At first blush, in the wake of the failed Chicago Midway (MDW) privatisation, the US airports sector would appear in shambles. The combined weight of an aborted privatisation and precipitous declines in passenger volume was enough to give even the most seasoned corporate traveler motion sickness.
Looking back on MDW, the transaction marked a dramatic departure for the Federal Aviation Administration’s Privatisation Pilot Program (FAA PPP). Before MDW, the sole participant in the FAA PPP was Stewart Airport, a small reliever (or secondary) airport in the Hudson River Valley north of Manhattan. After advancing successfully through the programme, the private operator had second thoughts and sold the facility to the Port Authority of New York/New Jersey for $78.5 million after only six years in private operations. Stewart Airport had traveled full-circle.
Thus, the infrastructure investor community heralded the September 2008 $2.5 billion enterprise valuation applied to MDW as a watershed moment for the domestic market and global airport valuation. Historical airport financials imply that the trailing EBITDA multiple exceeded 45 times. During the peak of the market, acquisition multiples ranged from 27.4 times for London City to the 30.9 and 32.5 times multiple paid for Leeds Bradford and Exeter Airports in the United Kingdom. In the “New Normal,” trade multiples have compressed with recent transactions by MAp Airports (ASX: MAP), formerly Macquarie Airports, and Ontario Teachers’ for the 35.5 percent stake in Bristol Airport at roughly 20 times EBITDA and Copenhagen Airport at nearly 18 times (despite the fact that the listed shares (KBHL: DK) trade at a multiple closer to 9 times).1 The latest benchmark is the BAA divestiture of Gatwick at the lowest multiple of about 9.2 times EBITDA.
Although private valuation has exceeded public market multiples by as much as 100 percent, the Gatwick multiple converges on the multiples observed in the public market due in part to the following:
• Private-to-private transfer instead of public-to-private; presumably, BAA through its relatively long history has optimised operations with management best practices;
• Divestiture order from the UK Competition Commission on competitive grounds, requiring BAA to sell at a time when multiples and equity valuations were close to an all time low; 2
• Financing: during the market peak, leverage increased to 90 percent, with credit spreads below 100 basis points for long tenors. That compares to today’s aversion to leverage, tripling of spreads and tenors down by 50-70 percent.
• Looming debt maturities in 2010 for the BAA securitisations. At the latest report, BAA had over £1.04 billion in debt maturing within one year, along with another £950 million in current liabilities;
• A temporary paring of infrastructure allocations by institutional investors and pension funds, due in part to outstanding alternative allocations (private equity, real estate etc.) exceeding policy asset allocation thresholds due to severe losses in public equity holdings.
Midway’s long shadow
In the US market, however, the Chicago MDW experience retains its unique resonance. Indeed, when the City of Chicago elected to cancel the procurement last spring, the hopes and dreams of city managers were brought back squarely to the tarmac. For the winning consortium, the decision was not without financial loss; having failed to achieve financial close, the consortium forfeited $126 million in earnest money paid to Chicago upon initial acceptance. Laid low by the financial crisis and hobbled by waning travel demand, the financial plan fell apart as co-investors stepped back to reassess and prospective preferred-share equity investors were not forthcoming.
Early indications from Chicago itself vindicated the newfound conservatism. In the first quarter of 2009, passenger volume at MDW had sunk from 3.9 to 3.5 million passengers – a 12 percent sequential decline from the fourth quarter of 2008. It was the fourth quarter of 2008, however, which marked the deepest decline in throughput at 12.7 percent, with the month of November enduring the sharpest year-over-year contraction at 23 percent. (By comparison, passenger volume fell 34 percent in September 2001 with a full recovery just six months afterwards.)
More recently, traffic has begun to bounce back at MDW and other reliever airports in the US. In fact, passenger volumes in the third quarter of 2009 turned positive, both sequentially from earlier in 2009 and from the third quarter of 2008. At present, MDW appears on pace for passenger volumes in excess of 16 million down just 6 percent from 2008. By 2010, the growth trend looks set to return over 17 million passengers to MDW nearly recovering, in full, the volume lost in 2008.
