| 2008 | 2009 | ||||||
| Price: | 43.61 | EPS | |||||
| Shares Out. (in M): | 0 | P/E | |||||
| Market Cap (in $M): | 6,117 | P/FCF | |||||
| Net Debt (in $M): | 0 | EBIT | 0 | 0 | |||
| TEV (in $M): | 0 | TEV/EBIT | |||||
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Ferrovial (FER SM)
Ferrovial is a unique opportunity to invest in a collection of world-class set of assets run by one of the great value creating families of
At €41, investors are paying €5.7bn (140mm shares) for Ferrovial. I think the core Construction and Services business is worth €3.8bn (€5.5bn for combined businesses - €1.7bn of parent company debt = €3.8bn or €27 per share). That is equal to 10x 2008 earnings. Its equity stakes in Cintra, Tubelines, and Budimex are worth another €4.1bn (€29 per share). All three stakes are valued at current market prices or last transaction value. Lastly, its equity stake in BAA is worth €3.6bn at cost (€26 per share) with future upside. Combined, I am getting at least €11.5bn (€82 per share) of valuable assets for half the price. Even if you assume BAA is worthless, I am getting €8bn of value for €5.7bn today, a 30% discount.
Quick SOTP Overview:
Core Construction €3.8bn €27 per share.
Cintra, Tubelines, Budimex stakes €4.1bn €29 per share
BAA at cost €3.6bn €26 per share
Total equity value of Ferrovial €11.5bn €82 per share
Share price today is €41.
Investors perceive Ferrovial as an over-levered Spanish construction company. In reality, Ferrovial is a misunderstood, core infrastructure services company that’s under-levered with additional debt capacity at the Services business and at Cintra.
Investment Thesis:
Great Management: Raphael del Pino is the Chairman of Ferrovial and has a track record of excellent decision making and value creation.
Undervalued: I believe that the stock is worth approximately €100/share or more than double its current price. Current share price implies negative value for at least one of the major assets
Consistent Value Creation: Ferrovial has a history of growing its businesses and increasing the company’s value. Since del Pino took over in the mid-1980s, he has increased the equity value over 10x.
High Management Incentive: The Chairman’s family owns 58% of the outstanding shares. I believe he owns ½ of the family’s stake.
Substantial Insider Buying: del Pino has purchased over $200-million worth of stock during Q4 2007.
High Quality Underlying Businesses: The underlying businesses are characterized by their high growth, barriers to entry, and stability.
Positive Catalysts Coming: The news-flow on the company is at an inflection as we approach a final regulatory decision and a refinancing at BAA.
Company Overview:
Ferrovial owns and operates a core construction and services business and has majority ownership of two concessions companies (BAA and Cintra). Its core construction operations in
Operations:
I think Ferrovial has 3 major buckets of value, Core Construction & Services, BAA, and Cintra. I value each separately in a sum of the parts. I have provided the SOTP analysis towards the end of the write up.
Services:
The services division encompasses four unique activities. They are involved in waste and urban services in
I value the Services ex-Tubelines at 9x 2007E EBITDA, €3,420mm. This represents approximately 8x my 2008E EBITDA and is 17x 2007E Net Income and 15x 2008E Net Income. The Net Income multiple is conservative because it assumes zero net debt. These service business can typically support a lot of debt due to the long-term and recurring nature of their cash flows. The multiples are at meaningful discounts to peers like Veolia and Aguas de Barcelona.
I value Ferrovial’s 67% holding of Tubelines at last transaction multiples. On Jan 31, 2005, Jarvis sold its 33% stake in Tubelines to Amey for £147mm, implying €388mm for Ferrovial’s stake. They were distressed sellers as Jarvis at the time, and I believe value has only grown at Tubelines in the past 2 years as margins and cash flows have increased. I do not believe the Tubelines contract should be valued on an EBITDA multiple since it is a 30-year PPP contract and should be valued on the cash flows. Ferrovial has told me they have received a €8mm dividend for 2007. Although the 2007 dividend is small, based on the declining capex profile of the asset, I expect dividends to increase rapidly. Nevertheless, the €388mm figure implies approximately 17x 2008E EBITDA.
Construction:
Ferrovial’s construction business encompasses three unique activities: core Spanish construction, 60% stake in Budimex (a listed Polish construction company), and Webber Construction, a wholly owned
The construction business is attractive because it has strong cash flow generation due to its low capex needs and negative working capital as the division grows. Furthermore, Spanish construction is largely an oligopoly split amongst 5-6 companies, which provides some margin stability. Ferrovial’s construction business today is strong with a backlog of greater than 22 months (YTD +13% YOY). Only 16% of the backlog is in residential construction. The vast majority of Ferrovial’s construction activity is in infrastructure, which is the highest margin activity. Overall Spanish construction activity is supported by an infrastructure plan where the Spanish government has outlined €294bn of infrastructure spending from 2006-2020. The government has a strong financial position and a large budget surplus, and the infrastructure is needed due to
In my SOP valuation, I have valued Construction ex-Budimex at €2,118 mm or 6x 2007E EBITDA. This represents approximately 5.5x my 2008E EBITDA. On an after-tax basis, this represents 11x 2007E Net Income and 10x 2008E Net Income. The two most comparable pure-play companies are Balfour Beatty and Bilfinger Berger, and the multiples are in-line.
