The Hindu Business Line : Airline mergers take wing

The world over, airlines continue to be strictly controlled by governments, which make laws that prevent foreign airlines from taking ownership stake in their national carriers. The reason why the airline industry has not consolidated, as any other industry, such as media, telecom or insurance, is because of such ownership norms. The airline industry is at this time considerably fragmented, with far too many national flag carriers, subsidised and protected by governments.

What was to have been India's first major airline merger and acquisition (M&A) deal — between Air Sahara and Jet Airways — is heading for a divorce even before the marriage vows were exchanged. The next in line is the proposed merger of the two state-owned airlines, Air India and Indian , also likely to be fraught with human resource challenges.

The most common reason for M&As between airlines is the unviable operations of one of the entities. The airline that is taken over soon loses its identity, its excess staff is forced to resign or retire, and its profitable assets, such as real-estate and subsidiary companies, are sold to unlock value.

For instance, two years after Air France acquired KLM in 2004, though the revenues of the merged entity have gone up marginally by about 20 per cent, its net profits increased eight times, at $3.2 billion in the last two years. Such one-time financial benefits of a merger may wear off in later years, often due to savings in staff costs, establishment costs, reduction in the number of flights on parallel routes, and revenues realised from the sell-off of assets such as office space.

More capacity, less yields

The year 2005-06 was a landmark in India's aviation history as there was a manifold increase in the number of airlines operating both on the domestic as well as international routes. As travellers enjoy good times, with better facilities and more frequent flights, airlines are unable to arrest declining yields. In India, with the entry of LCCs (low-cost carriers), air-fares are now much lower. In spite of the 100 per cent increase in fuel prices since 2004, airlines keep reducing fares. We live in interesting times, indeed!

The only recourse seems to be for airlines in India is to avoid cash losses by reducing all controllable operational costs, such as non-operating costs.

Cutting flab

Most traditional airlines have a 60:40 ratio between flight-related variable costs and fixed costs, the 40 per cent being the "flab". These fixed costs are a drag on airline profitability. LCCs have demonstrated that these fixed operating costs can be cut to the barest minimum. Mergers between airlines help identify operating costs arising from duplication of functions and greatly reduce staff and establishment costs. MRO (maintenance, repair, overhaul), sales, ticketing, marketing, etc., use up about 60 per cent of an airlines' manpower, though synergies can be brought about in several common areas of work through a merger.

Air Sahara and Jet Airways have identical aircraft — Boeing 737s — in their fleets. Most of the aircraft Air India has are long-range, large capacity Boeings, while Indian Airlines has mostly short-range Airbus-320s. Such lack of fleet commonality means there may not be much scope to reduce the M&E (maintenance and engineering) staff. However, ticketing and sales personnel comprise of another third of the staff strength, and this number too can be pruned by a merger.

When merged, the combined Air India-Indian Airlines entity is expected to garner revenues of over Rs 13,000 crore — three times the size of its nearest competitor, Jet Airways. A merger is expected to cut the operating cost of the state-owned airlines by 10-20 per cent with more efficient use of all resources.

M&A synergies

Both the government-owned airlines, Air India and Indian, are no longer the sole owners of India's ASAs (Air Service Agreements). With increasing competition, all airlines, private as well as public sector, have to be among the low-cost offerings.

The market share of Indian in the domestic skies has come down to from 62.9 per cent in 1997-98 to just 35.3 per cent in 2004-05. Air India's market share is also down to 19 per cent, as bilateral entitlements have been liberalised, as part of the open sky policy. Yet to be named, the Air India and Indian merged entity can ward off competition because of certain factors. These are:

Economies of scale;

Efficient use of capacity, facilities, infrastructure;

Better yields due to dominant market share in India;

Acquisition of ready pool resources such as trained manpower , and resources such as slots, maintenance hangars, parking bays; and

Integrating aircraft schedules, corporate facilities;

The theoretical benefits of merging both balance sheets, a common fleet, GHA (ground handling agents), the FFP (frequent flyer programme), and so on, are the low-hanging fruit.

The second wave of the merger exercise must tackle more contentious issues such as reducing excess staff, shrinking the airlines' size by realigning airline divisions into SBUs (strategic business units), or profit centres. Once airline ownership norms are liberalised by the government, airlines may seek foreign capital by the M&A route.

(The author is Principal Consultant with Infosys Technologies Ltd. The views are personal. Email Pankaj_Pandit@infosys.com)

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