PPP Airport Thesis S2

PUBLIC-PRIVATE

STRUCTURED

Dissertação

COMPLEX TRA

Presidente: Prof.

Orientador: Prof.

Vogal: Prof.

ATE PARTNERSHIPS IN THE AIRPORT

RED GUIDELINES FOR PPP IMPLEMENTATIO

ANDRÉ FRANCO PENA

rtação para obtenção do grau de Mestre em

RANSPORT INFRASTRUCTURE SYST

JÚRI

Prof. Luís Guilherme de Picado Santos

Prof. Maria do Rosário Maurício Ribeiro Macár

Prof. José Manuel Caré Baptista Viegas

NOVEMBRO 2011

ORT SECTOR

TATION

YSTEMS

acário

i

ACKNOWLEDGEMENTS

I would like to deeply thank my supervisor, Prof. Rosário Macário, for her guidance and

orientation, and for giving me the opportunity to collaborate in the research project AIRDEV –

Business Models for Airport Development and Management, which was the very first step for

the development of this thesis. Furthermore, I would also like to thank Dr. Vasco Reis and Prof.

José Viegas, both from the Technical University of Lisbon, and Prof. Sheila Farrell, from the

Imperial College of London, for their comments and suggestions, which revealed to be very

helpful.

It is also imperative to show my gratitude to my CTIS colleagues, for the fantastic group we

were along this year, for all the interesting discussions and for allowing the CTIS experience to

be much more valuable.

Finally, I must address the most special thanks to Sofia, my parents and my brother, for their

patience and support, for always standing by my side and for making me who I am today.

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ABSTRACT

The airport industry has developed significantly in the past decades, particularly due to the increase of private initiatives in the sector – while privatizations brought innovative ownership models, PPP severely revolutionized airport finance. Therefore, it is important to understand the consequences of this trend, assess their socio-economic impacts and look for correlations that may exist considering the triangle Ownership/Governance/Financing.

As far as PPP are concerned, despite their relevant role in the evolution of the transportation industry, examples of failure are quite frequent. Consequently, in-depth and thorough analysis are imperative, so as to identify the weaknesses of these models and find solutions that would allow minimizing investment’s risks and increasing the likelihood of success.

In addition to being vehicles of economic well-being, airports are also foundations of social development. With the purpose of providing more efficient infrastructures and overcoming the gap between airports’ demand and supply, it is pertinent to identify who are the new market players and understand how the business is being managed and financed. Moreover, it is mandatory to properly structure a framework for PPP implementation in airports. As a result, a set of guidelines is proposed, with the objective of helping policy-makers and potential investors developing successful partnerships.

Key Words: Airports; Public-Private Partnerships (PPP); Ownership Models; Project Finance; Infrastructure Finance; Privatization.

RESUMO

O sector aeroportuário desenvolveu-se significativamente nas últimas décadas, em particular devido ao aumento de iniciativas privadas no sector – enquanto as privatizações trouxeram modelos de propriedade bastante inovadores, as PPP revolucionaram o financiamento dos aeroportos. É, portanto, relevante compreender quais as consequências desta tendência, analisar os impactos socioeconómicos, assim como procurar correlações que eventualmente existam entre o triângulo Propriedade/Gestão/Financiamento.

Quanto às PPP, embora tenham um papel relevante no desenvolvimento da indústria dos transportes, exemplos de insucesso são bastante frequentes. Consequentemente, análises profundas e abrangentes são imperativas, para que se consiga identificar os pontos fracos das mesmas e encontrar soluções que minimizem os riscos de investimento e aumentem a probabilidade de sucesso.

Além de serem veículos de bem-estar económico, os aeroportos são também fundações do desenvolvimento social. Com o intuito de desenvolver infra-estruturas mais eficientes e ultrapassar o desfasamento entre a procura e oferta em termos de aeroportos, é pertinente identificar quem são os novos intervenientes do sector e compreender como o mercado aeroportuário é gerido e financiado. Além disso, é fundamental estruturar devidamente um plano de implementação de PPP em aeroportos. Assim, é proposto um guia, cujo objectivo é auxiliar o poder político e potenciais investidores a desenvolver parcerias com sucesso.

Palavras-Chave: Aeroportos; Parcerias Público-Privadas (PPP); Modelos de Propriedade; Project Finance; Financiamento de Infra-estruturas; Privatização.

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INDEX

1. INTRODUCTION ....................................................................................................................... 1

1.1. INTRODUCTORY NOTE .................................................................................................. 1

1.2. OBJECTIVE .................................................................................................................. 2

1.3. STRUCTURE OF THE DISSERTATION .............................................................................. 2

2. PUBLIC-PRIVATE PARTNERSHIPS IN TRANSPORTATION ............................................... 3

2.1. THE CONCEPT ............................................................................................................. 3

2.2. CONTRACT DESIGN IN INFRASTRUCTURE DELIVERY ....................................................... 5

2.3. MAJOR TYPES OF PUBLIC-PRIVATE PARTNERSHIPS ....................................................... 7

2.3.1. INTRODUCTION .......................................................................................................... 7

2.3.2. MANAGEMENT CONTRACTS ......................................................................................... 7

2.3.3. LEASING CONTRACTS ................................................................................................. 8

2.3.4. CONCESSION CONTRACTS .......................................................................................... 9

2.3.4.1 THE CONCEPT ..................................................................................................... 9

2.3.4.2 PROJECT AND STRUCTURED FINANCE .................................................................. 10

2.3.5. PPP CONTRACTS INVOLVING TRANSFERENCE OF OWNERSHIP RIGHTS ......................... 20

2.3.5.1. Private Finance Initiative (PFI) ......................................................... 20

2.3.5.2. Divestiture ........................................................................................ 20

2.4. EXAMPLES OF PPP VENTURES IN TRANSPORT INFRASTRUCTURES ............................... 21

2.4.1. ROAD INFRASTRUCTURES ......................................................................................... 21

2.4.2. RAILWAY INFRASTRUCTURES ..................................................................................... 21

2.4.3. MARITIME INFRASTRUCTURES ................................................................................... 22

2.4.4. AIR TRANSPORT INFRASTRUCTURES .......................................................................... 23

3. AIRPORT OWNERSHIP AND GOVERNANCE MODELS ..................................................... 24

3.1. INTRODUCTION ........................................................................................................... 24

3.2. PUBLIC OWNERSHIP AND GOVERNANCE MODELS IN THE AIRPORT SECTOR .................. 24

3.2.1. INTRODUCTION ........................................................................................................ 24

3.2.2. PUBLICLY OWNED AIRPORTS OPERATED BY A GOVERNMENT DEPARTMENT ................... 25

3.2.3. PUBLICLY OWNED AIRPORTS OPERATED BY A LOCAL GOVERNMENTS ........................... 25

3.2.4. PUBLICLY OWNED AIRPORTS OPERATED BY A GOVERNMENT AGENCY .......................... 26

3.2.5. PUBLICLY OWNED AIRPORTS OPERATED BY A PUBLIC CORPORATION ........................... 26

3.2.6. PUBLICLY OWNED AIRPORTS OPERATED BY NOT-FOR-PROFIT COMPANIES ................... 27

3.3. PUBLIC-PRIVATE OWNERSHIP AND GOVERNANCE MODELS IN THE AIRPORT SECTOR .... 28

3.3.1. INTRODUCTION ........................................................................................................ 28

3.3.2. PUBLIC-PRIVATELY OWNED AIRPORTS UNDER CONCESSION CONTRACTS ...................... 30

3.3.3. PUBLICLY OWNED AIRPORTS WITH PRIVATE OPERATION OF TERMINALS ........................ 33

3.3.4. PUBLICLY OWNED AIRPORTS UNDER MANAGEMENT CONTRACTS .................................. 33

3.3.5. PUBLIC-PRIVATELY OWNED AIRPORTS ...................................................................... 33

3.4. PRIVATE OWNERSHIP AND GOVERNANCE MODELS IN THE AIRPORT SECTOR ................ 35

3.4.1. INTRODUCTION ........................................................................................................ 35

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3.4.2. PRIVATIZATION MODELS ........................................................................................... 37

3.4.2.1. Management/Employee Buy-Out...................................................... 37

3.4.2.2. Trade Sale ........................................................................................ 37

3.4.2.3. Market Flotation via Initial Public Offering (IPO) ............................... 38

3.4.3. PRIVATE VENTURES IN THE AIRPORT SECTOR ............................................................. 39

3.4.4. AIRPORT PRIVATIZATION: FOR OR AGAINST? .............................................................. 41

3.4.4.1. Benefits of Airport Privatization ........................................................ 41

3.4.4.2. Drawbacks of Airport Privatization .................................................... 43

3.5. CONCLUSION ............................................................................................................. 44

4. AIRPORT FINANCE ............................................................................................................... 46

4.1. INTRODUCTION ........................................................................................................... 46

4.2. SOURCES OF CAPITAL ................................................................................................ 46

4.2.1. RETAINED EARNINGS................................................................................................ 46

4.2.1.1. Introduction ....................................................................................... 46

4.2.1.2. Airport Revenues .............................................................................. 46

4.2.1.3. Economic Regulation ........................................................................ 47

4.2.2. SPECIAL PURPOSE TAXES ........................................................................................ 49

4.2.3. GOVERNMENTAL GRANTS ......................................................................................... 49

4.2.3.1. Introduction ....................................................................................... 49

4.2.3.2. European Union Structural and Cohesion Funds ............................. 49

4.2.3.3. American Airport and Airway Trust Fund .......................................... 51

4.2.3.4. Japanese Special Account for Airport Development......................... 51

4.2.4. DEBT ...................................................................................................................... 51

4.2.4.1. Low Cost Loans ................................................................................ 51

4.2.4.2. Commercial Loans ............................................................................ 54

4.2.4.3. Bridge Financing............................................................................... 54

4.2.4.4. Bond Financing................................................................................. 54

4.2.5. QUASI DEBT-EQUITY ................................................................................................ 55

4.2.5.1. Introduction ....................................................................................... 55

4.2.5.2. Yield-Based Preference Shares ....................................................... 56

4.2.5.3. Mezzanine Debt................................................................................ 56

4.2.6. EQUITY ................................................................................................................... 56

4.2.6.1. Introduction ....................................................................................... 56

4.2.6.2. General Investors ............................................................................. 57

4.2.6.3. Investment Banks ............................................................................. 57

4.2.6.4. Private Equity Funds ........................................................................ 58

4.2.6.5. Venture Capital ................................................................................. 58

4.2.6.6. Stock Market .................................................................................... 59

4.3. CAPITAL STRUCTURE ................................................................................................. 60

4.3.1. INTRODUCTION ........................................................................................................ 60

4.3.2. CAPITAL CYCLE AND CASH-FLOW GENERATION .......................................................... 60

4.3.3. TAXES .................................................................................................................... 60

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4.3.4. FINANCIAL RISK AND FLEXIBILITY ............................................................................... 61

4.3.5. COST OF CAPITAL .................................................................................................... 62

4.3.5.1. Introduction ....................................................................................... 62

4.3.5.2. Cost of Governmental Grants ........................................................... 62

4.3.5.3. Cost of Retained Earnings ................................................................ 62

4.3.5.4. Cost of Debt ..................................................................................... 62

4.3.5.5. Cost of Equity ................................................................................... 63

4.3.5.6. Weighted Average Cost of Capital (WACC) ..................................... 64

4.4. CONCLUSION ............................................................................................................. 66

5. GUIDELINES FOR THE APPLICATION OF PPP IN THE AIRPORT SECTOR ................... 67

5.1. BRINGING PUBLIC-PRIVATE PARTNERSHIPS INTO POLICY AGENDA ............................... 67

5.2. STRUCTURING A NATIONAL PPP PROGRAM ................................................................. 68

5.2.1. INTRODUCTION ........................................................................................................ 68

5.2.2. SPECIFICATION OF REQUIREMENTS AND EXPECTATIONS .............................................. 69

5.2.3. ASSESSING TECHNICAL ISSUES ................................................................................. 69

5.2.4. DEFINITION OF ADEQUATE LEGAL, REGULATORY AND POLITICAL FRAMEWORKS .............. 70

5.2.5. DESIGN OF PROPER INSTITUTIONAL STRUCTURES ....................................................... 70

5.2.6. UNDERSTAND COMMERCIAL, FINANCIAL AND ECONOMIC ISSUES ................................... 71

5.2.7. STAKEHOLDERS ENGAGEMENT .................................................................................. 72

5.2.7.1. Why is it Important to Engage Stakeholders? ................................... 72

5.2.7.2. How to deal with stakeholders? ........................................................ 73

5.2.7.3. Managing relations with stakeholders ............................................... 74

5.2.8. ENSURE GOVERNMENT COMMITMENT AND DESIGNATION OF PPP CHAMPIONS .............. 74

5.3. IDENTIFICATION AND PRIORITIZATION OF THE PROJECTS .............................................. 75

5.4. DUE DILIGENCE AND FEASIBILITY STUDIES .................................................................. 76

5.5. PROCUREMENT AND CONTRACT AWARD ..................................................................... 78

5.6. IMPLEMENTATION, CONTRACT MANAGEMENT AND BENCHMARKING ............................... 79

6. FINAL CONCLUSIONS AND FURTHER DEVELOPMENTS ................................................ 80

REFERENCES ............................................................................................................................ 82

APPENDIXES ................................................................................................................................ I

APPENDIX I .................................................................................................................................. II

RESUME OF THE MAJOR CHARACTERISTICS OF THE DIFFERENT PPP MODELS (ADB, 2008)... II

APPENDIX II ................................................................................................................................ III

CONTRACTUAL STRUCTURE IN PROJECT FINANCE – APPLICATION TO AN AIRPORT PROJECT . III

APPENDIX III ............................................................................................................................... IV

CORPORATE FINANCE - PROJECT FINANCE CONTINUUM (COMER, 1996) ............................. IV

APPENDIX IV ................................................................................................................................ V

ROLES OF THE DIFFERENT PLAYERS IN PROJECT FINANCE VENTURES .................................... V

APPENDIX V ................................................................................................................................ VI

STRUCTURE OF ASSET-BACKED SECURITIES ....................................................................... VI

STRUCTURE OF CREDIT DEFAULT SWAPS ........................................................................... VI

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APPENDIX VI .............................................................................................................................. VII

STEP-BY-STEP APPROACH IN A PRIVATIZATION PROCESS (WELCH AND FRÉMOND, 1998) .... VII

APPENDIX VII ............................................................................................................................ VIII

ECONOMIC REGULATION - OTHER MODELS ....................................................................... VIII

APPENDIX VII ............................................................................................................................... X

CREDIT SCALE RATINGS OF THE THREE MOST PROMINENT CREDIT RATING AGENCIES ........... X

APPENDIX VIII ............................................................................................................................. XI

INTERESTS OF COMMON STAKEHOLDERS IN THE AIRPORT SECTOR ....................................... XI

APPENDIX IX ............................................................................................................................. XIII

DECISION TREE FOR THE PPP FAMILY INDICATOR (MFGI, 2010) ....................................... XIII

APPENDIX X ............................................................................................................................. XIV

DECISION SUPPORT SYSTEM FOR PPP IMPLEMENTATION ................................................. XIV

INDEX OF FIGURES

FIGURE 1 – REASONS BEHIND THE PPP RATIONALE (DUFFY, 2010) ................................................... 3

FIGURE 2 – FITTING THE PROJECT DELIVERY METHODS INTO THE FOUR QUADRANTS (MILLER, 2000) . 5

FIGURE 3 – STRUCTURE OF A MANAGEMENT CONTRACT (ADB, 2008) ................................................ 7

FIGURE 4 – STRUCTURE OF A LEASE CONTRACT (ADB, 2008) ........................................................... 8

FIGURE 5 – STRUCTURE OF A CONCESSION CONTRACT (ADB, 2008) ................................................. 9

FIGURE 6 – COLLATERIZED DEBT OBLIGATIONS STRUCTURE ........................................................... 14

FIGURE 7 – COLLATERIZED DEBT OBLIGATIONS, SCENARIO ANALYSIS ............................................. 14

FIGURE 8 – PRIVATE SECTOR INVOLVEMENT AND THE LEVEL OF RISK ASSOCIATED (DELOITTE, 2009)29

FIGURE 9 – BANGALORE INTL. AIRPORT, THE APPOINTED KEY FACTORS OF SUCCESS (DUFFY, 2010). 31

FIGURE 10 – CAUSES OF THE JUAN SANTAMARÍA INTL. AIRPORT PPP FAILURE (LEES, 2008) ............ 32

FIGURE 11 – EXAMPLES OF PARTIAL DIVESTITURES ......................................................................... 34

FIGURE 12 – PRIVATIZATION PROCESS (MACÁRIO, 2011D) .............................................................. 35

FIGURE 13 – STEP-BY-STEP APPROACH IN A TRADE SALE (WELCH AND FRÉMOND, 1998) ................. 38

FIGURE 14 – STEP-BY-STEP APPROACH IN AN IPO (WELCH AND FRÉMOND, 1998) ........................... 39

FIGURE 15 – BRIEF EUROPEAN AIRPORT PRIVATIZATION TIMETABLE ................................................. 40

FIGURE 16 – AIRPORT PRIVATIZATION IN CHINA, A FEW EXAMPLES ................................................... 41

FIGURE 17 – TYPICAL MARKET ABUSES IN THE AIRPORT SECTOR ...................................................... 43

FIGURE 18 – SCHEMATIC REPRESENTATION OF SINGLE-TILL (NEUFVILLE AND ODONI, 2003)............. 48

FIGURE 19 – SCHEMATIC REPRESENTATION OF DUAL-TILL (NEUFVILLE AND ODONI, 2003) ............... 48

FIGURE 20 – FINANCIAL CONDITIONS TO BE MET BY THE PROJECTS USING THE EUCF (ACI, 2010) .... 50

FIGURE 21 – MAJOR AFDB’S REASONS IN SUPPORT OF ENFIDHA INTL. AIRPORT (AFDB, 2009) ........ 52

FIGURE 22 – EIB LENDING REQUIREMENTS FOR THE AIRPORT SECTOR (ACI, 2010) .......................... 53

FIGURE 23 – CAPITAL STRUCTURE OF ATH (USD MILLIONS) (ODONI, 2007) ................................... 57

FIGURE 24 – STOCK CHART OF TAV AND THE INDEX DJ EUROSTOXX50 (REUTERS, 2011)............... 59

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FIGURE 25 – THE PROJECT DEVELOPMENT CYCLE - RISK VS. REWARD (LEHMAN BROS, 2003) ........ 60

FIGURE 26 – NORMAL YIELD CURVE (UN, 2004) ............................................................................ 65

FIGURE 27 – STEPS IN THE CREATION OF POLICY WINDOWS (VIEGAS, 2011B) ................................... 67

FIGURE 28 – BRINGING PPP INTO POLICY AGENDA, ADAPTED FROM (PARSONS, 1995) ..................... 68

FIGURE 29 – OVERCOMING GOVERNMENT FAILURES - PPP UNITS (SANGHI, ET AL, 2007) ................. 71

FIGURE 30 – FACTORS INCREASING THE ATTRACTIVENESS OF PPP PROJECTS ................................. 72

FIGURE 31 – LIKELY ISSUES TO BE RAISED BY AIRPORT STAKEHOLDERS (TAN, 2007) ........................ 73

FIGURE 32 – HOW TO MANAGE RELATIONS WITH STAKEHOLDERS (VIEGAS, 2011C) ........................... 74

FIGURE 33 – PROCUREMENT PROCESS .......................................................................................... 78

FIGURE 34 – STRUCTURING AND PREPARING A PROPOSAL FOR A PUBLIC TENDER ........................... 78

FIGURE 35 – BENCHMARKING PROCESS (ACI, 2006) ...................................................................... 79

FIGURE 36 – STAKEHOLDERS’ KPI, ADAPTED FROM (ACI, 2006) AND (SHERRY, 2006) ..................... 79

INDEX OF TABLES

TABLE 1 – POSITIVE AND NEGATIVE CHARACTERISTICS OF PPP ........................................................ 4

TABLE 2 – CHOOSING THE DELIVERY METHOD – EVALUATION CONSIDERATIONS ................................. 7

TABLE 3 – STRENGTHS AND WEAKNESSES OF MANAGEMENT CONTRACTS .......................................... 8

TABLE 4 – STRENGTHS AND WEAKNESSES OF LEASE CONTRACTS ..................................................... 9

TABLE 5 – STRENGTHS AND WEAKNESSES OF CONCESSION CONTRACTS ......................................... 10

TABLE 6 – ADVANTAGES AND DISADVANTAGES OF PROJECT FINANCE .............................................. 11

TABLE 7 – EXAMPLES OF COMMON STRUCTURED FINANCE DERIVATIVE TOOLS .................................. 12

TABLE 8 – DISPUTE SETTLEMENT TECHNIQUES AND THEIR SUITABILITY (KERF ET AL, 1998) ............... 19

TABLE 9 – EXAMPLES OF US AIRPORT GOVERNANCE MODELS (TRETHEWAY, 2001) ........................ 25

TABLE 10 – US AIRPORT FINANCE POLICIES (TRETHEWAY, 2001) ................................................... 26

TABLE 11 – INDEPENDENT NOT-FOR-PROFIT CORPORATION CHARACTERISTICS............................... 28

TABLE 12 – AIR TRANSPORT SECTOR EVOLUTION (MACÁRIO, 2011C) ............................................. 28

TABLE 13 – ARGUMENTS FOR SINGLE AND DUAL-TILL APROACHES (NEUFVILLE AND ODONI, 2003) ... 49

TABLE 14 – EVALUATION OF THE TAX IMPACT ON THE ROE OF DIFFERENT CAPITAL STRUCTURES ...... 61

TABLE 15 – DEFINITION OF LEGAL, REGULATORY AND POLITICAL FRAMEWORKS ................................ 70

TABLE 16 – 1ST ORDER EVALUATION CRITERIA, ADAPTED FROM (ANVUUR ET AL, 2006) AND (VIVES, ET

AL, 2010) ...................................................................................................................................... 75

TABLE 17 – 2ND ORDER EVALUATION CRITERIA, ADAPTED FROM (ANVUUR ET AL, 2006) .................... 76

TABLE 18 – 3RD ORDER EVALUATION CRITERIA, ADAPTED FROM (ANVUUR ET AL, 2006) .................... 78

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GLOSSARY

ABS

Asset-Backed Securities GOB

General Obligation Bonds

ACI

Airport Council International GNP

Gross National Product

ADB

Asian Development Bank IFB

Invitations for Bid

AdP

Aéroports de Paris IFC

International Finance Corporation

AfDB

African Development Bank IRR

Internal Rate of Return

ATM

Air Transport Movement LLCR

Loan-Life-Debt-Service-Cover Ratio

ATU

Airport Throughput Unit LOS

Level of Service

BAA

British Airports Authority MFGI

Ministry of Finance – Government of India

BOT

Build-Operate-Transfer MCDA

Multi-Criteria Decision Analysis

CapEx

Capital Expenditures MCAGI

Ministry of Civil Aviation – Government of India

CAPM

Capital Asset Pricing Model OpEx

Operational Expenditures

CDO

Collaterized Obligation Bonds O&M

Operation and Maintenance

CDS

Credit Default Swaps PPP

Public-Private Partnerships

CRA

Credit Rating Agencies PSO

Public Service Obligations

DER

Debt-Equity Ratio RFP

Request for Proposals

DSCR

Debt-Service-Coverage Ratio ROE

Return-on-Equity

EIB

European Investment Bank ROI

Return-on-Investment

EOI

Expressions of Interest SFB

Special Facility Bonds

EU

European Union SPV

Special Purpose Vehicle

EUCF

European Union Cohesion Funds SWOT

Strengths-Weaknesses-Opportunities-Threats

ESF

European Social Funds TOR

Terms of Reference

ERDF

European Regional Development Funds

VFM

Value for Money

FAA

Federal Aviation Administration WACC

Weighted Average Cost of Capital

GARB

General Airport Revenue Bonds WLU

Weight Loading Unit

GDP

Gross Domestic Product WTP

Willingness to Pay

1

1. INTRODUCTION

1.1. INTRODUCTORY NOTE

Nowadays there is clear evidence of the large gap that exist between the worldwide

infrastructure needs and the public resources available to be allocated to meet them, what

imposes significant socio-economic costs that have led countries towards lower productivity

levels and to a reduced market competitiveness (Eggars and Startup, 2006). Due to the current

financial constraints and the consequent lack of funds, governments have been driven to a

dead-end as infrastructure needs do not stop increasing and, at the same time, the market does

not allow acceptable financing conditions (especially in countries with low credit ratings).

Moreover, during periods of slow economic growth and financial crisis, there is a constant trend

for government to undertake serious investments so as to promote economic development,

nevertheless pressure on public finances becomes very intense, what leads to the well-known

dilemma: cut spending vs. stimulate the economy (e.g. infrastructure investments) (Vives at al.,

2010). Thus, in order to overcome this shortage and reduce the exposure of the public sector to

infrastructure investments, there has been a gradually increasing tendency for governments to

delegate to the private sector the development of major infrastructures.

This evolution opened many doors in infrastructure finance and, although it may never fully

replace traditional public procurement, the private involvement already plays a primary role in

covering worldwide infrastructure needs. Moreover, these partnerships between the public and

the private sectors constitute a step forward towards alternative financing sources, optimized

risk allocation/mitigation and maximization of projects’ Value for Money (VFM). These innovative

approaches allow a clear separation of roles, with each partner being responsible for the tasks

in which it is expert. Therefore, the private sector is assigned the responsibility of developing

customer and value-oriented businesses, while the public sector shall define the service to be

provided and which are the Public Service Obligations (PSO) to be complied, as well as to

regulate the market, with the purpose of preventing abuses.

On the other hand, the air transportation sector has grown hugely in the XX Century and the

market expectation is the continuation of this trend. This industry, an important vehicle of

national economic well being, also has a deep influence in the development of societies and in

the increase of mobility, allowing strengthening the financial competitiveness of countries but

with a constant inherent social perspective. However, airports are very capital-intensive

infrastructures therefore, despite the sector’s major positive socio-economic impacts, due to

political reasons, many governments become reluctant to fund such large scale projects and

end up neglecting its importance, inducing a significant infrastructure gap in the sector.

Although airports have typically been public assets, there is an increased trend for involvement

of the private sector in the industry. Despite the privatization tendency has already begun, fully

privatized airports are still rare, particularly because airports are believed to benefit from a

monopolistic status what has discouraged governments to pursue this path. Thus, Public-

2

Private Partnerships (PPP) appear as a possible solution for governments to keep enough

power to intervene in the sector and, at the same time, take advantage of the private benefits.

