Managing the cash

posted on 14th June 2018

Airside International looks at how airports are managing their finances and how priorities have changed as a result of privatisation

The major trend among airports today is towards privatisation, according to Rafael Echevarne, director of economics and programme development at Airports Council International (ACI) World Headquarters in Montreal, Canada.

The frequency of privatisations has increased recently, but they are a surprisingly recent phenomenon. The first airport privatisation was in 1987 when the former British Airways Authority (now Heathrow Airport Holdings, which runs four airports) was floated on the London Stock Exchange.

Echevarne notes: “Privatisation has changed the dynamics of the airport industry. Now you have shareholders looking for a return. Privatisations are occurring because governments are too tied up with other business, such as building roads, schools and hospitals, to look after airports. In the UK now, nearly all the airports are private and China has the highest number of private airports listed on the stock exchange. The major exception to the rule is the US, where no major airports are private, although Chicago Midway is planning to become private soon.”

Switzerland’s Zurich International Airport is a good example of a successful privatisation. Europe’s 15th-busiest air gateway, it adopted a public-private partnership structure in 2000. The airport is owned by Flughafen Zürich AG, a company quoted on the SIX Swiss Exchange. Major shareholders include the canton of Zurich, with one-third and one share, and the city of Zurich, with a 5% shareholding. No other shareholder’s holding exceeds 5%.

Privatisation has worked out well for Zurich, which is financially stable. Net profit for 2012 was 94.7 million Swiss francs (US$99 million). “Since privatisation, we have depended completely on capital market financing. If we need money we do placements on the bond market in Switzerland, or finance ourselves via private placements, or capital increases,” explains Zurich chief financial officer Daniel Schmucki.

Although US airports are exceptions to the privatisation trend, the distinction between public and private is not as clear-cut as it first appears. Orlando International Airport, in Florida, is a public concern, but it is subject to many of the same economic pressures that prevail in the global aviation industry.

Orlando is run by a government agency, the Greater Orlando Aviation Authority (GOAA), which also operates the far smaller Orlando Executive Airport. Orlando is the second-busiest airport in Florida, after Miami International Airport and the 13th-busiest airport in the US. The GOAA determines its annual budget, which for the fiscal year running from 1 October 2012 to 30 September 2013 was $445.9 million, a 2.3% increase over the previous year. In addition, GOAA allocated a $3 million budget for Orlando Executive Airport.

Though overseen by the GOAA, Orlando is run in many ways like a private company. “We are a government airport, so we don’t calculate profit and loss in the same way as a private airport, but we are obliged to reinvest profits in the airport under regulatory agreements with the Civil Aviation Administration,” observes Orlando’s executive director, Phil Brown. “Their regulations have turned the United States’ public airports into pretty closed systems. We can’t divert revenue out of the airport to general governmental purposes.”

Last year, Orlando’s profit was around $64 million. The airport’s signatory airlines shared a quarter of the profits, leaving the rest to be reinvested in the airport. Most of the profit paid for the upkeep of the airport, which has around $5 billion of assets. “With 35 million passengers a year, there’s a lot of wear and tear,” Brown remarks.

As a closed financial system, Orlando has to find ways of maximising revenue, just as a private airport does. “Airports are run very differently to 30 years ago when they were totally dependent on long-term agreements with airlines,” Brown points out.

“We went through deregulation in 1978. Prior to that, government agencies took all the decisions, such as deciding what routes we would take. After 1978, there was far more competition and airports were forced to reorganise and become more entrepreneurial. The low-cost airlines intensified the competition and there was an extended period when you saw a spate of bankruptcies, before the industry picked up.”

Financial priorities

The financial pressures on airports, whether they are private and listed on a stock exchange like Zurich, or public like Orlando, have led to a number of trends in airport economics, according to Echevarne. The first characteristic of modern airport economics, he says, is a heavy requirement for capital investment.

