CONSISTENT

PROFITS
THE SECRET OF
INDIGOS
How does the airline turn in
profits year after year in one of the
worlds toughest markets where
competitors are struggling?
hen IndiGo, Indias largest airline by passengers carried,
reported a profit of `787 crore in the 2013 financial year,
it stunned many in a manner unusual for an earnings
broadcast. Aviation has always been a thorny industry,
one as is said only half in jest that makes millionaires out
of billionaires, but Indian aviation has stood out as noto-
riously brutal owing to high taxes and costly airport
charges. The year to March 2013 also happened to be the
worst in recent years due to a steep increase in fuel pric-
es and weakening rupee. During the year, Kingfisher
Airlines shut shop and IndiGos competitors made losses
of more than $1 billion.
But IndiGo emerged unaffected from the wreckage.
The latest numbers, revealed by IndiGo president Adi-
tya Ghosh on September 24, burnished the airlines rep-
utation as the lone Indian carrier to prosper in a trou-
bled industry.
Even so, the quantum of profit was astonishing. Indi-
Gos profit had increased six-fold from a year ago.
The profit surpassed a projection of $100-110 million
(around `550-610 crore based on the then exchange
rate) by the Centre for Asia Pacific Aviation (CAPA), an
aviation consulting and research firm. IndiGos own es-
timate done three years ago presaged a modest profit of
`57.5 crore in 2012-13.
DECEMBER 22-28, 2013
06
:: John Samuel Raja and Binoy Prabhakar
W
cover story
IndiGo has
been much
more
efficient
with its use
of share
capital
IndiGo has
made
profits for
five
successive
years while
Jet and
SpiceJet
have lost
money
IndiGos
borrowings
are much
lower than
rivals
IndiGo Vs Competitors
IndiGo SpiceJet Jet Airways
2009-10 2011-12 2012-13
IndiGo is the only airline to
continuously make profits...
0
900
-300
-600
-900
-1200
-1500
600
300
With
lesser
promoter
funds,
IndiGo...
484.35
86.33
34.3
Share Capital 2012-13
Meanwhile, IndiGos fleet has
grown faster than rivals
NA
42
20
85
90
98
95
20
47
55
61
70
2009-10 2010-11 2011-12 2012-13
Fleet size
2009-10
Figures in `Cr
Source: MCA and Annual Reports
2010-11 2011-12 2012-13
3000
6000
9000
12000
15000
...With lesser borrowed money
0
Loan funds
...Grew its revenue by 3.5 times
2009-10 2010-11 2011-12 2012-13
0
5000
10000
15000
20000
S
tart-ups start small, right? In 2005,
IndiGo tossed this rulebook out of
the window a year before launch.
The airline shopped for 100 Airbus air-
craft, a massive order for any airline,
leave alone a fledgling one. IndiGo
swung the deal because the man-
agement of Airbus, the European
aircraft maker, was seemingly com-
forted by the presence of Rakesh
Gangwal at the helm. Gangwal, co-
founder and promoter of IndiGo, is
a true-blue aviation veteran. He
was previously associated in vari-
ous capacities with Air France, United
Airlines and US Airways, where he was CEO and president, stepping
down shortly after American aviation was devastated by the 9/11
attacks. Gangwal has vast experience in buying aircraft for foreign air-
lines, says a person familiar with IndiGos operations. He used his
knowledge and experience to put together a fantastic deal.
IndiGo president Aditya Ghosh says Gangwal carries a tremendous
reputation in the airline business, which translates into lots of credibil-
ity among aircraft makers. IndiGo made a bigger order in 2011, for
another 180 planes from Airbus. That order came when a lot of airline
powerhouses were chasing the order, says Ghosh.
The massive aircraft orders have been both springboard and suste-
nance to IndiGos success. Kapil Kaul of CAPA says Gangwals ability to
take risks and strike winning deals was reflected in IndiGos first 100
aircraft order, which proved game-changing
both strategically and financially.
Today, Gangwal and Rahul Bhatia, the other
promoter, play an equally important role at
IndiGo. Which is to stay away from manage-
ment despite their huge experience (Bhatia
runs InterGlobe, a travel services company).
Allowing the management do its thing is an
advantage, according to Ghosh. In many plac-
es, owners get involved with management
with disastrous results. The most striking and
recent example is Kingfisher Airlines and its
promoter Vijay Mallya. Neil Mills quit as Spice-
Jet CEO earlier this year owing to interference
from promoter Kalanithi Maran. Kingfisher has been grounded for
more than a year and SpiceJet is in turmoil.
