IndiGo flies into turbulence

With two of the largest airlines in doldrums, IndiGo’s addition to the pack is worrisome. The battle between the two sets of promoters may not have affected operations just yet. But, we have yet to see an instance where governance issues don’t eventually work their way into balance sheet challenges.

The recent allegations of the Gangwal faction (RG group) against the Bhatia faction (IGE group), both promoters of Interglobe Aviation Limited (IndiGo) with almost equal shareholding, revolved around three broad issues: (a) the Articles of Association (AoA) give the IGE group superordinate powers, (b) related party transactions between IndiGo and the IGE group were not conducted in a transparent manner, (c) the board decided not to convene an extraordinary general meeting (EGM) at the behest of RG group, even though they have the legal right to it. The mere suggestions of these – independent of which faction is correct – raises concerns over corporate governance standards at the board level.

Corporate governance at IndiGo can be strengthened. At a very basic level, the size of the board at six directors allows greater board control to the IGE group by virtue of their board nomination and executive director appointment rights (Exhibit 1). The median size of boards in India is between 9 to 10 members, and therefore board expansion will create room for more independent directors. Rakesh Gangwal, who was appointed to the board in June 2015, was not a member of any of the board committees – which effectively means that the same set of 5 people formed every board committee. The engagement of IndiGo’s directors post-IPO, reflected in poor attendance levels, was another element of concern: promoters together had attended less than 50% of the board meetings (Exhibit 2). It is only in FY18 that attendance levels increased – perhaps as the Kotak Committee proposed harsh re-election criteria for absentee directors or that the differences had started to simmer. The root allegation made by the RG group is that of managing conflict of interest. This is reflected in IndiGo’s audit committee composition, which included an executive director since its listing – Aditya Ghosh while he was still around, and then Rahul Bhatia once he took over as interim CEO – until recently (Exhibit 3). We believe having executive directors as members of the audit committee creates a conflict of interest that could best be avoided – more so, seeing that the main issues being raised are those of related party transactions.

Investors must question the need for related party transactions in the first instance. Why should allied services required by the airline be owned and provided by promoter-controlled entities? It is essentially the same question that Sun Pharma’s investors are asking of Aditya Medisales. Such operating structures add a layer of opacity and create investor mistrust at the first inkling of wrong-doing. While the IGE group can continue to assert that the related party transactions are a non-issue, such structures have often been the cause of financial leakages in other companies in the past.

IndiGo, in a sense, is the test case for what a differential voting rights (DVR) environment will look like. One of the concerns over differential voting rights is that it could result in management entrenchment. In IndiGo’s case, the disproportionate voting rights (because the RG group must vote with the IGE group) provides enabling conditions for board capture – which is perhaps reflected in the board decision to not acquiesce to hosting an EGM. The RG group will now have to use its privileges under regulation and host the EGM on its own (Exhibit 4).

Investors recognize the difference between leadership (having someone at the helm who is accountable) and management / promoter entrenchment. But holding disproportionate power can be detrimental to stakeholders. It is in this context that SEBI needs to think long and hard once again about its decision to allow differential voting rights. Independent of SEBI’s decision on this, stock exchanges, too, must not allow companies to list on their platforms under these circumstances.

With two of the largest airlines in doldrums, IndiGo’s addition to the pack is worrisome. The battle between the two sets of promoters may not have affected operations just yet. But, we have yet to see an instance where governance issues don’t eventually work their way into balance sheet challenges. It may be a while before lenders and investors trust them enough to give them access to capital. Most will ask them to sort out their internal battle first. Essentially, this means that if the airline wants to buy or lease more aircrafts to take advantage of the open slots, it will find it that much more difficult. Existing lines with banks may see some contraction if lenders believe the governance issues will impact credit quality. Some of these risks are now at the horizon. Investors must fasten their seat belt; this has the makings of a bumpy ride.

A modified version of this article was published in the Financial Express. The article can be accessed here: https://www.financialexpress.com/opinion/indigo-flies-into-turbulence-investors-must-brace-for-a-bumpy-ride/1639958/

Exhibit 1 – Rights afforded to the IGE group and the RG group in IndiGo’s AoA