Could Sydney Nancy Bird Walton Airport top a Kingsford Smith sale?

Summary

• The consortium hoping to buy Sydney Airport has upped its bid; due diligence will now take place and a sale seems likely.
• No counterbids yet, but there is still time…just.
• Some institutional investors hoping for AUD9/share to be reached, but that has never happened.
• Future valuations depend on the outcome for both domestic and international travel, which is still very much up in the air.
• The Australian Competition watchdog (Australian Competition and Consumer Commission, ACCC) has yet to have its say, but will probably take a relaxed approach to minority ownership of other airports by consortium members.
• Few seem to be factoring in the impact of the Western Sydney airport, only five years from opening, when aviation 'normality' is supposed to have returned.

Be patriotic - let us buy your airport

In mid-Jul-2021 CAPA reported on a conditional offer made for Australia's Sydney Kingsford Smith Airport by the Sydney Aviation Alliance - a consortium of IFM Investors, AustralianSuper, QSuper and Global Infrastructure Partners (GIP). The first three of them are Australia-based funds, and with a homey-like pitch not dissimilar to the ones employed by CIS state airlines in the 1990s, such as "Be patriotic - fly Air Kirzakistan!"

Such is the global nature of air transport investment, especially in the airports sector, that there was some method in employing this technique, which claimed that the consortium would "ensure substantial ongoing Australian ownership of a nationally significant infrastructure asset".

That they collectively hold in excess of AUD177 billion of infrastructure funds under management globally, including interests in 20 airports that together served more than 330 million passengers in 2019, would have helped as well.

But the key to it all is the price offered.

Bidding for an airport in the midst of a global pandemic is not to be recommended, to either buyer or seller. There is no way of valuing it accurately when passenger traffic levels are at 10% or less of what they were in 2019. At a time when what started as short term lockdowns were beginning to look like whole-life sentences for a crime that no one has committed.

Interstate domestic travel in Australia has been severely curtailed, and at a time when the government of the primary international air travel market, China, is both in turmoil still over a global pandemic that has returned and is making threatening noises about future trade to the country where the airport is situated, and worse.

But then again, airports are for the long term, if short term road bumps are not too important.

Original offer was AUD8.25 per share valuing it 21.6 times 2019 earnings, subsequently raised to AUD8.75 per share

The proposal comprised a cash consideration of AUD8.25 per Sydney Airport 'stapled security' (basically a share), which was a premium to recent and medium term market prices, and it implied an equity value for Sydney Airport of AUD22.3 billion and an enterprise value of AUD29.8 billion, which was 58.6 times 2020 earnings and 21.6 times 2019 earnings. The latter pretty much being par for the course for an airport transaction over the past five years or so with a little bonus on top.

But it wasn't enough, and determined not to be "in the interests of shareholders".

Then, on 13-Sep-2021 Sydney Airport received a further revised indicative, conditional and nonbinding proposal from the consortium (none, surprisingly, having emerged from anywhere else) of AUD8.75 per share. (This was a further premium of AUD0.50 on the first and AUD0.30 on the second offers, and valuing the company at AUD32 billion for the 140,000 shareholders.)

The airport notified those shareholders that it intended to grant due diligence on a non-exclusive basis (i.e. so they could examine its books and other relevant documents) to enable it to put forward a binding proposal, subject to entry into a Non-Disclosure Agreement on acceptable terms.

No counterbids, but they could possibly yet come

Surprisingly, no counterbids have emerged from anywhere else, including from the Macquarie Group or the usually aggressive Canadian pension funds, even though the due diligence granted to the consortium is on a non-exclusive basis, meaning another suitor could still come to the table. The Sydney Airport board's strategy has, accordingly, been one of encouraging the consortium to bid against itself, in the absence of other buyers.

That due diligence is expected to take four weeks from entry into the Non-Disclosure Agreement.

