A Study of Mergers & Acquisitions in Aviation Industry in India and Their

Impact on the Operating Performance and Shareholder Wealth

Nisarg A Joshi
Ahmedabad Institute of Technology

Jay M Desai
Ahmedabad Institute of Technology

ABSTRACT
The objective of this paper is to study, why organisations take the inorganic mode of expansion.
However, the main focus is on studying the operating performance and shareholder value of
acquiring companies and comparing their performance before and after the merger. To conduct a
uniform research and arrive at an accurate conclusion, we restrict our research to only Indian
companies. To get a perspective on India, we study aviation sector.

We will test feasibility that mergers improve operating performance of acquiring companies.
However on studying the cases, we conclude that as in previous studies, mergers do not improve
financial performance at least in the immediate short term.

INTRODUCTION

The air travel market grew up originally to meet the demand of business travelers as companies
became increasingly wide-spread in their operations. On the other hand, rising income levels and
extra leisure time led holidaymakers to travel to faraway places for their vacation. A further
stimulus to the air travel market was provided by the deregulation and the privatization of the
aviation industry. State-owned carriers that hitherto enjoyed monopoly status were now exposed
to competition from private players. However, one development that changed the entire
landscape of the industry was the emergence of low cost carriers (LCCs). These carriers were
able to offer significantly cheaper fares on account of their low-cost business models and thereby
attract passengers who might not otherwise be willing to fly. LCCs have achieved rapid growth
in market share in the U.S. domestic market, short-haul market in Europe and recently in Asia.
Since 1970, the international passenger traffic has grown by an average rate of more than 6%,
compared to a 7% increase in the domestic passenger traffic.

Electronic copy available at: http://ssrn.com/abstract=2025282

The aviation industry is highly cyclical. However, in times of recession, the decline in the
industry growth rate is much sharper when compared to the world economy. After witnessing a
strong growth during the late 1990s, the industry saw a sharp reversal in fortune as a result of a
global economic downturn in 2001. The situation was further aggravated by 9/11 attack, the Iraq
war and the SARS epidemic. The mammoth financial losses incurred by the scheduled carriers
during this period led to a long-overdue restructuring among the full service carriers (FSCs).
Many airlines embarked upon severe cost-cutting and fleet-rationalisation programmes as they
struggled to remain afloat. The conditions for FSCs were further worsened with the advent of
budget carriers in the U.S. and Europe.

There was however a strong rebound in traffic in 2004, led by a strong recovery in the world
economic growth and which continued for the next two years (2005 and 2006). According to
ICAO (International Civil Aviation Organisation), the revenue per passenger kilometers
(calculated as the number of seats multiplied by the kilometers flown) for international services
has grown by 8.5% in 2005 and is estimated to have grown by 6% in 2006. The strong growth in
the traffic and recovery of higher fuel cost through surcharges resulted in strong revenue growth
for airline companies. However, this did not translate into a recovery in profitability, primarily
on account of a significant increase in fuel costs. According to IATA, the combined losses
posted by the world's scheduled carriers amounted to US$ 6 bn in 2005, following a cumulative
loss of US$ 36 bn in the previous four years.

Future Outlook: As per the estimates of aircraft manufacturers and other industry bodies, the
world passenger traffic is expected to grow at 5% p.a. in the medium to long-term. The growth
will however be slower in matured economies, but faster in under-penetrated and growing
economies like India and China. The primary reason for the increase in passenger traffic over the
years has been decline in airline passenger yields. As per an estimate, after adjusting for the
general inflation, the average airline yields (revenue per passenger kilometers) have almost
halved since 1970. During the same period, the real revenue growth (by combining growth in
traffic and decline in yields) has averaged only 2% to 3%. Since aviation industry is a high fixed
cost industry, a small increase in operating cost can have a sharp impact on the profitability of
the companies. High fuel prices, congestion cost, higher security and insurance cost can increase
the overall cost of operations and thereby impact the demand for air travel services. However,
there is room for cost reduction in the form of distribution cost and cost synergies from industry
consolidation. Overall, we believe that consolidation is the only solution for addressing the
problem of excess capacity and poor financial ratios of the company.

OVERVIEW OF WORLD MARKET

Air travel remains a large and growing industry. It facilitates economic growth, world trade,
international investment and tourism and is therefore central to the globalization taking place in
many other industries.

In the past decade, air travel has grown by 7% per year. Travel for both business and leisure
purposes grew strongly worldwide. Scheduled airlines carried 1.5 billion passengers last year. In

Electronic copy available at: http://ssrn.com/abstract=2025282

the leisure market, the availability of large aircraft such as the Boeing 747 made it convenient
and affordable for people to travel further to new and exotic destinations. Governments in
developing countries realized the benefits of tourism to their national economies and spurred the
development of resorts and infrastructure to lure tourists from the prosperous countries in
Western Europe and North America. As the economies of developing countries grow, their own
citizens are already becoming the new international tourists of the future.

Business travel has also grown as companies become increasingly international in terms of their
investments, their supply and production chains and their customers. The rapid growth of world
trade in goods and services and international direct investment has also contributed to growth in
business travel.

Worldwide, IATA, International Air Transport Association, forecasts international air travel to
grow by an average 6.6% a year to the end of the decade and over 5% a year from 2000 to 2010.
These rates are similar to those of the past ten years. In Europe and North America, where the air
travel market is already highly developed, slower growth of 4%-6% is expected. The most
dynamic growth is centered on the Asia/Pacific region, where fast-growing trade and investment
are coupled with rising domestic prosperity. Air travel for the region has been rising by up to 9%
a year and is forecast to continue to grow rapidly, although the Asian financial crisis in 1997 and
1998 will put the brakes on growth for a year or two. In terms of total passenger trips, however,
the main air travel markets of the future will continue to be in and between Europe, North
America and Asia.

Airlines' profitability is closely tied to economic growth and trade. During the first half of the
1990s, the industry suffered not only from world recession but travel was further depressed by
the Gulf War. In 1991 the number of international passengers dropped for the first time. The
financial difficulties were exacerbated by airlines over-ordering aircraft in the boom years of the
late 1980s, leading to significant excess capacity in the market. IATA's member airlines suffered
cumulative net losses of $20.4bn in the years from 1990 to 1994.