1.2. OBJECTIVE

This project aims to reckon on the realities described above, focusing on how PPP might be

applicable in the development of the worldwide airport network. The objective is to define a set

of guidelines that will help policy makers structuring the political decision making process,

avoiding neglecting imperative points of analysis, and potential investors evaluating projects,

preparing proposals and raising awareness to matters deemed to be significantly important in

the development of PPP ventures.

1.3. STRUCTURE OF THE DISSERTATION

Firstly, it is carried out a thorough analysis of the state-of-the-art of PPP in Transportation,

clearly clarifying the concept, addressing the different types of contracts that exist and

highlighting their weaknesses and strengths. On the following section, focus is given towards

the different ownership and governance models present in the airport sector. Strongly supported

by real case studies, this section allows a comprehension of the huge variety of modalities that

exist regarding the shareholder structure of airports. The subsequent topic analyzed is Airport

Finance, with a careful identification of the different sources of capital available for the

development of airport ventures, as well as the factors that influence the definition of the capital

structure of an airport project.

Last but not least, the final section focuses on the core topic of the project: setting a batch of

structured guidelines for PPP implementation in the airport sector. The PPP issue is here

addressed since its initial stage, where it shall be found a policy window to bring the topic into

the political agenda, and proceed throughout all relevant stages until it reaches the project is

implemented and in operation. In all, this guide has the purpose of enlightening all players

involved in PPP procurement regarding the imperative issues that must be considered in the

development of successful PPP.

For many years PPP have been wrongly applied, with several cases of failure and very few

successful ones, what created a major prejudice concerning this type of infrastructure delivery

models. This project aims to prove that PPP have numerous potentialities and that, with

properly designed and carefully analyzed plans, it is possible to launch PPP endeavours with a

high likelihood of success, as long as some specific matters are taken into account in the

planning stage, and monitored until the end of the contract.

3

2. PUBLIC-PRIVATE PARTNERSHIPS IN TRANSPORTATION

2.1. THE CONCEPT

PPP are contractual agreements between the public and the private sector that aim, through a

proper allocation of risks, to assign the private sector responsibilities typically undertaken by

governments, in particular, infrastructure investments. In this context, while governmental

objectives may be to either achieve gains in efficiency or to reduce the public exposure to

capital projects as infrastructures, private goals shall be to take advantage and extract financial

benefits of business opportunities frequently restricted to the public sphere. In this document,

the PPP concept is broadly regarded, with every interaction between the public and private

sectors being considered, since management contracts until partial divestitures.

Considering the Principal-Agent Theory, in PPP the definition of roles is simple: while the State

plays the role of Principal, defining the necessary specifications for the development of the

project, the private partner plays the role of Agent, responsible for the delivery of service and

act according to the guidelines provided by the Principal (Viegas, 2011a). Despite their typically

high transaction costs (Miller, 2000), these models have been emerging in the past few years as

a common response towards public infrastructure delivery, specially because of the potentially

good risk allocation/mitigation it allows, as well as the cutting-edge management perspective

brought by the private sector that gives room to innovation and optimization (as long as

contractual incentives are previously defined).

Figure 1 – Reasons behind the PPP rationale (Duffy, 2010)

With the financial constraints the world is facing, the banking sector experiencing liquidity

problems, the countries’ overweighed Sovereign-debt and the clear attack to the sustainability

of worldwide economic system, PPP seem to be a valid alternative for the development of major

projects. In fact, the potential of these infrastructure delivery models may play an important role

towards the decrease of the impact of public investments in countries’ public deficits,

predominantly because PPP allow governments to allocate capital resources in a more efficient

way, tackling a more diversified range of projects and achieving higher VFM.

Maximization of the business

potential

Proper risk allocation

Reduction of the burden over public budget

Implementation of state-of-the-art technology

Alternative financing sources

4

Table 1 – Positive and Negative Characteristics of PPP

Positive Characteristics

Description Negative

Characteristics Description

Value for Money

• VFM means achieving a far superior service for a less than proportionate increase in costs. Ideally, PPP would allow higher benefits at overall lower costs;

• Achieve higher VFM is the major justification to launch PPP; • Demands minimizing life-cycle costs according to the

performance levels required, through the maximization of the use of the most innovative design and the best construction methods, together with the implementation of state-of-the-art operational systems and the best maintenance support,

• Requires long-term view in terms of risks/costs accountancy;

Private vs. Public Finance

• Public finance is always cheaper than private finance (typically 1-3% higher);

• Major aim shall be to maximize VFM and not to minimize interest rates;

• Determining VFM is not just about comparing interest rates; • Delivering more efficient services, with more long-term

benefits, mean higher VFM and a consequent outweigh of any additional margin on financing costs.

Construction Performance

• There are incentives for the private sector to avoid cost overruns and delays;

• As soon as the service is being delivered, the sooner cash flows will start being generated.

Public Sector Employment Conditions

• The private involvement in public structures will likely mean a staff restructurization;

• Although the loss of jobs is likely, it shall be considered this is a step towards more efficient services, provided at lower costs;

• Previously these inefficiencies in terms of human resources were being subsidized by the tax payers.

Operational Performance

• Full-service delivery ensures there is a focus on the whole life cycle of the project;

• Combining design/construction/operation is likely to bring create synergies;

• Private engagement brings know-how and allows the implementation of more dynamic business models;

• Elimination of redundancies and sources of inefficiency.

Ring-fencing structure

• Development of closed structures that might mislead the State and drive to situations of capture;

• Solution may be the implementation of a public institution, responsible for monitoring and publishing future PPP commitments to prevent spending departments over-reaching themselves.

Strengthen national Infrastructure

• PPP creates the opportunity to develop infrastructures and provide services, which probably would not be possible if to be publicly-led (due to budgetary constraints);

• Delivery better designed operated infrastructures.

Contract length

• The contractual length is argued to restrain political action; • Situations of lower levels of service are possible to occur

during the contract, thus benchmarking procedures must be included in the contractual clauses to prevent this.

Innovation and spread of best

practice

• There are incentives to constantly innovate and implement cutting edge procedures, as long it improves the overall service and attracts higher revenues and/or reduces costs.

High transaction costs

• Procurement implies very significant transaction costs; • Requires more demanding technical work than conventional

procurement; • Early PPP projects are costly, however the standardization of

these procedures and contract forms may reduce these costs; • Due to its costs, PPP ventures shall not be used in small

projects.

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In this type of solutions, contract design and management play a major role and may be

appointed as two of the most important steps in order to achieve successful partnerships and

satisfactory infrastructures and services (Genton, 2011). Despite their potential, the complexity

of these contracts has been highly criticized since they frequently lead governments to higher

public expenses than if the project was publicly held. Reasons such as contractual gaps, harsh

disputes1 or inappropriate risk management may drive to extremely difficult situations, such as

governments bearing “hidden” responsibilities and incurring in significant expenses, or

governments bailing projects out to ensure the continuity of the service (Fraport, 2011).

Opportunities that may arise from PPP are not a secret anymore, however it is imperative to

understand where potential is concentrated and how decision makers can optimize their usage.

2.2. CONTRACT DESIGN IN INFRASTRUCTURE DELIVERY

To properly understand the basis of contract design in infrastructure delivery, it is imperative to

understand the profile of the goods to be delivered. Transport infrastructures may be considered

mixed public-private goods, characterized by non-rivalry, since what is consumed by one is

independent from what is consumed by other individuals, but with the possibility of excludability,

as it is possible to discriminate someone of consuming a determined product (van der Laan et

al, 2001), through pricing policies, for instance. So, due to these characteristics and because of

the growing involvement of the private sector, specific regulation is mandatory to prevent

hypothetical market failures that may arise.

Regarding the available delivery methods, they may be separated in:

Figure 2 – Fitting the Project Delivery Methods into the Four Quadrants (Miller, 2000)

Taking into account the different stages in the lifecycle of an infrastructure, delivery methods

may be aggregated in two groups – Segmented or Combined – where in the former every stage

is contractually independent while in the latter, stages are combined in the same contractual

package. The choice criterion to decide upon this must be, the more the State is able to control

1 In transportation, the main reason for disputes is the low demand levels that do not meet the forecasted values, announced by the government in the procurement process.

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the quality/time/costs of each stage, the more segmented the delivery can be (Miller, 2000)

thus, if public institutions do not have the required in-house expertise to perform stage-by-stage

control, competence must be shown in specifying the delivery requirements, the technical

specifications, project deadlines, cost structures and the level of flexibility required with the

ultimate aim of assigning the development of the project to a specialized consortium.

The Segmented approach, although it can be an interesting solution for skilled governments, it

might contribute to a loss of value of the project, since less immediate risks may be transferred

to further stages (Miller, 2000). So, there has been a trend towards Combined approaches (e.g.

Build-Operate-Transfer (BOT)), where the success depends on the governmental competences

to specify the project’s requirements, to design and manage contracts and to transparently carry

out the procurement process (Iosa et al, 2007). In Combined Models, despite there is the

advantage of lower cross-stage risks, competitiveness of the tenders decreases substantially,

since the number of qualified bidders diminishes, consequently increasing companies’

bargaining power and implying an increased risk of State capture and litigation (Thobani, 1999).

Moreover, in the Combined approach, when carrying out the project’s lifecycle costs analysis,

special attention must be given to both the maintenance stage since, in periods of crisis, these

procedures may be neglected, leading to severe under-financing issues and consequent loss of

demand due to the lower Levels of Service (LOS) being provided (Miller, 2000).

Another relevant point that must be addressed concerns who will bear the investment costs. In

most cases, public interest has led governments to be the major infrastructure suppliers, being

usually included in the State budget2. Nevertheless, governmental capital sources have not

been enough to cover all the infrastructure needs, what has driven governments to call for

private involvement for the development of new ventures. Thus, taking this into account,

another criterion in infrastructure delivery arises – Direct and Indirect Finance – addressing

whether projects shall be publicly or privately financed. In order to maximize projects’ VFM, this

criterion aims to evaluate which option is the most beneficial (Miller, 2000).

To conclude, it is worth-emphasizing that as infrastructure investments have a huge socio-

political impact, bringing them to the political agenda may become a priority for many politicians.

The urgency for the State to build new infrastructures may derive in severe damaging national

outcomes, such as vaguely defined tenders being launched and projects being awarded,

causing highly inflated final prices or inappropriately assessed projects with poor risk allocation

plans, leading to situations of State capture. Both scenarios induce a costly spiral, where public

money is used to cover the errors from the past, therefore, in situations of lack of experience or

urgency in the agenda, despite the transaction costs are higher, shorter concession terms may

be preferable since the risks of State capture and project bailout are by far lower (Miller, 2000)

and allow a review of the process being conducted in a short period basis.

2 Usually taxes over direct (i.e. users) and indirect (e.g. land-owners or shop-keepers) beneficiaries of the infrastructure, as well as sources of funding from national, regional or local political level (Irwin, 2003).

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Table 2 – Choosing the delivery method – Evaluation Considerations

Delivery Method Evaluation Considerations

Segmented/Combined Delivery Method

• Cross Stage Risks: Coordination Problems, design and construction errors, etc; • Governmental expertise in controlling every stage of the project; • Governmental knowledge and certainty regarding the investment Program; • Governmental ability to specify construction and operational requirements; • Competitiveness in the tender and bargaining power by the private contractor.

Directly/Indirectly Financed Delivery

Method

• Private financing is more expensive than public (overcome by efficiency gains); • Project’s returns based on taxes, it is still public money being allocated; • Project’s returns based on user charges, the State can undertake bond financing

and use the charges to cover the investment3; • PSO and economic regulation4 may drive the State to bear more commercial risks; • Contract length may be incompatible with needed policy changes (Thobani, 1999); • So as to banks reduce loans’ interest rates, they may demand a DSCR of 1,5

(Farrell, 2011a), imposing the need for public funds so as to ensure financing5

2.3. MAJOR TYPES OF PUBLIC-PRIVATE PARTNERSHIPS

2.3.1. INTRODUCTION

PPP derivations are countless as they can involve the public and the private sectors in many

different forms, from simple to extremely complex partnerships, and they may vary in the

ownership structure, ultimate investment liability, risk allocation, contract length, etc. (See

Appendix I).. The suitability of each model depends on various factors but especially on the

goals and constraints predefined by the governments promoting the venture.

2.3.2. MANAGEMENT CONTRACTS

Management Contracts are short term contracts, typically 3 to 5 years, where a private player is

awarded the responsibility of managing a determined service (Tomová, 2009). As production

and commercial risks are not borne by the private agent, contracts are frequently designed as

performance-based, in order to incentivize the implementation of innovative practices.

Furthermore, as the purpose of a management contract is exclusively to bring managerial

expertise into the public sector, private parties are not aimed to invest in the project.

Figure 3 – Structure of a management contract (ADB, 2008)

3 Investments may be undertaken based on misleading forecasts, inducing the belief that user charges are enough to cover the investment when, in fact, they are not. 4 Legacy constraints may also arise. A good example is, for instance, tariffs set during the period when the public sector was running the service, which are not allowed to be increased by the private operator. 5 However the DSCR requirement is rarely referred, it has a strong effect on the project’s bankability.

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Depending on the aim of the government promoting the venture, management contracts may be

very useful since, within a relatively simple contractual model, they allow taking advantage of

the private sector´s expertise and, at the same time, keeping the asset’s ownership structure

public. However, the specification of periodical benchmarking processes is imperative in order

to allow a constant performance evaluation and a review of the goals/requirements/methods, to

better adjust the service according to the dynamics of the market and the societal needs and to

prevent situations of low performance periods (Viegas, 2011a).

Table 3 – Strengths and weaknesses of Management Contracts

Strengths Weaknesses

Operational gains without transferring assets to the private sector

Separation between the obligation for service and management, from financing and expansion planning

Less complex and relatively low-cost contracts with lower risks of public contestation

The management contractor may not enjoy enough autonomy to implement structural changes

Suitable for interim arrangements, allowing modest improvements and more comprehensive contracts

Attention shall be given to the veracity of the financial reports (prevent inflated achievements)

Trials for future increasing engagement of the private sector, allowing evaluation of the process

Awareness shall be raised concerning deficient maintenance procedures (to improve the balance-sheet)

2.3.3. LEASING CONTRACTS

In Leasing Contracts private agents in addition to managing the infrastructure, they also bear

the production and commercial risks generated by the development of the economic activity

(Iosa et al, 2007). These contracts assign the definition of the business strategy to the private

players, which shall meet the quality standards and technical specifications contractually

defined by governments, run the service, bear the O&M costs and have the financial capability

to deal with the likelihood of demand variability.

Figure 4 – Structure of a lease contract (ADB, 2008)

Since production and commercial risks are privately borne, this performs as a natural incentive

for optimization and improvement of the service. Nevertheless, it shall be considered that, in

leasing contracts, public authorities remain liable for the ownership rights of the infrastructure,

meaning that both expansion and refurbishment investments are to be publicly carried.

With typical contractual durations of 10 to 15 years, it is worth mentioning that leasing contracts

bring attached a high risk of litigation related to any external factors that may affect the demand.

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Table 4 – Strengths and weaknesses of Lease Contracts


Commercial risk being borne by the private sector plays as an incentive towards higher levels of efficiency

Awareness shall be raised concerning deficient maintenance procedures (to improve the balance-sheet)

Private partner pays a fee for using the public assets, although it does provide investment capital

As the private sector bears the commercial risk, abusive pricing structures may become a reality

2.3.4. CONCESSION CONTRACTS

2.3.4.1 THE CONCEPT

Concession contracts may be divided in two groups, concessions for public services or for

public works. While in the former, the concessionaire is assigned the role of delivering a

determined service, according to the respective specifications, and for developing minor and

very specific investments, in the latter the private party is responsible for the full-service

delivery, including construction, rehabilitation, operation, maintenance and management of a

major infrastructures, such as airports (ADB, 2008).

Figure 5 – Structure of a concession contract (ADB, 2008)

Typically awarded through competitive tenders, in Concession Contracts, private consortia are

usually composed by companies of different industries, with the purpose of covering the

different expertise areas required by the projects. The procurement process shall end when the

project is awarded to the proposal showing to extract best value from the project, through the

maximization of the VFM (Deloitte, 2009).

A typical approach within Concession Contracts is the BOT solution, where the winning bidder

is granted specific rights to build and operate a facility for a determined period of time, usually

between 15 to 50 years (Graham, 2008), during which the ownership rights are kept by the

private side6, being then transferred to the State by the end of the contract (Zarco-Jasso, 2005).

In this type of contracts, the majority of the risks are borne by the private sector during the

concession duration, what plays as a natural incentive for good performance.

6 This seriously depends on the national legislation, nevertheless the State usually keeps “step-in” rights over the concession, in the event the concessionaire fails to meet the contractual clauses.

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Table 5 – Strengths and weaknesses of Concession Contracts


Effective way to attract private finance Complex Contractual Design and Management

Provides incentives to the operator to achieve improved levels of efficiency and effectiveness

Need for governmental upgrade of the regulatory capacity

The transference of the operating and financing responsibilities enables more efficient resource allocation,

investments’ prioritisation and innovation

Limited competition given the limited number of qualified consortia

Within the concession model, some creative payment relations may be developed, such as

situations where the concessionaire pays the government for the concession rights or where the

government may also pay the concessionaire a determined rent7. In fact, especially in the initial

stages of some projects, governmental payments may be necessary to reduce the commercial

risk to be borne by the private players, so as to increase the attractiveness of the investment.

Moreover, it is important to make a comment on the length of these contracts. Due to the huge

capital investments associated to infrastructure development, these contracts are expected to

be long enough so that the project can mature and bring returns to private investors, otherwise

no private company would be willing to enter the venture (ADB, 2008). One typical contractual

incentive in concessions is the option of contract renewal for an additional period (Garcia et al,

2005), either to give private investors the chance of having more time to recover the investment

(in the event of the demand not being the forecasted), or because the contract extension allows

the continuity of the business.

A final worth mentioning mutation of concessions is the Interlinked Back-to-Back Contracts.

These agreements are similar to BOT, where the private sector is responsible to build and

operate an infrastructure for a certain period of time, differing only in the existence of an

imposition for the public side to build and operate some complementary/ancillary infrastructures

(Farrell, 2011a). This approach is very common in Greenfield port developments, for instance, in

which the terminal development to be carried out by a private consortium is conditional on the

public sector investment in breakwaters and dredging devices.

2.3.4.2 PROJECT AND STRUCTURED FINANCE

THE CONCEPT

Project Finance is a highly-leveraged8 type of long term infrastructure finance, based on the

projected cash flows of the project rather than on the shareholders’ balance sheets (Hillion,

2011). It is the typical financing model typically used in Concession Contracts, and more

particularly in BOT-type ventures, where the public sector instead of procuring the asset by

7 Only if the requirements imposed by the State are such that would make the project financially infeasible. 8 Usually, in project finance, debt accounts for 80 to 90% of the capital required to launch the project.

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paying for it full up front, awards the development of the infrastructure to a private consortium,

which creates a privately financed and operated corporation – the Special Purpose Vehicle

(SPV) – to carry out that specific venture (Estache et al, 2007) (See Appendix II). This way, it is

created an opportunity to properly allocate the risks between the public and the private sectors

considering their ability to manage them (Harris, 2003), and specially to reduce the sponsors’

exposure to the project’s risks. Besides, due to its structure, project finance ventures allow

project sponsors to undertake new endeavours without granting the lenders full recourse to their

assets, eliminating contagion risk. However, it shall be noticed that if the SPV faces difficulties

in complying with the debt terms, or especially in the event of default, senior lenders are entitled

to claim rights on assets and assume the managerial control of the project.

Table 6 – Advantages and Disadvantages of Project Finance

Advantages Disadvantages

Sponsors’ risk exposure is significantly reduced Complex structuring process

Maximization of the project’s leverage capabilities Higher transaction costs than traditional procurement

Off-balance sheet treatment of debt financing Private capital is more expensive than public’s

Sponsors’ creditworthiness is not affected by the project Demands intensive contract management procedures

Optimized risk allocation Loss of management flexibility due to high bureaucracy

Interest on debt is tax deductable9 Usual lack of transparency of project’s financial situation

Maximization of returns to the shareholders10 Significant risk of State capture

In general, project finance involves a consortium of equity investors associated to a strong

banking syndicate, which will be responsible for the design of the financial plan, for the

securitization of the investment, to assist in the equity capital raising and in the bond issuance.

For the sponsor-shielding to happen, the loans provided are non-recursive, meaning that the

project is exclusively secured by its own assets and revenue-producing contracts (Hillion, 2011).

Another important point to emphasize is the importance of risk management in project finance11,

as the identification and allocation of risks is a vital component in the assessment of the

financial feasibility of a project. In the majority of the cases, specialist risk management

companies are hired to design risk allocation plans with the purpose of creating acceptable

financing conditions. Riskier projects may require more complex structures that may include

options, insurance or other forms of credit enhancement (Tan, 2007).

Project finance has gained a huge relevance in the way how infrastructure investments have

been developed in the past few years and its major economic motivations were the off-balance

9 While, usually, dividends to shareholders are not. 10 Less equity capital implies lower cost of capital and consequently, higher returns to shareholders. 11 Topic is thoroughly addressed in a further section.

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treatment of debt finance, the non-recursive loans and the significant reduction of contagion risk

(See Appendix III to assess differences between Corporate and Project Finance).

With the increasing demand for larger, riskier and more complex projects, the concept of

Structured Finance arose, so as to overcome the difficulties felt in the definition of the financial

plan of the concerning ventures. In all, structured finance combines a batch of financial

techniques used to help splitting and transferring investment risks, to those more capable to

bear them or who are willing to bear them in exchange for financial benefits, with the ultimate

aim of allowing projects with special financing needs to be developed, with tightly controlled

risks and consequently better credit conditions (Servigny and Jobst, 2007). This risk

transference is achieved through complex financial operations based on derivatives, which are

securities whose value is dependent upon one or more underlying assets such as stocks,

bonds, commodities, currencies, interest rates or market indexes (Jobst, 2005). Due to the

misleading overuse of derivatives in the past, structured finance has been widely criticized and

pointed as the major source of the 2007-2008 financial crisis (Coval et al, 2008).

Furthermore, as these financial tools are generally debt-related, structured financing tools are

very susceptible to the ratings assigned by credit rating agencies (CRA). Typically, since

institutional investors are only allowed to buy debt with very high ratings, very often, it is needed

to proceed to credit enhancement, which is a solution of creating a security that has a higher

rating than the issuing company (Macário, 2011a).

Table 7 – Examples of Common structured finance derivative tools

Tools What are they?

Asset-Backed Securities Bonds based on pools of assets, or collateralized by the cash flows from a specified pool of underlying assets.

Collaterized Debt Obligations

Group of fixed-income assets, like high-yield debt or asset-backed securities, gathered into a pool and divided into various tranches.

Credit Default Swaps Contracts that provide insurance on debt, which does not demand setting capital apart to cover eventual losses.

To conclude, structured finance solutions allow companies/projects, which in principle would not

meet the minimum requirements to incur debt, to be financed, thanks to a thorough

mitigation/allocation of the investment risks. The reasons behind this lay on the fact that,

usually, loan providers specially focus on the borrower’s reliability and creditworthiness, in

contrast to structured finance where the emphasis in given to the robustness of the business

transaction (Coval et al, 2008).

STRUCTURING A PROJECT FINANCE VENTURE

Concerning the contractual network in project financing, the structures are usually very complex

not only due to the number of entities involved but mainly because of the direct and indirect

interactions between all players (See Appendix IV). These multiple and bilateral relations are

13

integrant part of any venture and that is why a thorough contract management procedure is

essential to ensure success. In fact, these contractual networks are the basis of risk allocation

and therefore it is imperative, particularly for lenders, to ensure that there are no gaps and that

every risk is properly allocated, in order to guarantee the strength of the consortium.

The complexity of these business structures lead many times to the ring-fencing of projects, not

allowing an easy comprehension of the project’s operation, which are the partners involved, the

existing contracts between them and especially about the financial status of the company

(Macário, 2011b). It is essential for the State to prevent situations like this, especially

considering that State capture is frequent in project financing ventures.

APPLICABILITY OF STRUCTURED FINANCING TOOLS IN INFRASTRUCTURE FINANCE

In this section, some practical examples will be given so that it is possible to easily understand

how structured finance actually works and why it is useful. In these hypothetical examples, three

types of financing tools will be addressed: Asset Backed Securities, Collaterized Debt

Obligations and Credit Default Swaps. As referred before, these tools are used to enhance the

credit quality of investments so that they may become financeable.

• ASSET BACKED SECURITIES (ABS)12

If an investment bank identifies interesting infrastructure investments and is chosen provide the

project promoters the capital for the development of their projects, it entitles the bank the right to

claim principal and interest (P&I) payments. However investment banks’ core business is not to

provide loans, so it may be interested to take these loans off their balance sheet (Gaisor, 2007)

and spread the credit risk (especially if there is high correlation of default between the loans).

So as to accomplish these objectives, an independent SPV is created to which the loans and

the rights over P&I are sold. The creation of this entity allows investment banks to take these

assets off their balance sheets, spread the risk and, at the same time, fund the loan operations

(Khan Academy, 2007a). This process is done through the “structurization” of the loans,

meaning that loans are pooled together, sliced in smaller tranches and then sold to investors.

These securities, also known as Asset-Backed Securities, grant investors rights over P&I.

This type of products is very exposed to the creditworthiness of the projects being financed,

thus the likelihood of default shall be carefully accounted. For instance, assuming that in the

case above, the yields applied to the loans are 10%/year however, considering historical data,

credit profiles, and past events, the likelihood of default is 20% (with only 50% of recovery,

through the sale of the underlying assets). This means that from the 10% annual interest rate,

10% is likely to be worthless, reducing the expected average interest rate to 9%.

In order to broaden the group of investors that could be involved in similar investments,

covering different investment profiles and bringing more varied capital to these operations

(Khan Academy, 2007a), the well-known CDO.

12 Check Appendix V for an illustrative figure of an ABS structure.

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• COLLATERIZED DEBT OBLIGATIONS (CDO)

So as to diversify the profiles of potential investors, new financial tools were developed, the

CDO, with the goal of attracting more and different capital. CDO are the result of slicing the SPV

in tranches which are not all equal (Ferguson, 2010), which have varied characteristics that aim

to suit different investment profiles.

