For Ferrovial, the Spanish infrastructure firm, November 20, 2007 will forever be an historic date. That’s when Ferrovial began to glimpse its future in the skies of Britain. Even after its earlier purchase of BAA — the British airport operator that owns Heathrow, Gatwick, Stansted and four other British airports — Ferrovial had not taken flight. The dimensions of that deal, valued at $24.74 billion, left the group’s future unclear because of the new tariff framework that BAA is negotiating with Britain’s Civil Aviation Authority. The November 20 agreement practically guarantees that Ferrovial can take wing again. Experts talked to Universia-Knowledge at Wharton about the issues, and questions, that still need to be addressed.


The hardest issue to clear up, most likely, will be whether Ferrovial can refinance its bulging debt of $46.02 billion, which originated largely from its purchase of BAA. “The announcement by CAA raised the price of BAA shares on the stock exchange, which can mean that its debt rating improves,” notes Antonio López de Ávila, director of the executive master’s program in tourism at the Instituto de Empresa (IE) business school in Spain. That won’t happen this year, he adds, but “if the CAA gives its approval in March 2008, the situation will have changed enough for Ferrovial to issue new bonds, with assurances that the market value of BAA will rise and that its investment plans have a good chance of succeeding in the future.”


López de Ávila is referring to the $18.62 billion in convertible bonds that Ferrovial wants to issue. This very ambitious move has already been described by the press as the greatest bond issue in history. Ferrovial, headed by Rafael del Pino, was hoping to carry that out before the end of this year but the subprime crisis, along with doubts about the new regulatory environment for Heathrow – especially everything related to the cost of capital – have forced BAA to postpone the bond issue and even to look into alternatives such as bank loans.


Financing a Take-off


According to Wharton management professor Mauro F. Guillén, director of the school’s Lauder Institute, “If Ferrovial does not go ahead with the bond issue, it won’t be because it lacks financial strength, negotiating vision or capability to manage. The problem is more that we find ourselves at a financial crossroads. Ferrovial has sold its ownership in certain consortia in order to raise cash. I think that it will emerge with flying colors from this temporary shortage of financing.


Since Ferrovial acquired BAA in the summer of 2006, it has made all sorts of proposals for improving the functioning of British airports in general and Heathrow in particular. Heathrow is the jewel in BAA’s crown, and the largest airport in Europe. Those proposals include constructing a third runway and a sixth terminal. Those two measures will enable Heathrow to increase its [annual] capacity from 480,000 take-offs and landings today to 700,000 in the future. It will be able to accommodate 125 million passengers [a year], up from 68.5 million today. Some plans appear to rely on backing by the British government, but BAA will need some investments that need to be reviewed within the regulatory framework set by the CAA.


According to Carles Roig, a professor at Esade, infrastructures of airports have demonstrated their capacity to serve large cities within a context of globalized economies. “HTW [Heathrow] is in a situation where its saturation rate is close to its maximum capacity. This makes it impossible to tend to growing internal demand. At the same time, it puts restraints on the development of other infrastructure on the ground that is absolutely indispensable for configuring its node of mobility services for its passengers and for managing logistical activities associated with the transportation of cargo.” London airports, adds Roig, “will not be able to satisfy the demands of travelers and airlines if BAA does not undertake these investments. Over the next few years, BAA and the United Kingdom itself will be betting the future of these airports and their role on the playing field of the European aviation sector.”


López de Ávila backs his words with numbers. “Heathrow is the only hub in the United Kingdom, and it is operating at 99% of capacity. This situation puts its passengers and infrastructure under great pressure that is unsustainable over the short term. The annual growth rate in its passenger volume has been 4.1% over the past decade. Complaints from passengers and corporations have been growing in recent years, and the topic has become increasingly important in the national media. Given this situation, BAA has announced that it will invest £9.3 billion in the three London airports – Heathrow, Gatwick and Stansted. This includes construction of the new Terminal 5 at Heathrow (which will be inaugurated in March 2008), the creation of Heathrow East, which will replace the current Terminal 2; the expansion of Gatwick, which would manage some 40 million passengers by 2015 (up from 32 million today); and the expansion of Stansted to accommodate some 35 million passengers by 2014.”


In addition, Ferrovial has just proposed building a third runway at Heathrow, as well as constructing Terminal 6. The details of the proposal won’t become clear until next fall when the government of Gordon Brown makes a decision. However, a period of consultations and analysis has already begun. The CAA has offered to collaborate [in this process] and it could provide its opinion in a report that it will present in March, when it unveils its definitive framework for regulating Heathrow and Gatwick over the five-year period from 2008 to 2013.  That announcement will provide few surprises compared with the news of November 20, when the CAA proposed raising airport fees at Heathrow by more than 15% and at Gatwick by 8.2%.


