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Divestment of Air India. Ashish Parikh Manavendra Singh Sial Nikolay Nazarov Pallav Jain. Agenda. Case Introduction Background Duke Air Background India Background Air India Transaction Issues Our Analysis Our Valuation Case Update. Case Introduction. Synopsis
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Divestment of Air India Ashish Parikh Manavendra Singh Sial Nikolay Nazarov Pallav Jain
Agenda • Case Introduction • Background Duke Air • Background India • Background Air India • Transaction • Issues • Our Analysis • Our Valuation • Case Update
Case Introduction Synopsis • Duke Air is considering an investment in Air India Learning Objectives • Cost of capital considerations • Comprehensive DCF Modeling
Background: Duke Air • Finland’s leading airline • Most profitable European airline in 2000 • European revenues make majority of total revenues • Interested to diversify into other markets
Background: India • Largest Democracy • Second largest country - population • Per capita GDP $471 • Huge income disparity • In the midst of economic liberalization • Severe corruption
Background: Privatization “…Learning from our experience, especially over the last decade, it is evident that disinvestment in public sector enterprises is no longer a matter of choice, but an imperative…” Address by the President to Parliament in the Budget Session
Background: Air India • Founded in 1932 as Tata Airlines • Nationalized in 1946 and turned into Air India • 1999 Revenues - $1B (Rs 44B) • 1999 Assets - $834M (Rs 36B) • 18,000 employees • 200 world-wide destinations • 3.37 million passengers annually
Background: Air India • 100% Government owned • Strong Brand image • Strong Operational Capabilities • Strategic partner would increase operational efficiencies • Competitive disadvantage due to small fleet size
Transaction • Acquire a 40% equity stake in Air India • Requirement of an Indian partner • Foreign partner can not have more than 26% stake • Additional 20% to be sold to Indian institutional investors • All cash transaction • Possibility of Indian Airlines divestment
Option to buy Indian Airlines • Probability of IA divestment by 2005 – 40% • Probability of acquiring IA after acquiring Air India – 50% • Expected synergies from such a transaction – 15% of Air India’s operating cash flows
Air India operating details • Air India travel market share of 21% (air traffic in India) • Indian Airlines travel market share of 11% • Major markets: • India/U.S. • India/U.K. • India/Europe • India/South East Asia
Air India operating details • Other sources of revenue (MM USD):
Air India operating details • Fleet size
Air India projections • Revenue growth of 10% • Major costs – aircrafts and fuels tied to US dollars • Fuel costs based on a stable oil price of 27.5 USD/barrel • High capital expenditure in 2003-2004 and 2006-2007 for fleet augmentation • Prices consistent with competitive carriers • Debt refinancing assumed to maintain high D/E ratio
Issues to consider • Adjustment to operating cash flows • Adjustments to cost of capital • Other adjustments • Incorporating Indian Airlines option (probability of 0.4 and 0.5) • Other qualitative issues
Analysis: Cost of Equity • ICCRC India • Assumptions: • Risk Free Rate = 4% • US Market Risk Premium = 3% • Anchored to US • ICCRC Cost of Capital for India Cost of Equity (ICCRC) 19.5%
Analysis: Use of Multiples • Acquisition Multiples • Not meaningful, due to regional and other differences • Trading Multiples • P/E: Regional differences, AI negative earnings • EBITDAR: Best multiple for industry, but also problematic due to high leverage and lack of comparables
Analysis:Changes in Valuation • DCF approach - Free Cash Flow to Common Equity (FCFCE). • Operating Cash Flows were adjusted down by 5% to reflect resource risk and operational inefficiencies. • Risk adjustments reduced the cost of equity capital from19.5%to19.03%
Analysis: Changes in Valuation • Scenario wrt. equity investment in Indian Airlines (real option) • Terminal Value growth rate – 2% • Exchange rate is determined from the Purchasing Power Parity - Assumptions - US inflation rate 2% - Indian inflation rate 5%
DCF Model • FCFCE projections for the next 13 years • Main Issues • Revenue Projections (10% growth rate over the next 10 years) • Alliance/Consolidation Benefits • Fuel Costs • Debt Pay down
Valuation • Monte Carlo Simulation • Jet fuel price is modeled as a function of oil price. • Simulation of oil price as random walk with a drift. • Embedded parameters in oil price simulation are conservative. • Since jet fuel is a part of COGS, after-tax effect is imputed.
DCF Present Value • For AI only Expected PV– US $75.16 million Likelihood of positive NPV – 80.76% • For AI considering the synergistic benefits from acquiring IA Expected PV (median) – US $115.96 million
Valuing AI with real option • Probability of IA divestment – 40% • Probability of acquiring IA by Air India – 50% • Decision tree framework – expected value for Air India
Bid Valuation: Bid Value • Bid - 77 MM USD • AI great strategic fit
Case Update • Duke Air did not win the bid • Political issues surrounded the privatization process • Trade unions raise concerns over divestment • Government defers divestment of Air India
Air India References • Information memorandum and valuation model from a leading Investment Bank • Other Emerging Market cases • Presentation by HSBC on divestment in India • Discussions with Ministry of Civil Aviation • Some of the case facts, cash flow projections and probabilities have been modified for simplification