Considering and Evaluating Airport Privatization (2012)

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83 Case studies can be a useful means of illustrating first-hand experiences and lessons learned from those experiences and therefore can provide helpful background for any airport considering the various privatization models. The purpose of this chapter is to summarize the lessons learned from the case studies that were undertaken for a range of airport sizes, priva- tization strategies, and forms of governance. They were con- ducted for successful and unsuccessful efforts. The following information comes from the case studies in Appendix H which documents in more detail (1) the initial goals and objectives of the airport sponsor for undertaking the privatization initia- tive, (2) a summary of the process employed, (4) a summary of the business terms of the initiative, (4) documentation of the experience to date, and (5) lessons learned. It is recommended that the reader review the case studies in their entirety to better appreciate the unique circumstances surrounding each case. Case studies for U.S. airports consisted of: Airport System Management Contract: 1. Indianapolis Airport Authority—airport system com- prising a medium-hub airport and five general aviation airports, which entered into an airport system manage- ment contract that later reverted back to public operation. Developer Financing and Operation: 2. John F. Kennedy International Airport Terminal 4 (JFK IAT)—large-hub airport, private development, financing, and operation of a major international unit terminal. 3. Boston Logan International Airport Terminal A—large- hub, terminal development, where private developer financing was initially considered, then airline special facil- ity financing was undertaken, which was followed by the airline’s bankruptcy resulting in a workout that required an amendment to the transaction documents. APPP Applicants: 4. Stewart International Airport—non-hub airport and only airport approved under the APPP, which reverted back to public operation. 5. Chicago Midway International Airport—large-hub air- port that occupies the only large-hub slot under the APPP, which was put on hold after the financial crisis in the fall of 2008. The case studies for Stewart International Airport and Midway Airport provide interesting contrasts and help- ful background for any airport considering privatization under the APPP. Full Privatization Outside the APPP: 6. Morristown Municipal Airport—general aviation airport with long-standing, long-term airport-wide management and development agreement. Summary of Case Studies Summaries of the U.S. case studies are available here and fuller summaries follow. The full case studies can be found in Appendix H. Indianapolis Airport Authority Type of Transaction: Airport-wide Management Contract Airports: Indianapolis International Airport and five general aviation airports Airport Owner: Indianapolis Airport Authority Private Contractor: BAA Indianapolis LLC Objectives: • Attract new airline service and encourage economic development by reducing airline costs through increased nonairline revenues and reduced operating expenses • Improve customer service and quality • Increase the expertise and diversity of Airport staff Level of Interest: Four private-sector firms plus the existing Airport Authority staff submitted proposals Solicitation Timeline: RFQ issued in September 1994 Contract Execution: October 1995 C h a p t e r 9 Case Studies

84 Contract Duration: Initially 10 years, but extended to December 2007 and later terminated in June 2007 Transaction Features and Highlights: • BAA was initially compensated on the basis of savings in airline payments per enplaned passenger versus a base- line cost defined in the contract • The agreement was amended to change the compensation methodology by providing for a fixed and a variable com- ponent due to the difficulty in determining the savings • The variable component was based on performance achieved towards different goals as opposed to the single goal of reduction of airline CPE • The Authority reassumed control of the airport system following the early termination of the agreement in June 2007 • BAA was not released from the requirements of Authority procurement ordinances • Once initial efficiencies had been gained by BAA, it became difficult to make ongoing improvements with effects similar in magnitude and parties started ques- tioning the value gained by retaining BAA relative to the fixed annual fee John F. Kennedy International Airport Terminal 4 Type of Transaction: Developer Financing and Operation Airport: John F. Kennedy International Airport Airport Owner: Port Authority of New York and New Jersey Private Contractor: JFK International Air Terminal LLC (JFKIAT), a joint venture of LCOR JFK Airport, LLC, Schiphol USA Inc., and Lehman JFK LLC; LCOR and Lehman left the joint venture in 2010 coincident with the announcement of the Delta expansion Objectives: • Preserve financing capacity for the Port Authority’s 5-year capital program • Minimize construction risk and management oversight • Reduce operational responsibilities • Deliver a functional terminal on time and on budget with no additional financing required by the Port Authority • Improve operational efficiency and increase terminal capacity by replacing exclusive use arrangements with common use arrangements and new pricing approaches • Gain PPP experience for possible deployment to other agency operations Level of Interest: Four proponents responded to the RFP Solicitation Timeline: RFQ issued in July 1995 Contract Execution: May 1997 Contract Duration: • The lease term was to expire on the earlier of the date (1) 25 years after the date of beneficial occupancy of the new facility, or (2) the day prior to the date on which the Port Authority’s lease with the City of New York for JFK (which was 2015 at the time the lease was signed) • Due to a significant capital expansion negotiated in 2010 to accommodate the operations of Delta Air Lines, the contract was extended through the earlier of 30 years from the date of beneficial occupancy of the expanded terminal or December 2043 Project Cost: 1997 initial project: $1,069 million; 2010 expan- sion project: $660 million Transaction Features and Highlights: • JFKIAT was the first private, nonairline entity to develop and operate an international air terminal in the United States • The lease required that JFKIAT complete the project within 5 years from the execution of the lease or face significant financial penalties • The project was completed on time, but at a construc- tion cost approximately 20% over the budgeted amount • The cost overruns required that JFKIAT obtain com- pletion financing, which was provided by the Port Authority and subordinate to the special facility bonds issued for the initial financing • JFKIAT sets airline rates and charges to reflect market demand for the facilities it offers rather than use cost- recovery formulas like most U.S. airports, including off- peak rates and volume discounts • In August 2010, the Port Authority, JFKIAT and Delta announced plans for a $660 million expansion to accom- modate the operations of Delta • The execution of the long-term lease with Delta in 2010 significantly changed the nature of the transaction to have features more similar to an airline special facility lease Boston Logan International Airport Terminal A Type of Transaction: Developer Financing and Operation Airport: Boston Logan International Airport Airport Owner: Massachusetts Port Authority (Massport) Private Contractor: Delta Air Lines Objectives: • Introduce private sector participation into airport operations • Redevelop Terminal A while preserving the Authority’s financing capacity for its sizable capital program Level of Interest: Seven teams submitted qualifications and five were short listed Solicitation Timeline: • 1996–1997: Massport studied approaches for private development and went through a competitive selection process that was abandoned • 1998: Discussions were initiated with Delta

85 Contract Execution: August 2001 Contract Duration: • Initial term began on the opening day (March 16, 2005) and lasted 5 years • Extension terms provided for 20 automatic one-year extensions unless Delta was in default • After Delta filed for bankruptcy, the “Amended and Restated Lease” term was also reduced from 25 to 10 years and Delta returned approximately one-third of its space Project Cost: 1997 project: $1,069 million (versus budget of $876 million); 2010 expansion: $660 million Transaction Features and Highlights: • Initially Massport explored a private developer approach for the replacement terminal, but due to state public bidding laws, and the private developers’ requests “to shift risk to the Authority” or for “subsidies” such as a share of rental car commissions, this approach was deemed infeasible • The negotiating process was lengthy and complex, in part to ensure that (1) the terminal’s design and construction met Massport’s goals and (2) it provided Massport with the ongoing flexibility after the terminal’s opening to maximize the utilization of the terminal and site • Unlike most special facility-backed terminal financings for airline tenants, this transaction gave Massport con- siderable leverage to take back facilities under certain circumstances • Massport retained control of and the revenues from the Terminal A concessions • The lease required that Delta complete the project within 5 years from the execution of the lease • Six months after the opening of new Terminal A, Delta filed for Chapter 11 bankruptcy • As part of a complex restructuring of Delta’s terminal lease and financing arrangements, Massport, Delta, the bond trustee, and the bond insurer negotiated amended terms to the Terminal A lease to avoid litigation over Delta’s potential rejection of the lease Stewart International Airport Type of Transaction: Long-Term Lease Inside the APPP Airport: Stewart International Airport (SWF) Airport Owner: New York State Department of Trans- portation (NYSDOT) Private Contractor: UK-based National Express Group (NEG), with the long-term lease subsequently acquired by the Port Authority of New York and New Jersey Objectives: • Leverage the expertise of the private sector to develop the underutilized airport to its fullest potential • Develop the real estate on the vast site to create jobs and economic development, which was a priority for the Hudson River Valley due to large industrial concerns laying off workers and closing plants at the time • Get out of the business of managing airports • Introduce private sector participation into airport operations Level of Interest: Four private-sector firms and the existing Airport Authority staff submitted proposals Solicitation Timeline: Five teams submitted proposals, of which four were deemed qualified bidders Contract Execution: • Lease signed November 1999 • Lease became effective in April 2000 after state comp- troller, state attorney general, and FAA approval APPP Timeline: • October 23, 1997, NYSDOT filed a preliminary applica- tion for participation • January 10, 1999, NYSDOT filed its final application • February 16, 1999, in an effort to clarify certain parts of the application, FAA staff requested responses to ques- tions from NYSDOT and NEG • April 8, 1999, the FAA published a Notice of Receipt of Final Application in the Federal Register • June 12, 1999, a public meeting was held • March 30, 2000, the FAA issued its Record of Decision approving the privatization application and approved the requested federal exemptions Contract Duration: 99-year lease, but NEG sold its interests in the remaining 91 years of the lease to the Port Authority of New York and New Jersey in October 2007 Transaction Value: Initial Lease Payment of $35 million and annual payments equal to 5% of gross income that were projected to begin on or about the 10th anniversary of the lease Transaction Features and Highlights: • Stewart International Airport was the first and only air- port to complete the APPP process • NYSDOT contracted with private companies to operate parking facilities, cargo facilities, and rest of the airport (under an airport-wide management contract); therefore, a significant amount of SWF operations were already out- sourced to contractors • The RFP gave the bidders the option of proposing on (1) the airport, (2) just the undeveloped land west (approximately 5,600 acres), or (3) both • NEG elected not to bid on the undeveloped land, and at the encouragement of environmental groups, most of the undeveloped land was set aside by the state under a “forever green” statute • NYSDOT did not request an exemption for use of airport revenue for general purposes because the airlines declined to approve NYSDOT’s request for an exemption • Shortly before the beginning of the lease term in Novem- ber 1999, NEG asked NYSDOT to be relieved of its lease