Should the Consortium make a binding offer at AUD8.75 cash per stapled security, then, subject to the parties entering into a binding scheme implementation agreement on terms acceptable to Sydney Airport (including as to the timeframe to implementation), and Sydney Airport having completed an assessment of the conditionality of the binding offer to its satisfaction, the current intention of the board is to recommend unanimously that security holders vote in favour of the proposal in the absence of a superior proposal - subject to an independent expert concluding that the proposed transaction is in the best interests of those Sydney Airport security holders.

Opportunistic? Or manna from heaven?

There must have been times when the company's share price was hovering around AUD7.60 in early Aug-2021, when Sydney Airport's recently installed chairman David Gonski wondered if he had made the right call in turning down the original proposal, declaring it "opportunistic".

He may well have realised since that there is so little M&A activity in the global airport business right now, apart from deals that were engineered long ago in Brazil and Japan, that any 'indicative bid' should be considered as a golden opportunity and one to be seized upon as if it were manna from heaven.

After all, if the Lambda and Mu variants of COVID-19 were to sail into Botany Bay and make their presence felt, then Mr Gonski might be looking at another year or so of lockdowns and 75% passenger losses and, ergo, might wish that he'd snatched the consortium's hand off in July.

Sydney Kingsford Smith Airport: passenger numbers/growth, 2019-2021

Source: CAPA - Centre for Aviation and Sydney Kingsford Smith Airport reports.

Sydney Kingsford Smith Airport traffic year ends in December.

Final bid is only 22 cents short of all-time high share price; equity issue recalibrates it at AUD9.5 per share

But as it happens, it isn't working out quite like that. It rarely does, and it has turned out that the board will probably be asked to accept an offer that is only 22 cents short of the all-time record high share price for the airport of AUD8.97 recorded on 26-Dec-2019, just as a virus was mysteriously transferred to humans.

If the offer is recalibrated to take into account Sydney Airport's equity issue last year, the adjusted price is around AUD9.50 per share.

The price fell as low as AUD4.33 early in the COVID-19 crisis. Investors had got used to the stock dawdling along at around AUD5-AUD6 and had not received a dividend since 2019.

Sydney Airport: five-year stock price, 2018-2021

Source: Google Finance.

Sydney Airport stock price and shares traded, past three months (weeks of 21-Jun-2021 to 13-Sep-2021)

Source: www.asx.com.au

Could that all-time high share price be reached again?

Of course, there is another way of looking at this.

As things stand, the share price of AUD8.26 (on 16-Sep-2021) is higher than it has been since early Feb-2021. And it is even higher than it has been for the bulk of the past five years. What's more, it took off like a rocket when the first indicative bid surfaced.

That is understandable, but it has not fallen back significantly despite the lack of an alternative bid emerging (and there is unlikely to be one now), and has increased by 10 cents over the past two weeks.

With the overall climate in Australia slowly improving and increasing talk of 'lights at the end of the tunnel' it is conceivable that the Dec-2019 share price could be reached again, and perhaps even exceeded.

When there is good economic news there is always a sort of halo effect where share prices are concerned.

Imagine - unlikely as it might sound - that a COVID-19 'cure' was announced in a few weeks' time, just after the board accepted this proposal. That share price would accelerate after the deal was done, and Mr Gonski could be vilified (more vehemently than was the UK Prime Minister Gordon Brown for selling off the country's gold reserves just before the price of gold went through the roof). Such is the predicament of being the chairman of a major airport in these remarkably uncertain times.

The reality is, though, that there will not be a spectacular recovery in the air transport sector, whether prompted by medical breakthroughs or not, but rather it will more likely be a patchy one, which would certainly justify a sale on these terms.

Institutional investor hopes to see AUD9 reached

Sydney Airport's stock is wholly floated but institutional investors account for much of it, as always.

Tribeca Investment Partners, (TIV) which owns about AUD60 million of Sydney Airport shares, expects investors would support the deal, given that the company faced a long and uncertain recovery from the COVID-19 crisis.

In a statement a TIV spokesperson said, "Many of us [are] hoping for the AUD9 mark, but we know [it] might take some time for the share price to naturally get there. It is a balancing act between some capital certainty at this point compared to a much higher share price when things return to normal."

