Wednesday, October 23, 2013

The UK's Largest Infrastructure Deal?

Miles Johnson and Andrew Parker of the Financial Times report, Ferrovial sells Heathrow stake to UK pension fund:
Ferrovial, the Spanish infrastructure and construction group, on Tuesday unveiled plans to sell a further stake in the holding company that controls London’s Heathrow airport to a UK university pension scheme for £392m.

Inigo Meiras, Ferrovial’s chief executive, said the deal was not prompted by the company’s objections to the proposed new regulatory regime for Heathrow –under which the airport would no longer secure inflation-busting increases in the landing charges paid by airlines for using its facilities.

Ferrovial, Heathrow’s largest shareholder, has agreed to sell an 8.65 per cent stake in FGP Topco, the holding company for Heathrow Airport Holdings, to the UK Universities Superannuation Scheme.

Ferrovial plans to remain the largest shareholder at FGP Topco, with a 25 per cent stake, after the planned deal.

“Following this deal, we reiterate our role in [Heathrow Airport Holdings] as the main shareholder and industrial partner in the long term,” said Mr Meiras.

He added that the deal with the UK Universities Superannuation Scheme implied an enterprise value for Heathrow that represented a 13 per cent premium to the airport’s regulated asset base.

The Ferrovial-led consortium that in 2006 bought BAA, Heathrow’s then owner, paid a hefty premium – and was subsequently required by competition regulators to break-up the airport group by selling Gatwick, Edinburgh and Stansted airports.

This month, the aviation regulator angered Heathrow by proposing that its landing charges paid by airlines should only rise in line with inflation over the next five years – in stark contrast to substantial real terms increases in these fees over the past decade.

Colin Matthews, Heathrow’s chief executive, also objected to the CAA’s proposed 5.6 per cent cost of capital for the airport, saying it did not provide an incentive for its shareholders to invest.

Heathrow originally said it would spend £3bn improving Heathrow’s facilities between 2014 and 2019 but subsequently warned that it could reduce this figure to £2bn because of the regulator’s proposals.

Mr Meiras said Ferrovial was leaning towards supporting spending of closer to £2bn than £3bn, although no final decisions had been taken by Heathrow’s board.

He also said the decision of the UK Universities Superannuation Scheme to buy a stake in Heathrow would not make it harder to try to persuade the CAA to provide a more generous regulatory settlement over the next five years.

This is the university pension scheme’s largest investment in UK infrastructure to date.

Michael Powell of USS Investment Management, the scheme’s investment adviser, said the CAA’s proposals were “very challenging” but the stake purchase at Heathrow was for the long term.

“We have confidence that the right incentives will be set in place to encourage the investment that Heathrow and the UK needs,” he added.

Ferrovial has been progressively reducing what was once a stake of more than 50 per cent in Heathrow’s holding company.

Heathrow’s other shareholders are Chinese, Qatari and Singaporean sovereign wealth funds, plus Alinda Capital Partners, the US infrastructure investment firm, and Caisse de dépôt et placement du Québec, the Canadian pension scheme manager.
Sarah Young of Reuters also reports, Ferrovial sells part of Heathrow stake to UK pension group:
Spain's Ferrovial has sold part of its stake in Heathrow Airport Holdings (HAH) to a British pensions group as part of a 392 million pound deal.

Ferrovial's disposal of 8.65 percent to Britain's Universities Superannuation Scheme (USS) is the Spanish group's latest sale from its holding in the airport company which owns London's Heathrow and three other airports in the UK.

Following the deal, the Spanish company will have a 25 percent holding meaning it is still the biggest shareholder in HAH, owned by a consortium including Britannia Airport Partners and Singapore's GIC, Qatar Holding and Alinda Capital Partners.

Ferrovial, which sold a 10.6 percent stake in HAH to Qatar last year for 607 million euros and 5.88 percent to Alinda for 325 million euros in 2011, said on Tuesday the sale was part of its investment diversification strategy.

USS said the purchase, valued at 463 million euros, was its biggest investment in British infrastructure to date.

"USS is investing for the long term. We have confidence that the right incentives will be set in place to encourage the investment that Heathrow and the UK needs," USS Investment Management's Michael Powell said in a statement.

Heathrow airport is facing a number of uncertainties.

HAH said earlier in October it was reconsidering its investment plans following a proposal by Britain's aviation regulator to cap the prices it charges as this would reduce returns to below the level at which shareholders were willing to invest.

HAH also wants to build a new runway at Heathrow but the Conservative-led government overturned a decision to do so after it came to power in 2010, and a number of alternative proposals to expanding Heathrow are currently on the table.

A government commission is due to reach a final verdict on the matter in mid-2015.

Ferrovial bought Heathrow, Britain's busiest airport, and a number of other UK airports as part of its acquisition of BAA in 2006 for 10.3 billion pounds in a highly-leveraged deal.

In 2006, BAA also owned Gatwick, the country's second busiest airport, and Edinburgh airport, but the group has since sold those two to meet regulatory demands and has subsequently been renamed HAH.
And Nathalie Thomas of the Telegraph reports, Ferrovial sells Heathrow stake to UK pension fund for £392m:
Spanish infrastructure giant Ferrovial has further reduced its stake in Heathrow after agreeing to sell 8.65pc of the airports group to UK pension fund, the Universities Superannuation Scheme, for £392m.

