Asset Beta for New Zealands International Airports

Comments on the Commerce Commissions Airport Draft Reasons Paper

Report to BARNZ
11 July 2010

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Authorship
Prepared by: Quality approved by: Version: Brent Layton Johannah Branson 4

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Executive summary
Significant increase in asset beta proposed
The Commerce Commission (the Commission) in its Draft Reasons Paper1 has used comparable entity analysis to determine an asset beta for information disclosure purposes for Auckland, Wellington and Christchurch international airports (New Zealand Airports). The asset beta is a key input into the weighted average cost of capital (WACC) estimate, which is used to assess whether an airport has earned excessive returns on the value of its aeronautical assets. The Commissions draft asset beta decision (0.65) provides for a significant increase in the WACC from its 2002 Airfield Pricing Inquiry decision. In 2002 the Commission determined that for specified airfield activities an appropriate asset beta for each of 2 the New Zealand Airports was 0.5, within a range of 0.4 to 0.6. This increase is primarily based on the comparator airport companies having an average unadjusted asset beta of 0.74. This is a significant increase from measured airport asset betas in 1999, 2003 and 2007 of 0.59, 0.45 and 0.44 respectively. 0.65 also exceeds the asset betas adopted by both Auckland and Wellington airports for pricing purposes.

New Zealand Airports are insulated from many macroeconomic risk factors
The proposed asset beta does not fit well with the likely level of systematic risk faced by New Zealand Airports. New Zealand Airports are afforded considerable pricing flexibility and a generous approach to capital investment. The light-handed economic regulation applied provides them with a substantial degree of insulation from macroeconomic risk factors. The stable aeronautical operating margins obtained by the New Zealand Airports over the last five years demonstrate their insulation from macroeconomic risk factors. Institutional investors in airports have commented favourably on the ability of lighthanded economic regulation to deliver stability in cash flows and returns.

Airports in countries with low incomes are not representative of New Zealand Airports
The unadjusted asset betas of the comparator airports used by the Commission overstate the unadjusted systematic risk faced by New Zealand Airports. One reason for this is that the sample of airports contains a number of airport companies (four out of 10) from countries with relatively low gross domestic product (GDP) per capita (e.g. Thailand and Mexico).

1 2

Commerce Commission, Input Methodologies - Airport Services: Draft Reasons Paper, May 2010. Commerce Commission, Part IV Inquiry into Airfield Activities at Auckland, Wellington, and Christchurch International Airports: Final Report, August 2002, pp. 223 (AIAL), 268 (WIAL) and 305 (CIAL).

NZIER Asset Beta for New Zealands International Airports

Returns to airports in countries with a low GDP per capita are more sensitive to macroeconomic risk factors. Analysis shows that domestic passenger growth is two to three times more sensitive to changes in GDP for airports in Mexico than airports in high GDP per capita countries such as New Zealand and Australia. This outcome is reflected in the Commissions 2010 sample. The average unadjusted asset beta of airport companies in low GDP per capita countries is 0.79 compared with around 0.71 for airport companies in high GDP per capita countries.

The global financial crisis has likely led to short-term increases in airport asset betas
Commentary from institutional investors indicates that airport stock prices have been affected by concerns over the level and complexity of their debt structures. They argue that the resulting impact on stock prices does not reflect the long-term stability in the underlying revenues and returns achieved by airport companies. Companies such as Macquarie Airports have restructured their debt positions in response to investor concerns. This suggests that the rise in the average unadjusted asset betas of airport companies measured post 2007 is unrepresentative of their likely future performance. The five year period adopted by the Commission for measuring airport asset betas arguably has an unrepresentative higher asset beta period without an offsetting lower period. The simple average unadjusted asset beta of airport companies from high GDP per capita countries from all the samples reported in Tables 1 and 2 is 0.52. Given the volatility that can occur in measured asset betas over time (e.g. Auckland Airports ranges from 0.14 to 0.88 in the samples reported in Tables 1 and 2), it would be reasonable for the Commission to place more weight on long-term evidence.

It is reasonable to share the benefits of light-handed economic regulation

A key objective of light-handed economic regulation is to provide an environment that facilitates efficient investment by New Zealand Airports. One way this is promoted is by providing the airports with pricing flexibility and monitoring arrangements that insulate them from systematic risk factors. In a workably competitive market, the benefits of improved productivity and/or a more stable operating environment are shared between suppliers and users. It is also reasonable that airlines (and ultimately passengers) also obtain some benefit from the regulatory arrangements. Section 52A(1)(c) of the Commerce Act 1986 specifies that one of the regulatory objectives is to promote outcomes that create incentives for the benefits of efficiency gains to be shared with consumers. The asset beta proposed by the Commission would be unlikely to promote the sharing of efficiencies achieved through light-handed regulation.