OVERVIEW OF AVIATION INDUSTRY IN INDIA

Air Traffic: The Airport Authority of India (AAI) manages total 122 Airports in the country,
which include 11 International Airports, 94 domestic airports and 28 civil enclaves. Top 5
airports in the country handle 70% of the passenger traffic of which Delhi and Mumbai together
alone account for 50%. Passenger and cargo traffic has growth at an average of about 9% over
the last 10 years.

Growth: Estimated domestic passenger segment growth is at 12% per annum. Anticipated
growth for International passenger segment is 7% while the growth for International Cargo is
likely to grow at a healthy rate of 12%.

Privatization: Privatization of International Airports is in offing through Joint Venture route.

Three Greenfield airports are getting developed at Kochi, Hyderabad and Bangalore with major
shareholding of private sector. The work on Bangalore airport is likely to commence shortly.

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Few selected non-metro airports are likely to be privatized.100% foreign equity has also been
allowed in construction and maintenance of airports with selective approval from Foreign
Investment Promotion Board.

Air movements: The total aircraft movements handled in October 2003 has shown an increase
of 15.4 percent as compared to the aircraft movement handled in October 2002. The international
and domestic aircraft movements increased by 15.4 percent each during the period under review.
The reason for increase in aircraft movements is due to increase of operation of smaller aircraft
by airlines and the introduction of new airlines viz., Air Deccan in southern region and
international airlines (Air Canada, Polar Air Cargo, Qatar Airways (Freighter), Turkish Airways,
Air Slovakia at IGI Airport with effect from October 2003.

Passenger Traffic: International and Domestic passenger traffic handled in October 2003 has
increased by 15.4 percent and 6.7 percent over the period of October 2002 leading to an overall
increase of 9.4 percent. The total passenger increased by 9.2 percent, 7.6 percent, 8.9 percent
and 17.0 percent respectively at five international airports six developing international airports,
eight custom airports and 26 Domestic airports.

Cargo Traffic: The total cargo traffic handled in October 2003 has shown an increase of 3.5
percent as compared to the cargo handled in October 202. The international and domestic cargo
traffic increased by 4.3 percent and 2.1 percent respectively during the period.

India's domestic aviation market expansion has been the strongest in the world - tripling in the
past five years, according to the International Air Transport Association’s (IATA) report. India
has also signed the bilateral Aviation Safety Agreement (BASA) with the USA.

India is currently the ninth largest aviation market in the world, according to a RNCOS report
“Indian Aerospace Industry Analysis”. The Government's open sky policy has attracted many
foreign players to enter the market and the industry is growing in terms of both players and the
number of aircrafts. Given the strong market fundamentals, it is expected that the civil aviation
market will register a compound annual growth rate (CAGR) of more than 16 per cent during
2010-2013. India's domestic air traffic grew at a rate, which is the second highest after Brazil,
according to global figures for June 2011, compiled by IATA. The country's domestic traffic
grew by 14 per cent in the same period as against Brazil's 15.1 per cent.

Indian airlines reported a continuous growth trend and a strong domestic passenger growth rate
of 22.3 per cent in July 2011. Passenger traffic has grown at 18 per cent year on year (y-o-y)
basis and the year 2010 closed at 90 million passengers both domestic and international. India is
the fastest growing aviation market and expected to be within 4-5 big aviation markets by 2020
and 3rd in terms of domestic market after US and China.

In July 2011, airlines in India handled 5 million domestic passengers, according to data released
by the Directorate General Civil Aviation (DGCA) on September 12, 2011, marking the 11th
consecutive month of double-digit growth. India’s domestic market has witnessed passenger
growth for 26 consecutive months now. In July 2011, India’s airlines handled 1.3 million
international passengers, an increase of 8.5 per cent y-o-y, according to DGCA.
Passengers carried by domestic airlines during Jan-Aug 2011 were 39.63 million as against 33.41
million during the corresponding period of previous year thereby registering a growth of 18.6 per
cent, according to data released by DGCA.

India is expected to cross the 450 million mark of domestic passengers by 2020. During the last
two decades from a fleet of only about 100, the scheduled operators now have reached 435
aircrafts connecting the nation and the world.

Private carriers are anticipated to post a combined profit of US$ 350–US$ 400 million for the
fiscal years 2011-12, as reported by Centre for Asia Pacific Aviation (CAPA) India, in its 2011-
12 - Aviation Industry outlook. Domestic capacity is also projected to grow by 12-14 per cent for
the assessment period.

The Role of Aviation Industry in India GDP in the past few years has been phenomenal in all
respects. The Aviation Industry in India is the most rapidly growing aviation sector of the world.
With the rise in the economy of the country and followed by the liberalization in the aviation
sector, the Aviation Industry in India went through a complete transformation in the recent
period.

Role of Aviation Industry in India GDP-Facts

• With the entry of the private operators in this sector and the huge cut in air prices, air
travel in India were popularized
• On February 18, 1911, the first commercial flight was made from Allahabad to Naini by
a French pilot named Monseigneur Piguet

Role of Aviation Industry in India GDP-Growth Factors

• The growth in the Indian economy has increased the Gross Domestic Product above 8%
and this high growth rate will be sustained for a good number of years
• Air traffic has grown enormously and expected to have a growth which would be above
25% in the travel segment
• In the present scenario around 12 domestic airlines and above 60 international airlines are
operating in India
• With the growth in the economy and stability of the country India has become one of the
preferred locations for the trade and commerce activities
• The growth of airlines traffic in Aviation Industry in India is almost four times above
international average
• Aviation Industry in India have placed the biggest order for aircrafts globally
• Aviation Industry in India holds around 69% of the total share of the airlines traffic in the
region of South Asia

Role of Aviation Industry in India GDP-Future Challenges

• Initializing privatization in the airport activities
• Modernization of the airlines fleet to handle the pressure of competition in the aviation
industry
• Rapid expansion plans for the major airports for the increased flow of air traffic
 • Immense development for the growing Regional Airports
Role of Aviation Industry in India GDP-FDI Policy
The Reserve Bank of India (RBI) announced that foreign institutional investors might have
shareholdings more than the limited 49% in the domestic sector.

