QSuper’s Heathrow Airport investment: even more than meets the eye

Three well-known types of unlisted investments,¹ infrastructure, real estate and private equity are important parts of QSuper’s Lifetime default series, as well as the pre-mixed Diversified options Aggressive, Balanced and Moderate. Below, QSuper outlines its investment in Heathrow Airport.

At the end of December 2018, the value of QSuper’s infrastructure investments totalled around $10.7 billion.

The investment case for infrastructure is powerful, in our opinion.

Demand for essential products and services provided by infrastructure businesses such as airports, ports, toll roads, utilities like water and energy distributors — to name some — tend to be more stable and less sensitive to price changes than non-essential products or services.

Infrastructure assets generally have long operating lives too, which makes them a good match for the multi-year and multi-decade time horizons of most super fund members.

The regulatory contracts or “concessions” (in industry jargon), underlying many of these assets aim to provide infrastructure owners with relatively predictable cash flows, which may be linked to inflation.

Our approximately 11% Heathrow Airport equity ownership, on members’ behalf, is the largest of QSuper’s infrastructure investments.

QSuper bought into Heathrow in two stages.

Firstly, in 2011, through an infrastructure vehicle managed by Alinda Capital Partners, one of the world’s largest infrastructure investment firms.²

The second instance (we’ll call this “Heathrow Part 2”) was in 2017 when we acquired a larger share from incumbent holders of Heathrow equity interests.

Heathrow Part 2 probably deserves a book or TV program to do it justice, but for time-efficiency reasons, what follows is a very condensed version.

Strong governance and delegated authority made deal possible

To begin with, the second Heathrow transaction was the biggest deal QSuper has ever negotiated. Ordinarily, armies of investment professionals and external experts are assembled to manage complex transactions.

However, in QSuper’s case, it was largely done by a four-person team from our Investments division comprising Charles Woodhouse (Head of Funds Management), Raymond Chan (Senior Portfolio Manager, Funds Management), Adam Murphy (Portfolio Manager, Funds Management), and Michael Pedler (Investment Analyst, Funds Management).

The very strong governance that has been created around QSuper’s investment practices since 2009 and delegated authority by the Board and Investment Committee to the investment team chiefly explain why we were able to move quickly in a short period of time to successfully complete the transaction on behalf of our members.

A small, nimble team meant that decision-making was swift, bid tactics could be developed close to the coalface and engagement with the vendor and advisors could be carried out efficiently on the ground in London.

Deals of the size of Heathrow Part 2 can take up to a year to finalise, however one of the key reasons why the vendor decided to engage with QSuper exclusively was our ability to complete the deal in just a few months.

Vast amounts of money have flowed into infrastructure businesses and assets across the globe over the past few years. Competition for good infrastructure assets, let alone iconic assets like Heathrow, can cause some to overpay.

Paying too much, naturally, leads to less satisfactory member returns.

In this case, we were able to avoid a competitive process and our investment team brought the same discipline to evaluating Heathrow Part 2 as any other investment in order to improve the likelihood that this investment will generate sufficient long-term, risk-adjusted returns for QSuper members.

At the end of the process, QSuper emerged with a larger equity position in Heathrow alongside other leading institutional investors who are committed to the business for the long-term.

More than an airport

While Heathrow is best known as an airport, it’s in fact much more than that. Heathrow is an immense enterprise with multiple business operations vital to the UK economy and Britain’s engagement with the world.

Heathrow is the largest UK airport by value and 33% of the country’s long-haul export goods (£106 billion by value) travelled through it in 2017.³ This was more than the combined value that went through through Felixstowe and Southampton, Britain’s biggest container ports.

It’s also one of the UK’s largest single-site workplaces with 76,000 people working in 400 businesses located across the airport.⁴

Retail operations ranging from specialist shops, eateries to car parking generated £716 million revenue in 2018.⁵

Heathrow’s London location boosts profits for airlines that fly from there. Business people flock to London, a financial and legal centre for the entire European continent.

If, for example, a Dutch company merges with a French company, the deal will still, most likely, close in London. Anyone who wants to fly from Europe to the United States or Canada later in the day must fly through Heathrow, because other major airports offer few flights then.

The sheer scale and diversity of Heathrow’s earnings sources, and global connections mean that it is not overdependent on one activity for financial success.

In summary, Heathrow is an economic powerhouse and QSuper’s equity share means that members can benefit from stable and predictable, regulated returns with limited volatility and cash flows linked to inflation for years to come.

Looking ahead, approval for a third runway (R3) at Heathrow, has been given by the UK government and documented in the Airports National Policy Statement (NPS).

Construction of the third runway is still subject to approval of the detailed plan, the Development Consent Order (DCO), which is expected in late 2021. When completed and operating (2026 timeframe), R3 would lift plane movement capacity from 480,000 to 740,000 per year.⁶

This could see the 78 million passengers a year (2018) that pass through Heathrow rise to an even more staggering 130 million passengers per year capacity,⁷ which would lift its already formidable earnings profile and enhance Heathrow’s status as a leading global hub airport.

This creates value for the traveling public, UK businesses and airline users at Heathrow. In fact, the UK Government estimates up to £61 billion in benefits to the economy from 3R over the coming decades.⁸

Of course, no investment is risk-free and so Heathrow does have some near-term as well as potentially longer-term challenges.

The drawn-out Brexit process of exiting the UK from the European Union could be a disruptive influence and so might potentially negatively impact Heathrow’s earnings, for a while at least.

Moreover, R3 could be delayed and perhaps not built at all, in a worst-case scenario. In this case, Heathrow would remain a successful and resilient hub airport, in our view.

Heathrow’s impressive management team has been successfully navigating a complex business and regulatory environment for a number of years, and is very mindful of such risks and is systematically working to gain public support for R3 through close consultation with local councils and communities.

Minimising disruptions to local neighbourhoods, including taking steps to minimise noise by restricting flight times and flight routes are part of the R3 plan.

Our conviction in Heathrow’s management team is very strong due to their demonstrated track record in delivering major capital projects, raising financing across global capital markets and becoming the UK government’s preferred location for 3R.

Without such a strong management team, QSuper may not have proceeded with the Heathrow Part 2 transaction.

All up, Heathrow provides the kind of investment and earnings diversification that is a hallmark of QSuper’s investment approach.
 

1 Unlisted investments and businesses are those that are privately owned rather than being listed and tradeable on stock exchanges.
2 Source: https://www.alinda.com
3 Source: https://www.heathrowexpansion.com/uk-growth-opportunities/trade-export-growth
4 Source: https://www.heathrowexpansion.com/the-expansion-plan/facts-and-figures/
5 Source: https://www.trbusiness.com/regional-news/europe/heathrow-reports-outstanding-8-6-growth-in-retail/159919
6 Source: https://www.heathrowexpansion.com/the-expansion-plan/facts-and-figures/
7 lbid
8 Source: https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/562567/heathrow-north-west-runway-economic-benefits.pdf