Considering and Evaluating Airport Privatization (2012)

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10 2.1 Privatization Continuum and Generic Models The term “airport privatization” is often understood to mean the transfer of an entire airport to private operation and/or ownership, but privatization does not have to be an all-or-nothing approach. Private sector involvement at air- ports can take many forms. Privatization refers to the shift- ing of governmental functions, responsibilities, control, and in some cases ownership, in whole or in part, to the private sector. Figure 2.1 illustrates the potential range of strategies avail- able for private sector participation in airport management, operation, and development. The range extends from the least level of private involvement to the most private sector involvement. A key distinction is made between: • Full Privatization—Full privatization refers to strategies where the full control and/or operation of an entire airport are vested with a private entity, including the long-term lease or sale, whether through the APPP or otherwise. As noted above, APPP is a program under which a long-term lease or sale can occur with full control vested in the pri- vate operator except for certain residual powers retained by the airport owner. • Partial Privatization—Partial privatization refers to all other strategies where partial control and full ownership of an airport remains vested with the public owner. The generic models are summarized below. All but pri- vate airport development are considered to be a form of privatization. • Service Contracts—Airport owners routinely contract out to the private sector certain airport services traditionally provided by government or internal employees in order to (1) achieve operating efficiencies through outsourcing the operation of functions that readily are available through the private sector (e.g., janitorial, escalator/ elevator repair, non-police security, parking operations), (2) enhance nonairline revenue (e.g., terminal concessions), or (3) provide project design and delivery (e.g., construc- tion management and program management) for capital improvements. • Management Contracts—Under a management contract, a private entity manages an airport or certain airport facil- ities for a specified period of time and typically provides little or no capital investment. The private manager’s objec- tive is to improve the financial and operational efficiency of the facility for which the manager is paid a fee and is reimbursed for its expenses, subject to a budget that is usu- ally set by the manager and approved by the airport owner. Most airports operate their public parking facilities using a management contract, and some use a management con- tract for the operation of individual terminals or master ter- minal concessions, hangars, warehouses, or, in a few cases, for their entire airport. • Developer Financing and Operation—Developer financing is the most common way to channel private sector invest- ment into public sector infrastructure. Money is borrowed (often through a tax-exempt conduit issuer of municipal bonds) for the specific purpose of financing a project, and lenders are repaid only from the cash flow generated by the project or, in the event the project fails, in some cases, from the value of the project assets. Thus, if project rev- enues never materialize because the project is abandoned during construction or if project revenues are disrupted because of operational problems, there is no alternative source of cash flow to meet debt service requirements. Most examples of airport project finance transactions in the United States involve special purpose facilities for single or multi-tenant use, typically an airline (e.g., unit pas- senger terminal, terminal equipment, or fuel storage and distribution systems), one or more cargo tenants (cargo C h a p t e r 2 The U.S. Context and Generic Privatization Models

11 buildings), or rental car companies (consolidated rental car facilities). Sometimes the developer is required to put its own equity capital at risk, but more frequently the project is financed with bonds that are secured solely from the revenues of the facility being financed. This type of transaction is sometimes referred to as a public-private partnership, PPP, or P3. • Long-term Lease or Sale—A long-term lease, long-term concession, sale, or other transfer of an entire airport to private operation and/or ownership (e.g., Stewart). • Airport Privatization Pilot Program or APPP—A pro- gram under the category of long-term lease or sale codified at 49 U.S.C. Section 47134, which was enacted by the U.S. Congress in 1996 to allow up to five airports (amended to 10 in 2012) to be leased or sold under specific conditions as approved by the Secretary of Transportation. As described later, the APPP authorizes the Secretary of Transportation to exempt these airports from certain regulations that otherwise may have discouraged airport privatization. • Private Airport Development—Development of an entire airport without the aid of federal or state grants by private investors to be operated as a for-profit busi- ness. It should be noted that private airport development without government support is not considered to be air- port privatization for purposes of the guidebook since it does not involve the transfer of control or ownership from the public sector to the private sector. For example, Branson Airport which was developed without the aid of federal or state grants is not considered a form of airport privatization. 