INDIANAVIATION：STEEPASCENTUNLIKELYTOCONTINUE1212.ppt

,IndustrialsAsian TransportIndian AviationSteep ascent unlikely to continueHSBC rating and target price changes,abcGlobal Research Impressive share price performance ofJet and SpiceJet reflects anticipation ofinvestment from foreign airlines Prospects of recapitalisation key,butstrategic benefits limited.Potentiallargely priced in,CompanyBloomberg tickerCcyPrice(10 December close)New TPOld TPNew ratingOld ratingHSBC EBITDA vs consensusFY13eFY14e*HSBC forecasts LBITDA vs consensus EBITDASource:Bloomberg,HSBC estimates,Jet AirwaysJETIN ININR514.7600575N(V)OW(V)15%11%,SpiceJetSJET ININR46.24442UW(V)N(V)n.a.*-25%,Downgrade Jet to N(V)and SpiceJet toUW(V)at increased target pricesForeign investment expectation drives rallyThe key attractions for a foreign airline investing in Indiancarriers are access to a traffic feed from India and a chanceto boost brand strength.However,for a foreign full-serviceairline looking for a strategic partner,investing in a low-cost,carrier may bring relatively little value.While speculationthat a foreign airline might invest in Jet and SpiceJet hasdriven a 34-47%rally in the two stocks over the last month(Sensex up 5%over the same period),these reports aremedia-led and unconfirmed by the companies.Few strategic benefits,largely priced in,12 December 2012Rajani Khetan*AnalystThe Hongkong and Shanghai Banking Corporation Limited+852 3941 0830.hkMark Webb*Regional Head of Conglomerate and Transport ResearchThe Hongkong and Shanghai Banking Corporation Limited,Although recapitalisation in any form would be a boon to theheavily indebted Indian airlines,we argue that the potentialstrategic benefits of a deal would be limited and are largelypriced in at the current levels.Further,while the prospects ofa foreign airline investment materialising appear better thanbefore,these could meet with regulatory and legal hurdles.Given the recent share price outperformance,along with a,+852 2996 6574,.hk,modest earnings outlook,we see limited upside from theseelevated share price levels.Downgrade Jet to N(V),SpiceJet to UW(V)As we roll forward our valuation,we raise our target pricefor Jet to INR600 from INR575,but downgrade our rating toN(V)from OW(V).We raise our target price to INR44 for,View HSBC Global Research at:http:/*Employed by a non-US affiliate of HSBC Securities(USA)Inc,and is not registered/qualified pursuant to FINRA regulationsIssuer of report:The Hongkong and Shanghai BankingCorporation LimitedDisclaimer&DisclosuresThis report must be read with thedisclosures and the analyst certificationsin the Disclosure appendix,and with theDisclaimer,which forms part of it,SpiceJet(from INR42)but downgrade our rating to UW(V)from N(V).SpiceJet,we argue,would make a less attractivestrategic investment for a foreign full service airline.Giventhe companys largely lacklustre earnings outlook,we thinkits recent share price rise is unwarranted and suggest takingprofits.While we have grown more bearish on the sector,weargue that Jet Airways still remains better positioned to benefitfrom a further sector re-rating,should one happen.,IndustrialsAsian Transport12 December 2012Jet Airways Strong share price outperformance led by anticipation of apossible stake sale Possible deal with Etihad could be win-win,but current share pricelargely reflects the potential upside,in our view;most earningsdrivers remain weak Raise target to INR600(from INR575),downgrade to N(V),abc,SummaryThe Jet Airways share price has seen a strong rallyin the past month,rising 47%and outperformingthe Sensex by 40%.This outperformance has beenthe result of press reporting that Jet Airways is intalks with a UAE carrier Etihad involving apossible stake sale.While both the companieshave declined to comment,the share price hasrisen in anticipation of a possible stake sale.In this report,we attempt to bring a globalperspective to this development,analyse what apossible stake sale deal could entail by looking atEtihads past airline investments and drawinginference from Etihads 2011 investment inGerman carrier Air Berlin which according to usoffers the closest reference point.We argue that although the prospects of a dealmaterialising appear brighter than before,therecould be regulatory and legal bottlenecks thatcould unfold.After the recent share price run,webelieve the potential upsides are largely built inthe price.In addition,we argue that a lacklustreearnings outlook will essentially cap any furtherre-rating of the stock and downgrade our rating to2,N(V)from OW(V)at an increased target ofINR600(was INR575).Jets old ties with the MiddleEastJet Airways association with the Middle East is notnew.In the 1990s,when deregulation allowed theentry of private carriers on Indian domestic routes,India permitted up to 40%foreign direct investment(FDI),including foreign airlines.Jet Airways at thetime was a fully owned subsidiary of Tail Winds,a private limited company incorporated in the Isleof Man that was 60%held