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AirAsia Group completes first step in its bid to launch an LCC in India

8-Mar-2013

On 06-Mar-2013, India's Foreign Investment Promotion Board (FIPB) granted permission for AirAsia to invest in a proposed joint venture with the Tata Group and Telestra Trading to launch an LCC in India. AirAsia, seeking to expand its dominance beyond the ASEAN region, believes that its model, which operates under the ‘now everyone can fly’ mantra, is well-suited to the highly-competitive yet high-potential domestic Indian aviation market, which is expected to almost triple to 160 million passengers annually by 2021.

The quick decision by the FIPB and the clarification that foreign airline investment is not limited to existing carriers but is also applicable to start-ups is a welcome move. However FIPB approval is just the first step of the regulatory process and AirAsia India will now need to apply for a licence from the Directorate General of Civil Aviation (DGCA).

AirAsia India will enter the market as a well-backed group with the support of a USD100 billion conglomerate, the Tata Group, together with Telestra Trading. The LCC will operate with a strong focus on low-cost/low-fare operations in a market that AirAsia Bhd CEO Tony Fernandes says is “now ready for a true low-cost carrier”.

While AirAsia, which has seen a sudden expansion of its portfolio and now has six brands (AirAsia, Thai AirAsia, Indonesia AirAsia, AirAsia Philippines, AirAsia X and AirAsia Japan), may have secured the right partners for its India venture, the local aviation market remains highly competitive and largely unviable. 

FDI but not quite as India’s Ministry of Civil Aviation had intended

AirAsia’s application to the Indian Foreign Investment Promotion Board (FIPB) follows a ground-breaking decision by the Indian government on 14-Sep-2012 to allow up to 49% investment by foreign airlines in the aviation sector. While the FDI decision has led to confirmed talks between Etihad Airways and Jet Airways, the AirAsia India announcement is the first commitment by a foreign airline to a venture in the Indian aviation industry. SpiceJet has confirmed that it is in preliminary talks with several potential partners over a stake sale, though it has not identified any of its suitors.

However, the move by AirAsia may not be exactly what the government had in mind. When the Indian government finalised the FDI decision, the aim was to encourage an infusion of foreign capital into the heavily indebted incumbent airlines, with the ultimate aim of supporting their recovery and expansion. Instead the move by AirAsia would in fact intensify competition in an already highly-competitive marketplace.

When the cabinet approved the policy in Sep-2012, the press statement noted: "There has been a need to consider financing options available for private airlines in the country, for their operations and service upgradation, and to enable them to compete with other global carriers. Denial of access to foreign capital could result in the collapse of many of our domestic airlines, creating a systemic risk for financial institutions, and a vital gap in the country’s infrastructure". Civil Aviation Minister Ajit Singh, was quoted as saying: “We are not giving licences for greenfield airlines. As of now, FDI in aviation can come only through existing airlines." The was some debate as to whether the Department of Industrial Policy and Promotion note on the subject permitted foreign airline investment in start-up carriers, however the FIPB decision has provided clarity on this issue. Limiting foreign airline investment to existing carriers would have been a fundamentally flawed policy as India needs strong, new airlines which are well-capitalised with partners that also bring industry expertise.

Meanwhile, India’s incumbent airlines will almost certainly resist the entry of such a force as AirAsia in representations to the government, which in turn will have to weigh up the consumer benefits from increased competition and the impact on the stability of the sector. AirAsia Group’s pricing strategy, utilisation of its brand asset and aggressive marketing tactics could pave the way for another shakeout in the market which has already seen the suspension of operations by Kingfisher Airlines in Oct-2012.

Mr Fernandes said he believes the planned establishment of AirAsia India is unlikely to put any Indian carriers out of business, noting: “Businesses put themselves out of business, not the competition. If an airline is rightly capitalised, follows the right business model and the right people are running it, there should be no problem." Telestra Tradeplace Pvt Ltd owner Arun Bhatia, in an interview with Live Mint, similarly stated: "We have a different business model from existing Indian carriers. And every brand should be different. Air Deccan was a great brand and IndiGo is also successful. We are working out details for competitive branding".