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Recommended asset beta for New Zealand Airports

In our opinion, the Commission has provided inadequate evidence to support an increase in the asset betas of New Zealand Airports by 30% from the level it set in its 2002 Airfield Pricing Inquiry. We consider there is a compelling case for reducing the asset beta afforded to New Zealand Airports down from the draft proposal of 0.65 to 0.55 or 0.50: the Commission has dismissed earlier lower asset betas without giving any explanation; a longer term perspective is desirable in view of the short term volatility of asset betas at for the same airport over time the Commissions new sample is small and unusual and cannot be considered as providing a good set of comparators for New Zealand Airports; four of the ten airports in the sample are from low GDP per capita countries and three of the airports are in the one developing economy Mexico; moreover, the variability between airports suggests a larger sample than ten observations is desirable the period from which the Commissions sample data is drawn is one in which there was a major financial crisis and concern over the debt levels of some airport companies increased the asset betas; calculated asset betas from this period are unlikely to provide a good guide for what they will be for the indefinite period in the future for which the Commission is fixing the parameter and New Zealand Airports operate in a light-handed regulatory regime which insulates them from many of the macroeconomic risks faced by airports in countries with more intrusive regimes; the Commissions sample includes asset betas for airports subject to more heavy-handed regulation than New Zealand Airports are subject to and this may have further biased the results.

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Contents
1. 2. 3. Introduction ............................................................................................................. 1 Previous asset beta outcomes .............................................................................. 2 Likely systematic risk faced by New Zealand Airports....................................... 5 3.1 3.2 4. Risk factors and New Zealand Airports .......................................................... 5 Exposure to GDP growth risk ......................................................................... 6

Empirical evidence on the systematic risk of New Zealand Airports................ 8 4.1 4.2 Aeronautical operating margins per passenger over the last five years ........ 8 Exposure to GDP growth risk ....................................................................... 10

5.

Recommended asset beta for New Zealand Airports ....................................... 12 5.1 5.2 5.3 Asset beta outcomes between low and high GDP per capita countries....... 12 The impact of the global financial crisis on airport asset betas .................... 13 Sharing the benefits of light-handed economic regulation ........................... 14

5.4 An asset beta consistent with the systematic risk faced by New Zealand Airports.................................................................................................................... 14

Appendices
Appendix A GDP and passenger growth...................................................................... 16

Figures
Figure 1 Aeronautical margins per passenger, major Australian airports, 2004/05 2008/09 ........................................................................................................... 9

Tables
Table 1 Previous estimates of unadjusted airport asset betas, 1999-2007 ........................ 3 Table 2 Commissions unadjusted airport asset betas, 2010 ............................................. 4 Table 3 Aeronautical margin per passenger and change in passenger volumes, New Zealand Airports, 2004/05 2008/09 ............................................................. 8 Table 4 Operating profits of selected Australasian airports, 2009 .................................... 10 Table 5 GDP per capita in 2009........................................................................................ 10 Table 6 Ratios of domestic passenger growth for a given change in GDP growth .......... 11 Table 7 Grouping of airport asset betas, low and high GDP countries............................. 12

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Table A 8 Grupo Aeroportuario del Centro Norte ............................................................. 16 Table A 9 Grupo Aeroportuario del Pacifico ..................................................................... 16 Table A 10 Grupo Aeroportuario del Sureste.................................................................... 16 Table A 11 Sydney Airport ................................................................................................ 17 Table A 12 Melbourne Airport ........................................................................................... 17 Table A 13 Brisbane Airport .............................................................................................. 17 Table A 14 Auckland Airport ............................................................................................. 18 Table A 15 Wellington Airport ........................................................................................... 18 Table A 16 Christchurch Airport ........................................................................................ 18

NZIER Asset Beta for New Zealands International Airports

1. Introduction
The Commerce Commission (the Commission) has recently released its Draft Reasons Paper relating to the setting of input methodologies for the purposes of information disclosure by the three major international airports in New Zealand: Auckland, Wellington and Christchurch (New Zealand Airports).1 The Commission proposes that the asset beta for the three New Zealand Airports should all be initially set at 0.65.2 It used comparable entity analysis to support this proposal. The proposed 0.65 represents a significantly higher asset beta than the 0.5, within a range of 0.4 to 0.6, the Commission adopted in its 2002 Airfield Pricing Inquiry.3 It is also greater than the asset betas used voluntarily by Auckland and Wellington airports when last setting charges. It is at the top end of the asset beta range disclosed by all three airports in their latest information disclosure reports. You have sought our advice on whether the Commissions proposal is reasonable, and, if it is not, what a reasonable estimate would be. Our analysis in response to your request is structured as follows: section 2 describes the measured airport asset betas available for 1999, 2003 and 2007 section 3 outlines why it would be expected that New Zealand Airports face low levels of systematic risk section 4 presents and describes the empirical evidence on the systematic risk of New Zealand Airports and overseas airports and section 5 contains the recommended asset beta for New Zealand Airports.

Commerce Commission, Input Methodologies - Airport Services: Draft Reasons Paper, May 2010. (hereinafter the Draft Reasons Paper). Draft Reasons Paper, p. 221. Commerce Commission, Part IV Inquiry into Airfield Activities at Auckland, Wellington, and Christchurch International Airports: Final Report, August 2002, pp. 223 (AIAL), 268 (WIAL) and 305 (CIAL). (Hereinafter the Airfield Pricing Inquiry).