86 obligations after reconsidering the company’s strate- gic priorities and interests in remaining in the airport industry • The transaction prohibited the sale of the lease to another party for 5 years • NEG paid $35 million in an upfront lease payment and made $10 million in capital contributions at SWF dur- ing its operation of the airport • NEG sold the lease after 7 years of operation to the Port Authority for $78.5 million, allowing it to recover its investments and realize a significant capital gain • Because the Port Authority is a public agency and not a commercial entity, the airport was no longer eligible to continue in the APPP under Port Authority control and its participation in the program was terminated Chicago Midway International Airport Type of Transaction: Long-Term Lease Inside the APPP Airport: Chicago Midway International Airport Airport Owner: City of Chicago Private Contractor: The winning bidder was Midway Invest- ment and Development Company LLC (MIDCo), a con- sortium comprised of Vancouver Airport Services Ltd. as the operator, and Citi Infrastructure Investors and John Hancock Insurance Company as investors Objectives: • Maximize sale proceeds for the City’s unfunded pension liability, infrastructure improvements, and other gen- eral fund purposes (primary objective) • Establish a new framework of rates and charges that provides lower and more predictable rates for airlines operating at the Airport • Improve the competitive position, service quality, growth prospects and efficiency of Midway Airport for the benefit of Chicago residents, airlines, and other users • Ensure that future Airport development is safe, func- tional, efficient and delivered when necessary • Minimize the City’s exposure to residual risks and liabil- ities from the process • Ensure fair and equitable treatment of existing Airport employees • Ensure a smooth transition from public to private man- agement in a timely manner Level of Interest: Six groups submitted qualifications, one was eliminated due to lack of qualifications, two teams decided to withdraw, leaving three teams that submitted bids Solicitation Timeline: RFQ issued February 2008 Contract Execution: The deal fell through in April 2009 after the consortium was unable to come up with the full up- front rent payment and had to pay the city a $126-million breakup fee APPP Timeline: • September 16, 2006: Chicago filed a preliminary appli- cation for participation • October 14, 2008: Chicago filed its final application for review and approval • January 12, 2009: the FAA said its final review of the privatization application could not be completed because critical financial documents had not been sub- mitted (financial agreements) • November 8, 2008: FAA held a public meeting in Chicago to receive public comments • April 1, 2009: the FAA granted its 1st extension to the City to provide additional information • Several extensions have been provided since April 2009 Contract Duration: 99 years (proposed) Transaction Value: $2.521 billion upfront payment (pro- posed, but not paid) Transaction Features and Highlights: • The City of Chicago holds the only large-hub slot under the APPP • The City was the only APPP applicant to secure airline approvals for its exemption to use airport revenue for general purposes after a lengthy negotiation resulting in an agreement that (1) capped airline rates and charges at a level below total 2008 charges and freeze rates for the first six years, (2) limited future rate increases to inflation for the remainder of the 25-year use agreement, (3) granted the airlines approval rights for capital improvement costs to be included in airline rates, (4) provided strong operat- ing and service performance standards, and (5) gave the airlines sign off rights on the bidders’ qualifications • Under special state legislation that was secured, pri- vate investors who lease Midway would be guaranteed property tax exemptions; however, runways could not be expanded beyond the current boundaries and all city workers directly employed at Midway must be offered substantially similar jobs at comparable pay • On the basis of discussions with potential bidders, the City decided to maintain responsibility for police and fire functions for Midway to mitigate the risks perceived by the potential bidders • Some people believe the only reason the transaction failed to reach financial close was due to the collapse of the debt and equity markets while other people have expressed skepticism on the ability for MIDCo to be able to make a profit, which is why they were unable to get financing • The $2.52 billion bid translated into an EBITDA multi- ple of 28x and might now be viewed as a high-water mark for airport valuations (London City Airport achieved a 30x multiple on the sale to GIP/AIG in 2007 and the failed 40x multiple valuation of a 60% stake in Auckland

87 Inter national Airport by Dubai Aerospace Enterprise also in 2007 was the highest ever and an outlier) Morristown Municipal Airport Type of Transaction: Long-Term Lease/Management Contract Outside the APPP Airport: Morristown Municipal Airport (MMU) Airport Owner: Town of Morristown Private Contractor: DM AIRPORTS, LTD. (DM), an affiliate of the DeMatteis Organizations Objectives: • Pay off $2 million in airport long-term debt • With the aid of federal and state grants, make substan- tial upgrades to the airport’s infrastructure that was in a state of disarray with the airport’s corporate users threatening to leave and the FAA threatening to close the facility if upgrades were not made to the airport • Turn the airport into an economic catalyst for the town and the region Level of Interest: The town studied various proposals and considered several potential developers to run the airport Solicitation Timeline: Proposals entertained during 1981 Contract Execution: December 1981 Contract Duration: 99 years Transaction Value: Annual lease payments to (1) pay annual rent to the town (intended to cover the town’s costs asso- ciated with the airport under DM’s operation, which consist of police services, auditing, and grant administra- tion), (2) pay all outstanding airport debt service when due ($2 million was outstanding), and (3) undertake all capital improvements Transaction Features and Highlights: • DM has wide discretion and is responsible for making decisions regarding the development of MMU (i.e., cap- ital improvement projects) and managing its operation, which includes among other things, negotiating leases, handling staff and services, and setting rates, fees, and charges • The only residual airport controls retained by the town are the signing of airport grants and approval of site plans, but the town is obligated to mutually cooperate with DM in securing such approvals • DM retains all revenues derived from its operation of the airport • The lease also gives DM the right to mortgage all or any portion of its interest in the lease (without the town’s consent) to obtain the most favorable financing needed for airport development • The lease is assignable “without restriction of any kind” • Although DM is the primary interface with the FAA and other federal agencies, the town remains the airport sponsor and must execute grant agreements; however, DM is responsible for all grant compliance • DM initially contracted the management and opera- tion of the airport to an airport management company because it did not have this expertise, but in 1992, after having achieved stability within the airport manage- ment team, DM allowed the contract to expire and hired the airport management staff to work directly for it 9.1 Indianapolis Airport Authority 9.1.1 Transaction Background In the 1990s, Mayor Stephen Goldsmith pursued many privatization initiatives as the City of Indianapolis faced pension funding deficits, unfunded infrastructure needs, and increased competition from suburban municipalities for jobs and wanted to establish Indianapolis as a leader in privatization. In 1994, the Indianapolis Airport Authority, a munici- pal corporation formed in 1962 and governed by an eight member board (with five members appointed by the mayor of Indianapolis), solicited bids to manage its airport sys- tem that included Indianapolis International Airport and five general aviation airports. The authority board created a managed competition committee to oversee a competi- tive bidding process for the rights to operate, maintain, and manage the airport system. Although the board considered an outright sale or lease of the authority’s airports, it decided against doing so because of the difficulty in getting regulatory approval. The winning bidder, BAA Indianapolis LLC, won a 10-year management contract extending from October 1, 1995 through September 30, 2005. The Authority staff participated in the competitive bidding process against four private sector firms, but lost the competi- tion to BAA Indianapolis LLC, a subsidiary of BAA USA, which was a subsidiary of BAA International (collectively BAA). Under the terms of the management contract, BAA was to be compensated on the basis of savings in airline pay- ments per enplaned passenger versus a hypothetical base- line cost defined in the contract. BAA and the Authority agreed to share in the reduction in airline payments per enplaned passenger versus the projected baseline assum- ing no efficiencies were gained. The savings were calculated annually as the difference between the baseline and actual airline payments per enplaned passenger number, times the number of enplaned passengers for that year. The agree- ment provided for BAA to receive 32.5% of the savings as a management fee, subject to a $4 million annual cap, escalated for inflation. The Authority’s share of the savings (67.5%) would accrue to the airlines in the form of reduced

88 rates and charges. (In essence, the airlines were to receive $0.675 of every $1.00 of savings produced by BAA.) During 2002 (and into early 2003), the Authority and BAA negotiated an amendment to the management con- tract, which was contemplated in the seventh year of the contract. Both parties had an incentive at the time to negoti- ate the extension. The Authority was motivated to change the compensation structure, as the annual processes required to calculate the fee became increasingly difficult to adminis- ter. BAA viewed its contract with the Authority as important experience in anticipation of similar opportunities arising in the future, especially after having its management contract for the Harrisburg airport system terminated in mid-2001. BAA also saw the extension as an opportunity to market planning and development services related to the Midfield Terminal redevelopment, which was at the time expected to be completed by 2007. 9.1.2 Objectives The overarching objective for pursuing a management contract by the Airport Authority was to attract new airline service and encourage economic development by reduc- ing airline costs through increased nonairline revenues and reduced operating expenses. Other objectives were to improve customer service and quality and improve the diversity and expertise of airport staff. 9.1.3 Stakeholder Interests Airlines. Airline tenants were primarily interested in reducing rates and charges, maintaining capital project approval (majority-in-interest) rights, and ensuring that any monies generated on airport remained in the airport system and were not diverted to other purposes. While the airlines were opposed in principle to paying management fees for a private operator, they were the beneficiary of efficiencies achieved at the airport as a result of the “residual” methodol- ogy employed for the calculation of airline rates and charges. Notwithstanding this benefit, the airlines regularly ques- tioned the value BAA contributed in relation to its annual fee. Labor. The management contract required BAA to use its best efforts to employ all Authority staff and offer each employee an initial compensation and benefits package similar to what the employee was receiving as an Authority employee. Substantially all Authority staff became employees of BAA. 9.1.4 Outcome Although the Authority initially viewed the managed competition concept as a way to change the way business was conducted over the long term at the airport, the Authority reassumed control of the airport system following the early termination of the agreement in July 2007. In the end, not all of the expectations were met. The Authority acknowledged that BAA was successful in gaining certain efficiencies and conceded that BAA was able to do so more quickly than the Authority may have been able to do so otherwise. There is also general agreement that BAA’s operation was beneficial for staff as a whole, as employees gained broader airport management expertise and the opportunity to interact with colleagues in the United Kingdom. This interaction was valu- able, as it brought to staff the private sector airport manage- ment perspective. BAA assumed operational control in the year that reflected budget cuts implemented by the Authority in advance of the competitive bidding process. Under the terms of the man- agement contract, in which the baseline was projected from the year before the reductions, BAA received the benefit of most of these operating expense cuts. As rental car and ter- minal concession agreements expired, BAA negotiated more favorable financial terms. BAA fully implemented the suc- cessful Pittsburgh “AirMall” concept with street pricing at the airport, which it later introduced at the airports serving Baltimore, Boston, and Cleveland. Although various attempts were made to increase parking revenues with the introduc- tion of new products such as valet parking, most of these ini- tiatives were not deemed to be particularly effective. While BAA did pursue outsourcing of services such as janitorial, in general, the savings were not significantly greater than the contracts the Authority already had in place. Air service marketing efforts were expanded, but without achieving the desired effect of new international service. From the first year of the contract, it became apparent that the compensation methodology prescribed by the agreement would be difficult to administer. Since under the residual air- line ratemaking structure, the airlines ultimately paid BAA’s management fee, they lobbied the Authority to ensure that BAA did not receive the benefits of “windfall improvements” not subject to BAA’s control. To protect its financial interests, BAA spent much time and effort in documenting and esti- mating the effects of its efforts. The financial effect of many of BAA’s initiatives, such as implementing a new customer complaint program for parking operations, employee training programs, and new schedules and other changes to shuttle bus operations, were impossible to measure meaningfully. The structure of the compensation calculation dis- incentivized BAA from implementing any customer service initiative that resulted in increased operating expenses, even though improved customer service was cited as a goal dur- ing the competitive bidding process and was supported by the spirit of the management contract. While the parties attempted in good faith to use a more technical approach to

