AENA’s part privatisation. By all accounts a success and shares climbed dramatically

1. The AENA privatisation process: Feb-2015 was crunch time for AENA's much delayed privatisation

AENA has been going through the privatisation mill for many years. The Spanish state airports and air navigation operator had been split; the separate parts being privatised independently. The navigation section is now referred to as Enaire, which was also the 100% owner of AENA S.A., which operates the airports. The airport section counts 46 airports and a couple of heliports. AENA also has interests in 15 foreign airports, in Europe and the Americas, some of which go back to the 1990s.

ENAIRE/AENA airports ownership prior to privatisation

Source: AENA website

A previous attempt to privatise AENA Aeropuertos in 2011 failed for several reasons.

The main opposition party, the People's Party (PP) led by Mariano Rajoy - which subsequently became the government that year - argued that the transaction was being forced through at the wrong time (in order to generate cash to offset the deficit) and at a lower price then might be achieved later. That transaction would have seen the two main airports of Madrid and Barcelona concessioned out first, to be followed by an IPO on AENA in its entirety later.

Subsequently the privatisation came back onto the radar but the IPO part was suspended for administrative reasons in midsummer 2014, ostensibly while the government found an acceptable auditor while the underlying agenda would seem - again - to have been the need to wait for improved economic circumstances. It was reinstated with the publication of the delayed IPO prospectus on 23-Jan-2015 with the listing to take place on or around 11-Feb-2015.

This 2014/15 transaction entailed the government retaining 51% of AENA, with 21% of the equity going to three cornerstone consortia - agreed in advance - and the IPO on the remaining 28%, shared between institutional and private shareholders and employees. The cornerstone investors were Ferrovial Aeropuertos (6.5%); Corporacion Financiera Alba (8% - associated with the Spanish owned Banco March, and which said it might also participate in the IPO to increase its stake); and the UK-based Children's Investment Fund or TCI (6.5%), which, like Alba, has no prior experience of the airports sector.

In effect that identifies the transaction as being more like a public-private-partnership (PPP) with the government retaining overall control with the (slightly) higher equity share. That sort of arrangement has worked well for Aéroports de Paris and Fraport though, where there is a similar equity split. It is quite possible those two operators were the model.

Valuation proved difficult owing to AENA's debt position

It was difficult to estimate AENA's value. Conservatively it was put at EUR2.5 billion allowing for AENA's massive - though recently reduced - debts. The estimated transaction valuation began to increase in proportion to the debt reduction and was thought be in the region of 8-10 times earnings, which is low compared to some recent transactions but still quite reasonable in the circumstances.

One issue that was evident right from the start is that there was a vast range of airports included in the deal, from the successful - by most measures ones like Barcelona - to those (and there are many) that are living hand to mouth. One estimate has it that all but eight of AENA's airports are regularly unprofitable. And some of the more remote ones do not even see daily flights.

The price would therefore be lower than it would have been if not all the airports were included and especially if only the top five or six performers were privatised.

This theory is a consequence of the strong economies of scale of airport management - one of the fundamental arguments for centralised control of Spain's airports in the first place - as only large and busy airports have the potential to be structurally profitable. Small and weak traffic airports tend to be loss makers and require the assistance of those that can stand on their own two feet (cross-subsidy). Spain is not unique in this of course, a similar situation applies in the sparsely populated Nordic countries where there has been little privatisation to date.

AENA and the government seem to be at odds over the smaller airports

But the Spanish government is committed to keeping all airports open, despite independent advice to the contrary and has stated on many occasions that the privatisation was intended to benefit the people, wherever they are located. It is, after all, the People's Party that is in power. Actually, the government may have some room to play with in this respect. AENA declared late in Dec-2014 that it was considering the closure of up to nine airports serving less than 100,000 passengers per annum, on the basis that European Union auditors had found that any airport serving less than that amount would lose EUR130 per passenger per year.

Traffic at those particular airports ranged from just 259 to 37,000 passengers between Jan and Nov-2014. One might conclude therefore that AENA and the government are at odds over this issue.

AENA's valuation continued to creep up towards the end of 2014, suggesting the government's timing was well judged, finalising the process just as the air transport environment was rapidly improving and at the same time well in advance of local, regional and national (general) elections in 2015. AENA's financials in the first half of 2014 and then in the first three quarters were positive right across the board with revenues rising by 6.3% in the latter period while EBITDA jumped 15.5%, indicating that costs were starting to come under control at last (see below).

The valuation estimate was revised so that AENA could expect a preliminary share price range of EUR41.5 to EUR53.5 once floated, implying a market value of EUR6.2 billion to EUR8 billion. Based on those figures, AENA would have an enterprise value of between EUR18.2 billion and EUR20 billion, or 11.7 to 12.8 times its 2013 EBITDA.

That would be higher than the group's main European competitors, with Germany's Fraport valued at 10.7 times EBITDA and France's Aeroports de Paris valued at a multiple of 10.5; both in a similar time period.

Demand for the shares increased accordingly. In fact by the end of Jan-2015 AENA was able to say that it had received "sufficient" demand from investors to cover its entire IPO.

AENA's share price increased dramatically

Shortly thereafter the share price range began to go up quite dramatically, initially by EUR2 per share, which would value the company at between EUR6.4 billion and EUR8.3 billion. Ultimately the share price was set at EUR58 per share, even higher than previously expected, and valuing AENA at EUR8.7 billion, due to the overwhelming demand for the 11-Feb IPO (EUR52.2/share for employees).

As a direct result Corporación Financiera Alba and Ferrovial tendered their resignations from the AENA board. (The Children's Investment Fund (TCI), Alba and Ferrovial had offered to purchase the combined stake of 21% in AENA at approximately EUR48.66 to EUR53.33 per share).

