Lessons from the collapse of SpiceJet

09 December 2014
In June 2010, Kalanithi Maran took over SpiceJet. I wrote an article around the
takeover, in the newspaper I used to work for at that point of time, starting with
the line "It takes a brave man to buy an airline."
Towards the end of the article I quoted Warren Buffett. This was something the
Oracle of Omaha had written in his annual letter to Berkshire Hathaway
shareholders, in February 2008. As Buffett wrote: "Now let's move to the
gruesome. The worst sort of business is one that grows rapidly, requires
significant capital to engender the growth, and then earns little or no money.
Think airlines. Here a durable competitive advantage has proven elusive ever
since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been
present at Kitty Hawk, he would have done his successors a huge favor by
shooting Orville down."
What made Buffett say this? "The airline industry's demand for capital ever since
that first flight has been insatiable. Investors have poured money into a
bottomless pit, attracted by growth when they should have been repelled by it.
And I, to my shame, participated in this foolishness when I had Berkshire buy
U.S. Air preferred stock in 1989. As the ink was drying on our check, the
company went into a tailspin, and before long our preferred dividend was no
longer being paid. But we then got very lucky. In one of the recurrent, but always
misguided, bursts of optimism for airlines, we were actually able to sell our
shares in 1998 for a hefty gain. In the decade following our sale, the company
went bankrupt," wrote Buffett.
After a shorter version of this piece of wisdom from Buffett, I closed the article on
SpiceJet, with the line: "Surely, Maran knows what he is up against." As it has
turned out, I was hoping against hope. SpiceJet is now in major trouble and has
had to scale back its operations.
Between October 2013 and September 2014, the company faced losses of Rs
928.9 crore. During the period July to September 2014, the company made
losses of Rs 310 crore. This, despite the fact that global oil prices fell during the
period.
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In the last few months the airline has also used what aviation industry insiders
term as the "Christmas tree" option. This essentially means that the airline is
taking out spare parts from its aeroplanes and using them for other planes in its
fleet. Long story short: it doesn't even have the money to pay for spare parts.
The commercial aviation business is a huge cash guzzler and has led many a
capitalist to his ruin-Vijay Mallya being the latest such example. And as things
currently seem Maran's SpiceJet seems headed that way.
This is not only an Indian phenomenon, it seems to be the case globally.
Economist Severin Borenstein examined the scenario in the United States in a
2011 research paper. He found that the airlines had lost around $60 billion (2009
dollars) between 1978 when the aviation sector in the United States was
deregulated and 2009. High taxes were a reason for the losses and so was the
fall in demand after 9/11.
A February 2014, article in The Economist suggests that profits margins
of airlines have been less than 1% on average over the last 60 years. This makes
me wonder why do businessmen still want to enter this sector?
Interestingly, airlines made a profit of only $4 per passenger in 2012. Another
interesting study carried out by McKinsey points out that in 2010, around $500
billion of capital was invested in the airline industry. The overall cost of capital for
this stood at around 7-8%, whereas the return on invested capital was at 2.8%.
No wonder investors constantly lose money on airline stocks.
What this tells us is that commercial aviation is a tough business to be in. And
why is that the case? There are several reasons for the same:

a. It is a highly capital intensive industry.

b. There is a lot of competition.
c. It gets impacted by a lot of things that are not under its control (the
overall economic sentiment, taxes, outbreak of illnesses, price of oil and
so on)
d. While the industry has to face a lot of competition, the industries that
airlines have to deal with are highly monopolistic. As an article in The
Economist puts it "Two firms-Airbus and Boeing-provide the majority of

the planes, and airports and air-traffic control are monopolies." Given
this, airlines are not always in the best position to control their costs.
e. For a very long period of time, airlines were run by governments, and
hence, profit was not the only motive. Over the last few decades, the
world has seen a spate of low cost carriers being launched. These
airlines have given tough competition to full service carriers.

These are general reasons as to why airlines find it tough to make money. Some
of these reasons apply to SpiceJet as well. But there are other major reasons as
to why the airline is in trouble. Unlike Vijay Mallya's Kingfisher which was
confused about being a full service carrier or a low cost airline, SpiceJet was
always a low cost airline. There was no confusion on that front.
But like Mallya, aviation is not Maran's primary business. His primary business is
spread across television channels, a cable TV distribution network and
newspapers in the state of Tamil Nadu and the other Southern states. Further,
these businesses have always had the political protection of the DMK party
(Maran is the grand-nephew of DMK boss M Karunanidhi).
Maran's lack of experience in the aviation sector started to come out as soon as
he took over the airline. After taking over the airline he went around installing his
own people to run the place. As a report in the Business World points out "With
the change in ownership, everyone at the airline knew that the chief executive
officer and chief financial officer would change...The replacements on the board
were largely Maran's own family members and trusted aides but not necessarily
people with experience of running a business - leave alone an airline."
The airline also saw a steady exit of employees who knew how the aviation
business operated. Another major blunder committed by the airline was allowing
IndiGo to capture the slots in the Delhi-Mumbai route, left vacant by Kingfisher,
after it stopped flying.
As the Business World report referred to earlier points out "SpiceJet had roughly
six to seven flights a day between the two metros and IndiGo had around seven
to eight. Today, IndiGo has close to 15 flights between the two metros. DelhiMumbai drives the aviation business in India and accounts for almost 60 per cent
of traffic in the country."
This was more because of the lack of experience of running an airline than

anything else. Moral of the story: It is one thing running a business with the
protection of a political party and it is another thing running a business which has
some semblance of competition.
To conclude, what the failure of airlines like Kingfisher, Air India and now
SpiceJet, clearly tells us is that you cannot "also" be in the commercial aviation
business. Mallya found this out the hard way. He also ran an airlines business,
along with his primary liquor business, real estate business and some sports
business. Maran seems to be headed Mallya's way with his huge losses. The
government owned Air India continues to accumulate losses, in a country where
Railway infrastructure remains very poor. A report in the Mint newspaper points
out that combined losses of airlines in India over a period of seven years ending
March 2014, stood at close to $8.6 billion.
What a mess!