Airports

Foreign equity up to 100% is allowed by the means of automatic approvals pertaining to
establishment of Greenfield airports

Foreign equity up to 74% is allowed by the means of automatic approvals pertaining to
the existing airports

Foreign equity up to 100% is allowed by the means of special permission from Foreign
Investment Promotion Board, Ministry of Finance, pertaining to the existing airports

Air Transport Services

Up to 49% of foreign equity is allowed by the means of automatic approvals pertaining to
the domestic air transport services

Up to 100% of NRI investment is allowed by the means of automatic approvals
pertaining to the domestic air transport services

OVERVIEW OF GROWTH OF AVIATION INDUSTRY

Growth Potential
In India, the industry sector continues to look promising. The liberalization of the Indian aviation
sector in the mid nineties resulted in significant growth due to the entry of private service
airlines. There was, and continues to be a strong surge in demand by domestic passengers, due
primarily to the burgeoning middle class with its massive purchasing power, attractive low fares
offered by the low cost carriers, the growth of domestic tourism in India and increasing outbound
travel from India. In addition, the Government has also focused on modernizing non-metro
airports, opening up new international routes, establishing new airports and renovating existing
ones. Some estimate industry growth at 25% YoY.

Unfortunately, most major airline operators in India such as Air India, Indian Airlines, Jet
Airways and Kingfisher Airlines have reported large losses since 2006, due to high aviation
turbine fuel (ATF) prices, rising labor costs and shortage of skilled labor, rapid fleet expansion,
and intense price competition. The problem was also compounded by new players entering the
industry even before the existing players could stabilize their operations. As a result of the
already weak domestic scenario, the airlines suffered even further when the recession, which
exacerbated all these factors, hit. Suffice to say, though that the Indian aviation industry has been
more resilient than its global counterparts.

Despite many private airlines being in the red, the industry itself remains robust. According to
Kapil Kaul, CEO India & Middle East, Centre for Asia Pacific Aviation (CAPA), India's civil
aviation passenger growth is among the highest in the world. “The sector is slated to cruise far
ahead of other Asian giants like China or even strong economies like France and Australia. The
number of passengers who will be airborne by 2020 is a whopping 400 million.” To keep pace
with this accelerated demand, existing players have been trying to increase fleets and widen their
footprint to regional destinations as well.

MAJOR COMPANIES IN THE INDUSTRY

An aircraft maintenance engineer (AME) is a licensed professional whose duties include daily
inspection and routine servicing of aircrafts to ensure that they fulfill national and international
aviation standard

Aviation - Market Players

• During July 2011, Vijay Mallya-promoted Kingfisher was the largest domestic
standalone carrier with around 1.1 million passengers, based on CAPA calculations. Jet
Airways/JetLite had a combined passenger level of 1.2 million passengers, or around 26
per cent of the market

• IndiGo started its international air services from September 1, 2011 after completing the
mandatory five years of wholly domestic operations. The low cost carrier (LCC), the
largest in the domestic Indian market, marks the start of its foray into international
markets with direct services to Dubai, followed by Singapore and Bangkok in the first
phase – connecting all key global business hubs

• Dubai's first low cost airline, flydubai, will start flights to the city of Ahmedabad in
Gujarat from August 27, 2011. Ahmedabad is the world's third fastest growing city in the
world and it will become the third Indian city on flydubai's rapidly expanding network.
The airline will offer seats from Ahmedabad to Dubai beginning at Rs 7,500 (US$
156.25) inclusive of taxes and seven kilograms of hand baggage. The flights will operate
once in a week on Saturdays only.

• Hyderabad-based GVK Power & Infrastructure would be paying Rs 114 (US$ 2.37) for
each equity share to Siemens Project Ventures to buy the latter's 14 per cent stake in
Bengaluru International Airport Ltd (BIAL)

Name of the players Market

Share
Kingfisher Airlines and Kingfisher Red (previously Air 28%
Deccan)
Jet Airways and Jet Lite (previously Air Sahara) 25%
Air India and Indian (previously Indian Airlines) 16%
IndiGo 14%
SpiceJet 12%
GoAir 3%
 Paramount Airways 2%
MDLR Airlines 0.004%

Commenced Ceased
Airline Headquarters
Operations Operations
Air Services of India 1936 1953 Kolkata

Airways (India) Limited 1945 1955 Kolkata

Archana Airways 1991 1999 New Delhi

Bhaarat Airways 1995 1999 Mumbai

Crescent Air Cargo 2000 2006 Chennai

Damania Airways 1993 1996 Kolkata

Deccan Airways 1992 2004 Mumbai

Darbhanga Aviations 1950 1962 Kolkata

East-West Airlines 1992 1995 Mumbai

Elbee Airlines 1995 2001 Mumbai

Gujarat Airways 1995 2001 Ahmedabad

Himalayans Air Transport & Survey

1934 1935 Kolkata
Limited

Himalayan Aviation 1948 1953 Kolkata

Indian 1953 2011 New Delhi

Indian National Airways 1933 1945 Kolkata

Indian Overseas Airlines 1947 1950 Mumbai

Indian State Air Service (ISAS) 1929 1931 Kolkata

Indian Transcontinental Airlines 1933 1948 Kolkata

Indus Airways 2006 2007 New Delhi

Irwaddy Flotilla & Airways 1934 1939 Chennai

Jupiter Airways 1948 1949 Mumbai

MDLR Airlines 2007 2009 New Delhi

ModiLuft 1994 1996 Mumbai

Sahara Airlines 1991 2006 Mumbai

Skyline NEPC 1947 1960 Chennai

Orient Airways 1946 1953 Kolkata

Tata Airlines 1932 1946 Mumbai

Vayudoot 1981 1997 New Delhi

VIF Airways 1993 1996 Mumbai

Vijay Airlines 1981 1997 Chennai

Paramount Airways 2005 2010 Chennai

Jet Airways:
This airline offers services to different countries like India,Hong Kong ,Italy , Japan ,Kenya,
Kuwait,Malaysia, Mauritius, Nepal,New Zealand ,Oman, Philippines ,Qatar ,Singapore and
many more places.It also provides domestic as well as international services.

