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Aus/US consortium bids for Sydney Airport. The M&A rush begins?

Analysis

During 18 months of the COVID-19 pandemic there has been precious little M&A activity in the airports sector apart from Brazil and Japan, where the groundwork had been long been laid anyway.

Many people have openly speculated when it would start up again, but all have been blindsided by an out-of-left-field proposal by an Australian/US consortium to take over Sydney Airport in what would be Australia’s biggest corporate transaction and the biggest single one in the airports sector for many a year.

No sooner had analysts picked themselves up than another major player in the sector was reported to be considering forming a consortium for a counter-proposal.

This report examines the history of Australian airport leases and sales, the consortium members making this proposal, the putative other investor that is being linked to Sydney Airport, how that airport has fared during the pandemic, and whether or not the investors might be better off to ‘stick’ or ‘twist’.

Summary

  • Australian-led consortium issues indicative proposal for Sydney Airport.
  • Consortium is made up of Australian and US interests with ample airport ownership experience.
  • Offer is equivalent to previous ones before 2020, in terms of valuation.
  • An existing shareholder would be required to stay ‘on board’.
  • Sydney Airport’s retort is that shareholders should wait for things to improve under existing control.
  • Its finances are in reasonable shape – considering.
  • Another bid may be in the process of being put together, and others could follow.  

IFM-led consortium proposes to acquire Sydney Airport

On 05 Jul-2021 the Sydney Aviation Alliance confirmed that on Friday 02-Jul-2021 it had approached the Board of Sydney Airport Limited with a non-binding indicative proposal to acquire all of the stapled securities in Sydney Airport Limited and Sydney Airport Trust 1.

The Sydney Aviation Alliance is an Australian-led consortium consisting of: the (Industry Funds Management) IFM Australian Infrastructure Fund and the IFM Global Infrastructure Fund; QSuper, a Brisbane-based pension fund; and Global Infrastructure Management, an arm of Global Infrastructure Partners, which is the US/UK funds manager that was once a major player in the airport sector. 

(By way of brief explanation, a stapled security is a type of financial instrument that is widely used in Australia but is relatively uncommon elsewhere in the world. It consists of two or more securities that are contractually bound to form a single saleable unit. Stapled securities are traded like a stock, but generally speaking the components cannot be traded separately. The two parts of the saleable unit are usually (1) a share in a company and (2) a unit in a trust related to the company. So a company that manages a trust may have units of the trust attached (stapled) to the shares of the company. The company may be responsible for managing the fund and development opportunities, and may charge the trust a fee. The trust, in turn, is the legal owner of the property assets. Stapling gives the management company an incentive to work for the benefit of the unit holders, rather than just their own shareholders. Some stapled securities may provide minor tax advantages.)

In a statement the Alliance said that members of the consortium are highly experienced infrastructure owners who invest directly or indirectly on behalf of more than six million Australian superannuation fund members, and collectively have in excess of AUD177 billion of infrastructure funds under management globally, including interests in 20 airports that collectively served more than 330 million passengers in 2019. (That year will be the benchmark for aviation for possibly as long as a decade).

‘Substantially Australian ownership’ to continue

The Alliance points out that the proposal would ensure substantial ongoing Australian ownership of a nationally significant infrastructure asset, with the consortium having “a proven track record of investing billions of dollars in airports and other significant infrastructure assets, helping create Australian jobs while enhancing passenger and customer experiences.”

Australian airports in which the consortium members have ownership interests have invested more than AUD3.8 billion in capital programmes over the past five years, including in the construction of a second runway at Brisbane Airport and terminal improvements at Melbourne Airport.

Significantly, it also highlighted the fact that the Australian airports have also provided more than AUD300 million in rent relief to retail and property tenants due to the impact of COVID-19.

The consortium also believes that the proposal, if implemented, “would deliver significant value and economic certainty to Sydney Airport security holders and is in the long-term interest of Sydney and the travelling public”.

An enterprise value of almost AUD30 billion – 20 times 2019 earnings

The proposal comprises cash consideration of AUD8.25 per Sydney Airport stapled security, “representing a substantial premium to recent and medium-term market prices", as well as the price for Sydney Airport’s AUD2 billion equity raise in Aug-2020, when it issued 19.4% of its issued capital at AUD4.56 per stapled security.

The consortium listed a series of offer premiums to the airport’s closing price on 01-Jul-2021 (43%) and to the volume weighted average price (VWAP) – a trading benchmark used by traders that gives the average price a security has traded at throughout the day, based on both volume and price – for one, three and six months, also on that date (all 38%). The premium to the offer price for Sydney Airport’s AUD2 billion equity raise in Aug-2020 is 81%.

