Jonathan Ford (FT) on the serious financing doubts: “Who will pay for Heathrow airport’s £14bn 3rd runway?”
With the vote on a possible 3rd Heathrow runway expected on 25th June, Jonathan Ford and Gill Plimmer write, in the Financial Times, of the very serious doubts over how the runway could be funded. They say: “Most agree that this leveraged structure is wholly inappropriate to support a project as large as the 3rd runway. It offers no leeway for construction risk on what will be a highly complex engineering challenge. There is also the question of how Heathrow might meet the financing costs, which could run to £2bn-£3bn over the six-year construction period, assuming an interest rate of between 4 -7%.” And …”investors have been pulling out more in dividends than Heathrow has been earning. Last year they received a payout of £847m even though post tax profits were just £516m, implying that the corporate debt was used, in part, to fund these returns.” … And “A key question is how much debt the markets will lend against the £2bn of operating cash flow Heathrow expects to have by the time construction begins in 2019.” … The Airports Commission said it could saddle Heathrow with up to £27 billion of debt. Ford also questions the opaque structure of Heathrow, with at least 10 corporate layers between Heathrow Airport Limited ….and shareholders.”
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Who will pay for Heathrow airport’s £14bn third runway?
Fears mount that taxpayers and passengers will be landed with big chunk of bill
22.6.2018 (Financial Times)
By Gill Plimmer and Jonathan Ford
– Leveraged structure seen as inappropriate for such a large project
– London mayor Sadiq Khan joins legal action against expansion
– Role of the regulator could be key
When Heathrow airport was originally proposed in wartime as “an airfield near London capable of accommodating heavy transport aircraft of the latest type”, the cabinet did not take long to reach its decision.
Notes of its meeting on November 12 1943 laconically authorise construction at the cost of 130 houses and some land “now used to grow vegetables”.
The main concern of ministers was the need to move a recently built sludge works belonging to Middlesex county council. This had taken “two years to complete and cost £500,000”.
MPs preparing to vote on Heathrow’s latest expansion plan on Monday must wish their only worries were a few lost market gardens and an inconveniently sited sewage plant.
Instead, they face many more contentious and costly hurdles. Finally proposed after a decade of wearisome debate, the contentious Heathrow Northwest Runway scheme is by a factor of 2 the most expensive option of the three considered.
It involves lavishing £14bn or more on a third runway that will have to bridge 12 lanes of the nation’s busiest motorway while keeping traffic flowing. It will also entail further billions in spending to upgrade train and road access links to what is already a highly-congested airport.
What puzzles onlookers is how these astronomical sums will be paid for.
Despite public recognition that more runway capacity is needed in south-east England, support for enlarging Heathrow has always been lukewarm. Propriety and EU law mean keeping public contributions to a minimum.
Fragile balance sheet
But there are doubts about Heathrow’s ability to raise the money given the fragile state of its balance sheet and the fear for MPs is that passengers and taxpayers might somehow get stuck with a big chunk of the bill.
Ever since Britain privatised its airports in 1986, infrastructure improvements have been the responsibility of private-sector owners. EU rules clarified in 2014 have further circumscribed the ability of governments to provide state aid to privately owned companies.
“If you have a lot of debt on your balance sheet you are less able to absorb any shocks.”
Martin Blaiklock, infrastructure consultant
Since 2006, when Heathrow’s then-listed owner BAA was removed from the stock market, the airport has been owned by a consortium led by the listed but family-controlled Spanish construction company Ferrovial. This has steadily expanded and now includes sovereign wealth funds from Singapore, Qatar and China, and the UK’s own Universities Superannuation Scheme Pension Fund.
The regulatory system surrounding airports allows owners to collect a return based on the regulatory value of their assets — inadvertently encouraging them to expand regardless of whether it makes sense.
This stable framework has allowed Heathrow to operate with almost no equity capital. According to Heathrow Airport Holdings’ 2017 accounts, borrowings stand at £13.4bn — not far shy of the £15bn value of its regulatory asset base. Equity stood at just £703m.
Problem with leveraged structure
Most agree that this leveraged structure is wholly inappropriate to support a project as large as the third runway. It offers no leeway for construction risk on what will be a highly complex engineering challenge. There is also the question of how Heathrow might meet the financing costs, which could run to £2bn-£3bn over the six-year construction period, assuming an interest rate of between 4 and 7 per cent.
There is scope to help bankroll the project by raising the charges Heathrow levies on airlines and passengers, a prospect that has prompted alarm from airlines.
Willie Walsh, the chief executive of IAG, British Airways’ parent company, has fiercely opposed the runway and has said he has “zero confidence” that it will be built on time and on budget.
The government has not ruled out increases, pledging only “to keep airport charges as close as possible to current levels”. These are already high— some 40 per cent more than competing European hub airports. Further rises might encourage airlines to move, making it harder to fill the new capacity.
Martin Blaiklock, an infrastructure consultant and former project banker, believes that Heathrow needs substantially more equity capital. He accuses investors of “gradually stripping the company of assets, so that the company is close to being “bust”.
