Operator Wins Right to Boost Heathrow Charges

Ferrovial will use higher passenger fees to fund infrastructure projects at London's airports—and pay off its own debt. Will airlines suffer?

by Mark Scott

Travelers to Britain's two largest airports are in for a costly shock. Beginning Apr. 1, the British Airports Authority (BAA), owned by Spanish construction company Ferrovial (FER.F), has won the right to raise passenger charges at London's Heathrow and Gatwick airports to help pay the cost of needed infrastructure improvements.

On Mar. 11 Britain's Civil Aviation Authority (CAA), the industry regulator, announced that BAA can boost charges by 23.5% to £12.80 ($25.65) per passenger at Heathrow, then by an additional 7.5% above the rate of inflation for the next four years. At Gatwick the increases start at £6.79 ($13.58)—a 21% rise over current levels—with charges growing by 2% over inflation until 2013.

The extra fees could come as a blow to airlines and passengers already suffering the effects of record fuel oil and rising ticket prices. But for Ferrovial, whose 2007 net income fell by 48.5% to €733.7 million ($1.1 billion), the additional revenue couldn't come at a better time. The Spanish company is trying to refinance at least £4.1 billion ($8.2 billion) in debt related to its 2006 acquisition of BAA (BusinessWeek.com, 6/27/06), which operates seven British airports. The company was recently forced to sell off its duty-free shops, and speculation continues that it may be forced to divest further assets, including possibly an entire airport, to meet repayments on more than $46 billion of net financial debt.

Airlines Quick to Condemn

Markets had mixed reaction to the news. Shares in Ferrovial rose as much as 9% on Mar. 11 and closed up 6.6%. But airlines, which will be forced to pass the fees on to passengers via higher ticket prices or take a hit to their profits, fell broadly. British Airways (BAY.L), which can better absorb the higher passenger fees thanks to its business class and international travelers, was down 1.6%. Low-cost carriers—for which the fees will constitute a much larger chunk of ticket prices—fell more. Britain's EasyJet (EZJ.L) was down 3.3%, while Ireland's Ryanair (RYA.I), Europe's largest airline by passenger load, sank 3.5%.

The airlines were quick to condemn the CAA's announcement. "Heathrow passengers will pay, on average, 17% more than the [British] competition commission recommended in September, 2007," said Paul Ellis, BA's general manager of airport policy and infrastructure, in a statement. "These overly generous charges far exceed what is required to upgrade facilities."

Industry analysts disagree, saying the extra funds are needed to bring Heathrow and Gatwick up to the standards of their Continental competitors—including everything from speeding up baggage handling to adding additional security lines for reduced waiting times. What's more, most don't think the added fees will drive business from Heathrow, still Europe's No. 1 airport, to competing hubs such as Amsterdam and Paris.

Boosting Ferrovial's Bottom Line

"Flights won't be cut back just because passengers' costs have increased," says Clement Wong, travel and tourism manager at market intelligence firm Euromonitor in London. "More investment is needed, particularly as the liberalization of Europe's airline market takes hold." The new transatlantic Open Skies agreement, set to take effect at the end of March (BusinessWeek.com, 1/14/08), will increase competitive pressure on Heathrow.

The biggest impact of the Mar. 11 announcement likely will be felt by Ferrovial, which is urgently trying to refinance its debt just as market conditions have choked off easy credit. Equity analysts say the additional passenger fees mandated by the CAA will boost Ferrovial's bottom line, helping it secure refinancing. Citigroup (C), for instance, now estimates the Spanish company's commercial revenues from Heathrow alone will reach £2.13 billion ($4.27 billion) by 2013, compared to £1.38 billion ($2.77 billion) last year.

Finalizing a new debt agreement—now expected to be completed in the second quarter of 2008—can't come soon enough. Ferrovial's debt-servicing payments rose from €1.23 billion ($1.89 billion) in 2006 to €1.9 billion ($2.9 billion) last year, predominantly due to obligations associated with the BAA acquisition. To help repay its outstanding loans, the Spanish company has been offloading assets, including its Budapest airport for £1.3 billion ($2.6 billion) in May, 2007, and its World Duty Free business for £546.6 million ($1.09 billion) earlier this month.

To be sure, BAA remains a highly profitable business for its Spanish owner. Operating margins topped 40% last year, and the British-based unit contributed just over half of Ferrovial's overall pre-tax earnings. By allowing Ferrovial to increase passenger fees at Heathrow and Gatwick, Britain's aviation regulator has handed the Spanish company a gift. Whether that will be enough to stop further asset sales remains to be seen. But it should lead to some much-needed improvements at Heathrow and Gatwick.

Scott is a reporter in BusinessWeek's London bureau .