89 identify appropriate baseline adjustments in the initial years of the contract, the annual compensation calculation eventu- ally became more of a negotiation. The negotiation became more contentious as the baseline projected in 1994 became increasingly meaningless as a result of changes in the airline industry, the economy, and new security requirements as a result of September 11. As noted earlier, the arrangement was terminated under mutual agreement by both parties to provide for (1) an early transition of personnel and operations back to the Authority and (2) a smooth transition in advance of the opening of the new $1.07 billion Midfield Terminal in late 2008. There was no significant change in the operation and management of the airport facilities after the transition. 9.1.5 Lessons Learned Lessons by the stakeholders in the Indianapolis Airport Authority airport system management contract included the following: • Government departments competing in managed compe- tition efforts can be disadvantaged, as regulations generally prevent them from partnering with private firms or guar- anteeing performance. Evaluation criteria may need to be assessed with this potential conflict in mind. • Whatever metrics are used to gauge performance should be transparent and easily measurable. Improvements made by BAA as measured by airline payments per enplaned passen- ger were difficult to track as they required the estimation of a hypothetical baseline comparison (including numerous categories of operating expenses and nonairline revenues, which can be extremely variable from year to year). Over the long-term agreement, especially after the operational changes necessitated by increased security measures fol- lowing the September 11, 2001 terrorist attacks, it became increasingly difficult to estimate meaningfully what the baseline would have been. In this respect, the annual man- agement fee became an annual negotiation between the Authority and BAA and frequently was contentious. • Tracking contract compliance became a substantial under- taking for the Board, which eventually hired professionals with airport and public management expertise to oversee the contract. Much time was spent defining a peer set of airports to use for benchmarking BAA’s performance, with inconclusive results. • Once initial efficiencies had been gained by BAA, it became difficult to make ongoing improvements with effects simi- lar in magnitude. For this reason, a strategy may be to con- tract with a private-sector firm on a short-term basis to gain the majority of potential efficiencies before transferring the operational responsibilities back to the public sector. The Authority-BAA contract worked in this regard to the extent that staff gained broader, international airport manage- ment expertise during the term of the contract. • From BAA’s perspective, once initial efficiencies were attained, it became increasingly difficult to attain further improvements and realize the full value of the manage- ment fee. Moreover, the relatively small maximum annual compensation amount (initially $4 million, reduced later to $1.85 million), while appropriate for a firm that may have viewed the opportunity as a “loss leader” necessary to achieve more lucrative contracts in the future, may not have been enough of an incentive to attain more difficult- to-achieve improvements.80 • When many goals are trying to be achieved through priva- tization, the compensation needs to be tied to each goal. The initial compensation structure for BAA was tied to improvement in one variable—airline payments per enplaned passenger—and not separately to the individual goals the Authority was trying to achieve (e.g., improved customer service and new air service). The amended agree- ment changed the compensation structure so that BAA was compensated for its progress against separate goals, but the new structure may also have been difficult to truly measure efficiencies for the purpose of justifying compensation. • To achieve the full benefits of privatization, it may be more effective to contract with multiple firms specializing in each area in which improvement was targeted. While BAA had successful U.S. experience with concession programs, other firms may have had more expertise in areas such as parking or building maintenance. While the management contract allowed BAA to contract with other firms, BAA often was incentivized to maintain as much control as possible. • With few exceptions, there were no ‘magic solutions’ that could not have been attained under continued public management. When acquiring services on behalf of the Authority, BAA was not released from Authority procure- ment regulations, which is often a large motivation in priva- tization efforts. However, BAA’s procurement of goods with their own operating funds was not considered ‘public’ dollars in the same way as the Authority’s funds. Moreover, BAA employed substantially the same staff as the Authority did before. In the end, BAA’s approach to improve perfor- mance involved typical airport management best practices to increase nonairline revenues with more advantageous contract terms, increase parking revenues without sacri- ficing market share, increase commercial development, and outsource non-core services. Notwithstanding these 80As a point of reference, the management fee for airport management services for Albany International Airport was fixed at $407,286 in 2010, an airport that accommodated 1.3 million enplaned passengers in 2009, compared with IND’s 3.7 million enplaned passengers.

90 industry-accepted approaches, having a private operator involved may have streamlined and improved certain pro- cesses, especially with regard to renegotiating concession, rental car, and other nonairline contracts. 9.2 JFKIAT Terminal 4 9.2.1 Transaction Background JFK International Air Terminal LLC (JFKIAT) was formed in 1997 in partnership with the Port Authority of New York and New Jersey (the “Port Authority”) to build, operate, develop, and manage the $1.4 billion Terminal 4 at John F. Kennedy International Airport (JFK). Terminal 4 replaced the original International Arrivals Building (IAB), which had been built, operated, expanded, and renovated by the Port Authority since 1957. Since the central terminal complex was developed in the late 1950s and early 1960s, the IAB has been the only terminal at JFK not exclusively leased, developed, and operated by airlines. For this reason, the terminal has tradi- tionally housed the operations of numerous foreign-flag air- lines, typically operating with low frequencies. (In November 2010, 38 airlines provided service at Terminal 4.) Recognizing that the IAB no longer functioned efficiently due to insufficient capacity and outdated building systems, the Port Authority initiated in 1993 planning and design studies for its redevelopment. Realizing that the project would require significant capital investment and program management and oversight, the Port Authority decided in 1995 to involve the private sector in the design, construction, and operation of the new facility on the site of the existing IAB. JFKIAT was selected by the Port Authority following a competitive bidding process. JFKIAT was a joint venture of LCOR JFK Airport, LLC, Schiphol USA Inc., and Lehman JFK LLC. JFKIAT assumed responsibility for the operation of the IAB and development of the new state-of-the-art international terminal building in May 1997 shortly after the financial closing of the special facility bonds issued to finance the project. JFKIAT was the first private, nonairline entity to manage an international air terminal in the United States. The 1.5-million square foot terminal opened in May 2001 with two concourses (Concourses A and B) and 16 loading- bridge-equipped gates and an apron capable of accommo- dating up to 24 remotely parked aircraft. Terminal 4 is the largest international terminal in the New York area, with fed- eral inspection services (FIS) facilities capable of processing 3,200 passengers per hour, and provides the only 24-hour FIS facility at JFK. Terminal 4 was generally recognized in the industry as the preeminent example of nonairline, private sector par- ticipation in terminal development and operation, with ben- efits having been realized in increased operating efficiency, enhanced levels of service for passengers and airlines, and reduced operating costs. In August 2010, JFKIAT, the Port Authority, and Delta Air Lines announced a $660 million expansion of Terminal 4 (the 2010 Expansion Project), which includes an extension of Concourse B to include nine additional loading-bridge- equipped gates, new airline lounges, centralized security checkpoints, a secure-side connector to Terminal 2, the demolition of Terminal 3, and expanded remote aircraft park- ing facilities. Construction is expected to begin in the fourth quarter of 2010, with all work to be completed within five years. In 2010, in connection with the proposed redevelopment, Schiphol acquired the LCOR and Lehman ownership stakes to become the sole partner. Subsequently, Delta bought a non-majority, non-controlling stake in JFKIAT in April 2010. 9.2.2 Objectives After the election of George Pataki as New York governor in 1994, political support of privatization initiatives at state agencies increased. In this environment, the Port Authority81 began considering involving private sector participation in its operations. The Terminal 4 redevelopment was identified as an attractive opportunity as its cost comprised approximately one-fourth of the cost of the agency’s 5-year capital program and the Port Authority wished to preserve future funding capacity. Other large-scale construction projects were planned or in process at JFK, including the quadrant roadway recon- figuration and the AirTrain rail transit system, which was to connect the terminal complex with subway and regional rail systems. The financial and management resources required to implement these complex projects along with the redevelop- ment of Terminal 4 provided further encouragement for the agency to explore alternative project delivery methods. Finally, the IAB was operationally intensive, with approximately 230 Port Authority employees staffing the facility at the time. In summary, the Port Authority’s primary objectives in partnering with the private sector to redevelop the IAB in 1997 were: • Preserving financing capacity • Minimizing construction risk and management oversight • Reducing operational responsibilities – Delivering a functional terminal on time and on bud- get with no additional financing required by the Port Authority 81The Port Authority is a bi-state port district established through an intergovernmental contract between the states of New York and New Jersey. The governor of each state appoints 6 members to the Board of Commissioners, which oversees the Port Authority.