Airsahara.net:
They have been in the business for over a decade and have made a secure place for themselves
in the domestic airlines industry. Take a look at the number of fleet they have. If you want a
career with them, find out what vacancies they have. You can easily view the facilities they
provide for their flyers and also all the special offers that they give. Find out now.

Book.goindigo.in:
Planning a trip? Want to go for affordable flights? Well, Indigo airline has the perfect solution
for you. Browse through their site and find out which routes they ply in and plan your trip
easily. Check flight status, ask questions at their information center or simply check the site for
its features. Visit the site now.

Spicejet.com:
Spice jet allows you travel cheap as well as in style. Now you can travel to a lot of places at not
so high price. Book your flight with this domestic airline and have a nice trip. Check spice
destinations and also get travel tips from them. They are here with the mission to become India’s
preferred low cost airline. Their high investment in safety and high level of maintenance will
take them a long way. Find out more from the site.
Jetairways.com:
Claiming to be the most preferred airline, Jet Airways has soared to new heights. View their site
to find out the routes they ply in. Look for the facilities this domestic airline provides. Do not
miss out on the new offers that they give you. Book your tour with Jet Airways and relax all the
way to your destination. Have a nice trip. Take a look.

Flykingfisher.com:
With them flying is an experience beyond just getting from one place to another. When you want
to fly in style, you fly Kingfisher. They put a lot of stress on flyer safety and in gaining their
trust. See the flight schedules online. If you are a travel agent you can become a member. There
are a horde of services that this domestic airline offers. Take a look to find out about all of them.

Paramountairways.com:
This domestic airline plies all over south India. So if you are traveling anywhere between
Bangalore and Vishakapattanam don’t forget to check out their flight details. You may retrieve
your booking at any point of time. Find a flight, create a profile, track a flight or check in with
the internet, you can do all of this in this site. Hurry up and take a look now.

Go air. in:
Still in its nascent stage, Go Air is quietly making a place for itself. It does not however cover all
the sectors like all the other big airlines. But for a start they have covered quite a big sector. Take
a look at their site and find out. Locate Go outlets in your city and find out fares with this airline.
Take a look now.

LITERATURE REVIEW
There are various strategic and financial objectives that influence mergers and acquisitions. Two
organizations with often different corporate personalities, cultures and value systems are bought
together. The terms ‘mergers’ and ‘acquisitions’ are often used interchangeably. In lay parlance,
both are viewed as the same. However, academics have pointed out a few differences that help
determine whether a particular activity is a merger or an acquisition.

A particular activity is called a merger when corporations come together to combine and share
their resources to achieve common objectives. In a merger, both firms combine to form a third
entity and the owners of both the combining firms remain as joint owners of the new entity
(Sudarsanam, 1995)[1].

An acquisition could be explained as event where a company takes a controlling ownership

interest in another firm, a legal subsidiary of another firm, or selected assets of another firm. This
may involve the purchase of another firm’s assets or stock (Donald M. DePamphilis, 2008)[2].
Acquiring all the assets of the selling firm will avoid the potential problem of having minority
shareholders as opposed to acquisition of stock. However the costs involved in transferring the
assets are generally very high. There is another term, ‘takeover’ which is often used to describe
different activities.
Takeover is slightly different than acquisition however the meaning of the later remaining the
same. When the acquisition is forced in nature and without the will of the target company’s
management it is known as a takeover. Takeover normally undergoes the process whereby the
acquiring company directly approaches the minority shareholders through an open tender offer to
purchase their shares without the consent of the target company’s management. In mergers and
acquisitions scenario the terms mergers, acquisitions, takeover, consolidation and amalgamation
are used interchangeably (Source: Chandra, 2001)[3].

Mergers of corporations in similar or related product lines are termed as horizontal mergers.
These mergers lead to elimination of a competitor, leading to an increase in the market share of
the acquirer and degree of concentration of the industry (M&A, Milford Green, 1990)[51].
However there are strict laws and rules being enforced to ensure that there is fair competition in
the market and to limit concentration and misuse of power by monopolies and oligopolies.

In addition to increasing the market power, horizontal mergers often tend to be used to protect
the dominance of an existing firm. Horizontal mergers also improve the efficiency and
economies of scale of the acquiring firm (Lipczynski, Wilson, 2004)[4].Recent examples of
horizontal mergers in the international market are those of the European airlines. The Lufthansa-
Swiss International link up and the Air France- KLM merger are cases of horizontal mergers
(Lucey, Smart and Megginson, 2008)[5].Horizontal mergers have been the most important and
prevalent form of merger in India. Various studies like those of Beena, 1998[6] has revealed that
post 1991 or post liberalisation more than 60% of mergers have been of the horizontal type as
cited in Mehta, 2006[7]. Recently there have been many big mergers of this type in India like
Birla – L&T merger in the cement sector.

The aviation sector has also witnessed quite a few such mergers like the Kingfisher airline –
Air Deccan merger and the Jet Airways – Air Sahara merger.

A vertical merger is the coming together of companies at different stages or levels of the same
product or service. Generally the main objective of such mergers is to ensure the sources of
supply (Babu, 2005)[8].In vertical mergers, the manufacturer and distributor form a partnership.
This makes it difficult for competing companies to survive due to the advantages of the merger.
The distributor need not pay additional costs to the supplier as they both are now part of the same
entity (learnmergers.com). Such increased synergies make the business extremely profitable and
drive out competition. Purchase of automobile dealers by manufacturers like Ford and Vauxhall
are examples of vertical mergers. Ford’s acquisition of Hertz is an example of a vertical merger
(Geddes, 2006)[9]. The acquisition of Flag Telecom by Indian telecom company Reliance
Communications Ltd was a very significant vertical merger.

