"Carving up BAA's Britain"

Sunday, October 21, 2007

Carving up BAA’s Britain
By Selwyn Parker
The Competition Commission has its sights on the UK’s biggest airports
operator. And there’s the very real prospect of it having to divvy up its
crown jewels
United Kingdom - The Glasgow Sunday Herald


BAA MUST think it has not got a friend in the entire UK. At the last count,
the enemies of the Spanish-owned group included British Airways's chief
executive Willie Walsh, his counterparts at several other airlines including
Ryanair and easyJet, London mayor Ken Livingstone, the Confederation of
British Industry, numerous captains of industry, new City minister Kitty
Ussher (who considers Heathrow a blot on London's commercial landscape), and
a steady stream of outraged letter-writers to the papers complaining of
delays, security, congestion and inadequate facilities.

And now it faces a possible break-up and sale of its portfolio of seven
airports, including three in Scotland, as the Competition Commission delves
deeper into its comprehensive inquiry into BAA's stranglehold on the airport
business in Britain. Ominously, the commission has already determined that
"important aspects of BAA's performance have been poor". For Madrid-based
Grupo Ferrovial, which paid a generous £10.2 billion for BAA last summer,
this is clearly an unhappy situation.

The commission's official brief is to "determine whether there are any
features of the market that prevent, restrict or distort competition and, if
so, what remedial action might be taken". But the key issue up for
consideration is whether common ownership is the best way to run Britain's
biggest airports, in particular the much-maligned Heathrow, Stansted and
Gatwick. So far, the six members of the airports inquiry group have talked
with BAA; the Civil Aviation Authority, with whom BAA has less than cordial
relations; full-service and low-cost airlines - in particular Ryanair chief
executive Michael O'Leary, who is BAA's main scourge; industry bodies;
unions; the Scottish government, which has yet to make up its mind on the
merits of a break-up; and the Office of Fair Trading.

The latter is certainly not a friend of BAA. It was the OFT that started the
break-up ball rolling, arguing earlier this year, largely on the basis of an
alleged lack of competition between Edinburgh and Glasgow, that BAA's
virtual monopoly on the major airport hubs was "not working for consumers".

But there is another issue of interest to practically anybody who uses a
BAA-owned airport because it affects the price of everything including
tickets. In tandem with the break-up investigation, the commission is
conducting a statutory review of BAA's fraught relationship with the Civil
Aviation Authority. Under this, the CAA imposes an inflation-based set of
price controls for Heathrow and Gatwick airports (but not for the Scottish
airports) that define exactly how much BAA can charge the airlines for the
provision of its services, use of runways and so on. The CAA's checks and
balances are supposed to protect the airlines from BAA abusing its monopoly
by overcharging them. In an arrangement that even the group's enemies
concede is a commercial straitjacket that inhibits its ability to charge
market prices and generally run the business properly, BAA is not allowed to
make a higher return on capital than the CAA permits.

So far, Ferrovial has lost this battle. Having strenuously argued that the
CAA-imposed margins for return on capital are too narrow, the Madrid owner
was shocked when the CAA announced plans to reduce them even further.

The battles of the past year have taken their toll on BAA, with a stream of
top people leaving the group in the last few months. The latest to go is
chief operating officer Stephen Baxter after just six weeks in the job,
lured away in October to run Peel Ports, owner of Clydeport among other
commercial harbours. Others to exit stage left mainly out of frustration
include the chief executive, the chief financial officer, the director of
corporate and regulatory affairs, the chief executive of Heathrow, who has
the critical task of overseeing the opening of the £4.5bn Terminal 5 next
March, the corporate affairs director, the media relations head and the
security chief.

The beleaguered BAA chief executive is now Stephen Nelson, a 44-year-old
veteran of the retail wars with J Sainsbury and drinks giant Diageo.
Originally hired as retail director, he was thrust into the job after the
Ferrovial takeover and BAA's subsequent de-listing. Since then he has had a
real-life seminar on crisis management. He has been dealt a terrorist scare
and the resulting barrage of new regulations that required massive and
overnight increases in security checks while his staff continue to push
60,000 people a day through a Heathrow that seems to have been in a constant
state of renovation for the last 10 years.

"It is a fragile system," he says about Heathrow. "In some places we are
coming up against the physical constraints of the building." And now, of
course, he faces possibly the biggest threat of all, the possibility of a
break-up.

Unsurprisingly, Nelson is convinced this would be a pointless step. "It is
the problems of congestion and delay which affect passengers," he insists.
"And they have their roots in lack of terminal and runway capacity, not in
the ownership structure of BAA." Any structural upheavals such as a break-up
would only delay any solutions. Nelson adds that CAA's tight controls only
serve to inhibit BAA's capacity to improve the passenger experience by
installing more escalators, travelators, X-ray machines, staff and other
infrastructure that would improve the "passenger experience".

