Measures to encourage more involvement by financial institutions in the privatization of Japan’s infrastructure assets mark a new phase in the development of the market, reports Hiroyuki Kachi
After a steady run of airport deals, Japan’s government is moving ahead with finetuning concession rules to make it easier for the private sector to join in.
New guidelines released earlier this year suggest a transformation, potentially allowing banks to take a broader role in financing the upcoming airports concession in Hokkaido along with other upcoming privatization deals across the water, sewerage and hydro plants sectors.
The guideline came out on 28 March, just a day before the implementation plan for the Hokkaido airports concession was released. A greater emphasis on the payment of an upfront lump sum amount – rather than installment payments over the concession period – caught investors’ attention.
Marunouchi Infrastructure’s CEO Shinichi Nao observed that installment payments have limited the amount of financing required for what he termed Japan-style PFI deals, at IIF Japan on 18 June. The change will make it less easy for corporate consortia members to fund the share from their balance sheets, he added.
Japan is now in a crucial transition
“Application guidelines are totally different,” in terms of the payment method for Fukuoka and Hokkaido airport concession fees, said Kazunari Kibe, board director at Japanese contractor Maeda at a recent press conference. “I think Japan is now in a crucial transition toward creating a concession market that can appeal to global investors,” he said.
The latest guideline left unchanged the previous description that both lump sum as well as installment payments can be utilized. But the new guideline stressed the importance of lump sum payment by adding a new phrase that “even if installment payment is picked, a certain amount of initial lump sum payment should be built in.”
“Some would find it easier to pick installment payment, but others contend a lack of sufficient size of payment in a lump sum makes the deal less attractive as advantageous investment,” says Baker McKenzie partner Naoaki Eguchi.
Eguchi points out that private companies which proceed with infrastructure concessions may be comfortable to pay for concession fees on an installment basis, as then they don’t have to rely on large bank loans.
But a greater upfront payment would increase demand for debt financing to the concessionaire. In addition, infrastructure funds would consider it attractive to invest into infrastructure projects, he says.
Kansai Airports has been paying concession fees in installments using annual cash flows, meaning that they don’t have to use bank loans, according to an Orix spokesperson. Orix and Vinci Airports each own a 40% stake in Kansai Airports, which has a 44-year concession to operate Japan’s third and seventh busiest airports: Kansai International Airport and Osaka International Airport.
Giving a certain business risk to the private sector is a good aspect of infrastructure concessions
But the installment payment method conflicts with the basic role of a concession says an analyst at a think tank in Japan. “Giving a certain business risk to the private sector is a good aspect of infrastructure concessions,” he says. He adds that payment in installments means the public side still has to bear finance risk during the concession period.
“A lump sum payment should be considered to help promote a scheme, in which the private sector takes the right risk partly in the form of loans from financial institutions,” the Cabinet Office said in the new guideline.
“In adherence of the spirit of PFI to utilize private sector fund, it is not desirable that the public sector will have to take the finance risk,” it added.
Observers contend that taking business risk through a lump sum payment has the potential to increase financial investor participation in concessions.
In addition, the guidelines include arrangements to guarantee the public side’s future buyback of assets constructed by a concessionaire; require more detailed and transparent disclosure of bidder screening processes; and call for vendor due diligence to be undertaken by the public sector as far as possible.
The revised guidelines were released after final bids were submitted for the Fukuoka Airport concession. The airport benefits from its prime location close to the city’s downtown area and potential to grow to a hub airport in Asia.
That helped mount investor appetite for the concession, with an estimated concession fee initially set at least JPY 161bn (USD 1.46bn) inflating to over JPY 400bn in the final screening.
But a higher price burden suggests bidders were under pressure to expand the scope of the airport’s operations, with a focus on luring more tourists.
The escalating concession fee seems to have led to bids to include other facilities like hotels, which eventually would cause ballooning costs and bode ill for the financial health of the bid winner, says a source familiar with the matter. “I think it is necessary to well balance sound fiscal management and aggressive management,” says the source.
After the preferred bidder was selected on 16 May, the president of consortia member Nishi-Nippon Railroad – Sumio Kuratomi – said the consortium will invite a five-star hotel to be built next to the airport.
The consortium includes Singapore’s Changi Airports International and Japanese trading house Mitsubishi Corp as well as a group of Fukuoka-based companies, including Nishi-Nippon Railroad.
Kuratomi also specified plans to expand the floor space of the airport’s international terminal building and construct a passageway linking the domestic and international terminals.
The Ministry of Land, Infrastructure, Transport and Tourism (MLIT) has said bidders for the Hokkaido airports concession are required to make an initial lump sum payment, in addition to the minimum bid price of JPY 72bn, or JPY 2.4bn each year over the 30-year concession period.
The minimum value of the upfront lump is set at zero but market observers expect bids of around JPY 100bn.
“It depends on how fierce competition would be,” in terms of the number of consortia joining in the fray, says the above-mentioned source familiar. Potential bidders for the Hokkaido airports are required to submit documents for the first round of screening by 16 August.
The bundle includes New Chitose Airport, which is the second biggest profit earner among Japan’s 19 state-controlled airports, after Tokyo International Airport. But the smaller six airports to be offered with New Chitose are loss-making.
The first screening selection criteria are: project concept (score out of 20); policy for development of route network (10), policy for development of intra-Hokkaido network and policy for promotion of wide area tourism (10); policy for operation of airport facilities (10); policy for safety and security (10); policy for project implementation structure (10); revenue and expenditure plan (7); consideration for operating right and total amount borne by the airport administrators (23).
Thus, while the consideration to be paid gets the highest weighting, it is only 23 out of 100 points in the first round, and 22.86% of 350 points in the second round. A second Q&A period is scheduled for 9-10 July, after the first period over 30-31 May.
Like Fukuoka, the Hokkaido concession is expected to attract well known international airport operators. In addition, at least one consortia bidding in the first round for the Kumamoto Airport concession on 15 June, is understood to have included an international operator. Still, market watchers fret that foreign interest will not be sustained after large-scale privatizations, such as Hokkaido, wind down.
The government has worked to build a pipeline of environment sector concessions, helping to retain continued investor interest. On 20 June, Japan’s Diet or parliament voted to extend its current session by a month, allowing more time for the long-delayed revision to the Water Supply Act to be passed, enabling the launch of water sector concessions.
Still, Takanori Fukushima, general manager of PPP and infrastructure investment research at Sumitomo Mitsui Trust Research Institute, observes that concessions are not the only means of privatization. He highlighted that the government could take other action to increase commercialization, such as bundling several different water companies into a bigger operation at IIF Japan on 18 June.
He observed that there hasn’t been water price hikes in Japan in a long time, which is not feasible over the long term. A review of the pricing scheme would see water assets attract more private sector interest. With cost reduction offered by private operation offering an “attractive thesis”.
Marunouchi Infrastructure’s Nao observed that improved business performance at airports operated by the private sector is helping to prove the case for expanded infrastructure asset privatization in Japan.