2.2 Extensive Privatization Exists Today at U.S. Airports There already is a wide range of strategies employed to enlist the support of the private sector in the management and operation of U.S. airports. For example: • Private companies often perform maintenance on load- ing bridges, baggage devices, escalators, elevators, moving walkways, etc. • Private companies (including airlines) provide ground handling of aircraft. • Cleaning companies frequently provide janitorial services. • Private parking operators routinely manage public and employee parking lots and associated shuttle bus operations and sometimes finance and develop the parking facilities. • Food and retail specialists develop and operate terminal concessions. • Airlines typically design and operate their own passenger processing and baggage handling services. • Fuel service companies normally operate and maintain fuel systems and fuel aircraft. • Consultants often perform planning, design, and con- struction management activities. • Investment and commercial banks underwrite a large share of the financing for capital improvements. • Fixed-base operators develop and operate facilities to service general aviation aircraft (including hangars, fueling, termi- nals, maintenance and avionics services, aircraft sales, char- ter services, aircraft training and flight support, and ramp) under long-term leases. As a result, commercial airports in the United States tend to be run through a form of partnership among the federal gov- ernment, state government, and local government and the pri- vate sector with varying forms of private sector participation. In fact, a study by the U.S. General Accounting Office (now the Government Accountability Office) in 1996 found that 90% of the people working at the top 69 airports in the United States (in terms of passenger traffic) were employed by pri- vate companies. The remaining 10% were employed by local and state governments (performing administrative or public safety duties) or the federal government (e.g., FAA air traffic controllers, military personnel).2 Private company employees work for airlines, terminal concessionaires, rental car com- panies, ground parking operators, transportation providers, fixed-base operators, and providers of contract services. 2.3 Evolution of Airport Ownership and Governance in the United States Since the advent of commercial airline service in the 1920s, U.S. airports have largely been owned and operated by local Partial Privatization Full Privatization LEAST PRIVATIZATION Service Contracts Management Contracts Developer Financing and Operation Long-term Lease or Sale (including Airport Privatization Pilot Program) Private Airport Ownership or Development MOST PRIVATIZATION Private Development Figure 2.1. Examples in the public/private continuum. 2U.S. Government Accounting Office, Airport Privatization: Issues Related to the Sale or Lease of U.S. Commercial Airports, Report to the Subcommittee on Aviation, Committee on Transportation and Infra- structure, House of Representatives, GAO/RCED-97-3, November 1996.

12 governments. Airlines and aircraft companies participated in the early development of airports (such as Pan American Field in Miami; United Airport, now Bob Hope Airport, in Burbank; and Grand Central Airport in Glendale). However, few private sources of capital stepped forward to invest in owning and operating airports, given the immature nature of the industry (measured by traffic levels, facility use, or rev- enue generation), the lack of comprehensive federal regula- tions, and macro-economic conditions of the era (including the Great Depression). In the 1940s, the federal government solidified local public ownership and operation of commer- cial service airports by (1) enacting the first federal grant pro- gram for airports, and (2) transferring excess military bases and related properties no longer needed after World War II to state and local governments under the Surplus Property Act of 1944 under the condition that they be used as public airports. For decades, the typical owners of commercial service air- ports have been municipal governments (cities and coun- ties), single-purpose airport authorities, multi-purpose port authorities, and state governments. Single-purpose airport authorities became more common as the industry continued to mature and communities recognized that many airports generated enough revenue to be financially self-sufficient. Airport authorities generally have a more autonomous gov- ernance structure that helps insulate management from local politics and gives them relatively more control over salary, procurement, and budgeting systems, resembling the private sector more than local governments. A number of airport authorities were also developed to recognize the regional role of airports in the local community by including representa- tives from multiple jurisdictions, sometimes sharing the cost to fund airport improvements and giving them more auton- omy to respond quickly to changing conditions. Although public authorities often operate with a degree of indepen- dence from state and local government, they typically are influ- enced by the government through the appointment of board members, the obligation to satisfy at least some of the same requirements as other local agencies, and other factors. Privatization can be viewed as another form of governance that could be used to address challenges or other structural issues that are facing U.S. airports as illustrated in Figure 2.2. The figure conceptually highlights the general relationship between operating cost and degree of local political control under alternative forms of governance. 2.4 Forms of Airport Governance Airports are often characterized by their ownership, but it is the governance structure that largely determines how an airport is managed, operated, and developed.3 The consider- ation of opportunities for increased privatization must begin with an understanding of the ways in which the public and private sectors participate in the governance of commercial service airports currently. As illustrated in Table 2.1, there are four generic models of governance for airports (ranging from least to most private sector control): • Public ownership and operation • Public ownership with some form of private operation • Mixed public/private ownership with private operation • Private ownership and operation Source: LeighFisher. Low High Government operating cost Low High Po lit ic al le ve ra ge Corporatization Privatization Authority Department Commission or Board Figure 2.2. The airport governance continuum. 3Daniel S. Reimer, John E. Putnam, James B. McDaniel, Airport Gover­ nance and Ownership, ACRP Project 11-01, “Legal Aspects of Airport Programs,” Transportation Research Board, August 2009.

