How To Understand The Financial Situation Of French Airports

Transcription

1 18 September 2014 Determining the Weighted Average Cost of Capital of Airports in an Evolving French Regulatory Environment By Jeanne Lubek and Stéphane Wakeford Executive Summary French airport regulation is relatively imprecise with regard to the parameters used to determine the Weighted Average Cost of Capital. In this context, approval of the investment program apart, the main decision of the regulator is the determination of the appropriate WACC. As a result, while French regulation is nominally a price-cap type of regulation, it is in reality closer to a rate of return form of regulation since it is the determination of the allowed Return On Capital Employed (ROCE), i.e. the WACC, which becomes both the main point of debate between users, operators, and the regulator and the main driver of the price-cap level. The negative effects of a rate of return type of regulation are well-documented, especially the Averch-Johnson effect, which is the tendency of regulated companies to engage in excessive amounts of investments in order to expand the volume of their profits. Incremental changes to the current regulatory framework along the lines of greater transparency and more normalized economic criteria for the WACC determination would be sufficient to renew with the spirit of a price-cap type of regulation. This would likely improve the efficiency of French airport regulation and would mitigate the perception of a possible conflict of interest for the state, which currently acts as both a regulator and a shareholder. Moreover, in the context of the planned privatization of regional airports, greater predictability would reduce the risk borne by potential buyers for the next price control periods and thus increase the value of airport assets held by the state.

2 European regulated environment Community case law requires that charges for use of airport infrastructure be established according to objective, transparent, and non-discriminatory rules, because of their status as essential facilities. 1 On 11 March 2009, the adoption of Directive 2009/12 / EC on airport charges created a common framework for Member States to regulate such charges. This Directive applies to airports with an annual traffic of over 5 million passengers. In France it thus applies to the airports of Paris Roissy-Charles de Gaulles, Paris Orly, Nice, Lyon, Marseille, Toulouse, and Basel- Mulhouse. This directive was transposed into French law in The evolving regulatory environment, a prerequisite for the privatization of regional airports In France, airport regulation began its evolution in 2005 with a law 3 transforming Aéroports de Paris (ADP), the public operator of all Paris airports, into a limited liability company and allowing publicly held regional airports to become regional airport limited liability companies ( Sociétés aéroportuaires Régionales or SAR). This law also introduced Economic Regulation Contracts for airports, which set price-caps for 5-year periods. Main French airports Million pax 2012 Pax CAGR CAGR aircraft movements Revenues 2012 ( m) % of airport owned by public entities Regulatory set-up Concession Planned regulatory evolution Aéroports de Paris (Orly + Charles de Gaulle) % -1.90% % Modified double-till Perpetual Economic Regulation Contract : to be signed in 2015, taking effect in 2016 Nice-Côte d Azur % -1.50% % Single-till Until 2044 Possible switch to Economic Regulation Contract over the next 3 years Lyon Saint-Exupéry % -1.60% % Single-till Until 2047 Economic Regulation Contract : to be signed 2014, taking effect in 2015 Marseille Provence % 0.90% % Single-till Until 2017 July 2014 legal transformation to a SAR Toulouse Blagnac % 2.60% % Single-till Until 2046 Economic Regulation Contract : signed in 2013 and in force since 2014 Bâle-Mulhouse % 2.40% % (half Switzerland and half France) Single-till Perpetual Possible switch to Economic Regulation Contract over the next 3 years Bordeaux Mérignac % -1.00% % Single-till until 2037 Possible switch to Economic Regulation Contract over the next 3 years Source: NERA Economic Consulting 2

3 While ADP became a limited liability company in the year following the law s adoption and floated a minority share of its capital (the majority still owned by the French State), the transformation of regional airports into public limited liability companies took more time. The first three SAR emerged in 2007: Aéroports de Lyon and Toulouse-Blagnac Airport in March 2007 and Bordeaux-Merignac Airport in May 2007, followed in June 2008 by the SA Aéroports de Côte d'azur (which includes the airports of Nice and Cannes-Mandelieu). In July 2014, it was the turn of Marseille Provence airport to turn into a regional airport company, more than 9 years after the adoption of the law. The establishment of Economic Regulation Contracts between airport operators and the State has been even slower than the adoption of the limited liability legal form, since currently only Paris and Toulouse airports have adopted this form of regulation. But Lyon Airport is about to sign an Economic Regulation Contract with the State (planned for the end of 2014), bringing to more than 60% the share of French passenger traffic affected by this new regulatory set-up, which should eventually spread to other airports in the coming years (Nice, Bordeaux and later, Marseille could sign Economic Regulation Contracts). This generalization of Economic Regulation Contracts is considered a first step towards opening up the capital of regional airports, as this regulatory set-up is expected to bring greater visibility to potential private airport shareholders: Aéroports de Paris shares were floated immediately after signing the first Economic Regulation Contract (in 2005, shares floated in 2006), and Toulouse is the first regional airport which is to be partly privatized (end of 2014). For regional airports, the State had informally agreed to maintain a majority public ownership until , but in 2011 the opening of their capital was already considered by the government. Faced with opposition from local shareholders (chambers of commerce, local authorities), the project was abandoned but has recently resurfaced in light of the current budgetary context. Regional airports which are already under an Economic Regulation Contract or are about to be (Toulouse and Lyon) have undertaken significant deleveraging. 5 Given that debt financing is currently available at a very low cost, this suggests that the state wants to optimize the capital structure of its assets in view of a possible privatization. The 2005 law states that only the initial capital must be held by public entities, which opens the way to potential privatizations. For airports with turnover of less than 150m (Toulouse, Marseille, Bordeaux) total or partial privatization can take place without a new law 6, which is not the case for the airports of Nice and Lyon as their turnover makes them subject to the 1986 privatization lax. This is also why Toulouse Airport is the first one to be considered for sale by the French state. 3

