Aviation and airports: Can technological and cultural changes trigger regulatory rethinking?
Cheaper airfares, lifestyle trends and cross-border business are fuelling the international travel industry. In 2016, when the number of international travellers hit more than 1.23 billion, up from 525 million in 1995, 54 per cent of international tourists travelled by air. In spite of uneven growth and perennial political discourses about climate change, geopolitical conflicts and terrorist threats, as many as 620 million visited a destination in Europe in 2016, while 303 million visited a destination in Asia, 201 million in the Americas, 58 million in Africa and 54 million in the Middle East. Globally, the travel and tourism industry generated over $7.2 trillion in 2016, including direct and indirect impacts. This figure was equivalent to 9.8 per cent of global GDP.
The commercial aircraft manufacturing market:
Growth in aviation, however, is increasingly led by demand from Asia, especially China and India. According to estimates by Seattle-based Boeing Co. and Toulouse-headquartered Airbus Group, more than half of new aircraft demand over the next 20 years will probably come from the Asian markets, especially China and India. The two companies also estimate that the world’s passenger aircraft fleet above 100 seats could double and surpass 34,000 passenger aircraft during the same period. In addition, they predict that around 70 per cent of new units will be single aisle (narrow body) aircraft which help airlines maintain high load factors, i.e. fill up the available flight seats with paying passengers.
More specifically, Boeing has said that it expects single-aisle models to account for 75 per cent of the 7,240 new planes estimated to be delivered to China between 2017 and 2036. Boeing’s and Airbus’ estimates are critical. Collectively, the two businesses account for more than 65 per cent of the total commercial airplane market. In 2016, the Airbus Group’s revenues hit $70.8 billion, while Boeing’s revenues, including more than $29 billion worth of sales from its defense, space and security division, amounted to $94.6 billion.
The Airbus Group is controlled by the governments of France (11.1 per cent stake), Germany (11.09 per cent stake) and Spain (4.2 per cent stake). Boeing is controlled by US institutional investors. The largest shareholder is Los Angeles-based Capital Group, a major investment firm. In addition, New York-based BlackRock, the world’s largest asset manager, Pennsylvania-based Vanguard Group, the world’s second largest asset manager, New York-based Evercore Partners, a major investment banking advisory firm, Baltimore-based T. Rowe Price Group, a leading investment manager, and Boston-based State Street Corporation, one of the world’s biggest providers of financial services, own major stakes.
Earlier in the week, in a challenge to Boeing’s leading position, Airbus agreed to buy a 50.1 per cent stake in Montreal-based Bombardier’s CSeries Aircraft Ltd. Partnership unit. Under the deal, which would come at no cost, Bombardier will own a 31 per cent stake while Québec Investissement, the investment arm of the Province of Quebec, will hold the remaining 19 per cent. Bombardier had invested more than $6 billion in the CSeries program, which is a family of narrow-body jetliners mainly seating 108 to 160 passengers. But the company had not secured a new order since April 2016, when Atlanta-based Delta Air Lines, the second largest airline in the world, had bought 75 CS100 jets for $5.6 billion.
Since the Government of Quebec had invested $1 billion in the struggling CSeries program in late 2015 in exchange for a 49.5 per cent stake in the program, this had prompted the Canadian government, led by Prime Minister Justin Trudeau, to provide $297 million in repayable loans over a four-year period in February for the CSeries and another Bombardier jet program. Simultaneously, Caisse de dépôt et placement du Québec, a state-owned pension fund, had paid $1.5 billion for a 30 per cent stake in Bombardier’s train-making unit. In turn, the debt-laden aerospace maker had committed to cut 10 per cent of its more than 70,000 employees over a two-year period in early 2016.
But last month the company was also threatened by a possible 300 per cent duty on US imports. The duty followed findings that Bombardier had sold the CSeries jets to Delta below cost, affirming Boeing’s complaints that the company had received illegal subsidies and dumped the planes at ”absurdly low” prices. Bombardier is controlled by the founding Bombardier-Beaudoin family, which has a 53.23 per cent voting stake, through multiple Class A voting shares. In addition, the Government of Canada possesses significant minority stakes.
Overall, the commercial aircraft market is shaped by an incessant demand for fuel-saving technologies and rising labor costs, which can partly be blamed on an inefficient supply chain. Around 65 per cent of the cost of a jet is from the supply chain. The main suppliers in the aerospace industry include Connecticut-based United Technologies Corporation, Kansas-based Spirit Aerosystems, Ohio-based GE Aviation, a subsidiary of General Electric, New Jersey-based Honeywell International, London-based Rolls Royce Holdings, and Safran, a state-owned French entity.
