by Sreevidya Raman
Vijay Mallya has been in the news an awful lot lately, seemingly for all the wrong reasons. Caught in the eye of a financial storm, he is struggling to keep Kingfisher Airlines afloat. But what brought about this nasty predicament?
An industrialist and a member of Rajya Sabha, Vijay Mallya is also the chairman of the United Breweries Group, one of the largest conglomerates (a combination of various subsidiary companies operating under a single corporate structure) in India, and most importantly (in the context of this article), chairman of Kingfisher Airlines.
Established in 2003 by United Breweries, Kingfisher Airlines began its domestic operations in 2005 and international operations in 2008. Surprisingly, it has been suffering losses since day one. Since its acquisition of Air Deccan in December 2007 it suffered a stupendous loss of over Rs. 1000 crores per year for three consecutive years. Still, it boasted the second largest share in India’s domestic air travel market until December 2011. By early 2012, however, as the airline accrued losses of more than Rs. 7000 crores, its market share sunk to lower than that of any other domestic carrier.
Kingfisher’s financial woes can be attributed to a number of factors including poor management, excessive debt, and increased competition within the Indian domestic sector that gave rise to a brutal fare-war between Kingfisher and its domestic competitors like Jet Airways, SpiceJet and IndiGo. Recent fuel price hikes, depreciation of the rupee and a slowdown in the world economy in general adversely affected the aviation industry, adding fuel to the fire that was already burning at Kingfisher.
Kingfisher’s biggest mistake, in terms of management, was its decision to merge with Air Deccan so early in its own establishment. It is understood that the reason for the merge lay in the desire to evade Indian laws on restricting international flight rights for emerging carriers. Indian aviation regulations required Indian carriers to fly domestic routes for five years before catering to international markets. Hence, Kingfisher decided to merge with Air Deccan, the older of the two, to be able to fly international routes sooner.
Air Deccan was a low-fare carrier with a matching low-cost structure. After its incorporation into Kingfisher, however, its costs raced upward. According to Air Deccan Director of Finance, Mohan Kumar, this was due to rise in input costs, chiefly fuel, and the introduction of 20 new aircraft. This eliminated its profitability and thus, brought debt to Kingfisher that it simply could not afford to pay out. Thus began its miseries, leading to strike after strike by its employees as it failed to pay wages to its workers for seven months.
Both the government and banks must move swiftly to minimize losses. Indian banks need to convert Kingfisher’s debt into 100 percent equity, thus allowing the public to purchase its debt. However, this move will not recover much of the debt since there is no incentive to purchase the equities. So, the government must step in and recover the remaining by selling mortgaged shares of United Breweries and Vijay Mallya’s assets.
The most logical steps in the recovery process are:
Cartelization is when a formal agreement is reached between a small number of competing firms on matters including price-fixing and market shares. In other words, the sudden disappearance of a domestic airline could lead to collusion amongst the remaining competitors to raise prices to maximize individual firm profits.
For the long term, the situation inevitably raises the question: What measures must the government undertake in order to prevent prolonging such a disaster?
When similar situations arise in the US, the problem would be rather easily dealt with by the company filing for Chapter 11 bankruptcy protection1. The creation of a similar system is suggested by a great many in the case of the Indian government.
According to The New York Times correspondent, Vikas Bajaj, India should seriously contemplate adopting a bankruptcy system similar to the US. When a company becomes bankrupt in India, bondholders suffer significantly with only 12 percent of the debt recovered and, in stark contrast, bondholders in China recover 36 percent of the debt. In the US, a magnificent 45 percent is recovered.
One argument against the US bankruptcy system is that it allows itself to be abused by managers and owners to fire thousands of employees following a successful grounding of the company. One can, at the same time, argue that Indian managers have similar power simply because employees do not have the legal means to enforce their rights against the managers. Nor is the legal system efficient enough to reprimand the managers.
A second argument for the creation of a US-style bankruptcy system in India is that in an American bankruptcy court, fraudulent managers can be easily replaced by an independent trustee working in their place. Thus, with the restructuring of the company’s management, the bankrupt company is rebuilt brick-by-brick.
Finally, the US Bankruptcy Code has been credited for being one of the main contributors to a vibrant economy, since it encourages risk-taking. Entrepreneurs world over choose to start their companies in the US because they know that in the worst-case scenario of a bankruptcy, they will get a tap on the wrist but can very likely start over. Thus, it is of utmost importance that the legal system provide for an adequate process of dealing with corporate mistakes as swiftly and painlessly as possible — similar to ripping off a Band-Aid.
The only argument against the US Bankruptcy Code is that there exists a strict hierarchy for the distribution of whatever assets of the company remain, which is strongly biased towards the top brass. As Vikas Bajaj and Heather Timmons of The New York Times put it,
Thus, the government needs to delve into the prospect of adapting a US-type bankruptcy code. In the meanwhile, the survival of Kingfisher Airlines, and to a large extent, the domestic aviation sector, depends on the banks’ move to convert Kingfisher’s debt into equity and sell mortgaged shares. To this end, the government of India has to step in to oversee the sale of Vijay Mallya’s and the United Breweries Group’s assets.
