A Study of Mergers & Acquisitions in Aviation Industry in India and Their Impact on the Operating Performance and Shareholder Wealth Nisarg A Joshi Ahmedabad Institute of Technology Jay M Desai Ahmedabad Institute of Technology ABSTRACT The objective of this paper is to study, why organisations take the inorganic mode of expansion. However, the main focus is on studying the operating performance and shareholder value of acquiring companies and comparing their performance before and after the merger. To conduct a uniform research and arrive at an accurate conclusion, we restrict our research to only Indian companies. To get a perspective on India, we study aviation sector. We will test feasibility that mergers improve operating performance of acquiring companies. However on studying the cases, we conclude that as in previous studies, mergers do not improve financial performance at least in the immediate short term. INTRODUCTION The air travel market grew up originally to meet the demand of business travelers as companies became increasingly wide-spread in their operations. On the other hand, rising income levels and extra leisure time led holidaymakers to travel to faraway places for their vacation. A further stimulus to the air travel market was provided by the deregulation and the privatization of the aviation industry. State- owned carriers that hitherto enjoyed monopoly status were now exposed to competition from private players. However, one development that changed the entire landscape of the industry was the emergence of low cost carriers (LCCs). These carriers were able to offer significantly cheaper fares on account of their low-cost business models and thereby attract passengers who might not otherwise be willing to fly. LCCs have achieved rapid growth in market share in the U.S. domestic market, short-haul market in Europe and recently in Asia. Since 1970, the international passenger traffic has grown by an average rate of more than 6%, compared to a 7% increase in the domestic passenger traffic. The aviation industry is highly cyclical. However, in times of recession, the decline in the industry growth rate is much sharper when compared to the world economy. After witnessing a strong growth during the late 1990s, the industry saw a sharp reversal in fortune as a result of a global economic downturn in 2001. The situation was further aggravated by 9/11 attack, the Iraq war and the SARS epidemic. The mammoth financial losses incurred by the scheduled carriers during this period led to a long-overdue restructuring among the full service carriers (FSCs). Many airlines embarked upon severe cost-cutting and fleet-rationalisation programmes as they struggled to remain afloat. The conditions for FSCs were further worsened with the advent of budget carriers in the U.S. and Europe. There was however a strong rebound in traffic in 2004, led by a strong recovery in the world economic growth and which continued for the next two years (2005 and 2006). According to ICAO (International Civil Aviation Organisation), the revenue per passenger kilometers (calculated as the number of seats multiplied by the kilometers flown) for international services has grown by 8.5% in 2005 and is estimated to have grown by 6% in 2006. The strong growth in the traffic and recovery of higher fuel cost through surcharges resulted in strong revenue growth for airline companies. However, this did not translate into a recovery in profitability, primarily on account of a significant increase in fuel costs. According to IATA, the combined losses posted by the world's scheduled carriers amounted to US$ 6 bn in 2005, following a cumulative loss of US$ 36 bn in the previous four years. Future Outlook: As per the estimates of aircraft manufacturers and other industry bodies, the world passenger traffic is expected to grow at 5% p.a. in the medium to long-term. The growth will however be slower in matured economies, but faster in under-penetrated and growing economies like India and China. The primary reason for the increase in passenger traffic over the years has been decline in airline passenger yields. As per an estimate, after adjusting for the general inflation, the average airline yields (revenue per passenger kilometers) have almost halved since 1970. During the same period, the real revenue growth (by combining growth in traffic and decline in yields) has averaged only 2% to 3%. Since aviation industry is a high fixed cost industry, a small increase in operating cost can have a sharp impact on the profitability of the companies. High fuel prices, congestion cost, higher security and insurance cost can increase the overall cost of operations and thereby impact the demand for air travel services. However, there is room for cost reduction in the form of distribution cost and cost synergies from industry consolidation. Overall, we believe that consolidation is the only solution for addressing the problem of excess capacity and poor financial ratios of the company. OVERVIEW OF WORLD