Conglomerate mergers occur between firms that are unrelated by value chain or peer
competition. Conglomerates are formed with the belief that one central office would have the
know-how or knowledge and expertise to allocate capital and run the businesses better than how
they would be run independently (Robert Bruner, 2004)[10]. The main motive behind the
formation of a conglomerate is risk diversification as the successful performers balance the badly
performing subsidiaries of the group (Brian Coyle, 2000)[11]. Conglomerate mergers can also be
explained as a merger between companies which are not competitors and also do not have a
buyer seller relationship. The general observation has been that such conglomerate mergers are
not very successful. Where only a few conglomerates like General Electronics (GE) have been
successful, most others have failed (Patrick Gaughan, 2007)[12].

Such acquisitions are not very commonly discussed while classifying mergers and acquisitions.
Such acquisitions are driven by the financial logic of transactions. They generally fall under
either Management Buyouts (MBOs) or Leveraged Buyouts (LBOs) (H. Ross Geddes, 2006)[9].

Factor affecting mergers change with the changing legal, political, economic and social
environments (Kaushal, 1995)[13]. Business Organization literature has identified two common
reasons which are derived out of mergers and acquisitions i.e. efficiency gain and strategic
rationale (Neary, 2004)[14]. Efficiency gain means the merger would result into benefits in the
form of economies of scale and economies of scope. Economies of scale and scope are achieved
because of the integration of the volumes and efficiencies of both the companies put together.
Secondly the strategic rationale is derived from the point that mergers and acquisition activity
would lead to change in the structure of the combined entity which would have a positive impact
on the profits of the firm. However, we shall discuss these and various other factors that lead to
mergers and acquisitions.

Synergy has been described as 2+2=5 (Pearson, 1999)[15]. In other words, the whole would be
greater than the sum of its parts (Sherman, 1998)[16]. It implies that the combined handling of
different activities in a single combined organisation is better, larger or greater than what it
would be in two distinct entities (Bakker, Helmink, 2004)[17].The word synergy comes from a
Greek word that means to co-operate or work together (Bruner, 2004)[10]. Mergers theoretically
revolve around the same concept where two corporations with come together and pool in their
expertise and resources to perform better. Estimating synergies and its effect is an important
decision in the merger process, primarily for four reasons. Firstly, mergers are meant for value
creation and hence assessing the value that would be created by the synergies is important.
Secondly, assessing how investors would react to the merger deal is another important
consideration. Thirdly, managers need to disclose these strategies and benefits of such deals to
investors and hence their perfect estimation and knowledge is important. Lastly, valuing
synergies is important for developing post merger integration strategies (Bruner, 2004)[10].
However important valuing synergies may be, practically very few companies actually develop a
transactional team, draw up a joint statement regarding the objectives of the deal or solve the
post closing operating and financial problems timely. Synergies can be further discussed as
being financial, operating or managerial synergies.

Operational synergies refer to those classes of resources that lead to production and/or
administrative efficiencies (Peck, Temple, 2002)[18]. Product related diversification mergers are
often carried out keeping operational synergies in mind. These synergies help firms bring down
unit costs due to product relatedness. Common technology, marketing techniques like common
brand and manufacturing facilities like common logistics are essentially the components of
operational synergy (Peng, 2009)[19].Operational synergy can be explained as a combination of
economies of scale, which would reduce average costs as a result of more efficient use of
resources and economies of scope, which would help a company deliver more from the same
amount of inputs (Bakker, Helmink, 2004)[17].

Financial synergy refers to the impact of mergers and acquisitions on lowering the cost of capital
of the merged or newly formed entity (DePamphilis, 2005)[20]. Financial synergies lead to
reduced cost of capital and / or increased borrowing power (Hankin, Seidner and Zietlow,
1998)[21]. Conglomerate mergers generally focus on financial synergies that increase the
competitiveness for each individual unit controlled by one centralized parent company beyond
what could have been achieved by each unit competing individually (Peng, 2009[19]). Along with
a lower cost of capital, financial synergies also bring about a larger capital base which helps
funding of larger investments. In case of conglomerate mergers, financial diversification can
bring about various other advantages like more stable cash flows, lower performance variations,
insurance gains and other tax advantages (Bakker, Helmink, 2004)[17]. Financial synergies are
possible between related and unrelated firms unlike operational synergies that take place only
between related firms. (Source: Peck, Temple, 2002).

Managerial synergy refers to the increased efficiency as a result of management teams of two
firms coming together. Often management teams have different strengths and their coming
together could result in improved managerial expertise (Ross,Westerfield, Jaffe, 2004)[22].These
synergies occur when competitively relevant skills possessed by managers of previously
independent companies can be successfully transferred to the merged entity (Hitt, Harrison,
Ireland, 2001)[23].

Growth is imperative for any firm to succeed. This growth can be achieved either through
organic or inorganic means. However, mergers (inorganic) are considered a quicker and a better
means of achieving growth as compared to internal expansions (organic). Along with additional
capacity, mergers bring with them additional consumer demand as well (Sloman, 2006)[24].

One argument often presented in favour of mergers is that they help in diversifying the group’s
lines’ of businesses and hence helps reduce risk. Risk could be interpreted as risk from the point
of view of shareholders, lenders i.e. insolvency risk, business risk, etc.

Mergers can benefit the corporations and individuals in their own way by helping them reduce
the tax bill. However, with stricter laws, undue advantage taken by corporations of tax reduction
can be managed. Often large profitable corporations merge with certain loss making ones to help
them take advantage of reduced expenditure on taxation. However, small shareholders of
acquired companies tend to receive substantial tax benefits on merger with large corporations.

There is a tendency among managers, especially those of corporations where ownership and
control are distinct, to enter into mergers for the lure of a higher pay packet and more rewards.

Mergers are often carried out to achieve a better standing in the market by means of an increased
market share and by becoming a leading player in the concerned sector. Reducing competition is
another key concern when contemplating mergers. Often it is necessary to protect a key source of
supply from a competitor which can be done through mergers.
Empirical Studies Regarding Post Merger Performances
Several researchers have tried to study the performances of acquiring firms post the merger.
However, there has been no concrete conclusion or consensus regarding the same. The most
popular forms of empirical studies are event studies, accounting studies, clinical studies and
executive surveys.