Bajaj, Vikas, and Heather Timmons. "Do Kingfisher's Woes Call For New Bankruptcy Rules?" India Ink. The New York Times, 24 Feb. 2012. Web. 17 Oct. 2012. <http://india.blogs.nytimes.com/2012/02/24/do-kingfishers-woes-call-for-new-bankruptcy-rules/>.
"Govt Likely to Shut Kingfisher Airlines as Fleet Remains Grounded." Govt Likely to Shut Kingfisher Airlines as Fleet Remains Grounded. Jagran Post, 06 Oct. 2012. Web. 17 Oct. 2012. <http://post.jagran.com/Govt-likely-to-shut-Kingfisher-Airlines-as-fleet-remains-grounded-1349499380>.
Geary, Sean. "Kingfisher Airlines Countdown to Bankruptcy." Emerging Money. N.p., 20 Mar. 2012. Web. 17 Oct. 2012. <http://emergingmoney.com/india/kingfisher-airlines-countdown-to-bankruptcy/>.
"Investor Relations." Investor Relations. Kingfisher Airlines, n.d. Web. 17 Oct. 2012. <http://www.flykingfisher.com/investor-relations.aspx>.
Vijay Mallya has been in the news an awful lot lately, seemingly for all the wrong reasons. Caught in the eye of a financial storm, he is struggling to keep Kingfisher Airlines afloat. But what brought about this nasty predicament?
An industrialist and a member of Rajya Sabha, Vijay Mallya is also the chairman of the United Breweries Group, one of the largest conglomerates (a combination of various subsidiary companies operating under a single corporate structure) in India, and most importantly (in the context of this article), chairman of Kingfisher Airlines.
Established in 2003 by United Breweries, Kingfisher Airlines began its domestic operations in 2005 and international operations in 2008. Surprisingly, it has been suffering losses since day one. Since its acquisition of Air Deccan in December 2007 it suffered a stupendous loss of over Rs. 1000 crores per year for three consecutive years. Still, it boasted the second largest share in India’s domestic air travel market until December 2011. By early 2012, however, as the airline accrued losses of more than Rs. 7000 crores, its market share sunk to lower than that of any other domestic carrier.
Kingfisher’s financial woes can be attributed to a number of factors including poor management, excessive debt, and increased competition within the Indian domestic sector that gave rise to a brutal fare-war between Kingfisher and its domestic competitors like Jet Airways, SpiceJet and IndiGo. Recent fuel price hikes, depreciation of the rupee and a slowdown in the world economy in general adversely affected the aviation industry, adding fuel to the fire that was already burning at Kingfisher.
Kingfisher’s biggest mistake, in terms of management, was its decision to merge with Air Deccan so early in its own establishment. It is understood that the reason for the merge lay in the desire to evade Indian laws on restricting international flight rights for emerging carriers. Indian aviation regulations required Indian carriers to fly domestic routes for five years before catering to international markets. Hence, Kingfisher decided to merge with Air Deccan, the older of the two, to be able to fly international routes sooner.
Air Deccan was a low-fare carrier with a matching low-cost structure. After its incorporation into Kingfisher, however, its costs raced upward. According to Air Deccan Director of Finance, Mohan Kumar, this was due to rise in input costs, chiefly fuel, and the introduction of 20 new aircraft. This eliminated its profitability and thus, brought debt to Kingfisher that it simply could not afford to pay out. Thus began its miseries, leading to strike after strike by its employees as it failed to pay wages to its workers for seven months.
Both the government and banks must move swiftly to minimize losses. Indian banks need to convert Kingfisher’s debt into 100 percent equity, thus allowing the public to purchase its debt. However, this move will not recover much of the debt since there is no incentive to purchase the equities. So, the government must step in and recover the remaining by selling mortgaged shares of United Breweries and Vijay Mallya’s assets.
The most logical steps in the recovery process are:
- to surrender control to an independent body of professionals who can take over and manage the crisis; and
- to sell to investors when the time comes
Cartelization is when a formal agreement is reached between a small number of competing firms on matters including price-fixing and market shares. In other words, the sudden disappearance of a domestic airline could lead to collusion amongst the remaining competitors to raise prices to maximize individual firm profits.
For the long term, the situation inevitably raises the question: What measures must the government undertake in order to prevent prolonging such a disaster?
When similar situations arise in the US, the problem would be rather easily dealt with by the company filing for Chapter 11 bankruptcy protection1. The creation of a similar system is suggested by a great many in the case of the Indian government.
According to The New York Times correspondent, Vikas Bajaj, India should seriously contemplate adopting a bankruptcy system similar to the US. When a company becomes bankrupt in India, bondholders suffer significantly with only 12 percent of the debt recovered and, in stark contrast, bondholders in China recover 36 percent of the debt. In the US, a magnificent 45 percent is recovered.
One argument against the US bankruptcy system is that it allows itself to be abused by managers and owners to fire thousands of employees following a successful grounding of the company. One can, at the same time, argue that Indian managers have similar power simply because employees do not have the legal means to enforce their rights against the managers. Nor is the legal system efficient enough to reprimand the managers.
