When Spanish infrastructure group Ferrovial bought UK airport operator BAA in 2006 it could not have foreseen the problems that refinancing the acquisition debt for its purchase would create. The securitization deal was already delayed when the credit crisis developed in 2007, and since then monoline capacity has evaporated as debt spreads move steadily wider. But although the turmoil in the credit markets since mid-2007 has made the refinancing of BAA’s acquisition debt immeasurably more difficult, the deal was unlikely to have been completed anyway – as Euromoney pointed out as early as April 2007.
The problem was a lack of regulatory clarity, as the UK regulator, the Civil Aviation Authority, was not due to finalize price caps on BAA’s airports until April this year. Trying to complete a refinancing of this magnitude in the absence of a clear CAA pricing regime has turned out to be a big mistake. It was always clear that the CAA’s price control review would not be completed until April 2008, and by attempting to secure existing bondholder approval for its plans before this, Ferrovial has created prolonged uncertainty and confusion about the feasibility of BAA’s securitization.
The CAA finally released its decisions for the period 2006 to 2013 in mid-March, creating a furore among the airlines because of their perceived generosity to BAA. In November 2007, the CAA stated that charges per passenger at Heathrow would be £11.97 but in March this had shot up to £12.80 – an increase of 7% in five months. According to British Airways, the price caps that have been imposed are 17% higher than those recommended by the Competition Commission last year. Have there been significant unexpected changes to BAA’s infrastructure or security spend that would justify such an increase? Last month’s opening of Heathrow’s Terminal Five may have been a fiasco but it can hardly be described as unexpected – it was given the go-ahead in 2001.
The nagging suspicion among the airlines is that the CAA has jacked up charges at BAA’s airports because it is aware of the company’s desperate need to sort out its debt burden – a suggestion that the CAA strongly denies. And the regulatory review will actually make life much more difficult for BAA because of its decisions with regard to weighted average cost of capital (WACC).
The CAA has been worryingly wrong-footed by the market on this front as it had already decided to cut BAA’s WACC from 7.75% to between 5.9% and 6.2% at Heathrow and between 6.3% and 6.7% at Gatwick – to reflect the much lower cost of funding that the company then faced. BAA’s cost of capital has clearly rocketed since last summer but the regulator is bound by its own parameters: it is therefore no surprise that the WACC for Heathrow has come in at the very top end of the range – 6.2%.
A regulated utility’s WACC is supposed to dictate the prices it can charge for its services – as prices are calculated based on what the regulator assumes it is costing the company to raise debt. But in this case the regulatory review has determined that while BAA’s cost of capital has fallen, the prices it can charge will rise. When the CAA initiated its review and set its WACC parameters no one could have foreseen what would happen in the debt markets in 2007. But it has imposed a WACC regime designed to reflect the debt market conditions of a year ago on a massively leveraged company now facing very limited refinancing options in a completely dysfunctional market.