Air Deccan - Cutting Costs, Not CornersThe Story of India’s First Low Cost Airline

Fin 456-Team 9: Ruchika Chinda, Ruibin Chen, Rishi Gupta, Anuj Sharma

Case Outline

• Air Deccan’s first flight took-off from Bangalore to Mangalore on Aug. 25, 2003

• Stunned the market by offering tickets at 10% of the regular rate, at an average price at 50% less than full service airlines

• Achieved a market share of 11%, two years after its debut, making it the second largest privately owned airline in India

• Plans to go IPO in 2006 with a goal to be the leading aircraft company in India providing a wide gamut of airborne services throughout the country

Questions to Ask

• With the increase in competition in the Indian aviation industry, is this

low cost model sustainable?

• Why IPO and why now?

• What’s the road-map for expansion after IPO?

• What is the optimal price of the offering?

Agenda

• Air Deccan’s business

• The aviation industry in India

• Major risk factors

• Suggested solution for the IPO

Air Deccan’s Business

• Positioning as a “low cost carrier” • Offers no in-flight service

• Single class aircraft configuration

• Internet booking and cheap fares

• Two aircraft strategy – Airbus and ATR

• Offering non-trunk short-haul routes and attracting high-end railway traffic through comparable fares

• Target market: Upper middle class in short term and lower middle class aggressively in long term

Air Deccan’s Business

• Target to expand fleet to 124 aircraft by 2013

• The Indian aviation market expected to grow at 20% annually for the next ten years. Air Deccan is targeting 18% market share by 2013

• Passenger load factors anticipated at 70%

• Revenues per customer to increase at 5% in the long run

• Targets to decease fuel expense as a percentage of total revenues from 30% to 26%, operating expense from 23% to 16% in 8 years

The Aviation Industry in India

• High growth potential due to economic boom and highly under penetration market• 0.02 trips per capita per annum• Long-term GPD growth at 8% annually

• It is forecast that India would be the second fastest growing travel and tourism economy in the world

• ATF (Aviation Turbine Fuel) prices and airport charges in India are among the highest in the world

• Regulatory and infrastructure bottlenecks have prevented accelerated growth in the industry

• The government is proactively looking to address the bottlenecks

The Aviation Industry in India

• Five-force analysis

• Rivalry: Increased competitive pressures due to new entrants

• Barriers to Entry: Easy entry but execution doubtful

• Resource & Supply: Inadequate airport infrastructure, shortage of pilots, high fuel costs

• Customers: Business travelers sector intensified by GDP growth, leisure customer market too a huge growth opportunity

• Substitutes: Railways, high price elasticity of common mans

Major Risks

• Increase in Competition • Excess capacity could lead to price wars

• Oil Price• Extremely vulnerable to oil price fluctuations due to government

regulations on price hedging

• Regulatory risk • A collapse of the current coalition government could trigger significant

changes in India’s economic liberalization and deregulation policies

Questions Recap

• With the increase in competition in the Indian aviation Industry, is this

low cost model sustainable?

• Why IPO and why now?

• What’s the road-map for expansion after IPO?

• What is the optimal price of the offering?

Q&AQ&AHow sustainable? Why IPO?

What to do after IPO? At what price to IPO?

Suggested Solutions

• How sustainable?

• High growth potential market

• The second fastest growing travel and tourism economy in the world

• Airport infrastructure improvement opening up new sectors

• The firm achieved break-even in its first year of operations, through a

combination of high load factors and low-cost operating economics.

Suggested Solutions

• Why IPO? Air Deccan wanted:

• to expand its fleet and enhance engineering and operational capabilities

• to establish a relationship with capital markets

• to have additional finance flexibility and ensure its long-term growth

• to enhance Deccan’s brand among common man

Suggested Solutions

• Risk Analysis & Cost of Capital Calculation

Risk Premium CalculationInputs Output Category

4.50 U.S. risk free in %3.00 U.S. risk premium in %

92.50 Current U.S. Credit Rating57.00 Institutional Investor country credit rating (0-100)

16.07 Anchored Cost of Equity Capital for project of average risk in country (ICCRC)

8.57 Country Risk Premium

Industry Adjustment1.10 Beta (Industry)

0.30 Sector adjustment

Project Risk Mitigation (-10 to 10; where 10=risk completely eliminated, 0=average for country)

Weights Score

Impact on Country Premium

Sovereign0.40 -2.00 0.69 Currency (direct, e.g. convertibility)0.10 7.00 -0.60 Currency (indirect, e.g. political risk caused by crisis)0.15 -2.00 0.26 Expropriation (direct, diversion, creeping)0.05 -1.00 0.04 Commercial International partners0.05 -1.00 0.04 Involvement of Multilateral Agencies0.05 -3.00 0.13 Sensitivity of Project to wars, strikes, terrorism0.05 0.00 0.00 Sensitivity of Project to natural disasters

.