AirAsia secures high-profile partners, but challenges remain

While AirAsia is a successful and experienced operator, and has secured strong local partners it will nevertheless operate in the same challenging market as India's incumbents, whom CAPA estimates will have accumulated losses of around USD9.5 billion in the six years to FY2013.

Operating costs in India remain high compared to Southeast Asia due to punitive fuel taxes, high airport charges and inefficient infrastructure. This is combined with high inflation and interest rates and GDP growth running at its lowest level in a decade.

Meanwhile, the government continues to intervene in commercial matters. The Ministry has expressed its displeasure at recent fare discounting by airlines (while previously expressing their concern when fares were at high levels in peak-demand periods). Reports also suggest that the Ministry has disallowed the aircraft import plans of some LCCs. The current policy, whereby Indian carriers are required to operate domestically for five years and reach a fleet size of 20 aircraft before they are able to expand internationally, is also another example of government restrictions on carriers, although this regulation will most likely be withdrawn in the near future.

However, Mr Fernandes and the AirAsia Group would seek to challenge what it deems as over-regulation and excessive costs. Mr Fernandes said the venture in India would work hard to try and convince the airport operators and the state governments to reduce airport charges in India. He also said the airline will avoid some airports because of high charges that made "no sense". In 2012 AirAsia X pulled out of Mumbai and Delhi citing high tariffs and taxes. AirAsia India plans to focus on tier II and III cities to avoid these cost pressures.  Another reason for avoiding congested airports such as Mumbai is non-availability of adequate slots.

AirAsia will likely place pressure on gateways to consider building dedicated low-cost terminals to attract LCCs. He noted: “India is a huge country with huge potential in terms of connecting the dots and we will provide the catalyst for private airport operators and government of India airports to develop third tier airports to jet capability". While 70% of domestic airline operations happen in the LCC segment, India does not have designated low-cost airports although the Indian government is now establishing the development of these airports.

AirAsia brand yet to gain traction in Indian market

AirAsia has a strong brand in the ASEAN region, though the brand has not had entirely smooth sailing in India since the carrier launched Kuala Lumpur-Tiruchirapalli service in Dec-2008. Mr Fernandes acknowledged that AirAsia has had a tough time in India in the past but this proposed expansion into India’s domestic market has been something that has been discussed internally for the past three years. 

One of the key reasons the group has struggled in India is because of its inability to access local distribution networks. Travel agents and online travel agents still account for most bookings in India (around 70-80% of ticket sales), and the AirAsia model does not fit into this traditional channel, with around 85% of its tickets being sold directly through its website. AirAsia has also said it would not work with India’s largest OTAs due to the exclusivity of its partnership with Expedia. Having to rely on direct website sales and its Expedia joint venture has limited AirAsia’s ability to penetrate the Indian market. However, the carrier is already taking steps to rectify this situation. Though the airline is expected to take off in the second half of the 2013, AirAsia has already begun forging tie-ups with travel portals including Yatra.com and makemytrip.com for wider distribution reach.  

AirAsia Group now serves five destinations in India with AirAsia from Kuala Lumpur to Chennai, Kochi, Kolkata and Tiruchirapalli and Thai AirAsia operating from Bangkok Don Mueang to Bangalore, Chennai and Kolkata. It has also previously served Gaya, Hyderabad and Thiruvananthapuram. The new venture will likely initially focus some of its domestic operations on connecting these existing AirAsia destinations, as it seeks to improve connectivity throughout the group.

The selection of Chennai International Airport, the nation’s third largest airport, as the operational base for AirAsia India is a logical move given the brand’s presence in this part of India. AirAsia launched Kuala Lumpur-Chennai service in Apr-2010 with Thai AirAsia adding Bangkok-Chennai service in Mar-2012, initially from Bangkok Suvarnabhumi but more recently from Don Mueang.

AirAsia X last year pulled out of India due to poor demand and profitability, in large part due to distribution challenges, although the carrier cited airport charges as the primary reason. India has been the only market in Asia that has seen a decrease in AirAsia capacity over the past 12 months. The AirAsia brand currently accounts for just about 10% of seat capacity in the India-Southeast Asia market, compared to about 14% one year ago.

In the current week, there are 5,171 weekly international services to/from India, according to Innovata, of which AirAsia operates 78 and Thai AirAsia operates 24 for a total of 102 services in the week. This makes the combined AirAsia Group the 16th largest carrier operating to/from India, or the 11th largest foreign airline group operating to India, with Malaysia Airlines having a larger operation to/from India in terms of seat capacity.