Corporación Financiera Alba and Ferrovial decided to exclude their participation from the partial flotation, abandoning 13 seats on the AENA board. TCI secured a seat on the board after acquiring a 5.71% stake or 3.81 million shares through the qualified investor market issuance.

So through its additional participation in the IPO, TCI was established as the largest privately-owned shareholder, followed by Morgan Stanley with 3.6% and Fidelity with 1.3% and it immediately increased its stake further, to 7.47%, and then to 7.714% after purchasing additional shares via its subsidiaries, Talos Capital Limited and TCI Luxembourg. So the most significant private sector influence in AENA is an organisation with no known sectoral experience whatsoever. Almost as if to make that point, the resignation was tendered of Ferrovial CEO Jorge Gil Villén, along with that of Corporación Financiera Alba VP Juan March de la Lastra, from the airport operator's board of directors, following the decision by both companies to abandon AENA's core membership.

The ramifications of this decision will become evident in time. It will probably be the absence at decision making level of Ferrovial, which issued a statement to say it would continue actively to seek new profitable growth opportunities in other markets, which will be most telling (see below).

AENA's privatisation was hailed as a success

Despite these last minute hitches, the privatisation - so far - is being hailed as a success. In the latter days demand increased five-fold in institutional and small investor markets. (Bear in mind too that some investors had been put off by lock up periods, lack of control over the investment and other factors). The offering was oversubscribed 5.5 times, with most of the investors identified as infrastructure investment funds and sovereign wealth funds.

Then the IPO closed with a share price increase of approximately 21% in the first day of trading from EUR58 to EUR70, increasing AENA's market capitalisation from EUR8.7 billion to EUR10.5 billion and the approximate enterprise value of AENA to EUR19.4 billion including the remaining debt. By 05-Mar-2015 the share price had gained by 45% to EUR84.6.

As this report is written it had climbed to over EUR100 before slipping back slightly. It has notably shot up since parts of the annual financial results (as opposed to the nine months figures referred to earlier) were released towards the end of Mar-2015.

Screenshot of AENA trading taken on 07-Apr-2015

Source: Bolsa de Madrid

And the company has pledged to start paying out half its profit in dividends. Anyone investing for a short term gain is very happy and the longer term investors have plenty to look forward to.

Final sale valuation puts the earnings multiple at close to 12x

The final sale valuation of AENA, as far as it can be ascertained at the time of writing, is as follows:

AENA does not publish complete financial statements until these are audited, and the financial year 2014 ended on 31-Dec-2014, so complete FY2014 figures and statements could not be available until Apr-2015. As mentioned earlier we know for sure that AENA's financial figures for the first nine months of 2014 were much improved.

So the final earnings multiple was much higher than initially expected. At EUR58 per share (the opening price) 100% of the equity was valued at EUR8.7 billion and the book value of equity was EUR3.4 billion. If one adds to this value of equity the financial and non-financial debt (EUR13.7 billion), and assumes that the anticipated EBITDA figures would be in the order of EUR1.9 billion for FY2014, then EV/EBITDA is 11.78.

AENA was expected to have repaid some more financial debt between September and December so that figure was unlikely to reduce. When AENA did release restricted annual financial data for the year ending 31-Dec-2014, on 27-Mar-2015, the full year EBITDA was shown to be EUR1.875 million, which supports previous estimates.

All in all, a far cry from the original estimate in the order of 8-10 times earnings and more in keeping with other European transactions over the last two years.

Table of recent European airport deals - transaction values and earnings multiples

Airport (group)/purchaser	Earnings multiple EV/EBITDA	Transaction value EUR million	Stake %	Year	Pax million p/a
Recent transactions
London Gatwick/GIP	12	1840	100	2009	34
Edinburgh/GIP	16.7	1067	100	2012	9.3
ANA Portugal	15	3080	95	2012	30
London Stansted/MAG-IFM	15.6	1800	100	2013	18
London Luton/AENA Int-Ardian (lease transfer)	13	502	n/a	2013	9
AENA Aeropuertos SA/Ferrovial-Alba-TCI-float *	11.75	8700	49	2015	200
SOU-GLA-ABZ (NDH1)/Ferrovial-Macquarie	15	1317	100	2014	12.5
Average earnings multiple recent	14.15

Source: CAPA - Centre for Aviation

2. What does the future hold for AENA investors, current and future?

If there is one thing that those that work in air transport understand only too well, it is to expect the unexpected. Be it wars, terrorism, plagues, natural disasters, you name it. If it happens - and it will - it will probably render all business and traffic forecasts redundant.

But all things being equal it is fair to say that the future looks bright for AENA right now and it is certainly the case that the potential benefits outweigh the pitfalls.

The beginning of the end for the Spanish recession

Firstly, there are signs that the Spanish economic implosion may have bottomed out at least, even if a full-blown recovery is still some way off. GDP has grown in each of the last seven quarters, though the quarterly amount has been tiny. In 4Q2014 that growth accelerated to 0.7%, approximating to 2% for the full year 2014. (The 1Q2015 figure is not yet available). Spain has actually been outperforming France and Germany in this respect. The lower oil prices across Europe may be having a greater effect than was anticipated.

For a year or more now export figures have also been high: at least the 'recovery' as it stands is led by exports rather than by the rampant construction sector that brought about Spain's problems in the first place (rather than dodgy mortgages). On the other hand, while exports have boomed, imports are now picking up, so Spain could easily tip back into a current-account deficit. The time for investors to worry is when the cranes reappear. There are over one million apartments across the country standing unoccupied.

