Has the trend line shifted? The impact on valuations Romil Radia, Funminiyi Oduko, and Robert Behan

Executive summary earnings before interest, tax, depreciation, and amortisation (‘EV/ The last year has continued to see EBITDA’) transaction multiples for transactions taking place in the UK European at or above 25x. airports’ sector, including OTPP Passenger traffic growth forecasts at increasing its shareholding in Bristol the time of these transactions Airport to 100% and Heathrow indicated expectations for continued Airport Holdings (HAL) announcing traffic growth from an all-time high. the sale of its interests in Glasgow, Aberdeen, and Southampton airports. But unlike more traditional This followed an active 2013, which infrastructure assets, airports serve saw Airport Group’s airlines as their primary clients and (MAG) acquisition of Stansted therefore share in the fortunes and Airport and other transactions in UK woes of a highly cyclical industry. regional airports. In addition, there Airport valuations are predicated on have been numerous European expected future cash flows, which are airport transactions, namely the sale in turn underpinned by passenger of Hochtief’s airport division to PSP demand for travel. Investments and TAV Airports’ acquisition of a stake in Sabiha Despite the resilience of airport cash Gokcen (Istanbul) from Limak Group. flows in the previous economic These transactions and other downturns, the onset of the global anticipated transactions across financial crisis led to lower passenger Europe in the near term demonstrate traffic and revised growth that there is strong ongoing interest expectations. Downside valuation in the airport sector. Understanding risks for airports became apparent. individual airport value drivers and These risks were subsequently borne associated risks remains key to out by airport transaction multiples securing a good deal. observed since 2008, which, on average, declined in line with traffic Airports are a unique class of asset. growth expectations. While they have historically enjoyed a moderate degree of cash flow This article explores the trends in UK certainty, they have also offered passenger growth and the movement greater potential for growth than in EV/EBITDA transaction multiples more traditional infrastructure assets. for airports over time. It also highlights airport valuation drivers and risks. Finally, we identify A unique asset class considerations important for In the mid to late 2000s, against a investors to take into account when backdrop of greater availability of valuing airports. credit and sustained passenger traffic growth, we saw enterprise value to

38 PwC | Connectivity and growth Given current sovereign debt burdens across Europe and the need for Today’s market is characterised by modest investments in key transport growth expectations and significant short- infrastructure in the emerging markets, partial or full privatisation term uncertainties. of state-owned airports may remain popular (examples include the partial privatisation of AENA and sale of a Today’s market is characterised by traffic recovery, nothing precludes number of Greek airports, both likely modest growth expectations and observing the higher level of to be completed by 2014/early 2015). significant short-term uncertainties. multiples again in the medium term, Furthermore, the uncertainty in For this reason, we do not for the if there are asset-specific reasons to economic outlook across the world moment expect to see a sustained justify this. makes airports a relatively attractive return to EV/EBITDA transaction asset class to invest in. multiples of more than 20x for Airports: a very current European airports last observed in Uniquely appealing assets valuation topic the mid to late 2000s. Many investors see airports as Airport transactions continue to hit Instead, airport transactions in the relatively safe assets. That is because the headlines: MAG acquired airports typically offer stable cash past five years indicate that regional Stansted concurrently with airports with higher traffic growth flows with the potential to realise Australian infrastructure fund IFM’s significant capital gains on disposal. transact within a range of between 14 purchase of a minority stake in MAG to 18 times EV/EBITDA, and larger, Indeed, having at times enjoyed in January 2013; Canadian pension traffic growth rates in excess of two more mature airports transact within fund PSP acquired the airport a range of 10 to 14 times EV/EBITDA. times GDP growth, listed European portfolio from Hochtief group in the airports, on average, have continued To date, apart from transactions third quarter of 2013. In addition, the characterised by government or local to outperform the Eurofirst 300 index Spanish public body Aena acquired over the last six years. (See Figure 1.) authority intervention, there has from Abertis in August been limited evidence of transactions 2013. Deal activity is likely to Even when air traffic falls during in underperforming airport assets. continue in the UK (witness HAL’s economic slowdowns, airports can For airports that would currently fall recent announcement of the sale of its still deliver growing dividends to within the respective 10 to 14 times interests in Glasgow, Aberdeen, and investors through the deferral of and 14 to 18 times EV/EBITDA Southampton airports) and European operating costs and rescheduling or ranges, once there is greater visibility markets into 2015. reducing capital expenditure. around the strength and pace of Airport investors Financial investors in airports such as Figure 1: Listed European airport share price performance infrastructure or pension funds are interested in the stable cash flows airports offer. And they often invest 160.00 with their eye on the long term. Many 140.00 focus on the internal rate of return 120.00 (IRR). They also try to enhance value 100.00 by implementing optimal financing x 80.00