Figure 6 – Collaterized Debt Obligations Structure

Seniority plays a vital role in the definition of the tranches and, in Figure 6 it is possible to

understand that senior debt holders are the first to get paid, then in the second line of seniority,

subordinated debt holders are the following group to be entitled to payments and finally

shareholders are eligible to get paid. Worth-emphasizing is the fact that if shareholders are not

paid any dividends, it does not mean that the company is not forced into default.

Figure 7 – Collaterized Debt Obligations, Scenario Analysis

For instance, in Figure 7, only in the last scenario the company is forced into default, beginning

a cascade effect that may lead to situations similar to the 2007-2008 financial crisis. An

interesting point is that the equity tranche, also known as residual tranche or toxic waste, is

15

usually kept by the originator of the loans (Khan Academy, 2007b), the investment bank,

justifying the partial collapse of the banking in the referred crisis13.

• CREDIT DEFAULT SWAPS (CDS)14

Essentially, CDS are insurance on debt, provided by institutions like insurance companies or

investment banks (Khan Academy, 2008). To exemplify the use of CDS, the following example

will be considered15:

o Two Pension Funds (PF) are willing to invest their cash reserves, but are only

allowed to invest in high rated (equal or higher than A- rating16).

o Corporations A (CA) and B (CB) want to develop capital-intensive projects;

o Both CA (BBB rating) and CB (BBB- rating) have a credit risk profile which does not

match PF’s requirements that would allow them to invest in the referred projects.

Taking this into account, an Insurance Company (IC), whose credit rating is compatible with

PF’s requirements (A rating), says it is confident CA and CB are solid companies and that it

would be willing to provide insurance on their debt (in exchange for a percentage of the

interest), meaning that in the event of default IC would repay the PF the money lent.

Considering this situation, CA and CB’s profile is upgraded from BBB and BBB- to A, allowing

PF to invest on them.

Despite the potential of these financial instruments, as they allow creating the adequate

conditions for enterprises to finance and undertake capital investments, credit derivatives have

been widely used with perverse objectives, particularly due to poor judgement in the decisions

made, what justifies the statement that they are “financial weapons of mass destruction” (Buffet,

2003). For instance, it is worth-mentioning some issues about the CDS:

o Institutions providing capital insurance created a very attractive business model,

generating revenue streams without actually doing/creating anything;

o Insurers are not required to set aside capital to guarantee repayment in the event of

default (Ferguson, 2011), meaning they may be insuring money they do not have;

o There are no clearly specified limits for the amount of capital that may be insured by

this type of companies (Khan Academy, 2008). Regulation is still very poor;

o The derivatives market is widely dependent on the opinions of CRA, which are

entities responsible for giving opinions on the creditworthiness of other entities.

Being private companies, CRA have their own agenda and motivations;

13 In the 2007-2008 financial crisis, the problem was related to mortgages, when interest rates increased significantly, and borrowers started not being able to comply with their payments (Ferguson, 2010). 14 See Appendix V for an illustrative figure of how complex the usage of CDS may become. 15This example, including the credit ratings assigned, are completely hypothetical. 16 The credit rating scale considered in the example is Standard & Poor’s - See Appendix VII

16

o In the past, CRA were indentified to be in the middle of situations of conflicts of

interest and market manipulation/speculation. The debate regarding the

transparency and validity of CRA is in the forefront of the financial industry, as their

incentives might drive to misleading market conclusions.

RISK MANAGEMENT IN PROJECT FINANCE

From what has already been referred, the importance of risk management in project finance is

evident. Before analyzing deeply each one of the risks involved in airport ventures, it is worth

emphasizing two aspects considered to be very relevant for the project’s profile:

� Country’s Risk Profile is an imperative factor of evaluation when investors/lenders

analyze the viability of investments. Stability and reputation, especially regarding

respect for private property rights and regulatory commitments, are very important

topics that can reduce investors’ risk perception;

� Private Consortium’s Reputation is a very important evaluation factor for the public

sector to evaluate bids. If the winning consortium is composed by reputed partners,

which imperatively need to preserve their reputation, there is a natural incentive for

good performance. In contrast, companies with contracts being withdrawn and

constantly involved in legal disputes or unknown start-ups may be dangerous partners;

Finally, for a proper management and transfer of risk, it is important that the public sector is

conscious that private parties will not be willing to take any risk that they are not in the position

of controlling. Therefore, both parties must understand which are the risks involved and try to

optimize the transfer of risk.17.

• PRODUCTION RISKS

o Design and Construction Risks

The private consortium responsible for developing the infrastructure may integrate (or

subcontract later) a designer firm and a strong conglomerate of contractor firms.

Typically, regarding the Design Risk, clear specifications are provided by the government for the

design, so the Designer Firm is responsible to meet all the requirements foreseen by public

authorities. From here three possible situations are possible:

� Design fault in the tender specifications, the public sector bears the risk;

� Contractor fault due to not meeting the specifications, liquidated damages are to be

paid by the SPV (Kerf et al, 1998);

� Sometimes, another entity, either public or private, may be contracted in order to review

if the proposed design meets the contractual requirements (Genton, 2011). In this case,

the design risk shall be then shared by the public and private sectors.

17 Rather than maximize the transfer of risk, as it would decrease the attractiveness of the investment.

17

Concerning the Construction Risk, typically being under turnkey contracts, the consortium shall

be the responsible entity for every cost overrun, delay in completion or failure to meet

performance criteria, being liable to pay liquidated damages. Nevertheless, there are two

exceptions where construction faults are not under the SPV’s control and therefore, they may

be entitled to capital aid or an extension of time for the delivery of the project (Genton, 2011):

� Force Majeure events - the risks are regularly transferred to an insurance firm;

� Government actions that affect the project - public sector bears the risks.

o Technological Risks

This risk, which falls squarely on the operational side, shall be assumed by the SPV. The

concessionaire must be the responsible entity for the maintenance and upgrading of

technological systems during the whole contract term, if either the systems are believed to have

become obsolete/deficient or if these may provide them with a competitive advantage.

o Environmental Risks

In a preliminary stage, environmental assessments should be carried by the government in

order to analyze the environmental viability of the project. Clear specifications regarding the

project’s environmental constraints must be specified and contractually defined by the State.

Throughout the lifespan of the project, the SPV must be liable for the impact of its procedures,

being responsible to implement environmentally adequate operations, as specified in the law

and/or in the contract.

• COMMERCIAL RISKS

o Demand Risks

There are several approaches considering the demand risk, however it is generally shared

between the State and the SPV (even though the latter is supposed to be the major bearer).

The most common scheme foresees a definition of a lower threshold of demand, below which

the State would either cover the operational expenses of the SPV and assign a monetary

compensation to the concessionaire, or extend the contract term for a longer period (Iosa, et al,

2007). It is important to ensure that this lower threshold is carefully defined so that problems of

State capture are avoided18.

In order to update and adjust the project throughout the contract term, it is imperative to carry

out periodical reviews of the contractual and operational conditions, control the project’s

financial health and prevent situations of demand decrease due to shortfalls in service quality.

o Competition Risks

Competition risks shall be borne by the SPV however, governments may have a word regarding

restraining nearby competition in order to protect the financial feasibility of the venture and

18 Defining a too high lower threshold may imply the concessionaire is bearing no commercial risk at all.

18

make it more attractive to potential investors. For instance, although it would be possible to find

more liberalized markets, with airports operating under perfect competition, the most common

approach, in airports’ PPP, is contracts explicitly referring that no competition shall be induced

in the market (e.g. definition of an exclusivity area around the airport to be developed).

Moreover, in the sector, competition shall be considered not only inside the industry, with

airports competing against each others, but also between modes. A good example is the

competition of air transportation and high-speed rail for distances up to 500km (Teixeira, 2010).

• CONTEXTUAL RISKS

o Financial Risks

While the macroeconomic risks should be shared by the private consortium and the public

authority promoting the venture, the rest of the financial risks should fall completely on the

private side. This is one of the main tenants of a PPP, however it is almost impossible to shield

governments from this risk because of the complex nature of these contracts. Many times,

governments are forced to take over the projects, due to bankruptcy issues, in order to

guarantee the continuity of the service.

When referring Financial Risks, these are:

� High Cost and Debt: To be borne by the SPV. Its competitiveness and its financial

sustainability shall be its own matter;

� Relevant future borrowing requisites: Depends on the context. If borrowings are a

governmental requisite, they may imply renegotiations of the contractual terms;

� Leveraged capital structure: To be borne by the SPV. The financial sustainability can

be measured by DSCR or DER, and must be controlled according to market conditions

and current practices;

� Thin DSCR margins: To be borne by the SPV. Attractive conditions must be created in

order to extract revenues that cover the debt obligations;

� Weak Cash-Flows and inadequate liquidity ratios: The SPV must be responsible for

its financial capacity and liquidity ratios therefore, if capital raisings are required to

increase the SPV’s liquidity, they shall be considered;

� Macroeconomic Crisis: This risk shall be borne by the SPV, however the State should

be required to give signs of confidence, in order to mitigate financial speculation, as well

as to provide financing for investments deemed to be imperative in the national context,

in the event market conditions do not allow acceptable access to credit.

o Regulatory Risks

Because of its position, the Government plays an imperative role in the mitigation of regulatory

risk, with a carefully planned liberalization and deregulation process of the market, in order to

provide the adequate conditions for the success of the venture. It is also important to

19

acknowledge that in developing countries, the risk of corruption is very high (Kenny, 2006), and

since high regulatory barriers may be an incentive for the practice of corruption, it might be a

better strategy to struggle it not with regulation but with parallel fights against the value

proposition of the implemented illicit structures (Lascio, 2011).

o Contractual Risks

Concerning the contractual risk, problems may arise when the contractual terms create the

possibility of State capture, especially when there is not enough risk transference from the

public to the private side. This may lead to the creation of parallel businesses, where the

governmental monetary compensations become the major revenue stream (Cuttaree, 2008).

When developing a PPP venture, it is imperative that the government is strong enough to

prevent private consortia from ring-fencing their operations to a point where monitoring is

impossible. This strategy may be carried out through the definition of incomplete contracts,

promoting a constant dialogue between parties, and setting up a dispute board, in order to

diminish the risk of disputes between project partners and to promote a win-win scenario for all.

It shall be emphasized that PPP were created with the ultimate purpose of reducing the overall

level of projects’ risks, rather than only transferring them between the entities involved. A

mandatory concern shall be assigned to situations where misleading contractual clauses may

condemn, a priori, one of the partners in the venture.

Table 8 – Dispute settlement techniques and their suitability (Kerf et al, 1998)

Characterist ics o fConcessions

Go als in D isputeSett lement

CourtsIndependentRegulato r

NonbindingA lternat ive D ispute

Reso lut ion

Internat ionalA rbitrat ion

M any occasions for conflictsAccess to reliable, neutral and

noncorrupt forums= = + +

Long-term nature of therelationship

Sustainability o f the parties'relationship

- + + -

Public nature o f servicesPrompt reso lution, open and

inclusive process- + + -

Large investment ininmobile assets

Enforceability = - - +

Complexity and sophisticationof pro jects

Expertise - + + +

+ Usually appropriate

- Usually inappropriate

= Appropriateness highly dependent on the independence and accountability o f the decision-making body

o Political Risks

The risk associated with governance transition is very significant and may have strong impacts

in the national framework regarding the structural decisions of a country (Fraport, 2011). A

solution to mitigate this risk could be the pre-definition of a Strategic Development Program, a

legal document, approved by the Parliament, establishing the priorities in terms of infrastructure

investments to be undertaken. The document should be above daily political discussion, not

20

giving enough room for too “political-oriented” debates, and efforts should be addressed in order

to respect it thoroughly.

The aim of the proposed document would be to prevent petty politically mind changes, avoid

giving priority to political agenda rather than public interest and put a stop to the allocation of

national funds in “white-elephant” projects, clearly defining which would be the real priorities of

the country. The program should be revised if the national and/or international framework

justified it, especially in situations of financial crisis where infrastructure investments are

generally target of re-evaluation and postponement due to the high capital needs associated.

o Public Acceptance Risks

Infrastructure investments are always very controversial and therefore, the stakeholders (e.g.

business agencies, neighbourhoods and interest groups) must be adequately engaged in the

debate for the implementation of an infrastructure, so that the communities can feel their

opinions actually count for the discussion (Friedman and Miles, 2006) and clarify the community

about the advantages and the disadvantages of the projects. Therefore, the risk must be borne

by a joint initiative of the SPV and the political power.

2.3.5. PPP CONTRACTS INVOLVING TRANSFERENCE OF OWNERSHIP RIGHTS

2.3.5.1. PRIVATE FINANCE INITIATIVE (PFI)

Essentially applied in the UK, in the PFI approach, the private sector is responsible for the

development and operation of the infrastructure, keeping also the ownership rights (in the end

of the contract, asset ownership may or may not be transferred to the public sector). The

products/services generated by the infrastructure developed are sold to the public sector,

through long-term purchase agreements at an agreed price, meaning that there will always be

direct governmental financial obligations (Clark and Root, 1999).

In transportation there is broad experience in the application of PFI, where the private bidder

responsible for the construction, management and maintenance of the infrastructure does not

bear the commercial risk of the project, being assigned an annual monetary compensation for

the investments undertaken (Government of Assam, 2011).

2.3.5.2. DIVESTITURE

Divestiture stands for the sale of an equity stake of a stately-owned asset to the private sector,

through a trade sale or listing the company in the stock market (Graham, 2008). Typically, these

operations aim to either bring management expertise to the company or to overcome public

budgetary constraints, depending on the governmental objectives.

On the other hand, typical national strategic, but financially infeasible, companies might be

subject to partial divestiture in order to keep the national interests ensured and, at the same

time, reduce governmental exposure to its huge expenditures (Welch and Frémond, 1998).

21

Besides, as private players are not willing to invest in unprofitable projects, these companies

shall be restructured in order to optimize its operational processes and eliminate the sources of

non-competitiveness and inefficiency.

Although it may be considered a simple transfer of ownership rights, the interaction between

both sectors in partially divested companies is quite relevant. In fact, not only in the allocation of

capital funds, but also in sharing management responsibilities, the public and the private parties

shall engage in a structured partnership so as to be successful.

2.4. EXAMPLES OF PPP VENTURES IN TRANSPORT INFRASTRUCTURES

2.4.1. ROAD INFRASTRUCTURES

PPP have been widely use in the development of road infrastructures, particularly highways.

With the car culture installed in the worldwide society, the demand for these infrastructures have

been increasing very significantly in the past decades, what led governments to reach a point of

abusive public deficits and prohibitive levels of Sovereign indebtedness.

The call for the private sector to enter PPP for the development of road infrastructures was

regarded by governments as an inevitable solution and the reality is that, nowadays, almost

every construction company has important subsidiaries addressing concessions, proving the

huge involvement of the private sector in the development of road concessions. Typically

consortia running for road development bid for the construction, operation and maintenance of

the infrastructure (e.g. BOT) with the tariffs being defined by a formula (based on inflation).

A fine example of the application of PPP in roads is the IP5 Shadow Toll Highway, in Portugal.

The 167-km project was a privately financed EUR 1,2B investment, whose capital structure was

composed by 8,5% of equity capital, 74,9% of debt and 16,6% of generated cash-flows.

Concerning the payment mechanism, being a shadow-toll highway, the financial burden is

transferred from the users to the tax-payers, as it is the State who assigns a monetary

compensation to the concessionaire for the investments undertaken, while users are exempt of

direct payments. In IP5, this compensation is based on the value of vehicle-kms travelled, being

heavier vehicles affected of a multiplicative factor to fairly reflect its impact on the infrastructure.

Regarding tariff increases, it was established, they would be annually increased in 90% of the

inflation rate (Cardoso, 2008).

2.4.2. RAILWAY INFRASTRUCTURES

The development of PPP ventures in railway infrastructures is not as common as in road, mainly

because the railway sector is not as attractive to the private sector. Due to its high sunk costs,

railway infrastructures are not particularly sound, especially when there are significant

operational constraints that do not allow to extract as many benefits as possible.

Although this is debatable and depends on local circumstances, the American and the

European markets shall be considered to illustrate two opposite situations. In the United States,

22

the railway system benefits from vertical integration of infrastructure and operation (but with

different owners in different parts of the network) and from a clear market specialization in

freight transport, what allows extremely high levels of efficiency (Macário, 2011c). On the other

hand, in the EU, the number of constraints is substantially higher. For instance, the railway

infrastructure is not the same across all Member States, what requires additional transfer

systems, meaning higher costs and serious time losses. Moreover, there is a strong national

protectionism over the sector, especially as regards to freight transport, what leads to severe

constraints in fully using the European railway network. Finally, the mixed usage of the railways,

for both passengers and freight, implies low operating speeds and significant delays (Teixeira,

2010). These examples clearly show how rail can be either a quite feasible, satisfactory and

potentially valuable investment or a financial disaster with very low efficiency levels.

Despite there is no huge experience in PPP implementation in railways, the attempts made

have embraced quite different contexts:

• Light Rail: So as to improve urban mobility, fight congestion and increase the offer of

more efficient and sustainable public transport, governments have been promoting the

development of light rail systems under private initiative. A clear case is the Nottingham

Express Transit, where a 30 year concession contract was assigned the responsibility

to build and operate the new urban light rail system (includes the provision of the rolling-

stock) (Buisson, 2006). As regards to urban mobility, the GBP 180 project was

considered to be a success as, after 5 years of operation, the system had increased the

public transport modal share in 8% (Railway-Technology, 2011);

• Heavy Rail: Due to its high investment costs, in the European Union (EU),

governments have been following a constant trend to call the private sector to develop

the European high-speed rail network. A fine case of this is the 44 km rail link crossing

the French-Spanish border, between Perpignan and Figueras, a EUR 1,15B investment

which was formally opened in 2011 (Railway Gazette, 2011). The 50 year concession

was granted to a French-Spanish consortium, which was assigned the responsibility to

build, finance (80% debt and 20% equity) and operate the infrastructure, at its own risk,

being assigned a compensation for the construction as well as to levy tolls on the train

operating companies (the tariff scheme was contractually defined, being adjusted to

inflation) (Vieillescazes, 2008).

2.4.3. MARITIME INFRASTRUCTURES

Most PPPs in the port sector take the form of landlord port authorities controlling privately-

operated terminals, through concession contracts. However, there are also significant examples

of divestiture of public assets and joint ventures (in addition to act as landlord/regulator, the port

authority is also a shareholder of the SPV).

Generally there are limitations to what private operators are allowed to do, usually in terms of

the types of cargo they are allowed to handle. The major aim is to encourage efficiency

23

increases through specialization, allowing more concessionaires in the same port, increasing

competitiveness and maximizing the extractable value to the port authority. Monopoly rights

used to be granted for a fixed period of time or until traffic would reach a certain level, however

nowadays there has been a leading trend towards the acceptance of competition, especially

due to the higher confidence in how PPP ventures are now procured and contractually defined.

As regards to investment requirements, there are three types:

• Obligatory: Clearly specified and with an agreed time schedule (common in

competitive tenders, majorly in countries with problems of corruption - specifying the

investment schedule increases the transparency of the bid evaluation process);

• Indicative: A broad Program agreed in advance but subject to change as the PPP

progresses;

• Discretionary: Left to the private operator on the understanding that investment will

take place when necessary.

Finally, about contract duration, around 65% of PPP ventures in ports have contract duration

between 20-30 years. Even though the concession duration is set according to the level of

investment costs, the breakeven period and the rate of return required by private operators,

contracts are generally longer than what would be expected (Farrell, 2011b).

An interesting case of PPP implementation in ports was the construction and operation of the

new container terminal of the port of Sines, which was considered to be a structural national

project. The 30-year BOT contract included a serious concern regarding intermodality and also

included the development of the railway accesses to the port. Curiously, APS, the Port Authority

of Sines, started a procedure of market research to assess the level of private interest of the

project, so as to further proceed with a proper competitive procurement. However, at the final

stage of the market research, the aim of launching a competitive tender vanished as the project

ended by being directly awarded to the PSA - Port of Singapore Authority, after exclusive

contacts were maintained between PSA and APS (Tribunal de Contas, 2010).

2.4.4. AIR TRANSPORT INFRASTRUCTURES

Several examples regarding this topic will be thoroughly addressed in section 3.3. Public-

Private Ownership and Governance Models in the Airport Sector.

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3. AIRPORT OWNERSHIP AND GOVERNANCE MODELS

3.1. INTRODUCTION

Along decades, with several constraints over governmental budgets and the need to reduce

public expenditures, together with the existence of the need for infrastructure investments, led

nations to call for the involvement of the private sector for the development of major

infrastructures, including airports. As a matter of fact, as regards to airports, due to the usual

profitability of the sector, they may be very interesting investments, what consequently

increases the interest of private players to invest on it.

Either through PPP or privatizations, the engagement of these new partners revolutionized and

brought innumerable new realities to the airport sector. Thus, it is now mandatory to

comprehend what actually changed in airports’ market positioning and their role in the society,

assessing the socio-economic potentialities and drawbacks of these new ownership and

governance models.

To sum up, the air transportation market is living a whole new paradigm, therefore not only

governments and airport players, but also general investors and the society itself must be ready

to face these changes and to adapt to these new market constraints.

3.2. PUBLIC OWNERSHIP AND GOVERNANCE MODELS IN THE AIRPORT SECTOR

3.2.1. INTRODUCTION

The most typical models around the world, in airport ownership and governance, are obviously

public. Still a continuation of what was the past reality, when the air transportation sector was

considered to be a strategic national asset, several countries keep having both the airport and

the airline sectors dominated by the State. Typically run with a major focus in its core function,

airports have been regarded in the past as non-commercial assets whose major aim was to

promote regional and national economic development, as well as to protect the monopolistic

power of national airline carriers, rather than focusing on the extraction of the commercial

potentialities the sector benefits.

However, even within the Public Models, completely new approaches appeared, significantly

changing the idea of how governments and the airport industry are related. Many governments

understood the potentiality of the sector, what has led to the marketization19 of the sector,

meaning that airport infrastructures started to be managed with a market-oriented perspective

and regarded as revenue-generating assets, rather than solely being public service providers.

Therefore, severe modifications were imposed to the industry with the purpose of improving

airports’ efficiency: better operational and management procedures, greater political autonomy,

definition of long-term plans and allocation of the decision power closer to daily management.

19 Marketization is achieved through the reduction of public subsidies, deregulation, corporatization, decentralization of the power and privatization (Lang, 2000).

25

3.2.2. PUBLICLY OWNED AIRPORTS OPERATED BY A GOVERNMENT DEPARTMENT

This is the most traditional approach, which is very typical in countries with central planned

economies (Tretheway, 2001), and stands for having the airport sector, owned and operated by

a Governmental Department (e.g. Ministry/Department of Transportation or Defence).

Despite there are several cases, where different institutions exist to deal with airport operation,

air traffic control and air navigation, there also numerous examples of countries where these

functions are merged in the same national government department, combining also:

• Regulator: Inducing likely conflicts of interests and lack of transparency;

• National Airline Operator: Encouraging the protectionism of the air transport sector.

Regarding accountability, although direct accountability of the airport to the public should be

expected, significant inter-governmental-levels disputes may arise because of different

agendas, consequently altering accountability transparency. Moreover, due to the very same

motive, the decision-making process is not obvious and does not allow open discussions about

the topics under evaluation, as decisions are made behind closed doors (Tretheway, 2001).

Finally, under this model, as airport investments have a huge impact in the public budget,

political agenda may not be aligned with the sector’s needs. Thus, serious underinvestment

issues may arise, due to their capital intensive character.

3.2.3. PUBLICLY OWNED AIRPORTS OPERATED BY A LOCAL GOVERNMENTS

Also known as the US Model, this model is based on the idea that decentralizing will promote

smaller and more efficient operating units, bringing the management teams closer to daily

problems. Taking this into account, the US airport governance is defined by assigning to local

governments the power to manage and operate their own airports.

Table 9 – Examples of US Airport Governance Models (Tretheway, 2001)

Political Level Involved

Description of the Governance Model

Direct Governmental

Municipal Operation

1. Either Municipal Board of Supervisors (e.g. Los Angeles), responsible for day-to-day decisions; or

2. Expert Board of Supervisors exclusively with an advisory role (e.g. San Francisco) and excluded from day-to-day management, being the ultimate decisions assigned to the Mayor/City Council representative.

County Operation

Airports are managed by representatives of the County Public Works Committee, who are the airports’ County Board of Supervisors (e.g. Miami-Dade);

State Operation

The Department of Transport keeps the responsibility of managing and operating the airport network. Only present in Alaska and Hawaii, representing the reminiscences of the time when they were territories rather than official states;

Quasi

Govern.

Authorities

In this approach, airport operation is assigned to Airport Authorities, considered as quasi-governmental, as they are at an independent level of the government. Some of these authorities have taxation powers (e.g. Seattle), zoning powers (e.g. Orange County) or veto power over local zoning decisions (e.g. Reno).

26

Regarding regulation, in the US, the Federal Aviation Administration (FAA) was assigned the

right to regulate airport pricing policies, however it has been generally underutilized. Since

industry incentives to set unfair prices are very low, as the great majority of airports are Stately

owned, FAA has found it would not be imperative to intervene in the way how the market was

evolving as the likelihood of market abuses regarding pricing is very low (Tretheway, 2001).

As far as airport finance is concerned, so as to avoid issues concerning political agenda and to

overcome constraints caused by the typically high municipal indebtedness, three major policies

have been widely used:

Table 10 – US Airport Finance Policies (Tretheway, 2001)

Policies Major Aims Issues

Bond Guarantees by Airlines

Airlines provide bond guarantees to airports, allowing higher leverage at lower interest rates.

Airlines have forced to be assigned veto power regarding major airport CapEx programs. Besides increasing airlines’ bargaining power, it has been used by airline companies to prevent investments that would promote competition20.

Airports’ Municipal Status

Awarding municipal status enables airports to issue tax-exempt bonds.

In the end, it is a form of subsidy. In this situation, general taxpayers are imposed higher tax rates, enabling airport users to enjoy lower taxes.

Added-Taxation Policy

Additional taxes over airline tickets, so as to provide capital grants for airport investments.

Airport grants are not proportional to the tax revenue generation. It is almost as a net subsidy from large to small airport markets.