Inbound tourism will be in the doldrums for a while

Australia's tourism industry for example, is not likely to 'bounce back' to pre-COVID levels any time soon.

Tourism is not as important to Australia as it is to some European countries where the sun shines most of the time, like Spain and Portugal, where it can account for 10% or more of GDP. In Australia's case it was just 3.1% in 2019. But 3% is 3%. Pennies make pounds as the saying goes.

And it was rising. In every year from 2011 tourism arrival numbers rose, and by up to 11% (2016). In 2020 numbers were down by 81%, and in Jan-2021 to Jul-2021 it is -93%.

Australia annual tourism: visitor arrivals, 2011-2021

Source: CAPA - Centre for Aviation and Tourism Australia.

More importantly, tourism involving one particular country is not going to recover quickly - namely from China.

While Australia has decided that the elimination of the Delta variant is impossible, and that it will have to get used to living with the virus, China, perhaps taken by surprise by the return of the virus in this form, is still pursuing a COVID-zero strategy.

That means that Chinese tourists returning home from an Australian holiday will be compelled to undergo a strict three-week hotel quarantine, a prospect that will almost certainly dull the enthusiasm of most Chinese travellers.

That matters, because in 2019 China provided the highest proportion of international visitors to Australia, even higher than New Zealand, at 15.2%.

Australia: visitor arrivals by market for 2019

Source: CAPA - Centre for Aviation and Tourism Australia.

What's more, China provided the second highest ratio of foreign visitors in 2020 (208,000) and has been first or second in every year since 2012. And the Chinese are by far the biggest spenders, per capita.

Accordingly, Australia is not likely to see this important Chinese tourist trade growing in the foreseeable future, and that is without any further deterioration in already difficult relationships between the two governments. A significant part of the Chinese tourist dollar has come from the education sector, as students found Australia a comfortable place both to learn and to learn English. This segment will be most under pressure in future as Australia-China goodwill evaporates.

Prospects are not good for business travel either, despite Zoom fatigue

Then there is the question of when business travel will return to 'normality'.

In common with those just about everywhere else, Australia's corporate executives have been arranging their meetings on proprietary products like Zoom and Microsoft Teams, and have become accustomed to such behaviour.

Does that mean they will eschew the business day trip by air from Sydney to Melbourne or Adelaide to Brisbane forever (surface transport alternatives being unrealistic in Australia owing to excessive distances)?

The jury is out on that. There have been online discussions arising over the past month or so worldwide, particularly on LinkedIn, as to whether businesspeople (and indeed everyone else) are beginning to suffer from 'Zoom fatigue' and would actually welcome the opportunity to resume some 'skin contact', even if any kind of actual tactile embrace remains off-limits. Or at least they would do so for those day trips, where they don't have to spend a night in a hotel.

As for longer trips within Australia, and especially international ones, to London or New York for example, they will probably stay off the menu for most business travellers for a long time to come yet. Until the chance of catching COVID-19 is reduced to, say, 10% or less. Companies will enforce that, never mind the travellers themselves.

And without business travellers many long haul flights on unconverted (i.e. not extra freight enabled) passenger aircraft are not economically viable.

Outbound leisure travel will be influenced by the medical scenario in the country being visited

For the leisure traveller there is likely to be a pick-up in international travel in the short term, if only for the simple reason that 2020 was, for the majority of people, a write-off.

The acid test for the VFR market particularly may be Christmas 2021, assuming that international travel between Australia and most countries is permitted at that time, because it was almost impossible in 2020.

But leisure travel generally? A weekend break or a two-week beach vacation? How will they fare?

People are likely to be more wary now of travelling than they were in the past, partly out of fear of being afflicted by COVID-19, but also because they're anxious about travelling to countries whose hospital systems are already pushed to the limit, which includes G7 countries.

But unless (probably expensive) top-of-the-range insurance policies are available covering COVID-19 and allowing access to well staffed private facilities, that risk will be a strong deterrent too. One Australian businessman was hospitalised in the US for several weeks in 2020 with COVID-19 and accrued a medical bill of USD10 million.

