Neighbours at war

THERE’S A DOGFIGHT in Indian skies—and the winner edges closer to taking the world. Etihad, the national airline of the United Arab Emirates, is in a pitched battle with Emirates, another UAE airline, for traffic out of India. Both see India as a vital market and figure that winning the largest chunk of international traffic from here will be the masterstroke in their plans to become the hub to the world. In this context, Etihad’s talks with Jet Airways to take a 24% stake in the second-largest Indian carrier has the industry buzzing with conjecture. With Jet’s market capitalisation being Rs 5,200 crore (on Jan. 29), that is estimated to cost Etihad a minimum of Rs 1,248 crore. But then, it will, in all likelihood, be a game changer for aviation in this region.

Airlines in West Asia, such as Emirates, Qatar Airways, and Etihad, essentially operate from a single city, which is their hub. With not much domestic traffic, these airlines have been targeting international passengers in fast-growing economies, making India an obvious choice. India has international traffic of 37.9 million (of which about 12.3% fly Emirates). There’s also an element of geography in the calculations: All traffic to Europe and the U.S. from India needs to ideally fly over West Asia.

Emirates, formed in 1985 in Dubai, started by flying to Karachi, Mumbai, and Delhi. Backed by aviation-friendly policies in Dubai, it grew strongly in the period that the city was trying to build itself as a business and trading hub. Unlike some of its neighbours, it had little oil, and aviation was seen as a major driver to this strategy. In fact, Dubai International Airport and Emirates were designed to match this ambition. Emirates is now the world’s largest carrier by international traffic, and the focus on this segment helped it make profits of $462.9 million (Rs 2,483.5 crore) in the six months till Sept. 30, 2012.

The Indian government’s decision in 2004 to liberalise its policy on bilateral flying rights, which allowed airlines such as Emirates to add capacity and frequency, to and from India, gave Emirates a boost. (Home-grown carriers such as SpiceJet, Air Deccan, Kingfisher, GoAir, and Indigo, were hamstrung by regulations that permitted them to go international only after five years of domestic operations.) From 2004, Emirates added capacity massively and increased the number of destinations in India. It now offers 185 flights weekly to 10 cities in India. With a rather high seat factor of 84% (this means 84% seats are taken on its flights; the global average is 78.3%, according to IATA), it controls 65% of traffic between India and Dubai. Its closest rivals on this segment are Air India and AI Express, which together have 14%. Emirates has earmarked 11% of its global network capacity for India, and earns 10.3% of its revenue from it.

Today, Indian carriers fly to international destinations, but can’t match Emirates, which capitalised on its head start, says Jitender Bhargava, a former Air India executive director. Anirudha Dutta, till recently an analyst with CLSA, a leading investment and brokerage firm, says it helped that traditionally strong international carriers that fly westward from India such as British Airways, were going through troubles of their own. This was made more grim by the not-so-smooth experience passengers had at Heathrow compared with the ease of transiting through Dubai. Indeed, Dubai even pitches its airport as a standalone destination.

EMIRATES IS THE grand old sheikh, and Etihad the young challenger. Eighteen years younger than Emirates, it is touted as the fastest-growing airline in the history of commercial aviation. Like Emirates, Etihad has the support of the ruling sheikhs; set up in 2003 by royal decree, Etihad is controlled by Abu Dhabi’s royal family, one of the wealthiest in the world. Abu Dhabi’s massive oil reserves are expected to deplete in a couple of decades and the rulers want to keep the economy chugging along, creating a hotspot for business, trade, and investment. In effect, Abu Dhabi wants to be everything that Dubai is, and more. (There’s a bit of irony in that: In the post-Lehman era, when Dubai’s economy crashed and it was not able to pay off its debts, Abu Dhabi bailed it out.)

Etihad has taken the inorganic route of creating alliances and taking minority stakes in airlines around the world to catch up with Emirates. Not that it’s anywhere close as yet: Emirates’ revenue in 2011 was $15.6 billion compared with Etihad’s $4.1 billion. Etihad has bought 40% in Air Seychelles, 10% in Virgin Australia, and 29% in Air Berlin over the last few years; it also has 40 codeshare partners across continents. (Codeshare agreements allow two or more airlines to share a flight; a ticket bought on one of the airlines lets a passenger fly a cooperating airline.) That’s the strategy that Etihad hopes will give it a boost in India, where Emirates is often called the country’s national carrier in aviation circles.

