Saturday, November 12, 2011

The Kingfisher bailout request - saving capitalism from capitalists!

In the past four years, bailouts have been at the center stage in many developed economies. Financial institutions, companies, and even countries have been bailed out in the aftermath of the bursting of the sub-prime mortgage bubble.

It should therefore come as no surprise that the B-word should find favor among struggling Indian companies. Sample this request from Kingfisher Airlines

"Facing serious financial turbulence, Kingfisher Airlines has sought government help for a bailout... The seriousness of the crisis was underlined by the urgent request Kingfisher owner Vijay Mallya made to finance minister Pranab Mukherjee and civil aviation minister Vayalar Ravi to help Kingfisher in infusion of funds through banks at low interest rates, besides other concessions in line with what Air India was getting."

And there are indications that this may be just the beginning. It is certain that all the other similarly struggling airlines will express their solidarity with Kingfisher and come forward with their own bailout requests. In fact, request for government help has already started,

"India’s private airlines have asked the government to cut taxes on jet fuel and force state-controlled Air India​ Ltd to raise fares, as losses mounted at private carriers that control at least 83% of the local passenger market. The airline firms have lost Rs. 3,500 crore in the six months ended September, more than the Rs. 2,900 crore they had lost in the last fiscal, according to an airline lobby group."

And what has been the government's preliminary response to this request,

"Union civil aviation minister Vayalar Ravi on Friday said he would talk to finance minister Pranab Mukherjee​ to get financially-troubled Kingfisher Airlines​ assistance from banks. The minister is also talking to state governments to reduce sales tax on aviation fuel."

The government does not need to be defensive on this. It is a great opportunity for the embattled government to atleast begin the process of its redemption. The sheer audacity and hypocrisy of the request is staggering. Kingfisher, the flag-bearer of hedonistic capitalism in India, wants equivalent treatment with a public sector entity. It wants the dregs of its orgy to be cleaned up with tax payer money. In simple terms, it is a request for socialization of private losses.

The fundamental tenet of Capitalism 101 is that market competition creates and destroys companies. In this case, a badly mismanaged Kingfisher and some other larger airlines, are reaping the sins of their earlier excesses (see this earlier blog post). Capitalism 101 tells us that when faced with such circumstances in a competitive market, we should let the market dynamics prevail. This would mean letting Kingfisher go bankrupt. Its equity holders and promoters should lose their shirts to repay the company's liabilities.

The details of the bankruptcy proceedings and resultant restructuring will vary and are debatable. There are real dangers of crony capitalism rearing its head. If the government intervenes to assist Kingfisher, there is the possibility of sweetheart debt restructuring deals, wherein portions of its debt owed to public sector banks will be foisted on them as equity without forcing the existing shareholders to take losses. In fact, there are already signs of something unpleasant brewing,

"A group of 13 lenders, including State Bank of India​ and ICICI Bank Ltd, bought a 23.21% stake in Kingfisher Airlines in April this year. SBI picked up a 5.67% stake and ICICI Bank 5.3%. The airline converted Rs. 750 crore of its total debt of Rs. 7,000 crore into equity at a 61.6% premium over its share price in what many considered a sweetheart deal. It allotted shares to lenders on 31 March at Rs. 64.48 apiece."

Kingfisher shares closed at Rs 19.65 on Friday, less than one-third the price at which the banks purchased their stakes. It was clear in April (when the stakes were purchased) that Kingfisher was on terminal decline. So why were the share purchased at such a premium? It would also be worth investigating the share transactions of the original promoters and largest equity holders in the aftermath of these deals and in recent months. It could turn out to be an excellent case study for corporate governance (or malfeasance) standards in India.

However, a note of caution is that the government should not be tempted into taking it over and merging with Air India. This would be letting the promoters of Kingfisher get away too lightly. It would be unfair on Air India. It will also generate long-term moral hazard concerns. More than anything else, it would reek of crony capitalism.