United Technologies, notably, is the owner of Pratt & Whitney, which may become the most important provider of both military and commercial aircraft engines in the world due to its ”geared turbofan” which is more fuel efficient than alternatives. Nonetheless, fearing that Boeing and Airbus could capture a larger share of the high-margin parts and services aftermarket, United Technologies agreed to pay $30 billion in September for Iowa-based Rockwell Collins, an avionics and interiors maker, in the biggest aerospace deal in history. The deal included Rockwell Collins’ debt and a total equity value of $23 billion. Earlier in the year, Rockwell Collins had itself spent $6.4 billion to acquire Florida-based B/E Aerospace, an aircraft interior manufacturer.
Vanguard Group and BlackRock are also leading shareholders in United Technologies, Honeywell, Spirit Aerosystems, General Electric and Rolls Royce Holdings while State Street Corporation has major stakes in United Technologies, Honeywell and General Electric. BlackRock, which has an estimated $5.98 trillion in assets under management, is led by Chairman and CEO Larry Fink, a member of the Democratic Party who has also provided policy advice to President Trump.
Vanguard Group, which has an estimated $4.7 trillion in assets under management, is led by Chairman and CEO Frederick William McNabb III but he will step down in January 2018 and be succeeded by Tim Buckley, the company’s Chief Investment Officer. State Street Corporation, which has an estimated $2.6 trillion in assets under management, is led by Chairman and CEO Joseph Hooley. The dominant position of the deep-pocketed investors is related to the swelling production costs and research and development expenses which makes aircraft manufacturing a highly capital-intensive industry.
Beyond falling airfares, fuel-saving technology, lifestyle trends and international business links, the increasing customer flow in the world’s major airports can mainly be attributed to the proliferation of budget airlines. Traditionally, budget airlines have mainly operated short-haul routes since state-owned flag carriers have been allowed to subsidize fares on intercontinental flights. In recent years, however, short-haul routes in Europe and North America have increasingly become saturated and many airlines have entered the long-haul market, including privately-owned airlines such as Air Asia, Wizz Air, Norwegian Air Shuttle ASA, WOW Air, LATAM Airlines Group, Qantas Airways, and Lufthansa, and state-owned carriers, such as Emirates, Qatar Airways, AirFrance-KLM, Singapore Airlines, Turkish Airlines, and the International Airlines Group (IAG).
Kuala Lumpur-based Air Asia is a unit in the Tune Group which is founded and owned by Chairman Tony Fernandes and CEO Kamarudin Meranun. Budapest-headquartered Wizz Air is owned by co-founder and CEO József Váradi and Chairman and longtime investor Bill Franke, who also serves as Chairman of Denver-based Frontier Airlines. Norwegian Air is owned by founder and CEO Bjørn Kjos. IAG, the holding company of British Airways, Spain’s Iberia and Ireland’s Aer Lingus, is controlled by its largest minority shareholder, Qatar Airways.
Reykjavík-based WOW Air is owned by its Icelandic founder and CEO Skúli Mogensen, who is also a major investor in technology, media and telecom assets in Europe and North America. Santiago-headquartered LATAM Airlines is controlled by its three largest shareholders, namely the Santiago-based Cueto family (28 per cent), Santiago-based Administradoras de Fondos de Pensiones, i.e. Chile’s privately-owned pension fund, (20 per cent) and Qatar Airways (10 per cent). Sydney-based Qantas Airways is controlled by a number of Australian and US institutional investors, including Blackrock.
Cologne-headquartered Lufthansa is controlled by a number of German shareholders, including Frankfurt-based Commerzbank, Europe’s second largest investment bank, and Frankfurt-based Deutsche Bank, Europe’s largest investment bank. German shareholders collectively hold a 68.4 per cent stake. In addition, BlackRock, State Street Corporation, Vanguard Group, New York-based Franklin Templeton Investments, New York-based JP Morgan Chase & Co., one of the world’s biggest investment banks, Norges Bank, i.e. Norway’s Central Bank, Luxembourg-based Assenagon Asset Management and London-based Lansdowne Partners, a hedge fund, possesses major stakes.