India schedule summary by largest international operations (weekly seats): 04-Mar-2013 to 10-Mar-2013

AirAsia is the fifth largest airline by international seats at Chennai Airport, with a 4.2% capacity share in the week ended 10-Mar-2013, increasing to around 6% including Thai AirAsia. Internationally, the Chennai market is dominated by Air India, with Emirates and SriLankan Airlines also having a strong presence. SpiceJet is the largest operator domestically from Chennai, with a 30% domestic capacity share in the current week. Jet Airways and IndiGo both have a 21% stake at Chennai, with Air India having a 17% domestic share, meaning there is a relatively even distribution of domestic capacity at the airport.  These carriers will likely strengthen their network from Chennai before the launch of AirAsia's domestic service, with Chennai Airport and consumers to be the key beneficiaries of this increased competition.

Chennai Airport capacity share (domestic seats per week):
04-Mar-2013 to 10-Mar-2013

Chennai Airport capacity share (international seats per week):
04-Mar-2013 to 10-Mar-2013

AirAsia India will connect tier II and III cities where price is the key driver. The carrier also said it would look at opening up new markets where there is no connectivity (50% of the routes it operates are new routes). In this strategy, the new venture will face competition from IndiGo and also SpiceJet, both of which have network strategies which cover these markets. 

In its network development AirAsia will be able be leverage its well-established networks in ASEAN countries, especially Malaysia, Indonesia and Thailand, to its advantage. While most Indian LCCs operating internationally, the connectivity AirAsia provides in the region is unmatched 

Key details of AirAsia India venture

Launch Details

The carrier would likely commence operations in 4Q2013.  Mr Fernandes said: "We are ready as soon as we get the approvals” and that the timing of the launch "was in the hands of the Indian regulator... but most likely it will start by the fourth quarter."

Partners

AirAsia (49%) through investment arm AirAsia Investment Ltd, Tata Sons Ltd (30%), Telestra Tradeplace Pvt Ltd (21%). Telestra Tradeplace is an investment company of Delhi-based businessman Arun Bhatia, owner of Hindustan Aerosystems Pvt. Tata Group said its contribution to the JV would be merely as a "financial investor”, with Telestra also to have a non-operational role. Arun Bhatia of Telestra Tradeplace Pvt Ltd, who is associated with AirAsia founder Tony Fernandes at the Queens Park Rangers (QPR) football club (Tony Fernandes is QPR’s chairman), will hold the remaining 21%.

Scope of business

The carrier would "provide low-cost scheduled passenger airline services operating single-aisle narrow-body aircraft flying under four hours initially on domestic routes in India and at a later date on international routes, if permitted by the government of India"

Fleet

The company will start operations with three to four A320s with Mr Fernandes adding: “We will scale up the size of the fleet quickly thereafter”. AirAsia Group said the majority of aircraft to be operated by the proposed AirAsia India venture will be owned by the company. Mr Fernandes ruled out using regional jets or turboprops.The board structure of the airline will be according to the government norms that mandates two third of board members should be Indian."

Branding

AirAsia will fulfil the role of a strategic partner in the business and will provide necessary support and know-how, which will include infrastructure to the JV company, technical and business training to the staff of the JV, training and assistance for preparing operating procedures for the business and support for leasing of aircraft on most favoured terms. The JV plans to use the AirAsia brand name in India since its already strong brand equity in Asia will help it gain traction in the Indian market as well. However the regulations are ambiguous on the ability to use a foreign airline brand for domestic operations in India.

Network

In its stock filing, the carrier said the JV would operate from Chennai, focussed on providing domestic tier II/tier III city connectivity. Carriers in India must complete five years of domestic operations and have reached a fleet size of 20 aircraft before being permitted to launch international services, although this regulation is under review. Mr Fernandes said AirAsia's Malaysian and Thai divisions would continue to operate international services to/from India. Although no confirmed route plans have been announced, AirAsia India has already completed a review of a number of likely domestic destinations.

Process

AirAsia received Foreign Investment Promotion Board (FIPB) approval for its 49% investment on 6-Mar-13. The proposed JV must now make an application to the Indian aviation regulator for an operating licence.