This growth is already boosting employment, thus prompting increased demand and more job creation. Both domestic and foreign investors are once again weighing up their options. And the European Central Bank announced EUR400 billion of cheap loans to euro-zone banks that lend more to businesses, Spain included. The government is promising small tax cuts. But no-one should get carried away, the unemployment rate remains depressingly high at close to 25%, public debt will be over 100% in 2015 and Spanish banks are still not exactly throwing money at borrowers.

All-in-all though the long term economic outlook is better than it has been for years.

Secondly, the lower oil price that has already been mentioned benefits Spain's airlines as well as others. No-one knows quite how long USD60/barrel oil prices will continue, for only three months ago it was </= USD50/barrel - but as most of the major producers seem to have set their stall out for a protracted 3-5 years of low prices perhaps we ought to defer to their opinion.

See the related report: Aviation and oil prices: potentially a negative for airport capital expenditure. Time for PPPs?

The lower oil price helps Iberia in particular

While lower oil prices may take some time to translate into lower airfares because of price hedging activities or other reasons it also helps fuel-thirsty aircraft such as the A340 to become more viable. Iberia has 21 of those in service, while it waits for deliveries of A330s and A350s.

Routes to Latin America that were closed down (some of which have since reopened anyway) might once again be flown, even with the A340. Iberia, which IAG seemed virtually to have written off 12 months ago actually made a (tiny) operating profit of EUR50 million in FY2014, its first in seven years (the British Airways division of IAG made EUR975 million).

Iberia projected delivery dates for aircraft (orders and options) purchased from OEMs and leased from lessors new aircraft order pipelines as at 07-Apr-2015

Source: CAPA Fleet Database
(Aircraft operated by subsidiaries/associates of the main carrier may be listed separately. Firm orders include those placed directly by the operator and by lessors assigned to the operator, from 6-Apr-2015 onwards)
(n.b. A330s and A350s will replace ageing fuel guzzling A340s - not for growth)

While Iberia has been dormant or contracting, the Mallorca-based Air Europa quickly moved to fill the gap with some of those Latin American routes that had put Madrid firmly on the European air hub map, as well as becoming very active in forging individual alliances with airlines such as Etihad, which should increase the number of transit passengers via Madrid's Barajas Airport from the east.

Both of Spain's two main airports, Madrid and Barcelona, and possibly others, can expect to see more full service mid and long-haul flights as the economy revives; and it should not be too long before Barajas Airport again is able to fill the role of primary European hub airport specialising in Latin America, similar to the one occupied by Miami in the Americas.

Air Europa Lineas Aereas projected delivery dates for aircraft (orders and options) purchased from OEMs and leased from lessors new aircraft order pipelines as at 07-Apr-2015

Source: CAPA Fleet Database
Aircraft operated by subsidiaries/associates of the main carrier may be listed separately. Firm orders include those placed directly by the operator and by lessors assigned to the operator, from 6-Apr-2015 onwards.

LCCs have a greater proportion of international seats than the Western European average

Having said that it is in the low cost segment that Spain has survived the economic downturn. LCC seat capacity internationally is in the order of 56.6%, and 38% domestically (FY 2014), both growing. That is a high figure compared to many other European countries, although it is usually lower than both the UK and Italy.

Iberia's own LCC, Iberia Express, is now being deployed on international routes, acting both as a point-to-point operator and a feeder to long-haul routes at Madrid, while it is the 90% owned IAG subsidiary Vueling Airlines that has the main responsibility for developing the Barcelona hub, something at which it has excelled. Vueling does operate an actual hub there, which is still unusual for an LCC.

Vueling's operating profit dwarfed Iberia's in 2014 at EUR141 million.

LCC market share (seats), Spain & Canary Islands: 2003 to Jan-Apr-2015

Source: CAPA - Centre for Aviation with data provided by OAG

LCC market share (seats), Western Europe: 2003 to Jan-Apr-2015

Source: CAPA - Centre for Aviation, OAG

One hidden benefit of the predominance of LCC operations is that they do not demand (and typical eschew altogether) opulent airport infrastructure. This helps AENA in two ways. The LCCs have been happy to move into older terminals at Madrid and Barcelona when grand new ones have been built, while the basic facilities that are available at the smaller AENA airports are often more than adequate.

In sum, they are not likely to encourage AENA into draining its resources further by building fancy infrastructure, even if it was allowed to (see below). (And in any case there is plenty of spare capacity throughout the network.)

Spain's tourism growth should be +7% in the following years but not everyone is happy

As a consequence both of the bottoming out of the recession and of steady LCC support, tourism, which had remained fairly stable during the lean years, has begun to pick up again. The tourism sector accounts for 10.9% of Spain's entire GDP and generates one in nine jobs, and as such is a strategic sector for both the present and the future of the economy. Spain is the third most visited country in the world, and the second destination in terms of foreign earnings from tourism.

With tourism representing 25% of all new jobs created in Spain in 2014, the sector remains one of the country's most important. In 2014, Spain received 65 million international tourist arrivals - a new historic record and the highest growth (+7%) in the last 14 years.

Those 2014 tourist arrivals were mainly, but not exclusively, by air and the statistics are similar. There was a 4.3% growth across all Spanish airports last year (of which there are hardly any outside the AENA family) with 5.2% recorded at Madrid and 6.5% at Barcelona. The coastal (vacation) airports were in the same ballpark with Alicante recording 4.2% growth and Malaga an impressive 6.7%.

To what degree air passenger numbers can increase over the next three years is unclear but a quick poll of two leading consultants there suggests in one case that a compound annual growth rate (CAGR) of 7% is achievable.

The other expects growth to be in the high end of single digits, but that it will be difficult to achieve double digit growth. In favour of growth he identifies the difficulties of other tourism destinations such as unrest in Tunisia, Turkey etc. Also, domestic demand within and ex-Spain seems to be recovering.

