YEARBOOK 2013 - The Wall Street...

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YEARBOOK 2013South aSia

2 2 aiRLiNE LEaDER | MAR-APR 2012

PROFILES

South aSia toP 10 aiRLiNESSOURCE: CAPA - CENTRE FOR AVIATION AND INNOVATA | WEEk STARTINg 31-MAR-2013

South aSia toP 10 aiRPoRtSSOURCE: CAPA - CENTRE FOR AVIATION AND INNOVATA | WEEk STARTINg 31-MAR-2013South Asia

OutlookIndIan avIatIon Is seeIng sIgns

of revIval after another difficult year marked by continuing losses, a 3% decline in traffic and the exit of Kingfisher, which up

until less than two years ago was the largest single domestic airline in the country ...

South aSia caPacity SEatS PER wEEkSOURCE: CAPA - CENTRE FOR AVIATION AND INNOVATA | WEEk STARTINg 31-MAR-2013

RaNkiNg caRRiER NaME SEatS

1 indigo 500,580

2 air india 442,828

3 Jet airways 413,303

4 SpiceJet 375,833

5 Pakistan international airlines 132,880

6 goair 129,240

7 JetLite 114,448

8 SriLankan airlines 95,606

9 air india Express 83,538

10 Biman Bangladesh airlines 34,032

RaNkiNg caRRiER NaME SEatS

1 Delhi indira gandhi international airport 919,165

2 Mumbai airport 831,365

3 chennai airport 352,124

4 Bengaluru international airport 332,111

5 Dubai international airport 309,142

6 kolkata Netaji Subhas chandra airport 278,652

7 hyderabad Rajiv gandhi international airport 252,504

8 colombo Bandaranayake international airport 187,126

9 kochi airport 140,679

10 karachi Quaid-E-azam international airport 133,442

Indigo

Air India

Jet Airways

SpiceJet

EmiratesPakistan Int’l

AirlinesgoAir

JetLiteSriLankan

AirlinesOther

0k 250k 500k 750k 1,000k

500,580

442,828

413,303

375,833

185,924

132,880

129,240

114,448

95,606

1,024,457

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South aSia fLEEtSOURCE: CAPA - CENTRE FOR AVIATION | WEEk STARTINg 31-MAR-2013

South aSia PRoJEctED DELivERy DatES foR aiRcRaft oN oRDERSOURCE: CAPA - CENTRE FOR AVIATION | WEEk STARTINg 31-MAR-2013

South aSia BREakDowN foR aiRcRaft iN SERvicESOURCE: CAPA - CENTRE FOR AVIATION | WEEk STARTINg 31-MAR-2013

South aSia MoSt PoPuLaR aiRcRaft tyPES iN SERvicESOURCE: CAPA - CENTRE FOR AVIATION

South aSia caPacity SEatS ShaRE By aLLiaNcESOURCE: CAPA - CENTRE FOR AVIATION AND INNOVATA | WEEk STARTINg 31-MAR-2013

Narrowbody Jet

Widebody Jet

Regional Jet

Piston Engine Aircraft

Turboprop

Small CommercialTurboprop

57.7%

17.7%

12.5%

8.9%2.8% 0.3%

A320

737

DHC6

ATR

777

Others

A330

DHC8

29.6%

26.0%7.8%

6.2%

5.9%

4.3%

4.2%

15.9%

Unaligned

oneworld

oneworld (affiliate)

Star

SkyTeam

83.3%

7.7%

5.4%3.4% 0.3%

800

600

400

200

0In service In storage On order

577

62

504

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

2023

2024

2025

0

25

50

75

A320 A330 A350 A380 777 787 737 DHC6

Lcc caPacity ShaRE (%) of totaL SEatS: 2001-2013SOURCE: CAPA - CENTRE FOR AVIATION WITh DATA PROVIDED by OAg

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Jan-Mar

2013

0

10

20

30

40

50

60

0.1%0.9%

5.8%

22.7%

38.6%42.8%

47.3%

50.0%50.0%

57.0%55.8%

0k 250k 500k 750k 1,000k

4

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Kingfisher’s exit in Oct-2012 has positively impacted market dynamics for the remaining carriers.

JET AIRWAYS EXPECTED ORDER OF NARROWBODIES

... Many of the structural challenges in Indian aviation – such as the uncertain and unpredictable policy environment, intervention by the regulator on commercial matters, high sales taxation on fuel, and the low productivity of airports and airspace – remain unaddressed. However, two key developments in recent months have given rise to greater optimism.

Firstly, Kingfisher’s exit in Oct-2012 has positively impacted market dynamics for the remaining carriers. The withdrawal of capacity, combined with pricing discipline, resulted in higher yields and improved financial performance in FY2013, at least up until 4Q when aggressive discounting returned.

And secondly, the historic decision by the government in Sep-2012 to allow foreign airlines to invest up to 49% in Indian carriers is a vital step in establishing a more professional and corporatised sector in India. It offers the promise not only of introducing strategic capital and expertise into the market, but also delivers a much needed confidence factor for other institutional funding.

CAPA estimates that India’s carriers will report a combined loss of approximately USD1.6 billion in the 12 months ending 31-Mar-2013, with most of this accounted for by Air India and Kingfisher Airlines.

Air India has delivered a significant improvement in its operational and financial performance in FY2013, but its beleaguered business plan is under attack on all fronts. With poor aircraft utilisation, a huge interest burden, a bloated workforce, insufficient recapitalisation and regular government intervention, the challenges are huge. If the carrier is to have any chance of success it must be radically restructured both financially and operationally. This will require a level of political will to take tough decisions, a feature that has been absent to date. If decisive action is postponed – as we expect – Indian taxpayers will bear the cost.

Taking advantage of the foreign investment reforms, Etihad looks set to acquire a stake in Jet Airways, India’s second largest international and domestic carrier. There is likely to be an extensive codesharing arrangement between the two new partners, network and scheduling coordination and integration of frequent flyer programmes. The Jet Airways-Etihad deal has the potential to be a game-changing combination. It brings together one of the most successful airlines in India with a well-capitalised Gulf carrier with global ambitions.

Critically for Jet this deal will provide it with the capital that it requires at this time. Jet Airways is expected to place an order in the coming months for up to 100 narrowbodies. Following the conclusion of the Etihad transaction, Jet Airways is also expected to have the capital to implement a clearer market segmentation strategy, in particular the establishment of a strong hybrid model under the JetKonnect brand.

IndiGo remains the leading performer in the market, both financially and from a brand perception perspective. The carrier continues to grow

aggressively on domestic and short-haul international routes and is also evaluating the possibility of launching a domestic regional subsidiary utilising turboprop aircraft. IndiGo’s international network strategy is founded on connecting multiple Indian cities to high-traffic destinations such as Dubai, Bangkok and Singapore. This is in contrast to SpiceJet, which has instead launched services on routes less travelled such as Kabul, Male and Guangzhou.

SpiceJet is another potential candidate for securing a foreign investor in 2013. The airline is understood to be in quite advanced discussions with more than one party, including foreign airlines as well as private equity funds. A narrowbody order may be finalised in the second quarter of 2013 after a new investor comes on board. The Boeing 737 MAX is the most likely equipment, particularly as there are no available A320neo delivery slots within the required timeframe. SpiceJet remains undecided on whether to exercise its options for a further 15 Q400s, however CAPA expects that the carrier will increase its regional fleet in due course.

When the Indian Government decided to allow foreign airline investment, the primary intention was to open a source of capital to support the recovery of the incumbent carriers, rather than enabling the entry of well-capitalised start-ups to compete with them. However in Mar-2013 the Foreign Investment Promotion Board (FIPB) ruled that foreign airline investment is not limited to existing carriers and as a result it approved a 49% investment by AirAsia in a proposed joint venture with the Tata Group and Telestra Trading. The carrier, to be named AirAsia India, intends to launch domestic services from a hub in Chennai to non-metro cities across the country.

FIPB approval is just the first step of the regulatory process and the joint venture

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The historic decision by the government in Sep-2012 to allow foreign airlines to invest up to 49% in Indian carriers is a vital step in establishing a more professional and corporatised sector in India.

will now need to apply for a licence from the Directorate General of Civil Aviation (DGCA). If AirAsia India is successful in securing a licence it will introduce a formidable new entrant into India’s airline industry. The venture combines a highly successful and aggressive LCC with one of the most respected and financially sound Indian business houses. It is also an important test case on the government’s stance towards foreign investment in general and the airline industry in particular, as well as the Ministry’s position on the award of new licences.

With intense competition on domestic routes – which could increase further if new licences are awarded – India’s airlines have been keen to expand overseas. However, the Indian Government’s stance on bilaterals has lacked clarity and transparency, which has made it virtually impossible for Indian carriers to plan their international strategy. One of the critical impacts of the Jet-Etihad deal is likely to be a liberalisation of the India-UAE bilateral. This will benefit not only those two carriers, but also Emirates, flydubai and Air Arabia. Meanwhile Qatar Airways, Turkish Airlines and Singapore Airlines are all waiting in the wings seeking an expansion of bilaterals as they have exhausted their current entitlements.