13 Virtually all commercial service airports in the United States are publicly owned and/or operated either by a state, county, city, single-purpose airport authority, or multi-purpose authority with various forms of private sector participation in their operation and investment. By contrast, international airports tend to have far more private ownership, investment, and operation. Some U.S. airports are owned by a government entity (state, county, or city) but are operated by a single- or multi-purpose authority under a long-term lease. Internationally, many governments have taken steps towards commercialization and/or corporatization as an alternative to, or as interim step towards, airport privatization where this process can generate sufficient revenue for operations and capital funding. Commercialization of airports refers to the application of business-like approaches to the management and operation of airports by shifting aviation management and operations from a government department to a business- focused entity to allow market forces, incentives, and mechanisms to drive the delivery of services. It is a shift in management not ownership of the airport and can include different degrees of private-sector involvement, such as retail development, commercial development, contracting for air- port management, or allowing private companies to develop and lease terminals. Commercialization is often the first step towards full privatization and transferring control of the air- port to the private sector, but full privatization does not have to follow. 2.5 What Makes the U.S. Airport Model Different? With the notable exception of the United States, airport ownership and governance have undergone significant change for much of the world since 1987 when the United Kingdom became the first country to privatize some of its major air- ports as shown in Figure 2.3. Full privatization (i.e., full control and/or operation of an entire airport by a private entity) has become a worldwide trend while partial priva- tization remains the primary organizational model in the United States. Only one airport in the United States was fully privatized—Stewart in 1999—which has since reverted to public operation. There has been little appetite for the long-term lease or sale of U.S. airports (full privatization) primarily due to three unique factors: (1) the financial structure for building and improving airports, (2) the U.S. regulatory environment, and (3) the special relationship between airport owners and air- line tenants. Table 2.1. Airport governance models. Level of Airport Privatization (from Least to Most) Ownership Public Public Public/ Private Private Investment Public Public/ Private Private Private Management Public Private Private Private Types of Private Sector Involvement Retail/service concessions Management contract Project Finance/ Build-Operate- Transfer (BOT) Airport-wide concession Airport-wide Build-Operate- Transfer (BOT) Trade sales Flotation/IPO Figure 2.3. 24-year history of worldwide airport privatization. 1990-1992 1987 1997 1993-1996 1999 1998 2004-2006 2000-2003 2007 Dublin Pisa St. Petersbur g Düsseldorf Hamburg French Regionals Athens Ecuador Chubu Hong Kong In di a Kolk at a Chennai Navi Mu m bai Prague Mi dw ay Schiphol Aeroports de Pari s Firenz e Larnaca Copenhagen Brussels Bratislava Budapest Delhi Mu m bai Bangalor e Hy derabad Narit a Fraport Lim a Ma lt a Sy dney Zurich GAP (M ex ico) Jak arta OM A Stewart Birm ingham Bolivia Brisban e Bristo l Dusseldorf Is tanbul Kent Me lbourne Naples Pert h Rom e Sanford Athens Belfast Bournem outh Cardiff Cochin Copenhagen E. M idlands London City Liverpool Prestw ick Southam pton Vienna BAA ASUR (M ex ico) Adelaide Argentina Auck lan d Australia n Regionals Canberra Costa Rica Eindhoven Hanover Hobart Luton Ma lay si a Sk avsk a South Africa We ll ingto n 2008 2009 Cairns London Gatw ick Bristo l Brisbane Ma ck ay London City Belfast City Blackpool 2010 London Gatw ick Peel Airports

14 2.5.1 U.S. Airport Financial Structure Unlike international airports that often turn to privatiza- tion for capital funding, the “three pillars” of airport capital funding in the United States are unique and make full priva- tization less necessary and desirable: 1. Airport Improvement Program (AIP)—The federal gov- ernment contributes significant federal funding for air- port planning and development through the Airport Improvement Program (AIP). The AIP provides grants to public agencies—and, in some cases, to private owners and entities—for the planning and development of public- use airports that are included in the National Plan of Integrated Airport Systems (NPIAS). 2. Passenger Facility Charges (PFCs)—PFCs are a source of local capital independent of use and lease agreements and a key instrument to promote competition and capacity. PFCs are an important source of funding for airport infra- structure and a frequent vehicle used to leverage capital. Privatization under the APPP permits the imposition of PFCs. Outside the APPP, a private operator is authorized to impose charges on passengers, subject to reasonable- ness and non-discrimination requirements of the grant assurances, but is not authorized to impose a PFC, which is separately identified on the passenger ticket. 3. Tax-Exempt Debt—The availability of tax-exempt debt provides public airports a cost of capital advantage over private entities. Airport financing under full privatiza- tion models would not be eligible for tax-exempt debt. Instruments such as governmental bonds, private activ- ity bonds, and Build America Bonds have been the major financing mechanism for capital improvements at large, medium, and some small hub airports and as a result pro- mote capital investment by state and local governments. 