Air Deccan - Cutting Costs, Not Corners

The Story of Indias First Low Cost Airline

Fin 456-Team 9: Ruchika Chinda, Ruibin Chen, Rishi Gupta, Anuj Sharma
Case Outline
Air Deccans first flight took-off from Bangalore to Mangalore on Aug.
25, 2003

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

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

Plans to go IPO in 2006 with a goal to be the leading aircraft company
in India providing a wide gamut of airborne services throughout the
country
Questions to Ask
With the increase in competition in the Indian aviation industry, is this
low cost model sustainable?
Why IPO and why now?
Whats the road-map for expansion after IPO?
What is the optimal price of the offering?
Agenda
Air Deccans business
The aviation industry in India
Major risk factors
Suggested solution for the IPO
Air Deccans Business
Positioning as a low cost carrier
Offers no in-flight service
Single class aircraft configuration
Internet booking and cheap fares

Two aircraft strategy Airbus and ATR

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

Target market: Upper middle class in short term and lower middle class
aggressively in long term
Air Deccans Business
Target to expand fleet to 124 aircraft by 2013

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

Passenger load factors anticipated at 70%

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

Targets to decease fuel expense as a percentage of total revenues from
30% to 26%, operating expense from 23% to 16% in 8 years
The Aviation Industry in India
High growth potential due to economic boom and highly under penetration
market
0.02 trips per capita per annum
Long-term GPD growth at 8% annually

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

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

Regulatory and infrastructure bottlenecks have prevented accelerated growth in
the industry

The government is proactively looking to address the bottlenecks
The Aviation Industry in India
Five-force analysis

Rivalry: Increased competitive pressures due to new entrants

Barriers to Entry: Easy entry but execution doubtful

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

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

Substitutes: Railways, high price elasticity of common mans
Major Risks
Increase in Competition
Excess capacity could lead to price wars

Oil Price
Extremely vulnerable to oil price fluctuations due to government
regulations on price hedging

Regulatory risk
A collapse of the current coalition government could trigger significant
changes in Indias economic liberalization and deregulation policies
Questions Recap
With the increase in competition in the Indian aviation Industry, is this
low cost model sustainable?
Why IPO and why now?
Whats the road-map for expansion after IPO?
What is the optimal price of the offering?
Q&A
How sustainable? Why IPO?
What to do after IPO? At what price to IPO?
Suggested Solutions
How sustainable?
High growth potential market
The second fastest growing travel and tourism economy in the world
Airport infrastructure improvement opening up new sectors
The firm achieved break-even in its first year of operations, through a
combination of high load factors and low-cost operating economics.




Suggested Solutions
Why IPO? Air Deccan wanted:
to expand its fleet and enhance engineering and operational capabilities
to establish a relationship with capital markets
to have additional finance flexibility and ensure its long-term growth
to enhance Deccans brand among common man