“The current (unsecured) creditors could bring LHR to its knees by demanding immediate repayment,” he said.
“If you have a lot of debt on your balance sheet you are less able to absorb any shocks such as cost overruns because you still have to keep paying the interest, whereas, if such costs are funded by shareholder equity, you can just stop paying distributions.”
Heathrow already needs to raise a lot of debt simply to stand still. Around a third of its borrowings — some £4.5bn — will fall due within the next five years. And while the rating agency Moody’s has given the company a stable rating, it noted that “this high level of maturities and the company’s high leverage limit its ability to withstand unexpected external shocks.”
A spokesperson for Heathrow said the airport is “backed by the biggest long-term investors in the world with over $1tn of funds under management”.
“We have an investment-grade credit rating and will maintain that position with new shareholder equity as we expand. Our shareholders have shown their commitment to Britain by making Heathrow a world-class airport, continuing to invest throughout the global financial crisis. They are exactly the people you want behind a £14bn investment in critical national infrastructure and will help us deliver it affordably.”
How much debt will the markets cover
Moody’s was sanguine about the airport’s ability to raise capital. Andrew Blease, associate managing director, argued that the airport’s large and powerful shareholders — particularly the cash-rich sovereign wealth funds — should be willing to inject more equity into what they see as a “trophy asset”.
But Ferrovial, which owns a 25 per cent stake, may be more reluctant — especially after its construction earnings almost halved last year following a £48m loss on the M8 upgrade in Scotland. Ferrovial declined to comment.
A key question is how much debt the markets will lend against the £2bn of operating cash flow Heathrow expects to have by the time construction begins in 2019.
According to the UK Airports Commission, an independent body set up in 2012 to consider how the UK can “maintain its status as an international hub for aviation”, the new runway could saddle Heathrow with as much as £27bn of debt.
Critics also question the propriety of Heathrow’s complex and opaque structure given its privileged status as an infrastructure asset of national importance, first built by the state. There are at least 10 corporate layers between Heathrow Airport Limited — which is licensed by the aviation regulator, the Civil Aviation Authority — and shareholders.
Heathrow has yet to provide a breakdown of the cost of the runway though it has tried to address airlines’ concerns by cutting the cost of the project by £2.5bn to £14bn.
This excludes likely cost overruns, legal claims and a dispute with the state-funded Transport for London over who will foot the bill for at least an additional £10bn on delivering new public transport infrastructure to accommodate the 50 per cent increase in demand and secure a significant shift away from car journeys, as well as burying the M25 in a tunnel.
On Thursday, Sadiq Khan, the mayor of London, said he would join legal action brought by local councils against Heathrow airport expansion if parliament votes in favour of a third runway next week.
Heathrow’s promised contribution of just £1bn towards the surrounding infrastructure could also be challenged under complex state aid rules.
Key role of the regulator
Much depends on decisions from the CAA, which has — like the water regulator Ofwat— largely been indifferent to the capital structure of its regulated providers. It has yet to set out the charges Heathrow will be allowed to levy to fund expansion.
“How the regulator manages the charges before and after construction will drive how much the company has to borrow to finance construction,” said one lawyer advising on the project who declined to be named.
“The regulator could construct a charging framework where the airport wouldn’t need to raise charges — by extending the capital expenditure over a much longer period than the construction itself, for example,” he said.
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But he acknowledged that this raised ethical questions. “If you’ve stripped out all the profits and dividends, and then you get a regulatory settlement that supports your new capital structures that really is having your cake and eating it,” he said. “Taxpayers are not funding them directly, but ultimately we will end up paying whether it’s through the price of a beer in the airport or the cost of the ticket.”
The CAA said it continued to develop the regulatory framework and expects “capacity expansion at Heathrow to be delivered in a way that is timely, affordable, financeable and, critically, in the interest of consumers”.
https://www.ft.com/content/98e6b128-7533-11e8-aa31-31da4279a601
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See earlier:
FT’s Jonathan Ford on massive doubts over Heathrow’s ability to fund its runway – without huge subsidy from taxpayers
Jonathan Ford, the City Editor of the Financial Times (who knows a thing or two about finance) on the Heathrow runway scheme. It would cost at least £14 billion (probably more with inevitable over-spends), and as Heathrow is already the most expensive airport in Europe, its ability to claw back money is limited – anyway, it cannot get airlines and passengers to pay until the runway is built and operating. Despite sales of some of its airports, totalling more than £4bn, its debt was still £13.4 billion in 2017. And “Heathrow’s 2017 accounts record a dividend of £847m for shareholders last year on after-tax profits of just £516m, implying that dividends were partially funded by taking on yet more corporate debt.” Shareholders are not going to be happy to receive almost no dividend for several years. “Heathrow might try to ease the burden by discreetly pressing for public subsidy, figuring that once the state is committed to the 3rd runway it will not want to see the project come off the rails. The government should stand firm. Its decision to pick the most expensive of three runway options on the table was always predicated on the idea that all could be financed without state support.”
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