Shakti Lumba, a former vice-president of operations at IndiGo, says
aircraft orders apart, Gangwal laid down the parameters on how the
airline should function. He is the visionary at IndiGo, guiding the air-
line at the macro level. IndiGos decision to stay the course with one
type of planes the A320s which renders benefits in terms of man-
aging and training personnel and costs was Gangwals. IndiGo has
stuck to its business plan and model religiously thanks to Gangwals
supervision, says the person familiar with its operations.
Gangwal, who earlier used to visit India occasionally, is now almost
permanently based in the US. Employees at IndiGo say they rarely see
him. He is low profile to the point of casting himself as a recluse.
Ghosh says it is difficult to fathom that Gangwal is a shareholder,
adding that the airline does not even have review meetings. I am
grateful for that.
Soaring Profits
What is the secret of IndiGos continued profits?
The airline has long been a subject of interest for
air travellers and financial analysts alike. Travel-
lers attribute IndiGos success to the efficient ser-
vice they experience on board and planes that
run on time. Analysts have speculated IndiGo
doesnt have to make public its earnings as it is
not listed that it makes most of its money from
sale-and-leaseback transactions.
Under this transaction, operators sell newly
acquired aircraft to leasing companies and in a
parallel transaction lease the same aircraft. The
price at which the aircraft is sold to a leasing com-
pany is usually higher than the price paid to air-
craft makers like Boeing or Airbus.
But InterGlobe Aviation the company that
runs IndiGo raised eyebrows when it revealed
that it did not make profits through the sale-and-
leaseback route. (It was the first time that IndiGo
chose to go public with its annual results.)
Ghosh told ET that IndiGo made an operating
profit of `993.2 crore, a figure he said will end spec-
ulation that a large part of his airlines profits is gen-
erated by sale and leaseback of aircraft. On how In-
diGo continues to deliver profits, Ghosh said the
customers are rewarding his airline for focussing on
a product that is basic, simple, even boring.
True, Ghosh and his team run an innovative
and nimble airline. A reputation for punctuality
has helped IndiGo, a no-frills airline, charge more
than full-service competitors like Jet Airways and
Air India on many routes. Fares actually rose by
more than 20% during the year, belying its claim
of offering low fares.
IndiGo has also shown it is ready to go against
the grain. It has introduced an airport lounge ser-
vice, again unusual for a no-frills airline.
Hormuz P Mama, an aviation expert, says In-
diGos aircraft utilization is the highest for any
Indian airline. That helps enhance revenues.
A Money-Spinner
This, however, is only half the story. An analysis
by ET Magazine of the airlines books reveals that
it is indeed sale-and-leaseback transactions that
helped IndiGo record higher profits. In some
cases, these transactions turned losses into prof-
its as it happened in fiscal 2011. Financial docu-
ments that InterGlobe filed with the Ministry of
Company Affairs
(MCA) also show
that the seven-year-
old airline consist-
ently reported prof-
its from its third
year of operations.
Of course, its not
as simple as that.
Three accounting
experts that ET Mag-
azine approached
say the transactions
done by IndiGo ad-
here to Accounting
Standards, and one of them called these account-
ing entries as financial engineering to drive more
value out of investment.
The combination of operational performance
and financial engineering has amplified IndiGos
valuation. From an initial investment of around
`100 crore as equity capital by promoters, the
airline today can be valued at `12,200 crore ($2
billion) depending on how investors treat the
sale-and- leaseback model, says Kapil Kaul, CEO
of CAPA South Asia.
Indeed, analysts linked IndiGos decision to fi-
nally publicize its annual results as a gamble to at-
tract investor interest and list on bourses.
In September, Ghosh denied any such plan,
saying the results were announced to end the bi-
zarre interpretations people draw from the one
or two sheets that are leaked every year when In-
diGo makes regula-
tory filings. So I
thought [it is] best
to be transparent
and take the mys-
tery out of it.
IndiGo, however,
did not share its
balance sheet or
profit and loss ac-
count with the me-
di a. On why i t
didnt, Ghosh said
he didnt think on
those lines and
gave out data from
the form submitted
to the DGCA [aviation regulator].
Reliable Model
IndiGo promoter Rahul Bhatia too insisted that his
airline is transparent. Anyone interested in exam-
ining IndiGos finances is free to approach the
regulators, he told ET in November.