2.5.2 U.S. Regulatory Regime The legal framework for operating public-use airports in the United States is also unique and has significantly influ- enced the experience and evolution of airport privatization. The U.S. legal structure provides abundant opportunities for airport owners and operators to enlist private participa- tion in certain airport functions and facilities while retaining primary responsibility and control over the airport (partial privatization). Conditions tied to the acceptance of AIP grants provide a disincentive for full privatization as a result of (1) the con- straints imposed by the grant conditions, known as “sponsor assurances” or “grant assurances,” particularly including the requirement to use airport revenue only for airport purposes and (2) the prospect that public entities would be required to repay prior grants upon the sale or lease of an airport to a private operator. Both federal law and the grant assurances strictly limit the use of airport revenue for non-airport purposes. Airport revenue is defined broadly to include the proceeds from the sale or lease of airport property. There are some narrow exceptions, such as for so-called “grandfathered” airports and for repayment of loans issued by sponsoring governments. However, Congress has expressed serious concern with rev- enue diversion and has prescribed onerous penalties for vio- lations. The prohibition on revenue diversion applies only to the airport sponsor, not the air carriers, FBOs, concessions, private airport managers, or any other private entities that conduct business on an airport. This has incentivized private ventures on airports but has dis-incentivized full privatiza- tion. It historically presented a particularly high barrier to full privatization because, outside the APPP, the public air- port owner is required to use the sale proceeds for airport purposes, and because the private operator, upon assum- ing responsibility for the grant assurances, must use revenue that it generates in connection with the airport for airport purposes. Public airport operators enjoy exemptions from property taxation pursuant to the U.S. Constitution and/or laws of most states. These exemptions typically would not apply to a private operator of a public-use airport. 2.5.3 Airline-Airport Use and Lease Agreements Another important distinction is the degree to which air- ports in other countries tend to be seen more as indepen- dent entities and businesses in their own right, with a far lower degree of airline control (contractual or statutory). In the United States, most airport owners enter into use and lease agreements with the airlines serving their airports. Among other things, these agreements set forth the terms and conditions for establishing airline rates and charges and investing in capital improvements. In particular, for air- ports operating under residual airline agreements—where the airlines guarantee to pick up, through their rates and charges, any airport costs not otherwise covered by non- airline revenues of either a particular cost center or the entire airport—airlines have substantial input into and control of capital investment decisions through “majority-in-interest” approval procedures. In other instances, the airlines have been permitted to form consortia that operate terminals or equipment. In other parts of the world, airline rates and charges are more likely to be defined by external-economic regulations and less by bilateral contractual agreements, although bilateral agree- ments can reduce or eliminate the role of the regulator. Those

15 U.S. airports that do not have airline use and lease agreements must set rates that comply with federal laws and regulations. Several factors affecting airlines rates and charges in the United States in relation to the privatization models are sum- marized in Table 2.2. As a result, airlines generally exert more political influ- ence over U.S. airport owners than they do for international airport owners. Indeed, with their access to public decision makers, some airlines believe they have more leverage with public operators than they could with shareholders and exec- utives of privately owned airports. In sum, the following features of the U.S. regime have lim- ited the interest in and opportunities for full privatization: • The historic pattern of public ownership of airports • Community desires to control their economic engines (airports) and community gateways • The availability of federal planning and development grants and in some cases state grants and loans • The ability to impose and require airlines to collect PFCs, which provide a capital funding source outside of a contrac- tual airline use and lease agreement or rate policy imposed by ordinance • Ready access to low-cost, tax-exempt financing through the U.S. bond market and in some states infrastructure bank loans with low-cost borrowing • The strict requirements of the grant assurances, accepted as consideration for federal grants • The obligation to use proceeds from the sale or lease of airport property only for airport purposes • The prospect that public entities would be required to repay prior grants upon the sale or lease of an airport to a private operator • The exemption from property taxes for municipal owners Table 2.2. Summary of U.S. economic rules under partial and full privatization. Factor Partial Privatization Full Privatization Under APPP Full Privatization Outside APPP (per FAA Order 5190.6B) Eligibility for AIP grants Public