Aircraft lessors, and the banks financing them, will also be watching the Indian market with interest in 2013. India is a signatory to the Cape Town Convention (subject to local regulations), which should in theory facilitate the repossession of aircraft in the event of default by carriers, as in the case of Kingfisher. However, this is proving to be a challenge as related government agencies have not allowed lessors access to aircraft due to their own outstanding dues with Kingfisher. Large global banks have taken a serious view of the situation. The Ministry of Civil Aviation has recently adopted a more cooperative stance with respect to resolving the situation. Unless addressed, this experience is likely to negatively impact future financing of Indian aircraft orders and increase lease charges due to a perceived higher risk rating.

Elsewhere in South Asia, SriLankan

Airlines is struggling to take advantage of the boom in inbound tourism to Sri Lanka following the end of the civil war. International visitor numbers have doubled in three years from 448,000 in 2009 to just over one million in 2012. However, SriLankan Airlines, which has been loss-making since 2008, reported a record loss of USD135 million for FY2012 and a similar result is expected this year. Europe contributed 60% of last year’s loss due to weak economic conditions and strong competition from the Gulf carriers. As a result the airline plans to re-orient its network towards India and North Asia over the next few years. With SriLankan expected to become a full member of the oneworld global alliance in the next 12 months a stronger relationship is likely to emerge with Cathay Pacific. As a result Hong Kong could provide a useful gateway for the airline into this region.

In the Maldives, the two locally-based international carriers are targeting complementary growth markets. Maldivian, the government-owned airline, which was earlier limited to domestic routes and a short-haul service to Trivandrum in India with its fleet of turboprops, took delivery of an A320 in Nov-2012. The aircraft has been deployed to open up routes to Mumbai, Chennai and Dhaka, with a second A320 expected to join the fleet in Apr-2013. The airline has stated that its primary focus at present is in developing Indian and other South Asian markets.

Meanwhile, private carrier Mega Maldives Airlines took delivery of a Boeing 757 in Jan-2013, to join its two Boeing 767 widebodies. The carrier is targeting a fleet size of seven aircraft by the end of 2014. Its international network includes scheduled services to China, Hong Kong and Korea, with several additional Chinese points served on a seasonal charter basis. Inbound tourism from China to the Maldives has been growing at over 50% per annum over the last three years, positioning China as the single largest source market, accounting for 24% of foreign arrivals in 2012. Mega Maldives is keen to expand its operations to North Asia and has also identified Australia and South Africa as key markets.

Bangladesh saw the launch of a fourth domestic operator in Jan-2013 with Novo Air joining Biman Bangladesh Airlines, Regent Airways and United Airways. The new carrier entered the market less than 10 months after GMG Airlines suspended operations. Despite being a price-sensitive market with very short domestic sectors, there are no LCCs operating domestically. Novo Air continues the status quo by positioning itself as a full-service airline. The domestic market remains small with less than one million passengers per annum. International traffic to/from Bangladesh has experienced steady growth in recent years, but it is dominated by foreign operators, which have a capacity share of over 70%.

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South Asia remains a market with huge potential, but is encumbered at present by weakness across its policy, regulation and fiscal frameworks.

International traffic in Nepal registered 8% growth in 2012 to reach three million passengers. However the market is dominated by foreign carriers with Nepal Airlines accounting for just under 7% of traffic. The national carrier has recently resumed discussions with Airbus on a new aircraft order to replace its two ageing Boeing 757s. A second international Nepalese airline, privately-owned BB Airways, launched in Oct-2012 with services to Kuala Lumpur and Hong Kong using a Boeing 757 aircraft. However by Feb-2013 the leased aircraft had been returned and services suspended. BB Airways reportedly plans to resume operations later in 2013 with a different aircraft.

The Pakistan Federal Cabinet’s Economic Coordination Committee (ECC) reportedly approved an interim business plan presented by struggling Pakistan International Airlines (PIA) for the next five years. The ECC allowed the Ministry of Finance to issue continuing fresh guarantees amounting to PKR49 billion (USD500 million) during the current year. The ECC also agreed to the request of the Ministry of Defence for USD46 million of funding to enable the carrier to lease five narrowbody aircraft in 2013 to address its capacity shortage. At present the airline is operating only 24 of its 38 aircraft with eight aircraft grounded temporarily for maintenance and six permanently.

South Asia remains a market with huge potential, but is encumbered at present by weakness across its policy, regulation and fiscal frameworks. Policy settings are in many cases negatively influenced in an effort to support struggling government-owned flag carriers. India, as by far the dominant market in the region, has the potential to present itself as a case study to emulate. The decision to allow foreign airline investment will deliver greater integration with the global aviation industry and exposure to best practice. As a result, there will be much needed additional pressure to address structural challenges, paving the way for a more efficient, professional and viable industry.

However, until a host of bureaucratic and political issues are squared away, investing in such a market can be a lottery. That is a fundamental issue for any government serious about encouraging measures which will generate consumer (and corporate) benefits.

... until a host of bureaucratic and political issues are squared away, investing in such a market can be a lottery.

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EtihaD aiRwayS ............................................................pp.9“Etihad’s potential investment in Jet airways to be a game-changer for india”first published on www.centreforaviation on 2nd february, 2013

aiRaSia gRouP .............................................................pp.19“airasia group completes first step in its bid to launch an Lcc in india”first published on www.centreforaviation on 8th March, 2013

aiR iNDia ........................................................................pp.31“air india: the time has come to stop procrastinating and act. the final scene is near”first published on www.centreforaviation on 19th february, 2013

SOuTh ASIA:Selected airlines

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Etihad Airways Key Data Fleet and Orders Etihad Airways Fleet Summary: as at 10-Apr-2013

Source: CAPA Fleet Database

Etihad Airways projected delivery dates for aircraft on order: as at 8-Apr-2013


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Route area pie chart Etihad Airways international capacity seats by region: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata Top routes table Etihad Airways top ten international routes by seats: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata

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Premium/Economy profile Etihad Airways schedule by class of seat - one way weekly departing seats: as at 8-Apr-2013


Etihad’s potential investment in Jet Airways to be a game-changer for India Jet Airways is expected to be the first incumbent airline to take advantage of the Sep-2012 decision by the Indian Cabinet to permit up to 49% foreign investment in Indian airlines. Allowing foreign airline investment is a vital step in establishing a more professional and corporatised sector in India. It offers the promise not only of introducing strategic capital and expertise into the market, but also delivers a much needed confidence factor for other institutional funding. However, a big drawback remains the weakness of India’s underlying regulatory framework and the structural challenges in Indian aviation. Until a host of typically Indian nit-picking bureaucratic and political issues are squared away, it remains a lottery investing into the country. That is a fundamental issue for any government serious about encouraging measures to generate consumer (and corporate) benefits. Etihad has made partnerships a fundamental point of its business Under CEO James Hogan’s leadership, Etihad has from the start actively pursued a strategy of developing a diverse network of interline agreements and more than 30 codeshare and partnership agreements. The carrier has equity shareholdings in a range of carriers from Aer

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Lingus to Air Berlin, Air Seychelles and Virgin Australia. And more recently in Oct-2012 it entered into an intra-European codeshare partnership between Air France, KLM and airberlin and a more sweeping alliance/partnership between Etihad and Air France-KLM. The investment in Jet Airways would extend this approach into the strategically important Indian market – at the same time introducing Jet to a range of new opportunities. Etihad expected to acquire 24% at a valuation of USD1.3bn - USD1.4bn In the first stage of the investment Etihad will, CAPA understands, acquire a stake of up to 24% in Jet Airways (just under the level at which an open offer would be triggered) at a valuation USD1.3 billion to USD1.4 billion. This represented a premium of around 35% on the market capitalisation of the airline in late January 2013 when the valuation is understood to have been conducted. Jet Airways' share price has since retraced by around 15% due to the delays in the consummation of the deal. Jet’s share price almost doubled between Nov-2012 and Jan-13 as a result of speculation about foreign airline interest and an improvement in market dynamics reflected in a sharp increase in yields. Jet Airways Share Price (INR) last 12 months

Source: CAPA – Centre for Aviation, Rediff The investment is expected to take place through the issue of preferential shares and warrants. At a later stage Etihad’s stake could be increased to 49% at which time the de-listing of Jet Airways may be an option, as the promoters may find a private structure to be more suitable. Other opportunities include a potential investment in the carrier’s loyalty programme, Jet Privilege, which could be hived-off as a separate business. Etihad can be expected to secure a seat on the Board of Jet Airways and have a say in the induction of some key executives, subject to obtaining the necessary regulatory and security clearances. As a result, Naresh Goyal, founding promoter and Chairman of Jet Airways, will for

