The chances of BAA making good on threats to cancel its £3.5bn redevelopment plans for Heathrow Airport rose sharply yesterday after the Competition Commission recommended a slashing of the profits it is allowed to reap from Europe's busiest airport.
In a highly critical statement that accused BAA of acting "against the public interest" in its running of Heathrow and Gatwick, the watchdog suggested a reduction in the allowed cost of capital from 7.75 per cent at the two airports to 6.2 per cent at Heathrow and 6.5 per cent at Gatwick. The cut comes despite furious lobbying by BAA and its Spanish parent Ferrovial, who argue that such cuts reduce the incentive for the proposed multibillion pound development schemes for the airports.
Stephen Nelson, chief executive of BAA, reacted furiously to the ruling. "We see little in the CC's report which delivers the incentives to transform the airports," he said. "Nor do we believe that the CC recognises the scale and nature of the challenges we face in seeking to deliver a step change in the passenger experience."
The Civil Aviation Authority, which suggested the same cut earlier this year, will consider the CC's ruling before issuing its firm price control recommendation by 20 November.
Mr Nelson's comments echoed those made earlier this year by Rafael del Pino, the chief executive of Ferrovial. At a meeting with journalists in Madrid, Mr del Pino, who paid £16bn in a highly leveraged deal to take over BAA last year, said the CAA had "not given us the incentive" and that it could be forced to abandon the redevelopment plans.
Heathrow in particular has come in for heavy criticism due to the long security queues and dilapidated state of its infrastructure. The airport was designed to handle up to 45 million passengers yearly, but now services close to 70 million. BAA will open Terminal 5 in March next year, which should provide some relief, but it is also set to begin work on Heathrow East, to replace Terminal 2, a project that could now be endangered.
The CC's findings are likely to intensify a public row between it and BAA as they try to arrive at a solution amenable to both sides. Once the CAA makes its final recommendation in November, it sets the clock running on a two-month consultation period before it imposes the definitive scheme governing the five-year period beginning in April of next year.
If Ferrovial and BAA are unsuccessful in their effort to secure more generous terms, they could be forced to sell assets. BAA also owns Stansted, Glasgow, Aberdeen, Southampton and Naples airports. The CC also recommended that landing charges at Heathrow can rise by 7.5 per cent per year above inflation, while at Gatwick they should increase by 0.5 per cent less than inflation.
Mr Nelson said: "At a time of increased complexity and risk in the UK airports sector, the CC is proposing – at Heathrow – a dramatic reduction in returns."
The findings also greatly complicate the financial predicament of Ferrovial. The acquisition of BAA saddled the construction firm with a massive debt load, rising from ¿9.7bn (£6.7bn) in 2005 to ¿32.9bn in 2006, equal to more than three and a half times its ¿9bn market value.
The company has spent most of the past year preparing the world's largest-ever asset securitisation. Under the complex transaction, Ferrovial would refinance £9.3bn of debt – much of it taken to pay for BAA – by moving it into a ring-fenced structure collateralised by BAA's airport assets. The new investment-grade structure would significantly reduce BAA's cost base by cutting the interest payments it now services.
BAA admitted yesterday that unless it can push back on the CAA's price control scheme, this plan could be jeopardised. In a statement to bondholders, BAA said that the price cuts "introduce a high degree of risk that the refinancing plans in the form developed over the past year might not be able to be implemented as currently envisaged."
Standard & Poor's, the credit rating agency, reiterated its negative outlook on BAA bonds.