entity is eligible Private entity may be eligible, but with lower discretionary federal share (70%) Private entity is not eligible Eligibility for tax- exempt debt Same terms as government No* No* Property tax exemption Not applicable Not unless special legislation Not unless special legislation Ability to impose a PFC Public entity is eligible Public entity is eligible Private operator can impose a charge on passengers, but not require the airlines to collect a PFC Prohibition on revenue diversion Government must comply Operator exempt Government must comply unless 65% airline approval at primary airports FAA is authorized to grant an exemption to permit the private operator to ‘‘earn compensation from the operations of the airport’’ Government must comply Operator permitted to be paid reasonable compensation for providing airport management services and reasonable return on capital investment** Reasonable terms, no unjust discrimination (subject to rates & charges policy) Government and operator must comply Operator cannot increase aeronautical rates by more than inflation without airline approval Operator must comply * To qualify for federal tax exemption, the assets being financed must satisfy the government ownership requirement that the lease term does not exceed 80% of the economic life of the asset. Also, to use tax-exempt debt to acquire an existing asset, at least 15% of the debt must be used to pay for a new asset and the proceeds must be spent within three years of the issuance. ** As stated in the FAA’s revenue use policy, “The FAA expects private owners to be subject to the same requirements governing . . . the recovery of unreimbursed capital contributions and operating expenses from airport revenue as public sponsors. Under section 47107(l)(5), private sponsors—like public sponsors—may recover their original investment within the six-year statute of limitation. In addition, they are entitled to claim interest from the date the FAA determines that the sponsor is entitled to reimbursement under section 47107(p). Any other profits generated by a privately owned airport subject to section 47133 (after compensating the owner for reasonable costs of providing management services) must be applied to the capital and operating costs of the airport.” 64 Fed. Reg. 7696, 7700 (1999).

16 • Other regulatory factors outlined in more detail in Chapter 6 • The influence of airlines, particularly those that carry the majority of an airport’s traffic, as a result of provisions in use and lease agreements providing a significant role in major capital decisions A combination of access to AIP grants, PFCs, and tax- exempt debt make partial privatization strategies more attrac- tive to U.S. airport owners. Conversely, limitations in AIP participation, inability to charge PFCs, and limited or no access to tax-exempt debt under full privatization schemes limit the ability of the private operator to attract capital rela- tive to a public owner. 2.6 Focus of Research The guidebook is focused on the relatively small number of airports that contribute disproportionately to air trans- portation and mobility in the United States and to economic output and impact. Virtually all of these airports are owned by government agencies. In the United States, there are 19,734 airports; how- ever, 14,555 of these (74% of the total) are privately owned, privately-used facilities as shown in Figure 2.4. An additional 932 airports are privately owned publicly-used facilities. Only 4,247 airports (21% of the total) are publicly owned, publicly-used facilities. Yet these airports account for vir- tually all scheduled commercial passenger boardings in this country, as there is only one privately developed, com- mercial service airport currently operating (in Branson, Missouri). Similarly, these airports account for the vast majority of general aviation and cargo activity, as virtually all of the busiest general aviation and cargo airports are publicly owned. Federal law and policy both reflect and support this fact. Almost all of the airports in the NPIAS are publicly owned. This includes commercial service airports, reliever airports, and select general aviation airports. Indeed, a commercial service airport, for which the majority of federal funding is reserved, is defined in federal law to include only airports owned by public agencies.4 The consequence of these and related laws and policies is that federal financial assistance largely has been limited to publicly owned airports. Further, passenger activity in the United States is highly concentrated in a relatively small number of the commer- cial service airports. As shown in Figure 2.5, the top 65 air- ports (representing the large and medium hubs) accounted for nearly 89% of enplaned passengers in the United States during 2010. The guidebook focuses on the role of the private sector in publicly owned, publicly-used airports, with particular attention to large commercial service airports that account for the vast majority of scheduled passenger traffic and cargo. Figure 2.4. Number of existing and proposed airports by ownership and use. Source: Federal Aviation Administration, National Plan of Integrated Airport Systems (2009-2013) Report of the Secretary of Transportation to the United States Congress, September 27, 2010. 4See 49 U.S.C. § 47102.

17 Figure 2.5. Passenger shares at U.S. commercial airports. Source: Federal Aviation Administration, CY 2010 Revenue Passenger Enplanements for primary and nonprimary commercial service airports (by rank), October 2011. 29 Large Hub 69.9% 359 Non Hub/Commercial Service 3.2% 74 Small Hub 8.3% 36 Medium Hub 18.6%