91 – Improving operational efficiency and increasing termi- nal capacity by replacing exclusive use arrangements with common use arrangements and new pricing approaches – Gaining PPP experience for possible deployment to other agency operations 9.2.3 Stakeholder Interests Labor. The Port Authority required JFKIAT to inter- view existing staff for possible employment, but JFKIAT was not contractually obligated to employ any staff. The Port Authority guaranteed jobs in other facilities to those not absorbed by JFKIAT and required JFKIAT to include $4 mil- lion in project costs for the Port Authority’s costs in realign- ing the IAB staff, which were mostly early retirement benefits. JFKIAT contracted most services out to third parties in order to realize operating expense efficiencies and the expertise of specialized firms. A number of the Port Authority employees were hired by these third party contractors and many skycaps all went to work for a concessionaire. Airlines. The IAB had historically been served by a large number of foreign-flag airlines, including approxi- mately 45 airlines at the time of the award. Airline interests in the redevelopment of Terminal 4 were divergent, but had the following in common: • Minimizing the disruption of IAB operations during the construction of Terminal 4 • Replacing the aging IAB with an operationally efficient ter- minal capable of accommodating forecast demand • Having certainty with regard to the availability of gate and other facilities for their operations • Minimizing increases in rates and charges • Ensuring levels remained competitive with other JFK terminals • Having the ability to enter into agreements whereby pref- erential rights such as gate assignments and lower rates and charges could be obtained in exchange for guaranteed activity levels • Improving customer service and the passenger experience 9.2.4 Outcome At financial closing (April 1997), JFKIAT intended to enter into a guaranteed maximum price (GMP) contract with its construction contractor with a projected date of beneficial occupancy of December 15, 2000. However, JFKIAT was unable to enter into a GMP contract due to the limited set of construction documents. The project was completed in May 2001 at a construction cost approximately 20% over the bud- geted amount. (The final cost of construction was approxi- mately $1,069 million, compared to an original estimate in 1997 of $876 million.) JFKIAT attributed the cost overruns to (1) staging costs, (2) unforeseen site conditions, (3) subcon- tractor disputes, and (4) architectural design features. JFKIAT was highly motivated to complete the project by May 8, 2001 (the deadline in the lease) because upon DBO it could increase the per passenger rates and realize significant increased rev- enues as well as avoid paying a significant penalty under the lease if not finished by then. Due to the loss of time dealing with the existing conditions, it cost more to accelerate the later stages of construction. The cost overruns required that JFKIAT obtain comple- tion financing, which was provided by the Port Authority through a $172 million subordinate loan as noted above. Since its completion in 2001, Terminal 4 has operated successfully, substantially improving operational efficiency compared with the IAB, in large part due to the new state-of- the-art building, and serving many airline tenants with diverse interests. Its operational and pricing structure has enabled it to respond more proactively to changes in the airline indus- try. As a full common use terminal, Terminal 4 was able to accommodate numerous airlines that operate at relatively low frequencies, thereby increasing utilization versus the IAB. Terminal 4 has also captured an increased share of passen- ger traffic at JFK, with its 13.2% share of passengers enplaned in 1999 increasing to 19.9% in 2009. JFKIAT attributes this increase to the terminal’s increased capacity and ability to accommodate new entrants. The low frequency airlines that are not affiliated with a major airline alliance generally prefer operating from Terminal 4 over other JFK terminals because it is not operated by an airline. While priority use rights are conferred to some contracting airlines, airlines operating from Terminal 4 have greater certainty that their flights will not be “bumped” due to the scheduling decisions of a landlord airline. Airlines also realize efficiencies in the sense that they can separately negotiate operating agreements with JFKIAT with provisions such as term and guaranteed traf- fic levels tailored to their needs, as opposed to negotiating under less flexible terms with the airlines operating the other unit terminals. Internal forecasts of concession revenues that were pre- pared during the planning process were not realized. JFKIAT attributes this shortcoming primarily to the (1) significantly worse-than-expected sales of duty free goods after the aboli- tion of duty free sales for intra-European Union traffic in July 1999, (2) traffic declines after September 11, and (3) passen- ger behavior changes after September 11 due to longer secu- rity checkpoint times. With the increased security measures put into place following the September 11, 2001 terrorist attacks, passenger behavior has changed with reduced pre- security dwell times as the majority of passengers proceed directly to their departure gates after check-in. Most con- cession outlets were located pre-security. This problem was

92 partially addressed by adding concession outlets post secu- rity and was addressed in a more comprehensive manner in the 2010 Expansion Project by consolidating and moving the security checkpoints before the main concession courtyard. JFKIAT has realized savings in operating and maintenance expenses by reducing personnel, outsourcing functions (major maintenance, janitorial and custodial, security, etc.), and introducing efficient work processes. By outsourcing certain services that had traditionally been provided by the Port Authority, JFKIAT was able to reduce in-house head- count by almost 75% (from approximately 230 to 60). Other operating efficiencies such as a building automation system were built into the energy-efficient design of the new termi- nal. The ability to operate outside of Port Authority procure- ment procedures, employment pay scales and contracts, and political influence allowed JFKIAT in many cases to obtain more advantageous contractual terms than could have been obtained by the Port Authority. In the end, JFKIAT had a strong incentive to maximize passenger throughput, “run a tight ship” and “sweat the asset,” as it would retain any excess revenues and operational savings. Terminal 4, which opened in May 2001, underperformed in the first two years of operations (2002–2003), reflecting the difficult operating environment in the early 2000s. The events of September 11, weak economic conditions, outbreak of Severe Acute Respiratory Syndrome (SARS), and Iraq war had a severe effect on international traffic in the United States and at JFK. These unforeseen external factors significantly affected the project’s operating performance. For example, total international passengers at JFK declined 18% between 2000 and 2003. However, since that time Terminal 4 has benefited from a strong recovery in passenger volumes, an associated increase in revenues, and the extension of the debt amortization period for senior and subordinate debt (from 2015 to 2025) as a result of the extension of the City Lease with the Port Authority in 2004. Ultimately, with the 2010 Expansion Project and Delta’s cost-recovery rates, more than half of Terminal 4 now effec- tively operates like other airline-financed terminals at JFK. 9.2.5 Lessons Learned The JFKIAT Terminal 4 project was a first-of-its-kind experiment and as a result has provided some lessons learned by the stakeholders, including: • The ability to access tax-exempt financing made the Terminal 4 redevelopment viable. LCOR estimated the tax-exempt financing provided a roughly 30% discount on private financing. • Although the Port Authority sought to attract private equity in the project, ultimately its access to the tax-exempt bond market on behalf of the developers and the associ- ated lower cost of capital dis-incentivized a large equity investment that would have required higher returns for the developer. JFKIAT’s contribution of $15 million was moti- vated by the Port Authority’s desire that the consortium have “skin in the game.” • JFKIAT was able to successfully experiment with market- based pricing, which very few public airports use. In particular, after the downturn in traffic resulting from September 11 and SARS, as a private entity JFKIAT was able to negotiate special pricing with airlines that could not have been accomplished under typical airport-airline ratemaking agreements. • Normally in the United States, airport terminals are sub- sidized by parking and rental car revenues given the large amount of public space. In this case, Terminal 4 had to stand financially on its own without these subsidies. As a result, the JFKIAT model is not universally transferable to other U.S. airports. It worked at JFK because of the inter- airport terminal capacity limitations, high user rate levels for competing facilities, high percentage of international traffic (which can support substantially higher charges), and ability to charge fixed, profit-based pricing to use the terminal. Therefore, the model may not be readily adapt- able in other locations without some form of subsidy from other nonairline revenues, particularly parking and rental car revenues. This model is best suited to application at large, multi-airline airports with unit terminals. • A frequently cited rationale for involving the private sector in facility development is to obtain construction and pro- gram management expertise and therefore mitigate the risk of cost overruns and schedule delays. While Terminal 4 was completed on-schedule, the final project cost was about 20% higher than the budgeted cost. One of the com- plexities in its development was the requirement to remain operational during construction. • The structure of the financial returns, whereby both the Port Authority and JFKIAT derived residual cash flow value from the project, helped to align a number of their interests. JFKIAT was highly motivated to complete the project as quickly as possible, much like a traditional real estate developer. • Risk avoidance in general is an overarching rationale for privatization. In the case of Terminal 4, however, one might question the magnitude of the “real” risk that was actually assumed by JFKIAT. JFKIAT only invested $15 million in equity, but did invest a great deal of time and effort in the venture as well as risk $33 million in predevelopment expenditures. Regardless of the financial viability of the project, the Port Authority in the end must serve the pub- lic interest of ensuring the busiest international terminal in the region remains operational. JFKIAT, on the other