3.2.4. PUBLICLY OWNED AIRPORTS OPERATED BY A GOVERNMENT AGENCY

Being a simple variation of the Government Department model, the Agency model is a small

step towards airport autonomy, since it is semi-independent. In this approach, the agency is

responsible for airport operations while the regulatory power is left for the Ministry, avoiding

further conflicts of interest. A good example of this model is AENA, the Spanish airport agency,

which is responsible for the airport/airway/air navigation operations, while the Ministry of

Transportation keeps the regulatory role (Gillen, 2007).

3.2.5. PUBLICLY OWNED AIRPORTS OPERATED BY A PUBLIC CORPORATION

This model brings a severe paradigm change in how the airport sector is owned, managed and

operated. In the Public Corporation approach, there is a clear separation of operation and

regulation, as the former is assigned to a publicly-owned company while the latter is a

ministerial responsibility, clearly eliminating the previous existing conflicts of interests.

Despite it must report its activity to the Ministry, the public airport corporation is a completely

independent entity, due to its corporate status, particularly in financial terms. In fact, as a

governmental corporation, this entity has its own accountability (independent from public

budget) and a higher level of flexibility to define its financial planning (Tretheway, 2001).

20 In 2000, the US Congress passed a law requiring airports to develop competition enhancing plans, so as to qualify for governmental grants and define projects that aim to increase competition (such as facilities to accommodate competitor carriers) (Reimer, 2007).

27

For instance, the British Airports Authority (BAA), established in 1966, was one of the first

autonomous airport authorities with a market-oriented management approach, quickly becoming

a role model in the sector. With its corporate status and high profitability, countries like Ireland,

Thailand, Israel or Mexico, soon implemented airport companies with similar business models.

Another good example of this model is ANA - Aeroportos de Portugal, S.A. In 1998, the

Portuguese public entity Empresa Pública de Aeroportos e Navegação Aérea, which used to

control both airport operation and air navigation, was split into two independent corporations:

ANA - Aeroportos de Portugal, SA (responsible for airport operation) and NAV - Navegação

Aérea de Portugal, EPE (responsible for air navigation). This structural change in the

organization of the Portuguese airport sector allowed ANA to gain autonomy from direct political

intervention and, with a corporate status, to benefit from independent accountability and power

to define its long-term strategic plans.

3.2.6. PUBLICLY OWNED AIRPORTS OPERATED BY NOT-FOR-PROFIT COMPANIES

Exclusively implemented in Canada, this model is the reflex of the difficulties that the national

transport authority, Transport Canada, felt regarding the management and operation of the

Canadian airport system (Tretheway, 2001). With several airports experiencing a gradual

reduction of the operational efficiency and the financial feasibility, in the early 90’s the Canadian

government decided to decentralize the power over the airport sector and assign to local

governments the power to take over their airports. With a natural incentive to perform well, as

benefits brought by improved airports would directly pass to the community, assigning to local

governments the power to run their own airports would promote the creation of smaller and

more efficient operating units closer to daily problems, with the ultimate goal of enhancing the

sector’s efficiency. In the end, the final plan was to set up local independent not-for-profit

companies21 (INFPC) responsible for managing the airports, under 60-year lease contracts.

These corporations are run by industrial or professional associations, such as the Chamber of

Commerce or the Professional Engineers Society, whose major goal is to promote regional

development rather than taking financial benefits out of it, proving the suitability of these entities

for the charge (Tretheway, 2001). A successful example of the application of this model is

Vancouver International Airport, run by YVR Airport Services Ltd., a local not-for-profit company

that started operating exclusively in this airport and is now a worldwide recognized player.

Despite the Canadian model has several potentialities, it has not been exported to anywhere

else in the world, probably due to its limitations regarding the access to equity capital and the

advantages brought by pure private sector businesses. Moreover, in a liberalized airline market,

with a constant changing environment concerning airlines business models the INFPC model

does not show the required adaptability and flexibility (Gillen, 2007).

21 An independent not-for-profit corporation is a company with no shareholders, implying no dividend distribution and meaning that profits are used to re-invest in the infrastructure.

28

Table 11 – Independent Not-For-Profit Corporation Characteristics

Topics What is different?

Contracts • INFPC are awarded 60-year lease contracts (Gillen, 2007); • After the contract term, both land and assets are transferred to the government.

Board of Directors

• In government-related entities, boards are governmentally appointed; • In INFPC, the board selection process is politically independent22; • Not subject to political cycles or governance transition; • Promotion of stability and long-term vision;

Revenue Generation

• Market-oriented perspective brings added focus on non-aviation activities, enhancing the revenues generated;

• Companies are subject to ground rent payments to the State (12% of gross revenues for any airport with annual revenues over $250M (Gillen, 2007)).

Regulation • No direct regulation of aeronautical charges;

Financing

• INFPC virtually operate with no State assistance23; • Revenues generated by the airport are used to reinvest in the airport

infrastructure, keeping the not-for-profit character of the operating companies; • Usage of PFC, incorporated in airline fares, to finance major investments.

3.3. PUBLIC-PRIVATE OWNERSHIP AND GOVERNANCE MODELS IN THE AIRPORT

SECTOR

3.3.1. INTRODUCTION

Characterized by its profitability, the airport sector is quite unique when compared to other

transport infrastructures. In fact, the concept of natural monopoly used to perfectly suit the

sector due to several motives (e.g. high sunk costs, economies of scale and scope or network

effects) (Hancioglu, 2002), however the market changed significantly and airport monopolies

became no longer such a strong reality. Particularly after the liberalization and deregulation of

the air transport market, a whole new perspective was brought into the sector, especially due to

the reduction of governmental protection of air transport and the appearance of the Low-Cost

Carriers, which revolutionized the market positioning of the airports (Hancioglu, 2002).

However, even with this new competitive paradigm in the sector, the market potential of the

sector is still a very positive indicator for private players willing to invest on it.

Table 12 – Air Transport Sector Evolution (Macário, 2011c)

Past Trend Current Reality

Air transport as a national strategic asset Air transport as a corporate commercial asset

Strong political protection (subsidization) Involvement of private finance partners

Closed networks with interline agreements Interline agreements losing “raison d’être”

Modal superiority and non-cooperative attitude Attitude towards intermodality

22 Although appointments by three local governments are allowed, once appointed, board members have a fiduciary liability to the airport corporation (Tretheway, 2001). 23 In transition periods, so as to give companies time to mature, corporations may be awarded capital grants or financial assistance through the postponement of ground rent payments (Tretheway, 2001).

29

This liberalization and deregulation of the airline sector led to the induction of competitive

pressure in the airport market and to a paradigm shift in the industry (Macário, 2011c). In fact,

nowadays, airports are not even considered simple transportation hubs anymore, they are now

global places where work and leisure meet together, due to the development of diversified new

businesses being offered to airports’ customers – the Airport-City concept (Iyer, 2011).

Regarding infrastructure investments in airports, if on one hand the State needs to develop

airports to promote national development, meet social needs, increase the mobility and

leverage economic growth, on the other hand the constraints to public indebtedness are very

tight and restraining and, frequently, the lack of in-house expertise to develop that type of

endeavours is quite significant (Duffy, 2010). Together with the private interest in the sector,

these motives prove that the PPP concept may be a valid solution for the delivery of these

infrastructures, bringing attached a completely new financial, mental and contractual structure in

project development.

The first aim of PPP is to develop infrastructures which deliver higher VFM, meaning that higher

benefits can be extracted with a less than proportionate increase in the capital invested (e.g.

socially - better service, financially - profitable ventures, and economically - boost of local

economy). Engaging the private sector in traditionally publicly-funded areas allows the search

for new sources of financing which goes beyond the boundaries that limit the governmental

action, and also makes possible the involvement of more competent partners, such as

experienced airport operators, banks, private equity funds, venture capital firms or any other

investment corporations.

The second point has to do with the already mentioned potentially better risk allocation. Since

this type of ventures is characterized by significant levels of uncertainty, it is important to

thoroughly understand the investments risks and respective sources. This is one of the major

causes why PPP consortia are so complex, since there is a clear pursue for the right partners to

be engaged, so as to that ensure investments risks are allocated to competent and skilled

enough parties, without exposing the others to risks they may not be prepared to deal with.

Figure 8 – Private Sector Involvement and the Level of Risk associated (Deloitte, 2009)

30

With this transfer of risk from the public to the private sector, PPP can take several forms

depending upon the level of risk the public and private sectors are willing to assume,

consequently shaping the type of governance of the project.

Typically, concessions are very common in transportation facilities with the public sector, due to

its risk adverse posture, simply becoming a landlord while the private partner assumes the

majority of the risks (e.g. BOT) (Cruz and Marques, 2010). However, other PPP approaches are

possible and the level of risks to be borne by the State shall be carefully analyzed by the

authorities in order to avoid the capture of the government in businesses where the private

sector is basically guaranteed a risk-free continuum cash flow, which take away the innovative

and efficiency-optimizer character. Moreover, this problem can also be spread to tenders, where

private players might start running for projects, even those with negative financial indicators,

since there would be a special focus on the government sponsorship rather than on the financial

performance of the project.

Last but not least, the ultimate purpose of PPP ventures in airports is to maximize their market

potential. Consequently, in PPP, there is a fierce attempt to ensure the maximization of the

lifespan of the airport system, optimize the utilization of the available resources and existing

facilities, develop coherent and comprehensive strategic plans that embrace the micro and

macroeconomic frameworks and finally to balance the airside and landside demand with

adequate capacity in every single phase of the project. Besides, it shall be emphasized the

importance of flexibility design in airports and its impact in the maximization of the projects’

value (Neufville and Odoni, 2003).

Several examples of PPP ventures in airports can be found all around the world, some quite

successful and others not so much. In the following sections, some examples will be referred,

with the purpose of demonstrating, with practical experiences, the implementation of PPP.

3.3.2. PUBLIC-PRIVATELY OWNED AIRPORTS UNDER CONCESSION CONTRACTS

In the 1990’s, India became a quite good example regarding the implementation of PPP in the

airport sector. The Indian government proposed a very broad PPP Program which aimed to

restructure and improve the national airport system (Graham, 2008), in order to meet the

infrastructure requirements of this emergent economy. By this time, India was also living several

difficulties as far as technological knowledge was concerned and the call for the private sector

to invest in the country was found to be the best solution to import knowledge and to bring the

technological state-of-the-art (MCAGI, 2006). Huge economic centres like Delhi, Mumbai or

Bangalore are only some examples that experienced the benefits brought by the Program,

which was revolutionary in the world due to its large scale.

The Indian Program also defined that there should be some level of public intervention over the

sector, even if minority, and a 26% stake of the companies developing the ventures was

assigned to the Airport Authority of India (AAI). The 74% left would be owned by the rest of the

31

companies composing each consortium, and was believed to be a reasonable stake that would

incentivize good performance by the partners developing these endeavours (MCAGI, 2006).

The Indian case has proved to be very successful and has shown how PPP can be a

sustainable and feasible solution concerning airport development. The Bangalore International

Airport, for instance, developed under a 30-year BOT, is today regarded as a role model in the

implementation of this approach (Lees, 2008).

Figure 9 – Bangalore Intl. Airport, the appointed key factors of success (Duffy, 2010)

Another quite interesting case in PPP implementation in airports is Australia, where the so-

called decentralization of the power was the fundamental measure. The national authority that

managed all the Australian airports launched a partial divestiture program for the largest

Australian airports, with long term concession contracts, which aimed to reduce the impact of

airports in the public budget and increase the operational efficiency of the Australian air

transportation sector (ICAO, 2008). These contracts defined an important clause of exclusivity,

where each private consortium would only be able to operate one airport, in order to prevent the

creation of monopolies, control the bargaining power of the economic groups involved and

promote exclusive focus in every single venture (Graham, 2008).

Concerning the smaller and non profitable airports, the Australian government decided to keep

them under public control, with the purpose of ensuring the mobility of remote communities

(ICAO, 2008). As the financial interest of these airports was reduced, bailout processes could

be foreseen beforehand.

The process began with the launch of 50-year concession contracts (with option of renewal for

another 49 year period) of Melbourne, Brisbane and Perth airports. These contracts assigned

both the commercial rights of the airports as well as the obligations to deliver quality service,

according to pre-defined standards, and to carry out expansions and/or refurbishments of the

infrastructures. The second phase comprised the launch of eight other concessions, while the

last phase included the total privatization of Sydney International Airport (Graham, 2008).

Brisbane International Airport, for instance, is a very successful example in PPP implementation

and has already been awarded the best privately run airport in the world, due to its quality of

service, operational standards and facilities (ATRS, 2009). Operated and developed by

1. Strong Private Consortium:

Led by the German company Siemens AG.

2. Organized Political Structure:

Joint venture between local and central government led to a very good integration of both taks and information.

3. Proper Tariff Regulation:

Controlled by a neutral department and defined under clear guidelines.

4. Airport City Concept:

The concept was developed in order to strenghten the attraction of the airport within the traveller community.

32

Brisbane Airport Company Ltd. (BAC), under a long term concession (50+49 years), BAC’s

shareholder structure is composed by major Australian and international organizations,

including the Dutch Amsterdam Schiphol Group, and other important institutional investors. It

shall be noticed that approximately 80% of BAC shareholders are ordinary Australian citizens,

through national investment funds (ATC, 2011).

Although the presented cases have proved to be very successful, the reality shows that the

PPP concept has several drawbacks, proved by the extremely high number of failed

experiences. The implementation of PPP can be very misleading mainly because of wrong

contract design, badly carried contract management or improper risk allocation and, despite in

airports the experience is not that bad, some failure examples are very well-known, such as the

Costa Rican Juan Santamaría Airport (SJO) or the Philippine Ninoy Aquino Airport (MNL).

SJO, in San José, became notorious for the failure of the PPP model implemented, where the

private consortium running the airport ended up being forced by major capital lenders, due to

accusations of mismanagement (Lees, 2008). A new tender was then carried and a new

consortium acquired the participation in the airport company and took over the project. This

conglomerate has been in charge of SJO’s operations after the definition of a solid and coherent

strategic plan, which aimed to turn SJO into a world class airport (ACI, 2010) and to put

competitive pressure in the Central-American airport market.

Figure 10 – Causes of the Juan Santamaría Intl. Airport PPP failure (Lees, 2008)

Political stability and transparency of how the projects are conducted are also essential factors

for the success of any PPP venture and the case of the Philippine International Air Terminals

Corporation (PIATCO), a consortium led by Fraport AG, is a very clear one. PIATCO was

awarded the BOT contract for the development of Terminal 3 and 4 of MNL however several

problems arose and ended up with the withdrawal of PIATCO’s operating licence (Renshaw,

2005). Before the completion of the construction, and after a governance transition due to

elections in the Philippines, the State argued that PIATCO had breached the pre-qualification

requirements, which stated that no foreign company could manage a stately-owned entity, like

an airport. The Philippine Supreme Court ruled in favour of the Government declaring the

contract null, leading the private consortium to file for arbitration in order to pursue a

compensation for the capital losses of the investment (Fraport, 2011).

Problematic Concession Design

Lack of Transparency in the Tender process

Under evaluation of the investment requirements

Concessionaire lacked of power to control pricing

33

3.3.3. PUBLICLY OWNED AIRPORTS WITH PRIVATE OPERATION OF TERMINALS

Especially in North America, it is very common situations where the ultimate liability over the

airport remains public but where private investors, usually airline companies, are who actually

develop terminal buildings (Tretheway, 2001). This type of approach can be identified in the

United Airlines’ terminal in Chicago O’Hare Intl. Airport, the several airlines’ terminals at New

York’s JFK Intl. Airport or Toronto’s Terminal 3.

Outside the Americas, a good example of independent terminal operation is the Asia-Oceania

market. In Australia, for instance, Ansett and Qantas developed their own domestic terminals at

all major Australian airports, sharing common use facilities for international flights (Tretheway,

2001). On the other hand, regarding the most recent Asian BOT ventures, their focus have been

majorly focused on terminal development, such as the referred case of MNL.

3.3.4. PUBLICLY OWNED AIRPORTS UNDER MANAGEMENT CONTRACTS

Several airport corporations have been growing significantly, representing today huge

companies with activity developed around the globe. The German group Fraport AG, the Dutch

Schiphol Group, the Singaporean Changi Group or the French Aéroports de Paris (AdP) are just

some examples of huge players that have been hunting important management contracts.

An interesting example of the worldwide expansion of airport groups took place in Saudi Arabia,

where the Singaporean Changi Group was awarded a 6-year Management Contract for the

King Fahd International Airport (KFIA), in Damman. Regarded as an “agent of change, to

transform and help raise the profile of KFIA” (Tan, 2009), the Changi Group was assigned the

task of managing KFIA by the Saudi Arabian Kingdom, which wanted to give greater autonomy

to the airport sector in order to import the industry know-how and the best practices. The

contract defined a first stage of diagnosis and recommendations and, a second stage of

deployment of the approved proposals, in a Saudi-Singaporean joint venture (Tan, 2009).

3.3.5. PUBLIC-PRIVATELY OWNED AIRPORTS 24

Air transportation sector has always been regarded as a national strategic asset and, despite

this reality has changed dramatically and private involvement is very frequent, the reality shows

that some of the most important airport groups are still partially owned by their respective

governments. Several motives may hide behind governmental decisions to carry out partial

divestitures and some of them are:

• Bring private expertise to the airport business: When the public managerial

expertise is not enough to take full advantage of the airport potential, but there is still

governmental will to keep airports as a strategic asset;

24 So as to be considered a PPP, only partial divestitures are considered in this section.

34

• Reduce public exposure to airport development expenses: When airports are not

profitable, governments may decide to partially sell the sector, willing for private

initiative to share costs and to bring enough expertise that might lead to profits;

• Raise capital for large scale investments: In case of CapEx needs, for instance,

large amounts of money are required and, when governments are not able to cover the

total costs, there may be a call for private involvement to invest in the sector;

• Strategic alliances with other airport players: Such as the case of Schiphol-AdP

alliance, whose aim is to develop a stronger player in the European market, with a

powerful dual hub formed by Amsterdam and Paris (Forsyth et al, 2009).

Figure 11 – Examples of partial divestitures

Moreover, calling for the private sector to get involved in airports is a call for innovation, break-

through management approaches and the will to change, optimize and do better. In all, the

private sector’s ultimate aim is to increase profits, and improving the commercial value25 is

imperative. Either existing a major or minor private position in the shareholder structure of the

company, the private presence is usually considered by stakeholders enough to proceed

towards a shift in the management perspective and to evoke strategic thinking as mandatory in

the definition of the economic and financial plans (Tretheway, 2001).

Regarding the structure of the company, the involvement of private parties as shareholders in

the airport company also brings significant advantages. The stability given to the board of

directors of the airport’s corporation (Gillen, 2007), considering that the board is no longer fully

appointed by the government, allows the development of longer term plans and preventing the

airport management of being too exposed to political cycles.

Finally, and especially in publicly traded airport companies, corporate accountancy is much

more likely to become more transparent, allowing a more serious reporting of its financial profile.

In contrast, a negative point that may discourage private players to enter the airport market is

regulation and how strict it can be (Gillen, 2007). Despite needed to avoid market abuses,

regulatory regimes may be too severe, influencing and limiting the commercial potential and

reducing its attractiveness for private capital.

25 Increasing an airport’s commercial value can be done through real estate investments, expansion of the airport space for commercial concessions or increasing the number of carriers serving the airport.

• Publicly listed in the Paris Stock Exchange since 2006• Sale of a 8% stake of the group to the Amsterdam Schiphol Group;• 56,3% is owned by the French Government.

Aéroports de Paris

(AdP)

• Sale of a 8% stake of the Group to Aéroports de Paris;• 92% is publicly owned (Dutch Governmnet, City of Amsterdam and

City of Rotterdam).

Amsterdam

Schiphol Group

• Publicly listed in the Frankfurt Stock Exchange;• Subject of a trade sale before its IPO;• 51,65% is publicly owned (State of Hesse and City of Frankfurt).

Fraport AG

35

3.4. PRIVATE OWNERSHIP AND GOVERNANCE MODELS IN THE AIRPORT SECTOR

3.4.1. INTRODUCTION

Privatization stands for the transference of ownership rights of an asset/corporation from the

public to the private sector. Defended and opposed by many, the roots of privatization argue

that it aims to increase efficiency, induce competitive pressure in the market, reduce

monopolistic power, decrease the level of governmental expenses, increase State revenues

and enhance economic growth and social welfare (Macário, 2011d).

In fact, privatization is defended to be the most important step towards competition, inducing the

market to be more dynamic, leading to efficiency improvements, decreasing operation costs and

allowing companies to set lower prices. However, depending on the context, privatization can

actually be a major source of benefits or drawbacks, what may lead to a wide set of outcomes.

To address this topic, it is important to clarify the concepts of Liberalization and Deregulation

since they must be the major basis for privatization processes to be successful. While the

former means opening the market for private involvement, the latter stands for

reducing/eliminating governmental control over how a certain business shall be conducted.

Figure 12 – Privatization Process (Macário, 2011d)

When the market is completely liberalized and opened for competition, even if the level of

regulation is still high, improvements in economic efficiency usually take place, meaning GDP

growth and increase of the rate of economic growth, due to incentives to innovation and cost

reduction (Macário, 2011d). On the other hand, if the sale of public corporations is associated

with a very low level of liberalization, no competitive pressure is induced in the market and

public monopolies are turned into private ones, seriously jeopardizing the level of social welfare.

Moreover, it shall be emphasized that private players do not invest in losing companies,

therefore when privatizing a non-profitable business which used to be highly subsidized by the

State, the new owners are likely to restructure the company strategy in order to make it

profitable, and changes in the pricing policy might probably be one of the first measures being

undertaken. Despite it may be argued that people will pay more for the service, their tax money

will not be channelled for the company anymore however, as tax reductions are not common,

the overall living expenses would actually become higher.

But, considering pricing techniques, economic regulation is an imperative issue to take into

account in privatization processes. Although an overall reduction of regulation is essential in

order to make the market more flexible, promote low market entry barriers and induce

competitive pressure, economic regulation is mandatory so as to protect society from market

abuses, especially in cases where public monopolies that turn into private (Vasigh, 2009).

Liberalization Deregulation Privatization Competition

36

Furthermore, despite privatization supporters affirm that privately held businesses bring more

transparent and less corruptive environments to the market, many times, governments lead

obsessive privatization programs and may enter into a corruptive spiral difficult to control

(Boehm and Polanco, 2003). For instance, to convince private players to buy non-profitable

companies, the State may create revenue-producing contracts, having the State as an off-taker,

generating immediate revenues but significant capital losses in the long-term. Another example

is the divestiture of lucrative public corporations, which are easily subject to veto, where side-

payments may be offered to objectors to rule in favour of the sale (Pablo and Manzetti, 1997).

The path towards privatization implies a complex decision making process by the responsible

national authorities, through comprehensive assessments of the reasons why the operation is

being considered, the legislation adjustments needed for a proper deployment of the solution

and mainly what impacts it will have in public accountancy, in the society and in the

development of the national economy. The former Director General of IATA Mr. Bisigani once

said that “privatization is far too important to be viewed as a quick fix to the Government's

current budgetary difficulties. Long-term vision is needed...”, therefore, opting for the alienation

of Stately-owned property shall be the last solution, after analysing every possible scenario,

such as restructuring the company, hiring a new management team to improve efficiency or

even implementing a PPP solution26.

As a response to safeguard the governmental interests in privatized companies, in the 1980’s,

the Golden Share concept was introduced by the British government. Golden shares are

governmentally-held securities that enable to outvote other shares and have the purpose of

protecting the considered national strategic privatized assets (Graham, 2008). In the EU, the

European Court of Justice declared this type of governmental intervention over private property

to be illegal, as it prevents capital transactions (ELF, 2003), however some examples can still

be found. Moreover, governments partially keeping the control over majorly private businesses

might have a deep influence in the market development since there may be conflicts of interests

by the State, due to the combination of roles: shareholder, policy-maker and regulator.

Finally, on the opposite corner of privatization is Nationalization which, although not common in

developed countries, is quite frequent in developing countries subject to harsh political regimes.

With the aim of increasing the economic resources of the State, nationalization stands for a

reverse privatization process, where private assets are taken over by the State, being the

private owners entitled or not to monetary compensations (Macário, 2001d). A good example of

what is argued to have been a nationalization in the developed world was the acquisition, by the

US government, of the airport security industry after the 9/11 attacks, justified by the authorities

as an attempt to increase the control and the efficiency over the the security systems in the

American airport network.

26 So as to help decision-makers making better and more structured decisions regarding privatization, a methodology of how to carry out privatization processes is proposed by in the Appendix VI.

37

3.4.2. PRIVATIZATION MODELS

3.4.2.1. MANAGEMENT/EMPLOYEE BUY-OUT

A Management Buy-Out (MBO) is a form or privatization where the acquisition of public

asset/corporation is done by its management team, with the belief that controlling the ownership

rights provides better conditions to make the business grow. In these cases, since they require

significant capital investments, the management team usually develops a joint venture with

private equity or venture capital firms in order to acquire the business, avoiding high gearing

levels. Other possible solution is Employee Buy-Out (EBO) where both managers and

employees buy the ownership rights of the asset, reducing the borrowing requirements and

avoiding the exposure of the real assets or the revenue-producing contracts to be used as

collateral to the borrowings.

For example, in the 1990’s, the Belfast International Airport was privatized in a MBO process,

after a highly competitive bidding process for the purchase of the infrastructure. The final offer

was GBP 50M and, in order to carry the operation, the management team and the airport

employees teamed up with the private equity firm Montagu with the purpose of fulfilling the

capital requirements needed for the acquisition of the airport.

3.4.2.2. TRADE SALE

Trade Sale is privatization method usually carried out through a public tender and stands for

partially/totally selling a public asset to the private sector. In the evaluation of the bidders,

technological expertise, strategic positioning and financial capabilities are imperative criteria for

selection (Graham, 2008), therefore in many Trade Sale cases, the winning consortium

generally integrates an important strategic partner such as professionally recognized partners.

In the airport sector, for instance, it is very likely to find important groups like the Singapore

Changi Group, the YVR Airport Services or the Zurich Flughafen in the consortia running for

concessions/privatizations of airports.

A good example of a trade sale is the Hyderabad Rajiv Gandhi International Airport (HYD). The

tender launched for the development of the new Indian airport implied the privatization of a 74%

stake of the company running the airport, and the winning consortium was composed by two

major partners, the local GMR Infrastructure and the Malaysian Airport Holding (Tomová, 2009).

Although this model is frequently carried out through a public tender, pre-negotiated

arrangements are also possible, especially in the event of sales to strategic partners.