MARKET Air travel remains a large and growing industry. It facilitates economic growth, world trade, international investment and tourism and is therefore central to the globalization taking place in many other industries. In the past decade, air travel has grown by 7% per year. Travel for both business and leisure purposes grew strongly worldwide. Scheduled airlines carried 1.5 billion passengers last year. In the leisure market, the availability of large aircraft such as the Boeing 747 made it convenient and affordable for people to travel further to new and exotic destinations. Governments in developing countries realized the benefits of tourism to their national economies and spurred the development of resorts and infrastructure to lure tourists from the prosperous countries in Western Europe and North America. As the economies of developing countries grow, their own citizens are already becoming the new international tourists of the future. Business travel has also grown as companies become increasingly international in terms of their investments, their supply and production chains and their customers. The rapid growth of world trade in goods and services and international direct investment has also contributed to growth in business travel. Worldwide, IATA, International Air Transport Association, forecasts international air travel to grow by an average 6.6% a year to the end of the decade and over 5% a year from 2000 to 2010. These rates are similar to those of the past ten years. In Europe and North America, where the air travel market is already highly developed, slower growth of 4%-6% is expected. The most dynamic growth is centered on the Asia/Pacific region, where fast-growing trade and investment are coupled with rising domestic prosperity. Air travel for the region has been rising by up to 9% a year and is forecast to continue to grow rapidly, although the Asian financial crisis in 1997 and 1998 will put the brakes on growth for a year or two. In terms of total passenger trips, however, the main air travel markets of the future will continue to be in and between Europe, North America and Asia. Airlines' profitability is closely tied to economic growth and trade. During the first half of the 1990s, the industry suffered not only from world recession but travel was further depressed by the Gulf War. In 1991 the number of international passengers dropped for the first time. The financial difficulties were exacerbated by airlines over-ordering aircraft in the boom years of the late 1980s, leading to significant excess capacity in the market. IATA's member airlines suffered cumulative net losses of $20.4bn in the years from 1990 to 1994. OVERVIEW OF AVIATION INDUSTRY IN INDIA Air Traffic: The Airport Authority of India (AAI) manages total 122 Airports in the country, which include 11 International Airports, 94 domestic airports and 28 civil enclaves. Top 5 airports in the country handle 70% of the passenger traffic of which Delhi and Mumbai together alone account for 50%. Passenger and cargo traffic has growth at an average of about 9% over the last 10 years. Growth: Estimated domestic passenger segment growth is at 12% per annum. Anticipated growth for International passenger segment is 7% while the growth for International Cargo is likely to grow at a healthy rate of 12%. Privatization: Privatization of International Airports is in offing through Joint Venture route. Three Greenfield airports are getting developed at Kochi, Hyderabad and Bangalore with major shareholding of private sector. The work on Bangalore airport is likely to commence shortly. Few selected non-metro airports are likely to be privatized.100% foreign equity has also been allowed in construction and maintenance of airports with selective approval from Foreign Investment Promotion Board. Air movements: The total aircraft movements handled in October 2003 has shown an increase of 15.4 percent as compared to the aircraft movement handled in October 2002. The international and domestic aircraft movements increased by 15.4 percent each during the period under review. The reason for increase in aircraft movements is due to increase of operation of smaller aircraft by airlines and the introduction of new airlines viz., Air Deccan in southern region and international airlines (Air Canada, Polar Air Cargo, Qatar Airways (Freighter), Turkish Airways, Air Slovakia at IGI Airport with effect from October 2003. Passenger Traffic: International and Domestic passenger traffic handled in October 2003 has increased by 15.4 percent and 6.7 percent over the period of October 2002 leading to an overall increase of 9.4 percent. The total passenger increased by 9.2 percent, 7.6 percent, 8.9 percent and 17.0 percent respectively at five international airports six developing international airports, eight custom airports and 26 Domestic airports. Cargo Traffic: The total cargo traffic handled in October 2003 has shown an increase of 3.5 percent as compared to the cargo handled in October 202.