93 hand, could “walk away” if the operation in its judgment became unfeasible. Ultimately the main risk for the project rested with the bond insurer and bondholders, not JFKIAT or the Port Authority. • Unlike toll road projects where the term of the transac- tion is usually 50 years or more, the relatively short term for this transaction (initially 15 years) limited the amount of equity that could reasonably be bid. Given the limited amount of equity, the return on investment is quite large. • The early years of the lease were the most vulnerable and the Port Authority played an important role in mitigat- ing risk in these early years. When JFKIAT fell upon hard times after September 11 and SARS, in conjunction with the accelerated debt amortization period (prior to the extension of the City Lease) and the need for completion financing, the Port Authority stepped up to assist JFKIAT by amending the lease agreement and providing sub- ordinate financing. Although JFKIAT felt it could access financing from the bond market, the financing provided by the Port Authority provided a win-win solution for both parties as JFKIAT had a credit rating at the time that was below investment grade. The level of cooperation pro- vided by the Port Authority to JFKIAT demonstrated its commitment to the facility and desire for its success. • The long-term lease meant that control over the site and the flexibility to respond to changing market conditions was relinquished by the Port Authority. While this factor was not important in the early years of operation, it became a more important consideration later on. From a customer service perspective, replacing Terminal 3 was a top priority for the Port Authority, and expanding Terminal 4 was the logical and most economically viable solution. However, the Port Authority only had indirect influence on the out- come of negotiations between Delta and JFKIAT, two par- ties with competing financial interests. In the end, Delta’s interest to pay cost-recovery rates and Schiphol’s interest to maintain a good relationship with Delta and its SkyTeam partners were met with Schiphol’s purchase of LCOR’s and Lehman’s stakes in JFKIAT. Although a short-term lease may be more appropriate to protect against industry uncer- tainty, a shorter term would be less attractive to private investors and harder to secure financing. • Key to the success of the Terminal 4 project was the fact that there was no “anchor tenant,” whose needs were driv- ing facility design and development at the expense of other tenants. With no airline having a large share of traffic at the terminal, any organized opposition to the project was difficult. (These dynamics have changed to some degree as a result of the Terminal 4 expansion project and Delta’s preferential-lease status.) • The project has also been successful because it is one of several terminals at JFK that must compete for traffic with other terminals. This competition works to keep rates from becoming unreasonable and to incentivize JFKIAT to run an efficient facility with high customer service standards.82 Competition between terminals minimizes the need for more heavy handed regulation, as JFKIAT must compete for airline customers. • JFKIAT also has a strong incentive to maximize the passen- ger throughput of the terminal based on the per passenger pricing regime and the associated passenger-related con- cession revenues. JFKIAT is also incentivized to minimize operating expenses; however, maximizing revenues in a competitive environment requires high service levels so the incentives are well aligned for both the Port Authority and JFKIAT. 9.3 Boston Terminal A 9.3.1 Transaction Background With political pressure to privatize Boston Logan International Airport and recognizing that a needed rede- velopment of Terminal A would require significant capital investment, the Massachusetts Port Authority (Massport) decided in 1996 to explore private sector involvement in the Terminal A project. Initially, Massport explored a private developer approach for the replacement terminal, but due to state public bidding laws, and the private developers’ requests “to shift risk to the Authority” or for subsidies such as a share of rental car commissions, this approach was deemed infeasi- ble. Massport then began negotiations with Delta to develop the new terminal. New Terminal A was developed under a special facility lease between Massport and Delta and was largely funded with special facility revenue bonds issued in August 2001, which were secured solely by Delta and insured by Ambac Assurance Corporation (Ambac). When the lease was signed on August 16, 2001, the terminal was considered fairly well designed. After the terrorist events of September 11, 2001, Massport and Delta worked together to redesign the terminal to incorporate additional security features and to reduce costs.83 Shortly after the opening of new Terminal A, Delta filed for protection under Chapter 11 of the U.S. Bankruptcy Code on September 14, 2005. To assist Delta in its reorganization efforts and to avoid the potential for costly litigation, Massport, with 82It should also be noted that JFKIAT has the obligation to provide fair and reasonable fees and avoid unjust discrimination pursuant to its lease with the Port Authority, which is responsible for assuring compli- ance of federal statutes, DOT/FAA policy, and FAA grant assurances by its tenants and contractors. 83Dave Bannard, Large Capital Projects, AAAE Airport Magazine, June/ July 2010.

94 the consent of the bond trustee and Ambac, agreed to restruc- ture the original lease and bond trust agreement. Under the restructuring, Massport is not obligated to make the debt service payments on the Terminal A bonds. If pledged facility rentals and associated reserves are insufficient to make the debt service payments, the payments become the responsibility of Ambac under the terms of the bond insur- ance agreement. 9.3.2 Objectives Governor Weld was committed to establishing Massachu- setts as a leader in privatization. Given the political environ- ment, Massport began considering alternatives for private sector participation in its operations. The redevelopment of Terminal A was identified as an attractive opportunity given its significant cost and Massport needed to preserve financing capacity for the Logan Modernization Program as well as its sizable airfield, sound proofing, major maintenance, and the other port facility improvements. 9.3.3 Stakeholder Interests Delta was the largest carrier operating from Logan (in terms of passengers) when Massport started talking to Delta about Terminal A. Delta wanted to continue to expand its operations at Logan and consolidate all of its product lines at that time in one building, which operated from different terminals at that time. Terminal A was the only site that had enough potential to accommodate all these products in one building. In addition, as the first terminal on the entrance road combined with new state-of-the-art facilities, Delta felt the new terminal would give it a competitive advantage over its competitors at Logan. 9.3.4 Outcome Six months after the opening of new Terminal A, Delta filed for protection under Chapter 11 of the U.S. Bankruptcy Code on September 14, 2005. To assist Delta in its reorgani- zation efforts and to avoid the potential for costly litigation, Massport, with the consent of the bond trustee and Ambac, agreed to restructure the original lease and bond trust agree- ment. Delta then signed an amended and restated 10-year lease dated July 1, 2006, reducing the number of aircraft gates it leased in Terminal A and associated space by approximately one-third (from 22 to 14 gates). Massport subsequently leased four of the relinquished gates and two regional air- craft ground loading positions to Continental Airlines, under a 5-year lease agreement (that expires in November 2012). After Delta and Northwest merged, Delta leased the remain- ing gates in Terminal A. 9.3.5 Lessons Learned This hybrid single airline special facility financing had a number of unique characteristics and as a result has provided some interesting and instructive lessons learned, including: • Despite the representations that developers and infra- structure funds are looking for opportunities to invest private capital in airport assets, as was the case for the JFKIAT project, the prospective developers contended that the Terminal A project could not be economically financed without significant access to tax-exempt debt or other airport revenues. • The experiences of Terminal A at Logan and Terminal 4 at JFK highlight the difficulties of financing terminal build- ings, with their high capital and operating costs, without the higher-margin parking and rental car revenues. A ter- minal developed by an airline, such as Terminal A at Logan, may be more feasible as the airline may be solving to mini- mize its overall operating costs rather than seeking satisfac- tory commercial returns on its investment. In the case of Delta, it was able to consolidate its operations that had been spread over two terminals into one building thereby saving on labor and equipment costs. • Each state has its own unique set of laws and regulations. When contemplating privatization options, it is important to undertake a comprehensive review of these laws. Given the unique public bidding requirements in Massachusetts, accessing tax-exempt conduit financing for private devel- opment was deemed infeasible. Once Massport determined that private developers needed the conduit debt, it had to seek other avenues for private participation in the project. • When contemplating a special facility financing on behalf of an airline or other party, an airport owner should be careful to ensure that the lease is a single lease that fits the parameters of a true lease (as opposed to a financing lease). • Logan is primarily an origin-destination (O&D) airport and has a diverse mix of carriers, with no airline account- ing for more than 20% of the passenger share in 2010. Under this type of situation an airport owner should con- sider the desirability of including gate and space take-back provisions, as used in the Terminal A lease, if using special facility debt. Also, an airport should evaluate the merits of maintaining the facility on behalf of the airline (and charg- ing associated rent) and retaining control over the conces- sions (and associated revenues). • With respect to the construction side of the project, the lessons learned are best summarized by Massport’s deputy chief legal counsel assigned to the Terminal A transaction: Take the time to carefully and clearly document the parties’ understanding before commencing the work, but provide for flexibility within that framework; ensure that everyone involved

95 in the project understands what has been agreed upon; maintain continuous communication throughout the project; and craft a structure that aligns all parties’ goals. By taking time upfront, sig- nificant time and money can be saved in the long run.84 • The lease required that Delta make annual maintenance reserve payments so that funds would be set aside for facil- ity renovation, renewal, replacement, or reconstruction, and for unusual or extraordinary maintenance or repairs. This feature addresses concerns about a private tenant turning back a facility at the end of a long-term lease in poor condition. Funds in the Terminal A maintenance reserve account can be dispensed at Massport’s discretion. 9.4 Stewart International Airport 9.4.1 Transaction Background In 1999, Stewart International Airport (SWF) became the first and only85 airport to complete the APPP process. It was operated by a subsidiary of UK-based National Express Group (NEG), under a 99-year lease with the state of New York (the owner). NEG operated the airport from November 1, 1999 through October 31, 2007, when it sold the remaining 91 years of the lease to the Port Authority of New York and New Jersey. Because the Port Authority is a public agency and not a com- mercial entity, the airport was no longer eligible to continue in the APPP under Port Authority control and its participation in the program was terminated. 9.4.2 Objectives Governor George Pataki wanted to be a leader in public asset and operation privatization alternatives and SWF was determined to be a good candidate for privatization. He believed that turning the airport over to the private sector would provide the Hudson Valley region with better air ser- vice, greater economic development, and a strengthened tax base. Therefore, the primary motivations were to (1) lever- age the expertise of the private sector to develop the under- utilized airport to its fullest potential and (2) develop the real estate on the vast site to create jobs and economic develop- ment, which was a priority for the Hudson River Valley due to large industrial concerns laying off workers and closing plants at the time. The RFP gave the bidders the option of proposing on (1) the airport, (2) just the undeveloped land (approximately 5,600 acres), or (3) both. In addition, it was recognized that managing airports was not a “core business” for the state and the New York Department of Transportation (NYSDOT) was continually funding SWF with no prospect of financial return. Finally, the certain parties to the transaction felt that NEG would turn the airport around, develop Stewart to its full- est potential, and consummate a landmark transaction that would become a model for airport privatization throughout the country. 9.4.3 Stakeholder Interests Airlines. The airlines declined to approve NYSDOT’s request for an exemption to use airport revenue for general purposes because they were concerned that granting the exemption for SWF would establish a precedent that could be used in the privatization of larger airports. Therefore, when filing its final APPP application for SWF, NYSDOT did not request an exemption for use of airport revenue for general purposes. Labor. Under the APPP statute, all collective bargaining agreements covering airport employees that are in effect on the date of the sale or lease of the airport cannot be abrogated by the sale or lease. Therefore, NYSDOT required NEG to develop a plan offering existing NYSDOT employees at the airport the option to remain in the employment of NYSDOT or to receive an offer of employment with NEG. One of the conditions of the lease was to retain the State Troopers as the airport security to avoid labor issues. NYSDOT contracted with Air Group International (AGI) to operate the airport under a management contract. In addition, the parking operations were contracted to another private entity and NYSDOT leased the airport’s cargo facili- ties. While the ownership of SWF resided with NYSDOT, a significant amount of SWF operations were outsourced to contractors. Community. The goals of the Stewart Airport Commis- sion (SAC), which acts in an advisory only capacity and has no governance authority over the airport, were and continue to be (1) improve passenger air service and (2) contribute to the region’s economic development. Under the lease, NEG was required to meet on a regular basis with SAC. 9.4.4 Outcome Shortly before the beginning of the lease term in November 1999, NEG approached NYSDOT asking to be relieved of its lease obligations. Apparently, NEG had already started think- ing about getting out of the airport business to focus on its core business in the bus and rail sectors, and in February 2001 sold its only other airport operations (3 airports in England). NYSDOT refused the request and NEG proceeded 84Dave Bannard, Large Capital Projects, AAAE Airport Magazine, June/ July 2010. 85As of November 2011.