Alert to these concerns, some SE Asian countries, desperate for the return of tourism, have established "sandbox" tourism destinations, beachside resort areas isolated from the main community, where inbound fully vaccinated tourists are being welcomed. Expectations are that point to point short haul travel will be first to return, but with the exception of Qantas' "Sunrise" non-stops between Perth and London, and some Gulf travel, the profile of Australian inbound and outbound travel is likely to be substantially changed for many months to come.

The competition watchdog will have its say, but may turn out to be toothless

So there are several potential outcomes yet from this putative transaction, and one of them that has not yet been discussed in any detail is scrutiny from the competition watchdog, the highly alliterative Australian Competition and Consumer Commission (ACCC) and what that could lead to.

The proposed takeover of Sydney Airport will assuredly face scrutiny from the ACCC, with airlines raising concerns about common airport ownership in a country that already has an ownership concentration, combined with one of the most 'light-handed' regulatory approached to be found anywhere. That means that airports are not constrained in the charges they can levy on airlines to use their facilities, as they are in Europe for example.

That laxity of regulation helped the Sydney Airport Group, for example, achieve an EBITDA of USD394 million in the financial year ended 31-Dec-2020, a 62% reduction on the previous year, but still generating an EBITDA margin (roughly an operating profits-to-revenue calculation) of 63% - well in excess of what was achieved in other regions.

And Sydney is not alone. Brisbane's margin was 61%, and at Perth it was 46%.

Note that these EBITDA and operating profit figures are taken from a table which will be published shortly by CAPA and which lists the World's Top 100 airport operators by revenues.

The ACCC must weigh up whether both airlines and consumers could be disadvantaged by the consortium acquiring the airport in full.

IFM already owns 25% of Melbourne's Tullamarine Airport, 20% of Brisbane Airport, 13% of Adelaide Airport and 77% of Darwin Airport - eight airports in all in Australia - as well as stakes in others in Europe and Latin America.

Active airports for Industry Funds Management (IFM Investors) in Australia

Source: CAPA - Centre for Aviation.

Concurrently, Australian Super owns 10% of Perth Airport, and QSuper owns a stake in Brisbane Airport through the Queensland Government's QIC Global Infrastructure, which manages its long term investments. QIC is now the third largest institutional investment manager in Australia and controls 25% of that airport.

That degree of concentration exists hardly anywhere else in the airport investment world, except perhaps in the UK, which has become a 'model' for airport privatisation since the turn of the decade.

There, the three main London airports and Manchester fall under the control of three entities, but otherwise those entities, which are also made up partly of funds - including IFM - have been divesting their other interests, in smaller regional airports. The concentration is relaxing rather than tightening, as it is in Australia.

"A nationwide monopoly of airports" - really?

The lobby group Airlines for Australia and New Zealand (A4ANZ, whose chairman is a former ACCC chairman) said that airlines were concerned that it would become even harder to bargain over landing fees and other charges if Sydney Airport was bought by the IFM-backed consortium, and they even talked of the possibility of a "nationwide monopoly" of airports, a COVID outcome that had probably not occurred to an industry which is perennially focused on the potential for airline (not airport) consolidation.

The ACCC's chairman, Rod Sims, said it would initiate a public review if the airport sale went ahead, which would focus on whether IFM's ownership status with other airports in particular could lead to higher airline charges because airlines could not "benchmark" or compare fees across the country.

Indeed, that was an important factor in why the UK model of disparate ownership arose, prompted by the UK Competition Commission's original decision to recommend the break-up of the London airports and the 'BAA', which accounted for seven airports nationally, 12 years ago.

The CAPA view on the potential intervention of the ACCC is that it is unlikely to have much of an impact, and may well take a relaxed view about what are only minority ownerships of other Australian airports. The bidders have been careful in ensuring there is no technical breach of the ownership rules.

But at the same time, the ACCC will be keen to remind everyone that it exists, and as such can be expected at least to go through the motions. One thing that seems certain is that the new owners will not be permitted a share in the federal government-owned Western Sydney International Nancy-Bird Walton airport (WSIA) when that is eventually sold down.