38

Figure 13 – Step-by-step approach in a trade sale (Welch and Frémond, 1998)

3.4.2.3. MARKET FLOTATION VIA INITIAL PUBLIC OFFERING (IPO)

Publicly listing corporations and trading their capital in the stock market is very common

privatization model, promoting investment and attracting investors worldwide. As in any other

privatization model, governments are allowed the choice of listing the whole or part of the

corporation, nevertheless, frequently the management board is given the option to acquire

shares on preferential terms, in a derivation of MBO. Usually, the capital raising generated by

the process may be used in two directions, either to fund future investments (e.g. Vienna

International Airport), or to capitalize governmental accounts (e.g. BAA) (Graham, 2008).

In the airport sector, listing companies in the stock market began with BAA privatization process

in the end of the 1980’s however, today, several examples can be found all around the world:

Grupo Aeroportuario del Sureste, AdP, Fraport AG, Malaysia Airport Holding, Beijing Capital

Intl. Airport, Auckland Intl. Airport, etc.

39

Figure 14 – Step-by-step approach in an IPO (Welch and Frémond, 1998)

3.4.3. PRIVATE VENTURES IN THE AIRPORT SECTOR

Clear evidence of airports’ financial strength has led governments to become reluctant to fund

the sector. However this strength was not enough to cover their capital demanding CapEx

Programs, imposing significant damages in the public budget and progressively increasing

national debt, what brought privatization to the political agenda as a possible solution to

maximize airport potential and transfer investments’ responsibilities to the private sector

(Doganis, 1992). For instance, in the 1980’s, the British Government was fighting unacceptable

debt issues, leading the State to launch a severe privatization program, which included the

divestiture of BAA, the national airport authority. BAA’s privatization was done through an IPO in

the London Stock Exchange and was the first case of airport privatization in the world,

revolutionizing the sector27.

Nevertheless, with the monopolistic market positioning of the airport sector, privatization can be

the gateway towards market abuses, therefore, a mixed solution was found and broadly

adopted around the world, partial privatization. This model has been highly defended since it

allows taking advantage of private participation but enabling governments to keep enough

27 BAA privatization included the divestiture of seven airports, including London’s Heathrow and Gatwick (Young and Wells, 2004).

40

decision power to protect social interests28. In Europe, apart from the UK, there was not any

national massive airport privatization, however many examples of isolated privatizations can be

found all around the continent (See Figure 15).

Figure 15 – Brief European airport privatization timetable

Together with the UK, New Zealand was pioneer in airport privatization. During the 1990’s, the

three largest national airport operators (Auckland, Wellington and Christchurch) were converted

into individual corporations, owned by a public consortium composed by the central and local

governments, with an ultimate aim of selling the central government’s stake. Auckland was the

first, with the government listing its 51,6% stake in both the Australian and New Zealand Stock

Markets, performing the first IPO of an airport company in the Pacific region (Graham, 2008).

The second step was the trade sale of the central government 66% stake of Wellington

International Airport, to the private utility company Infratil (Infratil, 2011). Regarding

Christchurch, the airport is still today under public ownership (25% owned by the central

government and 75% by the City of Christchurch) (Graham, 2008).

An also interesting example in airport privatization is China, where partial divestitures have also

been developing an interesting path. The Chinese market opening to the world was

accompanied by a strong liberalization and deregulation of the airport industry, growing a huge

interest by foreign investors and, despite the government still holds a significant position in the

industry, the Chinese airport sector is one of the most privatized in the world (Qin, 2010).

The Chinese airport privatization program started in the late 1990’s, with the IPO and trade sale

of five major airports, including the Beijing Capital International Airport (BCIA). BCIA’s capital

was divested in two stages, a first trade sale to AdP (10%) and to the Dutch bank ABN Amro

28 Similar to partial divestiture already referred in this document.

41

(8%), and a second operation done through an IPO in the Hong Kong Stock Exchange (17%)

(Yang et al, 2008). The Chinese State kept a major stake in BCIA (65%), however a second

IPO is already being considered, this time in the Shanghai Stock Exchange (Yan, 2011).

Figure 16 – Airport Privatization in China, a few examples

Today, Chinese airport ownership models are quite diversified, nevertheless the financial

capacity, the organizational flexibility and operational efficiency were definitely enhanced by the

presence of the private players in the sector (Qin, 2010).

To sum up, despite privatization may seem a good escape for governments to avoid

expenditures, both opportunities and risks exist and both must be considered by the authorities

when evaluating these processes. The air transport sector is a major industry in worldwide

development, thus assessing the likely final outcomes of privatizations, as well as, preventing

possible market abuses are imperative tasks that must not be neglected in similar processes.

3.4.4. AIRPORT PRIVATIZATION: FOR OR AGAINST?

3.4.4.1. BENEFITS OF AIRPORT PRIVATIZATION

Privatization supporters argue that these processes are full of potentialities and benefits, which

otherwise would be restricted to strictly public ventures (Graham, 2008). The major justification

is the way how investments are treated by the public and the private sectors which is completely

different, as the latter typically carries out a constant search for optimization and adjustments to

market shifts, bringing another business dynamics to the industry.

To begin with, similar to PPP, one main advantage of privatization is the financial flexibility of

infrastructure investments. For instance, prior to the privatization of BAA, its CapEx program

was controlled by government fiscal policies, limiting the level of investments allowed (Doganis,

1992). After the sale, BAA was freed from those financial constraints, as long as the company’s

(or the shareholders’) creditworthiness was enough to borrow money at reasonable conditions.

Chinese Airport

Privatization Experience

Beijing Capital Intl.

Airport

Shenzhen Intl. Airport

Shanghai Intl. Airport

Guangzhou Bayou Intl.

Airport

Xiamen Gaoqi Intl.

Airport

42

Therefore, privatization may be seen as a mean to make airport companies more flexible in

financial terms, allowing riskier and more ambitious projects.

Furthermore, private ventures usually bring cutting-edge management appraoches, in order to

improve efficiency, increase satisfaction levels and attract new customers. Diversifying the

services available in the airport or spreading the investments to other non-core businesses are

two ways of creating new attractions and, at the same time, creating new revenue streams

(Doganis, 1992). This is the basis of the airport city concept where there is the creation of

another image of the airport infrastructure, in a clear mutation from simple passage building

towards a leisure place with several amenities (Graham, 2008). Airports like Bangalore,

Amsterdam Schiphol or Brisbane are good examples of airports regarded by society as more

than just another transportation hub, as they have become an attractive point of the network.

While in many publicly owned airports, commercial businesses are limited to the range of

activities possible to be engaged, private companies have the freedom to expand their scope of

action, such as taking advantage of the full commercial value of land assets, like the

construction of hotels, building transportation links from the airport to other strategic points, etc

(Iyer, 2011). Nonetheless, the example of Amsterdam Schiphol is contradictory, since the

publicly-owned airport developed very effectively the concept of airport-city, without private

intervention (Schiphol, 2011). This fact allows the conclusion that Stately owned corporations

are able to develop innovative ventures, providing they are managed not only focused in the

airport’s core business but also with a market-oriented awareness.

Thirdly, the ultimate argument in favour of privatization regards taking advantage of the

managerial expertise of the private sector so as to increase airport efficiency (Qin, 2010). The

inertia of public agencies towards new challenges is incompatible with the competitive and

constant changing environment lived by the sector (Gifford and Stalebrink, 2002). In contrast to

public companies that generally rely on governmental subsidization, not needing to make

additional efforts for optimization or improvements, private parties need to be dynamic to face

new challenges that may arise, in order to look for a market leading position. Moreover, private

parties are likely to be more efficient since all the financial responsibilities and risks are borne

by them, inducing a more accurate focus on sharpening management procedures.

Finally, several public investments are known to be imprudent, what might lead to “white-

elephant” projects, whose benefits are not significant and with costs significantly higher than

what can generate in revenues, creating a never-ending public bills. As privatization allows the

transference of the financial risks from taxpayers to the private sector, there is a strong

incentive for private players to carefully carry out these projects, after detailed analysis

regarding the project’s feasibility. Therefore privatization may be an important step towards

decisions being made on economic and financial basis, rather than political.

43

3.4.4.2. DRAWBACKS OF AIRPORT PRIVATIZATION

When BAA was privatized many problems arose, what consequently led to several

governmental interventions due to the drastic differences in the management approach

undertaken. Because of BAA’s constant power abuse (e.g. abusive car-parking charges, duty-

free prices and prevention of competition (Doganis, 1992)) , the British government felt the need

to define strict regulation to prevent the new private owners from implementing measures that

would affect not only the social welfare but also the competitiveness of the British airport sector

(Scott, 2004). Despite the air transport market changed significantly in the past decades, the

conviction that airports enjoy a privileged monopolist situation still exist, what drives

governments to be reluctant about full privatization of the airport sector (Vasigh, 2009). Actually,

privatization shall be regarded as a way out of avoiding depriving society of other benefits, and

for that reason these processes must be carried out with a strong inherent social perspective.

Given this, the process should be publicly accompanied in all phases, first in the definition of the

privatization priorities and in the assessment of the existence of added value. Moreover, during

the operation of the privatized service, the State must be prepared to intervene in order to

prevent measures that would induce loss of welfare by the society.

Figure 17 – Typical market abuses in the airport sector

One of the commonest types of market abuses present in privatized airports is the significant

reduction of airport space for passengers and cargo, with the aim of maximizing commercial

slots. The huge growth of non-aeronautical revenues brought a whole new posture by airport

operators and the maximization of these services can be a very significant source of revenues

(for instance, in Munich Intl. Airport, a growth of 1% in traffic represents a 5% growth in

revenues (Macário, 2011a)). The minimization of effective terminal space for users is, as much

as possible, substituted by commercial concessions, so as to increase commercial revenues

(Doganis, 1992), but with a consequent significance reduction of the airports’ LOS.

Another important point that shall be emphasized is the possibility of establishment of

monopolistic arrangements with suppliers (e.g. ground handling companies, duty-free shops,

car hire or taxi companies), not allowing fair competition in these services. Under this

framework, concessionaires are allowed to extract monopolistic profits, which are then shared

between the concessionaries and the airport operator (Doganis, 1992). These agreements are

win-win games for both entities involved, while the users bear the costs of these collusions.

Furthermore, privatization through IPO may also bring attached a significant drawback

concerning the economic activity related to the company, which is imperfect information and

Secrecy about

corporate's status

Monopolistic Agreements

Profit Maximization Obsession

Loss of financial flexibility

44

biased action. Listing a company in the stock market implies accepting share flotation according

to the investors’ demand, therefore capital markets may be very risky according to rumours that

may arise concerning the company. Obviously shareholders are not very fond of price

fluctuations, since their aim is to earn a good ROI, through the valuation of the stock price

and/or good dividends. To avoid market volatility, companies may adopt an internal policy of

secrecy regarding its financial and economic activity (Graham, 2008), in order to control

rumours that might cause impacts in the stock price. This way, investors are not able to

accurately evaluate the company listed, and may even be misled in a better evaluation of the

stock than the real one. A real example of a similar situation is BAA, as the clarity and in-depth

of the company’s financial reports reduced drastically after the privatization (Doganis, 1992).

Moreover, one of the items considered as a positive point regarding privatization may also be

considered a significant drawback: the diversification of the core business. Despite these non-

core activities may be very good sources of revenues and important attractors of customers, the

reality is that many times these non-core economic activities are very unstable and more

exposed to economic cycles (Doganis, 1992). Furthermore, frequently, the investments needed

to implement these services are also very capital intensive and require a huge allocation of

capital resources for their development, what may lead the airport company to slower financial

reactions if the aeronautical business is affected by unexpected events, vanishing the private

sector advantages regarding capital flexibility and availability.

Last but not least, the airport company may develop a profit maximizing obsession, especially in

the first years of operation, solely focusing on profit-oriented management approaches, instead

of client or even value-oriented (Vasigh, 2009). A too rigid pursuit for profit may lead airline

operators, passengers or freight shippers, to a severe discontentment, discouraging customers

of using the airport. For instance, BAA faced some problems regarding the taxi operators, who

refused to provide services to/from London Heathrow because of the inadequate and not

proportionate fees implemented by the operator (Doganis, 1992).

3.5. CONCLUSION

There are several reasons why airports vary in their ownership and governance models, which

mainly depend on governmental ultimate goals, the national vision of how the sector should

evolve, country’s financial status, power of interest groups, level of competitiveness wanted to

be achieved, amount of infrastructure investments required and on the will of the private sector

to enter the market and to invest in the aviation industry.

To conclude, it is worth making a general assessment of how ownership and governance affect

airport performance and which models have proved to be better. Despite there are dozens of

indicators, (Gillen, 2007) refers that among expert economists, the most suitable metrics to

quantify airport performance is total factor productivity and/or cost efficiency. In (Oum, et al,

2006), the most evident conclusions were:

45

• Ownership homogeneity leads to cost efficiency: Fully private, majority private and

fully public airports are the most cost efficient, maybe because there are less conflicting

objectives (Gillen, 2007), allowing a more stable and goal-oriented management;

• Mixed public-private ownership (w/ majority public) models are the least cost

efficient: These models showed the weakest performance regarding cost efficiency;

• Governance models’ effect not explained: Although it was proved that there is impact

of governance models in the level of cost efficiency, no clear explanation was found.

In (Oum, et al, 2006), there is an additional note concerning entrepreneurship, as airports with

higher non-aeronautical revenues were more efficient. The business diversification approach is

generally found in privately managed airports, run with a market-oriented perspective.

Moreover, in (Vogel, 2006), it is affirmed that privatized airports are financially more efficient due

superior operating efficiency, asset utilization and capital structure.

On the other hand, taking the justification of capital homogeneity and its relation with cost

efficiency into account, public airports efficiency should be closer to private airports, in terms of

efficiency, nevertheless agency problems, lack of contractual incentives or institutional inertia

constitute a strong barrier to improvement. Furthermore, comparing private and public airports,

while in the former they are profit-seekers, where the level of output is a constraint, in the latter

output-optimization is the major concern, with cost efficiency as a constraint (Gillen, 2007).

Finally, some further thoughts shall be addressed to mixed public-private ventures, with public

majority, which appeared to be the most inefficient. As PPP approaches have been widely

adopted around the world, some deeper analysis should be carried, as the sector may be

following a misleading trend, which seems to be advantageous but which, in fact, is not.

46

4. AIRPORT FINANCE

4.1. INTRODUCTION

After the 2007-2008 financial crisis, and the more recent Sovereign debt crisis, the financial

industry had to reinvent itself and whole new paradigm was created. The reality is that, today,

infrastructure investments are much more constrained regarding capital availability and

therefore infrastructure finance is a prominent issue to be considered.

Airports, in particular, constitute some of the most capital-demanding infrastructures and the

level of risks to which these investments are subject to is very significant, severely diminishing

the ability of governments and/or private investors to undertake such endeavours. Moreover, all

these facts are aggravated by the self-sustainability of the sector, when in operation, as airports

are characterized by significant operational expenses29. Despite it is commonly defended to be

a very profitable industry, there must be a serious commitment by the management teams in the

implementation of sharp and rigorous strategies, so that they can extract it is possible to take

advantage of those benefits (Doganis 1992).

This chapter will focus on airport finance, covering topics like the available sources of capital for

airport development and how the capital structure of a certain venture is defined.

4.2. SOURCES OF CAPITAL

4.2.1. RETAINED EARNINGS

4.2.1.1. INTRODUCTION

Retained earnings come from airport revenues, which are majorly ensured by aeronautical and

non-aeronautical charges and off-airport revenues. These are the very first source of capital

available for airport companies to finance investments and launch projects.

4.2.1.2. AIRPORT REVENUES

AERONAUTICAL CHARGES

As the name indicates, aeronautical charges include every charge directly related to the

aeronautical business. Ultimately attached to the core business of the airport, aeronautical

charges are usually regulated under severe economic restrictions in order to prevent airport

operators to develop monopolistic pricing policies that would jeopardize users’ social welfare.

Some examples of these charges are: landing fees, air navigation fees, aircraft parking and

hangar charges, noise charges, passengers and cargo service charges, security charges,

ground-handling charges or en-route navigation charges, etc.

29 The airport cost structure includes labour, capital, services, maintenance, administration, etc. Worth mentioning is the fact that, generally, only labour and capital account for more than 60% of the total cost.

47

NON-AERONAUTICAL CHARGES

Concerning non-aeronautical charges, these are related to all the ancillary and non-core

services provided by airports.

This group of charges is composed by: concession fees for fuel and commercial activities,

revenues from car parking and rentals, rental of airport land for real estate development, fees

derived from provision of engineering services and other non-airport revenues, etc.

OFF-AIRPORT REVENUES

Off-airport revenues are a source of airport earnings which are derived from economic activities

not directly related to the air transport industry. Some usual sources are consultancy and

training services, management contracts or equity investments30.

4.2.1.3. ECONOMIC REGULATION31

The quasi-monopolistic market position of the airport sector led governments to define and

implement specific economic regulation, so as to prevent market abuses (Gillen, 2007). The

spread of economic regulation in the airport industry became a reality and a global consensus

was achieved regarding the regulation of aeronautical charges, however the approach

regarding how non-aeronautical revenues should be treated is still an undefined issue.

In the airport sector, the most common economic regulatory system is the Price Cap Regulation,

which is a system with low regulatory cost that provides incentives to promote cost efficiency, as

caps are imposed to the maximum levels of price growth allowed32. Considering RPI as the

inflation indicator, the maximum price increase formulae is given by (RPI – X), meaning that X is

the efficiency gain through process optimization:

�� = �� − � → �� > 0� = 0� < 0 → � �� (1)

The regulatory system is typically audited and reviewed every 5 years and includes the need of

above inflation price increases to cover costs on new capital investments (Gillen, 2007). Within

Price Cap Regulation, the two most common approaches within this method are: Single-Till and

Dual-Till, where the difference is how aeronautical and non-aeronautical charges are regulated.

In Single-Till, both aeronautical and non-aeronautical, are regulated indifferently, as the cap is

imposed to the combination of revenue sources, thus any restrictions to the rate of return of an

operator applies to the combination of both sources (Neufville and Odoni, 2033. Therefore, due

30 Management contracts and equity investments may or may not be linked to the air transport industry. Airport companies may be willing to spread its operational expertise to other areas rather than just its core business and/or to invest in other sectors so as to minimize its exposure to the airport industry. 31 See Appendix VII for more information on other regulatory models. 32 Associated to inflation, measured by the Retail-Price Index (RPI) or the Consumer-Price-Index (CPI).

48

to the high profitability character of non-aeronautical services, the room left for other sources is

very short, leading to considerable low aeronautical charges.

Figure 18 – Schematic representation of Single-Till (Neufville and Odoni, 2003)

In Dual-Till, aeronautical and non-aeronautical revenues are separated in two different “baskets”

(Gillen, 2007). The full cost recovery of aeronautical services is exclusively achieved by

aeronautical sources (consequently driving to higher charges), while non-aeronautical revenues

are treated apart (Neufville and Odoni, 2003).

Figure 19 – Schematic representation of Dual-Till (Neufville and Odoni, 2003)

In the US, there are two similar models: the Compensatory and Residual Methods. In the

former, airlines, according to the space they occupy in the airport, pay for the full cost recovery

of the share of space (facilities and services) used, while in the latter airlines take financial risk

over airport’s investments, through long term use agreements where they underwrite airport’s

debt. In the Residual Method, a share of the debt-service costs is agreed to be sponsored by

non-airline activities while the rest (the residual) is covered by airlines (Tretheway, 2001).

Regarding the suitability of the models, It is defended that Single-Till/Residual Method is more

suited to airports very exposed to demand risks, dependent of one or two airlines (i.e. providing

incentives for airlines to stay), while the Dual-Till/Compensatory Method better suit major

airports with no evident airline dependence (Neufville and Odoni, 2003).

49

Table 13 – Arguments for Single and Dual-Till Aproaches (Neufville and Odoni, 2003)

Single-Till Dual Till

The travelling public is the major beneficiary Airlines are for-profit companies and shall be fairly

charged so as to increase economic efficiency

Non-aeronautical business is very dependent of the

aeronautical, so airlines should be compensated

In congested airports, airlines are unlikely to pass

benefits to users

The core business should be relieved as airports extract

monopolistic profits from non-aeronautical businesses

Non-aeronautical revenues are a consequence of their

prime business location

4.2.2. SPECIAL PURPOSE TAXES

Commonly known as Passenger Facility Charges (PFC), this is a major source of capital so as

to finance key capital investments in the airport sector. These PFC are very common in the US,

where they are specifically used to improve security, safety or capacity issues (Graham, 2003).

In this type of taxes, they usually go directly to the airport operator, rather than going to a

governmental entity who would then assign a grant to the operator (Neufville and Odoni, 2003).

4.2.3. GOVERNMENTAL GRANTS


Governmental Grants are non-returnable sources of funding, provided by national or

international organizations, whose interest is the development of the project rather than taking

financial profit of it (UN, 2004). As referred, infrastructures have generally been regarded as

public interest therefore governments have been the major infrastructure providers. Due to this

reason, public grants still continue to be a major funding source in infrastructure delivery.

However, the enrolment of public money in large-scale projects always causes severe public

debate. In such investments, the benefits brought usually take long time to be passed to the

common citizen, making the period of public contestation longer and increasing the difficulties to

overcome these social issues. Furthermore, capital investments are very attached to the

existence (or idea of existence) of corruption (Kenny, 2006) and lack of transparency regarding

in what public funds are actually being used for, raising awareness to whether public money is

being applied in defending the so-called public interest or serving private interests instead.

One last point to mention is that public intervention can have other forms, rather than only

capital aid. The State can also contribute with new/existing facilities or land space, be engaged

as an off-taker or be the connection bridge between the concessionaire and potential clients.

4.2.3.2. EUROPEAN UNION STRUCTURAL AND COHESION FUNDS

The EU development funds are divided in two groups, the Structural and the Cohesion Funds,

where the former includes both the European Regional Development Fund (ERDF) and the

European Social Fund (ESF).

50

EUROPEAN UNION STRUCTURAL FUNDS

The European Union Structural Funds were created to reduce disparities in regional

development and to promote socio-economic cohesion within the EU, and aim to support

priority projects for Member States (ACI, 2010). Structural Funds are non-reimbursable financial

assistances that have the purpose of funding national projects, usually with a maximum 7-year

development period (Inforegio, 2004), and which must be approved both by the European

Commission and the Member States’ authorities.

As far as the ERDF is concerned, it particularly focuses on supporting regional development

programs, with a strong role in enhancing economic growth and national competitiveness. A

relevant point is that priorities include research, innovation, environmental protection and risk

prevention (Inforegio, 2004), rather than infrastructure investment.

Regarding ESF, the major concerns are to increase workers and enterprises adaptability to the

EU labour market, enhance employment access and to fight social exclusion, by combating

discrimination and facilitating access to the labour market. Thus, it is not suitable for airport

projects to be funded by ESF, however it may be used to fund related projects (ACI, 2010).

EUROPEAN UNION COHESION FUNDS

The European Union Cohesion Fund (EUCF) also aims to diminish socio-economic

discrepancies between EU States and to stabilize their economies. The fund is only eligible to

the least prosperous Members33 and allows financing, up to 85%, of major projects involving:

• Environment projects aiming to accomplish the goals defined in the European

Commission treaty and to develop projects in line with the EU Environmental policy;

• Transport infrastructure projects identified as priority in the TEN-T guidelines.

Working in a conditional way, State Members are only eligible to be funded as long as they

comply with the convergence program for economic and monetary union34 (ACI, 2010).

Besides, the criteria imposed by the European Commission, to evaluate projects’ eligibility are:

Figure 20 – Financial conditions to be met by the projects using the EUCF (ACI, 2010)

33 Nations whose GNP per capita is below 90% of the EU-average. 34 The EU Stability and Growth Pact.

Socio-economic benefits:

The benefits generated by the project, as demonstrated in the Cost-benefit Analysis;

Community contribution:

Project's contribution to Community objectives for the environment and/or TEN-T;

Priorities' Compliance:

Compliance with the priorities defined by each Member State;

Project's Compatibility:

Compatibility with Community policies and with operations undertaken by the Structural Funds.

51

A good example of EUCF usage is the improvement/expansion of Tallinn International Airport,

in Estonia, after that Baltic State joined the EU in 2004 (Republic of Estonia, 2003).

4.2.3.3. AMERICAN AIRPORT AND AIRWAY TRUST FUND

Created in the US in the 1970’s, the American Airport and Airway Trust is controlled by the FAA

and provides funding for the improvement of the airport network.

The sources of funding currently come from: collections related to passenger tickets, passenger

flight segments, international arrivals/departures, cargo waybills, aviation fuels and frequent

flyer mile awards from non-airline sources like credit cards (FAA, 2011).

4.2.3.4. JAPANESE SPECIAL ACCOUNT FOR AIRPORT DEVELOPMENT

A good example of public funding in the airport sector is Japan. The Japanese airport network

benefits from the National Special Account for Airport Development, a special fund supported by

airport charges, which is used to reinvest in the network if major capital investments are

required, such as construction, improvement or maintenance of airports and for environmental

countermeasures (Kanaya, 2010).

The existence of the fund allowed cross-subsidization between airports what led to a huge

spread of the network, creating a huge number of airports which are not financially feasible35 but

that were regarded as a major generator of regional development, inducing the creation of

commercial interests and public infrastructure development (Otha, 1999).

4.2.4. DEBT

4.2.4.1. LOW COST LOANS

FOREIGN GOVERNMENTAL AUTHORITIES FOR DEVELOPMENT

Many developed nations have founded governmental agencies that are willing to provide aid for

the development of relevant projects in developing countries. These authorities may act

altruistically or have specific business purposes, through the promotion of trade and commercial

relationships between the nations involved, when potentially valuable partnerships are foresaw.

Some countries have developed different agencies of this type and nowadays it is possible to

find similar organizations around the world, looking for interesting socio-economic international

partnerships. These cooperative ventures between the more and the less developed countries

are mainly based in exporting technology/equipments, as well as providing loans on preferential

terms (lower interest rates and longer/adjustable payment terms) (Dempsey, 2008).

A rather good example of the activity carried out by these agencies is the USD 186M loan

provided by the European Investment Bank (EIB) and the French Development Agency in the

project of Nairobi’s Jomo Kenyatta Intl. Airport upgrade (Balmes, 2010).

35 Only 10% of the total number of Japanese airports is financially self-sustainable (Otha, 1999).

52

Another notorious case of foreign governmental authorities’ intervention is the new Malé

International Airport, in the Maldives, a project to be developed under a 25-year BOT contract.