I value Ferrovial’s 60% holding on Budimex at market value of €330mm or €2.40/share. Budimex trades at peer Polish construction multiples on 2009 Net Income, which I think is appropriate. 2007 and 2008 multiples are distorted because Budimex has loss making contracts on its books that will run their course.
The core Services and Construction businesses combined are worth €5,538mm, excluding their stakes in Tubelines and Budimex. Ferrovial has approximately €1,700mm of net debt that is recourse to the parent and is associated with its core operations. The net value of the Core operations is €3,838mm. On a combined basis, that’s equal to 10x Net Income for the core businesses.
BAA:
BAA is the owner of the major London-area airports, including Heathrow, Gatwick, and Stanstead. These are the major airports in the London-area, giving BAA a major say in the economic development of the
We believe that BAA’s airports have a number of attractions. Airports are characterized by few substitutes and low competition. Additionally, it is nearly impossible to build new London-area airports due to space constraints and environmental concerns. The lack of substitutes and low cost as a portion of the total travel costs gives airports high pricing power to increase rates over time.
All of BAA’s London-area airports are operating close to capacity, which also creates pricing power. In addition to their pricing power, airports also have excellent growth. Historic passenger growth has been approximately 2x real GDP over the past 30 years.
Going forward, we believe that passenger growth is set to accelerate with the expansion plans at Heathrow and Stansted. In our opinion, the high pricing power means real prices should equal or exceed RPI over time. This is supported by the relative prices of BAA’s landing fees which are still substantially below global peers. Likewise, the value of landing slots at Heathrow suggests that prices are below market-prices and gives room to increase prices. We believe that the Open-Skies agreement will increase the number of long-haul passengers at Heathrow which will benefit BAA due to bringing higher value passengers and slots. There is also an opportunity for Ferrovial to earn money in its construction and service businesses through airport expansion.
The financial characteristics of airports are also attractive due to their high cash flow as a result of EBITDA Margins between 30-40% of revenues and maintenance capex of only 3-5% of revenues. Airports tend to be stable assets and have little cyclicality. For instance, passenger numbers at BAA recovered within 12-months of 9/11 and they continued to grow through the last recession.
In order to understand BAA, it is necessary to understand how its largest assets (Heathrow and Gatwick) are regulated. Heathrow and Gatwick (75% of BAA’s value) are regulated with a single-till RAB (Regulated Asset Base) system. RAB regulation seeks to define the total capital that has been invested in the business (defined as the Regulated Asset Base) as well as the Pre-Tax Real Cost of Capital of the business. Once the RAB and the Cost of Capital have been defined, the necessary EBIT is determined by the formula: Necessary EBIT = Average RAB * Cost of Capital. A single-till system means that all revenue streams at an airport (including landing fees, parking, etc) are included to project the airport’s EBIT.
The airports are regulated by the CAA (Civil Aviation Authority). The CAA is a UK Government Regulator whose job is to “promote the efficient, economic, and profitable operation” of airports in the
The current regulatory environment has worsened for BAA, but we believe that BAA can still earn attractive returns. Current returns at Heathrow are 7.75% pre-tax real but this is projected to drop to 6.3% for the next 5-years starting March 2008. Despite this decline, prices at Heathrow will increase by 28% in March and then by RPI+7.5% each year for the next 5-years. BAA’s high fixed-costs mean that price changes flow straight into EBIT. The CAA sets landing fees so that BAA can reach its targeted EBIT and earn its cost of capital. The CAA uses the formula Targeted EBIT + Projected Costs = Total Targeted Revenues. Total targeted revenues are equal to landing fees + projected non-regulated revenues (i.e. parking, retail, currency exchange etc). Total Landing Fees = Projected Passengers * Fee per Passenger. As a result of this framework, the CAA must project costs, non-regulated revenues, and passenger numbers in order to determine landing fees. BAA can outperform or under-perform the projections during each regulatory period, but the CAA resets its assumptions every 5-years. This creates a low-upside/low-downside regulatory framework. Assuming the allowed return = BAA’s cost of capital, the resets keep asset value near RAB and enable high leverage. Final price-caps for BAA’s airports will be released in February 2008.