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60.00 Trade buyers (such as other airport 40.00 operators) try to improve operational 20.00 efficiencies; for example, by - increasing commercial yields and by expanding the airport’s route Flughafen Zueric h AG (SWX:FHZN) Aéroports de Paris Société Anonyme (ENXTPA:ADP) network. We are observing an Københavns Lufthavne A/S (CPSE:KBHL) Flughafen Wien AG (WBAG:FLU) Fraport AG (XTRA:FRA) FTSEurofirst 300 Index - Index Value increasing trend of airport operators Listed European airport average forming consortia with financial Source: S&P Capital IQ investors with the aim of boosting value through operational and financial structuring improvements.

Has the trend line shifted? 39 In the case of airports, a primary driver of earnings growth potential is passenger growth.

The key messages arising from this Growth expectations and function of current earnings and paper are relevant and applicable to transactions expectations for future earnings both trade and financial investors. growth, with the simple relationship Figure 3 shows actual UK passenger being that the greater the growth traffic alongside UK traffic potential, the higher the multiple. UK traffic: Reversion to expectations in 2007, the last full year trend? prior to the global economic crisis. In the case of airports, a primary driver of earnings growth potential is Tracking growth against the In 2007, the expectation was that UK passenger growth. trend airport traffic would continue growing Figure 2 shows UK terminal passenger from its 2007 peak at a rate broadly in Back in 2006-2008, observers traffic (‘pax’) since 1976, with the line with the long-term growth trend. expected long-term passenger traffic long-term passenger growth trend With hindsight, it is clear that 2007 to keep growing at the rates seen in superimposed. passenger growth expectations did not the immediate preceding years rather materialise. than revert to the long-term trend. Put The graph shows that, up until 2008, it another way, they anticipated a Take a look at the EV/EBITDA typically took 4-6 years for traffic to one-off upward shift in the long-term return to the long-term passenger multiples between 2000 and 2014 for 10 traffic trend. growth trend following a recession or European airports in Figure 3. Of other economic shock. course, there are obvious challenges in These expectations were reflected in comparing transaction multiples increasingly higher transaction Thanks to these patterns, it has often between airports owing to each multiples paid over that period. In become conventional wisdom that airport’s specific operations and effect, investors in airports were traffic growth and associated airport individual growth potential. However, willing to pay high sums for the future cash flows will revert to the long-term it is fair to say that, on average, airport growth they anticipated in 2007. Once trend after a shock rather than grow at transaction multiples rose in the early investors realised that the expected a similar rate from a lower base. to mid 2000s, peaking around 2007 growth wasn’t going to materialise – Indeed, between the late 1990s and and, on average, have fallen since. and once credit markets tightened – mid 2000s, UK traffic saw significant transaction multiples declined. growth above the long-term trend. Perhaps unsurprisingly, passenger This was fuelled by a sustained period numbers in the UK have seen a similar of economic growth, greater pattern. The upshot of this analysis is availability of credit, and the relatively straightforward: at a basic emergence of low-cost carriers (LCCs). level, transaction multiples are a

Figure 2: UK airport traffic and GDP growth

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UK terminal pax Pax % change UK GDP Long term pax trend

Source: CAA, PwC analysis

10 The HAL transaction announced in Oct-14 is due to complete in Jan-15. The implied EV/EBITDA transaction multiple based on 2013 historic EBITDA is circa 16x.

40 PwC | Connectivity and growth Figure 3: UK airport traffic and European transactions

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UK terminal pax UK traffic expectations in 2007 (DfT) Transactions multiples for European airports Average transaction multiple Long term pax trend

Source: CAA, DfT, PwC analysis, Press

Over the past three years, we have Despite the improved UK economic useful valuation benchmarks, seen average transaction multiples outlook, smaller regional UK airports typically the discounted cash flow stabilise at around 15 to 16 times EV/ remain vulnerable to risks given the (‘DCF’) valuation methodology is used EBITDA. The latest UK traffic data (for shift in the balance of power to LCCs, as the primary approach to value the full year 2013 and for the eight who are increasingly mobile and can airports. This is because airports months to August 2014) suggests that relocate their operations at short generally have long-term projections future terminal passenger growth may notice. and Glasgow follow this revised long-term traffic Prestwick Airport were re- trend. nationalised recently after failing to attract buyers, while Furthermore, there have been recent () closed in May 2014 and encouraging signs on the UK economic Airport closed to front: based on the latest data released commercial operations in October in October 2014, IMF has upgraded its 2014. These developments UK GDP forecasts since October 2013 demonstrate that the divide in growth by over a full percentage point for prospects for UK regional airports 2014 (1.9% to 3.2%) and by over half a continues to widen. The key for percentage point for 2015 (2.0% to smaller regional airports is to ensure a 2.7%). Therefore, downside risk to the healthy balance in airline customer sustainability of future UK traffic dependence such that the traffic growth has lessened in the past year. growth expectation is sustainable. However, Eurozone GDP forecasts have remained broadly unchanged Note: The transactions we are talking over the period, and economic about here relate to European as well sentiment in the region has as UK airports. We believe that the deteriorated in recent weeks as a two airport markets are sufficiently result of deflationary fears and developed and similar to draw slowing growth in Germany’s consistent insights from the data. economy. Discounted cash flow analysis. While transaction multiples provide