In this venture, several international governmental institutions were involved in the development

of the airport master plan and providing consultancy services, like the International Finance

Corporation (IFC), the Dutch Ministry of Foreign Affairs, the Australian organization AusAid and

DevCo. For instance, DevCo is a multi-donor development agency funded by the UK’s

Department for International Development, the Dutch Ministry of Foreign Affairs, the Swedish

International Development Agency and the Austrian Development Agency, whose purpose is to

provide consultancy and advisory services to governments in developing countries (IFC, 2010).

DEVELOPMENT BANKS

Special international banking institutions have been founded with the purpose of helping

developing countries, assisting them in financing and implementing large scale projects, as well

as to provide consultancy services along the whole project development process, since

planning until operation. The rationale behind the project choice is similar to the EUSCF, where

projects must have national structural impact and play a major role in the leverage of economic

development. Projects chosen by these institutions are carefully studied, in order to estimate

their impact in local economies and how they will actually influence and foster economic growth.

The case of Enfidha International Airport (NBE), in Tunisia, regarded as a national priority in the

Tunisian infrastructure investment plan, is a very interesting example. Together with Monastir

Airport (MIR), both projects aimed to anticipate the huge growth of tourism and industrial

development expected to happen in the region (AfDB, 2009). Being one the most important

touristic regions in Tunisia, the anticipation of future demands would lead to a better fit of supply

and demand. In both cases, NBE and MIR, the Tunisian Government decided to launch BOT

contracts however, in NBE’s case, due to financial issues, lenders’ commitment reduced

significantly, leaving the venture’s capital structure with severe financial gaps. The African

Development Bank (AfDB), considering the importance of the project and its huge impact in the

Tunisian economic growth, decided to contribute with a USD 70M loan (AfDB, 2009).

Figure 21 – Major AfDB’s reasons in support of Enfidha Intl. Airport (AfDB, 2009)

Another worth mentioning example is Queen Alia International Airport (AMM), in Jordan. The

expansion, refurbishment and operation of AMM, developed under a BOT contract, constituted

the biggest private investment in the Middle East and was partially financed by IFC and the

Strong economic benefits

Strengthening of the macroeconomic policies

Important structural reforms in the Transportation Sector

Consolidation of human capital

53

Islamic Development Bank. Both institutions ruled in favour of the positive impact of the project

in Jordan’s economy and the final capital structure of the project counted with a USD 347M

senior loan, and an extra USD 40M subordinated loan, exclusively provided by IFC (PFI, 2008).

In Armenia, for instance, the impact of development banks was also felt through the USD 40M

loan provided by the Asian Development Bank (ADB), with the purpose of developing the

second expansion phase of the Zvartnots International Airport, the busiest Armenian airport.

The loan, with a 10,5-year term, was the first non-Sovereign intervention by ADB, since the

airport is operated by the American International Airports, a Delaware-based firm (ADB, 2010).

The major aim was to strengthen the relationships between Armenia and ADB and to develop a

vital project to improve the Armenian socio-economic framework.

Globally recognized and playing a very important role in the financing of major capital

investments, particularly in Europe, EIB is a key institution with an extremely crucial position in

the development of the European transportation network (ACI, 2010). EIB’s shareholder

structure is composed by all EU Member States and therefore, it follows EU principles so as to

define its own lending policies (EIB, 2007), which are quite restrictive. The consequence of this

restrictive EIB transport lending policy is very positive, as only financially, socially and

economically feasible projects are approved by the bank to be financed. Moreover, projects are

required to have sound Environmental Impact Assessments at the planning stage, otherwise

they will be rejected (EIB, 2007). Regarding international projects outside the EU, EIB does not

make any distinction and applies the same evaluation criteria as if projects were to be located in

the Union (ACI, 2010), even if local policies are less demanding.

An interesting example of EIB intervention in the airport sector development is the EUR 1B loan,

for the development of the new Berlin Brandenburg International Airport. The aim of the project

is to expand and upgrade the existing Schönefeld Airport and turn it into a major European hub.

Figure 22 – EIB lending requirements for the airport sector (ACI, 2010)

Projects under the TEN-T program;

Investments located in Convergence Regions, with a significant contribution to regional development;

Projects supporting local economies, which are highly dependent on air transport services;

Projects contributing to improved safety, reduced congestion or result in time savings for travelers;

Projects contributing to airport operating efficiency and innovation;

54

4.2.4.2. COMMERCIAL LOANS

Commercial loans are short/mid-term loans, 3-10 years (Neufville and Odoni, 2003), provided

by regular banking institutions. Similar financing mechanisms as the usual credit loans used to

buy cars or real estate, these loans are frequently characterized by higher interest rates, which

may be reduced by governmental guarantees (as the risk of default diminishes).

Commercial loans are very flexible and provide quick liquidity, because of its ready availability

(Neufville and Odoni, 2003), however, due to the higher interest rates, they are not an adequate

financing solution for large scale projects, being generally used to cover projects’ financial gaps.

Usually considered as senior debt, commercial loans are typically secured by projects’

underlying assets, nevertheless the importance of cash flows and revenue-producing contracts

are starting to gain relevance in credit evaluation and as a securitization tool (UN, 2004).

For example, in the USD 8,7B construction of the Hong Kong “Chek Lap Kok” International

Airport (HKIA), commercial loans were used as financing mechanism of the project. A huge

USD 2,8B loan was utilized to fulfil the financing needs of HKIA (Trani, 2011), however, at the

beginning of the 2000’s, HKIA restructured its debt and turned to bond financing (Chapman and

Georgoulias, 2010), what allowed more attractive lending conditions (e.g. lower interest rates).

4.2.4.3. BRIDGE FINANCING

Bridge financing is a short-term financing tool used with the purpose of making available the

capital for the project to be launched, while long-term loans are still under analysis, (UN, 2004).

Bridge financing, depending on the contractual agreement between the lender and the

borrower, may be considered as senior or subordinated debt and it can be provided by several

banking institutions, like regular commercial banks.

An interesting bridge financing instrument is the Transport Infrastructure Financing Unit, an

entity created by the British Treasury with the purpose of restoring banks’ confidence in the

long-term credit market, which started to be reluctant to provide financing after the global credit

crisis, in 2008. TIFU is a complementary financing tool, to be used alongside other financing

sources, and it is intended to be a temporary, reversible, and ‘last resort’ intervention, as the

Treasury foresees selling the loans, prior to maturity, when favorable market conditions return

(Farquharson and Encinas, 2010).

4.2.4.4. BOND FINANCING

Bonds are long-term fixed-rate securities, generally purchased by institutional investors36 and

then traded in the secondary market. Used by governments and corporations to finance

projects, bonds have become the largest source of capital in airport development (Dempsey,

2008). Their role varies significantly, depending on the airport’s size and the type of air traffic

36 Institutional investors may be insurance companies and pension, mutual or hedge funds.

55

served, being the large and medium airports the most prominent in the bond market regarding

trading volume. The most commonly used bonds in the sector are Government Obligation

Bonds (GOB), General Airport Revenue Bonds (GARB) and Special Facility Bonds (SFB).

Firstly, GOB are bonds issued by local or national governments, with the objective of financing

public projects. As the bond issuer is a public entity, GOB are generally tax-exempt and secured

by tax revenues, lowering the perceived default risk and, implicitly, the respective interest rates.

However, most nations are limited regarding the amount of GOB that may be issued (Doganis,

1992), so as to keep Sovereign indebtedness in reasonable values. These debt caps led

governments to look for new solutions when considering airport finance, such as GARB or SFB.

GARB are a special type of bonds, issued by airport companies, which are able to service debt

(UN, 2004). This type of bonds are secured by airport’s operational revenues (Doganis, 1992)

and other revenue-generating contracts (this may be measured by DSCR), such as business

agreements with airlines, allowing financing airport projects independently from governmental

budgets (but increasing the riskiness of these ventures). Consequently, the non-existence of

governmental guarantees implies that GARB have higher interest rates than GOB.

Some authorities, like Massport or the Port Authority of New York and New Jersey, whose

activity go far beyond the airport sector (also including ports, railways and urban public

transportation), and have such strong revenue sources from other activities that they can secure

GARB by their overall earning power. In contrast, in the event of airlines securing investments,

as it was mentioned, it is common the application of a residual charging system, being airlines

assigned voting rights in the airport’s strategic decisions (Neufville and Odoni, 2003).

Finally, SFB are a special kind of bonds, issued by airports’ sponsors, with tax-exempt status

and secured by the indebted facilities´ revenues (Doganis, 1992), like terminals and/or hangars.

Bond financing has several advantages like tax deductions and lower interest rates than

conventional commercial loans, however its exposure to credit ratings may be a reason for

instability regarding the interest rates applied. Moreover, bonds are generally considered to be

senior debt, meaning that in the event of default, lenders have “step-in” rights over the project.

A fairly good example of bond financing is the modernization and expansion project of the

Frankfurt International Airport (FRA), led by Fraport AG, which has planned to invest EUR 7B,

between 2007 and 2015. As EUR 3B are to be internally funded, the project’s financing needs

were around EUR 4B, being around 15% fulfilled through bond financing.

4.2.5. QUASI DEBT-EQUITY


Quasi Debt-Equity instruments are financial tools, structured with warrants and/or options, which

are placed in-between debt and equity, and may include mezzanine debt and yield-based

preferred shares (UN, 2004). Quasi Debt-Equity securities have very interesting points, such as:

56

• Voting rights are kept by the Sponsors (common shareholders);

• Higher claim on assets than equity (implying a lower cost of capital);

• Flexibility as it does not have the same restrictive covenants as traditional debt.

4.2.5.2. YIELD-BASED PREFERENCE SHARES

Preferred shares are equity securities, with some special characteristics which are similar to

debt. This special type of shares does not grant decision making power in the company’s

strategic decisions and dividends are generally defined at a fixed rate (similar to debt), however

failure to pay dividends does not mean that the company is forced into default (similar to equity).

Preferred shareholders are senior compared to common shareholders and are also entitled to

higher dividends37, in the majority of cases. Moreover, holders of preferred shares may even be

entitled to cumulative dividends, meaning that no payments are done to common shareholders

until missed dividend payments are actually paid, in full, to preferred shareholders (UN, 2004).

Technically, preferred shares are equity securities, therefore subordinated to debt.

4.2.5.3. MEZZANINE DEBT

Mezzanine debt’s range is between USD 5 and 100M, with 2-5 years of maturity periods (UN,

2004). As the name says, mezzanine’s payment priority is in the middle, between regular debt

and equity, and may have special features that allow it to be convertible to equity.

4.2.6. EQUITY


Equity is a type of capital investments, in which capital is traded in exchange of ownership rights

of a company/project. Being at the lowest seniority level (meaning higher risk), shareholders

have secondary claim on assets and are only entitled dividends after debt holders are paid38.

For investors willing to take the investment risk of becoming shareholders, it generally means

that the possibility of very attractive and sound rewards exists, which usually come as high ROE

and significant share valuations. In all, the cost of equity capital is the highest, recognizing the

level of risk to which shareholders are exposed (Duque, 2011).

The interest of private players in the airport sector has been growing very significantly in the last

decades, especially due to the high lucrative character of the industry and, together with the

reluctance of governments to fund airport investments, a privatization trend started and several

new players were brought into the sector.

37 It is a way to compensate the fact that preferred shareholders do not have decision making power. 38 Shareholders’ dividend distribution policy depends on each company’s management approach.

57

4.2.6.2. GENERAL INVESTORS

With the engagement of so many new partners, big players in other markets started to enter the

airport business due to the attractiveness of the investment, and a very good example is the

influence of construction companies in the industry. The development of subsidiary companies

to deal with concession contracts, led contracting companies to actually consider entering the

airport industry, not only through PPP but also in privatizations.

For instance, the already referred Hyderabad Rajiv Gandhi International Airport, in India,

developed under a BOT, is a joint venture between the national airport authority AAI, which

holds 26% of the shares, and the private consortium, headed by GMR Infrastructure Ltd., which

holds 74%. The USD 400M project was financed through equity (USD 84M), governmental

grants (USD 24M) and interest free loans (USD 70M), while the USD 222M left were issued

through debt (MCAGI, 2006).

Another example is the German group Hochtief AG, whose core business is construction, and

which, through its subsidiary Hochtief AirPorts, is a major player in the airport sector, owning a

very significant network that includes Sydney (SYD), Düsseldorf (DUS), Hamburg (HAM), Tirana

(TIA), Athens (ATH) and Budapest (BUD)39. For instance, regarding the project of Athens

Elefthérios Venizélos International Airport, the tender for the USD 2,4B project was won by

Hochtief AG, acquiring a 45% stake in ATH’s capital.

Figure 23 – Capital Structure of ATH (USD Millions) (Odoni, 2007)

4.2.6.3. INVESTMENT BANKS

Investment Banks (IB) are banking institutions which act like agents of individuals, corporations

or governmental entities, assisting in the development of financial plans, managing investments’

risks and providing consultancy services regarding the financial profile of the project.

Furthermore, IB are also responsible for performing the capital-raisings, issuing debt and

defining the securitization plans of investments.

The Espirito Santo Investment Bank (ESIB), for instance, has significant experience in airport

finance. The Portuguese bank was the lead arranger of the EUR 716M loan for the expansion of

39 The process of sale of Hochtief AG’s airport concessionaire is now under process, in a USD 1.3B deal.

1128

360

288

264

168144

48

EIB

Commercial Banks

Greek Airport Fund

EU Grants

Greek State Grants

Equity Capital

Secondary Debt

58

the Saint Petersburg Pulkovo International Airport, and assisted Global Infrastructure Partners

(GIP) in the GBP 1,5B acquisition deal of Gatwick International Airport (Lavanchy, 2011).

The British HSBC also plays an important role in worldwide airport financing and clear evidence

is the USD 400M limited recourse loan for the construction of the new passenger terminal, and

related facilities, at the Mexico City International Airport (Whalen, 2006).

IB also have their own funds related to infrastructure investments, allowing these banking

institutions to be more than intermediary entities. The stake acquisition in infrastructure

investments permits the diversification of the bank’s portfolio, reducing its risk exposure to

certain markets. This type of investment can be seen in the next section – Private Equity Funds.

4.2.6.4. PRIVATE EQUITY FUNDS

The involvement of new private investors also brought private equity funds into the industry,

which saw in the airport sector an attractive investment opportunity. Private equity funds are

financial structures, which may (or may not) be created by IB, and which create investment

mechanisms that focus in a determined market/sector, depending on the fund’s objectives.

For instance, the referred company GIP is a long-term investor fund and is the ultimate case of

a private equity fund which got involved in the airport sector. Jointly founded by Crédit Suisse

and General Electric, with an initial capital of USD 1B, the fund already accounts with a USD

5,5B portfolio, which includes London Gatwick and London City Airports (GIP, 2011).

A clear case of the situation where IB created its own infrastructure fund is the GS Infrastructure

Partners, a fund owned by Goldman Sachs (GS), which acts as the bank’s primary vehicle to

directly invest in infrastructures, such as toll roads, airports or ports (Goldman Sachs, 2011). An

important GS’s investment in the sector was the pre-IPO acquisition of 14% of the Turkish

company TAV Airports (Youssef, 2009), however the bank’s stake was soon sold afterwards.

Another case is JP Morgan Chase & Co., through JPM Asset Management – Global Real

Assets, invested in the Australian airports of Cairns and Mackay. In 2009, the bank decided to

buy 50% of these airports as part of its strategic investment plan (JP Morgan & Chase, 2011).

A final worth-mentioning case is the Australian IB Macquarie, which owned an infrastructure

fund specialized in airports, called Macquarie Airports. In 2009, the fund was spun-off, giving

birth to the MAp Group, a completely new corporation with a special focus, not only in owning

strategic positions in airport companies, but rather to own, manage and operate airports (MAp,

2011). MAp is listed in the Australian Stock Exchange and owns majority stakes in three

important airports: Sydney (SYD), Copenhagen (CPH) and Brussels (BRU).

4.2.6.5. VENTURE CAPITAL

Venture Capital (VC) is money provided to companies at their starting-up stage, whose

perceived growth potential is very high. VC stands as a very important piece of a national

economy, since it is a major source of funding for start-up firms, which do not have financial

59

record or reliable proof to access capital markets. Venture Capitalists, usually powerful investing

groups, in addition to providing capital, may also contribute with managerial and technical

expertise and generally choose investment opportunities characterized by high-risk/high-return.

A notable transaction was done by Siemens Project Ventures, a subsidiary of the German

group Siemens AG, which became the head of the leader consortium which developed the new

Bangalore International Airport (MCAGI, 2006). The German company have a 40% stake in the

airport company and invited the Swiss operator Flüghafen Zurich to integrate the consortium, so

as to bring the required expertise to ensure an adequate airport operation.

4.2.6.6. STOCK MARKET

A common privatization model is publicly listing companies in the stock market and the ultimate

case of this type of divestiture is BAA, an example already referred before. In fact, this trend

spread all around the world and nowadays there are several examples of listed airports.

Another interesting case is TAV Airports, which established its first BOT in Istanbul Ataturk

International Airport, in 1999, and now operates 11 airports in 5 different countries. In 2006 the

IPO in the Istanbul Stock Exchange valued TAV in more than USD 2,0B (Youssef, 2009).

Nevertheless, stock investments may be perverse, as the profitability searched sometimes

might not hold. TAV, whose IPO price was TRY 8.40/share, experienced a significant initial

valuation of ~25%, reaching the price of TRY 10.46/share. However, with the 2007-2008 crisis,

the firm was led to a severe market underperformance, throwing the share price to TRY 2.20. In

the first trimester of 2011, TAV was still not able to fully recover to its IPO price40.

Figure 24 – Stock Chart of TAV and the index DJ EuroStoxx50 (Reuters, 2011)

40 TAV is listed in the Istanbul Stock Exchange and was consulted between the 1 February 2007 and the 20 March 2011.

60

4.3. CAPITAL STRUCTURE

4.3.1. INTRODUCTION

Being, strongly dependent of market and local conditions, the capital structure is the

combination of debt, quasi debt-equity and equity securities which are used to finance all

different kinds of ventures.

The optimum capital structure is, in theory, when “the risk of bankruptcy is balanced with the tax

savings of debt” (Simerly and Li, 2000), however, in practice it is dependent on a batch of

factors, which are addressed in the following sections.

4.3.2. CAPITAL CYCLE AND CASH-FLOW GENERATION

The capital structure of a project is not static, being shaped according to the stage in which the

project is. As the capital requirements and the cash-flow generation vary along the different

stages, its capital structure also has to be adjusted to the particular needs of each stage.

Evaluating the whole length of a project, the initial stages are the riskier, including

construction/implementation, where the likelihood of cost overruns and delays is very high. At

these stages, sponsors are required to inject a significant amount of equity capital in the project

as there may not be enough will by lenders to provide financing to the project, because of its

high-risk profile at this particular stage.

In the following stages, project’s capital requirements start to diminish and cash-flows begin to

materialize, lowering the overall level of risk. At this point, a situation of capital restructure might

be considered (UN, 2004), so as to refinance the project using cheaper capital, consequently

decreasing the total cost of capital of the endeavour.

Figure 25 – The Project Development Cycle - Risk vs. Reward (Lehman Bros, 2003)

4.3.3. TAXES

The level of taxes applied in a country to a project can also be a very relevant parameter that

can play as an incentive (or disincentive) for the development of a venture. Therefore, a

61

thorough assessment of the impact of taxes on the overall cost of capital, earnings and sources

of capital shall be carried out.

Tax impact can significantly influence the way how ventures are structured, and especially how

the capital structure of a project is defined. For instance, if interest on debt is tax deductable,

sponsors may prefer to increase the project’s exposure to debt and diminish the share of equity

capital in the structure. On the other hand, if earnings are tax-exempt, an opposite incentive is

given, with equity capital being preferred over debt (UN, 2004).

Considering the following example of a EUR 100M investment with the following properties:

$%&%' (��1 → )* = 32(��2 → )* = 19 ,�/��0��

(��3 → )* = 01(*��1��1)��2 (��)�� = 6%(��*��1 = 20%(��05�� = 25%(2)

In Table 14, it is possible to conclude that in this particular case, the most attractive solutions,

regarding ROE, are Case 1 and Case 2, either due to a balanced distribution of the capital

structure or because of tax exemption on earnings. Moreover, it is easily noticed that in the case

of total equity capital, the return is not that attractive, meaning that the potential of the

investment is not being fully extracted.

Table 14 – Evaluation of the tax impact on the ROE of different capital structures

Case 1 Case 2 Case 3

D/E 1,50 0,11 0,00

Investment (M EUR) 100,0 100,0 100,0

Revenues (M EUR) 100,0 100,0 100,0

Expenses (M EUR) 80,0 80,0 80,0

EBIT (M EUR) 20,0 20,0 20,0

Interest (M EUR) 3,6 0,7 0,0

EBT (M EUR) 16,4 19,3 20,0

Tax (M EUR) 4,1 0,0 5,0

EAT (M EUR) 12,3 19,3 15,0

ROE 31% 22% 15%

4.3.4. FINANCIAL RISK AND FLEXIBILITY

Within the group of investments risks, financial risk is a major one and it usually plays a very

important role in the definition of the investors’ position regarding a certain venture.

Financial risk can be controlled through the level of leverage of the project, being the DER or

DSCR good indicators of the financial profile and of the capital structure of the project. A good

balance shall be found between debt and equity, in order to avoid situations where a project

may be profitable and cash-flows positive but, due to a bad structuring process of the capital, it

62

becomes not feasible. Cases of too leveraged projects (very high DER), where the revenue

streams are not enough to cover service debt, are a good example of this situation.

Finally, sponsors must also be aware that financial risks also demand a certain level of

flexibility, as far as capital availability is concerned. This means that in the event of financial

difficulties, construction delays, labour unrest, etc., additional financing may be required.

4.3.5. COST OF CAPITAL


The cost of capital indicates how much the capital, used to finance a determined project,

actually costs. An important topic to mention is that no money is free and that there is always an

associated cost of using (or not using) it.

Debt is cheaper than equity due to their risk profiles therefore, being equity a riskier investment,

a risk premium41 shall be assigned to shareholders, in order to compensate them for the higher

risk exposure (Duque, 2011). In all, the cost of capital can be resumed to the quantification of

risk and how much people are willing to pay for it.

4.3.5.2. COST OF GOVERNMENTAL GRANTS

The only type of capital that may be argued of being costless is governmental grants however,

although it is costless for the project, it has a cost for the entities providing it. National and/or

international governmental entities only decide to fund a project if there is interest in having it

developed and, in these cases, money is used to incentivize that development. More than

extracting financial benefits, these governmental entities are looking for the socio-economic

benefits that will be brought by the project.

As it does not bring costs for the project, governmental grants are many times used to reduce

the risk exposure of a project, lowering the overall project’s cost of capital.

4.3.5.3. COST OF RETAINED EARNINGS

Concerning retained earnings, despite it may look as free capital, it is not. In fact, its cost of

capital can be as high as the cost of equity (Duque, 2011).

Moreover, retaining earnings may be regarded as a very positive indicator for investors, since it

may indicate that either companies have strict valuation policies, keeping liquidity ratios high, or

that the creation of new ventures that will create additional wealth are being considered.

4.3.5.4. COST OF DEBT

The cost of debt must reflect the time the capital is being used and its credit risk profile,

addressing the issue of the borrower not being able to repay the loan to the creditor.

41 The risk premium is materialized by the possibility of a higher ROI.

63

Therefore, the cost of debt is composed by two factors, the cost of public debt and the credit

spread. The former, related to how much governments pay for their loans, is a consequence of

rating agencies evaluation of countries’ risk profile regarding debt. Since governmental entities

have always been considered reliable and relatively safe entities, countries’ ratings are almost

considered to be risk-free42, implying that the cost of public debt capital is very low (Duque,

2011). Regarding credit spread, it reflects the credit profile of the borrower entity and, standing

as the difference an agent pays so as to borrow capital from the market, the riskier the

borrower´s profile, the higher the spread.

To calculate the final cost of debt, the formula used is:

(��)�� = ��789:;<== + (�2��?��2(3) 4.3.5.5. COST OF EQUITY

The cost of equity capital also reflects the time the capital is being used and the additional risk

these investments embrace. Due to the high risk profile, shareholders shall be compensated for

their risk assumption and therefore, the risk premium, may lead the cost of equity to values up

to 25% (UN, 2004).

In contrast to bond financing, for instance, where capital gains are paid in a periodical basis

(interest payments) and a full-repayment of the loan at the maturity (principal payment), in

equity, capital gains may have of two distinctive forms: explicit and implicit. The former is related

to dividend payments, while the latter is related with the share valuation.

To quantify the cost of equity capital, it is generally used CAPM, a valuation model that

calculates the cost of equity of corporations, ranking a company’s assets and portfolio, taking

into account the systematic risk and clarifying the risk premium differences according to the

different classes of assets (Shapiro, 2011). In all, it describes the relation between the risk and

the expected return of an investment.

The general idea behind CAPM is that the cost of equity shall be calculated by the sum of two

parcels, the first addresses the time value of money (assumed to be risk-free), while the second

covers the risk exposure of the investment (risk premium):

(��*��1 = ��<89:;<== + @ × B��CD<:=E − ��789:;<==F(4) The risk premium is calculated considering two important factors. The first factor is the

Systematic Risk (β), also known as market risk, which is a measure of the market’s intrinsic

risk43 (e.g. interest rate fluctuation, financial crisis, currency exchange rate fluctuation, terrorist

attacks, wars, etc.). Due to its overall market impact, the only viable way to mitigate β is through

42 Although it is still true for some countries, with the Sovereign-Debt Crisis, many nations were downgraded in their credit profile, meaning that their debt may be considered as high-risk investments (e.g. Greece, Ireland or Portugal). 43 For instance, in the computation of risk-free interest rates, IntRiskfree, the systematic risk is considered to be null, while when calculating the market interest rate, IntMarket, the value is considered to be one.

64

hedging44, as diversifying the portfolio is not an effective unilateral solution (Fernandez, 2003).

The second factor is the market interest rate, IntMarket, which is related to the expected return on

the market portfolio owned by the company.

To conclude, the cost of equity indicates the expected ROI, representing the attractiveness of

the companies and consequently working as a valuation indicator.

