Fighting headwinds

ON THE FACE OF IT, it’s one of the most spectacular turnarounds in the Indian aviation sector. Barely three years ago, SpiceJet was going through a severely turbulent phase: It was saddled with mounting losses, its share price was plummeting, creditors and vendors were knocking at its doors, and it was even forced to ground its fleet briefly after it failed to pay its fuel bills.

Today, the budget airline seems to be in cruise control mode: It is the world’s best-performing airline stock, it has reported 11 straight quarters of profits, and it has been flying with a load of over 90% for over two and a half years. And the man widely credited with the revival of the once failing airline is its chairman and managing director, Ajay Singh, who bought the failing airline from Sun Group chairman Kalanithi Maran for a token amount of Rs 2 in 2015. “The manner in which people came back to flying SpiceJet is something that is truly incredible,” says Singh.

What’s certainly incredible is SpiceJet’s stock performance over the past three years. If you had invested roughly Rs 15 lakh in the airline’s shares in December 2014, it would be worth well over Rs 1 crore today. With a return on investment of nearly 800%, it is hardly surprising the airline makes it to the Fortune India 500 list for the eighth time. SpiceJet climbed to 202 this year from 227 last time, and is also one of the best-performing stocks on the list. Its revenue has also climbed to Rs 1,814.3 crore in the second quarter of 2017-18 from Rs 786.3 crore in the fourth quarter of 2014-15 soon after Singh took over.

But scratch the surface and you’ll see things aren’t really smooth for the country’s second-largest budget carrier. Despite its turnaround, SpiceJet’s net worth remains negative: In other words, its total liabilities outstrip total assets by more than Rs 330 crore. Moreover, Singh has been forced to pledge 40% of his shareholding with lenders to secure loans. And there’s a chance the airline could fly into a storm all over again if he loses a bitter legal battle with Maran over their share purchase deal. But more on that later.

Singh isn’t new to SpiceJet; he’s one of the airline’s founders. Along with Britain-based NRI businessman Bhupendra Kansagra, Singh started the carrier by acquiring private airline ModiLuft owned by S.K. Modi and Lufthansa, and renaming it SpiceJet in 2005. Over the next five years, Singh gradually reduced his stake, and sold out completely in 2010, as Maran acquired majority stake. Five years after, Singh returned as SpiceJet’s white knight.

He began by restoring SpiceJet’s fleet strength, which had fallen to 31 planes from a peak of 58. Within weeks of his acquisition, Singh started to wet-lease aircraft in order to cash in on falling aviation turbine fuel prices, and took the fleet up to 41 within nine months. In aviation parlance, wet-leasing means getting the aircraft and crew on loan.

“It was a matter of regaining the trust of the customers. Tickets had been booked in advance, so we had to make sure the flights were operating and by that time nobody wanted to give us planes on dry-lease anyway,” says Singh. “Wet-leasing was the only option left. It was expensive but it was an investment that needed to be made.”

THOSE WHO WERE WORKING in SpiceJet at the time give Singh credit for the decision. “If we hadn’t got the wet-leased aircraft we wouldn’t have survived. Ajay deserves full-credit for doing what was needed to make sure that the regulators did not delay allowing SpiceJet to wet-lease aircraft,” says a person with knowledge of the developments.

At the same time, Singh was also aware he needed to cut costs and increase revenue. He began by cancelling some unprofitable routes and focussing on bumping up ancillary revenues, or earnings from non-ticketing sources such as seat selection, meals on board, and extra baggage.

Singh says he renegotiated existing contracts with vendors to lower costs for SpiceJet and increased ticket prices. The changes paid off. After months of losses, SpiceJet posted a net profit of Rs 22.51 crore in the fourth quarter of 2014-15 and profits have since then leapt to Rs 105.28 crore in the second quarter of this financial year.

“I thought SpiceJet was selling tickets way too cheaply and so yield management needs to be corrected. Ancillary revenues were very low. I also thought that the network needed work as there were routes which were not profitable at all,” he says. “I saw that on the cost side, contracts needed to be renegotiated, aircraft utilisation needed to be increased, and other such initiatives were required.”