Has the trend line shifted? 41 What influences an airport’s value?

Discounted cash flow analysis. • Regulatory environment. Airports • Airline customer dependence. While transaction multiples provide are typically subject to regulation The degree of airline concentration useful valuation benchmarks, when regulators see them as at an airport will affect value. If an typically the discounted cash flow holding substantial market power. airport is highly dependent on one (‘DCF’) valuation methodology is used Regulated airports’ risk/reward or two key airline customers, a as the primary approach to value profile differs from those of reduction in aircraft capacity (due, airports. This is because airports unregulated airports – for example, for example, to reallocation of generally have long-term projections investors see regulated airports as aircraft capacity across an airline’s that offer cash flow visibility. The DCF more vulnerable to changes in network or airline bankruptcy) will approach is also more appropriate for regulatory regimes, which have a material impact on the differentiating between an airport’s translates into regulatory risk. airport. Further, airports typically revenue streams (aviation, retail, real Airports are also subject to different have to renegotiate tariff increases estate, external operations) and the regulatory environments in on a frequent basis with their main various regulatory mechanisms under different jurisdictions. In the UK, carriers, and single airline which airports operate. for instance, regulated airports are dominance at an airport will affect allowed to earn a return on their the balance of negotiating power in Airport transaction multiples. regulated asset base (RAB). RAB is favour of the airline. There are clear challenges in therefore a key valuation metric, • ‘Stickiness’ of airlines. The extent comparing transaction multiples and the market places significant to which an airline has the option to between airports. This is due to each emphasis on enterprise value to relocate operations to another airport’s specific operations and RAB multiples in assessing the airport that serves the same individual growth prospects. In value of regulated airports. addition to market factors and catchment area will determine the competitive bidding conditions at sale, • Catchment area penetration. The stickiness of an airline to a key factors affecting airport value and extent to which an airport has particular airport and will affect transaction multiples include the penetrated its primary and value. Stickiness subsequently following: secondary catchment areas affects determines the balance of its passenger growth potential. negotiating power in tariff • Maturity of the airport. Most negotiations (the extent to which • Capacity constraints. or large, mature airports have less tariffs can be increased without terminal capacity constraints tend potential to increase traffic than significant adverse effects of the to depress an airport’s traffic smaller regional airports and may airline moving its operations away growth potential. Alleviating these trade at a lower multiple. For a from the airport). It is difficult to constraints may require significant small regional airport starting from isolate the impact of airline capital expenditure as well as a low passenger base, attracting stickiness in a transaction multiple. planning and regulatory approval. two or three new airlines can However, we have observed adverse transform the business – a prospect • Airport traffic mix. The make-up impacts through the suppressed that is often reflected in transaction of an airport’s traffic – the mix of EBITDA margin of airports that do multiples. Conversely, larger short – and long-haul as well as not have strong power in price airports tend to have a broader business, leisure, charter, and negotiations with airlines. airline base, so they are less low-cost traffic – affects airport • Dividends. The history that an vulnerable to customer earnings. For example, traffic mix airport has demonstrated in paying concentration risk and volatility. can strongly determine an airport’s regular dividends and the potential commercial revenue spend per • Potential for yield improvements. capacity to continue paying these passenger. Domestic passenger Airports with non-aeronautical regular dividends will affect value. retail spending will tend to be lower revenues that are lower than those Given that airport investors often than that of leisure travellers (such of comparable airports can boost invest with their eye on the long as charter), owing to shorter airside their earnings by improving their term, the prospect of regular dwell time. Business traffic is a retail offerings, increasing parking dividend payments will cause lucrative revenue stream, given it fees, and making other similar investors to see the investment as will likely stay steady during an enhancements. This potential for more liquid. Airports also offer the economic slowdown, compared to better earnings can also be flexibility of being able to support other traffic types such as charter. reflected in transaction multiples. dividend payments during a However, to benefit from an slowdown through the deferral of enhanced non-aeronautical revenue operating costs and rescheduling or stream, can require significant reducing of capital expenditure. capital expenditure investment.

