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From the Globe and Mail:
GTAA investors could face Eurotunnel-sized failure
HARRY KOZA
Eurotunnel, the company that built and operates the rail tunnel linking Britain and France, has recently defaulted on its bonds and filed for protection from its creditors. It seems the company, while making an operating profit on booming travel (thanks to the World Cup and Da Vinci Code tourists), still can't cover the interest payments on its €9-billion ($13-billion) in debt.
Restructuring depends on persuading bondholders to give up half of what's owed them in exchange for shares in the restructured firm. Lots of luck: There are 800,000 individual shareholders in Eurotunnel in France alone, and while their equity has been vaporized, there are those who say they should end up with a big chunk of the post-restructuring equity. French politics being what they are, the prospect of maman et papa investors getting wiped out may be too much for the government to bear, and the bondholders may be asked to take an even bigger haircut in favour of shareholders. Besides, French law requires that the new plan be approved by shareholders anyway, and they are unlikely to approve anything that doesn't leave them with a big chunk of the new entity -- to the detriment of bond investors. La plus ça change.
Eurotunnel is a marvellous feat of engineering, but they blew it on so many fronts. All their projections were overly optimistic: They were going to put cross-channel ferries and airplanes out of business, generating 21 million passengers a year; they were going to build the biggest engineering project the world had ever seen on time and on budget. It ended up being completed late and six times over budget, and the passenger traffic maxed out at about a third of the forecast. Operators bought new, more comfortable modern vessels, dropped fares and kept their customers, while upstarts like Ryanair offered cheap flights to anywhere in Europe. Oops! Looks like Maggie Thatcher made the right call when she refused to put any government money into the project, insisting it be financed with private capital.
The whole thing got me thinking about Pearson Airport again. Will the Greater Toronto Airports Authority be the next Eurotunnel?
I mean, the new Pearson Airport is a lovely facility, and it will be used, but it has so far racked up around $7-billion in debt. What if the Pearson expansion comes in behind schedule and over budget, and the traffic forecasts aren't realized? Will they still be able to cover their interest payments?
Bond investors have loaded up on GTAA paper on the premise that the airport authority has a government mandate and near-monopoly power to set fees at whatever level is deemed necessary, so the bonds are as good as gold. That's fine up to a point, but I don't know. I think the market is being a little too sanguine about event risk. GTAA's fees are already among the highest in the world, and some airlines (El Al Israel Airlines, for instance) are already shifting flights to other airports. If some exogenous event -- like a SARS pandemic, terrorist attack or U.S. recession -- comes along to reduce traffic volumes, it may not have much room left for further fee hikes to make up lost revenue.
Of course, another SARS-like scare or recession will also push GTAA's airline customers to the edge, and they likely won't be able to handle yet another increase in landing fees, which would be making an already unfair tariff even worse. Also, what happens if the long-touted "open skies" regime ever actually comes into effect? The whole idea of GTAA as a major North American hub seems predicated on the assumption that open skies never happens. If it does, further fee increases could see a lot of airlines shifting operations to Buffalo or Hamilton. Someone told me today that you can already drive to Buffalo, stay overnight in a hotel and catch a flight the next morning, and it's still cheaper than flying out of Pearson for many destinations.
So where, Malcolm Gladwell might ask, is the tipping point? How bad does an exogenous event have to be before GTAA can no longer make its interest payments?
I don't know, but it seems to me the market may not be pricing such a possibility into GTAA paper. GTAA 6.47-per-cent bonds maturing in 2034 are quoted around 1.25 percentage points over similar-term Canada bonds. I wonder if that is enough spread for the risk.
The rating agencies and the Street's investment bankers seem unperturbed. The raters see GTAA as a "government-related issuer," meaning taxpayers will be the ultimate backstop of the credit. The investment banks are conflicted -- they make a lot of money underwriting GTAA bonds.
So, I'd be very interested in seeing some analysis of the GTAA credit in various "stuff happens" risk scenarios. Meanwhile, though I still own shorter-dated GTAA bonds in my RRSP, I'd be leery of strapping on any new positions in their longer issues, at least at current spreads.
Harry Koza is senior Canadian markets analyst at Thomson Financial and a columnist for GlobeinvestorGOLD.com.
