25-Oct-2011 12:23 PM

Scotch broth: Investors positive about Edinburgh airport sale but what would they be taking on?

Analysis

Under pressure from the UK's competition watchdog and still trying desperately to stave off the sale of London Stansted Airport, BAA has opted to sell off Scotland's Edinburgh Airport rather than nearby Glasgow, a move that was anticipated by some but queried by others. Less than a week after the announcement, Global Infrastructure Partners (GIP), Manchester Airports Group (MAG), Fraport and Aeroports de Paris (AdP) have already put themselves in the frame. All of them need to read the small print.

Some observers have been quick to suggest Edinburgh was the "logical choice" for a sale of one of BAA's Scottish airport assets (Aberdeen, possibly the airport with the best prospects in the country, was never in the mix), and were supported by an announcement by BAA CEO Colin Matthews who stated BAA chose to sell Edinburgh rather than Glasgow Airport because it believes Edinburgh will attract more bidders and command a higher price. "I want to be clear that we would prefer to keep both airports, but given we had to sell one the decision was pretty straightforward," he said. Mr Matthews added Edinburgh should "generate a long line of bidders" as it had proved to be resilient during the economic downturn.

But there is another way of interpreting this decision. In truth, there is little between the airports. Edinburgh is larger, with 8.6 million passengers in 2010 compared to Glasgow's 6.5 million. Edinburgh's passenger traffic growth rate in the first nine months of 2011 (excepting Apr-2011, the 'volcanic ash cloud' comparison month) was almost double Glasgow's 3.85% at 7.12%. However, in the last two months (Aug/Sep-2011), Glasgow's growth rate slightly surpassed that of Edinburgh for the first time this year. Both have a healthy traffic mix, with more emphasis on long haul and charter flights at Glasgow. Ryanair is the largest carrier at Edinburgh whereas it has no services at Glasgow.

Glasgow Prestwick Airport's future in doubt

But more to the point, there is some doubt about the future of (Glasgow) Prestwick Airport to the southwest of Glasgow, and which offers low cost competition to Glasgow International that Edinburgh does not have to deal with. There are indications that Infratil/Morrison, the New Zealand-based owners of Prestwick may try to sell it as it "isn't performing" and is "a difficult asset to see in the portfolio in the long term", according to Infratil's CEO, who might use the funds to bolster more profitable energy assets in Australia and New Zealand.

But if it is not viable as an airport for Infratil, for whom would it be viable? Regrettably this hints at another impending airport closure as with Plymouth in southwest England and Coventry before it, and possibly conversion to alternative use, as is about to happen with Woodford Airport near Manchester, a soon to be ex-military facility that was envisaged as a low-cost airport for Greater Manchester by Airport Investor Monthly during the boom period in the mid-2000s. The future for Woodford is now to be housing, commerce and even a film production facility. Who can say for certain the same will not happen to Prestwick, releasing back potentially 1.5 million passengers p/a to be gobbled up by Glasgow International? Back in Jul-2011 Ryanair's Michael O'Leary said he was "keen" to launch services from Glasgow even while admitting his relationship with BAA was "not good". Perhaps it was the prospect of having Ryanair at both Glasgow and Edinburgh, in addition to easyJet, which is one of the largest operators at both, that frightened BAA's management into this decision.

Can the BAA centre hold any longer?

In fact, Airport Investor Monthly would go so far as to say the decision to sell Edinburgh suggests that BAA has given up on holding it all together as an entity, understanding it will be successively broken up until it is down to Heathrow plus a handful of comparatively inconspicuous satellites (Glasgow, Aberdeen and Southampton), with the entity better off cashing in its better assets for as much as it can. If not, it surely would have opted to hang on to Edinburgh and tried to maximise Glasgow's value while the going was - comparatively speaking - good. A very simplistic way of looking at it would be that BAA assumes investors will value Edinburgh's terminal more highly while its rate of throughput growth exceeds Glasgow's by such a margin. You don't sell off the 'Jewel in the Crown' for no reason.

Getting the best possible price also helps out BAA's main (55.87%) parent, Ferrovial, of course. Earlier in October, Ferrovial reached an agreement with two investment vehicles managed by the US infrastructure investor Alinda Capital Partners for the sale of a 5.88% stake in FGP Topco Ltd, the parent company of BAA, for a price of GBP280 million (EUR325 million). The sale is unconditional, with closing expected to take place by the end of Oct-2011. Further to the sale, Ferrovial will hold an indirect stake of 49.99% in BAA, down from the 55.87% it previously held. The tantalising figure of 49.99% is no mere coincidence. By reducing its holding to (marginally) less than 50% Ferrovial thus reduces the overall BAA debt so that Ferrovial's accounts show around EUR5.19 billion of debt against the previous EUR19.75 billion, effectively moving BAA's debts from its balance sheet. BAA had been seeking a sale of up to 10% for some time but this will do nicely. The sale to Alinda values the remainder of the airport unit at GBP4.76 billion.