4.3.5.6. WEIGHTED AVERAGE COST OF CAPITAL (WACC)

The WACC represents the overall cost of capital of an investment and it is given by:

HI(( = JKJ + JK + * + ) ��789:;<== + *J + JK + * + )LM + )J + JK + * + )LN(1 − �)(5)

G – Gov. Grants (K = 0)

E – Equity Capital IntRiskfree – Cost of Public Debt (Risk-free)

KD – Cost of Debt

GL – Gov. Loans D – Debt KE – Cost of Equity t –tax rate

WACC is a dynamic value since it is very dependent on several outside factors. Some of these

sources of uncertainty are:

RISK PERCEPTION AND RECOURSE ON ASSETS

Investors risk perception depends on their profile towards investments and that defines the line

of business a company follows, deeply affecting the demand for certain sources of capital and

the more or less usage of certain sources of financing.

Moreover, different issuers have varied seniority levels and assorted levels of recourse on

assets, what also influences the posture of the company towards the market, its mainstream

line of activity and the solidness with which businesses are led.

TIME IMPACT AND LOAN TERM

Investors may also change their posture regarding an investment over a certain time span. The

risk perception over an investment might vary due to out-of-control parameters, which are very

dependent on when they actually happen. For instance, an improvement of the macroeconomic

framework, a surprisingly successful trimester, an increase in company’s available funds or the

improvement of credit conditions, are some factors that may affect WACC.

Regarding loan terms, it is an obviously important factor with deep influence on WACC, as the

cost of debt is very dependent on credit ratings and in which loan terms are one of the most

important evaluation criteria. Implicitly, the longer the term, the higher the likelihood of a default

scenario, what consequently leads to higher interest rates (See Figure 26).

44 The practice of hedging has been widespread all around the world and it basically means buying insurance to secure the occurrence of certain events.

65

Figure 26 – Normal Yield Curve (UN, 2004)

CREDIT RATING45

In all, the factors referred before may be resumed as factors that influence the credit quality of a

company/project and, in the end of the day, all of them are reflected by the credit rating

assigned. Indicators of credit reliability of the entity issuing debt/incurring loans, these ratings

consequently have a huge impact in the definition of the interest rates of bonds and loans.

CRA are privately owned companies contracted to rate companies and are free to set their

ratings without taking any responsibility over the impacts they may cause in the market (Katz, et

al, 2009). In fact, due to their profile, these companies are likely to have their own incentives

that may mislead investors and manipulate markets according to their own will (Bar-Isaac and

Shapiro, 2011). This situation has been widely criticized, as several corruption situations have

been identified during the 2007-2008 financial crisis. As a result, the misleading and speculative

ratings assigned to several financial products, companies and even countries have been

extensively accused of favouring the will of important worldwide interest groups (Utzig, 2010).

Regarding the airport sector, credit ratings of airport companies are generally good as the

sector has experienced very good moments in the past decades. Despite CRA are generally

very secretive regarding their evaluation criteria and methodology, it is known that for the airport

sector the most important criteria are (Kato et al., 2009 and Neufville and Odoni, 2003):

• Market Strength: Geographic potential and local economic profile;

• Air Traffic Profile: Traffic forecasts, airlines’ destinations range and market share;

• Infrastructure: Utilization of existing facilities and requirements for new ones;

• O&M: Cost-recovery method used and its suitability, airline contractual agreements and

concession contracts;

• Financing Profile: Cash reserves, existing debt and percentage of debt secured by

revenues, PFC and airlines;

• General Context: Political, legal and regulatory framework, and propensity to disputes.

45 See Appendix VII, to check the different scales used by Moody’s, Standard & Poor’s and Fitch.

66

4.4. CONCLUSION

Over the past decades, more and more, airports have become vehicles of economic growth and

regional development, with an increasing impact on global markets. However, due to the

sector’s capital intensive character and because of the current economic and financial situation,

airport finance has become a priority issue to be addressed in the industry and it is one of the

major sources of challenges for the years to come (ACI, 2010).

In order to address infrastructure needs, awareness must be raised so that airport players are

well informed regarding the different financial instruments and mechanisms available in the

market. Therefore, this section aimed to focus on the several possibilities that exist in the

financial markets to finance airport investments and especially to warn for the likely hazards

attached to each one of the options, as well as to highlight their respective potentialities.

To conclude, airport finance is a prominent issue that may not be discarded at any stage of

airports’ lifecycle, and thoroughly understanding this topic is imperative to promote a better

comprehension of airports’ financing requirements and how they may be optimized in future

endeavours. Despite airports are capital demanding infrastructures, they are nations’

development gateways and therefore issues like the one addressed shall always be on the

forefront of the industry discussion.

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5. GUIDELINES FOR THE APPLICATION OF PPP IN THE AIRPORT SECTOR

5.1. BRINGING PUBLIC-PRIVATE PARTNERSHIPS INTO POLICY AGENDA

Launching a PPP Program is a serious step forward in how economic and financial politics is

made. It requires strong political will and a very significant determination regarding what is

actually wanted, having long-term perspective when planning investments and political choices.

The generation of a policy issue can come up in two ways (Viegas, 2011b):

• There is a severe economic and financial crisis that severely restrains governmental

intervention over infrastructure delivery, demanding the involvement of private parties to

overcome infrastructure shortage;

• Some countries prepare their own PPP Programs, inspiring other countries to copy the

definition of these new models.

Despite policy issues may be quite urgent, may times the incorporation speed of these issues in

the policy agenda does not reflect that urgency, therefore moments of opportunity (also known

as Policy Windows) for policy discussion shall be found. Addressing public interest may be the

first major push towards the creation of these windows and, as population’s support is

imperative for a successful policy discussion, people must feel that concerns about their interest

are being considered at the political level. So, with the purpose of fulfilling the gap that

frequently exists regarding public involvement in the political discussion, using the power of

media is a very efficient way to reach wider publics, informing stakeholders and the general

public and raising awareness regarding the issues in debate (Parsons, 1995).

Figure 27 – Steps in the creation of policy windows (Viegas, 2011b)

Thus, bringing the discussion regarding PPP implementation into policy agenda shall cover

different steps of the policy process. More than making decisions, defining a PPP Program is

quite efficient in structuring decision-making and informing the process of debate and

deliberation, with the single purpose of eliminating political decision-making based on intuition,

consequently reducing inconsistencies and raising awareness for the true societal needs.

Moreover, it shall be emphasized that the posture of policy-makers shall always be transparent,

avoiding dubious decisions and not allowing interest groups to become particular supporters of

determined policy alternatives, as it may induce loss of credibility. In fact, the independence of

political agents may play as their major advantage when proposing/launching significant

changes in pre-installed mechanisms.

Recognize the problem

Find readiness for discussion

Align issue discussion with actors' agenda

68

Figure 28 – Bringing PPP into policy agenda, adapted from (Parsons, 1995)

5.2. STRUCTURING A NATIONAL PPP PROGRAM

5.2.1. INTRODUCTION

The launch of a national PPP Program is a major policy initiative, and several steps must be

covered when structuring such ambitious endeavours. In this section, a methodology for this

definition is proposed, so as to address every single important topic.

Some of the points may seem redundant, when comparing to the policy process but in fact, they

stand as a particularization and a more detailed version of the topics already addressed.

Problem

Definition

Indentify social needs regarding infrastructures

Define targets of socio-economic

benefits that should be achieved

Define a list of projects that would

be relevante in achieving targets

specified

Policy Design

Construct Policy Alternatives:

traditional procurement,

PPP, fully private

Consider every single option. Do not neglect any

because of preconceptions

Engage stakeholders and understand their needs, thougths

and opinions

Policy Legitimation

Through polls and debates,

acknowledge different opinions

Consider every societal levels of discussion: politicians, experts, stakeholders and general

public

Policy Evaluation

Evaluation of policy options , using as much

scientific methods as possible (so as to

promote transparency)

Consider different levels of evaluation : Aggregate Policy (socioeconomic

effects), Stakeholders (Social acceptability effects) and Practical Feasibility (Implemenation issues)

Impact Assessment

Understand the impacts of the

different solutions

Traditional procurement, PPP or fully private ventures: Consideration of social, economic

and financial factors when evaluating the impacts of the different infrastructure

delivery models

ConclusionUnderstand merits and weaknesses of the different

options

Acknowledge which would be the major constraints and future barriers to the

implementation of each policy alternative and how each one would be publicly regarded

Agenda SettingDefine nature, dimension and

distribution of the problem

Specify the difficulties to overcome, the broadness required for the PPP Programme

and give space for adjustements in the agenda: The solution shall not be rigid, but

the will to solve problems

69

5.2.2. SPECIFICATION OF REQUIREMENTS AND EXPECTATIONS

When preparing a PPP Program, governments must thoroughly assess which are the current

flaws of the system, the respective causes and, obviously, which are the major objectives of the

Program, specifically identifying what is aimed to be tackled.

Governments must consider that PPP are only one of the possible solutions and that each

project requires a tailored and customized answer to the problems. In infrastructure delivery,

issues may arise from the lack of technical expertise, inefficiency of the public sector to develop

capable infrastructures or budgetary constraints, and the reality is that there are several PPP

models that deal with each one of these difficulties, however not all infrastructure projects are

likely to adopt PPP ventures successfully and therefore, as it was referred, every single option

shall be discussed: traditional public procurement, PPP or full privatizations.

Moreover, attention shall be given to project requirements, such as the needed infrastructures

to be developed, the LOS to be provided, the imposition of performance standards, the

definition of a suitable economic regulation, etc. All of this must be accompanied by what

expectations governments anticipate when projects are deployed, like impacts on regional

development, promotion of economic growth, higher accessibility of users, etc.

5.2.3. ASSESSING TECHNICAL ISSUES

Assessing the current national state-of-the-art in technical terms is mandatory so as to define

which path is to follow, allowing spotting additional requirements to be stated in the Terms of

Reference (TOR) for the procurement process and understanding the level of in-house

expertise (and consequent needs to import foreign know-how).

In the airport sector, for instance, two illustrative situations may be:

• Countries with high expertise in airport operations: There could be an invitation (or

incentives given) for consortia to integrate national operators in their teams;

• Countries with lack of expertise skills in airport operations: This scenario demands

importing know-how, thus consortia must be required to bring this expertise.

Furthermore, the imposition of technical requirements in the TOR should be defined by expert

entities. The investment in hiring expert professionals seems to be counterproductive, as

typically government are already stretching their budgets carrying out these ventures but the

reality shows that experienced consultancy services are imperative to find more suitable

solutions and raise awareness regarding potential pitfalls. Only this way it is possible to define

rigorous CapEx plans and performance standards. Some of the roles of these advisors are the

definition of desired outcomes, choosing proper and relevant indicators to measure

improvement, identification of mandatory investments to achieve expected goals and designing

the most suitable procurement plan (Harris, 2003).

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5.2.4. DEFINITION OF ADEQUATE LEGAL, REGULATORY AND POLITICAL FRAMEWORKS

The three frameworks must be carefully and properly defined so as to ensure transparency,

sustainability and continuity of the Program. Internationally recognized Programs, with clearly

defined legal, regulatory and political frameworks will attract more players, increasing the

procurement’s competitiveness, and standing as an important step towards success.

Table 15 – Definition of legal, regulatory and political frameworks

Framework Description

Legal

• Address “Enabling Laws” (such as PPP law or a sector specific law - e.g. airport charges regulation) and “Impact Laws” (e.g. tax, labour, competition, foreign investment allowance and limitations, public procurement, environmental constraints, dispute resolution, etc.);

• Ensure public sector has the power to cancel the contracts if the private parties do not comply with the requirements specified;

• Careful definition of public capital intervention, to avoid situations of capture; • Promote a paradigm change towards awarding the contract to the proposal

with “best value”, rather than “minimum public cost”; • Imperative in the minimization of corruption and to encourage private initiative;

Regulatory

• When dealing with natural monopolies that would assign significant market power to the private players running the PPP, it is imperative to have a strong regulatory power that will be responsible for avoiding situations of market abuse and protecting the interests of users;

• Ensure that the regulatory bodies have the required skills so as to actually regulate the private sector activity;

• Regulators may act in two ways: Ex-ante, through regulatory rules, or ex-post through control mechanisms as penalties;

• Typical functions of the regulatory body include establishing performance standards, defining conditions of service supply, regulating tariffs, monitor performance or arbitrating and settling disputes (ADB, 2008).

Political

• Political will shall be spread across parties so as to ensure continuity of the Program even after elections’ period;

• This will make sure private players can commit their efforts in the investment of infrastructure projects, without fearing an hypothetical withdrawal in the future.

5.2.5. DESIGN OF PROPER INSTITUTIONAL STRUCTURES

Uncertainty related to institutional design will significantly increase the perceived risk by

potential investors, thus important efforts shall be assigned in the definition of strong institutional

structures but, at the same time, flexible enough that allows refinements and adjustments of

their roles along the process, giving additional confidence in the investment plan.

Particularly, regarding the regulatory power, it is imperative for governments to create

competent bodies that ensure the tasks mentioned in the previous section. The existence of

regulators implies that governments know what they are doing, what they want to regulate and

that the Program is not being lightly developed, but rather with in-depth and professionalism.

Still within the institutional area, it is worth mentioning the importance of the creation of PPP

central task forces, responsible for the entire PPP Program. Designated PPP Units, these

institutions are meant to overcome governmental failures (See Figure 29), as well as to facilitate

and manage infrastructure investments (through the provision of advisory services), create

policy to overcome legal/regulatory/technical/commercial issues and monitor projects

71

throughout their lifecycle. To ensure effectiveness, PPP Units must also be assigned necessary

executive authority, including veto power in decision-making processes (therefore setting them

in the Finance Ministry may be a good choice) (Hahm, 2010). These institutions present a high

positive correlation between how successful a PPP Program is and the number of functions

they were assigned to correct government intervention (Sanghi, et al, 2007), thus its role is of

great importance in the successful implementation of these ventures.

Considering the definition of a PPP Unit should begin with the identification of which

government failures should be addressed and how the unit can (or cannot) tackle them:

Figure 29 – Overcoming government failures - PPP units (Sanghi, et al, 2007)

5.2.6. UNDERSTAND COMMERCIAL, FINANCIAL AND ECONOMIC ISSUES

At this stage, it is intended to reach an agreement with stakeholders on the economic balance

of costs and benefits to be achieved by the Program, design a plan that allows achieving those

results and develop realistic financial plans that would attract private capital. To be successful, a

previous identification of who are the stakeholders is imperative.

Some relevant points shall be addressed at this stage:

• Define governmental objective: Understand what is needed, to increase operational

efficiency or to reduce public expenditures;

• Tariff-increases/Subsidization: Definition of cost-recovery and timeline expectation;

• Willingness-To-Pay (WTP): Assess if consumers are interested to pay for the service;

• Prudency of the commercial procedures: Understand the tariff regime, define a

customer-database and perceive the efficiency in bill collection;

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• Cost and revenue structures: Acknowledge every single source of expenditure and

revenue collection so as to accurately plan the business model of the venture;

• Banks’ role in the PPP process: Highly exposed to investments’ risks, banks will be

on the forefront of the project’s monitoring process. Banks frequently assist

governments in their analysis and control over PPP projects, demand reports of

project’s development (with the purpose of assessing the project’s financial status) and,

as senior lenders, may even have “step in” rights over the project, if the performance

reported does not match the expectations (Harris, 2003). As important allies of

governments, banks ensure everything is being dealt according to the specifications;

• Financial attractiveness of the Program: Only the definition of sound financial

projects will attract private capital. Thus, financial analysis must rely on consistent

assumptions and with clear identification of potential flaws and sensible topics.

Figure 30 – Factors increasing the attractiveness of PPP projects

5.2.7. STAKEHOLDERS ENGAGEMENT

5.2.7.1. WHY IS IT IMPORTANT TO ENGAGE STAKEHOLDERS?

Stakeholders’ consultation has been gaining importance in the development of any political

process and, in the case of structuring a PPP Program, this relevance is quite evident due to its

Bankability

• Projects must be bankable so that the international financial community becomes interested;• PPP cannot turn an unbankable project a good investment.

Good Credit Ratings

• A low perceived financial risk is very important to attract private capital;• Private parties' will to invest in risky countries is low, thus required guarantees may be unbearable.

Familar Contractual and legal Structures

• Try to use familiar structures, such as the ones defined internationally and recognized worlwide;• Doing something radically different may jeopardize attracting developing international interest.

Existence of a PPP Unit

• The existence of a PPP Unit addressing government failures, reflects governmental commitment and enhancesprivate sector's confidence.

Democratic and Unity Political Environment

• Democratic political regimes diminish the risk of revolutions and unjustified breaches of contract;• Political union regarding the Programme is imperative so as to avoid situations of cancelation of contracts, after

election periods.

Technical, Financial and Legal Capabilities of the Local Market

• Even though bidding consortia are typically composed by international companies, it is imperative to ensure localcapabilities in construction firms, banks, law firms and other service companies, as they may act as importantservice providers of those consortia.

Strong Financial Structures

• The existence of a long-term finance market is imperative in this type of ventures;• The initiative of structuring a long-term PPP Programme may be a good indicator of confidence.

Scope for Innovation

• So as to add value, reduce costs and increase service quality, the private sector must be able to extract benefitsfrom synergies between, design and operation.

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societal impacts. In fact, stakeholders are a critical factor in the sustainability and viability of

PPP, firstly because if the Program is not publicly supported, the risks of failure increase

drastically and secondly because they are valuable inputs to the design and practicality of the

projects, increasing the likelihood of more innovative approaches.

Poor communication with stakeholders significantly increases the danger of opposition, what

may reduce public commitment to the Program and cause dramatic effects in the project

development, such as delays, and consequent cost overruns. Disseminating information to

stakeholders increases the credibility of the Program and the probability of success.

Regarding the airport sector, possible issues that may arise due to stakeholders’ opposition are:

Figure 31 – Likely issues to be raised by airport stakeholders (Tan, 2007)

5.2.7.2. HOW TO DEAL WITH STAKEHOLDERS?

Relations with stakeholders may take four major forms (Viegas, 2011c):

• Ignore Groups: Do not consider determined groups, what may lead to future hazards;

• Public Relations: Advertising campaigns with the purpose of inducing a positive

perception of the Program - risk of disbelief if biased information is transmitted;

• Implicit “Negotiation”: No direct relation between agents, however stakeholder groups

are considered in the preparation of the document - risk of groups’ misperception;

Environmental impacts of the project , destruction of patrimony and impact of aircraft noise inthe liveability of the area where airport will be built

Uncooperative and over-bureaucratic State agencies difficulting the project development

Inadequate compensations for expropritations may lead to disputes over land acquisiton

Poor integration of the airport with existing infrastructures and failure to build ancillaryinfrastructures (e.g. railways, bus terminals, metro stations, etc.)

Financial problems that may lead to disputes between lenders and shareholders over theairport management and eventual need for bail-outs by the government

Lack of transparency of the procurement process may induce the opinion of underlyingcorruption and protection of private interests rather than public's

Problems with "anchor" airlines that are undergoing restructuring processes

Sale of assets to foreign corporations at low prices, promotion of "white elephant" projects,definition of too-ambitious projects and contestation over real estate market speculation

74

• Direct Engagement: Direct discussion with stakeholders allows better understanding of

the Program and increases the likelihood of agreements - time-consuming and risk of

excessive intromission by the group.

Considering that the best option would be Direct Engagement, the proper way of carrying out

the dialogue between agents is through an iterative process. Starting in the early stages of the

Program definition, continuing until its closure and during the implementation phase of the

projects, the document shall include communication mechanisms and enough budget allocation

so as to ensure that the following components are included (ADB, 2008):

• Opinion Research: Assesses behaviours, opinions and preferences of the stakeholder

groups, identifying potential supports and objectors. Usually includes questionnaires;

• Stakeholder Consultation: Discussions with stakeholder groups, which intend to

gather information about current perceptions, and respective motives, about the

Program. It aims to properly manage expectations and understand groups’ real needs.

It is typically carried through stakeholder discussion groups;

• Public Awareness: Aims to increase stakeholder’s awareness about the Program. This

general distribution of information has the purpose of informing the public and

promoting informed debate, and may be carried through media or community meetings;

• Public Education: Provides stakeholders the tools and information required to increase

understanding of the Program, on a deeper level than the previous step.

5.2.7.3. MANAGING RELATIONS WITH STAKEHOLDERS

Relations with stakeholders shall follow a determined path so as to be successful:

Figure 32 – How to manage relations with stakeholders (Viegas, 2011c)

In Appendix VIII, a table is presented with the identification of the typical stakeholder groups in

the airport sector and their respective common interests.

5.2.8. ENSURE GOVERNMENT COMMITMENT AND DESIGNATION OF PPP CHAMPIONS

High-level political support is a mandatory requirement so that a PPP Program may be

successfully defined and implemented. Political agents lead and promote cultural change and

they shall be the ones demonstrating the general public how a Program of this kind may bring

Identify and characterize the

different stakeholders

Analyze interests, behaviours and

strategies of each group

Identify emerging coalitions between

groups

Evaluate the power of each group and of the coalitions (due to

synergy effects)

Develop specific strategies for each group (or batch of

groups)

Define ways of communation /

interaction with the different groups

Develop strategies for value creation,

engaging groups and identifying groups'

managers

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added value to both the public and the private sectors. This allows a more informed discussion

and gives confidence to the private sector about national commitment.

A point that shall not be neglected is the fact that politicians usually tend to set unrealistic

objectives for their Programs, what may lead to situations of weak management of stakeholders’

expectations and consequent future contestation. It is quite important to help political agents to

define realistic goals and to transmit them appropriately, so that no misperceptions and

misunderstandings are created. Expert advisors play a major role in this point.

Moreover, pro-PPP champions are needed and shall be defined at political, civil service and

private sector level. As objectors will always exist and will probably make strong campaign

against the Program, it is imperative to show there are supporters at all hierarchical levels which

are available to discuss and present their arguments (ADB, 2008). Typically these champions

should be prominent members of the society, with good reputation and professionally

recognized, so that people believe in their credibility.

5.3. IDENTIFICATION AND PRIORITIZATION OF THE PROJECTS

After structuring the PPP Program, the very first step should be to carry out a second

identification phase of the infrastructure investments deemed to be relevant in the national

context. It shall be recalled that a first stage of project identification has already been carried

when bringing PPP into policy agenda, however this phase must be more detailed and based

on national strategic plans – typically Public Investment Programs (ADB, 2008).

The identified projects, in addition to being evaluated as regards to their socio-economic impact,

they must also be subject to a suitability test, whose purpose is to analyze if projects gather the

necessary requirements to be launched as PPP. Based on basic evaluation criteria and local

market conditions, a PPP Suitability Filter (MFGI, 2010) is proposed, in order to assess barriers

to PPP implementation and eliminate hypothesis condemned a priori, carrying out preliminary

VFM tests and developing SWOT analysis for different solutions. The basic evaluation criteria

and local market conditions are proposed to be separated in two types of evaluation factors,

Indispensable and Significant Factors, where the former are imperative to exist in a successful

PPP, while the latter are not mandatory but likely to have an important role.

Table 16 – 1st Order Evaluation Criteria, adapted from (Anvuur et al, 2006) and (Vives, et al, 2010)

Evaluation Parameters Elements

Indispensable Factors Political stability, credible PPP market, reliability of the estimated transaction and bidding costs, institutional capacity, size and location

Significant Factors Fiscal/budgetary frameworks, stable micro and macroeconomic environment, potential for improved services, possibility of financially sound projects, adequate legal and regulatory frameworks, WTP, and government support

Moreover, this stage also includes the development of pre-feasibility studies, a mapping of

financial sources and an analysis of the public sector’s ability to afford the project (MFGI, 2010).

76

Another very important point at this stage is the prioritization of projects. Governments must

clearly identify which are the priority projects to invest in, so as to assign specific focus on the

most relevant ventures. Although this prioritization process should begin early in the PPP

Program definition, it finishes with the definition projects’ priority raking. The prioritization of

projects shall be done through a Multi-Criteria Decision Analysis (MCDA), where project’s

economic viability must be the primary evaluation criterion, and others may be

minimum/maximum capital requirements, demand, financial feasibility, risk assessment, etc.

5.4. DUE DILIGENCE AND FEASIBILITY STUDIES

At this stage, the aim is to carry out studies that will provide the basis for the total understanding

of the physical, socio-economic and financial frameworks of the project, as well as to assess

which are the investment risks (Kerali, 2011). A thorough Cost-Benefit Analysis shall be led, so

as to acknowledge the socio-economic impacts of the investments, as well as to perceive which

projects will actually contribute more actively to the national economic development.

Furthermore, this stage is characterized by the computation of the Public Sector Comparator

(PSC), an extremely important tool to help decision-makers structure their decisions when

evaluating bids. The PSC’s purpose is to estimate the risk-adjusted cost of a project, if it was

traditionally procured, and allows evaluating if private proposals deliver VFM or not. Although it

shall not be used as a deterministic decision-making tool (as it usually is very optimistic and has

a low consideration of risks) (Kerali, 2011), it is an interesting benchmark for bid evaluation.

Regarding the MCDA started in the previous stage, it may be finalized here, from what will result

the Final Feasibility Report of the projects. This stage also includes the choice of the best-suited

procurement method, as well as the design of the first drafts of projects’ TOR.

As far as the most suitable infrastructure delivery method is concerned, the imperative point to

be mentioned is that it shall neither be “based on ideology nor confused by semantics” (Vives et

al, 2010), but rather that there will always be a tradeoff between service efficiency, on one hand,

and effective protection of investors’ property rights, on the other, therefore it is important to

consider all options, from traditional procurement, to PPP and finalizing with privatization.

Table 17 – 2nd Order Evaluation Criteria, adapted from (Anvuur et al, 2006)


Drivers Strong political leadership, commitment by the public sector to seek VFM, the potential for a diversified workload and good returns for private participants and the potential for off-balance sheet funding

Barriers Difficulty of achieving a proper allocation of risks or of demonstrating value for money and the lack of a track record

Defining the most suitable solution must be a tailored process to each case and shall consider

the national framework and all the points covered in the definition of a PPP Program. For this

process to be successful, 2nd order evaluation criteria are defined – the Drivers and Barriers –

77

which cover deeper factors whose focus is on how they encourage or hinder the development of

projects through PPP (Anvuur et al, 2006).

