PPPs could reinvigorate US airport privatisation

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CAPA last covered US airports and their privatisation in the report "Finance and Privatisation Review of 2013" in Dec-2013.

See https://centreforaviation.com/analysis/reports/airport-finance-and-privatisation-capas-review-of-the-year-2013---part-1-143540 for the full report.

In it, we asked if airport privatisation in the US had finally run out of steam, pointing to the second attempt to lease out Chicago's Midway airport collapsing, four years after the first. Since 1997 there have been just two privatisations under the Pilot Programme that was introduced in the previous year, despite the number of 'slots' for that procedure having risen from six to ten. One of them, New York State's Stewart International Airport at Newburgh, New York State was returned to the public sector where, incidentally, it has still not made the breakthrough that the Port Authority of New York and New Jersey might have hoped for, despite considerable marketing efforts by PANYNJ. A recent change in strategy by PANYNJ has placed more emphasis on establishing a regional cargo hub there, which should relieve JFK of most cargo shipping facilities and create room to expand potential amenities and services for JFK.

The other one, the Luis Munoz Marin Airport at San Juan, Puerto Rico, was leased to Aerostar Holdings (Highstar Capital and Mexico's ASUR) in Feb-2013 on a 40-year lease for an up-front payment of USD615 million together with a commitment to invest USD1.4 billion in the airport over the term of the lease.

Large hubs show no sign of pitching in for a privatisation slot

But the big one was Midway. Following the release of a demanding Request for Proposals (RfP) in 2012 a procedure reduced the number of bidders to two consortiums: Great Lakes Alliance (Ferrovial/Macquarie) and IFM (an Australia fund) with Manchester Airports Group. But when IFM/MAG pulled out, citing valuation reasons, Chicago Mayor Emmanuel, who never exactly fell in love with the notion of privatising that facility, decided the negotiations could no longer continue.

The Federal Aviation Authority (FAA) had put Mayor Emmanuel under intense pressure to fill the slot or relinquish it, so that any of the other 28 designated 'large hubs' across the US could have a go instead. But those hubs, which include the likes of Atlanta, Baltimore-Washington, Boston, Washington Dulles and Ronald Reagan, New York JFK and La Guardia, Los Angeles LAX, Minneapolis/St. Paul, and Philadelphia (as well as Chicago O'Hare!) show no sign of pitching in for the slot even though at least six of them have loosely investigated the concept of becoming "privatised" in the past.

To put it mildly, the political will is still lacking in the US despite a definable trend towards 'reinventing government' there and what it should and shouldn't do, seeking to replace monopoly government agencies with the competitive forces of the private sector, which has been around since the early 1990s.

But lack of political will is merely one of several well worn reasons why the US continues to retain the status quo where airport financing is concerned, the others being:

• The historic pattern of public ownership of airports;
• Availability of FAA grants for capital expenditure (albeit declining);
• Requirement on privatised airports to repay those grants under some circumstances;
• Access to tax-exempt municipal bond financing;
• Ongoing issues pertaining to the diversion of airport revenues to private entities and their misuse

However, while that political will may still be lacking, such are the massive unfunded pension liabilities of many US cities that it is certain some will calculate how much cash they might generate to shore up their ailing pension funds via a long-term lease of their airport.

There are a number of examples around the US momentarily where the private sector is taking an active part in proceedings or may do, but they are almost exclusively small secondary and tertiary level airports rather than the 'big hubs.' Ironically, despite the Midway flop, two of them are in or around Chicago. They include:

Airport	State	Procedure
South Suburban Airport, Chicago/Peotone	Illinois	Potential 75-year airport design-build-finance-operate-maintain concession PPP project with an investor-owned company to develop and operate the airport, which may be cargo-oriented (definitely white elephant territory in the US, on past experience). 40 miles south of downtown and would cover 20,000 acres. Illinois Dept of Transport has purchased the 288-acre Bult Field, a general aviation airport adjacent to the land the agency has acquired piecemeal in recent decades. The project has been discussed for nearly 40 years and may fold if recent RfI and 'Industry Day' event fail to attract investors
Gary-Chicago	Indiana	A done PPP deal (Jan-2014) by AFCO to operate and manage development at the airport for 40 years. Initial investment of USD25 million with a further USD75 million to follow
Ontario	California	A long-standing dispute between the municipalities to the east of Los Angeles and Los Angeles World Airports (LAWA) over a perceived lack of promotion of the Ontario Airport has spawned a desire to shift ownership to those municipalities, possibly as a precursor to private investment and management at a later date. Ongoing. Legal hearing in Oct-2014.
Paulding	Georgia	Situated 38 miles (61km) northwest of Atlanta. Propeller Investments (New York) wants to turn the airport into a reliever for Atlanta Hartsfield, which is approaching 100 mppa, focusing on the low cost segment. Opposed by City of Atlanta and Delta Airlines, the principal incumbent at Hartsfield. Propeller Investments has vague plans to replicate the model elsewhere. Similar to a scheme also concocted by Propeller Investments to convert Briscoe Field Airport, also close to Atlanta, for a similar purpose, which was rejected in Jun-2012 and immediately withdrawn. Ongoing.
Airglades/Hendry County	Florida	AIA (Airglades International Airport), the company seeking to privatise the Hendry County Airport, received FAA approval to take over management and operation of the airport, effective 12-Sep-2014. Airglades International Airport, LLC will do so on behalf of its sponsor, Hendry County, while FAA continues to review the draft purchase and sale agreement, as part of the application process under the federal Airport Privatisation Pilot Programme. AIA is a consortium of US Sugar Corp, Hilliard Brothers and Florida Fresh produce, which intends to act together in a PPP with Hendry County to take the huge import trade in cut flowers, fish and other perishables now flown into Miami International Airport from South and Central America, inspect and secure the goods, warehouse and refrigerate them only as long as necessary, and deliver them by truck or train to states north and west of Florida.

That sums up the level of privatisation activity in the US airport business at present. Other deals have collapsed or have been shelved during the last few years including New Orleans Louis Armstrong International Airport (which would have counted as a 'hub' airport), where the city fathers had a change of heart and concluded that "now isn't the time" in Oct-2010.

It seems it still isn't. (An application lodged by New Orleans' Lakefront Airport was terminated in 2008). Also the Toledo Express airport in Ohio, where inertia (on this occasion on the part of the Toledo-Lucas County Port Authority), the potential loss of the associated military base, and the realisation that privatisation would have implications for the FAA funding previously received led the appropriate politicians to end negotiations with private parties in Apr-2014.

Meanwhile a scheme to attract the private sector to the envisaged expansion of Austin Airport in Texas is on hold as is one at St Louis Lambert Airport.

PPPs have cost over-runs of less than one seventh of traditionally procured projects

Amongst this gloom and doom though, the fact that all of the deals in the table above will, might, or could have had an element of the PPP in them will prompt proponents of US airport privatisation to take heart. The PPP is popular in some parts of the world (notably so right now in India and Indonesia) and could be attractive to both cash-strapped municipalities and investors in North America. It can be constructed as a form of lease deal, which is required under the privatisation programme in the US: commercial scheduled airports there cannot be sold off outright.

So what is so popular about PPPs insofar as they can be applied to airport expansion?

According to a report from McKinsey, published in May-2014, for starters PPPs have cost overruns less than one-seventh that of traditionally procured projects, on average. For institutional investors green field infrastructure projects are ripe with opportunity. By structuring them as PPPs both parties have a better chance of meeting their individual goals.

Global all-sector infrastructure funding gap touching USD57 trillion

The McKinsey report on PPPs, authored by two partners at infrastructure investor Meridiam, estimates the global infrastructure funding gap across all sectors to be in the order of USD57 trillion, a figure with which the World Bank concurs. Given the lifelong span of many infrastructure assets - anything from 15 to 100 years - there is an argument that the fast growing savings managed by institutional investors - estimated at over USD75 trillion in 2011 by the OECD - must play a central role in filling that gap, and in particular dedicated pure infrastructure financial products such as unlisted equity investment in infrastructure and infrastructure project debt (as opposed to the likes of government bonds, infrastructure-related corporate equity and debt products).