In addition to undergoing an economic review, BAA is also the subject of a review by the Competition Commission. The Competition Commission is looking into whether BAA is operating an illegal monopoly. It is important to understand that not all monopolies are illegal. The monopoly would only be illegal if BAA is determined (1) to possess a monopoly and (2) to be abusing the monopoly. We believe that BAA would not be subject to fines because fines are typically only paid in the case of collusion to create or enforce anti-competitive conditions. If BAA is found guilty of operating an illegal-monopoly, the Competition Commission could require either behavioral or structural remedies. Behavioral remedies look unlikely due to the highly regulated pricing and system of performance-based penalties and rewards that is currently in-place. Structural remedies that could be enforced include the forced-sale of airport(s) and/or terminals. The most-likely structural remedy, the sale of an airport, could provide BAA with a windfall due to a likely change in regulation to dual-till regulation from single-till regulation. The current single-till regulation means that the highest returning areas of the airport, including parking and retail operations, subsidize the other operations. The decoupling of the cross-substitution would result in higher landing fees
We value Ferrovial’s stake in BAA based on a sum of the parts:
We build our DCF on an airport by airport level based on the explicit forecasts that have been released by the CAA. For instance, our Heathrow analysis looks as follows:
On a similar basis, we build up the RAB based on the CAA’s projections:
Lastly, this flows into our asset-level DCF calculation:
Lastly, BAA is worth at least cost based on a 5% dividend yield on €200mm of dividends in year 1, which grows to a 10% dividend yield by year 5 when they will receive €400mm of dividends.
Cintra:
Cintra is one of the world’s leading developers of transport infrastructures. It presently manages 23 toll highways in
I believe Cintra should trade at NAV and does not deserve a discount because of its releveraging and investment potential. Cintra has a pipeline of over €72bn in privatization deals that they are actively pursuing, the most notable is the Pennsylvania Turnpike which will come up for bid in 1H08. To take advantage of these investments, Cintra can relever €1bn-€2.3bn of additional debt at its concessions to finance these deals. I think this shows that the concerns regarding leverage at Cintra are exaggerated. Furthermore, the debt structure at Cintra prevents the holding company from being in danger even if one asset were to go bankrupt.
I think there is significant upside to Cintra and believe it owns the world’s best toll road in 407ETR. Nevertheless, investors who are uncomfortable with the sensitivity to yields, the lack of near-term FCF, and leverage, can short out their exposure to Cintra in Ferrovial and create the stub (1 share of Ferrovial – 2.5 shares of Cintra).
Sum of the Parts Analysis:
Main Bear Points:
Given the underperformance of Ferrovial in the market, the sensationalistic press coverage and commentary, and extremely negative investor sentiment towards Ferrovial’s “house of cards,” I believe it is necessary to give a full counterargument against the major bear points.
1) The Debt – Ferrovial is overleveraged due to its €31bn of consolidated net debt
At first sight, Ferrovial has a lot of debt. However, the structure of the debt and where it lies is crucial to understanding the risk to Ferrovial equity. The €31bn of consolidated net debt represents approximately 10x 2007E Consolidated EBITDA. I believe that this fails to take account of the recourse aspects of the consolidated debt. In total approximately €29bn of the debt relates to partially-owned assets and is non-recourse to Ferrovial. €19bn of the debt belongs to BAA. €8.3bn of the debt belongs to Cintra. €1.7bn of the debt belongs to Tubelines. These are all non-recourse to Ferrovial and only Ferrovial’s equity holding in each would be at risk. Even if all three of these assets are worthless, Ferrovial’s equity would still be worth €4.8-billion or €34 per share. Even if you assumed their stake in BAA and Tubelines were worthless, between the value of the services and construction businesses and market price of Cintra, you would be left with a total value of €58 per share or +26% from today’s price.
2) BAA Economic Regulation – The large decline in the allowed returns at BAA make this asset worthless
While BAA would be worth more with higher allowed returns, there is still substantial value at BAA. Under the new regulatory regime, BAA will still be able to earn returns above its cost of capital. In addition, there are substantial capex projects that will allow BAA to reinvest at the current allowed returns and therefore create value. Lastly, BAA has a substantial opportunity to outperform the CAA’s forecasts. The CAA’s ruling assumed low increases in retail sales despite the opening of Terminal 5 in 2008, which which will nearly double the retail selling space. The CAA also only assumes 1% real annual productivity improvements despite evidence of extreme waste, and the CAA assumes inflation in capex costs even though Ferrovial built Terminal 4 in Madrid for less than 50% of the per square foot cost of Heathrow’s T5.
Even if BAA under-earns current allowed returns in the current forecast period, the CAA will reset rates to allow BAA to earn its cost of capital in the next regulatory period. Unlike what is commonly believed, BAA is not at the sole mercy of the regulator because BAA has the right not to invest where they do not earn an appropriate rate of return.
