Brief on Airport Privatization in India

12TH SEPTEMBER 2008 SHEKHAR P PHADNIS

APPROACH BUSINESS PERSPECTIVE Need for Airport Privatization in India2 Overview on Airport Revenue and Cost Structure..4 Public Private Participation Initiative..5

FINANCIAL PERSPECTIVE Detailed Revenue Break-up and Its Drivers.8 Charge Structure of Bengaluru International Airport (BIAL)..9 Financial Comparison of BAA Vs AAI.11 Our Observations12

Annotations AAI Airport Authority of India PSU Public Sector Undertaking BAA Consortium led by Grupo Ferrovial (Spanish Infrastructure Company) AOCC Airports Operations Control Centre

BUSINESS PERSPECTIVE

Need for Airport Privatization in India - Recent global phenomenal in Airport Ownership and Airport Management Control is witnessing a Structural (not Cyclical) Change and Indian Airports are no exception to it. Reduction in Capital Allocation - Intense pressure on Airports profitability caused by cost cutting measures and an increased effort to improve load factors are forcing incumbent airport authorities to reduce capital allocation towards airports operating infrastructure. Policy Shift Till recently, Indian Government treated Airport

infrastructure as a mode of transportation for an elite group but now with a change in perception and greater emphasis on development of trade and tourism, government wants air travel to be made available to general masses. Congestion at the Existing Airports Liberalization in Air Travel Policy has triggered a significant increase in air traffic and early estimates suggest that air traffic will grow at more than 10% pa for next few years. This situation has led to a traffic congestion in some international airports at Mumbai, Delhi, Chennai, Thiruvananthapuram and also at some domestic airports like Delhi, Chennai, Bangalore, Goa, Ahmedabad, Cochin and Mangalore. Increased air traffic puts enormous pressure on the existing infrastructure by stretching the apron capacity to its limits. In Present World Airport Development is Treated as Ongoing Process- Traffic growth is a function of type and size of the air crafts handled by the Airport. Era of inexpensive oil has vanished and ATF (Aviation Turbine Fuel) prices have escalated to the roofs. Effective solution to this problem has instigated the demand for newer passenger

planes with different capacities and varied ranges in order to meet the requirements of complex route structure. All the airlines across the globe have announced fleet expansion plans with a sole objective of bringing down the cost per seat/kilometer while catering to increased demand. This development has a direct implication on the current state of the airport infrastructure and its ability to handle incremental capacity. Initial reports indicates that Indian Aviation sector requires approximately INR260,000 million of capital investments by way of purchasing new aircrafts, replacement of old fleet, modernization of airports and up-gradation of navigation/communication infrastructure. Now, modernization and upgradation of airport infrastructure in India is a headache for AAI (Airport Authority of India), as it owns and manages 126 airports and 26 civil enclaves at defense airfields. AAI also, provides air traffic services over the entire Indian airspace and adjoining oceanic areas. Such a mammoth of investment is unviable business proposition for Government and to make this as a lucrative business opportunity for private investors Government needs to change its style of running an airport from Traditional to Commercial. Transition form Traditional Airport Model To Commercial Model
Traditional Model
Under the Traditional Airport Structure ownership and management largely stayed with the Government and management was controlled by Governmental authorities like Ministry of Transport, Civil Aviation authorities etc. Airport's revenue generation capability was linked only to its Aeronautical OR Non-Commercial Operations and Airport's mission included providing services to its direct customers like Airlines, Passengers, and Freighters. Most of the Airport's from Canada were running on this model before 2000. Even today, few Airports can be found in China and Papua New Guinea which are running on traditional model style.

Commercial Model
Under Commercial Model two prime sources of revenues are identified; Aeronautical OR NonCommercial and Non-Aeronautical OR Commercial. Main mission statement of this type of Airport is nothing but profit maximization by all possible means. This type of Airport Model requires great shift in Ownership and Management Control from hands of Government to Private investors. In all modes of airport privatization in India retention of air traffic control is with the Government of India as air traffic is an important function of National Security. Commercial Model of Airport caters to wider spectrum of customers including employees, visitors, local communities, local businesses and local industries.

