Logic faulty in Kingfisher, Deccan merger

MUMBAI: In maths, two negatives make a positive. But does the same idea work in mergers and acquisitions? Do two humungous loss-makers make for a profitable match?

Between them, Kingfisher Airlines and Deccan Aviation, which decided to merge on Wednesday, have run up collective losses of Rs 2,000 crore.

Even assuming lots of synergies and cost-cutting, the bleeding seems unlikely to end any time soon. More so, when the marriage brings two airlines with completely different brand identities - one a no-frills budget carrier and the other an upmarket player - under one roof.

In fact, Capt GR Gopinath, when Deccan was still single, contemptuously dismissed liquor baron Vijay Mallya’s overtures as unworkable due to their differing DNAs.

“We are from different planets, he is from Venus, I from Mars,” Gopinath said about Mallya last May.

So what’s changed between Mars and Venus in seven months that they are not only hopping into bed, but also tying the knot formally?

Perhaps, the metaphor of two drunks propping each other to stand upright works better in their case.

Surbhi Chawla at Angel Broking says that while the decision on merging Kingfisher and Deccan could prove beneficial in the long run, a turnaround will actually be delayed because of the merger.

The merged entity would have to contend with a sea of red ink since Kingfisher has higher losses compared to Deccan.

In other words, the shareholders of Deccan, which is a listed entity, will only see an addition of red ink once they agree to take Mallya on board. Over the last two days, the markets have given Kingfisher-Deccan the thumbs down, with Deccan losing Rs 537 crore in market value.

Quite clearly, the merger is more about size, scale and overarching ambition (or desperation) than anything else. The upcoming integration of Kingfisher and Deccan Aviation will, in theory, create a huge airline with a market share of around 30%.

But when non-compatible brands join hands, two plus two often adds up to three. The marriage of a high-end brand with a cut-rate carrier could end up sending the wrong brand signals.

The moot point is: will Kingfisher’s upmarket travellers downtrade to Deccan, and thus reduce overall revenues? Or will the cost synergies from rationalising routes, fares and ground-handling be enough to outweigh this negative?

After the valuation of Kingfisher is done and the swap ratio is worked out, Mallya and his group are destined to hold a controlling stake in the company.

The listed Deccan Aviation will be rechristened Kingfisher Airlines while Deccan and Kingfisher will operate as separate brands. Officials in the civil aviation ministry say that though the proposed merger does not need any sanction from the ministry, the merged entity’s board of directors would need approval.

Also, combined slots and flying schedules would need clearance.

Perhaps as a precursor to the merger, Kingfisher is already planning to downsize its fleet acquisition plans. Kingfisher and Deccan currently operate a combined fleet of 78 Airbus and ATR aircraft; Kingfisher has 106 new Airbuses on order — including five superjumbo A380s — while Deccan has 54 Airbus A320 family aircraft awaiting delivery.

When DNA Money spoke to Kingfisher’s chief financial officer A Raghunathan a day before the board meet, he had said that “as per the existing schedule, only about 10-12 new aircraft are going to be delivered between now and 2010.” He declined to confirm if the order size is being pruned.

For Kingfisher, the main attraction would be that it can fly abroad earlier than planned, since the current policy allows only airlines that have been in business for five years to leave home shores.

Deccan gets to fly abroad in 2008. But this can only delay the turnaround of the merged entity. Reason: overseas operations typically take longer to turn profitable than domestic ones.

On the plus side, some of the operational synergies are already visible - crew dress code, aircraft livery, website, et al. A financial merger would also give the merged entity the benefit of carry forward losses. According to Kingfisher estimates, the merged entity should turn profitable by 2009.

A few optimistic analysts reckon that the merger will strengthen the company, as Kingfisher enjoys higher yields of Rs 4,200-4,400 as against Deccan’s Rs 2,700-2,900. Rati Pandit at Networth said that news of the merger is good since it offers “tremendous” cost synergies besides benefits on the fleet and route front.

But not everyone agrees that the picture is rosy. An analyst from a foreign brokerage house, who did not want to be named, said: “The bottomline for any business is profitability; Deccan was not geared towards profitability as much as towards expansion and market share.

It had grown too fast. Mallya has been making the right noises but it’s going to be a huge task to effect a turnaround. Realistic fares are probably the most important component in cutting down losses.”

The real reason for the merger is thought to be Mallya’s urge to fly abroad. An analyst said, “Mallya is taking delivery of the long haul Airbuses in 2008 and there is no way he would have allowed these high-cost assets to sit idle.” With Deccan’s permits, Kingfisher would be able to commence international operations by mid-2008, as Deccan completes the mandatory five years of domestic service.

But is it treading dangerous territory in terms of the brand image