs 799 m. Another way of looking at the big picture is that its accumulated liabilities are Rs 51 bn more than its gross asset base-and that is just the book figure. Put gently it means that the company has gone fully belly up, or to use a very blunt term it is insolvent. And this accumulated loss figure is only the beginning of a long winding story in the making. Not that it matters one bit, but it may interest readers to know that the assets include net deferred tax assets of Rs 40.5 bn. This in the main consists of 'unabsorbed losses, and of depreciation' amounting to Rs 34.8 bn and 'TDS on interest, commission, brokerage, rent and such like' amounting to Rs 7.9 bn not paid to the sarkar. This is indeed a sizeable notional asset. Likewise, the long term loans and advances include an entry titled 'Aircraft major maintenance reserve' amounting to Rs 7.3 bn. This is a statutory requirement but unfortunately would not require a specific transfer of cash to the company. In similar vein the Short term loans and advances includes a similar entry amounting to Rs 4.0 bn. The liabilities however are on more solid ground.

The liabilities include accumulated borrowings - both long term and short term amounting to Rs 87.2 bn at year end against Rs 70.3 bn previously. (The liabilities have increased during the year due to non payment of capital account dues and interest dues on debenture debt to the lenders). The notings on the collateral offered on these borrowings is quite a scream in itself. Among other eyebrow raisers the fine print states that the loans have been classified as secured on the basis of their market value as estimated by the management. No current valuation reports have been obtained! This is getting to be ludicrous to the extreme! The interest on borrowings debited to the P&L account in 2011-12 was of the order of Rs 12.7 bn against Rs 13.1 bn previously. How it managed a lower interest outflow on higher year end borrowings is another issue altogether. The percentage interest payout on a rough basis amounted to 14.9% for the year on the year end borrowings. The percentage interest payout in the preceding year was much higher at 19%. The lenders must have taken pity on the company or something and reduced the interest charges.

Auditor's qualifications

The auditor's notes to the accounts are peppered with qualifications of much import and are far too complex and befuddling to be enumerated on in this column. The wonder is that the auditor's actually got to complete the audit. But they repeatedly take cover under a very carefully crafted sentence-we do not express any independent opinion in the matter. (What then is the sanctity of the figures in the annual report?) The notes also include such exotica as non payment of tax deducted at source under the provisions of the IT Act 1961, to assorted service tax dues not paid up, which are disputed and are pending in various fora. The total liabilities on this score alone amount to Rs 2.9 bn. Then there are the undisputed dues in respect of tax deducted at source by the company on direct and indirect taxes etc. amounting to Rs 5.6 bn which remain unpaid to the ultimate recipient. These figures are however 'small change' compared to the other mega sized over dues.

If all the dues are added up to the accumulated losses in the balance sheet, then the humble 12 digit calculator will run out of column space in trying to tote up the full extent of the losses that the company is saddled with. The dues exclude contingent liabilities amounting to Rs 19 bn at year end against Rs 21.3 bn previously. Granted, the contingent liabilities may never actually accrue as its application is only in the event of an unforeseen event materialising. But in this specific instance it is the wording of the accrued liabilities in this schedule that call for caution, and more importantly, some of these liabilities are not ascertainable and hence no specific figure can even be apportioned to them.

That apart, the litany of acts of omission and commission by KFA as listed by the auditor's is frightening in its intensity, and includes funds raised for short term purposes of Rs 63 bn, which has been used for long term investment. How could the lenders have allowed such blatant misuse of funds, especially since any release of funds is supposed to be followed by close monitoring of the end use of funds? This is a clear policy violation on the part of the lenders. It appears that if the borrower has the requisite brand equity then the rules of etiquette do not apply. And the chairman of the board of Kingfisher Airlines has an overdose of it. His Rajya Sabha membership has come in handy in his hour of dire need.

Lenders eating out of the company's hands

The point to note here is that the financial peccadilloes have reached such a point of influx, that it is the company which has all its lenders and other business associates now eating out of its hand. 'If I owe you a thousand pounds then you own me, but if I owe you a million pounds then I own you'. That was the dictum of the late John Maynard Keynes. By default it has its survival kit carefully worked out, as the sums involved are so humungous that the company is simply too big to fail. Such large bankruptcies will not be allowed to occur in India, irrespective of how perilous the situation in the first place. There are far too many examples to fall back on in this respect. Recent news reports aver that some Middle East airlines have shown an interest in jumping on board - but with the reported rider that some scheme being first ironed out for containing the accumulated debt. This is a tall order and cannot be sorted out in a hurry. And mind you, the clock is ticking at some speed. Besides, the figures of overdues that I have enunciated here refer to the purported financial condition which prevailed some six months ago. The situation would have only deteriorated since then and must have more than reached a flash point of sorts. Just the interest accrued on the debt is frightening enough.

This alarming ground reality does not leave Mallya with any trump cards to deal with-though fate intervened following his offering of gold to the Gods. The share price has galloped by more than 100% because of the announcement of the new guidelines on FDI in aviation (period considered includes the run up to the announcement). The run up in the share price does not appear to have been based on any rational hope however. Mallya has not made any encouraging noises either barring saying that negotiations are on. In reality there is really very little to negotiate judging from even the figures published in the latest annual report. And the figures do not really tell the real tale.

