Why It Is Difficult To Work Out Air India's Valuation

The government has announced further modifications to the Air India disinvestment programme. This time, the changes deal with the valuation parameters. Put simply, bidders now can bid based on the enterprise value of Air India.

The change, by the government's own admission, is driven by changing geopolitical and macro-economic risks emanating from the Covid-19 crisis. The valuation requires multiple perspectives — all to be layered in at the same time and unlike a pure business valuation, Air India necessitates factoring in non-measurable parameters such as market access, potential for government intervention, talent, tradition and technology.

But that is easier said than done. So, how does one value Air India?

Looking at Air India from a purely financial lens, the value derives from the expected cash-flows that the airline will produce. Discount this back adjusting for risk and one arrives at a valuation.

But with the pandemic, the cash-flow forecasts involve predictions on consumer demand, consumer behaviour, interest rates and market realities — all of which are witnessing significant disruptions.

Thus, at the present time, this involves more unknown variables than known variables, which exponentially enhances the risk of uncertainty. This also translates into multivariate forecasts adjusted for the presumed risks, complexities and contingencies.

Such a valuation then, perhaps, is best summed up in the words of Warren Buffet, who stated:

The other alternative is a multiples-based approach, where one compares Air India to an entity that is similar and see what premium that is commanding.

But because there are no competitors that can mirror the business model, this only becomes more challenging. And at the present time, very large legacy national airlines (if any) are commanding a premium.

In looking to public markets, the listed competitors are Jet Airways, SpiceJet and Indigo — each extremely different.

Put simply, Air India in its current form is simply not comparable in its current form to competitors. Thus, even if one forces a multiples-based valuation, it will be misleading at best.

Eliminating the above valuation methodologies, the valuation approach one comes to is based on valuing the assets. This is how bidders are looking at Air India — and also an approach that has now got the government’s approval.

But since Air India’s debt is higher than the assets, this also becomes challenging. As is the fact that arriving at a value for the brand, the assets, loan quality, liability structures, liquidity and inter-corporate agreements is fraught with uncertainties and with unknowns.

With the valuation based on the assets, bidders are likely to use a building blocks approach.

That is, take apart the assets and liabilities and ascribe a value to each — in terms of time, money, risk appetite and investment returns. These assets include a mix of tangible and intangibles such as the airline operating certificates, unencumbered aircraft, trained talent, aircraft maintenance agreements, slots, bilateral flying rights and the frequent flyer programme.

Yet again, the challenge is compounded by the Covid-19 crisis. Take for instance, the value of aircraft. In better times, this is clearly discernible as they are driven by operating economics on the aircraft type, liquidity on the aircraft type and technical parameters.

But in the present scenario, all of these are changing. For instance, given the capital costs of older-versus-newer airplanes, it is now more economic to fly older aircraft; liquidity on many aircraft is constrained, making for a tough financing environment, and airline planners are constantly evaluating range and capacity requirements due to changing market dynamics.

Similar issues abound for all other assets that the airline owns…

Then, there is the issue of debt. As per the latest report, the airline now carries a debt burden of Rs 23,286 crore (USD 3.1 billion), but this will rise once the current financial year's figures are incorporated.

The assumption of this debt requires it to be paid back over a period of time. Depending on the nature of the debt, lenders aren’t very willing to take significant cuts.

It doesn’t help that banks recently have had to write down their exposure to Jet Airways, while several airlines in the country are at the edge of a precipice.

At the same time, given the margins in the airlines business, repaying this debt makes for a very tough proposition. And presumably, this has led to the decision to allow the bidders to bid on the level of debt they are comfortable absorbing.

Whether this makes for renewed interest remains to be seen.

With nine changes to the disinvestment document, as it pertains to Air India, there is no doubt that the valuation challenge is extremely complex.

But where the focus has been lacking has been to highlight the opportunity cost and highlight the value of a strategic acquisition. Arguably, this should be done by the buyers, but by equal measure, it has to be put forth in the disinvestment memorandum — in clear quantitative terms that speak to investors and not in lofty adjectives that lack substance.

One such focus has to be the assessment of opportunity cost, which must measure the investment against alternatives and pre-empt investor concerns.

That is, for any investor to go ahead, the case for investment must be highlighted in clear and certain terms where it is strong enough for the investor to disregard any other option.

Finally, with an assessment of the financial value and opportunity cost, one has to concurrently start layering in the strategic gain that will accrue to an investor.

Understanding this requires a clear compelling strategy, market expertise and an unbiased view of the situation.

This view is hard to come by because most stakeholders are entrenched. Banks want a bid to come through so the loans don’t go bad; consultants and lawyers that help with the bid may also be the folks who then work on the restructuring; vendors and employees are keen to see their pending dues cleared; and the government is keen to see a successful disinvestment.

Put together, all of these elements make for an extremely complex case and has parties pushing outcomes that, by their very nature, are misaligned. The difficulty of valuing Air India remains.