Adding a nice sale price for Edinburgh Airport sometime over the next six months or so, while continuing to fight a rearguard action against the sale of the ailing Stansted Airport until better economic times return (if they ever do), would be the icing on the cake.

As for Edinburgh's value, that has been estimated at up to GBP600 million (USD950 million) including assumed debt, putting it on an earnings multiple (2010) of 13.63 x (slightly above the recent norm), which will clearly please a BAA management that saw the four-times bigger Gatwick Airport sold off to GIP in Dec-2009 for only a little more than twice that amount. Edinburgh, Glasgow and Aberdeen, which once collectively operated as BAA's semi-autonomous Scottish Airports Group, have been valued at up to GBP1.4 billion.

Table: BAA financial highlights nine months ended 30-Sep-2011. (All financial figures GBP million)

Measure	Amount GBP million	Variation %
Revenue	1703	+10.2
(Aeronautical)	956.7	+14.2
(London Heathrow)	858.8	+15.7
(London Stansted)	97.9	+2.6
(Retail)	385.0	+10.0
(Other)	361.6	+1.0
EBITDA	897.8	+9.3
Adjusted EBITDA	842.2	+17.1
Passenger numbers	66.7 million	+4.3
(London Heathrow)	52.6 million	+6.1
(London Stansted)	14.1 million	(-2.1)
Retail income per passenger	GBP5.42	+6.2
(London Heathrow)	GBP5.76	+6.3
(London Stansted)	GBP4.17	+3.2
Net assets	371.5	(-41.0) when compared to period ended 31-Dec-2010
Cash at bank and in hand	GBP2.5 billion	-59.0% when compared to period ended 31-Dec-2010

Table: Ferrovial financial highlights nine months ended 30-Sep-2011. (All financial figures EUR million)

Measure	Amount EUR million	Variation %
Revenue	7640	(-16.3)
(Airports)	2161	+3.3
(BAA)	2158	+3.6
EBITDA	1691	(-14.5)
EBITDA margin	50.16%	n/a
(Airports)	1084	+13.8
(BAA)	1093	+13.8
Net profit	489.1	+53.2
Cap Ex	713.1	n/a
Total assets	42,070 million	-2.8% when compared to period ended 31-Dec-2010
Cash and cash equivalents	2137	-20.9% when compared to period ended 31-Dec-2010
Total liabilities	35,576 million	Stable when compared to period ended 31-Dec-2010

Edinburgh Airport total system seat capacity by carrier: 24-Oct-2011 to 30-Oct-2011

Investors will be attracted by annual passenger numbers at Edinburgh that are forecast to reach 12.3 million by 2020, up 43% compared with 2010, with aircraft movements 23% higher at 140,000. Another benefit of offering Edinburgh for sale now is the apparent settlement of a long-running dispute over a new tram system for the city, which, it has been agreed, will terminate at the airport. Some revised proposals for the hugely over-budget project had it bizarrely stopping short of both the city centre and the airport. In contrast, plans for a rail link to Glasgow Airport in time for the 2014 Commonwealth Games were scrapped in 2009 amidst political acrimony.

International capacity by region: 24-Oct-2011 to 30-Oct-2011

Any investor will face some essential expenditure. A second runway may be needed, but not until 2040, according to a BAA statement issued in Jul-2011.

Infrastructure investment at both Edinburgh and Glasgow has been high. BAA completed GBP42 million of improvements in Edinburgh last year, having invested more than GBP240 million pounds over the past decade. It has spent more than GBP200 million pounds at Glasgow and earmarked a further GBP31 million to extend the terminal, improve security and supply more restaurants and shops.

Capacity share by carrier type: 24-Oct-2011 to 30-Oct-2011

Capacity share by alliance: 24-Oct-2011 to 30-Oct-2011

The sale decision came as the Scottish Government stated the economy grew by 0.1% in the second quarter and 1.1% in the year to 30-Jun-2011, roughly in line with the wider UK, where growth has 'flatlined'. Political issues should not be underestimated by any investor in any Scottish airport, and certainly not the one that represents the capital city. During the weekend of 22/23-Oct-2011 at the Scottish National Party (SNP) conference in Inverness, Alex Salmond, the leader of the largest and governing party in the Scottish Parliament, again called for independence from the UK within five years, with a referendum to be held towards the end of this parliamentary term. Salmond was watched by a record number of diplomats from over 20 countries who clearly believe that independence is now a serious possibility.