However, neither is convinced that airlines will add that much additional capacity to the system. If we look at the "golden days" of 2000-2007, the rate of growth for the AENA network was never in double digits. Only a small number of airports achieved double digit growth, including the two big ones of Barcelona and Madrid. The high speed rail line is also affecting the main BCN-MAD route (more on that subject later).

Tourism may not grow by much in the peak season: Off-peak is the new target

Also, in terms of tourism capacity, Spain is reaching an all-time high in international tourist visitors (again, 65 million international tourists in 2014). But the UN World Tourism Organisation does not foresee growth in the Mediterranean above 3% (according to the UN WTO 2014 tourism edition) and there is scepticism that Spain can grow much more in the summer peak period.

There is even an ongoing debate in Barcelona that suggests that there are already too many tourists. The city council is trying to move tourists from the city centre to other "interesting" areas. Parc Güell, a public park system composed of gardens and architectural elements designed by Antoni Gaudi, is now limiting the number of visits per day. Barcelona's aim is to attract tourism for the off-peak months, especially winter. This partly explains the city's interest in organising the Winter Olympics at some point in the future (presumably in the Pyrenees Mountains). Alicante is another city where councillors have vigorously deliberated on the lack of out-of-season attractions.

If this debate is being replicated throughout Spain it suggests a need to attract more tourists, but in different seasons. Following that logic through it hints that peak season tourism will soon reach its peak. LCCs can add as many flights as they like. If the surface infrastructure does not match it tourists will seek alternative destinations.

Many expatriate residents potentially face a bleak future

One other aspect of 'tourism' that needs to be taken into account is the long term variety that is represented by legions of expatriates. Just as the UK for example provides the largest numbers of tourist air passengers into Spain so it has a huge number of permanent or temporary ex-pats living there. Estimates vary but there are thought to be over a million in mainland Spain and the Balearic and Canary Islands with countless more second home owners.

Other countries aren't far behind. Mallorca is particularly popular with the Germans, while the Russians have long been in evidence in the southern part of the Costa Blanca. They have invested nearly EUR1 billion in Costa Blanca properties.

But the longer the recession went on the more evident it became that these 'immigrants' were losing their popularity as they have successively become less able to contribute meaningfully to the economy. Indeed, with many ex-pats being older and having to survive on pensions the values of which were declining in real terms, foreign residents have become something of a burden on key aspects of the Spanish economy such as the health service (which is free to all residents) and social services, which are similarly abundant.

If the UK was to quit the EU (there will be a referendum before the end of 2017 if a Conservative government is returned to power on 07-May-2015) then the right of free movement in Europe would be lost and many British ex-pats might be forced to leave Spain altogether.

Difficulties could arise out of European Quantitative Easing

There is one other potential problem on the horizon, namely the policy of quantitative easing (QE) which was launched by the European Central Bank (ECB) throughout the Euro Zone in Mar-2015 in a programme that should last through until Sep-2016 - and which could be extended. The scheme, in which the ECB will try to revitalise the Euro Zone economy and counter deflation with a EUR60 billion-a-month government and private sector bond-buying programme will continue until inflation is close to the ECB's 2% target.

The problem might arise when the QE programme comes to an end. A stronger Euro again against the UKL and USD would mean less UK & overseas travel demand. Also, increasing financing costs in Spain would lead to less domestic demand.

So there is something of a mixed bag of potential outcomes where foreign tourism is concerned but overall it seems set to increase passenger numbers by between five and 10% per annum in the foreseeable future (Madrid Airport grew by 14% in Mar-2015, Barcelona by 7% and AENA as a whole by 6.5%), along with a gradual increase in Spanish domestic and foreign tourism.

DORA puts the brake on airport infrastructure investment - but much of it is in place already

A third benefit is that much of AENA's important infrastructure is already in place. Vast amounts of money were spent to equip the two leading airports, through the Plan Barajas and the Plan Barcelona, with adequate runways (four at Madrid and three at Barcelona) and new terminal buildings in advance of the privatisation.

Large sums were also allocated to key coastal vacation airports such as Malaga and Alicante to equip them with new terminals costing in the region of EUR500 million each (Malaga also got a second runway and will gain an aerotropolis) along with a terminal extension at Palma de Mallorca and at Gran Canaria. Expenditure on the myriad of smaller AENA airports was not so forthcoming but, as indicated earlier, not so necessary either.

And it continues. Transport Minister Ana Pastor is committed to a USD2.2 billion ongoing airport development plan in 2015, some of it in the important tourist province of Andalusia.

But that is where it ends, at least for now. An important feature of the 2014 Document for Regulation of Airports (DORA) that is discussed below, is that infrastructural expenditure on new projects will be limited to EUR450 million (USD488.6 million) each year in tandem with a tariff freeze that lasts until 2025. In short, investors can be confident that the infrastructure to handle growth in that aforementioned 5-10% p.a. bracket is in situ and that any further expenditure will - probably - only be where it is really needed.

This is important because in the 'boom years' money was thrown at airport projects, mainly in the private sector which AENA has now partly entered, as if they were going out of fashion. Some of this infrastructure could be classed as 'vanity projects' and has cost investors dearly. The DORA should put an end to that and ensure that in this respect at least AENA's financial leverage is improved.

Another benefit for investors is a little more debateable. It directly concerns the DORA and how it will influence aeronautical and non-aeronautical revenues. This document needs now to be explained. In advance of the AENA privatisation the government (Ministry of Development) brought into effect a new regulatory framework that had been absent in the 2011 process, which has become known as the DORA or Document for Airports Regulation, and which was drawn up in line with EU principles.

It has a five-year duration and became official through a Royal Decree performed by the Ministry of Development in Jul-2014. It seeks to guarantee citizens' mobility as well as social, economic and territorial cohesion, to guarantee quality of service, to keep the Spanish airports as a 'net' (entity, i.e. all of them together) and to boost economic development and competition in the industry through a tariff freeze until 2025.

