Heathrow's meagre returns to shareholders

https://realassets.ipe.com/news/ardian-buys-additional-10-stake-in-heathrow-airport-for-866m/10129147.article

After 19 years to the month, Ferrovial is finally exiting its investment in Heathrow Airport Holdings (HAH) with the news on 26 February that Ardian has agreed to purchase 5.25% from Ferrovial, 2.65% from CDPQ and 2.1% from USS. When the transaction closes, all three will be out of Heathrow completely. CDPQ and Ferrovial were the leaders of the Airport Development and Investment Limited (ADIL) consortium that bought a 27.8% stake in the London market in early 2006 and made a hostile bid for the rest of BAA, HAH's predecessor. After rejecting its initial offer, BAA's Board finally recommended ADIL's offer in June 2006 in competition to a rival offer from Goldman Sachs.

ADIL was c.62% owned by Ferrovial, 28% by CDPQ and 10% by GIC of Singapore, who currently has a 11.2% holding in HAH. After the current transaction, the other shareholders in HAH will be Ardian (32.61%), Qatar Investment Authority (QIA) (20%), Public Investment Fund (PIF) of Saudi Arabia (15.01%), Alinda (11.18%) and Chinese Investment Corporation (CIC)(10%).

The take-over share price of BAA was its all time peak of 950.25p (including a 15.25p per share dividend), 49% higher than the average share price of 637p in the 30 days ending on 6 February 2006, the day before Ferrovial's first announcement that it was contemplating making a take-over approach.

Now that Ferrovial has exited its investment in HAH, I have collected all of its cash flows in terms of equity investments, transaction costs, disposals and dividends to estimate its total shareholder return. They are shown in Figure 1 below.

Figure 1. Ferrovial - Cash flows of investment in BAA/HAH, 2006-2025 (￡ millions)

The answer is the shareholder return of Heathrow has been poor, despite the gain on disposal of a 19.75% stake to Ardian and PIF of €2.0 billion being the main contributor to Ferrovial's 2024 pre-tax profit of €3.6 billion that it reported last night. Ferrovial has easily recouped all of its investment of almost ￡3.0 billion with disposals of ￡3.6 billion and dividends of ￡1.15 billion for an overall surplus of ￡1.75 billion.

But the pre-tax IRR has been just 4.1% p.a. The IRR is even lower in Euro terms, Ferrovial's home currency, at 2.5% p.a. because of the 17% weakness in Sterling versus the Euro over the 19 year period. The return would have been higher on a less risky diversified portfolio of FTSE350 companies at c.6% p.a.

The return is little more than inflation. UK CPIH, for example, has been 2.7% p.a. on average over the same period, while the UK RPI index has risen by an average of 3.7% p.a. Yet Heathrow's regulated returns and asset base are linked to inflation. For the first eight years of the investment, airport tariffs were set to be on average RPI + 7.25% (during construction of Terminals 5 and 2) but were lowered to RPI - 1.5% between 2014 and 2021.

So why have returns been so meagre?

