Capital Needs.

The airline sector is once again attracting investors â€" this time they're headed to India â€" to finance an estimated $25-40 billion needed over the next 5-7 years for around 450 aircraft.

India's aviation sector is growing faster than its gross domestic product, a pace expected to continue during the next few years. Although this growth has made the industry exuberant, a nagging question remains: where will the money come from to fund all the aircraft Indian carriers have ordered?

Investors without enough capital reserves to ride out weak markets are likely to face big losses, says Executive Director M.K.Sinha of the Infrastructure Development Finance Corp. IDFC was established in 2002 to provide capital to enterprises building infrastructure in India and includes among the foreign investors providing 40% of its funding Deutsche Bank, the U.K.'s Commonwealth Development Corp., the Singapore government's investment corporation and AIG, the U.S. insurer.

"Consolidation in the domestic aviation market is imminent in the near to medium term," Sinha told a finance conference here. "The market will stabilize with three to four large domestic airlines with 50-plus aircraft each, and a few regional players."

In a market where bank finance is the dominant source of domestic debt, Indian lenders are unlikely to approve big aircraft loans, particularly for untested private airlines, says Sinha. For that reason, many of the country's newest entrants are likely to be thinly capitalized.

Besides the strain they will feel raising equity capital, new entrants will need to be able to cover their cash flow needs in a highly competitive market, he adds.

Meanwhile, the equity markets are maturing. "There has been a six times increase in market capitalization in the past decade and a 2.5 times increase in the number of listed companies," says Milind Patel, chief executive of Infrastructure Leasing & Financial Services. "A growing investment fraternity in Indian public [equity markets] has shown a good appetite for risk."

Initial public offerings have become popular with aviation companies:

• Jet Airways mobilized $432 million with an IPO that was oversubscribed 16.2 times.
• Air Deccan expects to raise $170 million with an IPO that began this month and extends through April.
• Kingfisher plans an IPO at year-end.
• Indian Airlines and Air India, both state-owned, plan to partially privatize with IPOs.

Jet Airways, the nation's largest private carrier, and SpiceJet, a new entrant, are the only airlines listed on the New Delhi exchange that have access to global market funds. SpiceJet has raised $80 million while Jet expects to raise $850 million.

While some of the aircraft used by startups will be purchased, the majority will be leased. After a heady mix of orders last year, Indian carriers have a combined backlog of 450 aircraft. However, the ordering pace is likely to cool this year in part because India's inadequate infrastructure makes takeoff/landing slots hard to come by.

"Indian carriers finance mainly by operating lease and finance lease â€" basically the only form of 100% funding â€" as airlines don't have ownership or residual value risks," says Patel.

Air Deccan, for instance, has financed 20 of its 23 aircraft on operating leases from foreign carriers. Jet Airways has financed 24 aircraft on operating leases and 26 on finance leases.

Interestingly, many longtime observers of India's aviation scene, including Boeing Senior Vice President Dinesh Keskar, say a shortage of funds isn't the market's problem, but the need to quicken the pace of airport development is.

Air India Chairman and Managing Director Vasudevan Thulasidas told Aviation Week & Space Technology that the carrier doesn't need to raise capital from the IPO. It wants to do an IPO so Air India will "become more accountable to the stock market and consumers."

Patel isn't worried that the buildup of new carriers in India is a bubble. "There is no bubble. Factors that can affect growth however, are policy and infrastructure."

Anil Patel, the Boeing Aircraft Financial Services director for the region, points to another positive sign for financing in India â€" the country's expected ratification of the recently passed Cape Town Convention. It establishes a global framework for protection of rights in the sale, trade and financing of aircraft and their engines. Its ratification process has just begun.

GRAPH: India's Firm Order Backlog

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By Neelam Mathews, New Delhi