The Luis Muñoz Marín International Airport “Privatization”:

A bad deal for Puerto Rico and the U.S.

Prepared by

José Antonio Herrero, economist

and

Mario Pabón Rosario, Esquire

November 18, 2012

1

1. Introduction.

FAA conducted public hearings in Puerto Rico on Friday, September 28, 2012 concerning to Puerto

Rico Ports Authority (PRPA) final application for participation of Luis Muñoz Marín International

Airport (SJU) in the Airport Privatization Pilot Program, Docket No. FAA2009-1144.

This document is a composite of two previously submitted documents and oral statements on

September 28, 2012 at the hearing. Statements made by José Antonio Herrero, an economist and

Mario Pabón-Rosario, Esq.

The composition of this document is basically the original and extended remarks of Herrero and

selected sections of the original statement of Pabón-Rosario. Nevertheless, both of the originals are

included in the form of an appendix.

There are five sections in what follows: 2. Study of desirability and convenience for Luis Muñoz

Marín International Airport, 3. Financial Analysis of P3A, LMM, International Airport, 4. Risk and Risk

Allocation between the parts to the contract and the fundamentals of the total transfer of risk from

the lessee to the lessor, 5. Conclusions and recommendation.

2. The Study of Desirability and Convenience (LMM-IA).

This study was prepared by Advanced Business Consulting under contract with Credit Suisse (USA),

the “Advisor” under contract with Public Private Partnerships Authority (P3A, The Authority), a Public

Corporation owned by the Government of Puerto Rico.

The relevance of this document is specified in the General Disclosure (Study, p.2 of 44).

The critical paragraph (¶3, lines 3-end) in page 2 states the following:

Neither the Authority nor the Advisor makes any representation or warranty

whatsoever, including representations and warranties as to the accuracy or

completeness of the information contained in this Study, including estimates,

forecasts or extrapolations. In addition, the Study includes certain projections and

forward-looking statements provided by the Authority with respect to the

anticipated future performance. Such projections and forward-looking

statements reflect various assumptions, and are subject to significant business,

economic and competitive uncertainties and contingencies, many of which are

beyond the control of the Authority. Accordingly, there can be no assurance that

such projections and forward-looking statements will be realized. The actual

results may vary from the anticipated results and such variations may be

material. No representations or warranties are made as to the accuracy or

reasonableness of such assumptions or the projections or forward-looking

statements based thereon. The Authority and the Advisor expressly disclaim any

liability for any representations or warranties, expressed or implied, contained

herein or for any omissions from this Study or for any other matter related to this

Study. The Advisor has not independently verified any of the information contained

herein.

This statement conceals the nature of statistical information. Estimations are subject to statistical

errors. There exists something called “standard error”, also “variance”, “standard error”,

“confidence intervals”, type I error, type II error, “correlation”, etc. So, to climb the top of the

mountain to enunciate that whatever information is given in the study, “NO REPRESENTATIONS OR

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WARRANTIES ARE MADE AS TO THE ACCURACY OR REASONABLENESS OF SUCH ASSUMPTIONS OR

THE PROJECTIONS…” (¶3, lines 10-end)

Interestingly enough is the following assertion: “The Advisor has not independently verified ANY of

the information contained herein” is not a responsible attitude and valid cop-out. Meaning that

Credit Suisse Securities (USA) bring the Advisor to P3A, under the umbrella of a $500,00 contract,

subcontracted Advanced Business Consulting and Credit Suisse did not care to review the document

that would Advise P3A as to the advisability of a project which is valued at approximately $2,000

million.

Law 129 requires, as part of the privatization process, the issuance of a “Desirability and

Convenience Study” (the “Study”). With regard to the privatization of LMM, as we have seen, that

Study was prepared with the active participation of parties who later became bidders in the process.

According to the P3A, a "Public-Private Partnership” (as it is identified in this privatization process), is

desirable and convenient when the following conditions are fulfilled:

1. There is a clear and urgent need for the Project;

2. There is clarity in the transfer of risks;

3. The value analysis is positive for the public interest; and,

4. The project is viable for the government1.

With regard to the LMM privatization process, the P3A concluded that establishing a “public-private

partnership” was necessary for the following reasons:

1. The PRPA has had a negative performance, which has caused its debt to be degraded, which

in turn makes it impossible to obtain funds for development and repairs at the airport;

2. The LMM airport has had a smaller growth than other airports in the total number of

passengers;

3. The LMM airport does not produce competitive earnings in areas such as food and

beverage, car rentals and parking, in comparison to other airports.