As of now, Dubai is much better serviced from India than Abu Dhabi, with various airlines having 352 direct flights every week compared to just 119 weekly to Abu Dhabi. Etihad wants to even out that imbalance by taking a stake in an Indian carrier. Both Etihad and Jet refused to comment; insiders say an announcement is likely soon. On Jan. 3, Jet informed the national stock exchanges that it was discussing a potential investment by Etihad; its communication with the exchanges stated that “these discussions have commenced recently, pursuant to the liberalised FDI policy, which permitted foreign investment in the shares of an Indian airline. The discussions are in progress but no terms have been firmed up at present.”

IF THE DEAL GOES through (though insiders at both companies say the operative word is “when”, not “if”), this is likely to benefit both airlines. Jet has been in the red for three of the last four quarters, and has had to give up its No. 1 position in terms of market share to IndiGo. (Jet has a market share of 25.2% compared with IndiGo’s 27.3%.) Funds infused by Etihad could help Jet’s founder and chairman Naresh Goyal raise money more easily from banks and manoeuvre better in a highly competitive market. Jet, say Rajani Khetan and Mark Webb, analysts at HSBC in Hong Kong, “is heavily leveraged and the interest burden is increasing due to rising risk aversion among banks towards aviation lending. This is leading to rising interest rates—the depreciating rupee against the dollar is also increasing interest expense.” They reckon that if equity of “say, $295 million is injected, it would lower Jet’s FY14 net debt to Ebitda ratio” and help it pay back its debts faster.

Jet has had a codeshare agreement with Etihad since 2008. However, a stake in the company by Etihad and an integration of operations could help Jet negotiate better on maintenance deals, fuel purchase, ground handling, ground services, training, and aircraft purchases.

Etihad’s other equity partnerships show that it loses no time in integrating its operations with the company it has bought into. Integrating operations has given it access to 11,600 flights and 327 destinations in all.

The December 2011 deal with Air Berlin is estimated to have yielded €100 million (Rs 723.7 crore) already in revenue and more than 300,000 passengers in 2012. Germany’s second-largest airline has two Etihad representatives on its board and there’s a cash infusion of $225 million over five years to buy planes. That’s something Goyal would love, says a senior executive of a Delhi-based private airline. Interestingly, the newly-appointed chief executive of Air Berlin, Wolfgang Prock-Schauer, was a Jet Airways CEO a few years ago and is familiar with the internal plumbing of the airline—that could aid Etihad’s integration with Jet.

“To aggregate demand out of India, Etihad will want the domestic network strengthened by adding more aircraft,” says Amber Dubey, partner and head of aviation at KPMG India. Jet’s international operations could also be rationalised to save money and increase efficiency, says Mark Martin, founder and chief executive of Dubai-based aviation specialist Martin Consulting, and a veteran in the sector, having worked with SpiceJet, RwandAir, and GMG Airlines. While Jet continues to attract a lot of traffic to Southeast Asian countries, the Gulf, and London, the hub it set up at Brussels has been a drain on its revenue, and analysts agree it may have to go.

A senior executive with a Delhi-based low-fare airline believes Etihad may also demand management changes as well as representatives on Jet’s board. Etihad too, stands to gain from the deal. Former executive director of Jet Airways, Saroj Datta, believes a partnership with Jet would give “the Gulf carrier concerned access to these markets at a lower cost”. Besides, a stake “puts the relationship of the two partners on a firmer footing on a longer-term basis than can be achieved through commercial and marketing arrangements such as codeshare agreements”.

Etihad will also be buying into the potential growth of one of the least penetrated major aviation markets in the world. The number of per capita air trips annually is under 0.05 in India compared to 2.5 in the U.S., says Martin.

The other airline, which was in the news for a likely alliance with Etihad was Kingfisher Airlines. However, industry experts believe that this could have been a ploy by Etihad to bring down Jet’s asking price. Grounded, with more than Rs 7,000 crore in debt, Vijay Mallya, chairman of Kingfisher, was reported to have been in touch with the Abu Dhabi royal family in 2009 to seek an investment through the state’s sovereign investment fund, but that never happened. (At that time, there was a restriction on investment from airlines abroad, but not on such sovereign funds.)

However, Kingfisher needs a sound recovery plan to attract investors and renew its licence, which aviation regulator Directorate General of Civil Aviation suspended recently. It has been talking about restarting limited services with Rs 650 crore from its promoter, Mallya. But for any meaningful scale, it will need at least Rs 3,000 crore.

Asks Martin: “Abu Dhabi has that kind of money, but why would they want to invest in it when there’s Jet Airways?