“The need to invest is never-ending. Look at Heathrow Airport, in London, which is always a construction site. Not only do airports need to provide greater capacity, with new runways and terminals, but they also have to update infrastructure to keep up with the times. This investment is very different to airline investments, as aeroplanes can be used on different routes, whereas airport infrastructure is an immovable asset.”

The second characteristic of modern airport economics, Echevarne believes, is the increasing importance of non-aeronautical revenue. Research carried out by ACI in 2012 revealed that non-aeronautical revenue makes up 44% of airport income globally. In North America, the figure was 47% and in Asia-Pacific it was 51%.

In the US, a high proportion of non-aeronautical income comes from car parking and car rentals. For car parking, the US figure was 39%, compared with 19% globally. For car rentals, the US figure was 16.8% compared with 6.1% globally.

Orlando International Airport is even more dependent on non-aeronautical income than most US airports. It derives 75% of its income from non-airline business. In 2012, Orlando earned $80 million from hire cars alone, as to be expected from a tourist destination. Its largest revenue payer was Enterprise Rent-A-Car, which provided $29 million. The second-biggest source of revenue was Avis Budget Car rental with $19 million. Trailing in third place was Southwest Airlines, with a contribution of $17 million.

Zurich Airport’s non-aeronautical sources were also significant, though less so than for Orlando. Out of a total of $998 million, around $570 was aviation revenue and $352 million was accounted for by non-aviation revenue. Of the aviation revenue, a high percentage was business-related. Around 60% of flights were for business and 40% were for leisure. The proximity of the financial district, which is 12 minutes away by train, is a great advantage for the airport. However, Zurich is investing heavily in its non-aviation infrastructure in order to further grow this side of the business.

Competition

The third characteristic of modern airport economics, Echevarne says, is the increasing competition between airports. “If, for example, I live in Newcastle in the north of England and I want to fly to China, I need to first fly to an intermediate point. It could be Amsterdam, Heathrow, Frankfurt, or Dubai. So, those airports compete for that business. This type of competition didn’t happen until recently because the bilateral air service regulatory structure didn’t allow airports to commence flights as freely as they can today. It’s up to the airports to attract business, hence the emergence of airport marketing as an important financial tool.”

Zurich and Orlando face intense competition, but it comes from slightly different sources. Zurich faces limited competition for point-to-point traffic. “There is some competition from airports in Basel, Geneva, Friedrichshafen and Stuttgart, but the Swiss are not in the habit of travelling 90 minutes by car to save a few francs, which may be different to customers in other countries,” says Schmucki.

Nevertheless, Zurich must compete with other airports for hub traffic. “We’re in direct competition with major European hubs, such as Frankfurt, Vienna, or Munich, but we don’t incentivise airlines to fly here by subsidising them. At the end of the day, the market mechanism has to function and they can either achieve the ticket prices which make them attractive enough or they leave the destination.”

In marketing itself as a transfer hub, Zurich has several competitive advantages, according to Schmucki. The airport has repeatedly won awards as one of the world’s best transport hubs and, like most Swiss airports, it competes well on price. It also has plenty of space: terminal capacity is for 35 million passengers, far more than the 24.8 million passengers it notched up last year.

Orlando does not face the same stiff competition for hub business because it is almost exclusively an origin and destination airport. Traffic is driven mainly by Florida’s tourist attractions. “Families fly in to see Disney World, Universal Studios, SeaWorld Orlando and Legoland. The great thing for us is that they’re all investing millions of dollars in expanding their offers,” Brown enthuses.

“Disney is revamping Fantasyland, SeaWorld is doing an attraction called Antarctica and Universal is developing the Wizarding World of Harry Potter. They’re doing the marketing and publicity and driving traffic to Orlando Airport.”

Orlando’s traffic is not all driven by tourism, however. The airport also feeds off a burgeoning simulation industry. The US carrier JetBlue does a lot of aircraft simulations at the nearby JetBlue University and a company called Flight Safety offers flight training for pilots.