Saturated Airports

There is one area where there might be a positive surprise for Ferrovial: the cost it must pay for the capital that it needs in order to carry out its investments in the two airports. At the moment, the fixed cost of capital at Heathrow (provided by the CAA) is 6.2%, compared with 7.75% in recent years. Gatwick’s cost of capital is 6.5%. At Heathrow, Ferrovial had hoped to get a rate of 7.2%, which is very far from the rate provided by CAA at the moment. However, the CAA has already said that it could raise its rate in March, although it is hard to believe that Ferrovial will be satisfied.


“Ferrovial would do well to express its viewpoints. That’s why there are negotiations,” notes Guillén. Adds López de Ávila: “I believe that its requirements are in line with what is needed because conditions at these airports were obsolete and they were terribly saturated. A high level of investment is required, and the British government has recognized that fact in its announcement.” You need to remember, he continues, “that these facilities are obsolete and over-saturated because it’s been a long time since there have been any investments in them. Management of the airports was privatized in 1986 and BAA focused on expansion, ignoring necessary investments in infrastructure.


“Nevertheless, since its acquisition last year by ADIL (62% owned by Ferrovial, 28% by Caisse de Dépôt et Placement du Québec, and 10% by GIC), BAA has set in motion an ambitious investment plan. The goal is to prevent these airports from losing their competitiveness and to guarantee their future in the new century. The volume of investment required now is extremely high, which means that support from the government is needed. Based on what we can gather from the CAA’s announcement on November 20, the government has done just that. You have to remember that Heathrow is one of Britain’s key economic assets and that the London Olympics of 2012 can bring total chaos to the airports and irreversible damage to the image of the country if something isn’t done soon.”


López de Ávila believes “the rate increases announced by the Civil Aviation Authority have been surprisingly favorable to BAA’s requirements. And I say ‘surprisingly’ because they’ve done that despite the fact they [the CAA] have been subject to constant and harsh criticism from the airlines, especially from low-cost airlines.”


In its defense, Ferrovial has made similar arguments. However, the big question mark is about something else — the anti-monopoly investigation being carried out by Britain’s Competition Commission, which could finalize the sale of one of the London or Scottish airports. Other topics under consideration are the practically certain deregulation of rates at Stansted, and the possibility that within a few years the same sort of debates will be surrounding Heathrow and Gatwick. That’s especially true if the authorities wind up forcing the sale of Gatwick.


Roig notes that many business models for airport regulation and management co-exist in Europe. “What we have learned, generally speaking, from comparing the results, is that a lower degree of intervention and a higher level of private-sector ownership have translated into better economic performance. Nevertheless, because these institutions have a strong component of public service, they have to take other factors into account beyond the purely economic.” Guillén agrees. “The less regulation there is, the better things are, although there always have to be minimum requirements. That is to say, the example of Stansted should spread to other airports.”


According to López de Ávila, “The topic of deregulation mainly affects low-cost companies that operate from Stansted, since it would permit BAA to set its prices freely, without state control. This fact, added to the ‘monopoly’ that BAA has over London airports, makes this topic an area for the government to consider.”


López de Ávila cites the Spanish model as an example. In that country, AENA, a publicly owned company, which is a larger operator than BAA, manages all of the airports. “To some degree, the deregulation of BAA is the consequence of a privatization process that began almost 20 years ago. Spain currently sees it as an abuse of authority by AENA when it is time for it to fix airport fees even though the fees have to be negotiated with the government itself. In England, they believe that a privately owned company should freely set its rates for using the airport. When all is said and done, in this day and age it is preposterous for government intervention to set prices that a private-sector firm must charge.”


In Spain, he adds, “some people currently defend the theory of mixed management of airports. Some argue that airports should be ceded entirely to Spain’s autonomous community governments, which would mean the disappearance of AENA. In England, they decided to privatize airports in 1986, and now we can see the results. The existence of a single managerial body makes it possible to distribute investments and reduce costs, among other things. Assuming that there is a consensus between the private and public sectors, I believe that any such system for regulating airports provides security to airlines and customers, while also preventing enormous increases in rates. The public justifies this by [the higher level of] investments in services and infrastructure… or by the publicly traded stock issued by the company that does the managing.”


Beyond such questions, one way to look at the future of this sector is to analyze what the people who know it best are doing – the Del Pino family, who own 60% of Ferrovial and, in particular, its current president Rafael del Pino. Between November 5 and November 15 – just before the CAA’s famous announcement of November 20 – del Pino raised his personal ownership in Ferrovial from 0.367% to 0.926%.