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the first time relinquish exclusive control and influence over the airline and move to a shared management structure. This will bring a new set of skills to the business, a positive development for Jet Airways as it prepares for its next phase of growth. Mr Goyal holds an 80% interest in Jet Airways through Tailwinds Limited, an Overseas Corporate Body (OCB) registered in the Isle of Man. OCBs are entities predominantly owned by non-resident Indians and such entities earlier used to be classified as having Indian nationality. A subsequent change in regulations meant that Tailwinds was considered to be an overseas investor and technically in violation of the 49% foreign investment cap in the aviation sector. As the breach occurred due to a change in definitions, Jet Airways received a temporary dispensation and was granted time to restructure its shareholdings in order to comply. This issue will need to be resolved as part of the transaction, to comply with the requirement that Etihad and Tailwind’s combined shareholding cannot exceed 49%. Without key strategic mistakes Jet Airways might not have required a foreign airline investor Aside from Tailwinds, the balance of 20% of shares in the airline are publicly held, since being listed in 2005. The decision to float only 20% meant that an important capital raising opportunity was not fully leveraged. During what was a buoyant period in the sector which afforded a strong valuation, the airline could have raised additional funds which would have enabled it to implement its growth strategy more effectively. In 2007, Jet Airways conducted its most significant strategic mistake, the acquisition of Air Sahara. Integration of the two carriers proved to be far more challenging than anticipated and drained capital which made the airline vulnerable. Air Sahara diverted management attention and precipitated the launch of a confused low cost strategy. The airline’s organisation structure has also become increasingly top-heavy, which usually results in management becoming distant from the front line and its passengers. As a result, Jet Airways’ customer proposition in terms of product and service delivery has been deteriorating, an unexpected outcome for an airline which until recently was remarkable for its high standards. A long time opponent of foreign airline investment, Jet is likely again to be the first beneficiary Ironically, Jet Airways is likely to be first beneficiary of a foreign airline investment reform that it was instrumental in preventing for many years. Its long stated position was that Indian aviation did not require the support of foreign airlines – meaning mostly that Jet was happy with its dominant position and did not see value in encouraging more competition. So, in reality, if the Etihad deal goes ahead, this would be the second time Jet Airways has been the recipient of foreign airline investment. In the 1990s when deregulation first allowed private carriers to enter domestic routes, initially as air taxis and subsequently as scheduled airlines, India permitted up to 40% foreign direct investment, including by foreign airlines. Jet Airways at the time in fact leveraged this provision to the full, with Gulf Air and Kuwait Airways holding a 20% stake each in the then-fledgling airline. This strategic investment undoubtedly provided Jet

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Airways with a number of benefits during the period 1993 to 1996, including access to expertise and international feed. However, in 1996 the Government of India – with some encouragement from Jet - announced that foreign airline shareholdings were not in the interests of India’s aviation sector and would no longer be permitted. Ostensibly this was because private carriers were still relatively small and the concern was that foreign airlines would control their development in such a way as to feed their offshore hubs, relegating the Indian carrier to the status of a regional carrier. But it was really a move designed to thwart the ambitions of the Tata Group and Singapore Airlines which were then planning a joint launch of a domestic carrier. As a result of this reversal of policy, Jet Airways had to buy back the shares from its Gulf investors. The outcome of this inward looking protectionist policy, among other things has been to leave India critically short of quality senior management in the airline sector. Jet Airways gains a much needed boost, while Etihad gains strategic entry into a long term growth market The practical implications of the deal will unfold over the coming weeks but the outcome is likely to be changes at Jet Airways’ senior management level, much deeper codesharing and schedule coordination between the two carriers and, probably, joint purchasing arrangements. It is not yet clear whether Jet Airways will establish a hub at Abu Dhabi, although this would certainly have merit in due course. Some issues to resolve include alliance membership and utilisation of bilaterals. Jet Airways has been leaning towards membership of Star Alliance, but the airline needs capital – something that none of the large Star members was prepared to invest at this time. If it comes to a choice between membership of Star and a partnership with a major growth Gulf carrier, along with capital investment, the decision becomes much easier. Etihad is unaligned, but has recently forged a partnership with Air France-KLM (one of the founding members of SkyTeam), at the same time as investing significantly in oneworld’s airberlin. There is nothing technically that would prevent parallel membership, as this is an area that is evolving rapidly since last year’s upheavals as Emirates moved to join oneworld’s Qantas and Qatar Airways to join oneworld. At present, in the absence of any Indian carrier being an alliance member, almost 70% of international capacity in the Indian market is unaligned. Etihad, already an important operator into the Indian market, would gain access to India’s potentially huge emerging demand. Since the market was opened up in 2004 domestic traffic has grown at a compound rate of 18.1% per annum, while international has expanded at 11.9% annually.

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India Domestic (light blue) & International (dark blue) Airline Passengers: FY01 to FY12

Source: CAPA – Centre for Aviation, Airports Authority of India Despite recent challenges India is expected to be amongst the fastest growing in the world over the next two decades. For Etihad, Jet Airways also offers:

• an airline with forecast consolidated group revenue in excess of USD3.4 billion in FY12/13;

• a combined Jet Airways/JetLite fleet size of 116 aircraft and almost 50 aircraft on order; • domestic market share of 25.2% (Jet Airways combined with JetLite), and the second

largest share of international traffic to/from India (likely to become the largest, given Air India’s problems);

• a very strong and established brand; • access to scarce infrastructure, particularly in the key premium market of Mumbai; • operation of India’s leading loyalty programme.

Indian Carrier Domestic Market Share Nov-12

Source: Directorate General of Civil Aviation

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Weekly India International Seat Capacity by Leading Carriers (28-Jan to 3-Feb 2013)

Source: CAPA – Centre for Aviation, Innovata As it is, the two airlines already have links that go back several years when several Jet Airways executives assisted in the setting up of the UAE carrier and, more recently, a successful codesharing arrangement. And the strong aviation links between India and the Gulf are clearly reflected in the fact that almost 50% of international seats to/from India are deployed on routes to the Middle East. India Weekly International Seat Capacity by Region (28-Jan to 3-Feb 2013)

Source: CAPA – Centre for Aviation, Innovata Although, at the prices being suggested, Etihad may be paying a premium on today’s share price, that does not tell the whole story. Firstly, this valuation has been depressed by current structural

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weakness across the aviation sector – so, from a long-term perspective Etihad is counter-cyclically acquiring an important strategic asset at a very attractive level. More importantly, the sum of the parts here will by no means represent the real upside. Combining the almost symmetrically complementary operations of the two airlines promises a much more powerful overall entity. In fact the first steps of a deepening relationship have already commenced with Jet Airways selling three pairs of slots at Heathrow Airport to Etihad for USD70 million and leasing them back, as well as wet-leasing an A330 aircraft to Etihad. From a broader perspective there are other benefits for Abu Dhabi - for example if Jet Airways were to make greater use of ADAT’s maintenance services. And the emirate’s aviation sector may be able to leverage its new footprint in India to recruit and train skilled resources to support its own growth. Jet Airways may also choose to directly import aviation turbine fuel from Abu Dhabi to circumvent the onerous sales taxation on local purchases, especially if the strength of Etihad can be leveraged to reduce the size of advance cash commitments that Jet has been unable to satisfy. If the infrastructure and logistics issues can be addressed and provided that Indian states do not adopt regressive entry taxes on imports, this channel could provide Jet Airways with an important cost advantage in the domestic market. For Jet Airways, the deal also provides multiple benefits, notably an infusion of cash for debt reduction and a basis for providing capital for growth. The Indian carrier gains access to a large global network, improved scale economies for procurement and – vitally - the ability to tap into a large pool of experienced management. In addition to the equity investment Etihad could potentially provide other financing support which may see Jet Airways accelerate its proposed order for 100 narrowbody aircraft. In short, the partnership could see the rate of both domestic and international expansion rapidly scaled up. SpiceJet and GoAir foreign airline investment deals are expected to follow soon Further foreign airline investment may not be far behind. SpiceJet could be next off the block and is understood to be in quite advanced discussions with more than one party, including reportedly an aggressively expanding Southeast Asian LCC, as well as private equity funds. A deal could be announced in the first half of 2013. GoAir is another potential candidate and it too is in discussions with foreign airlines. However, if it is unable to secure the valuation it seeks then it may instead consider an IPO in FY2013/14. The Indian Government is now faced with challenges in ensuring that investments can be implemented effectively So often and in so many areas, positive policy moves by the Indian government are undermined by the complexity of putting them into effect. The various levels of government and the always-bureaucratically imposed hurdles to any change have proven extremely effective in putting off all but the bravest and most persistent investors. And introducing a relatively major change in the airline investment system seems likely to need a great deal of shepherding if it is to be implemented smoothly.