96 as contracted to take over SWF operations. Moreover, the SWF transaction prohibited the sale of the lease to another party for 5 years, or until November 1, 2004. NEG hired an experienced airport manager to run SWF who was not an employee of NEG but was a contractor. The airport manager continued in that position until the airport lease was taken over by the Port Authority and reported to NEG’s U.S. subsidiary, which was a large bus operation. SWF had to perform as a competitive business enterprise within the NEG family of companies. Ongoing corporate investments and initiatives had to be justified by reasonable expectation of a satisfactory financial return over the life of the investment. Potential SWF investments also had to compete with poten- tial rail and bus investments within NEG’s capital portfolio. Beyond the lease commitments, investments at SWF had to be as good as or better than alternative NEG investments. NEG took over operations roughly 10 months before the terrorist events of September 11 and managed SWF during a difficult period for regional airports. It competed successfully for AIP grants and worked to attract real estate development and airline service, including JetBlue and AirTran (which subsequently exited the market). In terms of the profits from airport operations, the FAA concluded that despite a steady decline in passengers after NEG took over operation, NEG’s profit was similar to that achieved by NYSDOT under its last full year of operation, which was likely a result of operating efficiencies achieved by NEG.86 Although the SWF privatization did not materially improve passenger air service, it did continue economic development activity related to the airport and was able to accelerate con- struction projects relative to public operation. 9.4.5 Lessons Learned SWF’s entry and exit from the APPP provided a first-of- its-kind experiment and as a result has provided some inter- esting and instructive lessons, including: • As demonstrated by other case studies, strong political commitment was necessary to achieve privatization. The reason the initial privatization process succeeded was because Governor Pataki was a strong political champion. • Navigating through the APPP process took the state consid- erable time and resources (as it did for the city of Chicago). It took 34 months from the time NYSDOT submitted its preliminary application to the FAA until the FAA issued its record of decision approving the transaction. The pro- cess included preparing the preliminary APPP application, developing the RFP, evaluating the responses, selecting an operator, drafting and negotiating the complex lease terms, preparing the final APPP application, managing public participation, securing local approvals, and building politi- cal support. In considering the timeline, it is important to remember that there are both federal and local requirements. In the case of the SWF privatization, local approvals were required from labor groups, the state attorney general, and state controller, among others. It is important to remember, too, that this was the very first such transaction in the U.S., undoubtedly adding to the length of time required. • Although the state and NEG thought it was reasonable to include the cost of capital in the airline rates over and above allowances for inflation without having to seek airline approval under the APPP, the FAA said that rates could not increase faster than the rate of inflation with- out airline approval. • For-profit private companies must make strategic deci- sions in the interests of their shareholders, which may not always be in the best interests of the airport community. After operating the airport for 7 years, NEG was no longer interested in investing resources in airports. NEG exited the airport industry and concentrated on its core rail and bus businesses. There was no appetite to invest seed money into the airport because NEG was looking for an immedi- ate financial return. As a result, total operating revenue remained flat at best during the NEG operation. NEG ful- filled its lease requirements, but the original enthusiasm and energy for the business waned, and the state was dis- appointed that additional investments did not materialize. There is no guarantee that the private airport operator will achieve financial success, retain interest in the business, or be successful in its execution. Therefore, the challenge in structuring a successful transaction is to align the interests of the private company with the appropriate incentives. • NEG paid $35 million in lease payments and made $10 mil- lion in capital contributions at SWF. It did not materially improve SWF’s financial performance during its tenure, in part due to the significant cutbacks in air service after September 11, and in part due to the realignment of the company’s strategic priorities. It is likely that NEG did not realize the return on its investment as expected during its operation of the airport. In addition, NEG was facing a 5% of gross income lease payment beginning on the 10th anni- versary that would further dilute its earnings. NEG sold the lease after 7 years of operation to the Port Authority for $78.5 million, allowing it to recover its investments and realize a significant capital gain, which was not plowed back into airport improvements. • One of the intentions of the APPP was to evaluate the poten- tial for new private sector investment in airports through privatization. Indeed NEG invested $10 million of its own funds into SWF capital development, but it also received a 86U.S. Department of Transportation, Federal Aviation Administration, Report to Congress on the Status of the Airport Privatization Pilot Program, August 2004.

97 significant return on that investment and its $35 million lease payment from the sale of the remaining leasehold interest. • While there was significant economic development asso- ciated with SWF during the privatized period, the com- munity’s principal goal of improved air service was not achieved. There is only so much a regional airport opera- tor can do to entice sustainable air service. Some believe that the Port Authority has considerably more leverage to entice airline service at SWF due to its control over JFK, LaGuardia, and Newark airports, and its ability under fed- eral law to potentially cross-subsidize the facility. However, this remains to be seen. • One of the reasons NEG’s bid was considered the most attractive was due to its plans to operate express bus service between New York City and SWF similar to the services it operates linking the London airports. It was expected that the SWF bus service would stimulate low fare service from the airport; however, the bus service plan was never implemented. • SWF was improved on the margin by NEG due to the new leases and commercial development; however, the airport experienced significant challenges before, during, and after privatization—enplaned passenger traffic peaked in 1997 at 435,000, troughed in 2002 after September 11 at 170,000, peaked again in 2008 at 446,000, and then declined sharply again in 2009 to 187,000. Neither privatization nor public operation is a panacea for an airport that experiences chal- lenges attracting demand. • The state’s 5-year prohibition from selling the lease worked well. It was designed to prohibit the bidder from flipping the airport for a profit shortly after the transaction. • The Port Authority has the resources and capacity to make large investments in SWF to implement a long-term vision without expecting short-term financial returns. It does not have to justify its SWF investments and initiatives on a current business basis. As such, the Port Authority has the flexibility to implement a longer-term vision of SWF as a significant reliever airport for the greater New York area by making the infrastructure improvements and offering the marketing and financial incentives to achieve this vision. • A more local governance structure, such as ownership by the county, towns, or airport authority, may have been more involved in airport operations and management than a state department. 9.5 Chicago Midway International Airport 9.5.1 Transaction Background The proposed long-term lease of Chicago Midway International Airport (Midway) to a private firm was by far the largest proposed airport privatization in the United States and was posited to be a landmark transaction as the first priva- tization of a major commercial airport in the United States. In addition, the city of Chicago was the only applicant in the history of the APPP that was able to secure airline approvals for its application, which is needed for the city to use the lease revenues for non-airport purposes. In 2005, the city secured state legislation to extend the airport’s exemption from property taxes to a private owner, which paved the way for the transaction and committed the city to use 90% of the net proceeds to finance infrastruc- ture work or up to 45% of the net proceeds to shore up the city’s $9 billion (at the time) unfunded pension liability. These commitments were needed to secure the support of the powerful Chicago Federation of Labor. In October 2006, the city secured the only large-hub slot under the APPP. In February 2008, the city secured airline approvals for its APPP and immediately issued a request for qualifications (RFQ) for bidders. Bids were received on September 30, 2008 two weeks after Lehman Brothers Holdings collapsed (September 16), which triggered the global credit crisis. When the private consortium was unable to come up with the full up-front rent payment under the lease (purchase price) of $2.521 bil- lion in April 2009, the deal fell through and the consortium had to pay a $126-million breakup fee to the city, of which $75 million had been posted as collateral after city council approved the lease. Since that time, the FAA has granted the city’s requests for more time to complete the deal through a series of extensions to maintain its spot in the APPP. 9.5.2 Objectives The city began exploring the privatization of Midway Airport soon after it announced its $1.83 billion 99-year lease of the Chicago Skyway Toll Bridge System in October 2004, a deal considered the first long-term, major PPP involving an existing asset in the U.S. and which closed in January, 2005. Subsequently, the city entered into a long-term lease on its downtown parking garages in a $563 million deal which closed in December, 2006. In February, 2009, the City also leased its parking meter system for $1.15 billion. The primary motivation for the Midway transaction was to get “value out of the airport” by leasing the airport on a long- term basis to a private operator and using the proceeds for the city’s unfunded pension liability, infrastructure improve- ments, and other general fund purposes. Also as stated in the February 2008 RFQ, the city’s primary objectives were: Protect the Public Interest • Maintain the highest levels of public and passenger safety and security • Protect the public interest within the context of seeking value for the City and the airlines