The proposal implies an equity value for Sydney Airport of AUD22.3 billion and an enterprise value of AUD29.8 billion, which is 58.6 times 2020 earnings and 21.6 times 2019 earnings.

The latter figure is par for the course for airport transactions in recent years. The former is exceptional (although not unknown, even in ‘normal’ years), and is one of the first occasions on which an airport has been valued in this matter for transactional purposes since the pandemic began.

Major pension fund shareholder UniSuper required to reinvest rather than cash in

The proposal is conditional on Sydney Airport's largest security holder (i.e. shareholder in other jurisdictions), UniSuper, agreeing to reinvest its holding into an equivalent unlisted and illiquid interest in the privatised Sydney Airport. This “would serve to maximise the participation of Australian superannuation funds in the ongoing ownership of Sydney Airport”.

The proposal is also conditional on, among other things, a targeted due diligence review and entry into a satisfactory scheme implementation deed. Completion of any transaction would be subject to, among other conditions, certain regulatory approvals, including Foreign Investment Review Board approval and Australian Competition and Consumer Commission approval.

The consortium says it does not anticipate making substantive changes to management, services, operations or target credit ratings of Sydney Airport, and it acknowledges the legally binding nature of Sydney Airport’s current regulatory operating restrictions (such as regional slots, curfews and aircraft movement caps) and the importance of these to the broader community.

The consortium is also “highly supportive of, and organisationally aligned to, Sydney Airport’s commitment to net zero carbon emissions by 2030.”

(The importance of adherence to regulatory criteria, including carbon commitments, is perhaps more significant now than if this proposal had been put forward before work began on the new Western Sydney airport.)

(See the related CAPA report: Sydney KSA financially strong; Western Sydney airport under way [Jun-2021].)

The consortium concluded its statement by saying that it understands the requirement for Sydney Airport to undertake a detailed assessment of the proposal and that it recognises that there is no assurance that the proposal, or any other transaction, will be agreed or will proceed.

The most recent transaction in a series that is two decades old

The current ownership of Sydney Airport is an unusual case.

Most of Australia’s airports were privatised to a variety of invest and infrastructure funds by way of long term leases in the late 1990s, Sydney Airport being the main exception, owing to economic downturns at the time it was proposed.

But it was eventually sold in 2002 to Macquarie Airports (MAp), which at one time was one of the world’s premier airport investors, and which listed the company on the Australian Securities Exchange that year. Sydney Airport is the only publicly listed airport in Australia.

MAp divested its holdings in 2013 and UniSuper, another Australian pension fund, is now Sydney Airport’s biggest shareholder, having subsequently increased its shareholding.

Before assessing the reaction to the proposal, below is a brief breakdown of the Alliance’s members.

Industry Funds Management (IFM)

Industry Funds Management, or IFM, is an investment manager active globally. The vast majority of investors in IFM's Global Infrastructure Fund are institutional pension funds, spread over multiple jurisdictions, including Australia, the United Kingdom, Continental Europe, the United States and Canada. It has Australian and international infrastructure funds, both of which invest in airports, including nine across Australia, and it also has Australian and international private equity funds.

In Apr-2012 IFM emerged as a potential strategic investor in Manchester Airport Group (MAG). The deal, which was secured in Sep-2012, would materialise only if MAG was successful with a bid for Stansted Airport, as it ultimately was. IFM is currently a 35.5% shareholder in Manchester Airports Group.

IFM later went on to take a stake in Vienna Airport and to take 100% of OHL Concessions, the operator of the Mexico City Toluca Airport, which became Aleatica.

IFM has variously bid for airports which include Nice and Lyon in France, the Osaka airports in Japan, Chicago Midway Airport, several Italian airports and St Louis Lambert Airport, and also lodged notification of its intention to bid for Groupe ADP in France.

In Australia it also bid for Hobart Airport and expressed interest in operating the Western Sydney Airport, “should the government want to offer a long-term lease". In the unlikely event that were to happen, it could find it competing with itself in Sydney.

Active airports for Industry Funds Management (IFM Investors)

Global Infrastructure Partners (GIP)

GIP was founded in 2006 as a specialist infrastructure fund (later funds) by former senior executives from Credit Suisse and the General Electric Company, targeting investments in the energy, transportation and water/waste industries. When GIP's second fund, GIP2, was completed in 2012 it raised USD8.25 billion in investor capital commitments, making it the largest independent infrastructure fund in the world.

GIP was a major operator of airports at a similar time to Macquarie Airports, and at one stage announced itself as a bidder in virtually every airport of substance transaction that materialised. Its main asset was undoubtedly London Gatwick Airport, in which it held a controlling interest before divesting some of it to other funds from 2010 onwards.

More recently its ardour for the business seems to have cooled, as it allowed VINCI to take a controlling 50.1% stake at London Gatwick Airport (although actually increasing its own stake) and previously, in 2016, sold London City Airport to a consortium of funds for what is still a world record EBITDA multiple.