From most of the studies conducted till date, it only appears that mergers do not improve the
financial performance of the acquirers.

Event studies and accounting studies as such point to the fact that these gains are either small or
nonexistent. However, it must also be noted that there have been studies conducted that show
that post merger performance also largely depends on the industry or sector and cannot be
generalized.

Accounting Studies
This method involves the study of financial statements and ratios to compare the pre merger and
post merger financial performance of the acquiring company. It is also used to study whether the
acquirers outperformed the non acquirer’s .Various ratios like return on equity or assets; EPS,
liquidity, etc are studied. Whether a merger actually improves the operating performance of the
acquiring company is uncertain, but mostly leads to a conclusion that mergers do not really
benefit in improving operating performances. A research conducted on Indian companies also
showed no real signs of better post merger operating performance of the acquiring company.

Causes of Failures
There could be many causes of failed mergers and acquisitions. It is most likely that a failed
merger would be a result of poor management decisions and overconfidence. There could be
personal reasons considering which managers tend to enter into such activities and hence tend to
ignore the primary motive of mergers, creating shareholder value. Sometimes however, good
decisions may also backfire due to pure business reasons. These factors can be summarized by
the following points.

Overpayment
A very common cause of failed mergers is overpayment. This situation arises essentially due to
overconfidence or the urge for expansion. Overpayment often has disastrous consequences.
Overpayment leads to expectations of higher profitability which is often not possible. Excessive
goodwill as a result of overpaying needs to be written off which reduces the profitability of the
firm.

Integration issues
It is rightly said that “Few business marriages are made in heaven” (Sadler, 2003)[25].Both
merging companies need to be compatible with each other. Business cultures, traditions, work
ethics, etc. need to be flexible and adaptable. Inefficiencies or administrative problems are a very
common occurrence in a merger which often nullifies the advantages of the merger (Straub,
2007)[26]. Often it is necessary to identify the people needed in the future to see the merger
through. There must be some urgency between the parties and good communication between
them. Due to lack of these qualities, mergers often do not produce the desired results (Sadler,
2003)[25].

Personal Motives of Executives

Managers often enter into mergers to satisfy their own personal motives like empire building,
fame, higher managerial compensation, etc. As a result, they often lose focus on the fact that they
need to look at the strategic benefits of the merger. As a result, mergers that do not necessarily
benefit the organisation are entered into. These executives enter into these mergers for the
purpose of seeking glory and satisfying their ‘executive ego’, leading to failure of mergers.

Selecting the target

Selecting the appropriate target firm is an extremely important stage in the merger process.
Executives must be able to select the target that suits the organizations strategic and financial
motives and needs. Often the incapability or lack of motivation and interest on the part of
executives leads to incorrect target selection. Lubatkin (1983)[50] very appropriately said that
selecting a merger candidate may be more of an art than a science (Straub, 2007)[26].

Strategic Issues
Strategic benefits should ideally be the primary motive of any merger activity. However,
managers sometimes tend to overlook this aspect. Faulty strategic planning and unskilled
execution often leads to problems. Over expectation of strategic benefits is another area of
concern surrounding mergers. (Schuler, Jackson, Luo, 2004)[27]. These issues which form the
core of all merger activities are not addressed adequately leading to failures of mergers.

PROBLEM STATEMENT
It is said that a problem which is well defined is half solved. The main problem area which the
research is testing related to the subject of mergers and acquisitions.

In this, we want to investigate whether mergers and acquisitions have an impact on the operating
performance of the acquiring firm and does it create wealth for the shareholders.

This problem stems from the fact that there have been mergers and acquisitions which have
created wealth only for the acquiring firms and few have created wealth for only the target firms.

Likewise mergers and acquisitions have sometimes benefitted the shareholders of only the target
company and vice versa. We are trying to find out whether mergers and acquisitions impact the
operating performance of the acquiring firm and enhance shareholder wealth.

Aim of the Research

‘The main aim of the research is to analyze the feasibility and the impact of mergers and
acquisitions on the operating performance of the firm’.
DATA & ANALYSIS
The Indian airline industry underwent liberalization in the year 1990 when the private sector
companies were allowed to start its business. Many companies like Damania, East-West, Air
Sahara and NEPC entered the market but after nearly a decade none of them survived. However
in today’s scenario there have been number of private airline companies operating in this sector
with players like Air Deccan, Kingfisher, Jet Air, Go Air, Spice Jet and many other players. The
Indian aviation has only two Government controlled airline companies i.e. Air India and Indian
Airlines. Sahara Airlines is one of the oldest private sector airline companies in India which
commenced business in 1991 and then was rebranded as Air Sahara in 2000. Similarly the
government owned domestic airline company Indian Airlines was rebranded as ‘Indian’ under its
plan to revamp the position in the airline industry. Later the government announced the merger
of Air India and Indian which would build an airline giant in India. Jet Airways is one private
player which operated both on domestic and international routes in India and holds a major share
in the aviation industry in India. Spice Jet, Go Air and Air Deccan are the low cost no frill airline
companies in India. Kingfisher airlines was being considered as the closest competitor to private
players and it operates in both domestic and international routes.

Strategic alliance and mergers have been one of the buzz words in the airline industry. According
to Oum, Park and Zhang (2000)[28] for the airline industry ‘strategic alliances refer to a long term
commitment and partnership with two or more companies who attempt to gain competitive
advantage collectively by fighting their competitors by sharing resources, cutting costs and
improving profitability.

The following is the market share of different airline companies in the year 2008.

Indian Jet
18% 24%
Jet
Jet Lite
K Red
Indigo Jet Lite Kingfisher
10% 9% Spice Jet
Go Air Paramount
3% Go Air
Paramount
Indigo
2%
Indian
Spice Jet K Red
Kingfisher 10%
9%
15%
KINGFISHER AIRLINES AND AIR DECCAN MERGER
One of the significant moves in the airline industry was the merger between Air Deccan, the first
low cost carrier in India and Kingfisher Airlines. Air Deccan has created waves in the airline
industry by offering people the lowest cost flying experience and shifted rail travelers to airline
travelers.

