Taking Wing

The Sahara acquisition instantly gives Jet more market-share at a time whencompetition is keen. But the sentiment on the stock may not change untill the benefits are fully visible.

Jet Airways is once again readying for a take-off. The Mumbai-based airline, which saw a near 10 per cent fall in it's market share last year to 36 per cent, in a market that grew 25 per cent, has snapped up Sahara Airlines in an all-cash deal of $500mn (Rs 2,225 crore).

The acquisition gives Jet an enviable 48 per cent market share, a combined fleet of 76 aircraft, access to parking bays and prime time slots. If the company is able to use these assets efficiently, it could once again become the player it was before a host of Low Cost Carriers (LCC) arrived on the scene, paring fares by 50-60 per cent and sending the jet stock plunging to Rs 1054 and below its IPO price.

The stock is still grounded: at Rs 1150, it trades at a subdued multiple of just 14 times estimated FY07 earnings, a far cry from the multiple of 29 that it commanded soon after it listed.

Buying Market Share...
By taking over Sahara, Jet has managed to pre-empt other airlines, especially Vijay Mallya's Kingfisher Airlines , from mopping up marketshare. Mallya had been keen to buy Sahara, but withdrew his bid saying the price was too high.

Ernst& Young, which had worked on the valuation had arrived at an enterprise value (EV) of between $750mn-1bn. Jet finally agreed to cough up $500mn.

At this enterprise value of Rs 2,225 crore, the EV/EBITDAR (Earnings Before Interest, Tax, Depreciation and Rentals) multiple, paid for Sahara works out to between 5.5-6.5 times. The multiple for Jet, based on the EBITDAR of Rs 1409 crore for FY05 is around 8 According to industry watchers, the acquisition is not overpriced.

Explains Jayesh Desai, Head, Transactions, Ernst &Young, " It's a fair price to pay for a readymade market share of 12 per cent, because it's not easy to get market share quickly even if you spend." Desai contends that the important point is that is Jet getting a clean balance sheet.

However, not everyone is convinced. Nikhil Vora, Vice ""President, SSKI Securities believes that the deal may have been somewhat expensive for Jet.

"A large part of Air Sahara's capacity is deployed on Category 1 routes so Jet is not adding too many new routes," he says, adding that with the overlap on some routes, Jet may not be in a position to take full advantage of an 12 per cent market share.

However, the general consensus among sector watchers is that passengers who were flying Sahara are unlikely to fly any other airline but Jet.

"The fares on Jet are more or less comparable, it is reputed for its punctuality and the service is superior to Sahara's. So if 48 out of a hundred passengers were flying with Jet and Sahara on the same routes , they are all likely to fly Jet now. So, with more flights, Jet should be able to realize revenues from the entire 12 per cent share that it is acquiring, " observes an analyst.

....but a weak balance sheet
While Jet has bought out Sahara without any liabilities, Sahara's financials are not exactly in great shape.

According to sources, the company posted revenues of Rs 1800 for FY05 and notched up a net profit of around Rs 18 crore on an EBITDAR of around Rs 350-Rs 400 crore. The accumulated losses are believed to be in the region of Rs 200 crore.

The current liabilities, say sources are estimated to be around Rs 250 crore while the current assets are around Rs 650 crore. The equity capital of the company, say sources is Rs 276 crore. If that is so, it makes the earnings per share negligible. Again, Jet plans to borrow to fund the deal which could put a strain on the balance sheet. 
 

FINANCIALS
Year to March (Rs crore)	FY05	FY06E	FY07E
Total Revenues	4,338	5339	6114
EBITDAR	1409	1762	1935
EBITDAR Margin(%)	32.5	32.3	31.5
Net profit	392	617	731
EPS(Rs)	52	71.6	84
P/E @1150	22	16	14
Source: Analysts Estimates

Of planes, pilots and parking bays
In times of a severe shortage , it doesn't hurt to get a fairly young fleet of 19 Boeings (737s) and seven CR Jets , all of which are leased. Jet has always maintained that it would like to have a mix of leased and owned aircraft, so that should not pose problems.

Industry experts say Sahara's fleet is compatible with Jet's 42 Boeings and 7 ATRs , so maintenance should not be a problem either. What's more they come with pilots an engineers, who are also in short supply.