Although BAA is fighting on all fronts, it is the possibility of a break-up
which clearly most concerns the parent group and especially chairman Rafael
del Pino, the mastermind of Ferrovial's rapid expansion out of its home
base. Until last month Madrid maintained a dignified silence, preferring to
let Nelson do the talking. But he finally del Pino let fly, complaining that
after just one year of ownership Ferrovial was getting the blame for 20
years of problems. Indeed Terminal 5 has tuaken two decades to get through
the various regulatory bodies.

Ferrovial has much at stake. The acquisition of BAA - at nearly a third
higher than market estimates of the airport group's value - delivers an
extra £1.5bn a year into the group's accounts. Instead of depending on
revenue from its Spanish assets for most of its income, as it did before,
48% of revenue now flows from Britain. (Ferrovial also owns highway
maintenance group Amey as well as Tube Lines, which looks after three London
Underground lines and 100 stations.) In its determination to hold on to its
British airports, Ferrovial has meanwhile sold off Budapest airport for
£1.3bn to reduce debt. If a break-up was forced on the group, it may well
rue selling this plum asset.

The Scottish airports, which would be part of a break-up, are hardly
unimportant to Ferrovial either. In 2006-2007 Edinburgh, Glasgow and
Aberdeen produced a combined profit of £60.1 million, according to accounts
just lodged as Companies House. Even better for highly indebted Ferrovial,
they paid dividends of £167m.

The latest figures illustrate the fast-growing value of the Scottish
airports, not only to the parent company but also to the Scottish economy.
Deploying a route development fund that has spent £85m since 2000, BAA
Scotland has added new destinations and new airlines at a dizzying pace over
the last few years. Passenger numbers have risen accordingly; between them
Aberdeen, Edinburgh and Glasgow claim 84% of all passenger traffic in
Scotland. Although the three airports have competition within Scotland,
notably Ryanair's base at Glasgow Prestwick (about 10% of total passenger
movements) and Inverness, they would clearly become plum assets in the event
of a break-up. Indeed investment banks and private equity groups, always
scouting for assets with reliable income streams, have put a value on them
of around £1.5bn.

As it happens, BAA is not accused of abusing its dominance in Scotland.
Although the airports here are not subject to the same CAA strictures as in
the southeast, BAA applies them voluntarily anyway. Both Edinburgh and
Glasgow airports operate under price increases capped at the retail price
index (RPI) minus three percentage points a year, while Aberdeen is RPI
minus one. And anyway, the price of providing competition in Scotland, if
only to keep the competitive theorists happy, looks prohibitive. The
commission has already noted that even a small new airport here would for
economic reasons have to start with a runway capable of handling around 40
million passengers a year.

Clearly, this is a very expensive way of keeping the BAA monopoly honest.
Certainly, Aberdeen has a natural competitive advantage as the only truly
international airport in the region. As the commission puts it, the oil
city's airport is an example of "a single airport serving a locality which
could have an ability to price above both marginal and average cost". In
plain terms, BAA's monopoly in Aberdeen gives it the theoretical freedom to
load charges, but nobody seems to care too much.

One organisation very much in BAA Scotland's corner is the Scottish Chambers
of Commerce (SCC). Pointing out that that airports, in the absence of the
many ferry links available in southeast England, are essential for doing
business in Europe, London and the Midlands, the SCC weighed in with its own
submission to the commission inquiry. The BAA airports were "of huge
economic significance" and any change of ownership would only create
"uncertainty and risk". In short, the SCC wants the status quo - "The
current ownership model provides a solid basis for future investment and
growth of our airport capacity."

The main fear is that a break-up might jeopardise BAA Scotland's long-term
investment programme. Under this, Glasgow airport would get a much-needed
£290m over the next 20 years and Edinburgh £240m over ten years while
Aberdeen would get a new runway.

So far in its inquiries, the commission seems quite impressed with what it
has heard here, despite the routine rants of Ryanair chief executive Michael
O'Leary. "Many of the parties from whom we have heard have stressed the
importance of the BAA Scottish airports to the economic development of the
areas they serve," it noted in August. "We have to date received few
expressions of concern about their performance."

As the Competition Commission probes the intricacies of geographic
monopolies, the absence or otherwise of competition, the role of planning
restrictions, the inevitable and complicating EU directives on airport
regulation, price discrimination, capacity constraints and other fine points
of competitive economics, its task is not an enviable one. Nothing is quite
as simple as the break-up lobby claims. Take, for example, the issue of
capacity. A number of airlines have already told the commission that a lack
of spare capacity is the true barrier to competition between airports rather
than who owns them. This is because the maximum number of take-offs and
landings is affected by the availability of runways as well as by
restrictions on air space. In other words, a break-up might not make much
difference, competitively speaking.

Meanwhile, Heathrow remains BAA's crown of thorns. Although chief executive
Nelson has promised as much capital expenditure - around £9.5bn over the
next 10 years - as it takes to sort out Britain's biggest airport by far,
its users remain unimpressed. Airlines and passengers alike have simply run
out of patience. BAA and its parent can only hope that that the grand
opening of Terminal 5 in March, which will happen before the commission
delivers its verdict, could come just in time to save a break-up.

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