1. High price to pay. Stock markets are generally efficient and BAA had been traded publicly for 19 years since its privatisation, so to pay a 49% premium was always going to make future equity returns challenging. If ADIL had just paid the market price of 637p, annual equity returns would have been 7.6%. But a zero take-over premium would be unrealistic. An average take-over premium of 30%, however, would have returned 5.3% p.a. A 49% premium in hindsight was too high. The take-over premium in ADIL's initial offer was 27%. The high price was reflected in a high EV/EBITDA multiple of 16.6x compared to other listed airports at the time (e.g. Aéroports de Paris and Fraport) trading on c.10x. The take-over premium of Enterprise Value (￡16.4bn less non-regulated assets of ￡3.0 billion) to its Regulated Asset Base (RAB) (￡11.0 billion) was c.17%, whereas prior to ADIL's take-over approach, the premium to RAB of BAA was generally zero to +5%.
2. Forced disposal of Gatwick, Stansted and Edinburgh Airports. Within one year of the acquisition, the UK Office of Fair Trading (OFT) had referred BAA to the UK Competition Commission concerning its ownership of all three of the main London airports (Gatwick, Heathrow and Stansted) and the two main Scottish Airports (Edinburgh and Glasgow). The OFT accused BAA of abusing its market power in these areas and providing poor service to customers. After a lengthy legal battle, BAA was forced in 2009 to sell Gatwick, Stansted and one of Glasgow or Edinburgh within two years. It was a poor time to force disposals in the aftermath of the Global Financial Crisis. BAA sold Gatwick for ￡1.51 billion in October 2009 to Global Infrastructure Partners (GIP) at an Enterprise Value 10% lower than the value of its RAB and at an EV/EBITDA of only 8.9x, resulting in a loss on disposal to BAA of ￡668 million. Interestingly. GIP sold a 50.01% stake in Gatwick to Vinci in December 2018, valuing the equity at ￡5.8 billion with an EV/EBITDA of 20.0x. BAA also sold Edinburgh Airport to GIP in May 2012 for ￡807 million with an EV/EBITDA of 16.7x and gain on sale of ￡38 million. GIP sold a 50.01% stake in Edinburgh Airport in April 2024 to Vinci, valuing the equity at ￡2.54 billion. BAA sold Stansted Airport in January 2013 to a consortium led by Manchester Airports Group (MAG) for ￡1.5 billion at an EV/EBITDA of 15.6x and a gain on sale of ￡147 million. Overall, I estimate that BAA has missed out on at least ￡6.0 billion of equity value due to these premature forced disposals.
3. Implied equity value from stake disposals showed little change up to 2013. Despite debt re-financings, disposals of ￡3.7 billion of non-regulated assets and c.￡1 billion of further equity capital injections, the total equity value of HAH only advanced from ￡4.15 billion in 2006 to ￡4.5 billion in 2013. The first disposal by Ferrovial of a 5.88% stake to Alinda in October 2011 valued BAA's equity at ￡4.76 billion but equity valuation declined to ￡4.5 billion in 2012 and 2013. The forced sales of three UK airports cannot have helped BAA's valuation. But there were ￡3.7 billion of other disposals between 2007 and 2014, including Budapest Airport in 2007 (￡1.3 billon), stakes in Australian airports in 2007 (￡340 million), World Duty Free in 2008 (￡547 million), various properties for ￡270 million in 2008 to 2010 and its other three remaining airports (Aberdeen, Glasgow and Southampton) for ￡1.045 billion in 2014 (of which 50% to Ferrovial). But total equity gains from the ￡3.7 billion of disposals were only c.￡120 million. Despite the disposals and equity injections, net debt remained high at c.￡12 billion, reflecting the heavy capital spending that HAH was incurring in building Terminal 5 up to 2008 and Terminal 2 up to 2014.
4. COVID-19. Heathrow Airport claimed it had lost at least ￡2.5 billion as a result of the pandemic in 2020 and 2021 and that this amount should be added to its RAB. This was firmly opposed to by the airlines, who had collectively lost even more than this amount in London. For once, the Civil Aviation Authority (CAA) listened to the airlines but did allow Heathrow to recover an amount of ￡300 million. The consequence of the pandemic was that HAH could not pay dividends for nearly four years. I estimate that Ferrovial probably lost out on c.￡650 million of dividends (similar to its 25% share of the ￡2.5 billion COVID losses). HAH only resumed paying a dividend in February 2025, just as Ferrovial closed its position.
5. Strategic returns. HAH originally suited Ferrovial's life-cyle approach to infrastructure from construction through to operation and eventual disposal. In 2006, there was a lot of construction potential at Heathrow and some of the other airports that could usefully benefit Ferrovial's core construction business, Ferrovial Agroman. I am sure that Ferrovial made more than just a 4.1% annual return on its Heathrow investment in the form of construction contracts and fees. It was the main contractor on the Terminal 2 construction between 2010 and 2014 and it has a long-term contract to dismantle and demolish Terminal 1. The potential of expanding the airport with a third runway and new and expanded terminals could provide decades of construction opportunities.

Ironically, Ferrovial's 25% ownership of HAH and its position as the airport manager, being the largest shareholder, may have become a liability. The airline users have been quick to point out the conflict of interest between its ownership of the airport and its construction interests.

I used to think that if Ferrovial sells out of Heathrow, which it announced in 2023, it is a sign that it does not believe that Heathrow will ever be expanded. Now I think it is positioning itself to be an independent contractor who can work with either HAL on its runway and terminals or with the Arora Group, should it be successful in persuading the CAA to operate an independent terminal in competition to HAL. Ferrovial Agroman would also be eligible to work with the other London airports, all of whom have terminal expansion plans with Gatwick also looking to create a second runway by moving a taxiway.

With Ardian and PIF as new shareholders, HAL's equity value has shot up to ￡8.7 billion with an Enterprise Value of ￡25.5 billion at a c.25% premium to RAB value, the highest it has ever been. Despite the meagre equity returns over the years, most of the equity value upside has come in the last few months and Ferrovial (and CDPQ) have seized the opportunity to take profits.

Figure 2. BAA/Heathrow Airport - Valuation of stake acquisition and sales, 2006-2025 (￡ millions)