But strategically, things remained largely the same. SpiceJet continued to focus on regional routes or flights to smaller cities and carried on with extra-leg room rows to garner ancillary revenues. Even on the personnel front, Singh seemed to be happy with the status quo. Sanjiv Kapoor, now chief strategy and commercial officer at Vistara, continued as chief operating officer of SpiceJet for several months. Singh also tried to block other exits by approaching the Delhi High Court against employees who wanted to quit. Kapoor declined to speak about SpiceJet but several former employees, who did not want to be identified, said the management did not want to let employees leave for fear they would take strategic secrets with them.

In many ways, Singh was just lucky because oil prices fell to historic lows soon after he took over. Such a dramatic turnaround would not have been possible if crude prices hadn’t dropped so sharply. Singh disagrees: “Fuel prices had started going down already when I bought the airline. But despite that in that quarter the airline had lost nearly Rs 600 crore. I think that no amount of fuel price [drop] would have saved the company. If the fuel price had risen, we would have still made it, maybe it would have taken a longer time but it would have happened.”

The fall in fuel costs certainly helped increase profits after Singh took over. But overall costs, excluding fuel, didn’t fall significantly because of the high expenses on wet-leasing aircraft to increase capacity. The numbers are telling. The unit cost per seat per kilometre for the airline, or cost per available seat kilometre (CASK), excluding fuel, has actually increased since he acquired the airline. According to an investor presentation, the CASK, excluding fuel, rose to Rs 2.47 in the second quarter of 2017-18 from Rs 2.30 in the corresponding quarter in 2014-15. Fuel cost per ASK, meanwhile, dropped to Rs 1.13 from Rs 1.81 during the same period.

One of the key factors behind the airline’s turnaround was Singh’s political connections in the ruling Bharatiya Janata Party (BJP). Singh, who coined the slogan Ab ki baar Modi sarkar for the BJP’s 2014 general election campaign, continues to be close to the party’s leadership. The government went out of its way to make sure SpiceJet remained in the air to avert the economic embarrassment of the airline going under months after it took over with the promise of achche din.

Singh partially concedes the importance of government support in the airline’s turnaround. “I think the whole system at that time wanted the airline and its passengers to be protected. They wanted to ensure that the customers didn’t suffer and I guess that’s the reason why the regulators also moved very fast,” he says. “The work in government has helped me get a holistic view of how the system actually works. The system can sometimes be your friend. If you know how it works, it is easier to co-opt them in the work that you are doing. The government was a big piece in this whole turnaround.”

WHEN SPICEJET RAN INTO rough weather in the middle of December 2014, the Ministry of Civil Aviation wrote to oil marketing companies to give SpiceJet a 15-day reprieve till the end of the month to repay its dues and consider the option of staggered payment of dues. Its dues to foreign and domestic vendors, airport operators, and oil companies had leapt to Rs 1,230 crore on December 10, 2014 from Rs 990 crore just 18 days before that. Less than a month later, Singh bought a 58.1% stake in the airline, which despite its struggles, was valued at nearly Rs 765 crore. He paid just Rs 2 because Maran was desperate to exit the airline, which was groaning under the weight of Rs 3,871 crore in liabilities. To facilitate the deal, the Ministry of Civil Aviation also wrote to the markets regulator, the Securities and Exchange Board of India (SEBI), to exempt Singh from making an open offer under SEBI’s takeover code.

All the political connections and low fuel prices wouldn’t have helped SpiceJet survive without hard cash. And that was something Singh didn’t bring—it came from Maran. As part of the deal between Maran and Singh, the Sun Group supremo paid Rs 579 crore in return for warrants and redeemable preference shares, as well as repayment of overdue income tax payments. The money would have given Maran nearly close to 25% stake upon conversion.

But the warrants and redeemable preference shares were never issued to Maran. Today, Singh and Maran are locked in a legal battle over the deal, which could push SpiceJet into rough weather again. So far, Maran seems to be winning: A single-judge Delhi High Court bench ordered Singh in 2016 to deposit Rs 579 crore with the court until the share transfer dispute was settled.

Singh appealed the order in a division bench, where his lawyers argued the company hadn’t been able to issue the warrants and redeemable preference shares due to lack of permission from the BSE and SEBI. The court was scathing: “Niceties apart, the appellants’ pleadings as to the justification for their retaining the amounts, when they clearly cannot deliver their part of the bargain, is feeble and ineffective.”

