Further privatisation of UK NATS

NATS on the cusp of further change

In the UK, NATS (National Air Traffic Services) is about to undergo a further transformation, which may yet act as a model for at least some other ANSPs. To understand fully what is being proposed it is necessary to go back a decade or more to the initial introduction of private capital into NATS. In 2000, the UK's Labour Government, having declared while in Opposition that "our skies are not for sale", announced that it would after all partly privatise NATS, through a so-called Public Private Partnership. This involved the sale of 46% of the shares in the company to a Strategic Partner, with the Government retaining 49% and 5% allocated (for free) to employees. One particularly unusual aspect of the sale was that although the Strategic Partner would have only a minority shareholding, it would effectively control the company, with rights, inter alia, to appoint Senior Management, approve/veto the Business Plan, appoint a majority of Board Directors if necessary, etc. The objective was clearly to introduce private sector expertise to turn NATS into a more commercial, efficient and profitable company.

By the standards of most ANSPs, NATS was probably not a particularly badly run company. It was well respected in the industry and had a good safety record. But by private sector standards its performance left much to be desired. Its major projects were repeatedly delivered late and over budget, if they were delivered at all. Its quality of service, particularly in terms of flight delays, was poor, imposing substantial costs on its airline customers. And despite having some of the highest charges in Europe, its financial performance was modest. NATS was desperately in need of reform if it was to meet the growing demand for ATC services in the UK and across a large part of the North Atlantic. But reform would certainly be far from easy. Apart from a management with a well entrenched public sector ethos, NATS' employees, especially the controllers, were well paid and highly unionised, as were those of most other ANSPs. Controllers share with airline pilots the ability to severely disrupt air services relatively easily. Any reform would have to be handled carefully if industrial relations were not to suffer.

There was considerable opposition in the UK to the partial privatisation of NATS, especially from the trade unions and the left of the Government's own party. This partly explains the restrictions placed on the sale, notably a commitment to build a new ATC centre in Scotland and safeguards for employees and their pensions which were to prove costly for the new owners. Nevertheless, the Government pressed ahead with the sale. Three bidders were eventually shortlisted: Lockheed Martin, already a major partner of NATS in the provision of equipment for the new Swanwick ATC centre, the largest in Europe; Serco, a company specialising in buying public assets and turning the companies around; and a consortium of UK airlines.

Both the Lockheed Martin and Serco bids created issues for NATS's airline customers. There were doubts about having the company's principal equipment supplier as its Strategic Partner, and concerns that Serco's reputation for aggressive management would damage sensitive industrial relations, with the airlines taking most of the pain from any airspace closure or capacity reduction. These were certainly factors in encouraging an airline consortium to mount its own bid, but at least as important was a growing realisation that an efficient, customer-focused ATC system was critical to airline operations.

If the quality of NATS' services could be dramatically improved, the impact on the quality of the airlines' own services, and their profitability, could be marked. The airlines accepted that they would have to make a competitive bid, but they offered the added attraction of a so-called "not for commercial return" investment. In other words, their main return would come from cost savings for their own (and other carriers') operations, rather than directly from the investment in NATS. In the charged political atmosphere of the sale, that was quite a marketing ploy. (Incidentally, "not for commercial return" never meant "not for profit". The airlines always intended that they would get a reasonable financial return from their investment, but over a very long period, perhaps some 20 to 30 years). The risk of being accused of bias against the interests of other airlines was greatly reduced by inviting IATA to take a seat on the NATS Board.

The seven carriers which formed the so-called Airline Group (AG), British Airways, British Midland, easyJet, Monarch, Airtours, Britannia and Virgin Atlantic (Airtours and Britannia were later replaced by Thomas Cook and Tui following mergers among UK charter airlines) succeeded in being chosen as the preferred buyer of NATS in the first half of 2001. hey were always the politically favourite (or in the case of the trade unions, the least objectionable) bidders, but still had to come up with the highest bid. Some GBP800 million was paid to the Government, plus a commitment to a GBP1 billion investment programme over the following 10 years.

The investment was highly geared, reducing the capital call on each airline, an approach which didn't find favour with NATS' new economic regulator, the Civil Aviation Authority. The structure of the AG was that of seven equal partners, each with a single vote, and for most key decisions a majority of six out of seven was needed. The airlines owned shares in the AG and the AG held the 46% holding in NATS. Unfortunately, the high gearing of the bid created a serious early problem with the collapse in traffic after the events of 9/11. NATS finances were under severe pressure and a financial restructuring was needed, with additional capital provided by the Government, which retained its 49% stake, and by the airport operator BAA, which took a 4% shareholding, reducing the AG's stake to 42%. However, the AG's key Strategic Partnership Agreement, and with it effective control over NATS, remained in place.

So much for the history. How has the PPP worked out in practice?

The answer is: remarkably well. By almost every measure it has been a success. From the AG perspective, and perhaps surprising given that many of the airlines involved are usually fierce competitors (think BA and Virgin!), the shareholders have worked together effectively and co-operatively. Furthermore, they appear to have had a very positive impact on NATS. As for NATS itself, the company has been transformed.