More to the point, Mallya's craving for self aggrandisement continues to be insatiable. In 2010-11, when the airline was haemorrhaging he thought nothing of pocketing Rs 508 m as guarantee fees. However in the following year after creditors slammed on the brakes, he paid back Rs 140 m. In a follow through act of sorts, even the holding company took its generous share of similar tithes of Rs 580 m in 2010-11. There is no mention of the holding company paying anything back to Kingfisher.

Revenues and expenses

Suffice to say that in the financial year 2011-12 the company generated revenue from operations of Rs 55 bn, and rustled up other income of Rs 3.3 bn. The operating revenues are down 12% from the figure of Rs 62.3 bn previously. The other income is up 143% but this is mainly due to two fortuitous counts. It includes an exchange gain of Rs 1.1 bn and a write back of provisions of Rs 1.5 bn. But this income stream irrespective of its constitution is only a flea bite in the overall scheme of things. The operating revenues in turn accrue from two streams. There are the revenues that originate from the domestic sector, and the revenues originating from the international sector. The ratio in 2011-12 was 75% to 25%. The ratio was roughly the same in the preceding year. The 'segment results' schedule reveal a loss before interest and taxes of Rs 834 m from domestic operations, and a loss of Rs 3.3 bn from international operations, for a total segmental loss of Rs 4.1 bn. In the preceding year the respective figures were a profit of Rs 7.7 bn and a loss of Rs 781 m for a segmental profit of Rs 7 bn. This brings forth the logical question as to why the company persists with its international operations. Have none of the creditors ever put their foot down on this or something?

After accounting for assorted other expenses including depreciation, other unallocable expenditure, restructuring and idle costs, redelivery and other costs, and, other unallocable income, the company ran up a humungous loss of Rs 34 bn against a loss of Rs 15.2 bn previously. This situation was inevitable given that the revenue incomes declined but the company was unable to pull the plug on revenue expenses. What appears to be drawing this company under the table are the unallocable expenses of Rs 6.6 bn against Rs 8.2 bn previously (how can it have such large unallocable expenses), and restructuring and redelivery costs cumulatively amounting to Rs 9.7 bn against Rs 1.1 bn previously. The latter two items of expenditure have arisen from the company's inability to adequately service the aircrafts that it has taken under operating / financial leases. This is the crux of the problem.

The cash flow statement

The 'cash flow statement' adds to the intrigue of how the funds came in and how the funds flew out in a hurry. For starters where this company scores very high on the working capital front, and that in the main is due to its as poor as a church mouse status, is that, the trade payables at Rs 28.2 bn towers over that of the trade receivables of Rs 1.9 bn. But this mismatch also implies that the trade creditors are very unlikely to receive their dues in a hurry. In the 'cash flow from operating activities' column the company has correctly reduced interest expenses amounting to Rs 12 bn and inflated cash inflow from operations to a like extent. But the point is that in the 'cash flow from financing activities' column, the interest paid out is limited to Rs 6.6 bn. There is thus a mismatch of Rs 5.4 bn here. Where did the balance go? Sad to say but the company was badly out of pocket in the cash flow generation from operating activities, and so was it just as badly out of pocket on the cash flow generation from investing activities. Thanks to fiddles like the interest payment, the additional debt burden was to the tune of only Rs 20.45 bn.

It is difficult to see what aces he can now pull out of his sleeve up to save both his Kingfisher brand and his tottering airline. He may still have deep pockets given his varied interests in foreign shores, but he seems disinclined to bring in any money from overseas for whatever reason. He has very little leverage left from his Indian operations for sure - considering the many reported guarantees that group companies have already offered on behalf of Kingfisher, and their own monetary requirements to sustain their operations. It is even more difficult to see any white knight in shining armour come galloping in, given the circumstances, to put in good money to save bad money. More so since the new aviation guidelines allow only a minority 49% foreign equity participation and Mallya in any case is unlikely to offer management control to any incoming entity. For some morbid reason he seems intent on reviving the aviation biz come hell or high water. The correct way forward of course is for the creditors to take the bull by the horns and divest the airline from the iron grip of Mallya, convert a large chunk of their loans into equity and install a professional management in the driver's seat. In this manner there is some hope of ensuring that they get some return on their capital at stake. But, if wishes were horses then even I would be riding them.

The shareholding pattern

The shareholding pattern as at end of March 2012 is that two promoter entities - United Breweries (Holdings) Ltd and Kingfisher Finvest India Ltd together control 45.2% of the outstanding voting stock. In the preceding year the two entities controlled 52.9% of the voting stock. This could imply that the additional equity capital brought in during the year was by an outsider. Thus the statement of the company that the group has brought in addition al capital during the year is not exactly on target. One of the schedules states that United Breweries (Holdings) was the holding company till February 17, 2012, and since then it is an associate company. Why should this be so?

Interestingly, there are two other stakeholders with below 5% stake each, and they are State Bank of India and ICICI Bank Ltd. In the preceding year the two banks together controlled 10.98% of the outstanding stock-that is more than 5% each. It is not known whether the change in the percentage holding is due to a sale of their stock during the year, or whether the reduction is caused by the additional capital infusion. Also, some 89% of the preference capital of Rs 553 m is held by seven banks. And, leading the list is State Bank of India. So the interest of the lenders is a lot more than just the outstanding loans. How they got fooled into all this is another matter. It is of course possible that their hands were forced for starters.

Disclosure: I do not hold any shares in this company, either directly, or under any non discretionary portfolio management scheme

This column Cool Hand Luke is written by . 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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