The end game nears for BAA/Ferrovial

According to Dr Harry Bush, CAA Group Director of Economic Regulation,
"BAA enjoys a very strong market position in the UK airport market, owning a number of neighbouring airports that to varying degrees would otherwise be expected to act as rivals and compete for airlines and passengers. In the absence of sufficient competition in London, greater reliance has been placed on regulators to decide upon the airports' pricing and to guide the airports' investments in capacity and service quality. Economic regulation has brought benefits. But it is timely to ask the question whether greater competition would better serve consumers. It is now for the Competition Commission to consider how any adverse effects identified can best be remedied."

The CAA response comes as BAA reports an operating and pre-tax loss for the three months ended 31-Mar-08. BAA claims that 'results for the period have been negatively impacted by increased security and maintenance costs in relation to programmes implemented progressively throughout 2007 and 2008 to meet higher service standards. Aircraft tariffs that take into account these…costs are not effective until the commencement of the next regulatory period (from 01-Apr-08)'.

Costs relating to the delivery of Terminal 5, other exceptional costs and 're-measurements' on the revaluation of Group investment properties were also blamed.

The 1Q08 performance is somewhat short of the requirement to satisfy Ferrovial's avowed aim for BAA's profit to almost treble to USD1.3 billion (USD850 million) in the next four years. Heathrow Airport was affected by the problems experienced in the opening of Terminal 5 at the end of Mar-08, and this impacted on BAA's traffic total in Apr-08, where traffic fell 3.5% to 5.5 million.

Otherwise, the generally downward trend can be attributed to a worsening economic situation in the UK, although Easter did fall wholly in March this year, which would have played its part.

Figures like this do not do Ferrovial's confidence much good as it seeks to refinance up to GBP10 billion of debt by 3Q08, especially as it has promised to spend a further GBP4 billion on fresh infrastructure including Heathrow East and while investors nervously eye the perilous state of the Spanish construction market that is its core business. Nor does the news breaking at the beginning of Jun-06 of three major UK banks seeking fresh funding via rights issues as the credit crunch bites deeper, together with speculation as to who will be next.

Ferrovial planned to issue about GBP9 billion in asset-backed bonds to refinance acquisition debt and raise money for capital expenditure but it was scuppered last year by the sub prime crisis, which seized up securitised debt markets.

In May-08, it called holders of an existing GBP4.5 billion in BAA bonds to talks on the terms of the migration of the bonds into a special purpose vehicle, backed by the regulated assets of Heathrow, Stansted and Gatwick airports, as well as the Heathrow Express rail service. It is also seeking commitments from banks for a backstop facility worth at least GBP 5.5bn to help it cut interest bills, finance capital expenditure, and allow time to push ahead with plans to securitise the assets with bonds once market conditions improve.

It racked up one small success in May-08 when investors agreed to inject an emergency GBP400 million into BAA in a bid to prevent the group's credit rating falling to "junk" status.

Then, at the beginning of Jun-08, it notched up a bigger success when reports indicated that it had won the backing of eight banks to refinance GBP7.5 billion of debt by offering a six or seven-year loan that Ferrovial would repay with small bond issues as the debt market eases up.

According to reports in Spain, Caisse De Depot et Placement du Quebec, the pension fund manager, has reduced its stake in BAA by 5.5% to 23.15%. The buyer is understood to be an infrastructure fund. The Canadian investor has realised its profit despite Ferrovial's problems refinancing its original purchase.

Pressure continues to be ramped up on both BAA/Ferrovial and the CAA by IATA, which has constantly criticised BAA for the poor standard of service at its three London airports, where it has a 91% share of airport passengers in southeast England including Southampton Airport.

At the beginning of Jun-08, it increased even further when the IATA Director General described Heathrow as 'a national embarrassment' (a rather strong remark when he is not a British national) and implied that the CAA/Competition Commission's decision to permit Heathrow to increase charges by 86% over five years (which BAA is insistent is essential to fund reconstruction) could only take place in 'Monopolyland'.

With all these pressures coming together and just after the LHR T5 opening debacle, it seems only to be a matter of time before that 'monopoly' status passes into history.

This is an excerpt from the upcoming Jun-08 edition of Airport Investor Monthly. The BAA report in the next edition will also include sections on: