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 4.50 3.00 92.50 57.00 Output Category U.S. risk free in % U.S. risk premium in % Current U.S. Credit Rating 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) Impact on Country Premium Weights Score 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 0.13 Resource risk -0.15 Technology risk Financial 0.13 Probability of Default 0.00 Political Risk Insurance Sum of weights (make sure = 1.00) 17.03

0.05 0.03

-3.00 7.00

0.05 0.03 1.00

-3.00 0.00

Project Cost of Capital

Suggested Solutions
Revenue Projection

Suggested Solutions
Expense Projections
Air Deccan Expense Projections (1) Actual 2003 5.34% 1.32% 24.36% 24.74% 11.24% 14.71% 2.30% 0.47% 2004 13.72% 13.13% 15.80% 24.89% 10.61% 11.22% 1.97% 2005 29.03% 15.39% 14.09% 23.00% 9.92% 6.34% 2.00% Year ended March 31, 2006 2007 2008 30.00% 31.00% 30.00% 14.00% 14.00% 14.00% 14.00% 22.00% 10.00% 7.00% 3.00% 12.00% 20.00% 10.00% 8.00% 4.00% 10.00% 19.00% 9.00% 9.00% 4.00% Projected 2009 29.00% 14.00% 9.00% 17.00% 9.00% 9.00% 4.00% 4.00% 4.00% 4.00% 2010 28.00% 14.00% 8.00% 16.00% 8.00% 9.00% 2011 28.00% 14.00% 8.00% 16.00% 8.00% 9.00% 2012 27.00% 14.00% 8.00% 16.00% 8.00% 9.00% 2013 26.00% 14.00% 8.00% 16.00% 8.00% 9.00% Aircraft fuel expenses Aircraft/engine repairs and maintenance Aircraft/engine lease rentals Other direct operating expenses Employee remuneration and benefits Administrative and general expenses Employee stock compensation cost Advertisement and business promotion expenses Finance and banking charges Amortisation Depreciation Total Expenditure

6.46% 3.35% 1.39% 95.21%

5.74% 1.47% 1.66% 98.71%

3.19% 1.79% 0.96% 105.68%

6.00% 2.00% 3.00% 110.00%

8.00% 1.00% 7.00% 114.00%

9.00% 1.00% 10.00% 115.00%

9.00% 0.00% 8.00% 108.00%

9.00%

9.00%

9.00%

9.00%

0.00% 0.00% 0.00% 0.00% 7.00% 7.00% 7.00% 7.00% 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 2001 INCOME Total Income EXPENDITURE Preliminary expenses written off Total Expenditure Profit/(Loss) before taxation and prior period items EBITDA EBITDA Margin EBITDAR EBITDAR Margin EBIT Tax EBIT (1-t) Depreciation Amortization Capital Expenditures as a % of Sales Capital Expenditures Changes in Working Capital FCF WACC PV of FCF's Sum of FCF's Terminal Value PV of Terminal Value Enterprise Value Less Net Debt Equity Value No of shares outstanding Implied price per share 139 8 15 9.85% 62 42.42% 11 147 665 (351) (291) (92.62%) (185) (58.74%) (312) 2004 314 3,384 (715) (525) (19.65%) (73) (2.75%) (612) 2005 2,669 6,669 (112) 610 9.30% 1,528 23.30% 282 33.6% 187 197 131 20.0% (1,311) 0 (797) 15.0% (693) (3,856) 148,840 64,007 60,151 4,179 55,972 98.18 570.08 2006 6,557 11,806 (450) 1,367 12.04% 2,730 24.04% 459 33.6% 304 795 114 30.0% (3,407) 0 (2,194) 14.4% (1,676) Year Ended March 31, 2007 2008 11,356 17,314 (392) 2,992 17.68% 4,684 27.68% 1,130 33.6% 751 1,692 169 40.0% (6,769) 0 (4,157) 13.9% (2,811) 16,921 21,595 681 4,468 20.06% 6,473 29.06% 2,686 33.6% 1,784 1,782 0 37.0% (8,242) 0 (4,677) 13.3% (2,838) Projected 2009 22,276 26,234 2,494 7,091 24.68% 9,389 32.68% 5,080 33.6% 3,373 2,011 0 27.0% (7,757) 0 (2,373) 12.8% (1,298) 2010 28,728 31,453 2,935 8,437 24.53% 11,188 32.53% 6,030 33.6% 4,004 2,407 0 17.0% (5,846) 0 565 12.4% 281 2011 34,388 36,528 4,273 10,801 26.47% 14,066 34.47% 7,945 33.6% 5,276 2,856 0 7.0% (2,856) 0 5,276 11.9% 2,400 2012 40,801 42,566 5,416 13,093 27.29% 16,932 35.29% 9,735 33.6% 6,464 3,359 0 7.0% (3,359) 0 6,464 11.1% 2,780 2013 47,982

Suggested Solutions
Comparable Valuation
Comparable Company Analysis Comaparable EV/EBITDAR multiple Air Deccan 2008E EBITDAR EV Less Net Debt Equity Value No of shares outstanding Implied price per share 7.40 4,684 34,662 4,179 30,483 98 310.47 12.4 4,684 58,282 4,179 54,103 98 551.05

Thanks
If its on the map, we will get you there---Air Deccan