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Minister Ajit Singh and the Government of India certainly deserve credit for permitting foreign airline investment, an issue long-mired in political complexity and whose benefits were only likely to be seen in the longer term. This was a reform that was pursed with strategic clarity and rigour in order to be able to overcome the numerous obstacles. However, the policy and regulatory expertise in India may not be robust enough to understand the potential impact of foreign airline investment transactions on issues such as codesharing, alliances, bilaterals and competition, and to be able to respond quickly to the fast-changing environment. Air India is still an open question and will need resolving As the investment process evolves, the government will also have to grapple with the implications for Air India, the airline which is likely to face the greatest strategic impact as a result of foreign airline investment. The national carrier has in the last six months shown a substantial improvement in financial and operational performance, but has suffered a major setback with the grounding of the B787 this month, an aircraft which was a key element of its turnaround plan. If there are lengthy delays to the resumption of Dreamliner operations this will impact the viability of its international operations, at the very same time that its competitors are being strengthened as a result of foreign tie-ups. At present the government’s position is that debt-laden Air India is not open to a strategic partnership with a foreign carrier. If this route is considered beneficial for private operators and is expected to strengthen them, denying Air India the same opportunity prevents any opportunity for a level playing field. However, the government will need to commit to a major financial restructuring of the flag carrier before such an option can be considered. With up to three foreign airline investment transactions expected in the private sector in 2013, calls to provide Air India with the same opportunity are likely to increase. One positive outcome is that this could – at last - act as the trigger for a decision Air India’s future. This is a defining moment in the development of Indian aviation, whatever the outcome Indian aviation is (again) at a critical turning point and at such junctures the outcomes are difficult to predict. This is particularly so in light of the structural deterioration in Indian aviation since 2008 and the increased regulatory risk in the market. In such an environment it is not surprising that the first serious investment interest comes from a Gulf carrier. Aviation is viewed in the UAE as a critically important tool of economic development and the South Asian market in particular presents an enormous opportunity. Given the upside, Etihad and other carriers from the region are likely to have a higher risk appetite than airlines for whom the Indian market is not seen as core. However, one thing is assured, as a market with huge long-term potential, but encumbered at present by weakness across policy, regulation, taxation, skills and infrastructure, access to capital and expertise is critical. Foreign airline investment will also deliver greater integration with the global aviation industry and exposure to best practice. As a result, there will be much needed additional pressure to address structural challenges, paving the way for a more efficient, professional and viable industry. An investment by Etihad in Jet Airways, although only a first step, would be a defining moment in bringing India’s aviation sector into the mainstream.

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AirAsia Group Key Data Fleet and Orders AirAsia Group Fleet Summary: as at 10-Apr-2013


AirAsia Group projected delivery dates for aircraft on order: as at 8-Apr-2013


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Route area pie chart AirAsia Group international capacity seats by region: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata Top routes table AirAsia Group top ten international routes by seats: as at 8-Apr-2013


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Share price 2012/2013

Source: CAPA - Centre for Aviation and Yahoo! Financial

AirAsia Group completes first step in its bid to launch an LCC in India On 06-Mar-2013, India's Foreign Investment Promotion Board (FIPB) granted permission for AirAsia to invest in a proposed joint venture with the Tata Group and Telestra Trading to launch an LCC in India. AirAsia, seeking to expand its dominance beyond the ASEAN region, believes that its model, which operates under the ‘now everyone can fly’ mantra, is well-suited to the highly-competitive yet high-potential domestic Indian aviation market, which is expected to almost triple to 160 million passengers annually by 2021. The quick decision by the FIPB and the clarification that foreign airline investment is not limited to existing carriers but is also applicable to start-ups is a welcome move. However FIPB approval is just the first step of the regulatory process and AirAsia India will now need to apply for a licence from the Directorate General of Civil Aviation (DGCA). AirAsia India will enter the market as a well-backed group with the support of a USD100 billion conglomerate, the Tata Group, together with Telestra Trading. The LCC will operate with a strong focus on low-cost/low-fare operations in a market that AirAsia Bhd CEO Tony Fernandes says is “now ready for a true low-cost carrier”. While AirAsia, which has seen a sudden expansion of its portfolio and now has six brands (AirAsia, Thai AirAsia, Indonesia AirAsia, AirAsia Philippines, AirAsia X and AirAsia Japan), may have secured the right partners for its India venture, the local aviation market remains highly competitive and largely unviable.

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FDI but not quite as India’s Ministry of Civil Aviation had intended AirAsia’s application to the Indian Foreign Investment Promotion Board (FIPB) follows a ground-breaking decision by the Indian government on 14-Sep-2012 to allow up to 49% investment by foreign airlines in the aviation sector. While the FDI decision has led to confirmed talks between Etihad Airways and Jet Airways, the AirAsia India announcement is the first commitment by a foreign airline to a venture in the Indian aviation industry. SpiceJet has confirmed that it is in preliminary talks with several potential partners over a stake sale, though it has not identified any of its suitors. However, the move by AirAsia may not be exactly what the government had in mind. When the Indian government finalised the FDI decision, the aim was to encourage an infusion of foreign capital into the heavily indebted incumbent airlines, with the ultimate aim of supporting their recovery and expansion. Instead the move by AirAsia would in fact intensify competition in an already highly-competitive marketplace. When the cabinet approved the policy in Sep-2012, the press statement noted: "There has been a need to consider financing options available for private airlines in the country, for their operations and service upgradation, and to enable them to compete with other global carriers. Denial of access to foreign capital could result in the collapse of many of our domestic airlines, creating a systemic risk for financial institutions, and a vital gap in the country’s infrastructure". Civil Aviation Minister Ajit Singh, was quoted as saying: “We are not giving licences for greenfield airlines. As of now, FDI in aviation can come only through existing airlines." The was some debate as to whether the Department of Industrial Policy and Promotion note on the subject permitted foreign airline investment in start-up carriers, however the FIPB decision has provided clarity on this issue. Limiting foreign airline investment to existing carriers would have been a fundamentally flawed policy as India needs strong, new airlines which are well-capitalised with partners that also bring industry expertise. Meanwhile, India’s incumbent airlines will almost certainly resist the entry of such a force as AirAsia in representations to the government, which in turn will have to weigh up the consumer benefits from increased competition and the impact on the stability of the sector. AirAsia Group’s pricing strategy, utilisation of its brand asset and aggressive marketing tactics could pave the way for another shakeout in the market which has already seen the suspension of operations by Kingfisher Airlines in Oct-2012. Mr Fernandes said he believes the planned establishment of AirAsia India is unlikely to put any Indian carriers out of business, noting: “Businesses put themselves out of business, not the competition. If an airline is rightly capitalised, follows the right business model and the right people are running it, there should be no problem." Telestra Tradeplace Pvt Ltd owner Arun Bhatia, in an interview with Live Mint, similarly stated: "We have a different business model from existing Indian carriers. And every brand should be different. Air Deccan was a great brand and IndiGo is also successful. We are working out details for competitive branding". AirAsia secures high-profile partners, but challenges remain While AirAsia is a successful and experienced operator, and has secured strong local partners it will nevertheless operate in the same challenging market as India's incumbents, whom CAPA estimates will have accumulated losses of around USD9.5 billion in the six years to FY2013.

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Operating costs in India remain high compared to Southeast Asia due to punitive fuel taxes, high airport charges and inefficient infrastructure. This is combined with high inflation and interest rates and GDP growth running at its lowest level in a decade. Meanwhile, the government continues to intervene in commercial matters. The Ministry has expressed its displeasure at recent fare discounting by airlines (while previously expressing their concern when fares were at high levels in peak-demand periods). Reports also suggest that the Ministry has disallowed the aircraft import plans of some LCCs. The current policy, whereby Indian carriers are required to operate domestically for five years and reach a fleet size of 20 aircraft before they are able to expand internationally, is also another example of government restrictions on carriers, although this regulation will most likely be withdrawn in the near future. However, Mr Fernandes and the AirAsia Group would seek to challenge what it deems as over-regulation and excessive costs. Mr Fernandes said the venture in India would work hard to try and convince the airport operators and the state governments to reduce airport charges in India. He also said the airline will avoid some airports because of high charges that made "no sense". In 2012 AirAsia X pulled out of Mumbai and Delhi citing high tariffs and taxes. AirAsia India plans to focus on tier II and III cities to avoid these cost pressures. Another reason for avoiding congested airports such as Mumbai is non-availability of adequate slots. AirAsia will likely place pressure on gateways to consider building dedicated low-cost terminals to attract LCCs. He noted: “India is a huge country with huge potential in terms of connecting the dots and we will provide the catalyst for private airport operators and government of India airports to develop third tier airports to jet capability". While 70% of domestic airline operations happen in the LCC segment, India does not have designated low-cost airports although the Indian government is now establishing the development of these airports. AirAsia brand yet to gain traction in Indian market AirAsia has a strong brand in the ASEAN region, though the brand has not had entirely smooth sailing in India since the carrier launched Kuala Lumpur-Tiruchirapalli service in Dec-2008. Mr Fernandes acknowledged that AirAsia has had a tough time in India in the past but this proposed expansion into India’s domestic market has been something that has been discussed internally for the past three years. One of the key reasons the group has struggled in India is because of its inability to access local distribution networks. Travel agents and online travel agents still account for most bookings in India (around 70-80% of ticket sales), and the AirAsia model does not fit into this traditional channel, with around 85% of its tickets being sold directly through its website. AirAsia has also said it would not work with India’s largest OTAs due to the exclusivity of its partnership with Expedia. Having to rely on direct website sales and its Expedia joint venture has limited AirAsia’s ability to penetrate the Indian market. However, the carrier is already taking steps to rectify this situation. Though the airline is expected to take off in the second half of the 2013, AirAsia has already begun forging tie-ups with travel portals including Yatra.com and makemytrip.com for wider distribution reach. AirAsia Group now serves five destinations in India with AirAsia from Kuala Lumpur to Chennai, Kochi, Kolkata and Tiruchirapalli and Thai AirAsia operating from Bangkok Don