A second argument for the creation of a US-style bankruptcy system in India is that in an American bankruptcy court, fraudulent managers can be easily replaced by an independent trustee working in their place. Thus, with the restructuring of the company’s management, the bankrupt company is rebuilt brick-by-brick.
Finally, the US Bankruptcy Code has been credited for being one of the main contributors to a vibrant economy, since it encourages risk-taking. Entrepreneurs world over choose to start their companies in the US because they know that in the worst-case scenario of a bankruptcy, they will get a tap on the wrist but can very likely start over. Thus, it is of utmost importance that the legal system provide for an adequate process of dealing with corporate mistakes as swiftly and painlessly as possible — similar to ripping off a Band-Aid.
The only argument against the US Bankruptcy Code is that there exists a strict hierarchy for the distribution of whatever assets of the company remain, which is strongly biased towards the top brass. As Vikas Bajaj and Heather Timmons of The New York Times put it,
“…the first to be repaid are secured creditors like bank lenders, or equipment owners, then corporate bondholders, along with other unsecured creditors. (Along the way, bankruptcy lawyers and advisors take a very healthy cut — to the tune of more than $1 billion at Lehman Brothers, for example.)”Certainly, such a scenario cannot be allowed to pan out in India, as it would cause great unrest among labourers, who actually put in the work and are laid-off without much compensation. India already has a long and turbulent history of labour unrest due to its strict labour laws, which prevent the easy hiring and firing of labourers.
Thus, the government needs to delve into the prospect of adapting a US-type bankruptcy code. In the meanwhile, the survival of Kingfisher Airlines, and to a large extent, the domestic aviation sector, depends on the banks’ move to convert Kingfisher’s debt into equity and sell mortgaged shares. To this end, the government of India has to step in to oversee the sale of Vijay Mallya’s and the United Breweries Group’s assets.
Footnotes
1 Under Chapter 11, in a majority of cases, the debtor remains in control of their business operations as a ‘debtor in possession,’ whereby he is under jurisdiction of the court.References
Gopinath, G. R. "Banks Should Convert Their Debt into Equity, Remove Vijay Mallya to save Kingfisher Airlines: GR Gopinath." The Economic Times. N.p., 5 Mar. 2012. Web. 17 Oct. 2012. <http://articles.economictimes.indiatimes.com/2012-03-05/news/31124088_1_kingfisher-debt-kingfisher-airlines-vijay-mallya>.Bajaj, Vikas, and Heather Timmons. "Do Kingfisher's Woes Call For New Bankruptcy Rules?" India Ink. The New York Times, 24 Feb. 2012. Web. 17 Oct. 2012. <http://india.blogs.nytimes.com/2012/02/24/do-kingfishers-woes-call-for-new-bankruptcy-rules/>.
"Govt Likely to Shut Kingfisher Airlines as Fleet Remains Grounded." Govt Likely to Shut Kingfisher Airlines as Fleet Remains Grounded. Jagran Post, 06 Oct. 2012. Web. 17 Oct. 2012. <http://post.jagran.com/Govt-likely-to-shut-Kingfisher-Airlines-as-fleet-remains-grounded-1349499380>.
Geary, Sean. "Kingfisher Airlines Countdown to Bankruptcy." Emerging Money. N.p., 20 Mar. 2012. Web. 17 Oct. 2012. <http://emergingmoney.com/india/kingfisher-airlines-countdown-to-bankruptcy/>.
"Investor Relations." Investor Relations. Kingfisher Airlines, n.d. Web. 17 Oct. 2012. <http://www.flykingfisher.com/investor-relations.aspx>.
a) The recommendation that banks should convert debt to equity, thereby public can buy equity, is a dangerous proposition....which will lead many such industrialists to follow the path of fooling the common man! How rich is Mr Mallaya? Why should a middle class Indian fund Mr Mallaya via the banking system?
ReplyDeleteb) Why should Indians fly so much? India depends on imported crude for its energy needs! The real objective of India should be to curtail total dependence of anything imported, if it has to reach trade surplus. India still depends on the so called "Service sector" - which has given rise to new economic forces, in the name of airlines, carbonated soft drinks, fast foods, automotive industries etc...
c) India should try to open out the FDI in airlines, allow the airlines to fill their ATF in middle east when they fly out.
d) Our taxation system for fuel cant be rationalized since Government is so big and it wants revenue to fund itself. Hence it takes from fuel as the main source!
Venkatesh...
ReplyDeletea) Very valid. To filter sources of funding and asking, in-effect, the public to bail out Vijay Mallya is not right.
b) That's a naive statement to make; when you're asking people to cut down on flying. My friend got a job that pays Rs. 20k a month and he's flying to 5 cities in a week in the first month of his job. From cargo to manpower, airways are very important to us, domestically. Almost every country needs the international airways.
c) Agreed.
d) Taxation can be reviewed and perhaps concessional-ized, but the other leading airways such as IndiGo and GoAir are doing just fine so surely that is not an exit strategy for Mallya when he's asked for the top reasons as to why his airlines failed.