It has since bought, as part of a consortium, the fixed base operator which specialises in business jets, Signature Aviation, for USD4.7 billion. The sale of London City Airport, which faces numerous challenges, and the investment into Signature, which has profited from the pandemic, almost suggest that GIP saw COVID coming.

But GIP's interest in airports has not gone away entirely.

It still retains a large majority stake in Edinburgh Airport (Scotland, UK), as well as its interest at Gatwick. Moreover, in recent years and in some cases since equity disposals at Gatwick and Edinburgh, it has bid for a public sector 30% stake in Athens Airport (shortlisted in the delayed procedure) and also in the abandoned St Louis Lambert lease. It has expressed interest in Indian concessions and became an investor in the Paine Field Passenger Terminal at Everett Paine Field Airport (Washington State, USA).

GIP occasionally sounds out investors about initiating more investment funds. It has not ‘left the building’ as this putative Sydney transaction alone confirms.

Active airports for Global Infrastructure Partners (GIP)

QSuper, Australian superannuation fund 

QSuper, a not-for-profit Australian superannuation fund based in Brisbane, Queensland which was established in 1912, appears to be a ‘new entrant’, certainly in comparison with the other two consortium members.

But it is already an indirect investor in airports, at London Heathrow into which it bought in two stages, originally in 2011 and then in 2017 by way of an ownership interest in Alinda Capital Partners, which is a direct equity shareholder of Heathrow. This approximately 11% Heathrow Airport equity ownership, on its members’ behalf, is the largest of QSuper’s infrastructure investments.

QSuper is also likewise an investor in Scotland’s leading airport, Edinburgh Airport (9.5%) and has a stake in Brisbane Airport in Australia. Interestingly that means it is a co-investor with GIP in one UK airport but also an indirect investor in GIP’s #1 rival airport in London – Heathrow.

Active airports for QSuper

All three consortium members are essentially investors rather than operators and are believed to adopt a hands-off approach to management, apart from standard due diligence procedures. They all have adequate long term experience of overseeing management in airports of varying sizes.

Accordingly, there is no reason why they could not collectively make a good job of running the Sydney airport.

Sydney Airport board’s response paints COVID as a temporary nuisance

The objections from Sydney Airport’s board to the proposal hang on the fact that it has told investors that the COVID-19 pandemic has “hurt its shares”, and that “they should take no action on an unsolicited AUD22 billion takeover bid from a group of infrastructure investors” as its shares soared by 29% on the bid news.

The airport’s shares, which closed at AUD5.81 on Friday 02-Jul, were trading close to AUD9 before the pandemic broke out in early 2020.

But the stock jumped to AUD7.75 by the close on Friday, 9Jul-2021 – its highest level since Feb-2020.

Sydney Airport: share price and volume of shares traded

The Sydney Airport board told investors that the pandemic was expected to have “a short term impact”.

The board’s statement continued: "The indicative proposal has been made during a global pandemic[,] which has deeply affected the aviation industry and the Sydney Airport security price. The indicative price is below where Sydney Airport’s security price traded before the pandemic”.

UniSuper reported to have ‘a favourable view’

But UniSuper, Sydney Airport’s biggest shareholder with a 15% stake, said that “UniSuper has a favourable view of the consortium partners.”

UniSuper said that it did not have any information on the takeover proposal other than the information that had been disclosed publicly, adding, “A final decision will be made by UniSuper in due course and after all details have been considered”.

The takeover proposal is conditional, as mentioned earlier, on UniSuper keeping its equity stake in the airport, rather than taking the cash on offer.

The consortium argues that its proposal would ensure “substantial” ongoing Australian ownership of the airport by organisations that have invested heavily in Australian airports over the past five years. The consortium said it was not planning on making “substantive” changes to the airports that IFM already owns stakes in – namely Melbourne, Brisbane, Perth, and Adelaide airports, as well as Northern Territory (NT) Airports, which includes Darwin, Alice Springs and Tennant Creek airports.

Collapse in traffic and future uncertainties makes this a difficult time to make and assess a bid

Sydney, like most Australian airports, has struggled during the pandemic. With very few international passengers owing to international border closures, it has also been frustrated by the sporadic domestic state border closures across Australia in 2020 and 2021, because they have disrupted domestic aviation and made it difficult for people to plan vacations. Sydney and the state of NSW is now in full lockdown and is unlikely to reopen for at least another two weeks.

What the board did not say is that passenger growth had been stumbling along for seven or eight years at a fairly low level and fell to just +0.1% in 2019, before the pandemic.

It collapsed by 75% in 2020, but in the first five months of 2021 it has recovered to -46%.