However Air Deccan and Kingfisher Airlines have now merged and known as Kingfisher
Aviation. The merger started when Kingfisher Airlines owner Dr. Vijay Mallya bought 26%
controlling stake in Air Deccan.

Synergy

The combined entity now has a fleet size of 71 aircrafts covering 70 destinations and more than
550 flights in a single day. The merger would benefit the entity by offering operational synergies
like inventory management, maintenance, engineering and overhaul which would reduce the
overall cost by 4% to 5% i.e. around 300 million (Financial Express, 2007)[29]. Further the
company would be able to rationalize its routes in a better way by changing its fare structure
which will attract more passengers (Business Standard, 2007)[30]. The merged entity would also
have clear business model with reaching wider domestic base with Air Deccan capabilities and
Kingfisher Airlines would reach international destinations.

Synergies can be seen in two directions, financial and operational. On operational grounds this
merger would help Kingfisher expand its international base as it finishes 5 year mandatory
period to fly domestic before getting an international license. Secondly on financial grounds it
would mean a lot to Kingfisher because of savings on operation cost. With the growth expected
in the industry, the combined entity would make better profits in the coming years. Other reasons
for merger with Air Deccan was totally logistical like both the companies have the same
maintenance contract with Lufthansa Tecknik, both the companies have Airbus fleet and same
types of engines and brakes.

Financial Analysis
The merger between Kingfisher Airlines and Air Deccan took place in the year 2006. Hence
below analysis has been done two years prior to the merger i.e. during 2004-05 and 2005-06 and
two years after the merger i.e. 2007-08 and 2008-09 respectively.

Kingfisher Airlines 2004-05 2005-06 2006-07 2007-08 2008-09

Operating Profit Margin 10.2% -1.3% -21.9% -51.5% -26.5%
Gross Operating Margin -4% -24.6% -21% -47.8% -33.9%
Net Profit Margin -6.4% -27.5% -23.6% -13.1% -30.5%
Return on Capital Employed 15.4% -9.8% 7.5% -19.6% -24.4%
Return on Net Worth -143% -347.5% -287.4% -129.8% -809%
Debt-Equity Ratio 20.8 4.6 6.3 6.4 4.7
EPS -63.0 -347.5 -31.0 -13.9 -118.5
P/E -1.9 -0.3 -4.6 -9.6 -0.4
From the above ratios it can seen that before 2008 (Pre- merger) operating profit margin has
increased to 14.57 % from 10.23 % .The operating profit has increased to 22.33 % , so we called
it a successful merger. However, due to recession it has decreased to 10.50 %. From the above
ratios it can be seen that before 2008 (Pre- merger) Net profit margin has decreased over a period
of time. We called it a successful merger. Because net loss margin has decreased .However, due
to recession Net loss margin increased to (30.53) %. The figure of net worth has increased to
384.7 crores which was decreased after merger and due to the recession time it has decreased to
(2125.34) crores and debt to equity ratio has come closer to 2.66:1 which is near to ideal ratios.
To sum up, It was indeed a good deal Here, no of shares has increased which directly affected
the EPS of the company which resulted in to loss of the company in terms of per share `Of
(72.33).
Above ratios depicts that there is direct relationship between market price and EPS as both
figures were decreasing which resulted in to negative price to earnings ratio. Return on net worth
has increased to 75.7 % which attracts the investors to continue with the company and new
investors to put their money in company’s equity. From the above ration efficiency and
profitability of a company's capital investments has determined which is fluctuated over a period
of time. It was 10.62 % in June 2006 which comes to 63.54 %. So , there is overall increased in
return on capital employed .ROCE as currently defined is erroneous and capable of misleading
investors and other interested parties on the performance of an enterprise

JET AIRWAYS & AIR SAHARA MERGER

Jet Airways started its business operations in 1993 and is now the largest company in the airline
industry in terms of market share. The company has a fleet size of 88 aircraft and flies over 60
destinations worldwide with over 360 flights scheduled for a single day.

Synergy

Fleet Jet Airways Air Sahara Merged Entity

B737-300 - 2 2
B737-400 6 3 9
B737-700 13 7 20
B737-800 28 7 35
B737-900 2 - 2
CRJ-200 - 7 7
ATR-72 8 - 8
A330-200 2 - 2
A340-300 3 - 3
TOTAL 62 26 88
The major efficiency and synergy comes because both the companies use B737 as their domestic
fleet efficiencies. Air Sahara has B737s which are more than 10 years old and CRJ-200 which
were taken on lease for higher rentals. Jet Airways will have to rationalize the cost aspect of
operating and maintaining the fleet size. Since Jet Airways does not have a proper mix of
aircrafts this would lead to higher maintenance cost for merged entity.

Financial Analysis

The acquisition between Jet Airways and Air Sahara took place in the year 2006. Hence below
analysis has been done two years prior to the merger i.e. during 2004-05 and 2005-06 and two
years after the merger i.e. 2007-08 and 2008-09 respectively.

