The level of interest in the European airport sector shows no signs of abating, as both construction companies and infrastructure investors bid ever-more aggressively for assets.

The latest example involves London City Airport. Bankers say that around 80 parties expressed initial interest when it was announced that Irish multi-millionaire Dermot Desmond wanted to sell.

To date, sale advisors Morgan Stanley have lined up six serious bidding consortia: Balfour Beatty has teamed up with Merrill Lynch; Sacyr has teamed up with insurer Axa with advisory from HSBC; Fraport, has teamed up with Deutsche Bank's infrastructure fund in a consortium advised by NM Rothschild; Vancouver Airport has joined forces with ABN Amro, and potentially Australian fund manager AMP in a consortium advised by Citigroup; AIG has teamed up with the new Credit Suisse/GE infrastructure fund; and French investment fund Galaxy is backing Cologne-Bonn airport with advisory from IJK consultancy.

The rush for London City is typical for the airport market at the moment – bids are expected to range from £600 million to £700 million, with City expected to have earnings of £27 million this year before depreciation, amortisation, interest and tax.

Overpriced and over-financed?

For airport regulators, and for governments selling off stakes in airports, the current wave of liquidity brings with it concerns that some of these strategic parts of their national infrastructure could face refinancing risk in a few years time.

As Standard & Poor's has noted, the European airports' underlying business profiles are still sound, but the sector risks becoming a victim of its own success.

"The asset performance of the airport sector and other transport infrastructure is so strong that M&A activity is widespread," says Alexandre de Lestrange, Paris based analyst in S&P's Infrastructure Finance Ratings Europe team. "The resulting ownership changes and/or increased leverage pose a threat to the operators' credit quality."
"There is an imbalance between the supply of airport assets coming onto the market, and the large amount of money, such as infrastructure funds, currently looking to invest in the sector," says Colin Campbell, director in the global banking infrastructure team at Citigroup in London.

"That is having the effect of bidding prices up, but for governments, getting the highest price is not always the top priority when selling nationally important assets such as airports, since very high prices can create concern amongst policymakers that there may eventually be instability as bids are refinanced," he explains.

"But there are mitigants at hand," says Campbell. "For example, when the French government privatised the toll road operators last year, it imposed a minimum rating on each of the three companies, and going forward we may see more use of rating floors in the airport sector."

But the growing use of structured finance means that new owners may find ways to sidestep simple rating floors, so this may turn out to be something of a moving target for regulators.

"Governments clearly have an interest in the credit quality of airports, since they are strategically important, and governments would like to ensure that there is no struggle to refinance during a weaker part of the credit cycle," says Richard Tollis, partner at Ernst & Young.

"But whether that translates into a formal instruction will vary from one deal to another," says Tollis. "The nature of financing for airport acquisitions has changed over the past few years, and there is now much wider use of structured finance. This means that it is generally possible to maintain a credit rating at a higher level of gearing, so specifying a certain level of gearing may not necessarily be meaningful."

Of course it is not only regulators who have concerns about leverage. The bank lenders into either privatisations or private M&A sales of airport assets are also doing their own calculations regarding the high prices being paid for airport assets.

Banks or infra funds?

But all the signs are that there remains plenty of bank debt available. Even such a large syndicated loan as the £9 billion facility being put together for the Ferrovial takeover of BAA plc seems to be being comfortably absorbed by the market.

Even more telling, the Ferrovial deal has coincided with a period of airport chaos in the UK as a result of terrorist threats leading to extra security measures, but bank lenders seem to have been sanguine about long term effect on travel habits.

Part of the reason is the change in the bank market, where over the past couple of years more resources have been devoted to areas such as infrastructure, both on the lending side and as equity investors.

The result is a more sophisticated group of lenders. "They are willing to put a lot of work into deals before they are invited to tender," comments one market observer. "Some arranging banks are trying to decommoditise the financing by putting in a lot more work upfront, and there is plenty of innovative structuring. There is a distinction between banks that are serious players in the market, and those just invited along to the beauty parade, and some of the first group have a very big appetite."

"Five years ago both bank lenders and the rating agencies were quite uncomfortable with traffic risk in the airport sector," comments Manish Gupta, Director at Ernst & Young. "But post 9-11, airport cashflows have been shown to be quite resilient, and the sector has been re-rated by the credit agencies, and also by bank lenders, some of whom currently have a very strong appetite," he says.