2 3

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2. Previous asset beta outcomes

Regulators and advisory bodies have been measuring and publishing the asset betas of listed airport companies for over 10 years. There will always be empirical difficulties in using the estimated equity betas of airport companies as a basis for determining the aeronautical asset betas for individual airports. The airport companies are usually diversified, having controlling interests and/or strategic stakes in a number of airports. As noted by the Commission, the equity betas also reflect both the aeronautical and non-aeronautical sides of the airport companies. These difficulties mean that regulators will always need to apply a degree of professional judgement to the data in forming a view on an appropriate aeronautical asset beta. It is therefore useful (and perhaps even necessary) to include previous outcomes and undertake an investigation of underlying changes in forming a view over the likely future systematic risk faced by New Zealand Airports. The measured asset betas of airport companies in 1999, 2003 and 2007 are shown in Table 1. Significantly, the average unadjusted asset beta of airport companies remained below 0.60 for the eight years to 2007, with two outcomes of 0.46 and 0.45. Within each sample there are differences in the number of comparator airport companies (due to the availability of data) and considerable variability in asset beta outcomes. The measured asset beta of an airport company also usually fluctuates over time. For example, Auckland airports measured asset beta ranges from 0.14 (2003 sample) to 0.88 (2007 sample).

NZIER Asset Beta for New Zealands International Airports

Table 1 Previous estimates of unadjusted airport asset betas, 19992007

1999: Australian Competition and Consumer Commission. Adelaide Airport MUIT decision BAA Plc Vienna Airport Copenhagen Airports Auckland Airport Average 2003 PricewaterhouseCoopers report for Airservices Australia BAA plc Flughafen Wein AG Japan Airport Terminal Xiamen Airport Development Shanghai International Airport Unique Zurich Airport TBI plc Kobenhavns Lufthavne Fraport AG Frankfurt Airport Auckland International Airport Average 2007 UK Competition Commission AIAL Copenhagen Florence Fraport Flughafen Wien Flughafen Zuerich Macquarie Airports Average Asset beta 0.56 0.68 0.47 0.66 0.59 0.29 0.65 0.75 0.75 0.61 0.08 0.47 0.38 0.40 0.14 0.45 0.88 0.20 0.35 0.48 0.53 0.25 0.39 0.44

Sources: Australian Competition and Consumer Commission, Adelaide Airport, Proposal to Pass Through the Price Cap the Costs of a Multi-User Integrated Terminal, 1999: PricewaterhouseCoopers, Airservices Australia Review of the Weighted Average Cost of Capital for Regulated Services, 2003; and United Kingdom Competition Commission, Report on the Economic Regulation of the London Airport Companies, 2007

The Commission has examined a considerably different sample of airport companies in its 2010 Draft Reasons Paper (see Table 2). In particular, the sample contains a number of new airport companies from countries with substantially lower average levels of income (as measured by Gross Domestic Product (GDP) per capita), namely Mexico and Thailand. These airport companies tend to have higher asset betas than those from Europe, New Zealand and Australia.

NZIER Asset Beta for New Zealands International Airports

Table 2 Commissions unadjusted airport asset betas, 2010

Airport company Aeroports de Paris Airports of Thailand AIAL Fraport Flughafen Wien Flughafen Zuerich Grupo Aeroportuario del Centro Norte Grupo Aeroportuario del Pacifico Grupo Aeroportuario del Sureste Macquarie Airports Average Source: Commerce Commission, Draft Reasons Paper, 2010 Asset beta 0.70 0.76 0.69 0.84 0.67 0.72 1.00 0.59 0.79 0.66 0.74

Given the different composition and higher average asset beta contained in the 2010 sample, it is appropriate to consider whether: New Zealand Airports are likely to be subject to the same degree of systematic risk as the comparator airport companies and the recent rise in airport asset betas is representative of their likely future performance. We consider it to be important that the Commission explains why there has been a significant increase in the systematic risk faced by New Zealand Airports since it conducted the 2002 Inquiry and why this increase is likely to persist in the future. In this respect, we note that there is a 30% increase from the 0.5 asset beta adopted by the Commission in the Airport Price Inquiry to the 0.65 asset beta proposed now.

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3. Likely systematic risk faced by New Zealand Airports

The generally accepted macroeconomic factors that affect systematic risk include 4 changes or volatility in: inflation GDP growth interest rates commodity prices and exchange rates and tax laws. The systematic risk of an individual business will depend on the sensitivity of its returns to these market-wide or macroeconomic risk factors.