4 The prospect of privatization, a source of potential conflicts of interest for the French State Parliament had considered creating an independent regulatory authority for the airport sector in 2005, but the idea was abandoned and instead an Airports Advisory Commission, with only consultative powers, was set up. For the state to act both as a regulator and as a shareholder of airport companies gives rise to potential conflicts of interest when determining the level and the evolution of airport charges: the decisions of the state as a regulator have a major impact on the value of its assets as a shareholder. In its thematic report of July 2008, the French Court of Auditors itself 7 criticized the blurred lines resulting from the 2005 law. Moreover, in 2010, the French Competition Authority took issue 8 with the fact that this regulatory set up does not appear to meet the requirements of legal and functional independence of the regulator and the regulated laid down in Article 11 of Directive 2009/12/ EC, especially since the Court of Justice of the European Communities held in a similar context that "different directions of a single administration cannot be considered independent of each other". 9 An imperfect regulatory framework, especially with regards to the determination of the Weighted Average Cost of Capital The perception of a potential conflict of interest between the regulator and the regulated is especially damaging since the principles of Economic Regulation Contracts are not yet set in stone, as evidenced by the significant changes between the first and second Economic Regulation Contracts of Aéroports de Paris and Toulouse Airport, and since the most sensitive parameters in determining the price cap are subject to different interpretations by airlines and airport operators, particularly when it comes to the determination of the Weighted Average Cost of Capital (WACC). The WACC is at the heart of French airport regulation, the entire regulatory framework resting on the assumption that the Return on Capital Employed should be equal to capital costs. Yet the method to determine the WACC as set by the regulator is vague, the law merely stipulating that the weighted average cost of capital should be estimated by using the rate of return an investor can expect from the company and the average cost of its debt, in accordance with commonly used methods for the valuation of corporate assets. 10 For its part, ruling on the WACC of Toulouse Airport, the Airports Advisory Commission found that "The method used by Toulouse Airport in calculating the weighted average cost of capital method is the capital asset pricing model (CAPM). The Committee approves the choice of this method, which it considers accurate and consistent with financial theory and professional practice. 11 If this method is certainly consistent with financial theory, despite significant limitations 12, the regulation is silent on the key parameters used in calculating a WACC, most notably: The time horizon for calculating the various parameters (β, risk-free rate, market premium and funding spread in particular) The indices of reference for calculating the β (beta) The way to determine the relevant comparable 4

5 The lack of specific guidelines regarding these parameters leads to a large margin of interpretation. It should also be noted that the determination of the WACC relies on the use of comparable companies, which can be problematic because the number of listed European airport companies is very limited (ADP, Fraport, Flughafen Wien, Flughafen Zurich, Aeroporto di Firenze SpA, Societa Aeroporto Københavns Lufthavne, and Toscano) and they are very heterogeneous. They are indeed not subject to the same regulation and therefore the same risk profile, which may make them less relevant than companies in different industries but with a similar regulatory framework. Moreover, some of these operators manage airports in multiple countries. Fraport, the largest listed European airport company after Aéroports de Paris is not only manager of the Frankfurt airport but also of airports in Egypt, Turkey, Peru, India, Saudi Arabia, China, Russia, Senegal, and Bulgaria. The relevance of its inclusion in a comparable analysis is thus questionable given its exposure to emerging markets. Considering all these factors, the large discretion given in choosing key parameters for the WACC calculation can lead to widely divergent interpretations. Especially since the approach for the WACC calculation can be either economic or financial: the first focuses on determining an appropriate WACC for the price control period under consideration and does not internalize parameters that depend on the price cap (the valuation of equity for instance), while the second is oblivious to the impact of the WACC on regulated revenues and can internalize elements which are dependent on the price-cap fixed by the regulator. The distinction between economic and financial approach stems mainly from their different goals: the purpose of the economic approach is to determine a fair compensation depending primarily on the opportunity cost of capital in order to set an appropriate price cap. The goal is not to estimate as accurately as possible the actual financing cost of the airport but to determine what it should be given the specific risks of the asset and what is achieved by comparable entities. The financial approach adopts a purely descriptive and transactional perspective: it estimates the cost of funding for a given period based on a business plan that incorporates regulation as an external parameter. For the second Economic Regulation Contract of Toulouse Airport, the airport chose an economic approach for the determination of its WACC 13, while in its Economic Regulation Contract proposal currently under discussion, Lyon Airport chose a financial approach. The latter includes a valuation of projected EBITDA 14 to determine the target capital structure (debt/equity ratio) despite the fact that the WACC is used to determine the price-cap and thus has a direct impact on the projected EBITDA. The disparity of methods used by airport operators reflects the current uncertainty with regards to WACC calculations in the context of Economic Regulation Contracts. 5

