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VIEW: The crash landing of airports as an asset class

VIEW: The crash landing of airports as an asset class
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By Satyendra Pandey  May 28, 2020 1:36:52 PM IST (Published)

Airport investors face a turbulent flight-path ahead.

Consider this standard pre-corona growth narrative for Indian aviation. A standard set of parameters — usually favourable demographics, GDP growth and propensity to spend were looked at as leading indicators of air travel. Next was highlighting the air travel penetration using a metric such as seats per capita coupled with the growing middle class, and arriving at the conclusion that the only way to go is up. This was confirmed by airline plans that had voluminous orders in excess of 1000 aeroplanes. For each aircraft flying there were 1.7 aircraft on order. Passenger volume growth of 3.2X for domestic traffic and 2.1X for international traffic over the last decade and forecast growth of double digits through 2028 cemented the narrative. Yet with the pandemic, the aviation sector has come crashing down. Airports are one of the worst impacted sectors.

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Investors in India’s airports realised healthy returns
Most investors in India’s airports have come via equity positions into the two large airport operators in the country namely GMR and GVK. And overall these investors have fared well. The returns have been great. Consider these statistics. Malaysia Airports sold its 10 percent stake in Delhi Airport for a 2X multiple; Bidvest sold its 23.5 percent stake in Mumbai airport for a 7.7X multiple; Zurich Airport sold its 12 percent stake in Bengaluru airport for a 10.5X multiple; and Siemens sold its 6 percent stake in Bengaluru airport for a 19.1X multiple. The list goes on…
Investor interest in Indian airports has seen peaks and valleys. From heightened interest in the period from 1997—2006 which saw several privatisations, there was a lull from 2007 through 2014. The sector again attracted interest from 2015 onwards including from airport operators to sovereign wealth funds to pension funds. All were keen to gain a foothold into the sector. This interest continued driven by a host of factors including market returns, liquidity, market potential, and market access and privatisation parameters.
Airports until recently made for an attractive asset class
Airports' success as an asset class is linked to several factors. The key drivers were the explosive traffic growth and the land banks which could be monetised. This when coupled with the monopoly status, long term concession periods, low competition risk, favourable till-structures, stable cash-flows, commercial property development rights, a captive consumer base. Add to this a guaranteed return of up to 16 percent on large portions of the asset base—was the perfect recipe for strong and growing cash-flows. Thus while gestation periods were long but for investors that are looking at quality assets, the elements aligned to make for a compelling case for investment.
The policy environment was gradually revised towards even better concession terms
Cochin airport was the first PPP airport where the concession period was not defined and the revenue share was in form of a dividend to the government. Hyderabad and Bengaluru terms stipulated a sixty-year concession with a 4 percent annual concession fee. When it came to Delhi and Mumbai the revenue share was 46.99 percent and 38.7 percent respectively and the concession terms were 30 + 30 years in the case of Delhi and 30 + 10 years in the case of Mumbai. Later airports such as Goa had a 40 + 20 year concession period with a revenue share of 36.99 percent but a five-year revenue share holiday. Most recently the six airports won by Adani Airports have 50 year concession periods and per passenger payments to the government instead of the earlier revenue share agreement.
The airport development model for India was not fit for purpose. Yet for investors it made for an attractive offering. Recent policy measures also attempted to make for a friendlier investment environment. Whether it was the change in the nature of revenue share; or the till structure or the fast-tracking of various projects—the government was (and remains) clear in its intent of privatisation.
But the pandemic has directly hit revenues and cash-flows
With all elements, aligned airports were on a steady climb. Investors had already tasted success in no small measure. With over Rs 35,000 crores invested in India’s airports( around $5.5 billion adjusted for exchange rates), this amount was to double over the next decade, towards capturing the market potential. Because with a 300 million-strong middle class, low air travel penetration and an increasing propensity to spend, India was targeting 500 million passenger trips in the next 20 years. Airports would be key to facilitating this movement and investors were all but guaranteed healthy returns.
Over the last twenty years, investor interest in airports only grew stronger. Fairfax group paid around $ 466 million gradually increasing its stake to 54 percent ownership of Bengaluru International Airport Ltd; earlier in the year Zurich Airports (Flughafen Zürich AG) won the bid to build and develop the greenfield airport at Jewar (the project is estimated to be north of $3.1 billion); and very recently Groupe ADP (a French conglomerate) bought a 49 percent stake in GMR airports for $1.5 billion.
But things were not to be. The pandemic has come at a time where airports have committed to a significant amount of Capex—in no small part because of the regulatory model. This then was justified on the basis of traffic volume forecasts. But those very forecasts and the very business model that airports were counting on has now come to haunt them.
The past no longer informs the future
Even the most optimistic forecasts indicate that in the near and mid-term at best demand will be tepid at best. This driven by both structural and behavioural changes. Short sector traffic is likely to move to road and certain demand segments will evaporate altogether. Together these make for paradigm shifts. Traffic volumes may take years to rebound.
With public health emerging as a key concern post the pandemic, the airport experience now includes an element of health risk in addition to the security risk. The airline industry will emerge with fewer airlines, smaller fleets and lower traffic volumes. And the future traveller will pay more in airport charges further impacting demand. For travellers, the hassle will increase and the cost will increase, and for demand, this will act as a natural suppressant.
And that’s not all, there are also new risks that are emerging. The increase in aircraft ranges, the retirement of larger aircraft, the obsolescence of the hub-concept—to name a few. Similarly, revenue streams are strained, the future will see increased airport competition via dual airport systems and new geopolitical risks and changing sentiment towards air-travel will have a disproportionate impact on traffic. Airport investors face a turbulent flight-path ahead.
The beginning of the year saw around 48 percent of domestic capacity under public-private partnership (PPP) airports. This number is now 60 percent after the successful bids by Adani Airports for six airports. Another six airports including Tiruchirapalli, Bhubaneswar, Raipur, Indore, Amritsar and Varanasi are likely to be put out for bid—bringing the total airport capacity under PPP models to 65 percent. But with airports no longer being as attractive to investors the future remains uncertain.
Satyendra Pandey has held a variety of assignments in aviation. He is the former head of strategy at a fast-growing airline. Previously he was with the Centre for Aviation (CAPA) where he led the advisory and research teams. Satyendra has been involved in restructuring, scaling and turnarounds. Has also provided policy inputs and suggestions.
Read Satyendra Pandey's columns here.
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