And the city of Orlando has an array of medical facilities, including the Nicholson Center, which offers training on da Vinci robots and Lake Nona’s Medical City. Orlando has a medical school, boasts a diabetes research unit and is constructing a veterans’ administration hospital. “The confluence of all those activities means there’s a real opportunity for medical training and education, which all triggers off passenger activity,” Brown informs.

Long-term planning

Both Orlando and Zurich want to expand operations to increase revenue, which brings us to Echevarne’s fourth and final point about the forces impinging on modern airports. Financial pressure, he says, necessitates long-term strategy.

“Modern airport economics requires long-term planning,” he said. “No one guarantees traffic in the future. Airlines go bust and change strategy. If they are not careful, airports can be left with brand-new infrastructure which serves no purpose. This has happened at quite a few airports in the US. When airports decide to invest, they’d better be sure that the airlines will use the new facilities.”

Zurich almost fell foul of Echevarne’s principle when it decided to build a large new commercial facility following the gateway’s privatisation in 2000. The expansion began at the height of the economic boom, when the airport was spending approximately $9 million a day. But then the airport’s hub carrier Swissair, the Swiss national airline, went bankrupt.

“The timing could not have been worse, so we had to decide whether or not to proceed with the $2.5 billion investment project. We made the right decision to face the challenges and to continue with the development. After all, everything we do is for the long-term future. We typically plan 10-20 years in advance.

“Looking back, we were absolutely right to proceed. For one thing, Zurich Airport has a hub carrier again. Swiss International Air Lines is now owned by Lufthansa and is one of the world’s most profitable airlines,” Schmucki says.

Zurich’s focus is now on real-estate development in order to increase its non-aviation revenue. “We are planning up to 2030 and ready to become a ‘third-generation airport’. This means it will be developed as a service destination in its own right.”

Zurich’s plans are on a grand scale. A new $1 billion 200,000 square metre complex scheduled to open in 2017 is the largest construction project in Switzerland. ‘The Circle’ is to be located within walking distance of the airport terminals. The Circle will be operated by Fluhafen Zürich but will have different tenants and service providers. The Hyatt Hotel group is already on-board – there is to be two Hyatt hotels with conference and event facilities occupying 25 percent of the development’s space. Half the area of the Circle is to be taken up by offices while an additional five ‘synergistic’ modules will occupy the remainder of the available space.

“The Circle represents the next step in our evolution. In terms of turnover, we are already the third-largest shopping centre in Switzerland and last year we turned over more than half a billion Swiss francs in commercial revenues. But to become a service destination, we need additional hotels, event facilities, office space and other services,” Schmucki notes.

Orlando’s expansion plans involve attracting more international traffic. The domestic market in the US has been relatively flat and airlines have been managing their profitability by restricting seat numbers. “As a result, our focus has been on foreign carriers wanting to come to Orlando, such as Virgin Atlantic, British Airways and Lufthansa. But it’s still a relatively small portion of total traffic, around 3.5 million in total passengers, or around 10% of the total,” Brown says.

At current rates of expansion, he believes the airport will need to build another terminal in the next five to seven years. The gateway is evaluating a plan to expand to a new terminal in the south of the airport that would have about 16 gates.

But before starting on the new project, Orlando would need to achieve certain passenger thresholds. “Since we are very capital-intensive and these projects have a long-term planning process, we need to get the maximum out of the existing facilities before we expand,” he highlights.

Orlando would need to see between 2 and 2.5 million passengers passing through its federal inspection area, or a total of 40 million passengers through its doors, to warrant that investment. Right now, it has about 1.7 million passengers travelling internationally and an aggregate number of 35 million passengers. “Based on our forecasts using the Monte Carlo simulation method, we expect to reach those (target) figures in 2016-17. A new terminal would give us lots of opportunities to drive traffic internationally,” Brown concludes.