6 A price-cap regulation, which is a de facto rate-of-return regulation In this context, apart from validating or not the investment program of the airport, the main decision of the regulator is determining the appropriate WACC. Thus, if French regulation is nominally a price cap type of regulation, it is actually closer to a rate-of-return type of regulation since it is the determination of the authorized return on capital employed, i.e. the WACC, which becomes both the focus of negotiations between airport operators, airlines, and the regulator and the main driver of the price-cap level. The adverse effects of a rate-of-return type of regulation are well-documented, including the Averch-Johnson effect 15, which is the tendency of regulated companies via authorized rate of return on capital to over-invest in order to increase the volume of their profits. The French Competition Authority also notes that "the current regulation allows the airport operator to fully pass on higher costs through higher airport charges" 16, in direct contradiction with the purpose of a price-cap mechanism, which is meant to encourage the company to control its costs, including investment costs. Regulatory uncertainty burdens the airport sector as a whole In the context of the privatization of French regional airports, regulatory uncertainty regarding WACC calculation is problematic as the state acts both as a regulator and as a shareholder, thereby undermining the confidence of airlines in the current regulatory framework. Furthermore, the lack of predictability of the price setting mechanism burdens potential buyers of French airports with a strong regulatory risk regarding the next price control periods, which could negatively affect their willingness to pay for these assets. Incremental changes to the current system along the lines of greater transparency and more standardized criteria, including the formalization of the economic approach for the determination of the WACC, would likely make French airport regulation more effective while contributing to sustainable value creation for the airport sector. 6

7 Notes 1 TPICE, arrêt du 12 décembre 2000, Aéroports de Paris. 2 Ordonnance n , 14 Octobre Loi n du 20 April Les aéroports français face aux mutations du transport aérien Rapport thématique de la Cour des Comptes de Juillet Endettement net en baisse de 43m à Lyon entre 2007 et 2012 et en baisse de 27m à Toulouse entre 2011 et 2013 (cf. Dossier de consultation des usagers d Aéroport de Toulouse Blagnac - Avril 2013, Rapport annuel 2012 Aéroports de Lyon). 6 Loi n du 6 août 1986 relative aux modalités des privatisations. 7 Les aéroports français face aux mutations du transport aérien Rapport thématique de la Cour des Comptes de Juillet Avis n 10-A-04 du 22 février 2010 de l Autorité de la Concurrence. 9 Arrêt du 27 octobre 1993, Taillandier, C-92/91, Rec. 1993, p. I Arrêté du 16 septembre 2005 relatif aux redevances pour services rendus sur les aérodromes. 11 Avis de la commission consultative aéroportuaire sur la saisine du ministre de l'écologie, de l'énergie et du développement durable, en date du 23 juillet 2013 dans le cadre de la préparation du contrat de régulation économique d'aéroport de Toulouse Blagnac pour la période Fama, Eugene F; French, Kenneth R (Summer 2004). "The Capital Asset Pricing Model: Theory and Evidence". Journal of Economic Perspectives 18 (3): Dossier de consultation des usagers d Aéroport de Toulouse Blagnac pour le Contrat de Régulation Economique , publié en avril Dossier Public de Consultation d Aéroports de Lyon pour le Contrat de Régulation Economique , publié le 25 juin Behavior of the Firm Under Regulatory Constraint, Averch, Harvey; Johnson, Leland L. (1962); American Economic Review December 1962, v. 52, pp Avis n 10-A-04 du 22 février 2010 de l Autorité de la Concurrence.

8 About NERA NERA Economic Consulting ( is a global firm of experts dedicated to applying economic, finance, and quantitative principles to complex business and legal challenges. For over half a century, NERA s economists have been creating strategies, studies, reports, expert testimony, and policy recommendations for government authorities and the world s leading law firms and corporations. We bring academic rigor, objectivity, and real world industry experience to bear on issues arising from competition, regulation, public policy, strategy, finance, and litigation. NERA s clients value our ability to apply and communicate state-of-the-art approaches clearly and convincingly, our commitment to deliver unbiased findings, and our reputation for quality and independence. Our clients rely on the integrity and skills of our unparalleled team of economists and other experts backed by the resources and reliability of one of the world s largest economic consultancies. With its main office in New York City, NERA serves clients from more than 25 offices across North America, Europe, and Asia Pacific. Contact For further information and questions, please contact the authors: Jeanne Lubek Associate Director Jeanne.lubek@nera.com Stéphane Wakeford Economic Analyst Stephane.wakeford@nera.com The opinions expressed herein do not necessarily represent the views of NERA Economic Consulting or any other NERA consultant. Please do not cite without explicit permission from the author.