As a result, in spite of long term prospects of using capital markets financing, most deals continue to rely upon readily available bank debt.

"I think that the airport market will be dominated by bank debt for some time to come, though bond offerings are definitely on the horizon for the next couple of years," says Andreas Strasser, head of infrastructure, transportation and PFI at Bank Austria Creditanstalt in Vienna.

"There is still a very strong appetite from bank lenders, and the syndicated loan market has not had any capacity problems even on large airport deals," says Strasser, who adds that pricing on loans "is still coming under pressure."

Regionals next wave

"The very big airports are now more or less sold, and we are seeing a second wave on the regional side, with airports such as Wroclaw in Poland now getting attention," says Strasser. "The market is moving in the direction of refinancing for the big airports, and improvement and expansion for the second wave of regional airports."
Bankers note that, even with smaller regional airport deals, a lot of work is being put in by specialised infrastructure lenders in order to win business. And in the case of some deals in Central & Eastern Europe, this has meant time wasted as privatisations have proceeded slowly before eventually running aground as elections bring in new governments.

Privatisations in both Slovakia and Bulgaria have run into trouble at an advanced stage, and the pace is slow in Poland and the Czech Republic.

Nonetheless, the prospects for passenger traffic growth and freight throughput at airports in Central & Eastern Europe are very good, making infrastructure investors and bank lenders take a close look at any airports coming up for sale. In particular, the effects of the low cost carrier revolution are still just starting to be felt at many airports in Central & Eastern Europe.

Each airport deal is different from the last. It may involve a concession, a sale of an equity stake in an existing government owned airport, and be with or without major commitments to build new terminals or runways.
Some Central & Eastern European governments may be tempted to follow the strategy of the French government, and keep a majority stake in strategic airports while raising cash via an Initial Public Offering, as was the case with the flotation of Aeroports de Paris earlier this year.

"The motivations for the original public sector owners vary, some want additional new management skills but feel they have a long term interest in the airport so either keep the freehold or having some equity participation, in other cases they just want to raise cash," says one banker.

One recent concession deal, which took longer than the norm to complete, was the Cyprus Airports PPP. The deal reached financial close earlier this year and closed syndication earlier this month.

After another bidder had originally won the concession, it pulled out, paving the way for the Bouygues-led Hermes Airports consortium to win a 25-year concession to renovate both Larnaka and Paphos airports.
The four lead arrangers were ING, Royal Bank of Scotland, Societe Generale, and WestLB. The financing package included an equity bridge and a mezzanine tranche, while the Eu482 million 20-year senior tranche paid an initial 125bp, moving up to 160bp over time, making an eventual refinancing all but certain.

Ferrovial and BAA

Royal Bank of Scotland is also involved as one of the mandated lead arrangers on the £8.9 billion acquisition loan for Ferrovial to buy BAA.

The debt will be drawn by Airport Development and Investment, which is a consortium comprising Ferrovial, Caisse de depot et Placement du Quebec, and GIC Special Investments of Singapore.

But the Ferrovial takeover may not provide too many clues as to the direction of pricing on bank debt since, as one banker comments, "its sheer size makes it of limited value as a point of reference."

Clearly the Civil Aviation Authority (CAA) in the UK has been concerned about the potential high gearing of the deal, and has been looking for debt on the three big regulated BAA airports (Heathrow, Stansted and Gatwick) to be in some way ringfenced from other assets. Since typical airport deals currently feature a 7 to 10 year mini-perm, the CAA is taking a hard look at future refinancing risk, given the strategic importance of these three airports to the UK economy.

The success of the Aeroports de Paris float may mean that other governments look at taking the IPO route, while holding onto a strategic stake, but for any government looking to maximise the amount of cash raised, an M&A sale looks like remaining the best option in the medium term.

"M&A has always paid a substantial premium to the IPO market, premium is bigger notwithstanding something of a surge in listed public equity prices, as the sector has been re-rated," says one banker.

But the dedicated money in infrastructure funds means that the stock markets are unlikely to compete. One estimate suggests that various global infrastructure funds currently have anywhere between $85 billion to $100 billion earmarked to invest in infrastructure assets. With gearing, that could buy $400 billion worth of assets which far outstrips the likely volume of assets coming up for sale.