by Mr Naresh Goyal,20%by Gulf Air,and 20%by Kuwait Airways.In 1997 however,when regulations regardingforeign holding in Indian airlines were changedagain,Jet was directed to take steps fordisinvestment of equity shares held,directly orindirectly,by foreign airlines pursuant to theGovernment of Indias policy on foreign equityparticipation in the domestic air transport servicessector.Consequently,with effect from 15 October15 1997,Naresh Goyal acquired the 20%equityshares from each of Gulf Air and KuwaitAirways,respectively,and became the 100%,IndustrialsAsian Transport12 December 2012owner of Tail Winds which is an OverseasCorporate Body.Press reports,we analyseReuters and other press reported on 26 November2012 that Jet Airways and Etihad are in talks for aproposed stake sale deal with Etihad planning topick up a minority stake in Jet Airways.Followingthis,the Economic Times and other media reportedon 3 December 2012 that Jet is set to sell 24%stake(assume 24%of the enlarged share capital)to Etihad for INR16bn.Reports suggest that thedeal will be closed by March 2013 and Jet willseek the clearance from Foreign InvestmentPromotion Board for the transaction.We have,atthis stage,little clarity over the prospects of anapproval being granted as the transaction may becontingent upon Jets compliance with IndiasFDI regulations in place presently(putting a capof 49%on foreign investment against Jets 80%).Neither Jet Airways nor Etihad confirmed ordenied these reports.The only official commentmade by Jet Airways in a filing with the Indianstock exchange was,“With reference to the newsitem appearing in a leading financial daily titledBuzz on Jet-Etihad Deal Gets Louder,we areaware that recently there has been muchspeculation in the press.The company,however,cannot comment on such speculative reports.”Etihad issued no official filing but commented inan email to the press,stating,“If or when we makefurther investments of this sort,we will announcethem in line with regulatory and commercialrequirements”(source:Economic Times).We have at this stage little insight into possiblevaluations or a proposed deal structure apart fromthese preliminary indications by the press.So inthe next part of this report we analyse Etihadspast airline investments to get some insight into apossible structures of this deal and use thesepreliminary details to build scenarios on possible,Etihads past dealsEtihad Airways is the national airline of theUnited Arab Emirates and is 100%owned by theGovernment of Abu Dhabi.Having startedcommercial operations in November 2003,it nowoperates a fleet of 67 aircraft(mix of Airbus,Boeing,narrow-body and wide-body aircraftincluding six dedicated freighters)and plans togrow its fleet to 158 aircraft by 2020.A keyfeature of Etihads strategy so far has been itsstrategic partnerships and codeshares with airlinesall over the world.Air Berlin 29%In December 2011,Etihad increased its stake inAir Berlin(Germanys second-biggest airline bycapacity)to 29.21%to become its single largestshareholder.Etihad invested EUR73m equity andalso provided EUR196m debt financing,forminga strategic partnership with Air Berlin in exchangefor a minority stake and two seats on the Board ofDirectors of Air Berlin.Air Berlin redeployed its Berlin and Dsseldorfflights into Dubai to Abu Dhabi and ceasedoperations to Asian destinations(except a dailyservice from Abu Dhabi to Phuket in Thailand),driving its traffic to points to the east throughEtihads Abu Dhabi hub.Etihad Airwayscodeshares on all Air Berlin flights to/from AbuDhabi and beyond the four German hubs ofBerlin,Dsseldorf,Frankfurt and Munich to anumber of points in Europe and North America.Members of both airlines frequent flyerprogrammes,Etihad Guest and Air Berlinstopbonus can earn rewards and miles on eachothers flights.In his report of 3 August,European airlines:Stock picking in the lower leagues,our EuropeanAirlines analyst,Andrew Lobbenberg,wrote thathe considered this transaction more favourable toAir Berlin(AB1 GR;UW(V);TP EUR1).While,abc,current and implied valuations for Jet.3,IndustrialsAsian Transport12 December 2012he saw clear-cut benefits for Air Berlin from thisdeal,through recapitalization,the rationale forEtihad wasnt sufficiently evident.He argued:For Air Berlin this development was clearlyfavourable;prior to this development itsbalance sheet was under pressure.The Etihadcash strengthened the business and offered afuture potential source of support.The prospective benefits from the dealappeared relatively few from Etihadsperspective.While Etihad/Air Berlin couldgain some share in single connection marketsfrom Dsseldorf and Berlin to points in Asia,Andrew argued that the scale of these benefitswould be small.Although the traffic flows fromother Air Berlin network points could tap intothe broader Etihad network after the deal,but inmost instances Air Berlin/Etihad would offerdouble connection routings(e.g.Copenhagen-Dsseldorf-Abu Dhabi-Kuala Lumpur)whencompetitors offered a single