Key elements to the DORA:

• The government is established as the aviation regulator, meaning the operator and the regulator are one and the same, even if the government's shareholding reduced to 49% or less;
• It established the privatisation of AENA to a maximum of 49% of its equity and guarantees the retention of the 'net' of airports referred to above. It does take into account the possibility of closing or selling an airport under special circumstances;
• The DORA shall be the main regulatory and supervising tool of AENA S.A. It shall establish specific guidelines for action;
• Tariffs (charges to airlines) cannot increase until 2025. They are effectively frozen at levels considered by the government to be appropriate to the fostering of competition amongst airlines and the decision was reached owing to the efficiency levels achieved by AENA in the last three years, the size and scope of the airport 'net' and the addition of modern infrastructure;
• Airport infrastructure (Cap Ex) investment is limited to EUR450 million;
• It ensures the regulation of tariffs in line with certain expenditure factors (Op Ex, Cap Ex etc) and establishes a regulatory asset base;
• The regulatory system will switch from single to dual till (by 2018) under a phased procedure.

New charging mechanisms concern investors

Until 2011 regulation of Spanish airports bore little relation to other examples in Europe. Airport charging mechanisms were adjusted annually in line with charges for other Spanish public services (e.g. policing, street cleaning), not with charges at other airport operators; they did not increase by as much as they needed to and often simply did not cover costs. Moreover, those costs were barely kept under control (there was no competition either within the public sector or from the private one) and rampant over-expenditure was rife.

Remarkably, a piece of academic research in 2009 revealed that the coastal airports were often underwriting Madrid and Barcelona while those two categories together underwrote the smaller airports.

When regulation in its present form was introduced it was in the form of the single till system under which all of an airport's revenue-generating activities (regulated aeronautical and unregulated commercial) are taken into consideration to determine the level of the airport's charges to airlines. (Under the dual till principle, only aeronautical activities are taken into consideration; the airport's retail and other non-aeronautical revenue are not taken into account in setting charges to airline users.)

Airport charges derived using the single till approach are therefore likely to be lower than they would under a dual till because of the allocated "sharing" of revenues generated by commercial activities. Or cross-subsidisation, to put it another way.

Typically, airlines prefer single till while operators prefer dual till, for evident reasons. The single till is, generally speaking, the preferred method in use in Europe for setting airport charges.

The advent of a single till system did not prevent a huge hike in charges in 2012, which had the effect of causing important LCCs such as Ryanair and easyJet to reduce their routes and frequencies considerably and especially so at Madrid. easyJet went so far as to close its base there. Attracting them back required an appreciable tariff adjustment back down again.

The introduction of a staged switch/implementation, in tandem with the tariff freeze, over a period of four years (2014-2018) from single to dual till, with a decreasing proportion of the commercial costs and revenues to be included in the till over this five-year period, and within the remit of the DORA, seems to be driven by a need to assuage the fears of the airlines, and especially the LCCs. This year (2015), for instance, only 60% of commercial costs are included and none are to be included in 2019. The airlines have been concerned about the potential for a privatised monopoly taking over from the public one at AENA and applying unsustainable charges.

As this report is published (mid Apr-2015) an attempt is being made by Spain's National Competition Commission to finalise a resolution to end implementation of the dual till system on competition grounds. If this challenge is successful it could be a major issue as it could have a great impact on AENA's market value.

Irrespective of this latest development, the regulatory change is the major cause of concern to potential investors in AENA, many of whom cannot understand how a freeze on airline charges over such a protracted period of time can be beneficial to them.

What AENA hopes to do is to make airline operations viable at as many as possible of its airports - which should lead on to an increase in existing services and frequencies thereof, and the commencement of new ones - while freeing them up to engage much more forcibly in non-aeronautical revenue generation at which they have been lacking.

There is considerable potential to ramp up revenues from non-aeronautical commercial enterprises

The casual observer at an AENA coastal or island vacation airport, surrounded by an array of airside shops, cafes, bars and restaurants, might not think so but AENA's non-aeronautical revenue generation has traditionally been well below the level suggested by the trade association Airports Council International (ACI), which in the past has indicated a target figure of 50% of overall revenues as a minimum where that is practicable (it may not be under some single or hybrid till regulatory mechanisms).

Traditionally non-aeronautical vs. aeronautical revenues at Spanish airports have ranged between 25% and 35%, depending on the actual facility, which is a very low figure for the developed world. These figures have changed very recently as AENA has geared up for privatisation, and 'non-aero' should now be more of the order of 35%-40% of all revenues. Even so they are still below par. The feeling among some analysts in Spain is that this is due to the lack of a wholly commercial strategy from a public operator that has had limited concern, until now, about the bottom line.

And it gets worse. Revenue per passenger at restaurants/cafes/bars/shops at the main airports such as Madrid is reported to be considerably less than at comparable European hub airports such as Frankfurt, Amsterdam, London Heathrow, and Paris CDG, even dipping into the EUR3-4 pp category at Madrid compared to EUR6-7 at others. Attempting to compare these airports, even if they are all hubs, is perhaps a little disingenuous. For example while there are virtually no LCCs (or their passengers) at Heathrow while one fifth of all seat capacity at Madrid is on LCCs. (For the record LCCs currently account for 9.5% of seats at CDG, just 1% at Frankfurt and 17.6% at Amsterdam Schiphol - making it the closest to Madrid - but LCCs will be shifted from Schiphol to Lelystad as soon as it is practical).

This is important because most studies indicate that passenger expenditure at airports tends to be higher where there are fewer budget airline services and more 'full service/network' ones. Hence the concern of investors, though that concern should be tempered by the resumption of network services and the addition of new ones that was referred to earlier.