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Mueang to Bangalore, Chennai and Kolkata. It has also previously served Gaya, Hyderabad and Thiruvananthapuram. The new venture will likely initially focus some of its domestic operations on connecting these existing AirAsia destinations, as it seeks to improve connectivity throughout the group. The selection of Chennai International Airport, the nation’s third largest airport, as the operational base for AirAsia India is a logical move given the brand’s presence in this part of India. AirAsia launched Kuala Lumpur-Chennai service in Apr-2010 with Thai AirAsia adding Bangkok-Chennai service in Mar-2012, initially from Bangkok Suvarnabhumi but more recently from Don Mueang. AirAsia X last year pulled out of India due to poor demand and profitability, in large part due to distribution challenges, although the carrier cited airport charges as the primary reason. India has been the only market in Asia that has seen a decrease in AirAsia capacity over the past 12 months. The AirAsia brand currently accounts for just about 10% of seat capacity in the India-Southeast Asia market, compared to about 14% one year ago. In the current week, there are 5,171 weekly international services to/from India, according to Innovata, of which AirAsia operates 78 and Thai AirAsia operates 24 for a total of 102 services in the week. This makes the combined AirAsia Group the 16th largest carrier operating to/from India, or the 11th largest foreign airline group operating to India, with Malaysia Airlines having a larger operation to/from India in terms of seat capacity. India schedule summary by largest international operations (weekly seats): 04-Mar-2013 to 10-Mar-2013

Source: CAPA – Centre for Aviation & Innovata

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AirAsia is the fifth largest airline by international seats at Chennai Airport, with a 4.2% capacity share in the week ended 10-Mar-2013, increasing to around 6% including Thai AirAsia. Internationally, the Chennai market is dominated by Air India, with Emirates and SriLankan Airlines also having a strong presence. SpiceJet is the largest operator domestically from Chennai, with a 30% domestic capacity share in the current week. Jet Airways and IndiGo both have a 21% stake at Chennai, with Air India having a 17% domestic share, meaning there is a relatively even distribution of domestic capacity at the airport. These carriers will likely strengthen their network from Chennai before the launch of AirAsia's domestic service, with Chennai Airport and consumers to be the key beneficiaries of this increased competition. Chennai Airport capacity share (domestic seats per week): 04-Mar-2013 to 10-Mar-2013

Source: CAPA – Centre for Aviation & Innovata Chennai Airport capacity share (international seats per week): 04-Mar-2013 to 10-Mar-2013

Source: CAPA – Centre for Aviation & Innovata AirAsia India will connect tier II and III cities where price is the key driver. The carrier also said it would look at opening up new markets where there is no connectivity (50% of the routes it

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operates are new routes). In this strategy, the new venture will face competition from IndiGo and also SpiceJet, both of which have network strategies which cover these markets. In its network development AirAsia will be able be leverage its well-established networks in ASEAN countries, especially Malaysia, Indonesia and Thailand, to its advantage. While most Indian LCCs operating internationally, the connectivity AirAsia provides in the region is unmatched Key details of AirAsia India venture Launch Details: The carrier would likely commence operations in 4Q2013. Mr Fernandes said: "We are ready as soon as we get the approvals” and that the timing of the launch "was in the hands of the Indian regulator... but most likely it will start by the fourth quarter." Partners: AirAsia (49%) through investment arm AirAsia Investment Ltd, Tata Sons Ltd (30%), Telestra Tradeplace Pvt Ltd (21%). Telestra Tradeplace is an investment company of Delhi-based businessman Arun Bhatia, owner of Hindustan Aerosystems Pvt. Tata Group said its contribution to the JV would be merely as a "financial investor”, with Telestra also to have a non-operational role. Arun Bhatia of Telestra Tradeplace Pvt Ltd, who is associated with AirAsia founder Tony Fernandes at the Queens Park Rangers (QPR) football club (Tony Fernandes is QPR’s chairman), will hold the remaining 21%. Scope of business: The carrier would "provide low-cost scheduled passenger airline services operating single-aisle narrow-body aircraft flying under four hours initially on domestic routes in India and at a later date on international routes, if permitted by the government of India" Fleet: The company will start operations with three to four A320s with Mr Fernandes adding: “We will scale up the size of the fleet quickly thereafter”. AirAsia Group said the majority of aircraft to be operated by the proposed AirAsia India venture will be owned by the company. Mr Fernandes ruled out using regional jets or turboprops.The board structure of the airline will be according to the government norms that mandates two third of board members should be Indian." Branding: AirAsia will fulfil the role of a strategic partner in the business and will provide necessary support and know-how, which will include infrastructure to the JV company, technical and business training to the staff of the JV, training and assistance for preparing operating procedures for the business and support for leasing of aircraft on most favoured terms. The JV plans to use the AirAsia brand name in India since its already strong brand equity in Asia will help it gain

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traction in the Indian market as well. However the regulations are ambiguous on the ability to use a foreign airline brand for domestic operations in India. Network: In its stock filing, the carrier said the JV would operate from Chennai, focussed on providing domestic tier II/tier III city connectivity. Carriers in India must complete five years of domestic operations and have reached a fleet size of 20 aircraft before being permitted to launch international services, although this regulation is under review. Mr Fernandes said AirAsia's Malaysian and Thai divisions would continue to operate international services to/from India. Although no confirmed route plans have been announced, AirAsia India has already completed a review of a number of likely domestic destinations. Process: AirAsia received Foreign Investment Promotion Board (FIPB) approval for its 49% investment on 6-Mar-13. The proposed JV must now make an application to the Indian aviation regulator for an operating licence. Executive news: The airline has identified an Indian national for the position of CEO and more details are expected to be revealed this month, with Mr Fernandes noting that the majority of positions will be held by Indian citizens. “Initially, we will have staff strength of about 300 people.” he said. Regulations require that the Chairman and two-thirds of the directors on the Board must be Indian citizens. Board composition: AirAsia said the board of the JV would have six directors comprising two nominees each from AirAsia and Tata Sons and one representative from Telestra Tradeplace. There will be an independent director on the board who will also be the non-executive chairman. Tata Sons has nominated R Venkatraman, former executive assistant to Ratan Tata, and Bharat Vasani, the chief legal counsel of the Tata Group, on the board of the new JV. AirAsia will be represented by Tony Fernandes and Kamarudin Bin Meranun, who are among the largest shareholders in AirAsia Bhd. Arun Bhatia, will represent Telstra Tradeplace on the board of the newly formed venture. Investment: On the capital plans, Mr Fernandes said: “Our initial capital will be $30-60 million”. Tata Sons equity exposure is reportedly capped at INR500 million (USD9 million). The three partners, as per their application to the FIPB commit, not later than 14 days, USD9 million, with another USD21 million to be infused within 45 days of receiving the no objection certificate. AirAsia said the airline would not raise debt to fund the venture in India stating: “We will not risk any loan in India towards our contribution in the share capital of the JV”.

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Fares: Mr Fernandes said price would be the airline's biggest differentiator as the company has mastered the low-cost model India market could provide lucrative to AirAsia Despite the long list of challenges, the Indian market could prove lucrative to AirAsia. India has a rising middle class population, with increasing disposable income levels. In 2012, more than 58 million domestic passengers were carried by Indian airlines and this is expected to almost triple by 2021. Describing the potential of the market, Mr Fernandes noted: "First, there are a billion people in India; second, millions of people travel in trains; and third, there is big potential in under-developed routes." AirAsia plans to stimulate this market potential through low fares. Mr Fernandes commented: “Let's not kid ourselves, it will be price that delivers traffic to us”. He said AirAsia has been interested in India for a while and is optimistic about doing business in the country, stating: "We don't see any difficulties". He added: "We strongly believe that the current environment is perfect to introduce AirAsia’s low fares which stimulate travel and grow the market". Mr Fernandes added the India JV would further strengthen the carrier's position in the region, stating: "We can now solidify our base, as we have moved from being a South-East Asian player into a truly low-cost airline in Asia with our Japan and India ventures". AirAsia Group well-matched with Tata “We couldn’t have picked a better partner,” said Mr Fernandes when commenting on AirAsia’s tie-up with the Tata Group. Mr Fernandes acknowledged that although AirAsia has the operational expertise, it will rely on its partners to provide local market insights. Tata Airways was India's largest airline before the government took it over in 1953 and rebranded it as Air India, with the carrier’s founder J.R.D. Tata appointed the first chairman of Air India. Tata Group and Singapore Airlines had tied-up in the 1990s to launch a domestic carrier in India, but in an effort to block this venture the regulations were changed to exclude foreign airline investors from the market. With AirAsia India, Tata Group will re-enter the aviation sector after nearly eight decades. The Group notes: “When AirAsia approached Tata Sons with a proposal for a stake in the venture, we concluded that given its reputed business model, AirAsia could be a relevant and successful service provider in the sector." Mr Fernandes has said however it would try to persuade Ratan Tata, Chairman Emeritus of Tata Sons, to become the chairman on the new carrier, stating: "Mr Tata would be the right person as he would bring tremendous confidence to the regulators, to the consumers and to the government as well. Over the next few weeks we will start serious discussions with Mr Tata on the subject. He has neither said 'yes' nor said 'no' till now”. Tata Group also has nearly a 6% equity stake in SpiceJet but is only a financial investor in the LCC. Meanwhile, Telestra Tradeplace said its participation was due to the Bhatia family's close relationship with Mr Fernandes, who serves on the board of London-based football club Queen's Park Rangers alongside Mr Bhatia's son, Amit Bhatia. Telestra Tradeplace Pvt Ltd owner Arun

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Bhatia, in an interview with Live Mint, however said the involvement of Tony Fernandes was not the sole rationale for entering the Indian aviation sector through the proposed AirAsia India venture, stating: "We were extremely passionate about the industry. And we were looking at this industry for the last two years. We are bullish about the Indian aviation sector. But when you get illustrious and valuable partners like Tata group and Tony Fernandes, we should enter the industry eyes closed, no?". He continued: "Partnership is critical in this business. You need to get competent and progressive partners for this business. See our partners, they are fabulous. Look at Tony Fernandes. He is running a profitable airline in low-fare segment for years. Tata group is honest and diligent. With Ratan Tata involved in this deal, as I said, we can just enter this sector eyes closed". Reaction from incumbents The two largest LCCs in the market, IndiGo and SpiceJet, have offered limited public reaction to the AirAsia announcement. However, Jet Airways CEO Nikos Kardassis noted that “new foreign airlines setting up shop in India as a result of the new policy was expected. Long term, the new policy will have positive impact. But there will be pain”. Kingfisher Airlines promoter Vijay Mallya said: “With this deal, AirAsia is clearly going after the potential of the domestic market. This is one of the reasons why I have been relentlessly pursuing the re-start of Kingfisher, which I am very confident about with the support from all the stakeholders”. Air Deccan founder, Captain GR Gopinath, welcomed the news stating that the proposed AirAsia venture in India would likely "stimulate" the market by opening new routes. "They will break the 'cosy cartel' and offer cheaper fares. True low-cost carriers stimulate the market and expand the consumer base". More change in the ever-changing Indian market If AirAsia India is successful in securing a licence it will introduce a formidable new entrant into India's airline industry. The venture combines a highly successful and aggressive LCC with one of the most respected and financially sound Indian business houses. It is also an important test case on the government's stance towards foreign investment in general and the airline industry in particular, as well as the Ministry's position on the award of new licences. To date the Ministry has not been inclined to issue new licences for pan-India operations, instead encouraging proposed start-ups to commence with a regional licence. Other issues that are likely to come up during the licence application process include clarification on management control and the use of the AirAsia brand in India. The Ministry needs to come up with a transparent framework with respect to the award of new licences rather than an ad hoc case-by-case approach. AirAsia will not be the only applicant, other projects are also understood to be in the pipeline and hence the manner in which the Ministry deals with AirAsia will set a precedence. The arrival of AirAsia is sure to shake up the LCCs in the domestic market, although any significant impact is still some time away given that the launch of services is unlikely before the end of this year and it will take the carrier some time to ramp up to a reasonable scale. AirAsia will also face challenges in maintaining its industry-leading low cost base in an environment

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characterised by high fuel prices and expensive airports. And the operating environment is such that it will not be easy to achieve some of the fundamental characteristics of its business model such as high aircraft utilisation, labour efficiencies, low distribution costs and strong ancillary revenues. Nevertheless, AirAsia brings proven expertise and credentials and will, as it has done in other markets, aggressively seek to find inovative solutions to these issues. And if it succeeds it will be to the benefit of the entire industry. AirAsia Group, in the release of its financials through 31-Dec-2012, noted the potential in the market by saying that the nation has only 422 aircraft serving 1.2 billion people, compared to China which has a fleet of 1,981 fleet serving a population of 1.3 billion. This combined with strong GDP growth, a young population and the expansion of an expanding middle class growth presents huge opportunity that AirAsia is eager to tap. Mr Fernandes added: “There is a monstrous market opportunity in India. If you add up all the aircraft in India it doesn’t match the number currently in Malaysia, yet the population is around 50 times larger. This is a huge opportunity but requires change. We haven’t jumped in quickly. We have done our homework and go into the domestic market with our eyes wide open”. AirAsia India will no doubt face short-term challenges but the payoff is potentially very large. AirAsia’s move has been timed to ensure that it is in the market ready to take advantage of expected growth and improvements in the operating environment in due course, while further expanding the group's network and brand. For Indian aviation, a positive approach by the Ministry to clearing impediments to foreign airline investment and addressing structural challenges to create a competitive, sustainable and profitable industry, will enable the benefits to become visible to the sector and to the Indian economy.

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Air India Key Data Fleet and Orders Air India Fleet Summary: as at 10-Apr-2013


Air India projected delivery dates for aircraft on order: as at 8-Apr-2013


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Route area pie chart Air India international capacity seats by region: as at 8-Apr-2013

Source: CAPA - Centre for Aviation and Innovata Top routes table Air India top ten international routes by seats: as at 8-Apr-2013


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Share price 2012/2013 Air India schedule by class of seat - one way weekly departing seats: as at 8-Apr-2013


Air India: the time has come to stop procrastinating and act. The final scene is near Air India has delivered a significant improvement in its operational and financial performance in FY2013, partly due to improved market dynamics following Kingfisher’s exit, but also as a result of a serious and committed approach by the management of Air India, new marketing initiatives and measures adopted to rationalise its network. But India's ageing flag carrier is still soaking up over a billion dollars of India's precious budget each year – with no prospect of a serious turnaround for the airline in its present form. The easiest path for India's leaders to take is to avoid facing the problem and to keep applying a hundred million dollars of taxpayers money each month to apply bandaids to the ailing airline. Pricing discipline has been the most significant contributor to the improved performance. And over the last 12 months Air India’s domestic market share has increased from approximately 14% to 20%. The carrier may even report a small operating profit for the current financial year ending 31-Mar-2013 subject to the impact of the B787 grounding and market conditions in 4QFY2013. However, the net result will remain significantly in the red.

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Deep structural issues remain But despite these improvements, deep structural issues remain. As a result, in the five years from FY2008 to FY2012 inclusive Air India accumulated losses of close to USD5.25 billion, a figure which it is estimated will increase by a further USD950 million or more by the end of FY2013. International routes are bleeding particularly badly and account for 80-90% of losses. Air India net losses FY2008 to FY2013 estimated

Source: CAPA Research Piecemeal recapitalisation weakens turnaround efforts: The government has committed to fund the carrier’s turnaround plan. However rather than infusing capital on a one-time basis, it is drip-fed in over an uncertain schedule. When each small tranche is received it is largely absorbed by overdue vendor and salary payments rather than being utilised to implement turnaround initiatives. As a result the recapitalisation efforts are not providing the strategic stability required. Debt level imposes huge interest burden: Air India’s bank loans and aircraft-related debt total approximately USD9 billion, in addition to which there are vendor-related liabilities e.g. to fuel suppliers and airport operators, in excess of USD1 billion. In fact Air India’s debt is approximately twice that of all the other carriers in India combined. The chart below highlights the fact that all of Air India’s competitors are in a far better position. The three LCCs combined account for just 4-5% of total industry debt and this is largely aircraft-related. Even Jet Airways’ position is improving, the carrier recently repaid over USD400 million of loans. The infusion of cash from the proposed stake sale to Etihad will be further used to reduce debt and interest obligations which in turn will improve its net profitability.

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Indian Carrier Debt Levels FY12/13

Source: CAPA Research, Company Reports. Data for IndiGo and GoAir is as at 31 March 2012; Kingfisher and SpiceJet as at 30 September 2012; Air India (estimate) and Jet Airways as at 31 December 2012. Sub-optimal aircraft utilisation: Air India’s fleet utilisation is very poor with only around 100 operational aircraft out of a total registered fleet of 127 aircraft (including Air India Express). And even those aircraft in service have daily utilisation rates below the industry average. Recovery hampered by labour productivity: The productivity of Air India’s bloated workforce continues to be a major challenge. And the airline carries the historical baggage of unresolved issues related to the integration of employees during the merger of Air India and the former Indian Airlines in 2007. The implementation of the recommendations of the Dharmadhikari Committee set-up to look into this issue is likely to face resistance. The prospect of industrial action is always in the background, especially for licensed staff such as pilots and engineers, which could be triggered by the introduction of proposed wage restructuring initiatives. Meanwhile, Air India continues to lose B777 pilots and other skilled personnel to foreign carriers, and Air India Express is facing a shortage of B737-800 pilots. A further exodus of licensed staff, particularly to the Gulf, is expected which will place added pressure on turnaround plans. Fleet issues impose strategic limitations: Air India also faces significant current and forward challenges with its fleet structure across its domestic and international operations:

1. The B777-200LR, B747-400 and the A319 aircraft are poorly matched with the mission requirements of its international and domestic routes;

2. The grounding of the B787, which was a cornerstone of the airline’s turnaround strategy, is a major setback, especially as there is no clear timeline for the resumption of services;

3. The absence of a long-term fleet strategy, with no pending narrowbody orders and no long-haul aircraft commitments beyond 2015 limits the future business case.