98 • Establish a new framework of rates and charges that pro- vides lower and more predictable rates for airlines operat- ing at the Airport • Improve the competitive position, service quality, growth prospects and efficiency of Midway Airport for the benefit of Chicago residents, airlines and other users Risk Adjusted Value Optimization • Maximize sale proceeds • Ensure that future Airport development is safe, functional, efficient and delivered when necessary • Minimize the City’s exposure to residual risks and liabili- ties from the process Fair and Transparent Process • Protect the reasonable interests of current and future air- line users • Ensure fair and equitable treatment of existing Airport employees • Ensure a smooth transition from public to private man- agement in a timely manner 9.5.3 Stakeholder Interests Airlines. Under the APPP, in order for the city to apply lease revenues from the transaction for general city purposes, the lease must receive the approval of both 65% of the airlines operating at Midway and airlines representing 65% of the annual landed weight. This provision gave all Midway carri- ers, especially Southwest with 84.4% of the passenger market share in 2008, considerable bargaining power. The city and Southwest Airlines negotiated an agreement that would have generated millions of dollars in net pres- ent value savings for the airlines serving Midway. The use agreement would have extended through 2033, with five-year renewals afterward. Specifically, the deal won airline approval because it would: • Cap airline rates and charges at a level below total 2008 charges and freeze rates for the first six years. It should be noted that the residual airline rates that were in effect at that time did not include amortization of principal on the bonds issued to finance the terminal redevelopment. Therefore, the airlines would have been able to lock in very favorable rates before they spiked. Airline CPE ranged from $3.38–$7.55 from 2004–2009, with the high occur- ring in 2009. However, the budgeted CPE in 2010 increased sharply to $11.39, which had been planned due to the defer- ral of principal amortization and expiration of the applica- tion of Letter of Intent grants to debt service. The airport also projected CPE to increase sharply again in 2011, to $14.63, but remain near that level through 2018. • Limit future rate increases to inflation for the remainder of the 25-year use agreement. • Grant the airlines approval rights for capital improvement costs to be included in airline rates (i.e., the cost of ongoing capital projects would be added to annual airline charges only after airline approval). • Provide strong operating and service performance stan- dards, including a capital asset maintenance plan, capi- tal improvement program report, and five-year capital improvement program that must be developed on an annual basis by the private operator and submitted to the city and the airlines for approval by the city and a majority- in-interest by the airlines. These reports would define and describe the planned rehabilitation, replacement, and reconstruction capital requirements. • Transfer the risk of operations and maintenance costs from the airlines to the private operator. • Give the airlines sign off rights on the bidders’ qualifications. Not only would the transaction have provided the air- lines considerable net present value savings (especially in the near term), but it would have also provided stable, predict- able rates and charges, which is one of the airlines’ biggest concerns. The airlines also wanted to maintain the Midway Airlines Terminal Consortium (MATCO), which was formed to oper- ate and manage the terminal airline equipment and systems, including pre-conditioned air systems, aircraft ground power- 400Hz system, passenger loading bridges, potable water cabi- nets, baggage handling systems, MUFIDS, battery charging, security checkpoint equipment, and aircraft fueling systems. Labor. The city won the support of unions by ensuring that current employees would be offered jobs with similar pay and benefits in any lease. The city’s commitment to use the net proceeds to fund pensions and infrastructure also helped. The Illinois legislation that allowed the city to lease Midway requires the private operator to pay employees “an amount not less than the economic equivalent of the stan- dard of wages and benefits enjoyed by the lessor’s employ- ees who previously performed that work.” In addition, the private operator and the city must offer employment “under substantially similar terms and conditions” to municipal employees working at the airport. There is also a labor neu- trality and card check agreement covering unrepresented workers.87 It is important to note that the city was willing to 87In 2006, the Illinois General Assembly enacted Public Act 94-750, which provides for certain requirements that must be satisfied in con- nection with the privatization of Midway. These requirements relate to labor relations and employee protections; continued compliance with applicable ordinances governing contracting with minority-owned and women-owned businesses, prohibiting discrimination and requir- ing appropriate affirmative action; and application of the net proceeds of the privatization by the city.

99 offer the employees positions elsewhere in city government, which may not be an option in other situations. Community. In order to maintain Midway’s property tax-exempt status under private operation, the city had to negotiate with the state legislature. The tax-exempt status was considered necessary for the transaction to be economically viable and as such was a front end activity. In addition to the labor protections noted above, the state legislation also: • Required that at least 90% of the proceeds from the lease be used for infrastructure construction and maintenance and for contributions to the municipal employee pension funds. • Prohibited the expansion of any of the Midway runways.88 Potential Bidders. The city also met several times with potential bidders to learn about their interests and concerns to design a solicitation that met their needs. Through these discussions, it was determined that the city would need to maintain the police and fire functions for Midway to mitigate the risks perceived by the potential bidders. 9.5.4 Outcome The consortium of investors led by Citigroup Inc., a unit of Vancouver International Airport, and John Hancock Life Insurance Co. submitted the highest bid ($2.521 billion) to lease Midway in September 2008. The winning consortium was called Midway Investment and Development Company LLC (MIDCo). In the context of the global financial crisis, MIDCo was unable to raise the entire purchase price for the lease by the city’s deadline in April 2009 and as a result for- feited the $126 million in earnest money it posted to the city. People involved with the Midway transaction trumpeted its merits and win-win proposition to all stakeholders. They believe the only reason the transaction failed to reach finan- cial close was due to the collapse of the debt and equity mar- kets. Others have expressed concerns about the precedents set in terms of the amount of the bid proposal of the winning bidder and the favorable provisions in the airline agreement. They fear that other policy makers will expect to realize the same multiples (28 times revenues) and that the airlines will see the Midway lease as the benchmark for future privati- zation transactions even though the conditions are different for every airport. A number of people have expressed skepti- cism on the ability for MIDCo to be able to make a profit given the amount of the bid, the rate caps under the airline use agreement, the relatively well-developed terminal retail program, the operating efficiencies introduced by the city in 2009, the limited potential for land development, and limita- tions on passenger throughput growth due to the prohibition on runway expansion and lack of land for terminal expan- sion. A preliminary assessment would suggest that the highly leveraged environment existing before the collapse of the global markets had fueled unrealistic prices and expectations for some underlying assets whose values have since waned. 9.5.5 Lessons Learned This case study has provided some important lessons learned by the stakeholders, including: • A successful APPP application process requires strong political support and leadership. The city of Chicago had that in Mayor Richard M. Daley. There was also a very sup- portive administration in Washington, D.C., and there was political momentum from the large bid on the Skyway deal. • Going through the APPP is lengthy, complex, and time- consuming and can be an expensive process. The rewards to the airport owner can be potentially large, but success is not guaranteed. Any public sponsor should consider the level of effort, expense, and risk before applying. • Privatizing an airport under the APPP in the United States is far more complicated than privatizing toll roads or parking facilities given the highly regulated environment, complexities involved in operating an airport, the pace of technological changes affecting airports, and the multiple approvals needed, including the FAA, TSA, CFIUS (if the sale or lease of the airport is to a private operator that is a foreign entity89), labor, and airlines (if revenue is to be used for non-airport purposes) in addition to the local approval requirements (e.g., city council). • It is important to include in the airport’s privatization team technical advisors given the extensive and complex legal, financial, operational, and regulatory issues involved in the airport industry. The city had very capable external advi- sors and engaged airport staff productively in the opera- tional issues. • The goals for the privatization should be clearly articulated. The city’s goals were always transparent and well-articulated, which helped eliminate resistance to the transaction. • It is important to estimate the expected net proceeds early in the process to know if the transaction can yield positive benefits. The city retained financial advisors to run various scenarios to assist it in making the decision to go forward with the transaction.88The airport is located in a densely developed section of the city, includ- ing residential development. Also, in December 2005, a Southwest Airlines aircraft slid off a runway at Midway while landing in a snow- storm and crashed into automobile traffic, killing a six-year-old boy. 89Due to the lack of airport privatization in the United States most of the potential bidders tend to be global infrastructure specialists.

100 • The public sponsor needs to get key stakeholders on board early, including labor and airlines, to maximize the poten- tial for success. • Transparency and public outreach are important. The FAA sets up public dockets that contain valuable information, but local residents often are not aware of this resource. In the case of Midway, where homes are as close as 30 feet from the airport boundary, the local community was very supportive because the local community understood the economic value of the airport.90 • Maintaining property tax exemptions under private oper- ation of a long-term lease was important for the economics of the deal or would otherwise need to be reflected in the valuation of the airport. • Oversight and performance standards were important to include in the operator’s concession lease and they were coordinated with the airlines. The operator would be held accountable. • The length of a lease needs to be considered carefully. Initially it was expected that the Midway lease would be for “50 years or more” as U.S. accounting rules dictate that, for expenses to be deducted by the lessee, the length of the lease needs to equate to the remaining economic life of the asset, and this deal was approved for a term of 99 years to maximize the up-front lease payment to the City. The level of equity investment is tied to the term, which falls off dra- matically with shorter terms. On the other hand, with long- term leases it is important to ensure the operator does not neglect the asset in the final years of the lease. This is why the Midway operator was required to prepare a capital asset maintenance plan, capital improvement program report, and five-year capital improvement program each year and submit them to the city and the airlines for approval. • The city was not in a position to offer tax-exempt financ- ing to the bidders, which is one way to substantially lower the amount of financing needed by private investors (as shown in the JFKIAT case study). This is because in order to qualify for the federal tax exemption, the asset must be governmentally owned, which means the term of the lease cannot be greater than 80% of the useful life of the asset. As noted above, privatization models push for longer terms. In addition, under IRS regulations, tax-exempt bonds can- not be used to acquire existing assets unless at least 15% of the proceeds are used for rehabilitation expenditures for buildings associated with the property.91 • Privatization through the APPP is not a solution for every airport. It was attempted by the City of Chicago because it allowed for the net proceeds paid up-front under the lease to be used off-airport. However, and as best expressed by Amy Weaver of Southwest Airlines who participated in the Midway transaction, The APPP outlines a practical, effective process for privatiza- tion. Airports, airlines and any other players need to remember that each privatization deal is unique . . . The pilot program is flexible enough to accommodate . . . unique qualities.92 One of the reasons the airline rates could be frozen for the first six years at Midway was because the city had just completed a major terminal redevelopment program and the APPP rules provide airlines with negotiating leverage. 9.6 Morristown Municipal Airport 9.6.1 Transaction Background Morristown Municipal Airport (MMU) is a general avia- tion airport that is owned by the Town of Morristown and has been managed and developed by DM AIRPORTS, LTD. (DM), an affiliate of the DeMatteis Organizations, since 1982 under a comprehensive long-term lease. The airport is located in Hanover Township in Northern New Jersey in close proximity to New York City. MMU provides services for businesses located in Morris County where approximately 50 of the nation’s Fortune 500 com- panies are either headquartered or have major facilities. As a result, MMU has a significant number of high-end users at the airport and competes primarily with Teterboro Airport and Westchester County Airport for business. Therefore, DM is highly incentivized to provide strong customer ser- vice at reasonable prices to its clientele and offers special aviation enhancements. The Agreement of Lease between the town and DM was entered into in December 1981 with a term of 99 years commencing on May 1, 1982 and extending through April 30, 2081. Under the long-term lease, the town granted the full management and development control of the airport to DM in return for DM (1) paying annual rent to the town, (2) paying all outstanding airport debt service when due, and (3) undertaking all capital improvements. As such, DM has wide discretion and is responsible for making decisions regarding the development of MMU (i.e., capital improve- ment projects) and managing its operation, which includes among other things, negotiating leases, handling staff and services, and setting rates, fees, and charges. The only resid- ual airport controls retained by the town are the signing of 90Interview with Erin O’Donnell, Managing Deputy Commissioner of Chicago Midway International, September 20, 2010. 9126 USC 147—Sec. 147. Other requirements applicable to certain pri- vate activity bonds. 92Amy Weaver, Southwest Airlines says Midway indicates privatization can fly in the United States, HNTB Aviation Insight, Spring 2010.

