Airport disaster averted

 

The Hobart Airport consortium (TGC) has survived another year, avoiding looming disaster by injecting more equity and offloading a sizable chunk of debt. The recently released 2012/13 financial statements have revealed how consortium members, including RBF with a 49.9% interest had to find another $121 million to refinance and reduce debt. Finance costs and management fees have strangled the consortium since inception. Dividends have been conspicuously absent in the past three years and capital expenditure dependent on more borrowings.

Just a quick recap.

RBF’s 50.1% partner is the Macquarie Bank run Global Infrastructure Fund III (GIF III) The whole show is run by Macquarie.

Five years ago consortium members put in $200 million cash and organised borrowings of $209 million, $174 million of which was drawn at that stage, to assist with the purchase of Hobart International Airport Pty Limited (HIAPL) from the government owned Tasports for $352 million. After a further payment of $10.3 million in fees to investment bankers for arranging the deal and $4.2 million for borrowing costs, the balance was used for working capital. Interest on most of the borrowings ($172 million) was fixed at around 9% via an interest swap agreement taken out for a 15 year period. Since then interest rates have fallen. Hence considerably more interest has been paid than had TGC elected to stick with a floating rate.

Fixing interest rates for 15 years is unusual. For the consortium to fix rates at 9% suggested expected returns were in excess of 9%. Else why borrow? Why not divert other funds that were earning less?

When a borrower fixes a rate for 15 years there's always a party on the other side of the deal that fixes earnings for 15 years.

Imagine locking in a 9% return for 15 years with a super fund underwritten by a AA+ government.

Why would a super fund with government support agree to guarantee a third party a 9% return for 15 years when returns to its own members were less? The logic is not immediately apparent.

In November 2012 TGC renegotiated borrowings which by that stage were fully drawn, a total of $209 million, and also opted to exit the interest swap agreement. Because interest rates had fallen to around 4% the cost to exit the agreement with 10 years to run was a whopping $74 million.

The total cost to quit existing commitments was therefore $283 million.

A fresh banking syndicate agreed to a new facility of $175 million of which $158 million was drawn. Borrowing costs were $6 million.

To cover the cash shortfall TGC shareholders put in an extra $121 million, a figure roughly the same as the accounting losses since inception of $122 million.

Turnover $160 million for five and a half years. Losses $122 million. That’s it in a nutshell.

The cash inflows and outflows for 2012/13 are summarised in the following table. The consortium doesn’t produce consolidated financials but an abridged cash flow statement for the group tells the story. It’s basically a cash business so the cash flow statement is also a pretty good proxy for a P&L (with depreciation missing).

                                    

Airport turnover has grown steadily each year but the operating cash profit before tax and interest (EBITDA) has been pretty static at $21 million over the past three years. In the past year employee numbers rose from 28 to 32 and employee expenses increased by a third from $2.8 million to $3.7 million. The EBIDTA was needed to pay for capex and investment fees (mainly interest and management fees of $2.3 million to Macquarie). However TGC was left with a cash deficit of $6 million before the capital reconstruction.

When the costs of interest rate protection via the swap agreement are considered, the effective interest rate paid on the old borrowings, specifically the fixed amount of $172 million was approximately 17.5% pa. Effectively credit card interest on $172 million for five years.

By way of explanation an interest swap agreement is a separate to a loan agreement.

The loan agreement will provide for interest payments based on floating rates.

The swap agreement is an agreement for the lender to pay interest at the fixed rate while simultaneously receiving interest at the floating rate. The net amount is income if floating rates exceed fixed rates but an additional expense if fixed rates exceed floating rates. The latter is what occurred with TGC.

The fees paid by TGC to investment bankers have been:

·       fees associated with the purchase of the airport of $10 million

·       initial borrowing costs of $4 million

·       costs to renegotiate the borrowing facility of $6 million

·       additional interest costs via the swap agreement  of about $26 million

·       cost to exit the interest rate swap agreement of $74 million.

A sub-total of $120 million.

Yet the total operating cash over the same period has only been $105 million.

For the financiers to clean out every $ of operating cash, and more, leaving nothing to pay interest costs at floating rates and capex is a stupendous achievement.

To continue with the list of outlays over the past five and a half years:

·       amounts to investment bankers (from above) of $120 million

·       capex of $43 million

·       interest at floating rates of about $53 million

·       dividend in 2010 of $1.5 million

A grand total of about $220 million.

The cash shortfall was therefore $115 million as operating cash was only $105 million.

That’s why shareholders had to put in another $121 million.

Extra cash was also needed as the banking syndicate required TGC to maintain a bank account with at least enough to pay the next six month’s interest. At 30^th June the debt service reserve account had a balance of $6.5 million. A possible indicator of the bankers’ level of nervousness perhaps?

The Abbott government is likely to reward the errant behaviour and subsidise some of the losses, in other words to indirectly reimburse the consortium for some of the extravagant fees paid, with a $38 million grant spun as funding for the airport upgrade. Consortium members funded the investment banking extravagance but not extra capex? Leaving taxpayers to pick up the tab? They put in $121 million, why not another $38 million?

The consortium is now where it was five and a half years ago with similar debt, fortunately however facing lower interest rates.

It is likely shareholders will get a return in the future but maybe not a dividend. More likely a return of some of the extra capital subscribed to keep the ship afloat.

An interesting aside, which may be a portend, was when TGC renegotiated its borrowings the operating company HIAPL became the borrower. Previously it was HIAPL’s parent company Tasmanian Gateway Corporation P/L.

The parent is owned 100% by the holding company, Tasmanian Gateway Holdings Corporation P/L. RBF’s interest in the consortium is via a 49.9% interest in the holding company. Its partner GIF III is a fixed term fund due to be wound up in five year’s time coincidentally when the borrowings are due for review.

If one is to believe RBF’s public pronouncements that the airport is a good long term investment then it may well end up with the other half of the airport when GIF III withdraws but unless RBF grows a bit, 100% of the airport might be an imprudently excessive investment for a small fund.

If RBF ends up with 100% of HIAPL it will have no need for Macquarie as a manager nor the other companies in the consortium which only exist as part of the Macquarie designed paper shuffle.

Taking over HIAPL with whatever level of borrowings is sustainable and optimises returns may be a future option for RBF.

Being the actual operator however is not usually a preferred strategy for a super fund.

Opting to become a minority shareholder in a Macquarie shakedown is not much of a strategy either.

The broader question is not RBF’s involvement in this debacle but the wisdom of the public sector offloading natural monopolies to the private sector. Efficiency gains are not evident with the airport in private hands. All earnings from an essential service have been diverted to financiers and governments are preparing to step in with more handouts.
It’s been shameful public policy.