Fortunately, Kingfisher is neither too-big-to-fail nor does its bankruptcy pose any systemic risk within the industry or the financial markets. There were enough indications of this coming for some time now. It is widely known that the company is neck-deep in troubles and owes money to banks, oil companies, other airlines, DGCA, and the government (by way of taxes).

In fact, a Kingfisher bankruptcy will have several positive externalities. For a start, this outcome would be an acid test for India's bankruptcy laws. It would send out a strong signal to corporate India that private losses have to remain private and will not be borne by tax payers. The resultant disincentivization of bailout moral hazard will strengthen the institutional foundations of India's emerging capitalism. Furthermore, it will provide a much-needed boost to the beleaguered government in New Delhi. It will be a rare triple win for the government - political populism converging with sound economics and equally sound public policy.

An important dimension to this development is the role of the Director General of Civil Aviation (DGCA). What was the aviation regulatory authority doing when Kingfisher was merrily running up its Rs 7000 Cr debt? Why did it not pull the plug early? Should it not have raised the alarms much early than the belated attempts now? What powers should it be vested to ensure that such failures do not recur? Answers to these and the public policy response to the post-mortems will be a test of the government and corporate India's commitment to uphold high standards in corporate governance.

In conclusion, the Government of India is faced with the dilemma of saving capitalism from capitalists. Unfortunately, when faced with this dilemma governments have traditionally failed the test. Will this time be different?

Postscript - The fear of failure and the possibility of losing your equity through a bankruptcy is the "invisible hand" that disciplines risk-taking in any market. If this deterrent is removed, excessive risk-taking and other undesirable business practices - whose catastrophic effects have been made amply clear by the events across the world over the past few years - will be left with no institutional restraints.

Update 1 (17/11/2011)

After so many days, finally one piece of meaningful analysis of the KF crisis from Businessline.

Kingfisher's interest costs as a proportion of sales were as high as 22 per cent in the latest September quarter, compared to 6.9 per cent for Jet Airways and a negligible 1.2 per cent for low cost carrier SpiceJet. Costs other than interest payouts and fuel also seem to have had a role in Kingfisher's poor performance.

The airlines' cost per available seat kilometre (CASK), a key metric used to assess how competitive an airline is, was Rs 4.31 in the September quarter. This was much higher than the Rs 3.31 reported by Jet Airways. Of this number, Kingfisher incurred as much as Rs 2.46/SKM on costs other than fuel, 45 per cent higher than the Rs 1.69 for Jet Airways.

Incidentally, fuel cost, which is often painted as the biggest villain of the piece accounted for 54 per cent of sales for Kingfisher, compared with the 48 per cent for Jet Airways and 63 per cent for SpiceJet.


KP said...

Dear Gulzar,

This is one of the finests posts on the KF debacle. The morning papers today make for an argument along political lines - and that is itself strange.

Any socializing of KF's debt will be a smooth form of crony capitalism - I am also wondering whether the lenders have picked up stake with implicit guarantees from the government - otherwise it does not explain the spread of the participants and an upping of risks when everyone in the industry saw this coming. The source of this investment advise needs to be probed.

The following lines say it all "The sheer audacity and hypocrisy of the request is staggering. Kingfisher, the flag-bearer of hedonistic capitalism in India, wants equivalent treatment with a public sector entity. It wants the dregs of its orgy to be cleaned up with tax payer money. In simple terms, it is a request for socialization of private losses."

The questions of the regulators roles (DGCA) is pertinent - in fact the entire aviation ministry appears compromised - right from procurement of aircrafts , certification , and now this tax payer subsidy that the minister is suggesting.


Anil Nilugonda said...


this is an excellent piece and informative and also showcases the evils of corporate governance in India, its not only KF debacle, the promoters, public, regulators, management etc., have got their own pie in it. Let KF go down under its own spirits.

Tiju John said...

If KF board doesn't know how to run the business it should die. That is rule !!! We shouldn't waste our money saving it. Same for AirInida too...