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Business model needs to be reworked: Air India requires a comprehensive review of its business model. At present there are fundamental weaknesses in each of its key domains. On its long-haul routes for example it does not have the commercial strength to drive the necessary yields and premium traffic volumes. In the regional international market it is focusing on routes to/from Kerala but neglecting the significant opportunities elsewhere. While on the domestic front it faces a significant capacity crunch due to a limited fleet, which itself is dominated by an aircraft type that is not competitive on most of the routes that it operates. The absence of a domestic low-cost operation or a clear regional strategy means that it is not participating in the fastest growing segments of the market. Government intervention: In addition to these huge challenges, the management of Air India has to deal with excessive intervention by the Ministry of Civil Aviation and other ministries in the carrier’s turnaround. This leaves little time or space to pursue strategic activities. Without decisive action Air India will continue to decline As a result of management initiatives and improved market dynamics Air India could post a small operating profit this year. But at a net level losses are still expected to be close to USD1 billion, albeit 20-30% less than last year. Against the backdrop of a fast-changing environment and strengthening competition the concern is that this could be as good as it gets. Air India generates 80-90% of its losses on international routes. The Jet Airways-Etihad deal and the opening of bilaterals will surely exacerbate this situation. Meanwhile, in the domestic market where Air India performs relatively well the carrier is faced with a serious capacity constraint due to a lack of aircraft and the absence of a low-cost arm to participate in the fastest growing segment of the market. The likelihood is that despite the best intentions of Air India’s management, the carrier has an almost insurmountable challenge. Its domestic competitors will be increasingly strengthened by foreign airline investment, overseas carriers are likely to be granted greater access to the Indian market and meanwhile Air India itself will be politically hamstrung with regard to taking the difficult restructuring decisions required to develop a competitive cost base or investing in new fleet. Unthinkable funding requirements, fleet modernisation alone could require USD12-14 billion over 10 years, let alone operating losses In this scenario the government will be faced with having to drip feed billions of dollars over the next few years to finance deficits with no meaningful improvement in the carrier’s situation. The government is already having trouble committing to the funding required. This does not even take into account the investment that will be required in fleet modernisation and expansion over the next decade if the carrier is to maintain its share of traffic. CAPA estimates that the airline will need to order 240-280 aircraft for replacement and growth consisting of approximately:

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• 40-50 turboprops or regional jets; • 100-120 narrowbody aircraft for domestic operations; • 50-60 narrowbody aircraft for regional international operations; • 50 widebody aircraft for long-haul operations.

The cost of the above orders could conservatively be estimated at USD12-14 billion for which the government would need to extend a sovereign guarantee, something it is likely to be reluctant to provide at the current time. Air India as it stands today with all of its current challenges is not in a position to be able to take on such massive capital commitments. One of the key economic challenges for the government today is to bring under control its large fiscal deficits. In this environment it is unthinkable that the government can commit to the level of funding necessary to support Air India’s capital requirements and operating losses, especially when there are multiple private operators willing and able to provide air transport service. Scarce budgetary resources would surely be better diverted to supporting more important social objectives in health and education. Air India’s estimated loss for this year will for example exceed the government’s entire higher education budget. A solution requires transformational thinking, which has been sadly absent If the carrier is to have any chance of success it must be radically restructured both financially and operationally. This will require a level of political will to take tough decisions, a feature which has been absent to date. Bold and pragmatic action is required to provide the airline with a fresh start and a fighting chance to compete. For the process to be successful it must be led by an MD that has the full backing of the government to make the necessary cuts, as was the case at both Malaysia Airlines and Garuda Indonesia. Turning around a national carrier is a difficult and painful process. It is arguably more difficult today than it was 10 years ago because the global environment has changed so dramatically as a result of liberalisation, the advent of LCCs and the rapid growth of Gulf carriers. But if the necessary commitment exists it can be achieved. In the case of Japan Airlines’ bankruptcy in 2009 for example it was clear that incremental changes to the business would not deliver results and that radical surgery was required. The carrier retired 40% of its fleet and retrenched 16,000 employees and has successfully re-emerged from bankruptcy. A similarly aggressive approach is required at Air India. Sadly, a realistic assessment of the situation suggests that this is unlikely to happen. However, if Air India was to take this path, pursuant to the restructuring it should be granted a level playing field with respect to access to foreign airline investment and be permitted to secure a strategic partner holding up to 49%. Over time the central government could reduce its stake to 26% with the remaining 25% to be transferred to other public sector units. If decisive action is postponed – as we expect – Indian taxpayers will bear the cost With an election looming in 2014 the current administration may be reluctant to take such a bold step and prefer to leave it for the new government to deal with. But Air India cannot wait 18 months, by that stage it will be too late to recover.

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Given the importance and sensitivity of this issue, CAPA recommends that a bipartisan approach is required with a committee to be established with multi-party consensus to oversee the financial and operational restructuring of the airline. Under a special administration, as was established for Satyam, Air India has the best chance of turning around. A viable and long-term solution for Air India is imperative not only for the airline itself but for the industry at large because as long as it struggles under government ownership it will continue to drive distortions in policy. With Indian aviation set to receive close to USD100 billion of investment over the next decade, and given the potential for a vibrant aviation sector to play a critical role in enabling economic development, such distortions are not in India’s national interests. A combination of stronger Indian competitors as a result of foreign airline investment, the growth of LCCs, the opening up of the international market in the form of bilateral liberalisation and the changing nature of global alliances, will impact each of the three key areas of Air India’s operations – long-haul international, regional international and domestic – each of which we will consider in turn below. 1. Key issues for Air India’s long-haul operations Etihad investment expected to accelerate Jet Airways’ international expansion Despite the unfortunate complexity of entering equity transactions in India, there remains a strong likelihood that Etihad will acquire a substantial minority share in Jet Airways, to accompany the increasingly close working relationship the two are developing. The potential infusion of cash would be a major positive for Jet and will likely accelerate its domestic and international expansion plans. Jet Airways currently has a widebody fleet of 23 aircraft (13 A330s and 10 777-300ERs) of which five 777s have been sub-leased to Thai Airways, leaving an operational fleet of 18 aircraft. Jet Airways current and projected 2014/15 widebody fleet size

Source: CAPA Fleet Register; CAPA - Centre for Aviation

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Over the next 12-18 months the widebody fleet is expected to increase from 18 operational aircraft to at least 30 aircraft - although this is largely dependent upon the new network plan to be developed once the Etihad transaction is completed. This growth will be achieved as a result of:

• retaining at least two of the five sub-leased aircraft when they are returned at the end of their lease term later this year, with the remaining three possibly to be re-leased;

• taking delivery of six new A330-300s (out of a total of 10 to be taken on lease, of which four have already been inducted);

• introduction of five or six 777-300ERs in 2014/15. Meanwhile Jet is likely to defer its order for 10 787-8s (with 10 options) until after 2016 and possibly switch to the -9 variant. Jet Airways is also expected to evaluate the A350 as an option. The carrier will likely review its long-haul fleet strategy after developing a coordinated network plan in conjunction with Etihad. Jet’s international operations have stabilised financially; however the route network continues to evolve. In 2012 for example the carrier exited loss-making routes e.g. services to Johannesburg, Milan, New York JFK and Kuala Lumpur. Further changes can be expected in the short-term and a new network will emerge as the deal with Etihad evolves, especially as the two carriers compete on westbound routes from India. For Etihad, a key rationale of the proposed investment is to provide greater feed from the Indian market to support its intercontinental services to Europe and the Americas, which involves the development of Abu Dhabi as a hub. Jet Airways may in turn be used to develop Canada and other markets where Etihad faces challenges to securing bilateral entitlements. Indian government expected to liberalise bilateral agreements with key markets The Government of India’s stance on bilaterals has lacked consistency, clarity or transparency, making it virtually impossible for Indian carriers to plan their international strategy. The rationale of India’s bilateral strategy and the allocation of precious rights (which are treated as national assets) are ideally based on serving clearly defined national objectives – rather than the interests of any individual Indian or foreign carrier – to provide the necessary connectivity to support business, tourism, trade and social ties. From 2004 the market was opened up rapidly, only for bilateral access to be frozen again from 2008 with a view to protecting Air India. In response to growing pressure from private carriers and Air India’s inability to utilise the available bilaterals, several pending route applications were finally approved in early 2012 after significant delays. One of the critical impacts of the Jet-Etihad deal is likely to be a liberalisation of the India-UAE bilateral. This will benefit not only these two carriers, but also Emirates, flydubai and Air Arabia. Meanwhile Qatar Airways, Turkish Airlines and Singapore Airlines are all waiting in the wings, seeking an expansion of bilateral access, as they have exhausted their current entitlements.