101 airport grants and approval of site plans, but the town is obligated to mutually cooperate with DM in securing such approvals. DM retains all revenues derived from its operation of the airport. The 99-year term of the lease was deemed necessary for DM to recover its payment of the town’s outstanding airport debt and its investment in upgrading existing facilities and constructing new ones. DM also has responsibility for all air- port repairs, maintenance, and operations (except police ser- vices which are provided by the town) and compliance with all governmental regulations. In addition, DM is responsible for obtaining at its own cost all site plan approvals and zoning approvals and permits for airport development with the full cooperation of the town. The lease gives DM great flexibility in carrying out its charge of operating the airport as a public airport subject to all applicable laws, regulations and agreements, including compliance with FAA grant assurances. The lease also gives DM the right to mortgage all or any portion of its interest in the lease (without the town’s con- sent) to obtain the most favorable financing needed for airport development. In addition, the lease is assignable “without restriction of any kind.” Airport users pay fees and charges directly to DM and DM assumes the risk involved in covering both operating and capital costs out of those revenues. It is important to note that the Morristown privatiza- tion occurred before the FAA promulgated its revenue use policy and before the creation of the APPP. Therefore, it is not reasonable to expect to be able to repeat this expe- rience because the federal rules are much stricter now. Nevertheless, the lease served as a model for the Stewart lease under the APPP. 9.6.2 Objectives In 1981, after operating the airport unprofitably for many years, the town had accumulated over $2 million in debt for airport capital improvements even though its infra- structure was in a state of disarray. The airport’s corporate users were threatening to leave because the airport and the FAA was threatening to close the facility if upgrades were not made. The town recognized it did not have the talent on staff to run the airport properly and looked to a private company to operate and manage it on their behalf, pay off the debt, and make the necessary capital improvements to appease the FAA and tenants. After careful consideration, the town concluded that the airport could be better oper- ated and developed by a private entity. The town studied various proposals and considered several potential devel- opers to run the airport. Therefore, the primary objectives in the MMU privatiza- tion were to: • Pay off $2 million in airport long-term debt. • Make substantial upgrades to the airport’s infrastructure with the aid of federal and state grants, which was in a state of disarray. • Turn the airport into an economic catalyst for the town and the region. 9.6.3 Stakeholder Interests Labor. When DM took over operation of the airport in 1981, there were approximately 35 employees on the airport payroll. The maintenance and operations staff was offered positions by DM, but most of the senior employees moved to positions within the town government to maintain their municipal status and pension benefits. Local Government. The management contract has served the Town of Morristown well. The town’s only responsibili- ties for the airport are police protection, emergency medi- cal response, grant administration and audits, and site plan approvals. DM converted a facility in a state of disrepair into an economic engine by investing in the airport’s infrastructure and providing a high level of service to the users. This arrange- ment has also worked well for Hanover Township, where the airport is located, because DM must pay land taxes to the township unlike a municipal operator. Community. DM is responsible for all interactions with the community with regard to the airport. Morris County views MMU as a critical community asset for retaining and attracting business. Therefore, the Morris County Freeholders93 estab- lished an Airport Advisory Committee in 2003 to interact with DM and MMU tenants, which meets on a bi-monthly basis (but only if there is business to discuss). Although this com- mittee has no jurisdiction over the airport or DM, it has been instrumental in bringing together residents, pilots, govern- ment officials, and airport personnel to address noise issues at MMU, among other issues. It also helps DM to build goodwill with the community. Tenants. DM also actively engages airport tenants through various channels. The Morristown Aviation Association (MAA) is an association of mostly airport tenants and some transients that was established to provide a forum for tenant interaction. DM jointly sponsors a periodic publication on airport updates with the MAA and the Morristown Airport Pilots Association. 93In New Jersey, county legislators are called “Freeholders.”

102 MMU also has U.S. Customs and Border Protection ser- vices for international flights. Because MMU does not have sufficient volume to justify a federal agent being assigned to the airport, the tenants decided to set up a user fee association to pay for one. DM administers the user fee service on behalf of the Morristown Airport Customs Association. Tenants and transients pay to clear with higher rates for transients and non-members. Entities who clear frequently often become a member of the Association. The tenants also decided they wanted ARFF even though MMU is not a Part 139 airport94 and ARFF is not required because of the high-end aircraft they use. Like customs, ARFF is not a cost responsibility of DM, but instead is funded by a surcharge on fuel flowage per gallon. However, DM puts out to bid and administers the ARFF contract. The FAA funded 95% of the cost of the ARFF station through an AIP grant as well as 95% of the cost of the first ARFF vehicle (up to Index A). The tenants paid for the cost of a second vehicle through the fuel flowage surcharge because the FAA said it would not support an Index B service. 9.6.4 Outcome DM initially entered into the long-term lease for the air- port based on the potential for commercial development on and around the airport. DM had plans to develop property for commercial, hotel, office, industrial and/or manufactur- ing purposes. However, subsequently, wetland limitations and the taking of 11 acres of airport property for expansion of Route 24 eliminated the expected potential for commercial land development.95 Although DM had the option to termi- nate the long-term lease due to this land taking, it concluded that it could continue to successfully operate the airport without this developable property. DM paid off the airport long-term debt, made substan- tial upgrades to the airport with the aid of federal and state grants, and turned the airport into an economic catalyst for the town and the region. Over the first 28 years of operations (1982—2010), DM has: • Implemented capital improvements and provided the necessary facilities and services to meet aviation market demand • Improved customer service at the airport by providing superior facilities and services at competitive rates • Helped organize, manage, and participate in tenant cus- tomer service programs (e.g., the U.S. Customs and Border Protection and ARFF services) • Marketed the airport’s desirable location and high-end facilities to retain and attract customers for the benefit of the local economy • Transformed MMU into a financially self-sustaining, competitive facility for the region • Elevated MMU’s position to be one of the two premier general aviation airport in northern New Jersey, with Teterboro as the other • Fostered strong community relations by promoting the airport and engaging its tenants, the Morris County Freeholders, the local chamber of commerce, and other stakeholders • Established a corporate identity for the airport through participation in aviation trade association events and con- ferences and marketing efforts, including its user friendly website • Turned MMU into an economic engine for the town and the region By contrast, as noted earlier, under the town’s operation, the FAA was threatening to shut the airport down due to its state of disrepair. 9.6.5 Lessons Learned The case study for MMU provides helpful background for any airport considering full privatization outside the APPP, in particular for a general aviation airport. However, it should be noted that the 99-year lease was entered into before the FAA formalized much of its policy regarding airport revenue use and full privatization outside the APPP. • The MMU long-term lease did not require any special fed- eral or state legislation (such as the APPP). • However, like the JFKIAT Terminal 4 project, there appear to be special circumstances that make the MMU experiment successful, in particular the demand for high-end general aviation users. Although DM has been approached by sev- eral other airports, DM has declined these offers because the market was not there for a viable business opportunity, suggesting that the business climate in Morristown is some- what unique. • The DeMatteis Organizations learned that once a profes- sional staff was in place and successfully operating the airport it was no longer necessary to contract out the air- port management and therefore was able to save money by no longer having to pay the annual management fee. • According to DM, privatization allows for a more efficient and effective way to operate the airport. Decisions can be 94Although not required, some large GA airports do have 139 certifi- cates, which greatly affects staffing and operating expenses. 95As a result of the land taking, DM’s annual base rent was abated slightly. In addition, there was a negotiated settlement on the value of the land that was taken, which was shared approximately 80% by the town and 20% by DM.

103 made in a timely manner. Moreover, bureaucracy, politics, and competing funding priorities do not factor into the business decisions. Unlike the Indianapolis management contract, DM is not required to adhere to local municipal procurement regulations, which allows for greater operat- ing efficiencies and speedier delivery of services. • Due to the nature of the agreement (in particular its term and development responsibilities), DM pays land and improve- ment taxes to Hanover Township. Typically, public airport owners/operators do not pay property taxes. Therefore, this type of privatization allows a local municipality (other than the owner) to derive incremental tax revenues. • Community outreach is important for airports. Although not mandated in the lease, DM actively and successfully engages the community and its tenants. This is an area for possible improvement in a lease in the event the lessee was not as committed to the airport and its rapport with the community. • The lease does not include specific oversight and perfor- mance standards. This would typically be included in a long- term lease or management contract of this type. However, given the competitive nature of high-end general aviation use in the New York metropolitan area, DM is incentivized to provide a high level product. • The term of a long-term agreement, where the public sponsor grants full management and development control to the operator in return for the operator undertaking full capital improvements, needs to be considered carefully. Where significant airport development is anticipated, the term of the lease should be related to the length of time needed by the operator to recover its investment. In this case it was felt that a 99-year lease was needed due to DM’s obligation to defease the $2 million in outstanding airport debt and make the necessary improvements to the airport. Whether a 99-year lease is necessary or appropriate for a similar deal should be carefully considered. DM pays a relatively modest annual rent for the privilege of retaining all airport fees and charges in return for taking on the risk to cover operating expenses and capital expenditures (net of grants) out of those revenues. • The form of compensation–upfront lump sum versus annual rent–is also something to be carefully considered and evaluated. The town decided to take the annual rent to cover its cost to provide continuing police, emergency medical, and grant administration services for the airport. By comparison, the city of Chicago opted for an upfront payment and set aside funds for its ongoing obligation to provide police and fire protection for Midway Airport. • The lease does not have definable requirements for main- taining the airport other than “maintain the Airport in rea- sonably good operating condition subject to deterioration caused by wear and tear” and there is no obligation to set aside funds towards the end of its term to make sure the asset is in good condition when the lease expires. For exam- ple, under the proposed 99-year Midway lease the operator was required to prepare a capital asset maintenance plan, capital improvement program report, and five-year capital improvement program each year and submit them to the city and the airlines for approval. While DM has done a good job maintaining the airport after 28 years of steward- ship, there could be stronger requirements in the lease about maintaining the airport in the later years of the term.