Airport bid sheer opportunism

The best businesses to own, by definition, are those that generate the highest returns on equity.

The best businesses to own, by definition, are those that generate the highest returns on equity.

Who’d want to own an airport? Boil it down and the very best businesses to own are monopolies. Why? It’s simple really.

The best businesses to own, by definition, are those that generate the highest returns on equity. High returns on equity can only be maintained by a sustainable competitive advantage and the most valuable is the ability to charge a higher price without a detrimental impact on unit sales volume. Monopolies can do precisely that.

When asked how to identify a good business, Warren Buffett, distilling decades of experience in building an epic fortune, reportedly said you’d know because “someone is always trying to take it away from you”.

Sydney Airport shareholders – who have and who will continue to benefit from returns well in excess of the cost of capital – are well advised to remember Buffett’s quip.

They enjoy the benefits of monopoly, clipping the ticket of every person, plane and taxi that passes through its doors, which themselves are the main gateway to Australia. They own critical infrastructure with a 75-year licence to generate aeronautical and non-aeronautical revenues.

In 2018 Frontier Economics, in its report Market Power and the profitability of Australian Airports, calculated Sydney Airport’s internal rate of return between 1998 and 2017 at 22.9 per cent.

With Sydney Airport now in play, shareholders should ask themselves, would the middle of a global pandemic be the right time to put such asset on the market? The answer is a resounding no.

Of course, when one’s asset is publicly listed one cannot control who knocks on the door or when. But control is held over the response. And as a fund manager with a meaningful position in Sydney Airport – it’s a top five holding for The Montgomery Fund – we are compelled to carefully consider our response too.

A consortium led by Australian investment management company IFM, and including QSuper and Global Infrastructure Management, originally lobbed a takeover offer for Sydney Airport at $8.25 per share on July 5. On August 16 that offered was sweetened and increased to $8.45. In normal circumstances a $30bn offer at a high premium to the pre-offer price would be a no-brainer but we’re unmoved – as is Sydney Airport’s board, who have rejected both proposals.

To our way of thinking Sydney Airport is one of the highest-quality infrastructure assets in the country, if not the world. Its proximity to the CBD enables international travellers to be at their meetings inside 30 minutes. Meanwhile, the combination of pricing power and growth – air travel has grown at above GDP rates for decades – has resulted in compounded annual returns of over 20 per cent.

Before the pandemic sell-off, Sydney Airport scrip traded at around $9 – and keep in mind that was without a control premium. Had a bid for the asset been forthcoming then it would have to have been well above $10 to garner any interest.

It’s true Covid and its associated uncertainty has been a particularly wretched companion to airport owners, but we’ve all been here before. Following the devastating impact on air travel of the September 11 terrorist attacks and the SARS crisis in 2002, air travel ultimately returned to its previous trajectory of above-GDP growth.

The Covid crisis is worse. Its scale, its impact on human life and the unknowable exit path may make some shareholders believe a bird in the hand is worth more than 10 in the bush. But others, including us, believe current difficulties render IFM’s bid opportunistic, by definition. Sydney Airport’s board needs to remember that there are over 75 years to run in the airport concession. That’s more than enough time for a reversion to the long-term shareholder value-creation that has been hitherto demonstrated.

The pace of recovery in both leisure and business travel, when vaccination rates permit an easing of restrictions, can be blindingly fast, as has been demonstrated in both Europe and the US. It’s in the IFM consortium’s interest to paint a bleak and gloomy picture but if the long-term future is so miserable, why do they want to own Sydney Airport?

John Pearce at Unisuper is without question a very smart investor. Unisuper also has a significant investment in Sydney Airport. Indeed Unisuper is by far the largest shareholder. So I find it particularly intriguing that Unisuper should suggest Sydney Airport board engage with the consortium and perhaps even agree a deal. Why? Because they aren’t selling. Indeed, my understanding is it’s proposed they roll their shareholding to become part of the bidding consortium. As astute investors, with a very good understanding of the airport’s value, it’s telling they’re not selling.

Where to next? To their credit, Sydney Airport’s board has signalled that they are more than willing to engage with the bidders. That suggests they aren’t fighting for their jobs at the expense of shareholder value. Tick.

I expect, with a once in a lifetime opportunity to sell a monopoly in a growth industry, a critical piece of Australian infrastructure, and a 75-year concession, the board will ensure the bid they support reflects the long-term nature of the asset they control and shareholders own. I support them in that endeavour.

Roger Montgomery is founder and chief investment officer at Montgomery Investment Management.