Sydney Kingsford Smith Airport: passenger numbers/growth, 2012-2021

But that overall figure disguises a dichotomy between international and domestic travellers.

The airport’s international passenger numbers were down 93% in May-2021, for example, compared with the same month in 2019, before the pandemic broke out, whereas its domestic passenger numbers were down by only 39%.

The airport’s Chief Executive has called for Australia to develop a plan to open international borders in “a safe and risk-based way”, and also keep state borders open.

Looking at the seat capacity position, it has been healthier than in 2020 since Apr-2021, but in the week this report is written (commencing 05-Jul-2021) and following the one in which the indicative proposal was made, capacity took another backward step due to more lockdowns being imposed in certain states.

It is not the best time to be making any sort of proposal, for both parties.

Sydney Kingsford Smith Airport: weekly total system seat capacity, 2018-2021* (projected)

Sydney Airport benefits from the comparatively light pricing regulatory regime, compared to many of its international peers

The airport did not pay a final dividend for 2020, after suffering an AUD145.6 million annual loss, and is not planning to pay an interim dividend. It had delivered an AUD403.9 million profit the previous year in 2019.

However, as the previous CAPA report referred to earlier made clear, Sydney has fared rather better than peer airports in Southeast Asia – largely on account of retention of some domestic traffic – and its finances are also comparatively strong owing to the soft regulatory scheme, which permits high charges to be made to the airlines that have remained.

The airport actually achieved an EBITDA of AUD508 million in 2020 (year ending 30-Dec-2020). Although this was 62% down on 2019's result, it still represented an EBITDA margin of 71.2%.

The board is currently assessing whether the proposal reflects the airport’s underlying value, given its long concession – which lasts until 2097 – and “the expected short term impact of the pandemic”.

Better the devil you know…?

‘Do we stick or do we twist?’ is a choice that few investors in airports have had to face during the past 18 months. Apart from the concession deals that had already been lined up in countries like Brazil and Japan, there has been little deal activity anywhere else, and numerous other deals remain in abeyance. In contrast, and including debt, this would be the largest deal in Australian corporate history.

This one has come out of the blue, and could set a benchmark for others for aggressive unsolicited bids for airports, bids which attempt to capitalise on relative financial and operational weakness brought about by external factors over which the operator has no control.

The decision the shareholders have to make is which organisation can return the airport to some form of normality the quickest, while ensuring that profitability levels are re-established and preparing for the challenge of the new Sydney airport, which will be coming on line as that normality is achieved.

In the circumstances, it may turn out to be a case of ‘better the devil you know.’

Macquarie Group responds – a potential rival offer

It did not take long for ‘others’ to appear on the scene.

A consortium led by Macquarie Group Ltd (not the aforementioned MAp Airports) is believed to be exploring a rival offer in a potential challenge to the Sydney Aviation Alliance’s bid.

The Australian company is reported to have spoken with potential partners, including the ubiquitous local pension funds (of which Australia has several that are active investors in this sector), about making a joint offer. The bidding group could include funds managed by Macquarie Infrastructure and Real Assets.

The Macquarie Group as a whole embraces a number of funds located around the world which have long been involved in the privatisation of airports, since before the members of the Sydney Aviation Alliance, even GIP.

Again, the group is perhaps not as significant an investor in the sector as it once was. In 2019 it sold a long-standing stake in Brussels Airport, having disposed of its holding in Copenhagen Airports two years earlier, and also in Hobart Airport in Tasmania, leaving it with only a clutch of UK regional and business airports.

Active airports for Macquarie Group

On the other hand, Macquarie Group is, like GIP, shortlisted for the eventual sale of a public sector stake in Athens Airport, and it was poised to take over the Westchester County airport in New York State before that deal was terminated locally.

The point is, it could not sit by idly and watch an unsolicited bid for Sydney Airport – on its own doorstep – go unchallenged. It could use some of its own capital for the deal, as well as bringing in some of the MIRA (Macquarie Infrastructure and Real Assets) funds to join the consortium.

Suddenly, as if a tired old boxer, battered, bloodied and bruised, has dragged himself out of his corner to fight the 15th and last round against a vicious bare-knuckle thug called COVID, then instantly dropped him to the canvas with a haymaker, the business of buying and selling airports has come alive again.

Competition law issues may intervene

According to The Australian Financial Review on 12-Jul-2021, the Australian Competition and Consumer Commission chairman Rod Sims says the ACCC will take “an extremely close” look at the takeover bid if it goes ahead. Despite warm noises from the bidders about benefits to travellers, some industry figures are concerned the takeover would involve higher airport charges.

As a fundamental Australian asset, said Mr Sims, “It’s obviously a complicated issue when you’ve got different funds but we’re aware that issues can certainly still arise. We’ll look at it extremely closely.”

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