Are such conclusions based upon the facts? A detailed review of the Study shows that the answer is

in the negative. On the contrary, as the facts will show, these conclusions are based upon erroneous

premises, incorrect data and significant omissions, used to bootstrap the desired result.

2.1 The PRPA’s Negative Performance

When evaluating PRPA’s financial performance, it is important to keep in mind that PRPA is not only

the LMM airport, but includes all the other Puerto Rico’s airports, as well as the maritime ports. The

1 Estudio de Deseabilidad y Conveniencia: Descripción de Marco de Análisis y Metodología, document issued by the P3A dated

June 2010.

3

Study, at its page 12, concludes that PRPA has faced difficulties in increasing its earnings, based on

the fact that PRPA’s earnings have dropped from $157.8 million in 2007 to $136.5 million in 2008

and an increase to only $142.0 million in 20092. Nevertheless, when reviewing the income and

expense breakdown, it is clear that PRPA airport-based income has increased back to 2007-2008

levels, notwithstanding the fact that in 2008 American Airlines announced a 45% decrease in

capacity at LMM3. In comparison, the income from maritime operations has had a substantial

decrease, dropping from $77.6 million in 2007 to $58 million in 2008, increasing slightly to $61.8

million in 2009. It is clear that PRPA’s mediocre performance is not due to LMM operations, but to

other factors, including its maritime operation.

On the other hand, the Study describes a skyrocketing increase in PRPA’s operation costs from 2007

to 2009. According to the Study, the costs were $135.1 million in 2007, $172.5 million in 2008, and

$186.4 million in 2009. Conveniently, the Study does not contain a breakdown of which amount of

costs is attributable to the maritime operation and which amount attributable to the airport

operation.

Even if the source of the operational expenses had been duly broken down, the information would

not be sufficient to reach an honest conclusion regarding the LMM performance. In order to reach

that conclusion, it would be necessary to evaluate the earnings and costs of the 11 individual PRPA

airports, information which is not contained in the Study. A review of that information with regard

to the three largest PRPA airports (LMM, Aguadilla and Mercedita) shows the following (Source: FAA

CATS report 127):

AIRPORT 2008 2009 2010 2011

LMM

Revenues

$118,065,171 $35,474,5424 $76,704,960 $84,319,138

Expenses

(including

$96,618,740 $45, 898,590 $22,623,9015 $40,851,509

2 The income and expense amounts contained in the Study are very different from the amounts contained in the PRPA’s 2008

audited financial statements. There, it is stated that the 2008 earnings were $154 million (as opposed to $136 million), and the

expenses were $145 million (as opposed to $172 million). We do not know the reason why the wrong data was used; it

certainly shows a better performance by the PRPA than claimed in the Study. 3 Conveniently hidden somewhere else in the Study, and described as a “weakness” of the PRPA’s financial profile, it the fact

that Airline service levels declined sharply in FY 2009 due to the economic downturn and the decision by American Airlines to

reduce seat capacity to the Airport by 45%, but steady growth has returned since September 2009 (page 13 of the Study).

Ironically, that same fact is described as strength in the same page, indicating that Enplanement growth has resumed with

some strength since September 2009 due to increased service from several airlines. 4 The revenue part on the 2009 CATS report for LMM reflects 0 income from passenger airline landing fees, terminal arrival

fees, federal inspection fees and other passenger aeronautical fees, which is an anomaly.

5 The report for FY 2010 shows 0 depreciation. This is an anomaly.

4

depreciation)

Total Income

$21,446,431 ($10,424,048) $54,081,059 $43,467,629

AGUADILLA

Revenues

$2,940,095 $16 $2,713,671 $4,643,554

Expenses

(including

depreciation)

$8,394,577 $1 $6,222,720 $7,045,894

Total Income

($5,454,482) $1 ($3,509,049) ($2,402,340)

MERCEDITA

Revenues

$1,743,931 $379,989 $454,734 $1,456,226

Expenses

(including

depreciation)

$5,709,991 $5,807,253 $3,407,743 $4,541,317

Total Income

($3,966,060) ($5,427,24) ($2,953,009) ($3,085,091)

The logical conclusion from the numbers above (as unreliable as the data appears to be, as

explained in the footnotes) is that the mediocre or poor performance of PRPA is NOT due to the

LMM operation. Our inability to obtain the numbers relating to the maritime operation makes it

impossible to reach a conclusion regarding maritime vs. airport nature of PRPA’s losses.