Another important and growing branch of non-aeronautical revenues is car parking revenues

In this respect AENA is again believed not to have optimised the revenue stream as it might have and there is plenty of room for improvement.

In its recently published 2014 accounts, 'Estacionamientos ('parking lots') delivered 0.12% of AENA group terminal revenues and around 13% of all commercial revenues. (AENA does not publish itemised revenue streams per airport; only for the group).

If total passenger numbers were 195-200 million then car park revenue per passenger (CPRPP) is about EUR0.5-0.6 on average (per total passenger, not just the departing ones). (Sources: Información Analítica de Cuenta de Resultados Ejercicio 2014 por Aeropuertos de Aena S.A. (Individual, según PGC). (Analytical Information Year Result 2014 Account for airports Aena SA (Individual, according PGC).)

This compares badly with average CPRPP in Europe and elsewhere across various regulatory and ownership models, as reported in the annexes to the ACI World Economics Report 2013, which was based on 2012 data (the 2014 report is not yet available).

Non-aeronautical revenue per passenger - car parking (EUR)

Region - Europe	1.39
Euro Area	1.59
Global airports (lowest category <1 mppa)	0.61
Global airports (highest category 25-40 mppa)	1.72
Regulatory model - single till	1.04
Regulatory model - hybrid till	1.65
Regulatory model - dual till	1.14
Public ownership (100%)	0.88
PPP	1.19
Private ownership (100%)	1.56
AENA (max, 2014 data)	0.60
Average including AENA	1.21

Source: ACI World Economics Report 2013, Annex 19, reporting members' responses).
(RoE used here: USD1 = EUR0.9417 (10-Apr-2015). RoE used by ACI: USD1 = EUR0.778).

Even allowing for fluctuating exchange rates AENA fails to outscore the other selected categories. The closest fit is with global airports with less than 1 million ppa.

Higher profits forecast from new regulatory mechanism; but the absence of Ferrovial is a blow

To sum up this complex section no-one can know for sure what affect the DORA and associated regulatory change will have on AENA airports' earning power. All that can be said for sure is that the organisation itself, and the government, are hopeful that what it loses on the roundabout (airline charges) it more than gains on the swings (additional services/frequencies plus additional non-aero revenues). If it is of any comfort, at least one Spanish analyst calculates and predicts that although airport charges will remain frozen until 2025, the dual till practice will lead AENA to higher profitability levels and even to a higher yield than that achieved by the likes of Aeroports de Paris, Heathrow, Fraport and Amsterdam.

There is one problem though. It was mentioned earlier in the report that the core investor Ferrovial backed off from that status when the share price rose suddenly prior to the flotation. Ferrovial's CEO resigned from the AENA board. Ferrovial, apart from being a (privately owned) Spanish company, is an experienced operator since 2006 at London Heathrow, the world's second busiest international airport and which is expert at generating non-aeronautical revenues.

There was some surprise that Ferrovial was satisfied with an allocation of only 6.5% of the share capital on the basis that it would wish to take a more active role in the management of AENA than that would allow for. After all that is its usual strategy. On the other hand there was a strong belief that if further tranches of the government's stake were to be sold in the future then Ferrovial was well positioned to move from core investor to preferred shareholder status and possibly even take over the entity (or hived off parts of it) in the fullness of time. It should be borne in mind that influential organisations like the Competition Commission constantly pushed for a larger privatisation of AENA (60% rather than 49%) and that just as a first step to wholesale privatisation, possibly with two separate airport groups, one anchored on Madrid and the other on Barcelona.

But all this is now merely conjecture. Ferrovial's expertise in this business segment will not now be brought to bear.

Forthcoming General Election threatens the rise of Podemos…and even the fall of the privatisation

Most of the positive factors in AENA's favour have been discussed. What are the negative factors?

The first one is political, namely the phenomenal rise of the populist left wing political party Podemos (which translates into English as "we can").

The next general election in Spain must be held on or before 20-Dec-2015. The previous, 2011 election resulted in a landslide victory for the People's Party (PP), led by Mariano Rajoy, which had vigorously resisted the previous attempt to privatise AENA in that year. Despite having to navigate Spain through the recession and deal with several corruption scandals the PP has comfortably held on to its lead in the opinion polls until fairly recently.

The party that almost supplanted it in those polls at the turn of 2014-15 is Podemos, which was formed and came out of nowhere in early 2014 to register an intention to vote as high as 26% in Dec-2014. Its dramatic rise is evident in the chart below. At the time of writing, even though it has slipped back slightly in the polls, it can still be considered to be neck and neck with the PP and the PSOE, the party of the previous Prime Minister, José Luis Zapatero. Both of those parties have seen their combined support ratings plummet to unprecedented levels.

Opinion polling for the Spanish General Election 2015

Source: Wikipedia (poll of polls)

This is a 15-day average trend line of poll results from Nov-2011 to mid Mar-2015, with each line corresponding to a political party.

The Blue Line is the ruling People's Party. The Red Line is the PSOE, the previous government. Podemos is represented by the brown line from Jan/Feb-2014.

Podemos is the second largest Spanish party by number of members after the PP and it currently has over 350,000 members.

Podemos decided not to take part in municipal elections in May-2015 even though its potential vote in those was also very high. Instead, it decided that its members would support grassroots local candidates. For this reason there is no way yet of measuring its actual performance in elections in 2015. It was the fourth most voted for party in the European elections in Nov-2014.

There is nothing in Podemos' manifesto that indicates specifically it would attempt to reverse or even meddle with the AENA privatisation. Its more notable policies include:

• Healing the economy, which places emphasis on public control. This catch-all category is the one that could be invoked against the privatisation;
• Promoting liberty, equality and fraternity;
• Redefining sovereignty (revoking or curtailing the Treaty of Lisbon, withdrawing from some free trade agreements and promoting referenda on any major constitutional reform;
• Recovering land deals and promotion of public transport and renewable energy initiatives.