The runway ahead
Despite the MDW setback, the US airports sector remains an intriguing investment opportunity for patient global infrastructure investors.
The rationale for investment is predicated on both favourable regulatory and economic characteristics. On the regulatory front, the FAA PPP remains an accessible framework for investment. Irrespective of whether MDW re-trades, the existing framework would accommodate four additional small and medium-sized facilities (airports with fewer than 15 million passengers). Furthermore, no restrictions currently inhibit an airport authority from entering into long-term service agreements with the multitude of dedicated aviation service-providers. At present, there are no less than eight large commercial airports with various forms of private operating agreements for airport services (see map p. 36).
From a market perspective, the industry provides attractive economics through its dual-till regulatory nature. On the one hand, the airport sector is somewhat regulated with utility-like payments in the aeronautic segment. On the other hand, the non-aeronautic segment yields a cyclical income stream with significant opportunities for operational enhancement from the various retail concessions and parking businesses imbedded within the terminal facilities. Thus, the airport business enterprise benefits from stable cash flows via the aeronautic till, with the potential for revenue enhancement via operational optimisation in the commercial real estate business segments.
The case for the US airports sector is predicated, in part, on the optimisation potential inherent in the commercial concessions. The airports’ relationship with the broader aviation sector, however, will drive the opportunity set for commercial enhancement. For example, large hub airports, wherein transferees predominate, provide greater scope for commercial retail concessions. Passenger dwell-time will provide a key metric for determining whether an enplaned passenger might visit one of the retail concessionaires.
Conversely, an origin-destination (O&D) airport might provide added scope for optimising car park and rental car operations. As the new JetBlue Terminal 5 at JFK illustrates, O&D facilities may benefit from enhanced retail concessions as well. In other instances, operators of reliever airports may benefit from competitive cost structures to attract discretionary travelers from larger, hub airports in the same marketplace (playing to the Southwest/MDW strategy).
Indeed, MDW exemplifies the latter – a reliever airport with a preponderance of O&D travelers. While Chicago O’Hare benefits from its sheer scale, MDW provides a low-cost alternative for discretionary trip-making to Chicago residents. Considered a large hub in the FAA lexicon, MDW primarily serves O&D passenger traffic on Southwest Airways. O&D traffic accounted for about 74 percent of overall traffic volume.
For the private airport operator, the MDW experience may well provide an excellent case study for targeted investments. With an appropriate airport in hand, the four remaining slots offer compelling opportunities to compete for O&D passengers in local markets served by two or more commercial facilities – Southern California comes to mind for instance. From the enplaned passengers, operators can depend on substantial parking demand, while arriving passengers will desire rental cars, in turn, providing partnering opportunities with the various rental car fleet operators. Herein cost is a key consideration, however, with the airport operator compromising on lucrative gate fees in exchange for the increased throughput afforded by access to the LCC customer base.
Irrespective of ownership structure, the US aviation industry will remain an attractive asset class for global infrastructure investors. MDW notwithstanding, the opportunity set is far too compelling to allow one aborted effort to extinguish future endeavors. According to International Air Transport Association Economics, return on invested capital in the US is less than half the returns achieved in Europe. IATA attributes this to the non-profit ownership structure; from the opposite perspective, the differential provides substantial scope for private operational enhancement. In the end, the commercial aspects of airport administration argue for private capital. The lack of available funding at the municipal level necessitates it. The infrastructure investment community undoubtedly will find an attractive avenue to capitalise on the emerging sector.
Willem Sutherland is managing director of infrastructure finance and advisory at ING Capital LLC. Ryan Prince is a vice president in the same group.
1. Both transactions would appear to have been driven, in part, by portfolio considerations.
2. The UK Competition Commission published its final report on 19 March 2009 and ordered BAA to divest Gatwick and Stansted Airports to different purchasers, along with the sale of either Edinburgh Airport or Glasgow Airport. The timing of the divestiture order could not have come at a worse time, given the aforementioned compression in public market multiples and the decline in passenger rivaled only by the aftermath of the 11 September 2001 terrorist attacks.