The best-suited PPP model evaluation shall then be carried out and based on two additional

tools, the PPP Family Indicator and the PPP Mode Validation Tool (MFGI, 2010):

• PPP Family Indicator: Makes a preliminary assessment of which PPP model should

be adopted. For its evaluation, it is considered the existence of CapEx programs, the

ownership model to be adopted, the financing sources and the private sector

operational roles (See Appendix IX);

• PPP Mode Validation Tool: Helps deciding, through a thorough risk analysis, which

PPP model best suits the project. Essentially, a risk structure is proposed by the

procurer and then a comparison is made with pre-defined common risk allocations of

each model, so as to understand if there is a match. In the end, risk allocation

discrepancies are shown, clearly identifying the topics to be revised or discussed. The

tool shall also integrate the use of risk mitigation tools (e.g. political risk insurance,

credit guarantees, subsidies, local currency financing, etc.) (Anvuur, 2006).

Afterwards, projects’ financial feasibility must be assessed, as well as, if the project being

developed under the chosen model actually delivers VFM or not. Thus, two other tools are

proposed, the PPP Financial Viability Indicator and PPP VFM Indicator (MFGI, 2010):

• PPP Financial Viability Indicator Model: Assesses key topics concerning the

financial feasibility of the project, testing them with a scenario-analysis. The major

indicators to be computed here are the Project and Shareholders Cash-flows

(considering the IRR and shareholder’s predicted dividends), DSCR and LLCR, and

aims to understand the likelihood of the project to be attractive to private capital and

what implications it would have in the public sector (i.e. need for subsidies). The

scenario-analysis is based in alternative capital structures and project outcomes;

• PPP VFM Indicator Tool: Provides the indication of the expected range of VFM. The

model assigns a cost for every risk46. Using as inputs, the results of the previous

model, this tool will compare the result with the PSC, assessing which model delivers

higher VFM, The final result is shown as a VFM probability distribution47. At this stage,

it must be considered a 3rd evaluation level – Enhancers and Inhibitors – factors

boosting or diminishing VFM delivery.

In Appendix X, it is possible to find the proposed decision support system for the

implementation of PPP.

46 Uncertainty is modeled by the usage of probability distributions for the estimated costs of risks. 47 There are three possible scenarios: All positive – project delivers VFM, all negative – project does not deliver VFM, or partially positive/negative – demands a qualitative risk analysis.

78

Table 18 – 3rd Order Evaluation Criteria, adapted from (Anvuur et al, 2006)


Value Enhancers

Good independent regulatory oversight of PPP, flexible agreements with built-in adjustment mechanisms that also facilitate innovation, stakeholder support and ‘buy-in’, the use of relational contracting approaches, government guarantees, accurate determination of the performance-adjusted service fee, a good private consortium, and the ability to capture and transfer knowledge acquired from previous schemes

Value Inhibitors Inaccuracies in the assessment of the funding requirements or in defining the measurable level of service demanded, inadequacies in the briefing documents or client requirements and the inability to sustain competition

5.5. PROCUREMENT AND CONTRACT AWARD

At this stage, market sounding is a very important task as it aims to understand if there are, in

fact, private initiatives interested in the investments announced. Thus, the public sector

frequently requests Expressions of Interest (EOI) by interested private partners, to understand

the level of interest and the feasibility of the procurement, and where the evaluation criteria are

the financial strength of each EOI48 and previous experience in similar projects (MFGI, 2010).

Figure 33 – Procurement Process

After understanding the level of competitiveness in the procurement, Invitations for Bid (IFB)

and Requests for Proposals (RFP) are sent so that private partners can prepare their bids.

Being the final evaluation stage before awarding the development of the project, the appraisal of

proposals is much more rigorous, with exigent technical and financial evaluation criteria49.

Moreover, all proposals must be subject to VFM measurement, in order to acknowledge how

proposals are structured and if are being optimized, through a careful comparison with the

previous results. After appraisal, the preferred bidder is chosen and the contract is awarded.

At last, it is worth mentioning how the process of preparation of proposals by the private players

is conducted, its major steps, concerns and goals:

Figure 34 – Structuring and Preparing a Proposal for a Public Tender

48 Net worth and annual average turnover. 49 Experience, know-how, subsidization needs, revenue share and/or annuity payment offered.

EOI and IFB RFP Proposals' Appraisal and Evaluation

Technical and Financial Close

1. Indentification of the socio-economic

framework where the venture is to be set.

2. Analysis of the key bidding documents,

including evaluation of financial & operational

requirements.

3. Analysis of the base case scenario, including conseuqent

estimations of demand and revenue.

4. Setting up the consortium, including the engagement of

meaningful and credible partners.

5. Definition of the capital structure,

including negotiations with potential

sponsors & lenders.

6. Risk Analysis, including alternative

proposals to the risks allocation plan.

7. Financial Analysis, including uncertainty

and flexibility assessments.

8. Preparation and Delivery of the

Proposal.

79

5.6. IMPLEMENTATION, CONTRACT MANAGEMENT AND BENCHMARKING

Contract Management must begin at the pre-operative stages of the project and spread along

the operational period, until the contract closure and asset transfer. This step is of major

importance for the success of any PPP venture and governments must ensure the existence of

mechanisms that monitor airport performance, enforce the application of law, regulation and

contractual requirements, ensure VFM delivery and resolve disputes between partners.

Furthermore, it is mandatory to carry out benchmarking processes to compare productivity and

efficiency, evaluate specific processes, policies and strategies and to assess overall

organizational performance of the privately led business. Organizations need goals and targets

for their management, their stakeholders and their employees, and benchmarks are tools which

show whether the organization is meeting its objectives and where are the flaws.

Figure 35 – Benchmarking Process (ACI, 2006)

Besides, in addition to benchmarking against past indicators, it is essential that airports are

continuously compared to similar airports and their current figures, operation patterns and

overall quality perception by the clients. The goal of these exercises is to identify possibilities for

increasing efficiency and to monitor the ongoing strategic development of the airport in order to

ensure that the vision for the airport is being strived for.

Figure 36 – Stakeholders’ KPI, adapted from (ACI, 2006) and (Sherry, 2006)

1st Stage: Decide WHAT to benchmark (must be quantifiable);

2nd Stage: Decide against WHOM to benchmark;

3rd Stage: Analyse DATA and identify relevant KPI;

4th Stage: Set new performance GOALS;

5th Stage: MONITOR the process.

Passenger Indicators: Percentage of flights delayed, connecting times and waiting times atcheck-in, security or immigration and baggage delivery efficiency (e.g. lost bags);

Management Indicators: ATM per runway, annual pax & ATU per employee, operationalcost per pax, ton of cargo and WLU, CapEx as a percentage of revenues, EBITDA marginand operating profit per pax ,and aeronautical, non-aeronautical and total revenue per pax;

Near-by Resident Indicator: Number of noise level infringements, emissions per aircraftmovement, percentage of pax using public transport, etc.

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6. FINAL CONCLUSIONS AND FURTHER DEVELOPMENTS

The way how transport infrastructures have been regarded in the past decades changed

radically. What typically were publicly delivered services, due to the inherent public interest,

transport infrastructure investments are today more and more liberalized, with an increased

trend towards the engagement of private partners. The reality is that, because of severe

inefficiencies in public services or due to budget constraints, governments are increasingly

reluctant to undertake such capital intensive responsibilities, and calling for the private sector to

get involved has been gaining major importance in how the infrastructure gap is being fulfilled.

Moreover, there are also particular situations, like the current Sovereign-Debt Crisis, that

severely diminish governmental ability to service debt. However, as infrastructures are

imperative to ensure socioeconomic development, PPP and privatizations appear almost as

inevitable solutions to overcome these national needs, yet, private initiatives are not immune to

periods of crisis. In fact, they are likely to be critically affected, as their financing conditions also

become seriously worse, consequently jeopardizing the overall infrastructure delivery process.

This issue is still an unresolved subject and governments must address significant efforts, when

launching similar processes, to understand and evaluate the feasibility and sustainability of

private business proposals, since the typical solution to this problem has been governmental

bailouts, what seriously increases the already unacceptable levels of public debt.

Governmental decisions regarding PPP or privatizations must be carried out in a structured

manner, precisely defining which are the ambitions and specifying the trail wished for the sector

to follow. Moreover, governments must be ready to study, discuss and think, becoming detail-

oriented regarding every aspect that may influence the venture’s path, involving stakeholders in

the discussion and understanding their concerns, thoroughly analysing the suitability of the

national framework to private engagement and raising awareness to the structural changes a

country would need to successfully embrace such strong paradigm shift.

Concerning airport infrastructures, although the sector is now more competitive than it was a

few decades ago, its monopolistic status still exist, giving them a particular profile within the

group of transport infrastructures since the sector’s profitability is quite interesting. This fact

raises a huge interest by the private sector in the industry, and governments must be on the

forefront of negotiations, so as to maximize the extraction of benefits. The presence of private

players in airport development is no longer a taboo therefore, both public and private players

must be aware of the different interactions that might exist between them, so as to find the most

suitable model that best meets the social, financial and economic goals. Moreover, there shall

not be prejudices or preconceptions regarding any infrastructure delivery model, as added-value

solutions may be disregarded due to fixed ideas that may exist about certain matters.

The guide proposed in this document aims to help entities interested in giving a step forward

regarding airport infrastructures delivery processes. In many countries, PPP are now

considered as evil solutions that neglect public interest and protect privates’, however, this

81

guide proves that well-planned programs, with clearly specified goals, thorough analysis of

investments’ risks and transparent and independent due diligence and procurement processes

may lead to quite interesting answers regarding the development of transport infrastructures.

Furthermore, the guide is structured in a way that allows the analysis in the perspectives of both

the Principals – Policy-Makers – and Agents – Potential Investors. This is important because

PPP are partnerships and, for these venture to be successful, both sectors must, in fact,

engage in a joint venture and work closely together. The guide allows both entities to

understand which are the major points to be addressed along the process, since bringing the

subject to the political agenda, until the launch of the ventures. Issues, benefits, risks,

potentialities, requirements, drawbacks, advantages or tools are mentioned along the guide

and, in all, they act as stepping stones for better delivered services, with lower risks of State

capture and with an important socio-economic awareness.

The purpose of this guide is to encourage the transformation of the policy process, promoting

transparency and consistency, as well as to induce a sense of responsibility by political agents.

Structuring decision-making processes is probably one of the biggest flaws in the nowadays’

political process, therefore the proposed method is a clear attempt to overcome the problems

that have arisen in the past regarding PPP endeavours. Moreover, potential investors are also

benefitted by the proposal, as it is an eye-opener regarding the implementation of PPP,

mentioning several matters that could be disregarded by these players when appraising

investments or evaluating projects, as well as to raise awareness to matters that might be

neglected by governments and which are deemed to be imperative in the process. The

proposed methodology for PPP implementation stands as a bilateral guide, helping every entity

involved to understand which are the responsibilities of each partner, the tasks that should be

carried out, who should be assigned those tasks and which subjects are mandatory to be

addressed. In all, it significantly boosts the overall awareness regarding the PPP process,

consequently increasing the bargaining power of every entity engaged, as it provides a holistic

consciousness concerning the applicability of PPP in the airport sector.

To conclude, a relevant number PPP ventures has been erroneously led in the past what

developed, in many countries, a preconception that these models have been exclusively

designed to favour private interest, rather than public’s. However, there are several other

examples that prove the potentiality of PPP and how they can lead to successful ventures,

when properly designed, implemented and monitored. The infrastructure gap is severely felt in

the airport industry (what can be understood by the number of existing congested airports),

therefore a counterattack is imperative to overcome these needs, in terms of airport

infrastructures. Especially due to the most recent financial crises, both governments and private

players are now much more restrained in terms of financial capability to undertake such

investments thus, taking into account the current financial framework, joint ventures between

governments and private corporations may probably be one of the most valid solutions to

overcome the referred gap between infrastructure demand and supply.

82

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I

APPENDIXES

II

APPENDIX I

RESUME OF THE MAJOR CHARACTERISTICS OF THE DIFFERENT PPP MODELS (ADB, 2008)

Management Contracts Lease Contracts Concessions BOT Divestiture

Scope of Private Sector’s Role

Management of entire operations or a major component

Responsibility for management, operations and specific renewals

Responsibility for all operations, financing and execution of specific investments

Investment and operation of a specific major component.

Partially or fully responsible for all the issues related to the airport corporation

Asset Ownership Public Public Public/Private Public/Private Public/Private or Private

Duration 2-5 years 10-15 years 25-30 years Varies -

O&M Responsibility Private Private Private Private Private

Capital Investment Public Public Private Private Private

Commercial Risk Public Shared Private Private Private

Level of risk borne by the private sector

Minimal/moderate Moderate High High Very High

Compensation Terms

Fixed fee, preferably with performance incentives

Portion of tariff revenues All or part of tariff revenues Mostly fixed, variable related to production factors

Governments may be asked to be an off-taker

Competition One time only, contracts not usually renewed.

Initial contract only, subsequent contracts usually negotiated.

Initial contract only, subsequent contracts usually negotiated.

One time only, often negotiated without compensation.

Airports’ competition is generally limited in contract design

Special feature Interim solution during preparation for more intense private participation

Improves operational and commercial efficiency. Develops local staff

Improves operational and commercial efficiency. Mobilizes investment finance. Develops local staff

Mobilizes investment finance. Develops local staff

See 3.4.4. Airport Privatization: For or Against?

Problems of Challenges

Management may not have adequate control over key elements, such as budgetary resources, staff policy, etc.

Potential conflicts between public body which is responsible for investments and the private operator

How to compensate investments and ensure good maintenance during last 5-10years contract

Does not necessarily improve efficiency of ongoing operations. May require guarantees

See 3.4.4. Airport Privatization: For or Against?

III

APPENDIX II

CONTRACTUAL STRUCTURE IN PROJECT FINANCE – APPLICATION TO AN AIRPORT PROJECT

IV

APPENDIX III

CORPORATE FINANCE - PROJECT FINANCE CONTINUUM (COMER, 1996)

Dimension Corporate Finance Project Finance

Financing vehicle Multi-purpose organization Single-purpose entity

Type of capital Permanent - an indefinite time horizon for equity

Finite - time horizon matches life of project

Dividend policy and reinvestment decisions

Corporate management makes decisions autonomous from investors and creditors

Fixed dividend policy - immediate payout; no reinvestment allowed

Capital investment decisions Opaque to creditors Highly transparent to creditors

Financial Structures Easily duplicated; common forms

Highly-tailored structures which cannot generally be re-used

Transaction costs for financing

Low costs due to competition from providers, routinized mechanisms and short turnaround time

Relatively higher costs due to documentation and longer gestation period

Size of financings Flexible Might require critical mass to cover high transaction costs

Basis for credit evaluation Overall financial health of corporate entity; focus on balance sheet and cash flow

Technical and economic feasibility; focus on project’s assets, cash flow and contractual arrangements

Cost of Capital Relatively lower Relatively higher

Investor/lender base Typically broader participation; deep secondary markets

Typically smaller group; limited secondary markets

V

APPENDIX IV

ROLES OF THE DIFFERENT PLAYERS IN PROJECT FINANCE VENTURES

Actors Roles

Sponsors

• Equity Contributions and Subscription Agreements; • May include a group of contractors, investment banks (sponsors, not lenders),

an infrastructure operator and eventually a group of general investors like private equity and/or venture capital firms;

• The ownership rights of the project company belong to these entities.

Government

• Specification of the requirements deemed mandatory for a successful venture with a properly provided service and launch the tender;

• Right to monitor construction stage, as well as to define both the maintenance periodicity and the operational standards

• Right to demand the creation of a dispute board in order to engage every partner in the contract management;

• Carry out gradual benchmarking analysis, even if costly, in order to prevent the existence of low-performance periods;

• Keep the process as transparent as possible to avoid corruption and less acceptable behaviours during the process, starting in the launch of the tender until the end of the concession term.

Lenders

• A syndicate of investment banks shall assist in the development of the financial plans, managing the risk level of the investment and providing consultancy services regarding the financial activity of the venture during the whole concession term;

• The syndicate will be responsible for carrying and assisting the equity capital raising, the bond issuances and gathering commercial banks, which will provide the loans;

• These institutions also responsible for the securitization of the investment, through derivative financial tools.

Contractors

• Generally under turnkey contracts; • Responsible to bring in all the required knowledge and the necessary

subcontractors necessary for the completion of the project; • Project awarded after a tendering process; • Each contractor bids for a fixed fee, rate or total cost; • In many cases the contractor consortium is part of the sponsors.

O&M Companies

• O&M contracts assign exclusive authority to manage, operate and maintain a project facility;

• Normally, in Project Finance, the term of the contract is at least equal to the length of the debt financing;

• Readjustment and review of goals, requirements and methods at the end of each contract so as to follow the market dynamics, to meet the needs and tastes of the users and finally to lower the risk of poor fit of the service to the society.

Suppliers • Supplying contracts with performance assessment during the contract term

and re-evaluation of the goals for the following period.

Off-Takers

• The project company usually enters with a public or private company (the “off-taker”) into a long term sale and purchase contract in respect to project outputs;

• According to the off-take agreement, the off-taker agrees to buy from the project company a certain of project output, for a certain period of time and at pre-established prices;

• One of the key functions of the off-taker contract is to provide some certainty that the project will generate sufficient cash flow to cover debt service and operating costs, and still provide a reasonable ROI.

VI

APPENDIX V

STRUCTURE OF ASSET-BACKED SECURITIES

STRUCTURE OF CREDIT DEFAULT SWAPS

VII

APPENDIX VI

STEP-BY-STEP APPROACH IN A PRIVATIZATION PROCESS (WELCH AND FRÉMOND, 1998)

VIII

APPENDIX VII

ECONOMIC REGULATION - OTHER MODELS RATE OF RETURN REGULATION:

• Usually applied in utility corporations, such as the electric and telecom industries, where

prices are freely set as long as the company does not exceed a certain rate of return;

• Prices do not have a significant margin to increase and are usually set a slightly above

costs, allowing a reasonable rate of return50;

• No consensus on whether capital investments should be measured in historical or

replacement costs and if new investments shall be allowed in the rate base51;

• Situations of lack of know-how by the regulator are frequent. Many times, the

complexity of the process leads the regulated entity teaching the regulator how to

perform, inducing the regulator to rule in favour of the operator, even when it should not;

• So as to increase prices, detailed applications must be approved by the regulator;

• Complex, inefficient and expensive regulatory method.

COST OF SERVICE REGULATION:

• Typically used as economic regulation of transport carriers, such as airlines, rail or

bus operators;

• Companies are allowed to set rates based on the operational cost and on the right to

earn a reasonable profit;

• Regulator must approve every price change52 and may even have power over

service delivery decisions;

• Companies able to forge costs and/or over-invest can increase prices

indiscriminately, leading to operational and financial inefficiency;

• A similar approach is Cost-Plus Regulation where the regulatory agency sets the

prices slightly above operational costs, allowing a reasonable profit. No incentives are

given to efficiency improvement;

• Expensive, unresponsive to market dynamics and does not protect users efficiently.

TRIGGER REGULATION:

• No regulatory intervention until there is a formal complaint against the pricing

policy (the trigger). If complaint is accepted, the regulator has the power to intervene

and set prices;

50 Setting a reasonable Rate of Return is not a clear matter, however it usually takes into account DER, the riskiness of the industry and return required to attract investors. 51 This may lead to situations associated with the Averch-Johnson effect (Averch and Johnson, 1965), meaning that capital investments give room for price increase, therefore severe problems of over-investment are very likely. 52 For regulators to approve price increases, documentation proving the increase in the cost structure shall be provided. However, as regulators are not experts in process optimization, cost increases may be accepted even if not justified.

IX

• Based on the belief that companies have the perfect reasoning regarding

unreasonable prices and are aware that above a certain threshold, complaints are

likely;

• In order to prevent random use of the trigger, several measures were integrated:

expensive application requirements, if regulator rules in favour of the operator the

invoker must pay for the legal costs of the process, material harm must be shown

before the application and public interest shall be demonstrated along the whole

process (Tretheway, 2001);

• Costless regulation as no costs are incurred until the trigger is pulled, allowing the

flexibility for the operator to set its own prices.

SELF-REGULATION:

• Standards/codes of conduct dictate the acceptable corporate actions towards users;

• Despite it is the most flexible and least costly method, Self Regulation is very

challenging as setting the right batch of standards that provides enough flexibility and,

at the same time, protects the users is not an easy task;

• Industry must be prone to engage the code in its conduct.

REGULATION BY CONTRACT:

• Likely to be implemented when a firm has a small number of customers and these

are prone to engage in long term contracts;

• Airports are good applicants as many airlines enter into long term agreements for

terminal usage;

• Airlines must be aware of market economics and dynamics, being the contracts supposed to include clauses regarding cost adjustments and pricing provisions to the whole contractual length.

X

APPENDIX VII

CREDIT SCALE RATINGS OF THE THREE MOST PROMINENT CREDIT RATING AGENCIES

CRA Moody's Standard & Poor’s Fitch

Investment Length

Long-term Short-term Long-term Short-term Long-term Short-term Credit

Description

Ratings

Aaa

P-1

AAA

A-1+

AAA

F1+

Prime

Aa1 AA+ AA+

High grade Aa2 AA AA

Aa3 AA- AA-

A1 A+ A-1

A+ F1 Upper medium

grade A2 A A

A3 P-2

A- A-2

A- F2

Baa1 BBB+ BBB+ Lower medium

grade Baa2

P-3 BBB

A-3 BBB

F3 Baa3 BBB- BBB-

Ba1

Not prime

BB+

B

BB+

B

Non-investment grade

Ba2 BB BB Speculative

Ba3 BB- BB-

B1 B+ B+

Highly speculative

B2 B B

B3 B- B-

Caa1 CCC+

C CCC C

Substantial risks

Caa2 CCC Extremely

speculative

Caa3 CCC- In default with little

prospect of recovery

Ca CC

C

C

D /

DDD

/ In default / DD

/ D

XI

APPENDIX VIII

INTERESTS OF COMMON STAKEHOLDERS IN THE AIRPORT SECTOR

Hierarchical

Level Stakeholder Group Common Interests

Political Level

Political Decision-Makers

Political decision-makers (PDM) aim to develop infrastructure projects

successfully, relying on the capital of the private sector, and improving

social welfare, ensuring universal access to a basic service, at affordable

prices. PDM will also want to create conditions that will attract private

initiatives, promote fair competition and maximize revenues.

Administrative Level

Investors

(Public and Private)

Investors’ major purpose will be to attract the highest number of

passengers possible so as to maximize profits. However, there is an

implicit will in ensuring the existence of a stable and transparent regulatory

process, being able to restructure the organic structure of the airport

company and allocating assets that favor increases in efficiency, as well

as, generating more investment opportunities. Furthermore, in the PPP

market it is important to show good performances in the ventures led, with

the purpose of building relevant reputation, so that the likelihood of the

companies to win another concessions increases.

Management Team

The management team will be interested in the best performance

possible, as long as incentives are defined contractually (when

management teams are also investors, there is already an implicit

incentive for good performance). Incentives may take several forms, such

as yearly bonus depending on performance (performance shall not be

solely measure in terms of profits because it may lead to situations of

under-investment).

Regulators

Ensure the creation and enforcement of proper regulation that will protect

users of market abuses and monitoring the activity of the private sector, so

as to guarantee that contractual requirements are being met.

Users Level

Passengers

Passengers will be interested in having a diversified offer in the

destinations and airlines, at fair prices, high LOS and with improved

quality and reliability of the service.

Airlines

Airlines will aim to have improved services and facilities at reasonable

prices. Typically airlines will favor airport investments however, in the case

of dominant carriers, airlines may be objectors to investments as

opportunities to increase competition may arise.

Cargo Operators

Cargo operators will also aim to have improved services and facilities at

reasonable prices. Moreover they may also be interested in the

development of logistic platforms near the airport so as to better integrate

their economic activity and to increase efficiency in their services.

Other business partners

(e.g. concessionaires)

Other business partners will also require taking advantage of the improved

services and facilities, at reasonable prices. Due to expansions or space

reorganization, many times in CapEx interventions new business

opportunities arise for these ancillary businesses.

XII

Financial Level

Financiers

Financiers’ interests rule in favour of project success. Being extremely

exposed to investment risks, financiers will act as a monitoring entity of

the project health and may have “step in” rights, so as to assume the

management of the airport company, or at least provide close consultancy

services until the project’s results reach the expected levels.

Large landowners

Large landowners will be benefitted by the increase in market value of real

estate. They may actually be the responsible entities for that speculation,

buying significant amounts of land at low prices and immediately after the

project announcement put them on the market. Although privileged

information is illegal, this is current practice in many developing and

developed countries. To prevent situations like these, the implementation

of earmark policies may be a fairly good solution.

Nearby businesses

An airport is, in the majority of the cases, a source of business

opportunities, both for already established local businesses to grow and to

attract more investment capital to set up new ventures, promoting and

strengthening of the local economy.

Speculators

Speculators may exist in two sides: real-estate (addressed in Large

landowners) and stock market. The latter means that when airport

companies are listed in stock markets, they may be target of financial

speculation by investors, both in the stock valuation as well as in the

devaluation (short-selling). This may lead to some secrecy by airport

companies, when disclosing their financial information so as to avoid

significant price flotation that obviously does not please shareholders.

Small absentee landlords

Small absentee landlords will probably be expropriated without being

assigned any monetary compensation. Typically these situations are

associated with complicated legal processes related to complex share of

inheritances.

Social Level

Airport Employees

Rationalization of staff resources is one of the first measures of airport

operators so as to optimize airport efficiency. Represented by strong

Unions, employees fear massive lay-off procedures and aim to keep their

jobs with the same benefits they used to have before. Extensive

negotiations with Unions shall be carried out, with the purpose of reaching

the most benefiting solution for both parts.

Squatters

Private parties may be required to build social housing so as to

accommodate squatters and other affected individuals. Squatters aim to

be relocated preferably to free social housing but, due to their common life

patterns, will probably relocate themselves to other empty buildings.

Mass Media Mass media aim to work closely with both proponents and objectors of the

Program, so as to promote informed, reliable and intense debate.

Nearby residents

(renters and home-owners)

Deeply affected by environmental and noise impacts. Usually organized in

community organizations, residents will be interested in minimizing the

environmental impact of the airport and in the implementation of strict

noise-control policies, with the purpose of the keeping their livability as

closer to what it was as possible. Speculation over real estate market may

also have deep influence on the ability of previous residents to afford the

house prices’ escalation.

XIII

APPENDIX IX

DECISION TREE FOR THE PPP FAMILY INDICATOR (MFGI, 2010)

XIV

APPENDIX X

DECISION SUPPORT SYSTEM FOR PPP IMPLEMENTATION

PPP Airport Thesis S2

Documents

Transcript of PPP Airport Thesis S2