3) BAA Competition Regulation – Investors fear BAA will be broken up by the Competition Committee
I believe that the positives from a breakup substantially outweigh the negatives. There is an opportunity to monetize an airport in a clear seller’s market for both airports and UK RAB-regulated assets. Such a sale will make the refinancing easier because the amount to be refinanced as well as the Debt/RAB ratios would decline. This will also open the potential to have the airport regulation changed from single-till to dual-till.
Also, the potential forced sale will not prevent a refinancing. There has been a long history of whole business securitizations that allow for asset sales as well as re-tapping the securitization. Nor will a forced sale of an airport hurt Ferrovial’s pricing power. All London-area airports are capacity constrained, which means there is no motivation for a competitor to cut costs (can’t increase volume). All London-area airports currently undercharge when compared to their international peers (i.e. Heathrow costs about 65% of
4) BAA Refinancing – BAA will be unable to refinance and the BAA equity will be worthless
I believe that BAA can refinance even in the current markets. Infrastructure assets are among the few asset classes where LBO activity has continued. There have been three recent LBOs of RAB-regulated assets in the
Even if it weren’t possible right now, BAA does not need to rush to refinance and thereby lock-in historically unattractive rates for 20+ years. BAA still has 4 years remaining on its bridge credit facilities. While not cheap, the bridge credit facilities are reasonable at L+200 and the cost only increases by approximately 15bp/year. BAA can fully-fund all of its planned capex for the next two years before becoming liquidity-constrained. At that point, BAA can either sell assets or cut back on capex.
From my analysis, the targeted debt level of 85% debt/RAB still appears achievable based on the recent LBOs. BAA’s existing £2bn of subordinated debt can be left outstanding so that a debt/RAB level of only 70% would be needed or £3bn of new debt.
5) Spanish Construction – Spanish construction will implode
So far, the problems are isolated to Spanish residential construction. There has been no slowdown in commercial or civil works activity. Within the Spanish residential industry, the problems are largely concentrated to small, independent construction players focused on the coastal regions. The major construction players have remained strong, and Ferrovial’s residential backlog is +5% YTD. Most importantly, Ferrovial’s construction division does not have much residential exposure (<16% of backlog today). As for the prospects of its majority civil works business, infrastructure construction activity will be supported by Infrastructure Plan 2020.
6) Cintra Concerns – Cintra is Overleveraged and Overvalued
I do not believe Cintra is overleveraged. Cintra has €8.3bn of net debt as of Sept 2007, which is approximately 10x Net Debt to EBITDA. While optically high, Cintra has high quality assets that support a lot of debt, require low capital expenditures, have low volatility, and are long-term concessions. Like Ferrovial’s financing structure, all of Cintra’s concessions are project financed with non-recourse debt to the parent. In fact, Cintra parent has €200mm of net cash. Even if one concession were to go bankrupt, the holding company itself is not at risk. Cintra can in fact raise an additional €1bn-€2.3bn of debt at their concessions, signifying the continued releveraging potential.
Many investors point to the premium Cintra has versus toll road peers and claim it is overvalued. I believe Cintra should trade at a premium to toll road peers. Its ssets have substantially longer lives than peers. Cintra’s average concession life of 73 years is more than double the 20-40 years of European peers. Also, the majority of Cintra’s assets are immature and are under-earning today so the multiple should be higher. Lastly, Cintra has much better toll regimes than peers. 407ETR, its largest concession, has toll freedom as long as it attains certain traffic levels. The tolls for Chicago Skyway and
7) Others: Habitat, Tubelines
The press has written much about Ferrovial’s investment in Habitat, the Spanish real estate company to which it sold its real estate business in early 2007. People fear Ferrovial will be forced to inject equity into Habitat. Recent reports suggest the crisis at Habitat is over with the purchase of €100mm assets from Habitat and that a resolution is coming soon. Ferrovial also has €250mm of Habitat’s debt. Even if Habitat were to go bankrupt, which it sounds like it will not, the debt is senior to equity so I would expect some recovery. Also, one should keep in mind that Ferrovial’s exposure to Habitat is under €3/share.
A sell-side analyst is making the case that Tubelines is negative value for Ferrovial. As stated earlier, Tubelines debt is non-recourse to the parent. I also believe Tubelines is value positive since Ferrovial is receiving dividends from the PPP. Worst case scenario is that Tubelines is a 0, but like Habitat, it represent’s less than €3/share to Ferrovial.
Conclusion:
At current levels, Ferrovial is a high margin of safety investment. Current prices imply negative value for at least one of its major assets. I think now is the start of the turning point for Ferrovial, as it gets final regulatory approval, a refinancing, and a potential buyback at Ferrovial post BAA refinancing. Ferrovial is worth double its current stock price today. Investors who do the work will be richly rewarded.
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