ECONOMICS Last modified on August 1, 2013

China's mission

Peter Morris and Joanna Lu report on the financial challenges facing China’s airports as the country bids to upgrade its infrastructure to cope with future growth.

For many observers, the opportunity presented by investment in airport infrastructure has often appeared as a ‘no brainer’. Up to the year 2000 and in many cases beyond, the average traffic demand at the vast majority of global airports showed consistent 6% per annum growth over many decades, and those airports recorded solid and sometimes substantial returns on capital invested.

The revelation of the further financial opportunity presented by airport privatisation was first seen in the UK, then Sydney, followed by Delhi, Mumbai and others.

It excited everyone from governments to potential investors. For airports it meant a new opportunity to shrug off the shackles of government control, direct or indirect, and start to perform as a commercial business.

For governments, it meant that a borrowing requirement was offloaded, funds received, and a state-of-the-art facility appeared as if by magic.

Customers saw new and improved facilities. Even the airlines seemed pleased when some of these new airport entities focused on reducing their reliance on aeronautical charges and opening up the potential of new revenue streams from a range of other services.

And, for investors increasingly nervous about short-term economic stability, it provided an opportunity for stable long-term returns above inflation. It seemed almost too good to be true.

It was, however, partly a product of an asset bubble valuation carried by cheap debt financing that did not last. Aviation markets followed economies down. Those with capital became increasingly nervous about long-term capital commitments and public authorities were often unrealistic in their value and regulatory expectations.

From 2005/06, when Budapest Airport and others attracted multiple bids at up to 30 times earnings levels, we see relatively few bidders and 10-15 times multiples in recent Gatwick or Stansted transactions.

Yet while the investment pendulum has now swung back from the extremes of the early to mid-noughties, the business fundamentals of the airport investment model still appear sound:

  • Long-term demand for aviation will still outpace GDP
  • Governments which face rising problems of employment, education, healthcare and dependency budgets are keen to realise value for public sector capital in ‘non core’ areas
  • The opportunities for former public sector airports to expand revenues and reduce costs can be considerable

In particular, the need for airport infrastructure investment to meet demand growth continues apace in China, Middle East, Africa, India and South America. The challenge continues to be to find appropriate ways to balance the expectations and needs of multiple parties from government to airlines, passengers to wary financial investors, airport operators to concessions operators, and, to do this over the long lives of airport assets. China is an example which has its own special considerations.

China’s challenge

China has faced the considerable challenge of air passenger growth which has averaged 15% per annum for more than three decades, and is still expected to continue to grow at around 8% yearly for the next 20 years.

China has responded with the most comprehensive airport plans in the world, planning a further 50 airports (in addition to needed expansion of the current 180) by 2015.

Although opportunities for foreign investment were potentially opened through Provisions of Foreign Investment in Civil Aviation (CCAR-201) published in 2002, the reality has been that most infrastructure funding has been sourced domestically.

Limited examples of foreign investment in Chinese airports are Hangzhou, Nanjing and Xi’an, and there have been some failures.

The Provisions on the Domestic Investments into the Civil Aviation Industry (for Trial Implementation) published in 2005 has further liberalised the investment in, or even control of, airports by domestic private capital.

Exceptions are airports in the specified nine cities including Shenzhen, Xiamen, Dalian, Guilin, Shantou, Qingdao, Zhuhai, Wenzhou, Ningbo.

Since the need for foreign airport infrastructure funding appears not to have been an issue to date, perhaps the question is what the global airport market can look to offer to China?

Taking a broad view, this might potentially come from examples of revenue diversification, global performance benchmarking or the benefits of outsourced competition. These elements have proved successful in various airports around the world to increase the value generated from the airport investment.

Some practical examples of this are seen by the improvements in Shanghai Hongqiao, Hangzhou and Zhuhai after management co-operation with Hong Kong airport.

One particular area of interest for Chinese airports is in the development of revenue coming from non-aeronautical activities.

Looking at a selection of the top airports in terms of profitability and non-aeronautical revenues, Hong Kong secures a higher profitability associated with its share of non-aeronautical revenues- despite generally facing a lower annual traffic growth rate.

One feature of this additional revenue is revenues from outsourcing. Shanghai Pudong and Shenzhen also appear to benefit from their more diversified non-aeronautical revenues.

While the Civil Airport Charges Reform Plan (2008) has given airport management more freedom on pricing aeronautical and non-aeronautical services within a price-cap framework, the different market conditions, location and opportunities between the airports, we believe, call for a much more diversified charging regulatory system to realise the full business potential.

From the end of 2004, CAAC experimented with a franchised operation model at five airports in four cities – Beijing, Shanghai, Shenzhen and Xiamen. The franchised operations included ground service and commercial business. CAAC is also now promoting this operating model around the country.

Later, the State Council of the People’s Republic of China released Management Ordinance of Civil Airports (the Ordinance), which was officially implemented from July 2009.

The Ordinance tries to further liberalise the non-aeronautical services in China’s airports but currently give the airports the choice if they will use the franchise mode in airport operation.

While this has been a big step for Chinese airports to develop their non-aeronautical business in a more professional way, the pilot airports, such as Beijing and Shanghai, still tend to use a joint venture mode in ground handling, air catering and advertising activities to retain control of the business.

For the airport retail and food & beverage service, although most of the pilot airports started adopting the franchise mode, more work is needed to regulate pricing and service standards. Guangzhou, Shenzhen and Xiamen still have ground handling or catering service provided by the airport company directly.

The evidence from European airports on the introduction of ground handling competition suggested that there were clear reductions in cost, and improvement in service quality possible.

One particular success of the European model, has been the introduction of new entrants, who bring with them skills learned from global logistics and across multiple airports.

The major mainland airports are still in the early stages compared to Hong Kong in outsourcing competition, but they will appreciate the potential benefits of operational excellence and cost reduction that are possible.

International Airport Services Co Ltd was officially put into operation in Shanghai on February 27, 2013 after a three-month trial. The company was a joint venture by Shanghai Airport Authority, Shanghai International Airport, Cathay Pacific Airways (CX) and Air China (CA).

The true success of an airport business model needs to be measured through a mix of operational, financial and customer satisfaction parameters.

China is one country where good planning and ample funding for airports can then be turned in to an optimum business model using the lessons learned by airports worldwide.

About the authors
Peter Morris is chief economist for Ascend – a Flightglobal advisory service. Colleague, Joanna Lu, is a managing consultant in the firm’s Hong Kong office.
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