3.1

Risk factors and New Zealand Airports

The light-handed economic regulatory arrangements afforded to the New Zealand Airports substantially insulate them from most macroeconomic risk factors. New Zealand Airports are free to set aeronautical prices as they think fit subject only to consultation with the airlines together with monitoring of their pricing behaviour. This ability to set prices as they think fit is contained in the Airport Authorities Act which governs airports. The Court of Appeal held last year that there is no prohibition on monopoly pricing contained in the Airport Authorities Act and the prices set by the airports cannot be judicially challenged on the grounds that they contain monopoly profits or are unreasonably high. Pricing flexibility also allows each airport operator to structure its charges on airlines in a way that diversifies the basis on which charges are levied and hence provides for greater revenue stability. For example, Auckland airport levies a combination of weight-based, passenger-based and fixed monthly charges. This diversity in pricing reduces the volatility of overall revenues to a change in each macroeconomic factor, for example, a reduction in GDP growth. Each airport operator also has the ability to reset prices in response to unexpected and generally uncontrollable changes in costs or reductions in demand. While each airport operator is required to consult with airlines before changing prices, it has the underlying pricing flexibility to moderate the impact on its profitability of unexpected changes to costs or demand. The airport operators have expressed a desire not to change prices over the remainder of the current pricing periods. Nevertheless, they have expressly retained the right to do so should circumstances change. The most likely circumstance under which this would occur would be in response to a significant increase in costs or reduction in traffic volumes. This means that there are
4

See for example, the Australian Energy Regulator, Electricity Transmission and Distribution Network Service Providers Review of the Weighted Average Cost of Capital (WACC) Parameters: Final Decision, 2009.

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effectively caps on the downside level of risk while all unexpected gains can be retained by the airport. The Commissions approach to rolling forward the regulatory asset base (RAB) from 2009 has the effect of insulating New Zealand Airports from systematic risk, especially unexpected changes in capital costs. This approach to asset valuation means prices and returns are assessed against each airports underlying cost base. As such, any unforecast increase in the construction costs incurred when undertaking capital expenditure projects (e.g. a period of high construction demand and tight supply) is automatically rolled into the RAB of each airport. Prices can then increase in future pricing agreements to cover such unexpected increases and will reflect the actual costs of any capital investment. This is highly likely to reduce exposure to systematic risk compared with the market in general. It certainly provides investors with the confidence over the returns they can obtain on their investments.

3.2

Exposure to GDP growth risk

The pricing flexibility and economic regulatory environment effectively limit the systematic risk of New Zealand airports to fluctuations in GDP growth and, in particular, the sensitivity of passenger volumes to GDP growth. As noted earlier, even this factor is moderated by each airports ability to reset prices for unexpected changes in demand. It is generally accepted that a countrys long-term growth in airline travel is primarily determined by its growth in GDP. As an example, in developing passenger forecasts for Airservices Australia, the International Air Transport Association (IATA) used 5 Australias GDP growth to model past outcomes and forecast future demand. A key factor in considering the systematic risk of New Zealand Airports is, therefore, whether they are more or less exposed to GDP growth risk than the comparator airports contained in the 2010 sample. An institutional investor in airports has published a useful model for assessing this factor. Investors in airports have a strong financial interest in understanding the drivers of growth in airport passenger demand. AMP Capital Investors which has a substantial investment in airport infrastructure has published research on modelling 6 the demand for travel. It argues that the demand for medium and long haul travel in an economy is linked to GDP per capita and population growth. Critically for consideration of the comparator companies the Commission has chosen, AMP Capital Investors argues that as GDP per capita increases, the influence of growth in GDP will decline:

5 6

IATA Projection of Flight Activity Through Australian Airspace, 2003. At the time of publishing its research, AMP Capital managed, on behalf of its clients, a 51% holding in Australia Pacific Airports Corporation (APAC), the owner and operator of Melbourne and Launceston Airports. It also managed SITES, which has a quasi-equity investment in BAA, the owner and operator of six British and one Italian airport.

NZIER Asset Beta for New Zealands International Airports

...travel demand per capita growth declines as wealth per capita increases, as there is only so much time an individual can devote to travelling. That is, per capita demand tends to a saturation limit. The data shows that demand growth relative to GDP/capita can be accurately described by a logistic curve, also known as a saturation curve. The extremely high growth rates in travel achieved in some high-growth developing economies can therefore be seen as a natural consequence of high growth rates of individual wealth from a low initial base, often combined with relatively high population growth rates. Conversely, in developed economies, where per capita wealth is higher and population growth lower, more moderate growth rates in travel demand can be expected, even if a relatively high GDP per capita growth is achieved. A consequence of demand saturation is that the elasticity of demand to GDP per capita will decline as individual wealth increases. Failure to account for this in forecasting will lead to an overestimate of future demand growth.7 The clear implication of this research is that the GDP growth elasticity of demand for air transport will tend to be higher for countries with a low GDP per capita than for countries with a high GDP per capita. This means that airports in countries with a low GDP per capita will tend to be exposed to more systematic risk a given change in GDP growth will cause a greater change in passenger volumes, aeronautical revenues and returns to investors. This is an important implication because the sample of airport companies used by the Commission contains a number of airports from countries with a low GDP per capita; and three airports in the sample are from one low GDP per capita country - Mexico. In our view, the Commissions new sample cannot be considered as providing a good set of comparators for New Zealand Airports.

