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Monday, May 15, 2006

Deccan Aviation — Flying high at low cost


The initial public offering of Deccan Aviation, operating Air Deccan, is appropriate only for investors with a penchant for risk and a medium-term investment horizon. This low-cost, no-frills passenger airline is offering shares in the Rs 150-175 price band.

Exposure can be taken at cut-off, as that will make investors eligible for the offer even if the final price is fixed at a lower level in the book-building process.

We will be comfortable, however, if the final price is fixed at the lower end as that will provide greater scope for capital appreciation, especially given the highly capital intensive and volatile nature of the airline business and the risks associated with managing brisk growth.

First-mover edge

As the leading low-cost player, with a first mover advantage, Deccan Aviation is well-positioned to use the low-fare concept to stimulate demand in new and established routes alike. The upbeat economic environment, a growing leisure-spending class, a young affluent yet cost-conscious air traveller are all likely to sustain the buoyant growth rate of this sector.

The low-cost concept promoted by Deccan Aviation through Internet booking and cheap fares, paid in-flight services and single-class aircraft (such as Airbus 320 for trunk routes and ATR 42/72 for short-hauls) has caught the fancy of the air traveller in India.

The cheap fares are turning out to be competitive alternatives to premium class railway fares for the middle-class and the cost-conscious businessman.

The total aviation market that grew by 20 per cent in 2005 is expected to maintain the momentum in the 15-20 per cent range for the next few years.

On the flip side, however, the competitive pressures from a growing number of low-cost carriers, the operating losses in the core business as of November 30, 2005, the mounting unhedged fuel costs and the regulatory/infrastructure bottlenecks are challenges to contend with in the medium term.

Consolidating the core

Deccan Aviation has a fleet of 29 aircraft, operating 226 flights daily as of March 3s1. It had a market share of 14.2 per cent as of February. Operating out of six major cities — Mumbai, Delhi, Chennai, Bangalore, Kolkata and Hyderabad — the company services 52 locations. It plans to spread wings with the addition to the fleet size.

According to the offer document, in March, Delhi was the company's largest base measured by the number of passengers served. Apart from the six urban centres, it is establishing a base at Thiruvananthapuram. Outside this, it operates in 46 regional business, leisure and religious destinations.

To build scale and take on competition from other low-cost airlines such as SpiceJet and GoAir, as of March 31, 2006 Deccan Aviation had placed orders for 96 aircraft, which are to be delivered in a phased manner by December 2012.

Fifteen-nineteen aircraft are to be added in 2006-07. As part of its route strategy, Deccan plans to judiciously mix trunk and regional destinations, depending on the demand assessment and the availability of takeoff and landing slots.

Besides this, Deccan Aviation also operates as a chartered aircraft service provider with a fleet of ten helicopters and two fixed-wing aircraft.

Helicopter charter and other services contributed about Rs 30 crore out of the total revenues of Rs 518 crore for the eight months ended November 30, 2005.

Strengths

First mover advantage: As the economic outlook for the economy remains buoyant, the demand for leisure travel and tourism will be substantial.

As airfares will drop further with competition intensifying in the low-cost carrier space, the scope for keeping the load factor above 70 per cent will be fairly high.

The first mover advantage and scale of operations will help the company wrest significant market share from low-cost competitors is well-proven in many high growth sectors, such as telecom, retailing or hotels.

Removal of regulatory bottlenecks: With the proposed moves to modernise the Mumbai and Delhi airports and the work on Bangalore, the infrastructure bottlenecks such as airport congestion, landing rights, or parking slots that have hampered the growth of aviation sector should be a thing of the past in a couple of years.

Companies such as Deccan Aviation, that proactively invest in building scale can benefit significantly from their growing fleet strength.

In the telecom sector, early investors such as Bharti, gained immensely from their focussed capital investment strategy.

Enhancing ancillary revenues: By allowing advertising on storage space, headrests, tray tables, baggage and outside surfaces of aircraft, the company aims to notch up 3-5 per cent of revenues from these ancillary sources. This will also provide greater leeway in improving the operating performance.

Valuation yardstick

Assuming the aviation market grows at 15-20 per cent annually, revenues earned per passenger at Rs 3,000 and keeping the load factor (level of filled seats in a flight) at 70 per cent, the implied value per share of the company works out to Rs 165-170 for 2006-07. This value will be pushed up.

If the company is able to either increase the revenues on a yearly basis or control its operating costs.

The market capitalisation based on the price band will be Rs 1,500-1,700 crore, working out to a price by revenues about two times.

Offer details

Deccan Aviation is offering 2.45 crore equity shares through this book-built offering at a price band of Rs 150-175 per share. The promoters are expected to hold 75 per cent of the post-offer equity of Rs 98 crore.

The offer size works out between Rs 370 crore and Rs 430 crore. The offer proceeds are to be used for setting up a training centre, a hangar in Chennai, infrastructure at airports, market development and debt repayment.

About 40 per cent of the offer proceeds will be used towards debt repayment to reduce the aircraft financing costs.

The lead managers to the offer are Enam Financial and ICICI Securities. The offer opens on May 18 and closes on May 23.