But these products so far amount to only 5% of institutional investors' asset allocation, rising to 10% for the large Canadian and Australian pension funds.

Green field infrastructure, or 'new infrastructure' as it is also known, which is developed as PPPs, is gaining speed though it remains a limited share of total infrastructure investment. It is more common in the UK but is gaining ground in mature economies such as the US, while it is expected to play a major role in tackling infrastructure challenges in fast-growing economies such as are found dotted around Africa. (See the related report: https://centreforaviation.com/analysis/reports/airport-investment-in-africa---overlooked-by-airport-and-other-infrastructure-investors-181092).

The report goes on to argue that green field infrastructure is attractive to institutional investors because:

• Traditional infrastructure market players such as governments and utilities are under financial pressure and their budgets are constrained (that is certainly the case in the US);
• They are increasingly looking to private investment to fund infrastructure projects (there is some evidence of that in the US airport sector, see below);
• PPPs can offer a number of benefits including a whole-life costing approach that can optimise construction, operation and maintenance costs, better risk management and efficient project delivery;
• Well-structured PPPs can help ensure that green field projects are delivered on time and within budget and at the same time generate attractive risk adjusted returns for investors.

The report goes on to say that investors that enter a project in its early stages can capture a premium of several percentage points in the form of 'patient' or long term capital. While investors must wait for the end of the construction period before yield returns begin to accrue - and that can be a very long time in the case of projects in transport such as high speed rail lines and airport runways - investors in patient capital are usually willing to forego quick returns for more substantial long term ones, while also valuing the economic and social benefits of a project (which clearly will be a more attractive proposition to governments and independent minded politicians).

The key to this philosophy is that in order to secure this premium, investors have to ensure that the risks associated with the project are properly managed; and those risks will inevitably include social ones. Again, this is attractive to politicians who fear public backlash from agreeing to the inclusion of an 'untrustworthy' private sector and especially one that is foreign; a suspicion that lingers in the US.

Contract frameworks can bring structure and discipline to the execution of green field infrastructure projects (which, incidentally, McKinsey identifies as offering greater construction risk than brown field projects). By transferring construction risk to experienced contractors and by establishing fixed prices and specific design and build deadlines, project managers and investors can protect against the delays and cost over-runs that all too often plague infrastructure projects.

The McKinsey paper references experts that have evidence that the average cost over-run is below 3.5% for project finance schemes (especially PPPs) versus 27% for a traditionally procured project.

Political risk assessment and management is essential over the long term. An infrastructure asset's performance relies on the willingness of local parties to respect the commitments made at inception. Critical assets with proven added value must also address environmental, social and governance aspects of all infrastructure projects. Project participants that do so are more likely to secure and sustain support from key government shareholders and simultaneously protect their investment over the long term. A win-win all round.

A clear pipeline of opportunities is required

The report also offers advice on what governments can do to encourage this type of investment. It says governments are more likely to attract long term investment if they can provide a clear pipeline of opportunities. The rationale is that investors will only develop internal knowledge and skills in a specific sector such as infrastructure if such a pipeline exists. Procurement agencies must also avoid any 'stop and go' process emerging when launching infrastructure projects.

But that would be a problem for the US government in the airport sector. There is comparatively little investment in new airports where the private sector might play a part in both the construction and subsequent operation of a facility, be it a terminal building or an entire airport. CAPA is only aware of seven green field airport projects, actual or anticipated, in the whole of North America (including Canada) and with one exception they are small ones. While there have been a couple of new secondary level airports constructed on green field sites in Missouri and Florida during the past few years, the last primary airport was built 19 years ago (Denver).

This figure compares miserably with the similarly sized Europe and even more so with Latin America and Africa.

Green and Brown field airport projects by region

Source: CAPA Airport Construction and Cap Ex database

Moreover, secondly, the McKinsey paper insists that long term investment necessitates visibility into cash flow. PPP frameworks and particularly contracted cash flows provide this visibility and also ensure predictability, which in turn contributes to the attractiveness of PPP projects for institutional investors seeking assets that match their long term goals.