Article by AMP Capital Investors for the Centre for Asia Pacific Aviations Airport Investor Monthly, http://www.centreforaviation.com/news/2010/03/04/amp-capital-global-infrastructureairport-valuations-airports-aint-airports/

NZIER Asset Beta for New Zealands International Airports

4. Empirical evidence on the systematic risk of New Zealand Airports

Empirical evidence supports the proposition that New Zealand Airports face a low level of systematic risk compared with many overseas airports. This conclusion is based on observed aeronautical operating margins per passenger and the ratio of domestic passenger growth to GDP growth.

4.1 Aeronautical operating margins per passenger over the last five years
A good measure of an airports exposure to macroeconomic risk factors is its aeronautical operating margin per passenger (total aeronautical revenue per passenger less aeronautical operating costs per passenger). Given the pricing flexibility afforded to New Zealand Airports, each airport could be expected to obtain stable aeronautical operating margins over many years. It is not possible to usefully examine the return on aeronautical assets as a benchmarking measure. This is because airport companies periodically revalue their assets, which invariably leads to increases in asset values. Asset revaluations suppress measured returns and understate the returns achieved on the actual amounts invested. The aeronautical operating margins per passenger together with the changes in total passenger numbers from 2004/05 to 2008/09 are shown in Table 3. Regardless of whether passenger volumes increased or decreased, New Zealand Airports have almost always maintained and improved their operating margins per passenger over the last five years.

Table 3 Aeronautical margin per passenger and change in passenger volumes, New Zealand Airports, 2004/05 2008/09
Airport Auckland Margin passengers Christchurch Margin passengers Wellington Margin passengers Unit $/pax % $/pax % $/pax % 2004/05 $8.53 3.9% $3.61 3.1% $6.52 3.9% 2005/06 $9.47 2.8% $3.55 -2.3% $6.97 -0.2% 2006/07 $9.30 2.2% $3.81 -1.2% $6.65 1.3% 2007/08 $9.93 13.2% $3.92 9.0% $7.00 8.8% 2008/09 $10.08 -1.5% $4.66 1.3% $7.32 5.1%

Source: Compiled from New Zealand Airports Information Disclosure Statements

The outcome for New Zealand Airports is also consistent with the aeronautical operating margins per passenger obtained by Australian airports (see Figure 1). Australian airports are also subject to light-handed economic regulation, which

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provides considerable pricing flexibility. This pricing flexibility also insulates them from systematic risk factors.

Figure 1 Aeronautical margins per passenger, major Australian airports, 2004/05 2008/09

Source: Copied from Australia Competition and Consumer Commission, Airport Regulatory Accounts, 2008/09

The stability of returns achieved by Australian airports including the supportive role offered by a light-handed economic regulation is acknowledged by both the airport operators and institutional investors. Sample comments are provided in Box 1.

Box 1 Statements about the stability of returns achieved by Australian Airports

Comments on Perth Airport: Perth Airport has recently announced its intention to invest up to $1 billion in a major redevelopment of the airport. For a company with total assets of $1.2 billion this is a major investment. The current regulatory regime is delivering investor confidence to embark on such a major investment program. Comments on Brisbane Airport: a continuation of light-handed regulatory oversight, which has supported the stable operating and financial position for the Airport and the sector. Comments on Melbourne Airport: APAC has delivered strong returns to AIX security-holders over a long period and we are delighted to increase our exposure to this high quality investment. Sources: Perth Airport Submission to the National Aviation Policy Review, June 2008, p.5 http://www.voxy.co.nz/business/moody039s-lowers-brisbane-airport039s-rating-baa2outlook-stable/5/53094, Hastings Funds Management ASX Announcement 2010 on Acquisition of 2.21 percent stake in APAC and equity raising. The advantages of operating under a light handed regulatory regime are reflected in Jacobs report on the performance of 50 of the worlds leading airports. This shows

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that Auckland and the major Australian airports rank among the top airports in terms of operating profit as a share of turnover and operating profit per passenger.

Table 4 Operating profits of selected Australasian airports, 2009

Operating profit as % of turnover Airport Auckland Sydney Melbourne Brisbane Perth Rank 1 6 2 3 4 % 66.9 54.1 64.1 63.9 61.3 % relative to sample average 215.1 173.9 206.1 205.5 197.1 Operating profit per passenger Rank 2 5 10 6 8 SDR's per passenger 9.37 6.85 5.56 6.85 6.11 % relative to sample average 242.1 177.0 143.6 177.0 157.9

Notes: (1) SDR means special drawing rights an standard international currency Source: Jacobs Consultancy, Airport Performance Indicators, 2009, Tables 20 and 21.

4.2

Exposure to GDP growth risk

As described earlier, airports in countries with a high GDP per capita are likely to be subject to less systematic risk from GDP growth. There is a very large divide in Table 5 which shows GDP per capita in the countries of the Commissions comparator airports. In particular, the GDP per capita of Thailand and Mexico is only around one third to half that of the other countries included.

Table 5 GDP per capita in 2009

US dollars, current prices Country Thailand Mexico New Zealand France Austria Australia Switzerland Source: International Monetary Fund, Global Economic Outlook. GDP per capita 8,060 13,628 26,708 33,679 38,839 38,911 43,007

The sensitivity of an airports returns to GDP growth risk can be measured by the sensitivity of its passenger numbers to GDP growth. This is because changes in passenger numbers are a good proxy for changes in revenues and returns given that airports are dominated by fixed capital and operating costs. It is more appropriate to examine changes in domestic passenger numbers for a given change in GDP rather than total (domestic and international) passenger numbers. This is because international passenger numbers are far more susceptible to specific risk factors. International passenger numbers are heavily influenced by the economic conditions of overseas countries.