Ghosh, also the airlines spokesman, did not
comment on the finances for this article. We do
not discuss any of these [financial] items in the
press, he said.
Nevertheless, the sale-and-leaseback model
helps explain why IndiGo reports consistent prof-
its while competitors are losing money and are
saddled with mounting losses. Still, it begs the
question: why cant other airlines do the same?
Actually, many airlines, including those in India,
do. The benefits of this transaction are significant
(see Sale-and-Leaseback Model). In their book
Foundations of Airline Finance: Methodology And
Practice, Bijan Vasigh, Ken Fleming and Liam Fac-
kay wrote that thanks to sale and leaseback, the
airline will receive a cash inflow which will then be
used to pay down the debt associated with the air-
craft. If the sale value is greater than the amount of
debt against the aircraft, the airline will receive a
positive cash flow.
A leasing company agrees to such an arrange-
ment, they wrote, because it is provided with an
asset and an established customer without hav-
ing to buy a brand new aircraft, but still generates
lease income from the airline.
Alex Wilcox, CEO of JetSuite, a private jet com-
pany in California, says airlines in the US typically
own about half their fleet and lease the other half.
Some airlines capitalize their leases and long-
term maintenance and some expense them,
says Wilcox who was earlier COO at grounded
Kingfisher Airlines.
As a financial model, sale and leaseback is pop-
ular among no-frills airlines for the flexibility it
renders to keep balance sheets light. As aircraft
are owned by a lessor, an airline can save on the
depreciation provision, which increases profit
and saves tax.
As it happens, IndiGo has been the most active
user of sale-and-leaseback financing among no-
frills carriers, according to Flightglobal, a news
DECEMBER 22-28, 2013
07
cover story
:: Binoy Prabhakar
The Reclusive
IndiGo Promoter
Gangwal was
previously
associated with
Air France,
United Airlines
and US Airways,
where he was
CEO and
president
From an initial
investment of
around
`100 crore as
equity capital by
promoters,
IndiGo today can
be valued at
`12,200 crore
IndiGo has been
the most active
user of sale-and-
leaseback
financing among
no-frills carriers
in the past two
years to May 1
and information website. IndiGo completed 37 such
transactions in the past two years to May 1, followed by
Virgin Australia with 35 transactions and Lion Air, Indias
SpiceJet and Norwegian with 28 each, it said in a report.
But the key difference in IndiGos strategy was to incor-
porate the purchase of 100 aircraft into its business plan
even before launch. Other operators even now are talking
of only a fraction of that order size, according to Kaul.
Humongous Order
Placing a huge order helps airlines to bring down the
cost price sharply. GoAir CEO Giorgio De Roni says a
huge order hands the buyer huge bargaining power. It
is true for not just airlines, but also people who buy to-
matoes and potatoes, he says.
A January 2013 report by accounting and consulting
firm PricewaterhouseCoopers (PwC) on aviation fi-
nance says the list price of
all airline order back log is
$1.2 billion as of mid- 2012,
but the real cost is likely to
be in the order of $700
million. That is a dis-
count of 42%.
Mark D Martin, founder
of Martin Consulting and
an aviation industry ex-
pert, says he would not be
surpri sed i f I ndi Go
grabbed a discount in ex-
cess of 40% of the list
price. He reckons the sticker price for an Airbus A320
the only type of aircraft IndiGo uses at $60 million in
2007 when the airline signed the agreement.
Using one type of aircraft helps IndiGo keep opera-
tions simple. It is a trick it learnt from Americas South-
west Airlines, the only airline in the world to make
profits without fail for nearly 40 years, which flies the
Boeing 737.
Quoting Chris Wahlenmaier, vice-president of ground
operations at Southwest, Seth Stevenson wrote in Slate: us-
ing one type of aircraft results in all manner of cost-saving
efficiencies: we only need to train our mechanics. We only
need extra parts inventory. If we have to swap a plane out
at the last minute for maintenance, the fleet is totally inter-
changeable all our on-board crews and ground crews are
already familiar with it
Operational gains apart, airlines
can derive other significant advantages by buying one type
of plane from a manufacturer. Pascal-Emmanuel Gobry,
the founder of Noosphere, a market research firm, wrote
earlier this year discount airlines are almost always the big-
gest customer, which means plane companies are eager to
please them and give them volume discounts. For exam-
ple, [European airline] Easyjet, which is committed to Air-
bus like Southwest is to Boeing, placed the biggest order in
Airbuss history after 9/11. They got them at bargain-base-
ment rates [they went on to resell the planes at a profit].