connection(e.g.Copenhagen-Dubai-Kuala Lumpur).Following the deal,to strengthen its balance sheet,Air Berlin now plans to divest its frequent flyerprogramme into a strategic joint venture in whichit will hold a stake.Although the identity of theinvestor for the frequent flyer scheme is not known,it may be Etihad or a related party.OthersAir Seychelles 40%In January 2012,Etihad acquired a 40%stake inAir Seychelles(the remaining shares in theSeychelles national airline are held by theGovernment of the Seychelles).Air Seychelles isthe national airline of the Republic of Seychelles,an island country to the east of mainland Africamainly known for its appeal as a tourist attraction.The stake purchase also included a codeshareagreement to include Etihad Airways marketedflights across Air Seychelles network in return4,for cooperation for Air Seychelles on EtihadAirways flights from the Seychelles to Abu Dhabiand beyond to the latters destinations acrossEurope,the Middle East,Asia,Australia and theGulf.The airlines have also integrated theirfrequent flyer programmes.Virgin Australia 10%Etihad has a 10%equity stake in Virgin Australiathat entails codesharing on flights,joint marketinginitiatives and reciprocal earn-and-burn on theirrespective frequent flyer programmes.Together,Etihad and Virgin operate 24 flights a week betweenAbu Dhabi and Australia.Etihad codeshares on allVirgin Australias domestic Australian and trans-Tasman services.Aer Lingus 3%Etihad acquired a 2.987%stake in Aer Lingus(Irish national carrier)in May 2012 whichinvolves interline and codeshare agreementsbetween the two carriers.What could a potential Jet-Etihad deal entail?A study of Etihads past deals suggests that itsstake acquisition in German carrier Air Berlin isprobably the closest we could get to drawingparallels with a potential deal with Jet.The dealwith Air Berlin involved both equity and debtfrom Etihad.While that deal appeared morefavourable to Air Berlin,the prospects for Etihadappear better from a potential deal with Jet as weexplain in detail later.From Jet Airways perspective,the mostsignificant advantage from a potential deal wouldmean more equity and access to loan funds(onsimilar lines to Air Berlin).The main benefit toEtihad could probably largely be from bettertraffic feed from India into Abu Dhabi.,abc,IndustrialsAsian Transport12 December 2012Possible attractions to Etihad1.Better traffic feed from India into an adjacenthub in Abu Dhabi,direct flights per week connecting India andDubai versus 119 per week to Abu Dhabi.India-Dubai routes,abc,As we illustrate in detail below,presently Dubai is,Annual seats(000),No of airlines,HHI score,a far bigger hub for outbound traffic from Indiathan is Abu Dhabi.A possible deal with Jet couldenable Etihad to use Jet to route traffic feed intoits adjacent hub in Abu Dhabi.Abu Dhabi or Dubai which is UAEs jewel?,12345678,BOM-DXBDEL-DXBHYD-DXBMAA-DXBCOK-DXBBLR-DXBCCJ-DXBTRV-DXB,2,1281,484948923691640570432,65433232,3,5303,8824,6195,6054,6848,3044,1435,940,The United Arab Emirates(UAE)is a federation ofseven states comprising Abu Dhabi,Dubai,Ajman,Fujairah,Ras al Khaimah,Sharjah and Umm alQaiwain.Of these seven,Dubai and Abu Dhabi bothhad a population of roughly 2m each in 2011 andtogether account for nearly 60%of UAEs totalpopulation.While most of UAEs oil reserves arefound in Abu Dhabi,Dubai maintains its attractionas the regions financial and tourism centre.Dubai is more popular.In terms of connectivity,9 CCU-DXB 310 1 10,00010 AMD-DXB 297 2 7,705Key:BOM=Mumbai;DEL=Delhi;HYD=Hyderabad;MAA=Chennai;COK=Cochin;BLR=Bangalore;CCJ=Calicut;TRV=Trivandrum;CCU=Calcutta;AMD=Ahmedabad;DXB=DubaiNote:Herfindahl-Hirschman Index(HHI)is the square of the market share of each participanton the route.For example,a monopoly generates a score of 10,000(100 squared).Highconcentration tends to mean that there is a low level of competition on the route,which mayindicate excessive airfares or underserved markets.Source:Flightglobal,HSBCAlthough the number of airlines operating flightsto/from Dubai has increased with the entry of low-cost airlines in this market,the HHI scores remainhigh,as Emirates still holds 65%of this market.,from India,Dubai stands out.Airlines have 352Non-stop destinations from Dubai on EmiratesSource:Flightglobal,HSBC5,IndustrialsAsian Transport12 December 2012Non-stop destinations from Abu Dhabi on EtihadSource:Flightglobal,HSBCIndia-Dubai market share,India-Abu Dhabi routes,abc,Airlines,Total annual seats(000),Market share,Annual seats(000),No of airlines,HHI score,EmiratesAir India+ExpressIndiGoJet AirwaysSpiceJetFlydubaiTotalSource:Flightglobal,HSBC,5,5121,2017865242811188,423,65%14%9%6%3%1%100%,123456789,BOM-AUHDEL-AUHCOK-AUHTRV-AUHCCJ-AUHAMD-AUHBLR-AUHHYD-AUHMAA-AUH,385313306226211103103103103,332221111,3,4703,3335,2015,0355,12810,00010,00010,00010,000,As is clear from the tables above,Jet Airwayspresence in this market is fairly small.Indeed,its,Note:BOM=Mumbai;DEL=Delhi;HYD=Hyderabad;MAA=Chennai;COK=C