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Most of the airlines seeking additional rights are sixth freedom carriers. Further liberalisation will place further competitive pressure on Air India’s key routes. The historical weakness of international services by Indian carriers - largely the result of incoherent Indian policies - means that close to 40% of Indian international traffic travels to its final destination via an intermediate offshore airport, with Middle East hubs capturing just over half of such flows. Location of offshore hubs for sixth freedom Indian traffic, 12 months to Nov-12

Source: CAPA – Centre for Aviation and IATA AirportIS Air India’s long-haul operations are further compromised by widebody fleet issues Air India is currently the largest international operator to/from India, but will face increasing competition on international routes. The airline is poorly equipped to meet this challenge in terms of its fleet composition. Air India has a widebody fleet of 33 aircraft, with a further 21 (all B787s) on order. This relatively small fleet is spread across five different aircraft types, adding complexity and cost. And two of these types – representing 13 aircraft (eight 777-200LRs and five 747-400s) – do not have a good strategic fit with Air India’s operations. The airline has not been able to generate the necessary traffic volumes and yields – particularly in premium cabins – to support the high trip costs of these large aircraft. As a result, aircraft which are ideally suited to long-haul missions are instead being sub-optimally deployed on medium-haul routes, with relatively low utilisation. The airline has been trying to sell at least five of its 777-200LRs – and possibly all eight – but has not been successful to date. The 747-400s may be reconfigured for VIP operations and sold to the Government of India. Until recently this left Air India with just the 12 777-300ERs, supplemented by a couple of A330s, as the only widebody aircraft suited to its mission requirements. For this reason the right-sized 787 with its superior seat mile costs was eagerly awaited and the aircraft was a cornerstone of Air India’s turnaround plan. The strategy was proving effective with

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routes such as Delhi-Frankfurt turning to an operating profit within just a few weeks of deploying 787s. But with the grounding of the Dreamliner and no clear timeline for the resumption of services, Air India will have to increasingly deploy its 777-200LRs which are poorly matched with the demand profile on its key long-haul routes. Air India current widebody fleet size

Source: CAPA - Centre for Aviation Research As noted, Air India has a further 21 787s on order, all of which were due to be delivered by 2015, although the schedule is now uncertain. And with B787 pilots sitting idle Air India may be forced to incur re-training costs on other types if the grounding is extended. At the same time B777 pilots – along with other skilled, licensed staff – are being poached by Gulf carriers and a continuing exodus is likely. Membership of an alliance might strengthen Air India’s commercial reach and feed, and with Jet Airways now set to partner with Etihad, there is a (remote) possibility that Star Alliance could resume discussions with Air India. Beyond 2015 Air India has no committed fleet expansion. Together with its commercial weakness, the opening up of bilaterals and the strengthened competition it will face from Indian and foreign carriers, LCCs and sixth freedom behemoths, this imposes a structural limitation on its long term business plan. Air India is already bleeding badly on international routes which account for 80-90% of its total losses, and these developments will significantly weaken the business case. 2. Key issues for Air India’s regional international operations Air India’s low-cost international subsidiary, Air India Express, which operates primarily on routes to the Gulf and Southeast Asia, will also face increased competition. Firstly, Indian LCCs are expanding on short-haul international routes. Secondly with the opening up of bilaterals,

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foreign carriers such as the UAE's flydubai and Air Arabia are also keen to increase their presence in India. Air India Express has a fleet of 21 737-800s, of which 17 are owned and the balance leased. The carrier was earlier planning to increase its fleet size to 35 aircraft by 2015 and launch domestic operations. A combined domestic and international network would enable the carrier to increase its aircraft utilisation with a more flexible combination of sector lengths. However, with the airline facing a pilot shortage and under-utilising its current fleet, such a rate of expansion appears unlikely at this stage. In addition to this, Air India Express does not operate at genuine arm’s length from Air India and lacks a dedicated corporate structure. Air India’s senior management is preoccupied with the myriad challenges at the core business and have neglected the subsidiary. As a result, Air India Express has also seen its financial performance deteriorate since FY2008. Air India Express net profit/loss FY2008 to FY2012

Source: CAPA - Centre for Aviation Research Air India Express is preparing to strengthen its base in the state of Kerala. However, this would appear to be a politically rather than commercially driven decision. Although the state accounts for the majority of the carrier’s capacity today this may not always be the case going forward. If Air India Express truly wishes to be one of India’s leading international LCCs there are route opportunities from airports right across the country, not just from Kerala. Investing in developing a new base in a location which might not be the primary focus of the airline in future could result in an unnecessary duplication of resources. It would appear to be a strategic mistake to neglect other important markets and leave them open for Indian or foreign LCCs to develop their own fortresses. And despite Air India Express making a commitment to Kerala, it is still not seen as being sufficient or in line with requirements by the state government, which is preparing to launch a

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competing low-cost airline, Air Kerala. It is unfortunate - to say the least - that the one market which is receiving Air India Express’ attention is seeking to undermine it. With the central government considering removing the regulation which requires domestic carriers to operate for at least five years and have a fleet of 20 aircraft before being granted permission to launch international routes, any new start-ups could in future also potentially compete with Air India Express on its key routes. 3. Key issues for Air India’s regional domestic operations; failure to introduce a domestic LCC leaves it at a disadvantage Air India currently operates a domestic fleet of approximately 40 aircraft, with no further equipment on order. However, around 60% of the fleet comprises A319s which have limitations in that they are not competitive against larger narrowbodies such as A320s and 737NGs as used by most Indian carriers, but are too large for regional routes. The airline has been seeking permission to lease up to 12 A320s to augment its domestic capacity however this continues to be held up. There does not appear to be a clear domestic strategy and Air India has hesitated in launching a domestic low-cost subsidiary to complement Air India Express internally. This is largely for fear of cannibalising its parent operations. However, as a consequence, it is the only airline group not participating in the fastest growing segment of the market. And it has only a small regional fleet comprising a mix of regional jets and turboprops – several of which are dedicated to operations in the northeast of the country – with no clear market proposition. Against this backdrop of capacity stagnation, Air India’s competitors are set to expand aggressively. Indian carrier narrowbody current and expected orders

Source: CAPA - Centre for Aviation Research Jet Airways is expected to place an order in the coming months for up to 100 narrowbodies, which may consist of a mix of 737 MAXs for the full service operation and A320neos for

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JetKonnect. Meanwhile 46 B737-800s from an earlier order are still to be delivered. Following the conclusion of the Etihad transaction, Jet Airways is also expected to have the capital to implement a clearer market segmentation strategy, in particular the establishment of a strong hybrid model under the JetKonnect brand. IndiGo has around 30 A320s from its 2005 order still to be delivered of which some will be used for replacement. However, from 2016/17 it will start to take delivery of the first of its 150 A320neos, as well as a further 30 A320s. As a launch customer placing what was at the time the largest civilian order by number of aircraft, IndiGo will have obtained very attractive pricing on its aircraft (as it did when it placed its original 100 aircraft order in 2005) providing it with a competitive cost base. IndiGo is also evaluating the possibility of placing an ATR order to establish a regional subsidiary. SpiceJet has 30 737-800s on order with deliveries set to commence from next year. A further narrowbody order may be finalised by early Apr-2013 after a new investor comes on board. The 737 MAX is the most likely equipment, particularly as there are no available A320neo delivery slots within the required timeframe. SpiceJet remains undecided on whether to exercise its options for a further 15 Q400s, however CAPA expects that the carrier will increase its regional fleet in due course. GoAir, with its more cautious, but basically profitable strategy, will see its fleet size increase from 13 to around 20 aircraft over the next couple of years, to be followed by the first of its 72 A320neos on order from 2017. The airline is also considering inducting turboprops to serve Tier 2 and Tier 3 cities. In sum, beetween them, Air India’s competitors could have 500 narrowbodies on order by the end of this year (over 360 narrowbodies currently on order, with up to a further 140 aircraft to possibly be ordered in the coming months). And this is just the incumbents. There is no certainty at present regarding the approval of new licence applications for pan-India operators, but as and when the government decides to open up market access again there are two or three serious joint ventures in the pipeline. Although the Ministry may hold off granting permission to start-up national carriers for now, they will eventually launch. Meanwhile, regional airline licences will be approved and while new start-ups are likely to be small, these new carriers will nibble away at Air India’s operations in Tier 2 and Tier 3 cities. Air India meanwhile has no current or impending orders and is expected to face a severe capacity crunch which will leave it unable to participate in domestic market growth. Its government owner is not prepared to inject capital to place Air India in a position to compete effectively, nor does it have the policy commitment to restructure the heavily loss-making company. In this policy vacuum, the only area likely to flourish at Air India is the level of annual subsidy paid to it.

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