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Table 6 shows the estimated average change in domestic passenger numbers for a given change in GDP for individual airport companies together with averages for New Zealand, Mexico and Australia. Details of the airports are provided in Appendix A. The ratios support the proposition that the returns to airports in countries with low GDP per capita are far more sensitive to changes in GDP growth.

Table 6 Ratios of domestic passenger growth for a given change in GDP growth
Airport company Auckland International Airport Wellington International Airport Christchurch International Airport New Zealand average Grupo Aeroportuario del Centro Norte Grupo Aeroportuario del Pacifico Grupo Aeroportuario del Sureste Mexico average Sydney Airport Melbourne Airport Brisbane Airport Australian average Notes: Ratio 2.9 2.0 4.2 2.9 6.7 4.9 4.0 5.3 1.5 1.6 1.8 1.7

Excludes negative ratios from the analysis (eg positive GDP growth but negative domestic passenger growth). Source: See Appendix A

It is worth noting that domestic passenger growth in New Zealand in 2007/08 was very high (9% to 13%) primarily due to Pacific Blue entering the market and the competitive responses from other airlines. If the 2007/08 result is removed, then the average passenger growth to GDP growth ratio for New Zealand Airports falls to around 2.0. With New Zealand and Australian averages of 2.0 and 1.7, respectively, domestic passenger numbers in Mexicos airports are two to three times more sensitive to a given change in GDP. This outcome supports the conclusion that airports in low GDP countries face more systematic risk than New Zealand Airports and emphasises the concerns we have raised over the inappropriateness of the inclusion of airports from countries with a low GDP per capita in the sample of airport companies used by the Commission.

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5. Recommended asset beta for New Zealand Airports

The Commissions comparator airports have average and median asset beta outcomes of 0.74 and 0.71, respectively. The average outcome represents a significant increase above previous estimates in 1999, 2003 and 2007. It is also greater than the asset betas used voluntarily by Auckland and Wellington airports when last setting charges. It is at the top end of the asset beta range disclosed by all three airports in their latest information disclosure reports. If the 2010 sample outcome is applied to New Zealand Airports, this implies that there has been a significant increase in their underlying systematic risk in recent years. This level of asset beta and its recent increase are not readily reconciled with the pricing flexibility afforded to New Zealand Airports, the stability in their aeronautical operating margins per passenger, and their lower exposure to GDP growth risk than less developed economies.

5.1 Asset beta outcomes between low and high GDP per capita countries
Part of the increase in the average asset beta contained in the 2010 sample can be explained by the inclusion of airports from low GDP per capita countries. The average unadjusted asset beta for airport companies in Mexico and Thailand is 0.79 compared with 0.71 for high GDP per capita countries (Table 7).

Table 7 Grouping of airport asset betas, low and high GDP countries
Airport company Low GDP per capita country airports Airports of Thailand Grupo Aeroportuario del Centro Norte Grupo Aeroportuario del Pacifico Grupo Aeroportuario del Sureste Average High GDP per capita country airports Fraport Flughafen Zuerich Aeroports de Paris AIAL Flughafen Wien Macquarie Airports Average Source: Commerce Commission, Draft Reasons Paper, 2010. Unadjusted asset beta 0.75 1.00 0.59 0.79 0.79 0.84 0.72 0.70 0.69 0.67 0.66 0.71

It is therefore difficult to accept that the asset beta outcomes for airport companies in Mexico and Thailand are representative of the systematic risk faced by New Zealand Airports. There is a strong case for either removing or heavily discounting the usefulness of the asset beta outcomes from these low GDP per capita countries

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when estimating an asset beta for airports operating in New Zealand and under the light handed regulatory regime applicable in New Zealand. It is worth noting that the 2003 sample also contains two airport companies from China, which has a lower GDP per capita (although rising rapidly). If these companies are removed, the average asset beta in the 2003 sample falls from 0.45 to 0.40. If the low GDP per capita countries are removed from all four samples reported in Tables 1 and 2, the sample average unadjusted asset beta is 0.52. Given the volatility that can occur in measured asset betas from one sample period to the next (e.g. Auckland Airports ranging from 0.14 to 0.88), it is reasonable for the Commission to place some considerable weight on the available long term evidence.