Structure Overview on Airport Revenue & Costs Structure 3 Point Revenue AND 3 Point Cost Structure We believe it is important to understand the Revenue and Cost structure of an Airport, irrespective of the Airport Model (Traditional OR Commercial). Pay User Concept is an important, simplified and contemporary function which identifies three end users who consume almost all services provided by the airport. 3 Point Revenue Structure - Pay User Concept Identification of users and how much they are willing to pay is the key determinant of Airports funding process. Pay User Concept covers all possible revenue generating opportunities that an Airport should earn. These three broad categories are as follows:
Aeronautical (Non Commerical) Revenue Airlines Passengers Runway Passenger service charge landing & take-off charges Airport security Aircraft parking charge charges Airbridge charges Cargo Non-Aeronautical (Commercial) Revenue Ground Tenants Retail revenue (from shops, catering, foreign exchange vendors etc.) Car parking & car rental Advertising Concession Other non-aeronautical (consultancy, visitor & business services, property development etc.) Recharges (for gas, water, electricity etc.)

3 Point Cost Structure Distinct from the revenue reporting standards (segregating Aeronautical revenues versus Non-aeronautical revenues) there is no specific guide line for reporting operating costs. We believe that its simple to identify all operating costs under three broad categories as follows:
Broad Classification of Operating Costs Labour Capital Other Operating Costs

PublicInitiative Public-Private Partnership (PPP) Initiative Need for privatization throws light on Indian Governments inefficiencies to raise the standard of existing airport infrastructure at par with international levels. PPP is a correct initiative to bridge the resource gap between the huge capital investments required to meet the growing demand and also, to improve upon the managerial and operational efficiencies across entire Air Service Spectrum. The existing legislative framework (The Aircraft Rules, 1937) is very conducive for privatization process and allows Central Government, Public Sector Undertaking (PSUs), State Governments, Urban Local Bodies, private companies, individuals and joint ventures involving one OR more of the above to own and manage airports in India. In some high cost projects like developing a Aerotropolises (covered later in detail under financial perspective non-aeronautical revenues) Government has recognized a need of bilateral cooperation with other countries in order to bring in requisite expertise and financial muscle to complete such projects. Foreign participation in such case is allowed upto 74% with an automatic approval and 100% under special circumstances. Bengaluru International Airport Limited (BIAL) Shareholding Aug08
KSIIDC (Agency owned by Karnataka Sate Govt. 13% Siemens Project Ventures, Germany 40%

Airport Authority of India (AAI) 13%

Larsen & Toubro, India 17%

Unique (Flughafen Zrich AG) Zurich Airport, Switzerland 17%

Government has kept an option open with respect to which type of PPP model should be adopted with respect to the privatization process that too on case by

case basis. So far Government has signed four agreements; two under Greenfield development process (Bengaluru and Hyderabad) and remaining two under Brownfield process (Delhi and Mumbai). De-risking of airport business requires huge plots of land to built sustainable flows of revenues from Nonaeronautical (Commercial) operations. At Bengaluru the concessionaire got about 300 acres of land and at Delhi 250 acres were allotted for commercial development. Ownership Clause Government has kept 26% stake in all the PPP projects either through Airport Authority of India (AAI) OR through State Government of India. By retaining 26% stake Government can veto certain major fundamental resolutions like increasing equity capital, change in directors etc. As per the Companies Act 75% stake holder can have complete control over companys decision making powers but here in Airport Privatization case Government has not sold its 25% stake Or lesser than that to private consortium. Main Characteristic in Concession Agreement To facilitate the larger chunk of revenues from Non-aeronautical OR Commercial operations Government has leased out land for the period of 30 years to a concessionaire at a nominal rent. It allows construction, development, operations and maintenance of the airports by the concessionaire and with his sole discretion lease can be extended for another 30 years (60 years in total). Unique Feature in Airport Privatization Government of India will not carry out any action in contradiction with Concessionaire Agreement which would deprive Concessionaries from their economics interest. All the Governmental bodies to the agreement including State Government are obliged to ensure all the requisite statutory compliance and grant all the permissions to the Concessionaire. This obligation on Government makes Airport Privatization a unique process different from Road and Port Privatization.

