Not long ago, Alitalia was one of the largest airline companies in the world. Today it is a pale shadow of its former self, having burned massive amounts of taxpayer money before filing for bankruptcy. The principal culprit of this debacle was the Italian government, which held over 60% in the Italian airline.
By avoiding the political pain that a real (and sincere) restructuring would have caused, the government continued to pour good money after bad. The government’s subsidised financing included a bailout in September 2004. As our government plans a similar bailout of the ailing Air India, policymakers should imbibe the lessons from the Alitalia fiasco.
Throwing money at a drug addict without reforming him only perpetuates his abuse and shortens his life. Similarly, providing subsidised financing to Air India without a true restructuring would be akin to writing its death verdict. To be successful, this restructuring requires several elements.
As in the Alitalia bailout, the government intends to infuse equity into the ailing company. To avoid a similar outcome, the bailout plan should have the following components: (i) the government should provide capital in the form of “convertible debt;” (ii) the lending decision should be made by a syndicate comprising the government as the largest lender and a consortium of commercial banks; (iii) the consortium should bear some percentage of the last losses on this security; and (iv) existing Air India debt should be restructured through partial debt-for-equity swaps.
As an investor, the government should maximise its return on investment; after all, taxpayers’ money has a high opportunity cost since this capital could fund necessary infrastructure instead. Academic research in finance points out that debt financing can enhance organisational efficiency since debt financing bonds the management of the company to make periodic interest payments. While the government’s plan includes a monthly review by a four-member committee of secretaries, the necessity to make periodic interest payments to the lending syndicate will have the hard binding effect that monitoring cannot accomplish.
Why convertible debt instead of plain, vanilla debt? Convertible debt would provide the government the option to convert into equity. Typically, investors of convertible debt convert into equity when they expect the company’s performance to shoot north. The government could do likewise once Air India’s restructuring exhibits signs of success.
How should the parameters of the convertible debt – such as the interest rate – be set? This brings me to the second component of the bailout plan.
The financing must minimise the risk that Air India wastes the resources without implementing the necessary restructuring. For example, while Eastern Airlines filed for bankruptcy in the United States in 1989, it failed to undertake the necessary restructuring and kept flying until its asset value had been driven down to zero. To avoid this problem, I propose that the lending decision be made by a syndicate comprised of the government as the largest lender and a consortium of commercial banks. To align the consortium’s incentives, some percentage of the last losses on the security must be borne by the consortium. In this way, the government would ensure monitoring of Air India’s post bailout performance by both the private parties and the government.
The bank consortium could also put together a restructuring of Air India’s existing debt. Without such restructuring, any capital infusion by the government will only serve to fulfil existing debt holders’ obligations. Reducing Air India’s leverage through debt-for-equity swaps will enable it to use the capital infusion to fund necessary investments and emerge healthy after the bailout. The bank consortium could also arrange “bridge financing” that Air India needs to tide over its current liquidity woes.
Before providing Air India the financing, its management needs to put forward a concrete plan encompassing strategic, financial and operational aspects. On the strategic side, a critical analysis of the international and domestic routes and their profitability must lead to specific entry/ exit decisions for each route.
On the financial side, Air India needs to decide if it is going to hedge the risk posed by oil price fluctuations. Since its primary business is that of an airline, its competence does not lie in predicting future oil prices. Therefore, prudence demands that Air India hedge this risk.
On the operational side, the management needs to be forthright about the wage and manpower cuts that are necessary to trim its waistline. The government must commit to implementing these hard decisions. For example, the Alitalia management had requested a workforce cut of 5,000 out of the 20,700 existing workforce in September 2004. The Italian government dragged its feet on the politically sensitive decision and the resulting cut was restricted to 2,500 – half the originally slated target.
The outcome that befell Alitalia is one that Air India must avoid at all costs.
By avoiding the political pain that a real (and sincere) restructuring would have caused, the government continued to pour good money after bad. The government’s subsidised financing included a bailout in September 2004. As our government plans a similar bailout of the ailing Air India, policymakers should imbibe the lessons from the Alitalia fiasco.
Throwing money at a drug addict without reforming him only perpetuates his abuse and shortens his life. Similarly, providing subsidised financing to Air India without a true restructuring would be akin to writing its death verdict. To be successful, this restructuring requires several elements.
As in the Alitalia bailout, the government intends to infuse equity into the ailing company. To avoid a similar outcome, the bailout plan should have the following components: (i) the government should provide capital in the form of “convertible debt;” (ii) the lending decision should be made by a syndicate comprising the government as the largest lender and a consortium of commercial banks; (iii) the consortium should bear some percentage of the last losses on this security; and (iv) existing Air India debt should be restructured through partial debt-for-equity swaps.
As an investor, the government should maximise its return on investment; after all, taxpayers’ money has a high opportunity cost since this capital could fund necessary infrastructure instead. Academic research in finance points out that debt financing can enhance organisational efficiency since debt financing bonds the management of the company to make periodic interest payments. While the government’s plan includes a monthly review by a four-member committee of secretaries, the necessity to make periodic interest payments to the lending syndicate will have the hard binding effect that monitoring cannot accomplish.
Why convertible debt instead of plain, vanilla debt? Convertible debt would provide the government the option to convert into equity. Typically, investors of convertible debt convert into equity when they expect the company’s performance to shoot north. The government could do likewise once Air India’s restructuring exhibits signs of success.
How should the parameters of the convertible debt – such as the interest rate – be set? This brings me to the second component of the bailout plan.
The financing must minimise the risk that Air India wastes the resources without implementing the necessary restructuring. For example, while Eastern Airlines filed for bankruptcy in the United States in 1989, it failed to undertake the necessary restructuring and kept flying until its asset value had been driven down to zero. To avoid this problem, I propose that the lending decision be made by a syndicate comprised of the government as the largest lender and a consortium of commercial banks. To align the consortium’s incentives, some percentage of the last losses on the security must be borne by the consortium. In this way, the government would ensure monitoring of Air India’s post bailout performance by both the private parties and the government.
The bank consortium could also put together a restructuring of Air India’s existing debt. Without such restructuring, any capital infusion by the government will only serve to fulfil existing debt holders’ obligations. Reducing Air India’s leverage through debt-for-equity swaps will enable it to use the capital infusion to fund necessary investments and emerge healthy after the bailout. The bank consortium could also arrange “bridge financing” that Air India needs to tide over its current liquidity woes.
Before providing Air India the financing, its management needs to put forward a concrete plan encompassing strategic, financial and operational aspects. On the strategic side, a critical analysis of the international and domestic routes and their profitability must lead to specific entry/ exit decisions for each route.
On the financial side, Air India needs to decide if it is going to hedge the risk posed by oil price fluctuations. Since its primary business is that of an airline, its competence does not lie in predicting future oil prices. Therefore, prudence demands that Air India hedge this risk.
On the operational side, the management needs to be forthright about the wage and manpower cuts that are necessary to trim its waistline. The government must commit to implementing these hard decisions. For example, the Alitalia management had requested a workforce cut of 5,000 out of the 20,700 existing workforce in September 2004. The Italian government dragged its feet on the politically sensitive decision and the resulting cut was restricted to 2,500 – half the originally slated target.
The outcome that befell Alitalia is one that Air India must avoid at all costs.
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