42 PwC | Connectivity and growth Given the number of circumstances affecting an airport’s value, investors need to carefully assess airports’ comparability and adjust transaction multiples where appropriate.

Where do we go from here? The speed at which traffic may return reverts to long-term historical trends to the long-term trend line hinges on must be questioned. The picture is continuing to improve for the pace of economic recovery. Figure certain advanced economies. But 4 sets out current passenger number Looking at current growth expectations emerging economies like India, expectations for the UK aviation and market uncertainties, we do not Indonesia, Turkey, South Africa, and market, but also projects a range of expect to see a sustained return to Brazil have run into trouble over the potential passenger growth profiles the 20+ times transaction multiples past year as capital has begun flowing based on forecast UK GDP growth and observed in the mid-2000s in the short back to the advanced economies. While a range of income elasticities. term. this situation appears to have subsequently stabilised, the pace of In Figure 2, we saw that in the early However, once there is greater European economic growth remains 1980s and 1990s, it took four to six years visibility into the strength and pace of uncertain and the economic impact of for traffic to revert to the long-term traffic recovery, nothing precludes the Fed ceasing its quantitative easing trend after an economic slowdown. seeing this level of multiples in the programme and raising interest rates is medium term if there are asset-specific unclear. The patterns in Figure 4 suggest reasons to justify this. As can be seen that even in a high-growth scenario, in Figure 3, airport transaction After generally disappointing growth passenger numbers are unlikely to revert multiples are perhaps stabilising. in 2011 and 2012, the UK economy to the trend line before 2022-2024. showed signs of recovery in 2013 and Given current market evidence, we GDP forecasts have continued to be Given that the drop in UK passenger would continue to expect higher upgraded throughout 2014. Consumer traffic since 2007 has been markedly growth regional airports to transact spending growth is projected to follow sharper than that observed in previous within a range of 14 to 18 times EV/ a slightly more optimistic GDP growth periods of economic recession, a 10-12 EBITDA, and larger more mature rate in the UK. Yet downside risks to year period for reversion to the airports in the range of 10 to 14 times growth remain, albeit to a lesser long-term trend does not appear EV/EBITDA. extent than in 2013, owing to the unlikely. Indeed, if one were to focus There is certainly significant interest possibility that the current relative on lower passenger growth profiles, it in the airport assets coming up for calm in the Eurozone may not last. could be argued that the long-term trend line is shifting downwards and sale, and competitive tensions may that the premise that traffic always increase transaction multiples observed.

About the authors: Funminiyi Oduko Figure 4: UK airport traffic – reversion to trend and Robert Behan are airport valuation professionals at PwC UK. Romil Radia leads the PwC airport valuations team in . 350 40%

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UK terminal pax UK traffic expectations in 2007 (DfT) Forecast UK traffic (GDP elasticity 2) Forecast UK traffic (GDP elasticity 1.6) Forecast UK traffic (GDP elasticity 1.2) UK traffic expectations in 2013 (DfT) UK GDP forecast (IMF) Pax % change Long term pax trend Source: CAA, DfT, IMF, PwC analysis

Has the trend line shifted? 43 If you’re thinking about investing

Cyclicality should be built into long-term cash flow projections

When assessing the value of an airport, it is essential to recognise the cyclicality of the industry, consider where we currently sit in the economic cycle, and build sensitivities into cash flow projections to reflect economic downturns and other risks. Recent evidence suggests that airport performance 1 is not as immune to wider market volatility as perhaps once thought.

Airport transaction multiples are unlikely to reach pre- recession levels in the short term

Given current growth expectations and market uncertainty, we do not expect to see a sustained return to the +20x EV/EBITDA transaction multiples for European airports in the short term. However, once there 2 is greater visibility around the strength and pace of traffic recovery, there is nothing to preclude observing this level of multiples again in the medium term, if there are asset-specific reasons to justify this.

A comprehensive assessment of comparable transaction multiples is required if used as valuation benchmarks

While airport transactions clearly provide useful valuation benchmarks, it is imperative to undertake a comprehensive assessment of the 3 comparability of transactions and make appropriate adjustments if it becomes apparent that they are incorporating different, or even unrealistic, growth expectations.

Reversion to the long-term passenger traffic trend will take several years

An assessment of historical UK passenger traffic suggests that growth rates are not constant. With potentially a 10-12 year period before traffic reverts to historical passenger growth trends, it seems timely to revisit 4 the premise that traffic always reverts to long-term trends.

Airport operators and financial investors are increasingly joining forces to deliver airport value improvements

We see an increase in airport operators forming consortia with financial investors with the aim of delivering value enhancement through operational and financial structuring improvements. The key messages 5 arising from this paper are relevant to both trade and financial investors.

44 PwC | Connectivity and growth