Jet Airways 2004-05 2005-06 2006-07 2007-08 2008-09

Operating Profit Margin 33.2% 24.8% 14.7% 8.6% 5.2%

Gross Operating Margin 24% 19.8% 6.6% 4.1% -6.4%

Net Profit Margin 9% 7.9% 0.4% -2.9% -3.5%

Return on Capital Employed 31.6% 21.2% 13.8% 6.3% 4%

Return on Net Worth 22.4% 21.1% 1.3% -13.7% -31.1%

Debt-Equity Ratio 1.7 2.3 2.9 6.5 12.6

EPS 45.4 52.4 3.2 -29.3 -46.6

P/E 27.6 18.5 195.8 -17.7 -3.3

On carefully looking at the above figures it can be seen that the operating margins of Jet Airways
were very strong in the year 2004-05. Later the operating margins started slowing down in the
coming years. Post merger the operating margins of Jet Airways had gone down to 5.2% from an
earlier five year high of 33.2%. Gross Profit margin was very strong at 24% in 2004-05 however
post merger it has moved into a negative territory of (6.4%). Return on capital employed proves
the efficiency with which the business is maintained. Looking at the post merger results the
shareholders who act as owners would surely be disappointed with only 4% return compared to
31.6% in 2004-05. Similarly the return on Net Worth for the company has also gone negative
and post merger it has not added any significant value for shareholders. The debt-equity ration of
the firm at the current level is around 10 times higher than in the year 2004-05 which shows the
level of leverage which the company wants to drive on. The EPS which is the crude factor for
any shareholder has seen a dip of -46.6%. Looking at the P/E ratio clearly shows that the stock
has been highly undervalued and shareholders wealth has been deteriorated.
Overall it can be seen that Jet Airways has been able to post positive operating margins post
mergers however Kingfisher Airlines have failed to do that. Kingfisher Airlines also has a
negative return on capital employed compared to Jet Airways. But on other parameters like EPS,
Return on Net Worth and Net Profit Margin have been negative for both the companies. It can be
thus inferred that mergers and acquisitions have not created enough shareholder wealth post
merger.

CONCLUSION
In 2007 alone, Indian aviation saw three mergers -- Kingfisher Airlines acquiring Air Deccan at
Rs 550 crore (Rs 5.5 billion) and Jet Airways acquiring Air Sahara at Rs 1,450 crore (Rs 14.5
billion) besides the forced merger of national carriers Air India and Indian Airlines. Industry
analysts say Kingfisher's merger with Air Deccan gave the merged entity rights to fly
international.

After considering the state of Jet Airways and Air Sahara along with the scenario of the Indian
Aviation Industry this acquisition was a good decision taken at the right time. This move further
strengthened the position of Jet Airways and helped it fight with the other competitors and
maintain its market leadership. Also Air Sahara found an easy bailout option to clear its debts.
Thus this deal was beneficial for both Jet Airways and Air Sahara.

Jet-Sahara or Kingfisher-Deccan and Air India-Indian Airlines had different corporate cultures.
This makes a merger process difficult. Fortunately, Jet Airways has kept JetLite as a subsidiary.
"Otherwise they would have killed the airline."
However, some feel that apart from the reasons cited above, external factors like slowdown in
the Indian aviation market because of recession have contributed to the failure of the merger.

Post merger the operating margins of Jet Airways had gone down to 5.2% from an earlier five
year high of 33.2%. Gross Profit margin was at a very strong 24% in 2004-05 however post
merger it has moved into a negative territory of (6.4%). Return on capital employed proves the
efficiency with which the business is maintained. Looking at the post merger results the
shareholders who act as owners would surely be disappointed with only 4% return compared to
31.6% in 2004-05. Similarly the Return on Net worth for the company has also gone negative
and post merger it has not added any significant value for the shareholders.

Shareholders wealth of Kingfisher airlines has deteriorated significantly post merger with Air
Deccan. The P/E ratio of the firm also states that the stock has been undervalued over the years
and does not look that an immediate upward movement in share price or EPS basis which the
P/E will go up.

Overall it can be seen that Jet Airways has been able to post positive operating margins post
merger however Kingfisher Airlines have failed to do that Kingfisher Airlines also has a negative
return on capital employed compared to Jet Airways. But on the other parameters like Earnings
per share, Return on Net Worth and Net Profit Margin have been negative for both the
companies. It can thus be inferred that mergers and acquisitions have not created enough
shareholder wealth post merger.
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Appendix 1:

KINGFISHER INCRORE 2004-05 June 2006 June 2007 March March 20009
AIRLINES 20008
Operating Profit Operating profit 31.28 -113.44 -262.4 -325.18 -553.2
Margin Net Sales 305.55 1285.42 1800.21 1456.28 5269.17

Net Profit Margin Net Profit -19.53 -340.55 -419.58 -188.14 -1608.83
Net Sales 305.55 1285.42 1800.21 1456.28 5269.17
Return On capital EBIT 20.11 -150.97 -290.91 155.16 174.37
Employed Capital 189.37 241.75 852.25 445.95 -274.42
Employed
Return On Net Worth Net Profit -19.53 -340.55 -419.55 -188.14 -1608.83
Net Worth 13.66 224.13 384.7 198.88 -2125.34

Debt-Equity Ratio Debt 284.48 451.66 916.71 934.38 5665.56

Equity 13.66 224.13 384.7 198.88 -2125.34

EPS PAT -19.53 -340.55 -419.58 -188.14 -1608.83

No. Equity 1,553,226 49,904,959 99,326,445 135,668,051 222,434,428
Share

PE MPS 85.85 137.65 122.05 33.25

EPS -68.23 -42.24 -13.87 -72.33
Appendix 2:

JET AIRWAYS INCRORE 2004-05 2005-06 2006-07 2007-08 2008-09

Operating Profit Margin Operating profit 1461.39 1431.64 1037.12 755.1 601.83
Net Sales 4338.01 5693.73 7057.78 8811.1 11,571.15
Net Profit Margin Net Profit 391.99 452.04 27.94 -253.06 -402.34
Net Sales 4338.01 5693.7 7057.78 8811.1 11,571.15

Return On capital EBIT 1212.68 1071.08 873.1 734.71 310.29

Employed Capital 3895.11 5801.42 6072 12394.15 16198.98
Employed

Return On Net Worth Net Profit 391.99 452.04 27.94 -251.86 -402.34
Net Worth 1750.89 2143.86 2104.81 1851.75 1294.65

Debt-Equity Ratio(lakh) Debt 2,964.84 4,895.6 6,056.3 12,015.04 16,323.53

Equity 1,750.84 2,143.86 2,104.81 1,851.75 1,294.65

EPS PAT 391.99 452.04 27.95 -251.86 -402.34

No. Equity Share 7.298 8.633 8.633 8.633 8.633

PE MPS 1210.05 933.4 647.75 557.5 172.9

EPS 45.78 52.1 3.23 -29.31 -46.4