Moreover, its campaign programme reads like a wish list, with little detail about how it could be financed at a time when Spain is still struggling under a heavy debt burden. (Such absences are commonplace in smaller parties in elections in other EU countries just now and especially so in the UK). It would surely not be so foolhardy as to send out a message that Spain is not a safe investment prospect when such a message could be fatal.

The danger remains though that Podemos could continue to model itself on Syriza in Greece, which threatened to pull the plug on the (previously agreed) privatisation of 14 regional and island airports there (to Fraport of Germany). Syriza has backed off since but that deal has still not been rubber stamped and won't be until Oct-2015 at least.

In order to pose a threat to the privatisation process Podemos, which will probably not win the general election outright, would need to play a part in a coalition. But unlike the practice in neighbouring countries, elections in Spain that result in hung parliaments rarely result in coalition governments at the national level. Rather, the party with the most seats will form a minority government with the confidence and support of other parties, relying on legislature pacts. Judging from the voting intention as of mid Mar-2011 that would see Podemos keeping a less left wing party, the PP, in power, which might well satisfy many of its aims without risking a split over the AENA transaction that the PP had arranged.

While that is the interpretation of the CAPA author it must be said that within Spain itself there is much less confidence that the privatisation process will be completed if there is a change of government - the most likely outcome.

Other political factors to bear in mind include the propensity of the current government to produce a continuous flow of sometimes contradictory acts and decrees. That means that although the DORA - the applicable regulatory framework - is in place as detailed earlier and depending on the economic and tourism outlook, this existing regulatory framework could easily change, either before the election or after it.

The consensus appears to be that arbitrary decisions regarding tariffs are the chief regulatory risk to the outcome of the privatisation to date.

The trade union threat diminishes

The trade unions have often posed a real and present problem to the government and air transport operators. In the recent past the two main transport unions have been able to mobilise multi-sector and virtually national strikes in their support over issues such as air traffic control reform, job losses, salaries and pensions and the AENA and other privatisations.

As the AENA privatisation process (stock market float) was coming to fruition the unions threatened 25 days of strikes but were talked out of such draconian measures by the government. The feeling now is that they are a spent force and will no longer be an issue. If the AENA transaction had not been successful that might have been a different story.

Some account must also be taken of the reaction of some of the regions of Spain to the privatisation. During the 2011 process most of the opposition came from Cataluña (aka Catalonia), the northern province based around Barcelona which craves independence. It was also evident in Andalusia in the south. There was less resistance in nationalistic Madrid.

Map of Spanish provinces

During the 2014/15 procedure, and while the Balearic Islands were in favour, most resistance came from the Canary Islands, whose government commenced legal action to suspend the privatisation of AENA until the islands were excluded from it. A local MP stated the Canary Islands should not be subject to "speculative" funding from the private sector, citing: "airports are not an instrument to raise cash for us... they are powerful elements of the economy because we [rely on] connectivity and the tourism sector." The appeal was subsequently rejected by the Congress of Deputies, on 26-Feb-2015. Subsequently the Third Chamber of the Supreme Court rejected an injunction requested by the Canary Island's Government that the archipelago's airports remain provisionally outside the public offering of shares in the privatisation. The court assessed the injunction as "impossible" to adopt because the sale of shares had already taken place.

Finally, the terror threat needs very briefly to be considered. Had ETA, the armed Basque separatist and independence supporting group, still been an active organisation in this sphere it would have been a negative force. But in 2011 ETA announced a "definitive cessation of its armed activity". Since then ETA has announced it is ready to negotiate a "definitive end" to its operations and to disband completely.

A separate terrorist threat remains on "Al Andalus" (Muslim Spain in the south) but against that must be weighed the fact that none of Spain's neighbouring countries are risk-free and in fact, the situation is perhaps worse in countries like France, Tunisia and Morocco, which could well put Spain in good light in this respect.

Other potential negatives facing AENA include cost control and the influence of the AVE high-speed rail service

Can AENA control its costs? Fundamentally the same managers are still in charge of its daily operations as they were before the partial privatisation. The track record of AENA in this respect is not impressive. The organisation became a liability partly because of the recession and partly because of a combination of over-investment (though that is now dealt with by the DORA); a charging system where charges were not necessarily related to cost (the charging system is now also determined by the DORA) and weak incentives to save costs.

As mentioned earlier, the lack of cost control together with the benchmarking of charges to other government services rather than other airports actually led in the mid-2000s to a situation in which the larger coastal airports specialising in tourism were cross-subsidising larger ones like Madrid and Barcelona, which then collectively subsidised the minor airports. (Source: Bel and Fageda (2009).)

In the latter category, those incentives still remain weak. There is no competition either internally or externally. Madrid and Barcelona airports simply co-exist, connected by very comprehensive air and rail services. The former British Airports Authority once owned and operated Heathrow, Gatwick, and Stansted airports in London as a shared monopoly.

And when the Margaret Thatcher government privatised BAA, it ignored the advice of several think tanks and privatised the entire BAA as a single company. It was several decades before the idea of competing airports gained credibility, and BAA was required to divest Gatwick and Stansted. Has the Spanish government made the same mistake?

The spate of private or public-private airports, many of them vanity projects seems to have fizzled out with only Castellon Airport, which has attracted Canada's SNC Lavalin Invest to operate it, still in the running. With Ryanair declaring intent to commence operations at least that airport will begin serving its region at last but it took five years and there is no guarantee about the future. Meanwhile the Ciudad Real airport in the Castile-La Mancha region to the south of Madrid, which was supposed to be the low cost airport for Madrid and then a logistics facility, closed completely two years ago and is now to be disposed of by auction.