Unanswered questions about independence

There is no absolute certainty about independence. Some polls place its support as low as 25%. But the very fact that the British (Westminster) Government is rumoured to be closely examining the possibilities of holding a (national) vote on Scottish independence on its own terms - and supported by other national parties - clearly demonstrates its increasing anxiety. One can only guess how English voters would respond at the polls. An investor must realise that it might buy a British asset and end up, not very long after, owning a Scottish one.

Would that matter? Most certainly. There are all manner of unanswered questions about Scottish independence (as opposed to Scottish devolution, which exists presently), that are continuously swept under the carpet such as the way the country would be administered, funded, taxed and defended. Most pressing is how long could an independent Scotland last if there was to be another financial crisis? Scotland alone could not have afforded to bail out the Royal Bank of Scotland in 2008 and would have ended up in the same boat as Iceland.

Scotland pleads to be another special case for APD

There are other, less severe but equally pressing, political issues to be considered. One of them is the increasing call for Air Passenger Duty (APD) to be reduced in selected parts of the country, following the decision to do so in Northern Ireland where air services were threatened by proximity to the Republic of Ireland where the equivalent 'tourist tax' is only EUR3 per passenger. It is unlikely that the Government will make any more 'special cases' but some of the loudest calls are coming from Scotland. For example, Edinburgh Airport's MD, Jim O'Sullivan recently warned plans to reduce the APD on long-haul services from Northern Ireland from Nov-2011 could cost Scotland's tourism industry millions of pounds. "Scotland cannot afford to put any barriers to its links with the outside world. These barriers will stifle our competitiveness and ability to drive our economy from recession, and will also discourage visitors from coming to us," he said.

Experience tells us that if the UK Government is going to buckle further on this issue, it will only do it in a way that favours Scotland and Wales rather than the English regional airports and definitely not for the southeast of England. But if it does that would mean northern English airports that already passively suck in Scottish passengers (especially Manchester and Newcastle) could become much more aggressive, to the detriment of the new owners at Edinburgh.

One would assume that investors will ask these questions and the many others that will arise, but so far none of this seems to be putting them off. So far, GIP, MAG and Fraport have expressed interest while AdP has also done so while cautioning it is too early to state with any certainty if it will bid. Vinci says it is not interested "at this juncture". Both MAG and Fraport have spoken positively about Edinburgh in the past.

Fraport is already involved in the current 'big three' transactions - the sale of Hochtief's airport assets, the Luis Munoz Marin Airport concession in Puerto Rico and the now delayed concession on the Madrid and Barcelona airports in Spain - but has more than enough capacity to handle another. AdP was bidding for both Madrid and Barcelona airports in a consortium. Vinci is still feeling its way back into airport M&A activities and has not touched the UK since an abortive pre-9/11 enquiry for TBI, which eventually went to an Abertis led consortium, ACDL.

GIP does not appear to be involved in the current transactions and has a big job to recreate the ex-BAA London Gatwick Airport in the image it envisages as well as preparing London City for 2012's Olympic Games. MAG has not been active in airport M&A for several years with the single exception of its failed consortium bid (with Borealis and the Greater Manchester Pension Fund) for London Gatwick in 2009.

It would doubtless welcome the opportunity to spread its risk by acquiring Edinburgh (though Manchester Airport itself has started to grow again this year) and that would also give it the opportunity to part with some of its under-performers like Bournemouth and the partly-owned Humberside.

Don't underestimate the nationalistically inspired local bid

Who else could yet appear in the running? The days when an airport like Edinburgh would stimulate bids from dozens of companies are over, at least for now, and there is no obvious attraction for the likes of GMR, TAV and Changi Airports Group, all of which keep Britain at arm's length, the APD playing a large part in that decision. Vancouver Airport Services has more than enough on its plate trying to make a fist of the Peel airports (Liverpool, Durham Tees Valley, Doncaster-Sheffield, Manchester City) without adding another British airport. Although it could be argued that, like MAG, acquiring Edinburgh would give it a reason to at least try to offload one or more of those already in its portfolio (or close them down in the case of Durham). MAp is simply out of it, back in Sydney and probably feels better for being so.

It is possible that a US investor, perhaps with Scottish connections, might be attracted to a 'heritage' city airport like Edinburgh. Such an out-of-left field bid should never be discounted, particularly one from a Scottish based consortium that is based around nationalistic issues. It is already being reported there is at least one such consortium, centered on Inverleith, a small investment bank, with support from a former CEO of Edinburgh Airport, who was also, more recently, CEO of the aforementioned tram company, and that they have held preliminary talks with investors.