The biggest shareholders in Commerzbank, it can be added, is the Government of Germany (15 per cent stake), New York-based Cerberus Capital Management, a private equity firm, (5 per cent stake), and BlackRock (just below 5 per cent). Cerberus Capital Management is owned by its CEO and co-founder Steve Feinberg and Senior Managing Director and co-founder William Richter. Feinberg’s net worth is estimated at $1.56 billion. In 2016, he first donated $200,000 to former Republican Governor of Florida Jeb Bush’s presidential campaign, and when he had dropped out of the race, he donated $1.5 million to Donald Trump’s campaign.
Furthermore, the senior leadership of Cerberus include former Republican Vice-President Dan Quayle, who serves as Chairman of Cerberus Global Investment, and former Republican Treasury Secretary John Snow, who serves as Chairman of Cerberus. The biggest shareholders in Deutsche Bank are Hainan-based HNA Group, a conglomerate which is involved in aviation, real estate, financial services, tourism and logistics, and Qatar’s royal family, which both own stakes just below 10 per cent, while BlackRock owns a 5.9 per cent stake.
The airfare competition has spurred airlines to focus on ancillary income generating activities, such as seat selection, early boarding and in-flight meals, to diversify their revenue streams. But airfare competition and mounting wage and tax pressures have forced three major European carriers, including Air Berlin, Alitalia and Monarch Airlines, to file for insolvency while Monarch Airlines has collapsed in 2017. London-headquartered Monarch Airlines was a unit in the Monarch Group which is owned by London-based Greybull Capital, an investment firm. Air Berlin and Rome-based Alitalia were both controlled by Etihad Airways, a state-owned Abu Dhabi-based entity, which held a 29.21 per cent stake in Air Berlin and a 49 per cent stake in Alitalia.
Following a brief bidding process, Lufthansa, Germany’s biggest airline, agreed to pay $249 million for large parts of Air Berlin, Germany’s second biggest airline, including its Austrian leisure subsidiary Niki, regional unit LGW and 20 other aircraft. The offer, however, was widely considered in breach of EU competition rules and the EU’s competition authority was forced to take a closer look at the deal. Lufthansa also offered $590 million for large parts of Alitalia, including planes, pilots, air crew and air slots.
Regulation of airports:
Airport owners also face mounting challenges but rarely challenge the regulatory framework. Almost 60 per cent of airports in Europe are fully publicly owned airports and 25 per cent have mixed public-private ownership. Only 15 per cent of Europe’s airports are fully privately owned. Europe, nonetheless, is the region with the highest number of fully-privatized airports in the world. The European countries with most privately owned airports include Cyprus, Hungary, Slovenia, Portugal and Britain. In all, approximately 86 per cent of the world’s roughly 4,300 airports are government owned. Besides, governments tend to raise airport taxes when privatizing airports. The UK’s Air Passenger Duty constitutes the highest passenger tax levied anywhere in the world. What started out as $6.50 for short-haul flights and $10 for long-haul flights in 1994 reached $17 for economy class and $33 for all other classes in 2016 while passengers flying further than 2,000 miles were eligible to pay a whopping $95 for economy class and up to $189 for all other classes.
Another obstacle is the growing availability of high-speed rail, a fuel efficient and thus environmentally-friendly mode of transport. The proliferation of high-speed rail has resulted in declining passengers in China and parts of Europe on routes of up to 500 km. The EU, nonetheless, allowed its members to subsidise regional airports handling up to three million passengers annually without prior approval in June. More than 420 airports across the EU fall under this category. Globally, most airports handling less than one million passengers per years are unprofitable.
In all, global airport revenues amounted to $152 billion in 2016 when total passenger numbers hit 3.77 billion, up from 2.48 billion in 2009. Non-aeronautical revenues, i.e. retail, car parking, car rental and real estate, accounted for roughly 62 per cent of revenues. But owners of shops and restaurants in airports, especially in Europe and North America have to deal with soaring rent and labor costs. As a result, three of Europe’s busiest airports — Charles de Gaulle Airport in Paris, Frankfurt Airport and Amsterdam’s Schiphol Airport -, which are all state-owned, reported drops in spending per passenger in 2016 between 4–8 per cent. In addition, airport owners must meet increasingly ambitious air-pollution targets.