Executive news

The airline has identified an Indian national for the position of CEO and more details are expected to be revealed this month, with Mr Fernandes noting that the majority of positions will be held by Indian citizens. “Initially, we will have staff strength of about 300 people.” he said. Regulations require that the Chairman and two-thirds of the directors on the Board must be Indian citizens.  

Board composition

AirAsia said the board of the JV would have six directors comprising two nominees each from AirAsia and Tata Sons and one representative from Telestra Tradeplace. There will be an independent director on the board who will also be the non-executive chairman. Tata Sons has nominated R Venkatraman, former executive assistant to Ratan Tata, and Bharat Vasani, the chief legal counsel of the Tata Group, on the board of the new JV. AirAsia will be represented by Tony Fernandes and Kamarudin Bin Meranun, who are among the largest shareholders in AirAsia Bhd. Arun Bhatia, will represent Telstra Tradeplace on the board of the newly formed venture.

Investment

On the capital plans, Mr Fernandes said: “Our initial capital will be $30-60 million”. Tata Sons equity exposure is reportedly capped at INR500 million (USD9 million). The three partners, as per their application to the FIPB commit, not later than 14 days, USD9 million, with another USD21 million to be infused within 45 days of receiving the no objection certificate. AirAsia said the airline would not raise debt to fund the venture in India stating: “We will not risk any loan in India towards our contribution in the share capital of the JV”.

Fares

Mr Fernandes said price would be the airline's biggest differentiator as the company has mastered the low-cost model

 

India market could provide lucrative to AirAsia

Despite the long list of challenges, the Indian market could prove lucrative to AirAsia. India has a rising middle class population, with increasing disposable income levels. In 2012, more than 58 million domestic passengers were carried by Indian airlines and this is expected to almost triple by 2021. Describing the potential of the market, Mr Fernandes noted:  "First, there are a billion people in India; second, millions of people travel in trains; and third, there is big potential in under-developed routes."

AirAsia plans to stimulate this market potential through low fares. Mr Fernandes commented: “Let's not kid ourselves, it will be price that delivers traffic to us”. He said AirAsia has been interested in India for a while and is optimistic about doing business in the country, stating: "We don't see any difficulties". He added: "We strongly believe that the current environment is perfect to introduce AirAsia’s low fares which stimulate travel and grow the market".  

Mr Fernandes added the India JV would further strengthen the carrier's position in the region, stating: "We can now solidify our base, as we have moved from being a South-East Asian player into a truly low-cost airline in Asia with our Japan and India ventures".

AirAsia Group well-matched with Tata

“We couldn’t have picked a better partner,” said Mr Fernandes when commenting on AirAsia’s tie-up with the Tata Group. Mr Fernandes acknowledged that although AirAsia has the operational expertise, it will rely on its partners to provide local market insights. 

Tata Airways was India's largest airline before the government took it over in 1953 and rebranded it as Air India, with the carrier’s founder J.R.D. Tata appointed the first chairman of Air India. Tata Group and Singapore Airlines had tied-up in the 1990s to launch a domestic carrier in India, but in an effort to block this venture the regulations were changed to exclude foreign airline investors from the market.

With AirAsia India, Tata Group will re-enter the aviation sector after nearly eight decades. The Group notes: “When AirAsia approached Tata Sons with a proposal for a stake in the venture, we concluded that given its reputed business model, AirAsia could be a relevant and successful service provider in the sector." Mr Fernandes has said however it would try to persuade Ratan Tata, Chairman Emeritus of Tata Sons, to become the chairman on the new carrier, stating: "Mr Tata would be the right person as he would bring tremendous confidence to the regulators, to the consumers and to the government as well. Over the next few weeks we will start serious discussions with Mr Tata on the subject. He has neither said 'yes' nor said 'no' till now”. Tata Group also has nearly a 6% equity stake in SpiceJet but is only a financial investor in the LCC.