GTAA investors could face Eurotunnel-sized failure
HARRY KOZA
Eurotunnel, the company that built and operates the rail tunnel linking Britain and France, has recently defaulted on its bonds and filed for protection from its creditors. It seems the company, while making an operating profit on booming travel (thanks to the World Cup and Da Vinci Code tourists), still can't cover the interest payments on its €9-billion ($13-billion) in debt.
Restructuring depends on persuading bondholders to give up half of what's owed them in exchange for shares in the restructured firm. Lots of luck: There are 800,000 individual shareholders in Eurotunnel in France alone, and while their equity has been vaporized, there are those who say they should end up with a big chunk of the post-restructuring equity. French politics being what they are, the prospect of maman et papa investors getting wiped out may be too much for the government to bear, and the bondholders may be asked to take an even bigger haircut in favour of shareholders. Besides, French law requires that the new plan be approved by shareholders anyway, and they are unlikely to approve anything that doesn't leave them with a big chunk of the new entity -- to the detriment of bond investors. La plus ça change.
Eurotunnel is a marvellous feat of engineering, but they blew it on so many fronts. All their projections were overly optimistic: They were going to put cross-channel ferries and airplanes out of business, generating 21 million passengers a year; they were going to build the biggest engineering project the world had ever seen on time and on budget. It ended up being completed late and six times over budget, and the passenger traffic maxed out at about a third of the forecast. Operators bought new, more comfortable modern vessels, dropped fares and kept their customers, while upstarts like Ryanair offered cheap flights to anywhere in Europe. Oops! Looks like Maggie Thatcher made the right call when she refused to put any government money into the project, insisting it be financed with private capital.
The whole thing got me thinking about Pearson Airport again. Will the Greater Toronto Airports Authority be the next Eurotunnel?
I mean, the new Pearson Airport is a lovely facility, and it will be used, but it has so far racked up around $7-billion in debt. What if the Pearson expansion comes in behind schedule and over budget, and the traffic forecasts aren't realized? Will they still be able to cover their interest payments?
Bond investors have loaded up on GTAA paper on the premise that the airport authority has a government mandate and near-monopoly power to set fees at whatever level is deemed necessary, so the bonds are as good as gold. That's fine up to a point, but I don't know. I think the market is being a little too sanguine about event risk. GTAA's fees are already among the highest in the world, and some airlines (El Al Israel Airlines, for instance) are already shifting flights to other airports. If some exogenous event -- like a SARS pandemic, terrorist attack or U.S. recession -- comes along to reduce traffic volumes, it may not have much room left for further fee hikes to make up lost revenue.
Of course, another SARS-like scare or recession will also push GTAA's airline customers to the edge, and they likely won't be able to handle yet another increase in landing fees, which would be making an already unfair tariff even worse. Also, what happens if the long-touted "open skies" regime ever actually comes into effect? The whole idea of GTAA as a major North American hub seems predicated on the assumption that open skies never happens. If it does, further fee increases could see a lot of airlines shifting operations to Buffalo or Hamilton. Someone told me today that you can already drive to Buffalo, stay overnight in a hotel and catch a flight the next morning, and it's still cheaper than flying out of Pearson for many destinations.
So where, Malcolm Gladwell might ask, is the tipping point? How bad does an exogenous event have to be before GTAA can no longer make its interest payments?
I don't know, but it seems to me the market may not be pricing such a possibility into GTAA paper. GTAA 6.47-per-cent bonds maturing in 2034 are quoted around 1.25 percentage points over similar-term Canada bonds. I wonder if that is enough spread for the risk.
The rating agencies and the Street's investment bankers seem unperturbed. The raters see GTAA as a "government-related issuer," meaning taxpayers will be the ultimate backstop of the credit. The investment banks are conflicted -- they make a lot of money underwriting GTAA bonds.
So, I'd be very interested in seeing some analysis of the GTAA credit in various "stuff happens" risk scenarios. Meanwhile, though I still own shorter-dated GTAA bonds in my RRSP, I'd be leery of strapping on any new positions in their longer issues, at least at current spreads.
Harry Koza is senior Canadian markets analyst at Thomson Financial and a columnist for GlobeinvestorGOLD.com.