The eroding non-aeronautical revenues has prompted airport owners to levy higher landing fees on the airlines and increase investments in automated self-services, such as facial recognition machines and concierge robots. An early mover was Switzerland’s Geneva Airport, a state-owned enity, which introduced a robotic self bag drop on wheels, called Leo, in 2013. The robot was produced by Type 22, a Dutch start-up, which is now a unit in Geneva-based Sita, a quasi state-owned air transport technology firm, which is jointly run by more than 400 air transport industry members, including airlines and airports.
The soaring demand for aviation services, however, requires expansion of airport capacity even though airport construction is also a capital intensive business with substantial fixed costs. This has helped Istanbul-based TAV Airports, which also runs Istanbul Atatürk Airport, Turkey’s biggest existing airport become the world’s leading airport construction firm, since Western engineering groups tend to deploy business models centred around advanced design capabilities which require costly specialized labour. The largest shareholders in TAV Airports include Groupe ADP (46.12 per cent), a state-owned French entity, which operates 34 international airports across the world, Ankara-based Tepe Insaat Sanayi A.Ş (meaning Tepe Construction Industry Inc.) (8.1 per cent), one of Turkey’s largest construction firms, and Istanbul-based Sera Construction (2 per cent), another construction group.
A consortium of five different Turkish companies also won approval in 2013 to construct and run a new mammoth airport, which is envisaged to have a 150 million passenger annual capacity, outside Istanbul for a 25-year period commencing in 2018. The consortium paid more than $30 billion for the tender and the total project cost of the airport is expected to be around $8.2 billion, excluding financing costs. Turkish construction groups have also expanded into the buoyant Gulf markets.
Crucially, both Turkey and the UAE aspire to consolidate their positions as key hubs for intercontinental flights between Asia and Europe and Asia and the Americas and the UAE government has unveiled plans to invest up to $46 billion in airport expansion over a period of 15 years. So far, however, the cost-conscious Turkish companies have not penetrated the booming Chinese and Indian markets. The Chinese government has committed to invest up to $130 billion in airport capacity expansion during the same period while the Indian government has said it will invest up to $45 billion.
Apart from soaring labor and taxation costs, airport construction companies are often also pressurized by cumbersome political processes. Heathrow’s long postponed plan to construct a new 3,500 meter runway at an estimated cost of around $20 billion is a significant example. Heathrow, Europe’s busiest airport, operates at 98 per cent of its capacity and expansion is detrimental but residents in the densely populated area north of the airport site where the runway would be constructed have resisted the project which would see their homes compulsarily purchased. Prime Minister Theresa May’s government approved the project in 2016 after 25 years of debate but the outcome of the parliamentary vote on the project, which will be held in 2018, remains uncertain.
Heathrow Airport Holdings is controlled by five minority shareholders including Madrid-based Ferrovial S.A. (25 per cent stake), one of Europe’s largest infrastructure groups, state-owned Qatar Investment Authority (20 per cent stake), Caisse de dépôt et placement du Quebec, a state-owned Canadian pension fund, (12.62 per cent stake), state-owned China Investment Corporation (10 per cent stake) and Liverpool-based Universities Superannuation Scheme, Britain’s largest private sector pension fund (10 per cent stake). Most of these investors, however, have only come on board in recent years.
India’s Navi Mumbai International Airport project also exposes the nature of the poorly regulated airport construction sector. Initially, Mumbai’s second airport had been proposed in 1997 and the project was cleared by the government in 2007 but land and environmental issues has delayed the project since the residents of five villages in the area have mobilised political support against the project. In addition, the project has been postponed due to problems in dealing with mangroves and rain/storm water drains. Government negotiators, however, resolved the dispute earlier in the year and construction of the airport is slated to begin by the end of the year.
The giant project, which is projected to handle up to 60 million passengers per year in 2030 when full capacity has been reached, will be executed by Mumbai International Airport Ltd., a joint venture between Airports Authority of India, a state-owned entity, and Hyderabad-based GVK Group. The debt-ridden conglomerate, which also runs the Chhratrapati Shivaji International Airport, Mumbai’s only existing international airport, outbidded the debt-laden GMR Group, which operates the airports in New Delhi and Hyderabad, to secure the $2.4 billion contract. In order to reduce its debts and secure the contract, the GVK Group sold a 33 per cent stake in Bengaluru’s international airport to Toronto-based Fairfax Financial Holdings Ltd., one of Canada’s biggest financial services companies, in the spring. Fairfax is led by its Hyderabad-born founder, owner and Chairman Prem Watsa.