Besides, Jet also now has access to 17 per cent of all parking bays in the country and three hangars too, important because it means lower costs, a fact that LCCs are learning. Jet could have waited for parking bays to be built says one set analysts, but then time is money say others: at a time when demand high, it makes sense to cash in on it, even if it mean paying a little extra.

It's business as usual
With Sahara's EBITDAR margins at a low 20-21 per cent, compared with Jet's 32 per cent in FY05, the Jet management has room for improving efficiencies.

Though Jet could opt to change its business model to one which operates in both the business and value segments, E&Y's Desai believes that Jet would do well to continue to cater primarily for business traffic.

"The LCC model is unlikely to work too well in India, given the inadequate infrastructure," he explains, adding that the relatively low employee costs in India leave the cost structures of all carriers at similar levels, so that LCCs don't really have an edge.

Jet has all along positioned itself as the businessman's airline, setting new standards for service, in addition to increasing the frequency of flights on key routes at convenient times.

Typically, two-thirds of the passenger traffic is accounted for by business travel with the remainder contributed by leisure travel and the ratio is unlikely to change significantly. The overall market is tipped to grow at around 15-18 per cent for the next five years, which means the addressable space for Jet is large.

Solo Performance Overseas
With Sahara under its wing, Jet has ensured that it will be the only private sector carrier to fly international routes for the next three years till Air Deccan, becomes eligible in August 2008.

DGCA rules specify that an airline should have been in operation for at least five years before it can fly international routes. However, rules can be relaxed, so while Jet has a head start (it already flies to the UK, Singapore, Malaysia and plans to fly to the US soon), it may not be flying solo for very long.

Jet's international operations are yet to become profitable, mainly because it had offered introductory fares in a bid to attract traffic, though executive director Saroj Datta says any route achieves break-even within 12 months. Jet's lower employee cost of 8-10 per cent of revenues gives it an advantage over international players who pay anything between 20-30 per cent of revenues.

By 2008, Jet hopes to earn 25 per cent of the airline's revenues from international operations, not an ambitious target. It's not immediately clear to what extent Sahara's overseas flying rights will help Jet-- Sahara can fly to five countries""whether it's a duplication or an addition. Even without Sahara's rights, Jet should be able to meet its target.

Stormy weather ahead
The challenge for Jet lies in exploiting synergies, never easy in the best of times. Jet will need to act quickly fast to reap the advantages of the merger, since rivals such as Kingfisher are moving fast in their attempts to scale up their businesses.

Not just that, rivals may try to create obstables for Jet. Indeed, the management's abilitiy to manage the political environment and obtain regulatory clearances will be tested in the days ahead. Delays in getting approvals to use the airport facilities could cost Jet dearly.

It should be mentioned that Jet has taken a log time to get the go ahead to fly to the USA. It will also need to integrate the workforces , another uphill task because analysts say the work cultures at the two organisations are completely different.

The market's not buying
Not surprisingly, the market's response to the buyout has been rather lukewarm, even negative: the stock tripped on Friday, after rising just a couple of percentage points on Thursday. The company had posted very average numbers in the September quarter, partly due to the floods in Mumbai.

The Q3 numbers are unlikely to set the markets on fire given that the net profit has fallen from Rs 129.6 crore in Q3FY05 (when the company was not listed) to Rs 61 crore in Q3FY06. 
 

QUARTERLY NUMBERS
Rs crore	Q3FY06	Q2 FY06	Q1FY06
Net sales	1,478	1279.6	1310.5
Other Income	20.7	44.6	34.8
Operating Profit	261.9	264.3	313.9
Interest	61.8	56.2	60.4
Depreciation	104.7	97.2	98.3
Tax	34.4	42.1	59.7
Net Profit	61	68.5	95.3
EPS (Rs)	7.07	11.55	11.04

Revenues however, are up at Rs 1478.2 crore from Rs 1230 crore in Q3FY05. While the management may have some plausible explanation, it's unlikely that the market will be comfortable till Jet gets necessary approvals for the merger.

Even after that, it will take some evidence that the merger is working to get investors to bite.