Meanwhile, Telestra Tradeplace said its participation was due to the Bhatia family's close relationship with Mr Fernandes, who serves on the board of London-based football club Queen's Park Rangers alongside Mr Bhatia's son, Amit Bhatia. Telestra Tradeplace Pvt Ltd owner Arun Bhatia, in an interview with Live Mint, however said the involvement of Tony Fernandes was not the sole rationale for entering the Indian aviation sector through the proposed AirAsia India venture, stating: "We were extremely passionate about the industry. And we were looking at this industry for the last two years. We are bullish about the Indian aviation sector. But when you get illustrious and valuable partners like Tata group and Tony Fernandes, we should enter the industry eyes closed, no?". He continued: "Partnership is critical in this business. You need to get competent and progressive partners for this business. See our partners, they are fabulous. Look at Tony Fernandes. He is running a profitable airline in low-fare segment for years. Tata group is honest and diligent. With Ratan Tata involved in this deal, as I said, we can just enter this sector eyes closed".

Reaction from incumbents

The two largest LCCs in the market, IndiGo and SpiceJet, have offered limited public reaction to the AirAsia announcement. However, Jet Airways CEO Nikos Kardassis noted that “new foreign airlines setting up shop in India as a result of the new policy was expected. Long term, the new policy will have positive impact. But there will be pain”.

Kingfisher Airlines promoter Vijay Mallya said: “With this deal, AirAsia is clearly going after the potential of the domestic market. This is one of the reasons why I have been relentlessly pursuing the re-start of Kingfisher, which I am very confident about with the support from all the stakeholders”.

Air Deccan founder, Captain GR Gopinath, welcomed the news stating that the proposed AirAsia venture in India would likely "stimulate" the market by opening new routes. "They will break the 'cosy cartel' and offer cheaper fares. True low-cost carriers stimulate the market and expand the consumer base".

More change in the ever-changing Indian market

If AirAsia India is successful in securing a licence it will introduce a formidable new entrant into India's airline industry. The venture combines a highly successful and aggressive LCC with one of the most respected and financially sound Indian business houses. It is also an important test case on the government's stance towards foreign investment in general and the airline industry in particular, as well as the Ministry's position on the award of new licences.

To date the Ministry has not been inclined to issue new licences for pan-India operations, instead encouraging proposed start-ups to commence with a regional licence. Other issues that are likely to come up during the licence application process include clarification on management control and the use of the AirAsia brand in India. The Ministry needs to come up with a transparent framework with respect to the award of new licences rather than an ad hoc case-by-case approach. AirAsia will not be the only applicant, other projects are also understood to be in the pipeline and hence the manner in which the Ministry deals with AirAsia will set a precedence.

The arrival of AirAsia is sure to shake up the LCCs in the domestic market, although any significant impact is still some time away given that the launch of services is unlikely before the end of this year and it will take the carrier some time to ramp up to a reasonable scale. AirAsia will also face challenges in maintaining its industry-leading low cost base in an environment characterised by high fuel prices and expensive airports. And the operating environment is such that it will not be easy to achieve some of the fundamental characteristics of its business model such as high aircraft utilisation, labour efficiencies, low distribution costs and strong ancillary revenues. Nevertheless, AirAsia brings proven expertise and credentials and will, as it has done in other markets, aggressively seek to find inovative solutions to these issues. And if it succeeds it will be to the benefit of the entire industry.

AirAsia Group, in the release of its financials through 31-Dec-2012, noted the potential in the market by saying that the nation has only 422 aircraft serving 1.2 billion people, compared to China which has a fleet of 1,981 fleet serving a population of 1.3 billion. This combined with strong GDP growth, a young population and the expansion of an expanding middle class growth presents huge opportunity that AirAsia is eager to tap. Mr Fernandes added: “There is a monstrous market opportunity in India. If you add up all the aircraft in India it doesn’t match the number currently in Malaysia, yet the population is around 50 times larger. This is a huge opportunity but requires change. We haven’t jumped in quickly. We have done our homework and go into the domestic market with our eyes wide open”.

AirAsia India will no doubt face short-term challenges but the payoff is potentially very large. AirAsia’s move has been timed to ensure that it is in the market ready to take advantage of expected growth and improvements in the operating environment in due course, while further expanding the group's network and brand. For Indian aviation, a positive approach by the Ministry to clearing impediments to foreign airline investment and addressing structural challenges to create a competitive, sustainable and profitable industry, will enable the benefits to become visible to the sector and to the Indian economy. 


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