Another factor to bear in mind is that the latest offer from the consortium is the largest cash deal in Australian history. It is testament to the fact that the airport is a prized monopoly and a "once in a generation opportunity" for these industry funds looking for long term investments outside the listed space.

Western Sydney International Airport (WSIA) - the elephant in the bush?

Or at least it will be a monopoly until late 2026, when WSIA is scheduled to open.

The impressively titled airport belies the fact that it was first talked of as a cheap budget airport for low cost flights to take a little of the pressure off Kingsford Smith.

No longer.

Location of Kingsford Smith and Western Sydney airports

Source: Google Maps.

Just recently it was revealed that the Australian Government had already committed AUD5.3 billion (USD3.9 billion) to the delivery of WSIA and AUD9 billion (USD6.6 billion) for the vital rail and road links that will help transform the region and support the development of an airport city there. This includes the AUD3.5 billion (USD2.5 billion) for new major road infrastructure and upgrades under the Western Sydney Infrastructure Plan and AUD5.25 billion (USD3.8 billion) towards the first stage of the Sydney Metro-Western Sydney Airport rail link.

So the government, which is the WSIA developer so far and although it has said that the private sector could have a role to play later, has committed almost AUD15 billion already to this project - half the latest offer price for Kingsford Smith. There is no suggestion there that five years from now WSIA will be playing second fiddle to Kingsford Smith, let alone it being a 'monopoly'.

One caveat to the announcement that the Sydney Airport board supports the deal is that fact that it is conditional on the bidder finding no nasty surprises when it undertakes due diligence. There is no hidden foreign ownership potential (GIP is openly a US-based series of funds and well known to be), and as suggested earlier, the ACCC is unlikely to intervene in the deal.

But WSIA may not merely offer a 'nasty surprise'. It is the 'Elephant in the Bush'. And it is making no effort to disguise itself.

As part of the original privatisation of Sydney's main airport early this century, the buyers gained a right of first refusal to acquire the second Sydney airport - when it would eventually manage to navigate the political minefield laid to avoid making the difficult NIMBY selection (the first sod had actually been turned at the site over 30 years ago, but politicians of all colours shied away from its risk until it became unavoidable). This anomalous decision was designed to ensure the best price at the time.

However, when the time came to exercise the option, the owners overplayed their hand, refusing to commit to the expense deemed necessary, so the federal Liberal government, led by former investment banker Malcolm Turnbull, bit the bullet and went ahead independently. This may prove to be one of the more profitable long term investments the government has ever made, quite aside from the extensive social and economic benefits it will certainly bring.

The federal government will be keen to maximise its profit from the eventual privatisation of WSIA, implying that there will be as few restrictions as possible imposed on it.

For example, it has plans for 24 hour operation, contrasting with Sydney Kingsford Smith's tightly controlled curfew and movements cap. Paradoxically, the bidders may see some blue sky in that respect, as aircraft become quieter and the political climate may change - but then that equation could move either way, as climate change influences aviation expansion plans.

Might WSIA be a better investment, if the government chose to encourage it now?

All this begs the question as to whether a patient - but admittedly even less risk averse - investor might be more attracted to what might be done at WSIA.

A fair comparison would be with London's Heathrow Airport and Stansted.

Stansted Airport is similarly distant from London (42 miles/65 km) in the suburbs and was developed in the late 1980s/early 1990s, again as a budget bucket and spade airport, yet since then has gone on to be the country's fourth busiest and primary base for one of the world's largest LCCs - Ryanair.

Where the post-COVID aviation world is likely to be more highly populated by low cost short to medium to haul international operations, the parallels are interesting.

As things stand, investors will be asked to vote on the change of ownership proposal in the early months of 2022. Domestic travel is expected to be flowing more normally by then, whereas international travel will still be lumpy at best.

In the worst case scenario neither domestic nor international travel would be flowing, and then those investors - and the consortium - might be wondering if they'd have been better off putting their money down at the Randwick Racecourse. But they are probably more patient and conservative than that.