Operating0.05 -3.00 0.13 Resource risk0.03 7.00 -0.15 Technology risk

Financial0.05 -3.00 0.13 Probability of Default0.03 0.00 0.00 Political Risk Insurance

1.00 Sum of weights (make sure = 1.00)

Project Cost of Capital 17.03

Suggested Solutions

• Revenue Projection

Suggested Solutions

• Expense ProjectionsAir Deccan Expense Projections (1)

Actual Projected

Year ended March 31,

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Aircraft fuel expenses 5.34% 13.72% 29.03% 30.00% 31.00% 30.00% 29.00% 28.00% 28.00% 27.00% 26.00%Aircraft/engine repairs 1.32% 13.13% 15.39% 14.00% 14.00% 14.00% 14.00% 14.00% 14.00% 14.00% 14.00%and maintenance Aircraft/engine lease 24.36% 15.80% 14.09% 14.00% 12.00% 10.00% 9.00% 8.00% 8.00% 8.00% 8.00%rentals Other direct operating 24.74% 24.89% 23.00% 22.00% 20.00% 19.00% 17.00% 16.00% 16.00% 16.00% 16.00%expenses Employee remuneration 11.24% 10.61% 9.92% 10.00% 10.00% 9.00% 9.00% 8.00% 8.00% 8.00% 8.00%and benefits Administrative and 14.71% 11.22% 6.34% 7.00% 8.00% 9.00% 9.00% 9.00% 9.00% 9.00% 9.00%general expenses Employee stock - - - - - - - -compensation cost Advertisement and 2.30% 0.47% 1.97% 2.00% 3.00% 4.00% 4.00% 4.00% 4.00% 4.00% 4.00%business promotion expenses Finance and banking 6.46% 5.74% 3.19% 6.00% 8.00% 9.00% 9.00% 9.00% 9.00% 9.00% 9.00%charges Amortisation 3.35% 1.47% 1.79% 2.00% 1.00% 1.00% 0.00% 0.00% 0.00% 0.00% 0.00%Depreciation 1.39% 1.66% 0.96% 3.00% 7.00% 10.00% 8.00% 7.00% 7.00% 7.00% 7.00%Total Expenditure 95.21% 98.71% 105.68% 110.00% 114.00% 115.00% 108.00% 103.00% 103.00% 102.00% 101.00%

Note:(1) All numbers are a percentage of revenue.

Suggested Solutions

• DCF ValuationAir Deccan Discounted Cash Flow- (Rs in million)

Actual Projected

Year Ended March 31, 2001 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

INCOME Total Income 147 314 2,669 6,557 11,356 16,921 22,276 28,728 34,388 40,801 47,982

EXPENDITURE Preliminary expenses written off - - - - - - - - - - -

Total Expenditure 139 665 3,384 6,669 11,806 17,314 21,595 26,234 31,453 36,528 42,566

Profit/(Loss) before taxation and prior period items 8 (351) (715) (112) (450) (392) 681 2,494 2,935 4,273 5,416 EBITDA 15 (291) (525) 610 1,367 2,992 4,468 7,091 8,437 10,801 13,093 EBITDA Margin 9.85% (92.62%) (19.65%) 9.30% 12.04% 17.68% 20.06% 24.68% 24.53% 26.47% 27.29%

EBITDAR 62 (185) (73) 1,528 2,730 4,684 6,473 9,389 11,188 14,066 16,932 EBITDAR Margin 42.42% (58.74%) (2.75%) 23.30% 24.04% 27.68% 29.06% 32.68% 32.53% 34.47% 35.29%

EBIT 11 (312) (612) 282 459 1,130 2,686 5,080 6,030 7,945 9,735 Tax 33.6% 33.6% 33.6% 33.6% 33.6% 33.6% 33.6% 33.6% EBIT (1-t) 187 304 751 1,784 3,373 4,004 5,276 6,464 Depreciation 197 795 1,692 1,782 2,011 2,407 2,856 3,359 Amortization 131 114 169 0 0 0 0 0 Capital Expenditures as a % of Sales 20.0% 30.0% 40.0% 37.0% 27.0% 17.0% 7.0% 7.0% Capital Expenditures (1,311) (3,407) (6,769) (8,242) (7,757) (5,846) (2,856) (3,359)Changes in Working Capital 0 0 0 0 0 0 0 0

FCF (797) (2,194) (4,157) (4,677) (2,373) 565 5,276 6,464 WACC 15.0% 14.4% 13.9% 13.3% 12.8% 12.4% 11.9% 11.1%PV of FCF's (693) (1,676) (2,811) (2,838) (1,298) 281 2,400 2,780 Sum of FCF's (3,856)Terminal Value 148,840 PV of Terminal Value 64,007

Enterprise Value 60,151

Less Net Debt 4,179

Equity Value 55,972 No of shares outstanding 98.18

Implied price per share 570.08

Suggested Solutions

• Comparable ValuationComparable Company Analysis

Comaparable EV/EBITDAR multiple 7.40 12.4Air Deccan 2008E EBITDAR 4,684 4,684 EV 34,662 58,282

Less Net Debt 4,179 4,179

Equity Value 30,483 54,103 No of shares outstanding 98 98

Implied price per share 310.47 551.05

Thanks“If it’s on the map, we will get you there”---Air Deccan