Go First Bankruptcy: Airlines And The Undercapitalisation Challenge

Go First—India's third largest airline by market share—declared insolvency this week. The insolvency filing was preceded by a press release, where the airline blamed their engine supplier for their woes. Specifically, the failure to deliver reliable engines and the failure to comply with an arbitration order asking the supplier to provide engines.

Even so, the path to grounding was not a straight line. Looking back, the dots connect to reveal an airline that was faced with multiple challenges. An airline that was once profitable and attempted an initial public offering in 2021. But, at the same time, an airline that was flying in a sea of sameness and found wanting for additional capitalisation. The numbers reveal just how much the cash shortfall was and by extension, how capital intensive the airline business is. As importantly, they reveal the undercapitalisation challenge that may be of interest to investors and regulators alike.

The skies often see airlines that by virtue of balance sheets are technically insolvent, yet continue to operate. The continued operations are facilitated by extension of credit in spite of poor fundamentals. Reasons cited often include employment, contagion and connectivity. Even so, the credit extension inevitably has consequent impacts on the entire industry. This includes higher risk premiums, lower margins and lower returns on capital.

In some cases, weaker airlines get credit at a cost of borrowing that is lower than that extended to the stronger airlines. This is repeated for financing and renegotiation. A spiralling effect follows. Because most of the capital is used towards continuing operations rather than growth.

Consequently, effects on capacity, capital deployment and improving the balance sheet are negative. In a textbook case of intent versus impact, distressed airlines are kept afloat while the industry suffers from diluted pricing power, reduced capacity utilisation and distortion in borrowing rates. Weak balance sheets that are partly responsible for this fragile situation become weaker. And several months down the line, the scenario and cycle repeats itself.

The numbers in the Go First case are astounding. Fifty-five aircraft, of which 30 are grounded. Bank dues of over $800 million. A claim against the engine supplier for $900 million. Aircraft leasing dues of $300 million. Passenger refunds that may be north of $45 million. This on the heels of losses well in excess of $100 million for the recently concluded financial year. And similar losses for the past two years. Everywhere one looks, there is bleeding.

At the same time, one looks at banks that were extending credit and financiers that were financing airplanes for the very same airline. Presumably, this was justified to their own credit committees and boards, citing the growth and growth potential of Indian aviation. After all, with domestic passenger volume set to soar north of 155 million fliers within the year, cargo volumes expected to cross 3.5 million tonnes and international travel volumes to be in the 70 million range and over 3 million takeoffs and landings, the numbers are exhilarating. Or the lending and financing may have been justified for reasons of market entry.

And the promise of growth, when factored with geopolitics, further influences the risk appetite. Indeed, on a standalone risk basis, several of the proposals may not make it to approval, but weighed against other factors, risk also takes a backseat.

Ironically, the high risk does not translate into high rewards. Specific to the context of aviation, financing higher risk may actually lead to painful processes down the line where on a total cost basis, the returns are not to be found.

For undercapitalised airlines, the red flags are often the same. These include a frequent change in auditors, lack of continuity in management, a pull-out by quality financiers and, most importantly, weak operational performance—reflected in true cancellations, reliability, refunds and passenger complaints as opposed to self-reported numbers. And in hindsight, every airline grounding or shutdown has these flags. But they are often overlooked.

The solutions to alleviate undercapitalisation are not simple. Because by their very essence, they involve regulation, which for an already extremely regulated sector, does not bode well. Neither does it bode well for lawmakers or free-market theorists. Looking to other markets, monitoring mechanisms or insurance mechanisms may be well worth considering. Or routine financial audits. Or an accurate reporting of data on customer complaints, cancellations and refunds that is captured rather than self-reported by airlines. This, at the very least, can highlight to the travelling public the risk of ruined plans and wasted vacations. And for airlines, the risks of potentially higher risk premiums and market premiums. And for stakeholders, the risks of investing and financing.  

As Indian aviation rapidly ascends towards becoming the third largest aviation market in the world, the market potential is immense. But potential is just that. What matters is capturing that potential and at a profit. And this point is often lost. In the most recent case, whether or not Go First airline will revive remains to be seen. But in either case, the airline would have cost the taxpayer, stakeholders and financiers millions in losses and write-offs. Losses and write-offs that could have been alleviated by focusing on adequate capitalisation.

Satyendra Pandey is the managing partner for aviation services firm AT-TV.

The views expressed here are those of the author, and do not necessarily represent the views of BQ Prime or its editorial team.