Finally, financial regulations help ensure economic and financial stability. The US, UK and other countries are all too aware of how the corollary is equally true; a lack of them can result in disastrous instability.

Such regulations also affect long term investment. The McKinsey paper opines that governments must think strategically about how regulations can encourage long term investment in infrastructure projects and whether they reflect the risk-reward equation of these nuanced investments. It makes reference for example to the European Solvency 2 Directive that will come into force (theoretically) on 01-Jan-2016 and which will codify and harmonise the EU's insurance regulation, potentially having knock-on effects on infrastructure investment.

The paper also calls for regulation to be built on 'hard facts' and the need for an academically validated index for equity investment in infrastructure projects that would be instrumental in ensuring that all parties are aware of the financial realities associated with infrastructure, and especially the green field variety.

Call for more public development banks

It concludes by stating that government agencies can play a key role in addressing market failures, either directly or through public development banks. They can act as facilitators and provide credibility to infrastructure projects. By taking an active role development banks can provide a strong signal to the private sector; their presence implies political support and stability over the long term. In addition, dedicated financial instruments such as seed investment and early development stage facilities can encourage long term investment.

While the US may be home to the World Bank and the IFC, and while the BRIC countries collectively craved a new development bank of their own, which was agreed in Jul-2014, such an all-embracing institution is missing from the US scene. Having said that, there are more limited ones that operate in specific sectors such as environmental projects (the North American Development Bank, a joint US/Mexican initiative) and state-specific institutions such as the California Infrastructure and Economic Development Bank (IBank), which was created in 1994 to finance public infrastructure and private development.

And there are, at least, periodic proposals for a National Infrastructure Bank to be set up.

The paper concludes that channelling wealth and savings into productive investments, including green field infrastructure, will be essential for the global economy to grow and that for all concerned this is the 'way to go'.

Having established the theory, what about the practice? What is the viewpoint on the street, so to speak?

ACI supports privatisation but links it to quality and customer satisfaction rather than the bottom line

Global airports representative body ACI Europe remains committed to seeing further privatisation generally, without specifying a preferred method, if it means that airports are better financed, and investments are made in quality and customer satisfaction. We must accept that as a considered opinion as privatisation is now four decades old and even older if we take into account the very earliest models (which were a version of the PPP) and which actually were in the US. ACI notes the increase in the privatisation of hubs globally, and the move away from them being purely government owned. As we have seen though, that patently is not happening in North America where hubs are concerned. On the contrary there is very little desire to go down the privatisation road.

At the same time, the ACI North America division is concerned the US is falling behind due to the lack of funds being invested into developing gateways, as Asia and the Middle East invests in state-of-the-art new airports, terminals, and other infrastructure. CEO Kevin Burke recently observed that "The biggest challenges in the US to the airports are getting air services and airport financing. In my view they are intricately linked."

ACI NA has been attempting to convince the US government that the nation's airports continue to be a tremendous source of economic activity around the country and across all hub sizes, that the airport is the cornerstone of many local economies, while making the point that collectively airports spur an annual output of more than USD1 trillion, supporting 9.5 million jobs and a myriad of other industries; a "powerhouse" for local, state and national economies."

That message is being repeated around the world, but often falling on deaf ears in the corridors of power. If there is another global economic slump on the way though - and the markets seem to believe that is the case, at the time of writing - then the US needs to get a move on if it wants to sub-contract the future development of its airports system to the private sector to a appreciable degree.

So the airports' own bodies support the continuation of the flagging privatisation drive. There is support from other organisations too, and especially so for the PPP.

The Commissioner for Aviation in Chicago, where the Midway lease foundered twice but where the South Suburban airport might yet be built (there are calls locally in the media that it is time either to build the airport or scrap the project) recently noted that US airports, which are virtually all federally owned, are now looking at the PPP operating model, and the US is likely to see them established in the future.