5.2 The impact of the global financial crisis on airport asset betas
Commentary from institutional investors in airports indicates that airport stock prices have been affected by concerns over the level and complexity of their debt structures. This concern has introduced volatility into airport company stock prices unrelated to their underlying level of systematic risk. As argued by AMP Capital 8 Investors: Investment conditions in 2008 were particularly challenging across all asset classes, with listed investment sectors in particular experiencing falls in value as a result of negative market sentiment, global deleveraging (the sale of assets to meet debt obligations) and tightening credit conditions.... ...In the infrastructure sector, global listed infrastructure in particular was impacted by weak economic data and concerns about the highly geared complex vehicles driven by investment banks and as a result unlisted assets have outperformed their listed counterparts by a large margin over the last 12 months. It is also argued that the volatility that the Commissions proposed asset beta suggests is not consistent with the stability in the underlying revenues and returns which have been achieved by infrastructure assets, including airports: ...we believe infrastructure continues to offer defensive characteristics and efficient portfolio diversification....Companies both in the infrastructure and utilities sectors are expected to generate less volatile earnings.9

8 9

AMP Capital Investors AMP Capital Core Infrastructure Fund Update, April 2009, p. 1. AMP Capital Investors, April 2009, p.1 and 4.

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In the specific case of Australia Pacific Airports Corporation (APAC), AMP Capital 10 Investors argues that: In 2008 APAC, the owner of Melbourne and Launceston Airports continued to experience increasing passenger growth despite the economic downturn... ... APAC is on a sound footing, with management focused on proactively addressing the issues presented by the current economic environment. This has enabled the business to roll debt without distress; maintain dividends; and adjust capex and operating expenditure to match the outlook. It is also worth noting that Macquarie Airports has restructured its debt position in 11 response to investor concerns. The case of Macquarie Airports further highlights the fact that recent share price outcomes are being heavily influenced by concerns over the level and complexity of debt structures rather than the ability of the airports to continue to obtain stable revenues and returns. The comments by institutional investors suggest that the rise in the average unadjusted asset betas of airport companies since 2007 is unrepresentative of their likely future performance. The five year period adopted by the Commission for measuring airport asset betas arguably has an unrepresentative higher asset beta period without an offsetting lower period.

5.3 Sharing regulation

the

benefits

of

light-handed

economic

A key objective of light-handed economic regulation is to provide an environment that facilitates efficient investment by the airport companies. New Zealand Airports benefit from stable cash flows and aeronautical operating margins. It is reasonable that the benefits of light-handed regulatory regimes be shared between the users and the airports and not retained solely by the airport companies. An asset beta derived from a sample of overseas airport companies weights the intended benefits of the regime almost exclusively towards the airport companies. Section 52A(1)(c) of the Commerce Act 1986 specifies that one of the regulatory objectives is to promote outcomes that create incentives for the benefits of efficiency gains to be shared with consumers. The Commissions proposed asset beta will be less likely to do this.

5.4 An asset beta consistent with the systematic risk faced by New Zealand Airports
We consider there is a compelling case for reducing the asset beta afforded to New Zealand Airports down from the draft proposal of 0.65 to 0.55 or 0.50:

10 11

AMP Capital Investors, April 2009, p.3. See Macquarie Airports Announces Buyback http://www.news.com.au/business/macquarieairports-announces-buyback/story-e6frfmbi-1111117247682

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 the Commission has dismissed earlier lower asset betas without giving any explanation; a longer term perspective is desirable in view of the short term volatility of asset betas for the same airport over time the Commissions new sample is small and unusual and cannot be considered as providing a good set of comparators for New Zealand Airports; four of the ten airports in the sample are from low GDP per capita countries and three of the airports are in the one developing economy Mexico; moreover, the variability between airports suggests a larger sample than ten observations is desirable the period from which the Commissions sample data is drawn is one in which there was a major financial crisis and concern over the debt levels of some airport companies increased the asset betas; calculated asset betas from this period are unlikely to provide a good guide for what they will be for the indefinite period in the future for which the Commission is fixing the parameter and New Zealand Airports operate in a light-handed regulatory regime which insulates them from many of the macroeconomic risks faced by airports in countries with more intrusive regimes; the Commissions sample includes asset betas for airports subject to more heavy-handed regulation than New Zealand Airports are subject to and this will have further biased the sample results towards a higher asset beta than justified. In our opinion, the Commission has provided inadequate evidence to support an increase in the asset betas of New Zealand Airports by 30% from the level it set in its 2002 Airfield Pricing Inquiry.

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Appendix A GDP and passenger growth

Table A 8 Grupo Aeroportuario del Centro Norte
Calendar year 2005 2006 2007 2008 2009 Real GDP (billions) 8,114 8,514 8,798 8,929 8,346 % change 4.9% 3.3% 1.5% -6.5% Passengers (000) 8,119 9,258 11,741 14,061 11,518 % change 14.0% 26.8% 19.8% -18.1% Ratio 2.8 8.0 13.3 2.8

Source: International Monetary Fund, Global Economic Outlook, Grupo Aeroportuario del Centro Norte passenger traffic statistics

Table A 9 Grupo Aeroportuario del Pacifico

Calendar year 2005 2006 2007 2008 2009 Real GDP (billions) 8,114 8,514 8,798 8,929 8,346 % change 4.9% 3.3% 1.5% -6.5% Passengers (000) 12,477 15,737 14,618 12,678 % change na 26.1% -7.1% -13.3% Ratio na 7.8 -4.8 2.0

