Link debacle sounds alarm for government plans but officials still confident about Chek Lap Kok The legal challenge that shelved the Housing Authority's Link Reit, or real estate investment trust, has cast a long shadow over the government's larger privatisation programme. However, according to a senior public official, the fiasco centred on 151 grubby commercial retail outlets and 79,000 parking spaces has not dissuaded the government from privatising one of its crown jewels - Hong Kong International Airport. 'We will watch [the Link proceedings] carefully and see how they develop,' Sandra Lee Suk-yee, permanent secretary for economic development and labour, said in an interview with the South China Morning Post. 'We've heard people say they agree with privatisation although, admittedly, most people say they [have reservations]. We have not heard anyone advocating an alternative route to privatisation.' A public consultation on the Airport Authority's proposed privatisation was initiated last month and is due to continue until mid-February. But what was a benign political environment at the consultation's outset has turned tempestuous, after the humble court challenge of a 67-year-old semi-literate public housing tenant, Lo Siu-lan, upended the best-laid plans of the chief executive's administration, its investment bankers and legal advisers. The Housing Authority's right to sell its retail and parking assets has so far been upheld by the courts at every turn. Ms Lo's challenge, however, exposed an insufficient legal framework for the privatisation of public assets and a government consultation process that - in the case of the Housing Authority - was at best opaque and at worst incompetent. With the possibility that Ms Lo would appeal the lower court rulings, the Housing Authority late last night announced that it was pulling this morning's $21.3 billion Link IPO, which would have ranked as the world's largest reit. Consultation meetings over the airport's privatisation have so far been held with the Board of Airline Representatives - which includes the airlines which operate at Chek Lap Kok - and with airport concessionaires and franchisees, employees, staff unions and academics. The government has also met with the Aviation Advisory Board which encompasses representatives from the wider trading community of shippers and freight forwarders. 'It's hard to talk to consumers directly, so we've tried, rather, to talk to a cross section of the public,' Ms Lee said. According to Ms Lee, the most contentious issue to emerge from the consultation was the design of an aviation charging mechanism that is deemed fair by all stakeholders. 'I can see this as being the most contentious issue for everyone. How do we determine a rate of return for the airport?' Ms Lee said, adding that a solution hinged in part on independent talks already under way between airlines and the airport. 'It really depends on a charging mechanism to be worked out between the AA and its users.' This hinges on a clear distinction of the airport's aviation and non-aviation revenues, how prices should be regulated and a consensus on the airport's future growth potential. 'These are the parameters for the AA to do their books,' Ms Lee said. 'What is aviation revenue and what is revenue from franchisees and concessionaires? They have to determine what goes into the mix. 'They also have to agree on traffic forecasts and growth forecasts for the airport going forward, as these things will also affect the future charging process. These are the kinds of details that are being discussed,' she added. 'Who drives growth, the airlines or the commercial franchisees? It's very difficult to draw the line, but we also want to avoid excessive cross-subsidies.' According to Airport Authority finance director Raymond Lai Wing-cheung, if the airport were listed today it would easily be valued at at least $40 billion - or about 30 per cent more than the $30 billion that the government still has locked up in Chek Lap Kok. 'That is my own personal speculation,' he said. 'Most airports are lucky if they can get book value, but I believe Hong Kong will be able to get more.' Mr Lai's estimate does not include the $6.38 billion that the government will receive from the authority this year, in the form of a $6 billion capital restructuring and a $380 million first-time dividend. While a $10 billion paper profit on its $30 billion investment sounds attractive, by the time the listing goes ahead in 2006 it will represent only a 3.66 per cent compound annual rate of return since Chek Lap Kok opened in 1998. Moreover, applying the $380 million dividend as a capital gain against the additional $6 billion returned this year yields just a 1 per cent annual return since 1998. Notwithstanding such financial engineering, the authority will need a valuation in excess of $50 billion for the total return on its original $36 billion investment to beat a benchmark long-term rate offered by long-term US government bonds. That would help it to achieve a 5 per cent average rate of return per year. However, Mr Lai maintained that a $40 billion valuation would be a positive figure for the first tranche of Airport Authority shares to be sold. 'You have to remember that this privatisation will only be a partial privatisation exercise,' he said. 'When the MTRC [Mass Transit Rail Corp] listed its first tranche of shares on the stock market, the valuation was at below book value.' Howard Lee Tat-chi, principal assistant secretary for economic development, said that the difficulty of arriving at a fair return for the Airport Authority was reflected in its recently published public consultation paper. 'In the paper, we intentionally left out numbers because we just wanted to talk about what mechanisms should be in place first,' Mr Lee said. 'Numbers are just a snapshot of any one year, rather than what should be the case going forward.' Profit issues aside, Mr Lee added that a privatised Airport Authority was also preferable because it would have more fund-raising flexibility. Up to now, the authority has relied on debt issuance to raise capital. 'That's good because interest rates are low now,' he said. 'But if rates rise significantly, being a listed company would allow it to tap the capital markets.' Zhang Anming, director of the Centre for Transportation Studies at the University of British Columbia in Vancouver, warned that a strong regulatory framework for a privatised Airport Authority will be a critical aspect of maintaining Chek Lap Kok as a driver of economic growth for the community. 'Airport charges of an unregulated profit-maximising airport are higher than those of public airports ... even after taking into account concession effects,' Mr Zhang said. 'Commercial freedom given to management is important, but not necessarily ownership type.' Studies had shown, he added, that 'there is no clear evidence of a positive link between privatisation and productivity' at airports. 'It is true that the Airport Authority is already run under prudent commercial principles,' Ms Lee acknowledged. 'But we think that as a publicly listed company, it will allow for greater public participation and transparency in its running. 'The airport business is no longer just about bringing in planes. It needs a lot of packaging and work with outside partners, such as other airports and other aviation entities, for more business freedom and flexibility. Alliance-forming is very crucial these days. We want to release it, and let it go on its own to do these things, rather than for it to have to go through Legco each time it wanted to do something new.' At issue, she said, were fundamental questions about the government, its economic role and method of operation. 'The question is, do you want more government interference or less?' Ms Lee asked. 'We're embracing transparency. If we put an umbrella regulation in place, then everyone will know how the AA must operate under it. 'We will install safeguards, but only to regulate where public interest is at stake. It's a balancing act because once it is a listed company, there are lots of things that we can't interfere in. As such, the charging mechanism becomes essential. And we want to include more consensus-building into the airport's development, rather than adversarial-type discussions.' As an example, Ms Lee said that early on in the British Airports Authority's (BAA) privatisation model, government regulation was 'very heavy-handed'. 'But now they've realised the need for a much more consensus-driven approach,' she added. 'Of course, they've had a much different history than Hong Kong. The BAA was run by bureaucrats before, and brought the private sector in to turn it around.'