High on Returns

Airport industry makes a strong business case for private investments

The airport business is complex in nature. It requires capex at periodic intervals for expansion of existing infrastructure and has a high level of fixed costs with variable costs being rather low. Meanwhile, the aeronautical segment is subject to stringent regulations. That said, this sector has been the only one where the public-private partnership (PPP) model has fared well. Moreover, the airport industry has benefited stakeholders across the board – lenders, private equity investors, the government and developers.

At a recent India Infrastructure conference, infrastructure and airport expert Sidharath Kapur shared his views on the airport sector’s progress, highlights some of the challenges and recommended key measures for sector growth…

Complex business model

The airport business comprises three distinct segments from which revenues are earned. The first is the infrastructure segment which yields aeronautical revenues and covers the amount charged by the airport developer/ operator from passengers and airlines. These charges are largely used to recover capex. The second is the real estate component, which is a part of most concessions in the case of private projects. The third segment of an airport project is the commercial/retail component. The Delhi and Mumbai airports, for example, have undertaken commercial development within the airport premises to attract passengers. Globally, almost half of the airport revenues come from non-aeronautical activities including real estate and commercial development. In India, the numbers vary from 30 to 40 per cent. However, there is a lot of growth potential and as airport projects mature, commercial activities will gain traction.

The airport industry is a public-facing business and many stakeholders have touchpoints with this sector. The concession agreements are very intricate and performance standards are very high. There are independent agencies to monitor airport service quality (ASQ) ratings and compare them across airports. Most of the concessions require airport developers to meet the minimum ASQ standards.

Success of PPP

In India, the airport sector has seen some of the most successful PPP projects. When compared globally, India is at the forefront with regard to PPPs in the sector. Almost two-thirds of the total passenger traffic is being handled by private airports. Passengers and airlines have access to world-class airport infrastructure. This has aided the airline industry to grow manyfold. So far, the private sector has invested close to Rs 350 billion in airport infrastructure as capex, and in the next five years, this investment is expected to double for upgradation and creation of infrastructure.

The PPP model’s success can be seen from the fact that no lender has a non-performing/stressed asset in the airport sector. Besides, the economy has also benefited in terms of job opportunities. It is estimated that the sector has the potential to create 4-5 million jobs. Apart from these, the government too has gained from airport privatisation. The Delhi and Mumbai airports alone have contributed revenues of Rs 300 billion to the exchequer since their privatisation.

Private equity (PE) investors have also been a happy lot, buoyed by the high returns. A case in point is Delhi airport where PE investors, including the Macquarie Group and Standard Chartered, invested in a structured instrument and received an internal rate of return of 18 per cent over the past 10 years. These superior returns have not been generated in any other infrastructure sector in the country. In addition, the sponsors have made money as well. For instance, in the case of Bengaluru airport, the original shareholders, including Siemens, Zurich Airport and Larsen & Toubro, exited at almost 10 times their original equity investment in a span of 10-12 years. The subsequent investor GVK Group exited at almost twice its investment in a span of three-four years. As per media reports, the current investor, Fairfax, is looking at partly divesting its stake at 2x its investment. Meanwhile, GMR and GVK are considering divesting up to 49 per cent stakes in their respective airport holding companies with a return expectation of 5-7x of their original investments in a span of 12-14 years.

In all, the airport sector has yielded fairly good returns to investors and sponsors alike. The recent aggressive bidding for six airports – Ahmedabad, Jaipur, Lucknow, Guwahati, Thiruvananthapuram and Mangaluru – is also reflective of the bullish sentiment among stakeholders. Despite the crunched timelines due to the elections, there were 10 bidders, including three international bidders, for these airports. Emboldened by the positive bidding response, the

government is looking at divesting stakes in another 20 airports in Tier II and Tier III cities. This time, many more players are expected to participate in the bidding rounds.

Key challenges

On the funding side, one of the critical issues has been debt financing for airport projects. Most of the debt funding has been provided by commercial banks. Considering the returns that investors have reaped in the past, equity funding has not been hard to come by. The issue with airport financing has been getting the “right kind” of borrowing and not the actual availability of funds. Regulatory issues in the past created a serious cash flow mismatch for developers. Delhi airport, for instance, saw a 350 per cent hike in airfares in 2012 in its first tariff increase, followed by a 90 per cent drop in 2015-16. The ensuing huge cash flow mismatch led to realisation of the fact that an amortised debt structure is not the right way to go. Globally, airports are funded via bond issues. However, the domestic bond market lacks liquidity. Therefore, GMR Airports decided to tap the overseas bond market for financing Delhi airport. Buoyed by the success of its first $300 million bond issue, GMR floated another bond issue raising $500 million in the space of one year. The proceeds were used to repay bank debt. A similar bond issue had been floated for Hyderabad airport. Meanwhile, Bengaluru airport recently tied up funds for a period of 20 years.

In the past, the regulatory framework had been a pain point for airport developers owing to problems associated with the single till policy, etc. The government took cognisance of the fact that this is impacting investor interest, and unveiled the National Civil Aviation Policy, 2016, which provided for the transition to the hybrid till regime. The regulatory environment has thus evolved over the past couple of years and today there is a fair degree of predictability and certainty. This has revived the interest of overseas players in the space.

After the bidding of the Delhi and Mumbai airports, the response to subsequent bidding rounds for airports such as Bhogapuram, Goa, Nagpur and Navi Mumbai was lukewarm, with the number of bidders limited to two or three. This was on account of suspicion of revenue leakage due to creative accounting practices adopted by private concessionaires. After a relook, the government introduced a fixed fee per passenger model. The requirement of airport operation experience of the bidder or consortium was also done away with. The government also removed restrictions on related-party transactions. These measures bolstered private sector confidence resulting in successful bidding for the six brownfield airports.

The way forward

A slew of issues have constrained the growth of the airport industry. A contentious issue is that the bid amount per international passenger paid by the bidder to the authority is double that for a domestic passenger. This shifts the focus of airport operators to domestic passengers in order to maximise value (minimising the payout to the Airports Economic Regulatory Authority). Therefore, an average fee per passenger that has to be paid by the operator irrespective of whether the passenger is international or domestic must be worked out.

In the past, airports have used deposits (such as proceeds from real estate monetisation) as equity/quasi-equity for funding capex plans. While the model is good, it has raised issues under the revenue sharing regime as it reduced the regular revenue stream, thereby squeezing the government’s share in revenue. Thus, in subsequent concessions, restrictions were placed on the amount of deposits that could be raised. A key recommendation is that this restriction must be done away with, as bidding is not on the basis of the revenue sharing model. In fact, raising deposits will improve bidding outcomes and help raise part of the equity via asset monetisation. Further, the bar on joint ventures/subsidiaries must be removed for promoting greater value creation.

The privatisation of six brownfield airports, once completed, is likely to generate cash flows of Rs 10 billion in the first year itself. The government must continue with this approach and reinvest the proceeds in airport projects coming up in remote areas and aerodromes.

The country clearly needs more greenfield airports to meet the growing demand for air transport. The existing airports are bursting at the seams. However, issues pertaining to land acquisition and environmental clearances need to be dealt with. On the funding side, lenders have been supportive in funding greenfield projects as they have debt in a secure and performing asset. Sponsor backing becomes important in the initial years of cash loss due to sluggish traffic growth.

In sum, the Indian aviation industry is at an interesting juncture – there is greater regulatory clarity, a burgeoning middle class, high private sector interest and a supportive policy framework. These, coupled with brownfield opportunities, are expected to provide strong growth momentum to the airport sector.

 

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