The deal, which values Heathrow at £4.5 billion, is the fourth time Ferrovial has trimmed its holding in the airports group in two years and reduces its stake to 25pc, down from 62pc when it bought BAA in 2006 in a £10.3 billion deal.

BAA, which changed its name to Heathrow Airport Holdings (HAH) last year, has changed dramatically since the 2006 takeover, as the UK’s competition authorities have forced the company to sell off Edinburgh, Gatwick and Stansted airports. Heathrow still owns Aberdeen, Glasgow and Southampton airports.

Ferrovial will remain the largest shareholder in Heathrow following the deal with USS, which is expected to complete on Thursday.

USS will hold the seventh biggest stake behind China Investment Corporation, the sovereign wealth fund which bought 10pc of the airports operator in October 2012.

Ferrovial’s chief executive, Íñigo Meirás, insisted the Spanish company remained committed to Heathrow in the long-term, despite cutting its holding significantly in the last seven years.

“This sale of a stake in HAH is a further part of Ferrovial’s investment diversification strategy. Following this deal, we reiterate our role in HAH as the main shareholder and industrial partner in the long term,” Mr Meirás said.

Ferrovial is selling the stake in FGP Topco, the holding company for Heathrow.

USS is the final salary pension scheme for universities and other higher education institutions in the UK. It manages around £40 billion, making it one of the largest pension schemes in the UK.

In October 2011, Ferrovial sold a 5.88 per cent stake to Alinda Capital Partners for €325m. Less than a year later, in August 2012, it struck a deal with Qatar Holdings before further reducing its holding to 33.65 pc last October through an agreement with China Investment Corporation.

The latest deal with USS comes amid a row with airlines and the UK’s airports regulator over the maximum return Heathrow’s shareholders should be allowed to generate on their investments.
There are several things that ran through my mind as I read this latest airport deal. First, is this more evidence that pensions (and sovereign wealth funds) are inflating an infrastructure bubble? The UK Universities Superannuation Scheme paid a hefty premium for this stake. Some airport deals I covered in this blog make more sense than others. For example, PSP's  big bet on airports was reasonable given the terms of the deal (don't know if it is finalized).

The second thing that this deal shows is how regulatory risks loom large in infrastructure investments. Ferrovial and other shareholders of HAH still have to persuade the CAA to provide a more generous regulatory settlement over the next five years. Inigo Meiras, Ferrovial’s chief executive, and Colin Matthews, Heathrow’s chief executive, objected to the CAA’s proposed 5.6 per cent cost of capital for the airport, saying it did not provide an incentive for its shareholders to invest.

Third, I ask myself why are the Ferrovials and Hochtiefs of this world selling their stakes in airports to large pension funds and sovereign wealth funds? Is it really part of a 'diversification strategy' or are they worried of the changing regulatory landscape? To be clear, Ferrovial still has a significant stake in Heathrow even after this deal is finalized but I wonder why the major infrastructure conglomerates are selling their airport stakes to pensions and sovereign wealth funds.

Fourth, there are those that argue UK pensions have been slow to invest in infrastructure, in sharp contrast to their Canadian and Australian counterparts. Canadian pensions own huge stakes in British infrastructure. Pensions are attracted to infrastructure assets because they are long-dated assets whose duration matches the duration of their liabilities. These are long-term investments which make perfect sense to pensions from an asset-liability standpoint. But infrastructure assets carry significant risks, the most important one being regulatory risk.

As always, welcome feedback from my network of experts and will update this comment accordingly. If you have any comments, feel free to email me (LKolivakis@gmail.com). One infrastructure expert shared this with me:
Heathrow is a complicated infrastructure investment in the sense that it requires new capital investment as it continues to grow.

It is quite rare that you see open exchanges in the press between an operator and its regulator. In my experience, it rarely works and is a symptom of an oversight structure that has become dysfunctional. In many ways, this is not surprising because most Public-Private partnerships are not structured to accommodate large changes. There are also fairly large conflicts of interest that need to be managed.

So, it leads me to believe that this is a strategic move by Ferrovial to diversify its shareholder base such that it includes more UK representation. This should help them improve the relationship with their regulators. Anyway, it should be interesting to follow over the next few years.
And a private equity expert shared this with me:
At the heart of infrastructure investing is the quaint notion that governments/taxpayers have and endless ability and priority to protect investors who take equity risks. The fact is all infrastructure have demand and refurbishment risks that governments did not intend to, or cannot, bear fully, especially under circumstances of political context.

What one will witness over the next few years is that those who thought they had bond like stable and matching cash flows, actually have highly leveraged equity investments with all the cyclicality and variability of the underlying economies. Maybe true long term investors will be ok with this, but it is another reminder that higher returns require risks, and just taking risks does not guarantee higher returns.
Below, Neil Petroff, executive vice-president and chief investment officer of Ontario Teachers' Pension Plan, speaks at the UK Infrastructure panel of the Global Investment Conference 2013.