So where competition and costs go, it is still much the same story.

The high-speed rail network (AVE) is the second biggest in the world after that of China. It has without doubt had an adverse effect on the Madrid-Barcelona air route, once one of the world's busiest. Moreover it is now possible to travel between Barcelona and Paris on the same train, where previously passengers had to change at the border.

Spain's AVE network

But even with an ever-growing AVE network (new high-speed railway works will continue in 2015 at a cost of EUR2.4 billion) mainland Spain alone is still a large country to cross by surface transport which explains the predominance of low cost airline services, both those of Spanish and foreign airlines.

Recently Iberia and RENFE, the state rail operator, have been talking about co-operation rather than competition. That would appear to be the way forward, with air travel between the main cities supplemented by co-ordinated rail services to smaller ones. On the other hand that does spell trouble for AENA's smaller airports.

3. Could there be more privatisation to come?

The 2011 procedure would have seen AENA as an entity privatised by way of an IPO after the concession procedures on the MAD and BCN airports was completed. As mentioned earlier there are movements in Spain, the Competition Commission amongst them, which would like to see further privatisation. The CC and the Consulting Cabinet on Privatisations had pushed for 60% of the equity being made available to the private sector via a sale and/or float and presumably that was what Ferrovial was looking to as the next step when it decided to become a core shareholder (and then subsequently stepping back from that commitment).

There were concerns that level of privatisation would result in an increased demand by the private sector investors for a higher return on their investment which would then have led to higher airport charges. But under the DORA those charges are frozen for 10 years. The other major concern was that the smaller airports might be closed. But the government has made statements that all but guarantee the existence of these airports - at least for now.

The best guess we can make is that further privatisation is possible, even beyond 60%, and that it will be in the form of a further float aimed at institutional investors. The dismemberment of the organisation into two or more strands has less chance of being realised.

The final question is whether AENA will pick up again on its previous interests in foreign airports through its subsidiary AENA Internacional, having been one of the original privatisers and very active in Latin America in the 1990s. The short answer to that is yes. Statements have already been made to the extent that opportunities in Mexico and Columbia are under scrutiny and in Apr-2015 AENA's President, Jose Manuel Vargas, claimed the company plans to strengthen its internationalisation over the medium term by acquiring airports Europe and Latin America.

He said the international investment policy of AENA is conditional on having an optimal leverage to achieve investment grade. The new expansion strategy is to take control with majority stakes in airports whose traffic is between five and ten million passengers per annum.

Summary & Conclusions

• A previous (2011) attempt to privatise AENA failed following opposition party objections;
• The pre-privatisation valuation of AENA fluctuated according to its debt position;
• The transaction could be more viewed more strictly as a PPP, in which the controlling shareholder remains the Spanish state and the actual control rests still in government hands;
• The sale price was lower than it would have been if only the larger profitable airports had been offered;
• AENA and the government are at odds over the future for the smaller airports; the government is committed to keeping them all within AENA;
• Better financials from AENA meant the share price went higher…
• …prompting two core investors to withdraw from the process;
• An investment fund with no prior experience of the sector was left as the principal non-governmental stakeholder;
• The offering was oversubscribed 5.5 times;
• The share price climbed to over EUR100 by the end of Mar-2015;
• The final sale valuation put the earnings multiple at almost 12x, closer to recent European norms than had been anticipated;
• Spain is at the beginning (the very beginning) of an economic recovery ;
• The lower oil price is helping the flag carrier Iberia in particular;
• The two main airports - Madrid and Barcelona can reasonably expect the resumption of hubbing activity to/from Latin America (Madrid); and additional air services to/from the east (both);
• Iberia is benefitting from the lower oil price;
• LCCs operating is Spain have a greater proportion of international seats;
• Tourism and air pax growth over the next three years to be in the order of 7% CAGR…
• …but the fastest growth may come in the off-peak seasons;
• Some ex-pats have left Spain, and many more may do so thereby reducing national income through expenditure but also reducing the drain on scant resources;
• There are some potential difficulties arising from the instigation and subsequent cessation of quantitative easing in the Euro Zone;
• Much of AENA's infrastructure is already built thus increasing AENA's financial leverage; there is overcapacity momentarily;
• The DORA (Document for Airport Regulation) established the privatisation of AENA; introduced a staged change in the regulatory system for airport charges in favour of a dual till mechanism; froze airport charges, and capped infrastructure investment;
• The new charging mechanisms are of concern to investors, especially the freezing of tariffs. Those mechanisms are being challenged by the Competition Commission;
• But there is considerable potential to improve non-regulated non-aeronautical revenue streams;
• Politics has played a big role throughout the process and could continue to do so;
• Trade Union power is diminished;
• Most regions of the country have accepted the privatisation;
• The terror threat is also diminished;
• The high speed rail system may offer as many co-operative opportunities as difficulties;
• There are still few incentives to control costs;
• More privatisation could follow but still pitched at institutional investors rather than operators;
• AENA will resume its investments abroad

Issues for the future:

(1) Can AENA improve its ability to control costs, a shortcoming brought about in the first place by a lack of competition between its own airports and because of no competing private sector to speak of;

(2) What is the prognosis for the smaller airports? Of the 46, less than ten are habitually in the black;

(3) How will the General Election influence the outcome? Will Podemos follow the recent Greek backflip? If so, will it back the privatisation or try to reverse it, or seek some middle way?

So even under semi-private ownership many of the issues remain for the new set of AENA owners to contend with. But a majority verdict is that the future for AENA's investors is at least much brighter than it was.

(Note: Some parts of this report are abridged from the recently published CAPA report 'Airport Finance and Privatisation review 2014/15'.)