Even so, Easyjet was an established airline, having
started its operations in 1995. IndiGo was not even off the
blocks. It also had just `100 crore (around $20 million) of
promoter money. Yet, it managed to strike a deal for 100
aircraft and by parting with a low down payment at that.
How did IndiGo do it? The credit goes to co-founder
Rakesh Gangwal, a veteran of nearly 35 years in the air-
line business (see The Reclusive IndiGo Promoter).
IndiGo is one of the few airlines that tracks and
ensures it capitalizes on the warranty and guaranty
clauses, says a person familiar with the airlines op-
erations. It has a full section in finance just tracking
these financial items.
Deal for a Steal
The rules governing aircraft financing stipulate that a
down payment of only 4% for an entity with credit rat-
ing of AAA- BBB-, and 7.5% for the ones with lowest rat-
ing (CCC- C), according to the PwC report. (The rest is
paid to the aircraft maker from the proceeds of the sale
to the leasing company).
This means IndiGo with a 40% discount on list price for
Airbus 320 would have had to make a down payment of
$151 million (see How IndiGo went about it) for placing an
order for 100 aircraft. The companys
balance sheet then shows it was well
capitalized `337 crore ($82 mil-
lion)to meet the payment schedule.
An accounting expert, who did not
want to be named, says the discount
received from manufacturers will not
be shown separately as it is in the nor-
mal course of business. But other
forms of cash and non-cash payments
from aircraft manufacturers can be
counted in financial statements.
That explains why the global fleet
under leasing has now touched nearly
a third from less than 12% in 1990, says
the PwC report. (The numbers repre-
sent the entire leasing transactions
and not just sale and leaseback.)
In my estimate, every sale and
leaseback brings $4-5 million profit
to IndiGo. And this acts as working
capital, says Kaul of CAPA. Curi-
ously, the finances of IndiGo in the
past six years do not show any profit
for the sale and leaseback of aircraft.
DECEMBER 22-28, 2013
08 cover story
Using one type of
aircraft helps
IndiGo keep
operations
simple and earn
great discounts
from Airbus
The Sale and
Leaseback
Model
YEAR 0 YEAR 8
AIRFRAME
MAKER
ENGINE
MAKER
AIRCRAFT
RETURNED TO
LEASING
COMPANY
Pays 5% down
payment while
placing an order
Airline operator signs
aircraft purchase
agreement, lets say
for 20 aircraft for
$55 million apiece
The lease is for five
years. At the end of
it, aircraft is
transferred to
leasing companies
Three separate back-to-back transactions:
the first to take delivery of the aircraft, the
second to sell to leasing companies at $60
million, making a profit of $ 5 million and
the third to lease back the same aircraft
AIRLINE
YEAR 3
AIRCRAFT
DELIVERED
SELLS TO
LEASING
COMPANIES
FOR A PROFIT;
USES
PROCEEDS TO
REPAY WHATS
OUTSTANDING
TO AIRCRAFT
MAKERS
LEASING
COMPANY
RENTS TO
AIRLINE
FOR 5
YEARS
Assuming the discount is around 45% on list
price (industry average), IndiGo would have
had to pay only `620 crore to place an order
for 100 planes. Such amounts are not paid at
one go. In any case, the company had money
Because it was a bulk order
(at around `41 to $)
(promoter plus loan)
How IndiGo
went about it
LIST PRICE
COST PRICE
ORDER SIZE
ORDER SIZE
DOWN PAYMENT @ 5%
INDIGO WAS WELL
CAPITALIZED
$55 MILLION
$30.25 MILLION
100 PLANES
$3,025 MILLION
$151.25 MILLION
OR
$82 MILLION
OR
`620.12 CRORE
`337 CRORE
IndiGo prom
oter Rahul Bhatia (left)
and president Aditya Ghosh.
The airline m
ade public its
annual results for the first tim
e
in Septem
ber
A
S
H
W
A
N
I

N
A
G
P
A
L
Amounts are indicative and
for explanation purposes
If IndiGo cant show the discount it receives from
purchase of aircraft, industry experts say it should be
able to book profits when it sells newly acquired air-
craft to leasing companies. Their logic is simple the
price paid by leasing companies for a plane is always
higher than the cost price.