Suggested Solutions
Risk Analysis &
Cost of Capital
Calculation
Risk Premium Calculation
Inputs Output Category
4.50 U.S. risk free in %
3.00 U.S. risk premium in %
92.50 Current U.S. Credit Rating
57.00 Institutional Investor country credit rating (0-100)
16.07 Anchored Cost of Equity Capital for project of average risk in country (ICCRC)
8.57 Country Risk Premium
Industry Adjustment
1.10 Beta (Industry)
0.30 Sector adjustment
Project Risk Mitigation
(-10 to 10; where 10=risk completely eliminated, 0=average for country)
Weights Score
Impact on
Country
Premium
Sovereign
0.40 -2.00 0.69 Currency (direct, e.g. convertibility)
0.10 7.00 -0.60 Currency (indirect, e.g. political risk caused by crisis)
0.15 -2.00 0.26 Expropriation (direct, diversion, creeping)
0.05 -1.00 0.04 Commercial International partners
0.05 -1.00 0.04 Involvement of Multilateral Agencies
0.05 -3.00 0.13 Sensitivity of Project to wars, strikes, terrorism
0.05 0.00 0.00 Sensitivity of Project to natural disasters
.
Operating
0.05 -3.00 0.13 Resource risk
0.03 7.00 -0.15 Technology risk
Financial
0.05 -3.00 0.13 Probability of Default
0.03 0.00 0.00 Political Risk Insurance
1.00 Sum of weights (make sure = 1.00)
Project Cost of Capital 17.03
Suggested Solutions
Revenue Projection
Suggested Solutions
Expense Projections
Air Deccan Expense Projections
(1)
Actual Projected
Year ended March 31,
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Aircraft fuel expenses 5.34% 13.72% 29.03% 30.00% 31.00% 30.00% 29.00% 28.00% 28.00% 27.00% 26.00%
Aircraft/engine repairs 1.32% 13.13% 15.39% 14.00% 14.00% 14.00% 14.00% 14.00% 14.00% 14.00% 14.00%
and maintenance
Aircraft/engine lease 24.36% 15.80% 14.09% 14.00% 12.00% 10.00% 9.00% 8.00% 8.00% 8.00% 8.00%
rentals
Other direct operating 24.74% 24.89% 23.00% 22.00% 20.00% 19.00% 17.00% 16.00% 16.00% 16.00% 16.00%
expenses
Employee remuneration 11.24% 10.61% 9.92% 10.00% 10.00% 9.00% 9.00% 8.00% 8.00% 8.00% 8.00%
and benefits
Administrative and 14.71% 11.22% 6.34% 7.00% 8.00% 9.00% 9.00% 9.00% 9.00% 9.00% 9.00%
general expenses
Employee stock - - - - - - - -
compensation cost
Advertisement and 2.30% 0.47% 1.97% 2.00% 3.00% 4.00% 4.00% 4.00% 4.00% 4.00% 4.00%
business promotion
expenses
Finance and banking 6.46% 5.74% 3.19% 6.00% 8.00% 9.00% 9.00% 9.00% 9.00% 9.00% 9.00%
charges
Amortisation 3.35% 1.47% 1.79% 2.00% 1.00% 1.00% 0.00% 0.00% 0.00% 0.00% 0.00%
Depreciation 1.39% 1.66% 0.96% 3.00% 7.00% 10.00% 8.00% 7.00% 7.00% 7.00% 7.00%
Total Expenditure 95.21% 98.71% 105.68% 110.00% 114.00% 115.00% 108.00% 103.00% 103.00% 102.00% 101.00%
Note:
(1) All numbers are a percentage of revenue.
Suggested Solutions
DCF Valuation
Air Deccan Discounted Cash Flow- (Rs in million)
Actual Projected
Year Ended March 31,
2001 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
INCOME
Total Income 147 314 2,669 6,557 11,356 16,921 22,276 28,728 34,388 40,801 47,982
EXPENDITURE
Preliminary expenses written off - - - - - - - - - - -
Total Expenditure 139 665 3,384 6,669 11,806 17,314 21,595 26,234 31,453 36,528 42,566
Profit/(Loss) before taxation and prior period items 8 (351) (715) (112) (450) (392) 681 2,494 2,935 4,273 5,416
EBITDA 15 (291) (525) 610 1,367 2,992 4,468 7,091 8,437 10,801 13,093
EBITDA Margin 9.85% (92.62%) (19.65%) 9.30% 12.04% 17.68% 20.06% 24.68% 24.53% 26.47% 27.29%
EBITDAR 62 (185) (73) 1,528 2,730 4,684 6,473 9,389 11,188 14,066 16,932
EBITDAR Margin 42.42% (58.74%) (2.75%) 23.30% 24.04% 27.68% 29.06% 32.68% 32.53% 34.47% 35.29%
EBIT 11 (312) (612) 282 459 1,130 2,686 5,080 6,030 7,945 9,735
Tax 33.6% 33.6% 33.6% 33.6% 33.6% 33.6% 33.6% 33.6%
EBIT (1-t) 187 304 751 1,784 3,373 4,004 5,276 6,464
Depreciation 197 795 1,692 1,782 2,011 2,407 2,856 3,359
Amortization 131 114 169 0 0 0 0 0
Capital Expenditures as a % of Sales 20.0% 30.0% 40.0% 37.0% 27.0% 17.0% 7.0% 7.0%
Capital Expenditures (1,311) (3,407) (6,769) (8,242) (7,757) (5,846) (2,856) (3,359)
Changes in Working Capital 0 0 0 0 0 0 0 0
FCF (797) (2,194) (4,157) (4,677) (2,373) 565 5,276 6,464
WACC 15.0% 14.4% 13.9% 13.3% 12.8% 12.4% 11.9% 11.1%
PV of FCF's (693) (1,676) (2,811) (2,838) (1,298) 281 2,400 2,780
Sum of FCF's (3,856)
Terminal Value 148,840
PV of Terminal Value 64,007
Enterprise Value 60,151
Less Net Debt 4,179
Equity Value 55,972
No of shares outstanding 98.18
Implied price per share 570.08
Suggested Solutions
Comparable Valuation
Comparable Company Analysis
Comaparable EV/EBITDAR multiple 7.40 12.4
Air Deccan 2008E EBITDAR 4,684 4,684
EV 34,662 58,282
Less Net Debt
4,179 4,179
Equity Value 30,483 54,103
No of shares outstanding
98 98
Implied price per share
310.47 551.05
Thanks
If its on the map, we will get you there---Air Deccan