That viewpoint is championed by the US' leading private sector airport developer - but one that does most of its work now outside of the 50 states and federal district - the Houston-based Airports Worldwide (previously ADC&HAS), which certainly lives up to its new name. Airports Worldwide bills itself as the only US-based global airport investor-operator platform. While it has a presence at six airports in North America (one PPP and five management contracts) and three in Latin America, its more recent activities have been in Europe (UK and Sweden) and its scours the globe for investment opportunities (it has a strategic co-operation with Canadian pension fund OMERS) and developmental ones, rather than the US. With these transactions alone Airports Worldwide has elevated itself to the status of a world player on the airport investment stage.

The company recognises that the US airport privatisation market has been "relatively slower" in its development compared with elsewhere globally and that patience and creativity with different structures will be required to develop the US market further. It feels that PPP structures similar to the one that Airports Worldwide is involved in with the Sanford Airport Authority (near Orlando, Florida) is something that has significant potential to be replicated elsewhere in the US. Overall, US airports will continue to need to be privately funded; there is underfunding of airports in the US at the moment, and they are losing their competitiveness.

Under the existing structures Airports Worldwide works collaboratively with public sector partners. Alternative structures that it favours include such as those used by the Port Authority of New York and New Jersey (PANYNJ) for the development of Terminal 4 at New York's JFK Airport and more recently for the Central Terminal Building at La Guardia Airport. Airports Worldwide feels they could also be models for privatisation in the US.

The La Guardia project is certainly one that has attracted attention from around the world. It is a USD3.6 billion redevelopment that has drawn the interest of three consortiums comprising La Guardia Gateway Partners (Vantage Airport Group, Skanska, Meridiam Infrastructure, Walsh Construction, Parsons Brinckerhoff, Morgan Stanley, Citigroup and Wells Fargo); LG Alliance (Macquarie Capital Group, Lend Lease, Turner, Hochtief, Parsons and Gensler); and LGC Central Terminal (a joint venture of Aéroports de Paris, TAV Construction, Goldman Sachs, Suffolk Construction, STV, Arup and Kohn Pedersen Fox).

La Guardia "the worst airport in America" - says Governor Cuomo

New York Governor Andrew M Cuomo has prioritised the construction of the new central terminal building at La Guardia as "it is ranked as the worst airport in America." The State Authorities decided to remove management responsibility from the Port Authority for construction at both JFK and LaGuardia airports.

There are two intriguing aspects to all this. Firstly that the civic authorities should have chosen to transfer such large projects away from the designated authority - PANYNJ -, a corporatised entity that was once itself earmarked by a previous governor for privatisation. That mirrors activities elsewhere in the US where there is a power struggle between authorities such as Los Angeles (over the Ontario airport) and Charlotte (between the City of Charlotte and the local Airport Commission).

Secondly, that the private sector should have been attracted to the scheme in such large numbers, and with such a degree of variety. Foreign firms such as TAV and Aeroports de Paris are included in the consortiums as well as the home grown investment bank Goldman Sachs through one of its infrastructure funds. TAV and AdP have worked together on PPP projects before and AdP owns 38% of TAV.

TAV's CEO, Dr Sani Sener, is a big fan of PPPs, regarding them as the most effective model to operate airports.

This is how all of TAV-operated gateways are financed, and he believes the chances of success if they are just publically financed or private is lower, than if there is a combination of the two. He also believes however that some state involvement is beneficial due to the regulation needs of the aviation industry, while he thinks the development of PPPs to operate airports in the US is very important in the future.

There does appear to be a coming together of ideologies here, almost by chance rather than as a result of direct intervention by government. Current events such as the La Guardia project just might be a catalyst for further opportunities for PPPs in the US airport sector.

Bob Poole, Director of Transportation Policy at the US think tank The Reason Foundation, concurs. He said, "The jury is still out on whether airport privatisation will gain a foothold in the United States, beyond the early-2013 lease of the San Juan, Puerto Rico's airport. In the near term, I think there will be more deals like the PPP procurement under way to replace LaGuardia's central terminal, especially in fast-growing cities such as Austin, Texas. And there are also longer-term prospects for more-speculative deals to lease and turn-around lagging secondary airports like Ontario that might grow faster with private-sector management and investment."

As Airports Worldwide senior VP corporate development and asset management Amit Rikhy says, patience and creativity with different structures will be required to develop the US market further.