Safety, already at a high level, has improved significantly. Flight delays have come down to levels where they are no longer of any real concern for customers. Project delivery is top quality, usually on time and on budget. Progress has been made in reducing borrowing and the long-term pension burden, although NATS does remain a high cost producer, with charges to match. The company is far more customer-focused than before. Finally, it now produces healthy profits and has started to pay a steady dividend. In fact, the financial return for the AG shareholders has proved to be far more attractive than was originally envisaged, even before any further share sale.

NATS has now been a partially privatised company for some ten years. Given its transformation, it is perhaps not surprising that at least some of the airline investors have considered selling their shares, in whole or in part. At the same time, the parlous state of the UK public finances means that any asset sale is attractive to the Government. There is unlikely to be a shortage of willing buyers. NATS is a respected ANSP brand with a monopoly over a large slice of European and North Atlantic airspace, with (according to its airline customers) a weak regulator whose reputation has yet to recover from its failure to control BAA effectively. There is the prospect of a steady and growing stream of dividends and potentially a key role in any reorganisation of European airspace.

Where to next?

For many, however, that still leaves the question: what type of company will NATS be after a further sale of shares? To get close to understanding the answer it is necessary to consider the options now facing the current major shareholders, both the airlines and the Government.

First, how many shares to sell? It seems very likely that BAA will sell all of its 4% stake at the earliest opportunity. NATS is less of a strategic investment for the airport operator than it is for airlines and BAA has never been a particularly active shareholder. As for the Government, it is almost certainly true that some (notably the Treasury) would like to sell the whole 49% stake. At the same time, the Government has been lobbied to maintain at least a 25% shareholding in order to retain influence in Europe, where the Single Skies and SESAR initiatives are now building up momentum. Sources suggest that no final decision has yet been made, and may not be for some time. What the Government does have to do quite quickly, however, is seek Parliamentary approval for a sale. This process could take several months and may be controversial. There are still politicians who regard the UK's airspace as a key strategic asset and are concerned that control over it should not pass into "undesirable" hands.

It appears that the airline shareholders in the AG are no longer united in their vision of the future. Press reports suggest that easyJet, now NATS' largest customer, would prefer to maintain the status quo. At least two of the charter carriers, on the other hand, do not seem to see any reason to retain a shareholding at all. The positions of the other airlines may lie somewhere between these two extremes, and may indeed be flexible to at least some extent, depending on the details of any sale. One factor does seem to be clear, however: none of the airlines see much benefit in just being shareholders in NATS, despite the attractive dividend stream. If they retain all or some of their stakes, they want to continue to exercise real influence, which means retaining the Strategic Partnership Agreement in some form. It is difficult to envisage the current SPA surviving untouched, but how much of it can be saved will depend to a significant extent on what kind of sale is pursued.

One option is a public sale of shares, an IPO. This might have a number of attractions. For example, it would produce a wide spread of new shareholders, with no one single party likely to be dominant. It would also make it easier for those current shareholders who might not want to sell all their shares immediately, as they would have the option of further sales at later dates of their choosing. On the other hand, an IPO would also have potential disadvantages, not least in failing to maximise the sale proceeds. The AG Strategic Partnership Agreement would almost certainly disappear and any remaining influence by the airlines be limited to the size of their retained stakes in the company. Finally, there would be little to stop a single investor buying up all or most of the shares post-IPO. Potentially, this could be an embarrassment to the Government, especially if an "undesirable" investor was involved. Post full privatisation there may be little the Government could do to influence such an outcome.

The alternative to an IPO is a trade sale. As already mentioned, NATS is potentially an attractive investment to certain companies and financial institutions. Both Lockheed Martin and Serco were shortlisted in the original PPP in 2001. Some of the AG shareholders appear to be concerned that financial institutions looking for a relatively short-term investment (say 5 to 7 years) would not be in the interests of either NATS or its customers. ANSPs are long-term businesses, with investment programmes spread over many years. There is a fear by some that the company could be fattened up for an early on-sale without due regard being paid to the longer-term implications. Financial institutions with a longer-term horizon, on the other hand, such as pension funds focused primarily on a steady stream of dividends, might be more willing to support a continued role for the Airline Group, and hence help to ensure that the customers' interests are protected. It is perhaps not surprising that at least some AG shareholders are said to favour such a model. Finally, one should not ignore the possibility that another ANSP, perhaps DFS of Germany or NavCanada, might join a consortium to bid for NATS. That would introduce a very different possible scenario, especially with the political pressure in Europe to consolidate ANSPs.

Too many players

Air traffic control is the sector of the aviation industry where reform has had least impact. Overwhelmingly it remains government owned and controlled, treated as a strategic asset. As a result, there are far too many companies operating inefficiently, with the additional costs, both direct and indirect, borne by the airlines and ultimately their passengers. Nowhere is this more evident than in Europe, where every State, from Germany to Malta, has its own ANSP and jealously guarded airspace. Things are moving, albeit slowly. The political pressure to change is gaining momentum. The UK's NATS was the first significant ANSP to introduce private capital and a unique partnership with its principal customers.

Others such as Canada and Australia also commercialised their operations, but in a different way. The NATS model has certainly been a success, and it is perhaps surprising that as yet it has not been copied elsewhere. Growing pressure on national finances might well see a move in that direction before too long in several countries. NATS is now about to move to its next stage, with additional, possibly full, privatisation. There are clear risks involved, but also opportunities. What seems certain is that a further ten years from now, the air traffic control business is likely to look quite different from what it does today.