SpiceJet then appealed to the Supreme Court where Justice Rohinton Nariman dismissed the matter. Singh has since been forced to submit Rs 250 crore in cash and Rs 329 crore in bank guarantees to the Delhi High Court and an arbitration tribunal is close to deciding on whether Maran needs to be financially compensated and, if so, by how much. Maran and Sun Group have engaged an independent global business advisory firm, FTI Consulting, to determine the amount and the tentative figure, according to sources, is roughly Rs 2,000 crore.

If SpiceJet is forced to fork out this amount, it would only further dent its balance sheet which on September 30, 2017 was saddled with total liabilities of Rs 4,044.2 crore that it owes creditors, lessors, and service providers like airports and oil marketing companies. Its total assets are much lower, at Rs 3,711 crore.

SpiceJet can hardly afford to fly into another financial storm. The airline found itself in dire straits after Maran bought a 38% stake in the airline for Rs 750 crore in 2010. Global crude oil prices hit all-time highs between 2010 and 2014, pushing the airline into huge losses: By December 31, 2014, the airline had accumulated losses of Rs 3,233 crore. By July 2014, Spice- Jet’s share price was on a downward spiral. As pressure from creditors and vendors mounted, Maran began negotiating with private equity and investment firms Texas Pacific Group (TPG) and Indigo Partners. But a month later, the Central Bureau of Investigation charge-sheeted him in a bribery case (he has been acquitted since) which spooked TPG and Indigo Partners. Creditors weren’t willing to risk even Rs 300 crore, which, according to those in the industry, could have kept Maran in control of the airline.

THE BAD NEWS CONTINUED to push share prices down in September that year. With SpiceJet’s recapitalisation plans in the doldrums and vendors cutting off credit lines, the airline’s working capital requirements started shooting up. The Directorate General of Civil Aviation dealt the next blow by limiting advance sale of tickets. SpiceJet had to resort to sending back aircraft and found an ingenious new way of taking a bridge loan from the government—not depositing TDS and incurring the penalty for it later. Eventually, Maran called it quits. On December 16, 2014, SpiceJet informed the Ministry of Civil Aviation the airline might not be able to fly.

Three years later, SpiceJet is flying high—except for the legal battle with Maran. Singh is making every effort to ensure the optics are good for the budget carrier despite its legal woes. He placed an order for 100 Boeing 737MAX aircraft in January at a list price of $11 billion (Rs 69,487 crore). Along with an order placed in 2014, SpiceJet is expected to receive 142 aircraft from Boeing, starting in the second half of 2018. But with rising fuel prices and a weak balance sheet, funding the aircraft order could strain SpiceJet’s finances. Singh has no intention of raising cash by shedding his stake anytime soon, but his hand could be forced once SpiceJet starts paying Boeing for the deliveries. When the order was announced at the Paris Air Show in 2017, Singh told Reuters he was weighing financing options: He ruled out raising fresh equity or taking on more debt but said sale and leaseback was an option.

THE VIABILITY OF the sale-and-leaseback model is increasingly being questioned. For nearly a decade, Indian airlines considered sale and leaseback the best method of acquiring aircraft. Airlines buy planes from a manufacturer at a discount, sell them at a higher price to a lessor, and lease them back immediately while pocketing the difference. The model allows airlines to refresh their fleet faster and add more fuel-efficient aircraft as technology advances. But the thinking is changing in the industry and airlines now prefer to buy aircraft for the long haul because there is little danger of technological obsolescence with modern aircraft. IndiGo, the country’s largest airline, recently prepared investors for the possibility of funding aircraft through outright ownership. “Over the longer term, owning an aircraft tends to have a lower overall ownership cost than leased planes,” Rohit Phillip, chief financial officer of IndiGo, told an analysts’ call in July.

For now, SpiceJet remains the darling of Dalal Street. Its market capitalisation tops the more established Jet Airways and brokers are convinced by the management’s argument that demand is growing, the company is focussed on controlling costs, and it is expanding into high-yield markets. “Profitability is expected to be good, owing to a balanced demand-supply market, along with the benefits of an appreciating rupee and crude oil prices,” said Vishal Rampuria of HDFC Securities in a research note. But lately some traders have turned cautious. Oil prices are up again and SpiceJet’s shares have fallen 3% in the past three months. Brokerage firms are also keeping an eye on the verdict of the arbitration panel: if Singh loses the case, he could end up losing control of one of the country’s best performing airlines.

(The article was originally published in the Dec-March special issue of the magazine)