Global infrastructure investors would have taken note of news that the Airports Authority of India may privatise some of its profitable airports. Airport infrastructure in India has the potential to yield significant returns and is critical for a growing, consumption-driven economy. However, developing and growing airport assets in the country will require investors to make some critical decisions around business models to ensure profitably.
Firstly, for each airport, it will be crucial to decide whether the primary revenue driver will be aeronautical revenues or non-aeronautical revenues. Aeronautical revenues are those that the airport operator derives from terminal rents, landing fees and other services provided to the airlines. Non-aeronautical revenues are from activities such as retail, parking, hotels and business parks.
In Indian airports, given low per capita incomes, the passenger-driven non-aeronautical revenues such as retail will be relatively low and will pick up only as incomes rise. Also, some of the airports under the proposed privatisation will cater primarily to domestic demand, thereby leading to a lower retail spend per passenger.
Therefore, for investors, the asset returns will be based on generating aeronautical revenues and maximising non-passenger, non-aeronautical revenues. For certain airports, real estate development to create a critical mass of non-aero revenue assets will be crucial to make them profitable. Therefore, the decision regarding the business model will be a crucial because the most important commodity is the land available.
Building significant non-aero revenue-generating assets would mean that if passenger growth were to pick up in the years to come, then there would be less land available for terminal and runway expansion. On the other hand, not building non-aero assets would imply more land available for the future but also a lower revenue stream. In a dynamic economy such as India, passenger growth predictions coupled with exceptional real estate asset management will be critical to delivering optimum returns.
Secondly, investors will also have to take a call on the type of airport that is of interest to them. On the one hand, there are those in which passenger traffic is at over-capacity, and on the other are those that are growing, with the catchment area still being determined.
The trade-off the investor faces is a critical one. Airports operating at over-capacity will need capital expenditure to grow the asset, therefore requiring development work. Such expenditure can result in high growth through capturing higher passenger traffic, but is also a riskier investment proposition. On the other hand, acquiring one that is still operating at under-capacity is more of a yield play. Utilising the existing assets to increase business will be the key focus.
Given that investors tend to approach assets using their past experiences, if the airport privatisation goes through, it will be interesting to see the investor pool at play.
Thirdly, as the privatisation discussions pick up, potential investors will be keyed in on the revenue model that the government proposes for the airports. Investors would be looking for policy clarity on whether all airports will be privatised using the “hybrid till” policy. In common parlance, “hybrid till” is where 30 per cent of non-aeronautical revenues are used to cross-subsidise aeronautical charges.
As opposed to this is a “single till” mechanism, in which all non-aeronautical revenue is used to subsidise aeronautical charges, while in a “dual till” there is no subsidy. Policymakers must walk a fine line between lowest charges per passenger under “single till” versus the other end of the spectrum in a “dual till” that generates the best revenue profile for the airports.
It is important to note that if airports need to make significant expansions and hence incur substantial capital expenditure, a hybrid or a dual till model is a better solution. Eventually, airports, airlines and regulators must decide on which revenue mechanism works best. It is imperative to ensure consistency in policy and keep in mind economic returns. However, each asset must get due attention because an airport with over-capacity will have significantly different dynamics from one which is still growing and relatively under-utilised.
Talks about airport privatisation have been around for a while now. Given the growth in air traffic and economic benefits that airport infrastructure creates, now is the opportune time to privatise airports to generate capital to develop new infrastructure. For investors, airports are an asset class that deserves attention for those bullish on the Indian growth story over the next few decades.
(Taponeel Mukherjee heads Development Tracks, an infrastructure advisory firm. Views expressed in are personal. He can be contacted at [email protected] or @Taponeel on Twitter)