Source: International Monetary Fund, Global Economic Outlook. Grupo Aeroportuario del Pacifico, Annual Report Pursuant to Section 13 OR 15(D) of the Securities Exchange Act 1943

Table A 10 Grupo Aeroportuario del Sureste

Calendar year 2005 2006 2007 2008 2009 Real GDP (billions) 8,114 8,514 8,798 8,929 8,346 % change 4.9% 3.3% 1.5% -6.5% Passengers (no.) 5,226,554 5,766,726 7,180,597 7,675,039 6,737,948 % change 10.3% 24.5% 6.9% -12.2% Ratio 2.1 7.3 4.6 1.9

Source: International Monetary Fund, Global Economic Outlook, Grupo Aeroportuario del Surests, Operational Information http://www.asur.com.mx/asur/ingles/inversionistas/trafico_pasajeros/trafico_pasajeros.asp

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Table A 11 Sydney Airport

Financial year 2004/05 2005/06 2006/07 2007/08 2008/09 Real GDP (millions) 1,065,629 1,097,354 1,138,818 1,182,297 1,196,600 % change 3.0% 3.8% 3.8% 1.2% Passengers (no.) 19,204,596 19,737,069 21,254,057 22,507,611 22,388,029 % change 2.8% 7.7% 5.9% -0.5% Ratio 0.9 2.0 1.5 -0.4

Source: Australian Bureau of Statistics. Australian Competition and Consumer Commission, Airport Monitoring Report, 2008/09.

Table A 12 Melbourne Airport

Financial year 2004/05 2005/06 2006/07 2007/08 2008/09 Real GDP (millions) 1,065,629 1,097,354 1,138,818 1,182,297 1,196,600 % change 3.0% 3.8% 3.8% 1.2% Passengers (no.) 16,296,331 16,874,908 17,806,272 19,362,783 19,743,319 % change 3.6% 5.5% 8.7% 2.0% Ratio 1.2 1.5 2.3 1.6

Source: Australian Bureau of Statistics. Australian Competition and Consumer Commission, Airport Monitoring Report, 2008/09.

Table A 13 Brisbane Airport

Financial year 2004/05 2005/06 2006/07 2007/08 2008/09 Real GDP (millions) 1,065,629 1,097,354 1,138,818 1,182,297 1,196,600 % change 3.0% 3.8% 3.8% 1.2% Passengers (no.) 12,033,472 12,454,966 13,636,193 14,449,754 14,797,752 % change 3.5% 9.5% 6.0% 2.4% Ratio 1.2 2.5 1.6 2.0

Source: Australian Bureau of Statistics. Australian Competition and Consumer Commission, Airport Monitoring Report, 2008/09.

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Table A 14 Auckland Airport

Financial year 1999/00 2000/01 2001/02 2002/03 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 Real GDP (millions) 107,583 109,767 113,803 119,846 124,553 128,554 132,251 136,264 137,978 136,830 % change 2.0% 3.7% 5.3% 3.9% 3.2% 2.9% 3.0% 1.3% -0.8% Passengers (no.) 3,206,806 3,383,242 3,635,221 4,056,663 4,640,851 4,823,916 4,958,786 5,068,794 5,740,089 5,653,306 % change 5.5% 7.4% 11.6% 14.4% 3.9% 2.8% 2.2% 13.2% -1.5% Ratio 2.7 2.0 2.2 3.7 1.2 1.0 0.7 10.5 1.8

Source: Statistics NZ. Auckland International Airport Ltd, Information Disclosure Statements.

Table A 15 Wellington Airport

Financial year 1999/00 2000/01 2001/02 2002/03 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 Real GDP (millions) 107,583 109,767 113,803 119,846 124,553 128,554 132,251 136,264 137,978 136,830 % change 2.0% 3.7% 5.3% 3.9% 3.2% 2.9% 3.0% 1.3% -0.8% Passengers (no.) 3,168,398 3,198,355 3,234,772 3,454,387 3,864,796 4,015,358 4,006,576 4,060,313 4,418,381 4,645,129 % change 0.9% 1.1% 6.8% 11.9% 3.9% -0.2% 1.3% 8.8% 5.1% Ratio 0.5 0.3 1.3 3.0 1.2 -0.1 0.4 7.0 -6.2

Source: Statistics NZ. Wellington International Airport Ltd, Information Disclosure Statements.

Table A 16 Christchurch Airport

Financial year 1999/00 2000/01 2001/02 2002/03 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 Real GDP (millions) 107,583 109,767 113,803 119,846 124,553 128,554 132,251 136,264 137,978 136,830 % change 2.0% 3.7% 5.3% 3.9% 3.2% 2.9% 3.0% 1.3% -0.8% Passengers (no.) 2,756,326 3,209,169 3,208,720 3,571,835 3,944,895 4,066,665 3,973,139 3,926,591 4,279,503 4,333,294 % change 16.4% 0.0% 11.3% 10.4% 3.1% -2.3% -1.2% 9.0% 1.3% Ratio 8.1 0.0 2.1 2.7 1.0 -0.8 -0.4 7.1 -1.5

Source: Statistics NZ. Christchurch International Airport Ltd, Information Disclosure Statements.

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