Have you ever wondered that how India’s largest airline operator IndiGo operated by Interglobe Aviation flies high despite the tumultuous nature of the airline industry? Well, the answer is the business model on which the carrier operates. The business model, known as the Sale and Leaseback Model, has been one of the consistent reasons for the carrier's soaring profits.
Read on and find below about this intriguing model.
What is this business model?
Simply stated, the Sale and Leaseback model is a transaction wherein a person can lease (rent) the asset to himself after selling it. In other words, an asset that was earlier owned by the seller is sold to someone else after which it is leased back to the first owner for the long term. One who grants the use of the asset to the other party is known as lessor, while one who uses the asset in return for periodic payments is known as the lessee.
This has precisely been the business strategy of the airlines ever since it commenced its operations.
How does the model work?
- The airline operator signs an aircraft purchase agreement say for ten aircraft for $40 million.
- After the delivery of aircraft is undertaken, the airline will undertake to sell the plane to the leasing companies. For instance, the aircraft is sold at $45 million. In that scenario, the airline makes a profit of $5 million after which it asks the new owner to lease back the same aircraft.
- The lease is for 5 to 8 years after which the aircraft is transferred to the leasing companies.
Advantages of the Lease Back transaction
Benefits of an existing brand name to the lessor
The lessee (IndiGo Airlines) pays the lessor from the income earned by the airlines using the aircraft. The leasing company also agrees to such an arrangement because it provides an asset and an established customer base without having to buy a brand new plane.
Cash Flow Generation
The Lessee when it sells the aircraft generates cash which could be used to relieve the balance sheet of the company from debt. Also, when the company sells the plane to a lessor/lender, obviously the original aircraft owner (IndiGo airlines) will be able to earn some cash which could be reinvested elsewhere.
Reduction in Tax Liability
Under the sale and leaseback model, the company does not have to pay any taxes on the appreciation of the asset. Further, the lease paid on the asset is recorded in the profit and loss account, which reduces the net profit, which will, in turn, reduce the tax liability.
Safety from Maintenance Repairs
In a Lease Back agreement, it is the responsibility of the lessor to bear the maintenance repairs. This, as a result, significantly reduces the cost of the airlines.
The Sale and Leaseback model is called as the golden goose for IndiGo Airlines. Apart from excellent services, this model is the prime reason behind IndiGo's success story. IndiGo Airlines continues to perform well, reporting net profits worth Rs 1200 crore in the first quarter of FY 2020, despite subdued demand. However, we believe that this model is not purely free from disadvantages.
This is because, in the wake of uncertain circumstances, such as, a surge in the price of aviation turbine fuel or merely a weakening demand, lease payments certainly increases the pressure and become a burden on the company.
It is therefore important for each and every company in the aviation industry to avoid being complacent and take lessons from the crashing of Jet Airways and create a business model that is both dynamic and has the ability to withstand any misfortune.