Stringent Construction Timelines for Brownfield Projects In Greenfield projects Concessionaire can carry out construction work with a relaxed timeline approved in the specific Master Plan. Where as in Brownfield projects development of a Master Plan itself has a stringent timeline (maximum six months after signing of an agreement). Delay in submission of the Master Plan would force Concessionaire to bear a monetary penalty of US$65000 per day. Secondly, with regard to the construction work of parallel runway at Delhi airport has an estimated timeline of 24 months after signing the agreement; any failure in completion of work within the stipulated timeline would cause a Concessionaire hefty US$ 25 million fine or even in excess of that.

FINANCIAL PERSPECTIVE

After understating the 3 point revenue and cost structure, now lets discuss these three broad categories of revenues and cost in detail. This is possible by taking a close financial perspective on revenues and costs drivers of an Airport. For analyzing purpose we have taken all data from AAI and BAA 2006-07 annual reports. Currently, AAI manages 11 international and 89 domestic airports. Revenue Break-up and Drivers A] Aeronautical Revenue is further divided into following three types 1) Traffic Revenue 2) Non Traffic Revenue 3) Cargo Revenue
Traffic Revenue Route Navigation Facilities Charges Landing Fees Parking & Housing Fees Terminal Navigational Landing Charges Passenger Service Fee Non-Traffic Revenue Public Admission Fees Trading Concessions Rent Services Cargo Revenue Freight
* MTOW maximum take-off weight

Drivers No. of aircrafts handled per *MTOW Per hour per **MT No. of aircrafts handled per embarking passenger Drivers Percentage of No. of passengers handled Royalty payments decided by Government Avg rate per m2 Drivers per MT

**1 MT = 1000 kgs

Aeronautical Revenue is sensitive to following three major activities:

Activity Aircraft Movements Passengers Freight Units Nos. Nos. Tonnes Type International Domestic International Domestic International Domestic

Charge Structure of Bangalore International Airport Limited (BIAL) MayAus08

Landing Charges
Weight of Aircraft International Flight Other than International Flight INR170.80 per MT INR17,080 + INR229.50 per MT in excess of 100 MT
Weight of Aircraft

Parking Charges
Housing charges Parking Charges

Up to 100 MT Above 100 MT

INR227.70 per MT INR22,770 + INR306 per MT in excess of 100 MT

Up to 100 MT Above 100 MT

-NA -NA-

INR3.70 per hour per MT INR370/- + Rs. 4.90 per MT per hour in excess of 100 MT

(A minimum fee of INR5000 shall be charged per single landing of international flights and INR3000 shall be charged per single landing of other than international flight. (Minimum charge of INR1000 per single landing applied from 24 May 2008 to 26 May 2008)

The BIAL spread over 4000 acres, is located 40 kilometers north of the citys central business district. Its commercial (Non-Aeronautical) revenue comes from hotel, shopping mall, food courts and other convenience amenities which will be completed in upcoming phases. Other Highlights of Airport Charges at BIAL Parking time is calculated based on ON BLOCK and OFF BLOCK time as recorded at Airport Operations Control Centre (AOCC Parking time will be calculated based on ON BLOCK and OFF BLOCK time as recorded at Airport Operations Control Centre (AOCC) For calculating chargeable parking time part of an hour is rounded of to the next hour In aerobridge stands normal rates are applicable for 2 hours after allotted free parking period. After the 4 hour period parking charges would be doubled that of normal charges INR200 per embarking passengers are charged (out this INR70 towards facilitation and INR130 towards security) Infrastructure Charge from Passengers - INR952.30 per international embarking passenger as User Development Fees (USF). UDF is a charge for enhancing current facilities to match with international standards. Till

30th June 2008 UDF was collected at the airport but July 2008 onwards it is collected from airlines Infrastructure Charge from Airlines
Towards passenger boarding bridge and 400Hz power supply Aircraft type Narrowbody aircraft Initial aerobridge usage charge INR4500 for the first hour or part thereof Subsequent hours usage charge INR4500 per hour or part thereof INR4500 per hour or part thereof