Tidy Profit
CAPAs Kaul estimates that IndiGo makes a profit of $4-5
million for every plane sold to leasing companies, and
this translates into a monthly saving of around $50,000
on lease rentals. The entire fleet, barring 4 planes, is
leased by IndiGo and any saving on lease rentals which
account for 19% of expenses will boost profitability
(see How IndiGo Boosts Profits).
The Flightglobal report confirms that IndiGo makes
$4-5 million from sale-and-leaseback of each aircraft.
With an average lease term of five-and-a-half years, the
airline is also benefitting from the frequent renewal of
its fleet by avoiding costly maintenance repairs that
creep in after six years, according to the report.
Mama the aviation expert says returning aircraft to
leasing companies after five or six years helps. The
maintenance cost will be lower for new aircraft. More im-
portant, the D-Check (the most comprehensive
check for a plane) approaches around that time. It is
very expensive. By returning planes before the D-
Check is due, IndiGo makes big savings.
The only problem is that IndiGo has never dis-
closed profit from sale of
planes to leasing compa-
nies. Instead, the only
items it shows are cash
incentives and non-cash
incentives of around `265
crore. These were re-
duced from lease rentals,
boosting profits by a third
in fiscal 2012 and helping
the airline report a surplus
in fiscal 2011.
Without directly refer-
ring to IndiGo, Jamil Khatri, global head of account-
ing advisory services for KPMG, says aircraft manu-
facturers might have given cash incentives instead of
discounts for placing the bulk order. Typically, non-
cash incentives given by manufacturers include free
spare parts, extra engines, free training to pilots and
engineers and support in obtaining credits from lend-
ers. IndiGo is likely to have assigned a value to such
spares and engines.
Another accounting expert says, If a company owns
the asset, the practice would be to reduce the cost of ac-
quiring the aircraft in the balance sheet. But in IndiGos
case, the airline has leased the aircraft and so it is propor-
tionately reducing it from the lease rentals.
If the cash incentive was $5 million on a purchase
price of $50 million, the actual cost in the balance sheet
would be only $45 million after reducing the cash incen-
tive. But in IndiGos case, the aircraft is sold to leasing
firms and so would not be accounted in its books. And if
the lease period is for five years, $1 million that is one-
fifth of cash incentives would be reduced from lease
rentals every year.
In IndiGos case, this yearly component totalled
`262.7 crore for a fleet of 64 aircraft. Assuming 60 of
them are leased, the cash and non-cash incentives alone
amount to `4.37 crore a plane a year. The amount of
such incentives that can be claimed in future is `1,180
crore, or `19.6 crore per plane.
Long-term Gains
IndiGo started disclosing the quantum of cash and non-
cash incentives only from fiscal 2011 in the financial docu-
ments submitted to the MCA, the regulator of companies.
Prior to 2011, the company only disclosed that it receives
credits from aircraft makers and these were being re-
duced from lease rentals. One might argue that it is more
appropriate to present this as income if a direct relation-
ship with rentals is absent which is often the case, says
the accounting expert quoted earlier.
Khatri of KPMG says there is another possibility why
cash incentives are subtracted from lease rentals. He
points to Accounting Standard 19, which deals with
sale and lease back transactions. Under this, lets say if
a company makes a profit of $5 million from selling a
plane but in return leases the same at a rental higher
than the market rate, the excess value has to be re-
duced from lease rentals.
If IndiGo pays $400,000 as lease rentals a month
compared with the market rate of $350,000, the ex-
cess $50,000 would be reduced from lease rentals.
In our example, the excess would be $600,000 a
year and it would have to be reduced from profit on
sale of aircraft. That means only $400,000 will be
considered as profit.
If IndiGo shows only reduction in
lease rentals and no profit from sale
of aircraft, it would possibly mean
the entire profit from sale and
leaseback is being erased by high-
er lease amount.
On a net basis, IndiGo still gains as
lease rentals drops, boosting profits. Accord-
ing to Martin, the amount of discount negotiated by
IndiGo would be much higher than other Indian
airlines because of the order size. That is one key
reason why IndiGos operational cost is much low-
er than its competitors.
DECEMBER 22-28, 2013
09
cover story
IndiGo started
disclosing the
quantum of cash
and non-cash
incentives only
from fiscal 2011
in its documents
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How IndiGo
Boosts Profits
In 2012-13, cash and non-cash
incentives contributed
`359 crore, or 45% of total profits
Figures in `crore
Figures in brackets are
a % of total expenses
Source: Companys
financial statements