Widebody aircraft INR10500 for the first two hours or part thereof

B] Non-aeronautical - Basic OR parameters on which non-aeronautical revenues are earned International experience states that non-aeronautical revenue contributes larger pie in total revenues earned from both, aeronautical as well as non-aeronautical segments. Upcoming Greenfield projects have better opportunity to earn nonaeronautical revenues and Indian Government has recognized this fact. It requires lot of subsidized land procurement to construct real estate assets. BIAL is the first airport in the country which is built on the concept of Aerotropolises. Aerotropolises is a concept developed by American academician John D. Kasarda which means, erecting an entire city around the airport. On the lines of Aerotropolises BIAL has set aside 215 acres of land for the first phase of commercial and real estate development. In comparison with Londons Heathrow airport BIAL handles far lesser traffic but it has 1.4 times more area than Heathrow. We have done a comparison of 2007s consolidated revenues of AAI with BAA. BAA is the worlds leading airport company which owns seven UK airports, has 65% stake in Naples airport and manages retail contracts (Nonaeronautical OR Commercial operations) at three US airports. Observations states that BAA has balanced revenue structure with respect to Aeronautical and Non-aeronautical revenues; whereas AAIs revenues are skewed more towards aeronautical operations. Unlike, revenue structure the operating cost break-up of

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both the companies is similar. EBITDA margins for both the companies are very high. BAA 2007 Revenue Break-up
NonAeronautical (Commercial) 49%

AAI 2007 Revenue Break-up

NonAeronautical (Commercial) , 36% Aeronautical (Noncommercial), 64%

Aeronautical (Noncommercial), 51%

BAA 2007 Operating Cost Break-up

Other Operating Expenses 42% Staff Costs 36%

AAI 2007 Operating Cost Break-up

Other Operating Expenses 41% Staff Costs 38%

D&A, 22%
D&A 21%

Revenues, EBITDA and EBITDA margins Comparison

INR 200,000 INR 180,000 INR 160,000 INR 140,000

INR 181,074 54%

INR 120,000 INR 100,000 INR 80,000 INR 60,000 INR 40,000 INR 20,000 INR 0

INR 86,468

48%

INR 37,262 INR 19,962

55% 54% 53% 52% 51% 50% 49% 48% 47% 46% 45% 44%

2007 BAA Revenue EBITDA

2007 AAI EBITDA margins

Notes: We have converted BAA groups consolidated 2007 revenues & EBITDA @ 1 = INR80.585. In 2007 BAAs Aeronautical revenues stood at 1093 million and Non-aeronautical revenues were at 1154 million. Operating costs (excluding exceptional items) after adjustment of capitalized costs was at 1174 million.

EBITDA margins

millions

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Observations Inconsistency in Punitive Damages of Brownfield and Greenfield Projects - Under the Greenfield environment Concessionaire is liable for financial damage only after six months of date on which airport is supposed to be operational. Under such delay Concessionaire is liable to pay at the rate of US$2500 per day. (Greenfield punitive damage is US$65000 per day). There is a huge gap of US$62500 per day between punitive damages for Greenfield and Brownfield. Basis on which Punitive Damages are Calculated are also Inconsistent in Nature Concessionaire in Greenfield project is liable for financial damage under only one circumstance i.e. delay in opening of an airport. Contrary to this Concessionaire in Brownfield project will bear financial consequence under 20 different parameters like security delay, check in delay etc. Delay in forming a Regulatory Authority is inexplicable We feel that the performance of the major infrastructural projects like Airport Privatization should be gauged by an independent Regulatory Authority (like TRAI for Telecom) which will look after regulatory standards, approval charges, imposing penalties, settlement of dispute between Government and Concessionaire etc. Indian Government was obliged to form such a Regulatory Authority for Airport Privatization but as of now even after signing first Concession Agreement back in July 2004 Regulatory Authority has not become a reality. Once such authority is formed power to resolve any dispute between Government and Concessionaire becomes a tricky issue as few experts are of the opinion that arbitrator should ideally possess such power and it might dampen the spirit of foreign partners.

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Acquisition of large pieces of lands for Greenfield projects could be a politically sensitive issue

Concession Fees an issue to ponder upon Although through privatization initiative Government is diluting its stake in all major airports across India still it collects Concession Fees, Royalties and rents from the airports. Few experts states that under such scenario airlines and passengers ends up paying 150% of the infrastructural costs.

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