Section 3.2.2 of the Study discusses PRPA’s credit profile. Since LMM does not have

independent credit capacity, and has to incur indebtedness on the basis of the PRPA credit profile,

the Study emphasizes that such credit profile is weak and dependent upon the Government

Development Bank. Similar information appears in PRPA’s evaluation reports from Moody’s and

Standards & Poors. Even if accurate, the fact that PRPA has a weak credit profile does not

necessarily reflect LMM economic capacity in comparison with the other PRPA components, nor

does it justify removing LMM from PRPA’s credit profile. On the contrary, and as will be shown later

in this paper, removing LMM from PRPA’s portfolio, particularly in light of the Lease agreement,

signed with Aerostar, can result in a domino effect that would make it impossible to operate the

remaining airports and seaports in Puerto Rico.

6 The Aguadilla report for 2009 was pro-forma.

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2.2 The LMM reduced growth

According to the Study, during recent years there has been a reduction in the LMM number of

passengers due to factors such as (1) the 45% capacity reduction by American Airlines, (2)

“managerial challenges” at the airport, (3) increase in competition from other airports for

passengers in transit, (4) contraction in the Puerto Rican economy, (5) reduction in the number of

U.S. tourists, and (6) increased competition from other destinies in the Caribbean. Furthermore, the

Study indicates that “the airport has not been able to control its costs, as appears from the landing

fees”, which makes it less competitive. That last statement finds no basis in the information

included in the Study.

The Study indicates that the landing fees increased from $2.46 per pound of takeoff weight in

2006 to $2.72 in 2007; were then reduced to $2.58 in 2008, and were kept at the same level in 2009.

The Study estimated the charges as $3.84 for 2010 and $3.65 for 2011, without explaining the origin

of such significant increase. As it turns out, those were the charges adopted by the current

administration via regulation in 2010 and 2011 while reducing the sources of income from

commercial activities inside the Airport.

The Study also discussed the income for aeronautical activities (“aero”), which refers to

activities such as the use of the runways, terminals, etc. According to the Study, LMM produces 40%

more than other medium hub airports in aero revenues. Also, LMM is 37% cheaper than the closest

international hub (Miami International). Nevertheless, the Study, in a clear effort to draw negative

conclusions regarding LMM, cites “increasing costs” as the reason why American Airlines reduced its

capacity in Puerto Rico.

By the same token, the Study indicates that “While LMM does generate significant aero

revenue, the Airport has very high operating costs”. It continues: “[LMM] has the second highest

operating expense per enplanement among comparable medium hubs, with levels near major US

international hubs”. For that purpose, the Study uses a graph (page 19) which, at close examination,

shows the fallacy of this argument. If we compare the aero revenues established on page 18 of the

Study with the costs detailed on page 19, we can see the following:

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RSW, MSY, HOU, SAT and DAL are medium hubs, the same category in which LMM finds itself.

However, contrary to these airports, which are all small city airports or secondary airports in large

cities, LMM is the main airport for the island of Puerto Rico. Although LMM’s costs are higher than

the other medium hubs, all those other hubs operate with losses much higher than LMM’s.

Contrary to the picture that the Study tries to paint, the cost/income ratio is not a factor that

justifies privatizing the LMM operation.

The Study also alleges that LMM does not have quality alternatives for dining, reason for which

the food and beverage income is only $0.16 per enplanement. According to the Study, this is

extremely low when compared with airports such as JFK, LAX, MIA and ORD. Such argument

contains various false premises. First, and contrary to what the Study indicates, since American

Airlines reduced its operation in Puerto Rico, LMM is not a major transit airport. On the contrary,

82% of its operations are origin-destination, and only 18% are connecting flights7. Obviously, in

origin-destination flights, the passengers do not necessarily stop to eat and drink at the airport,

contrary to what they do in connecting airports such as the ones cited by the Study. Second, most

of the connecting flights in Puerto Rico are flights connecting between AA and American Eagle,

connections which occur at the AA terminal, the terminal with the least food/drink alternatives in

the entire airport. A visit to the terminal back in 2010 and even today would show that terminals B

and C (the terminals that were in operation back then) have sufficient and varied food and beverage

alternatives, and at reasonable prices. Third, the Study fails to take in consideration that a

substantial number of passengers are flying low cost carriers such as JetBlue and Spirit, airlines that

fly at odd hours of the day when there is no need to eat or drink. Although there is always space for

7 Moody’s PRPA evaluation report, November 2, 2009

AIRPORT AERO

REVENUE ($ per

enplanement)

COSTS ($ per

enplanement)

DIFFERENCE ($ per enplanement)

IAH (Houston Int’l) 12.82 9.04 3.78

ORD (Chicago Int’l) 13.71 12.72 .99

JFK (New York) 28.50 27.84 .66

MIA (Miami) 23.69 23.38 .31

SJU [LMM] 14.10 14.12 (.02)

ATL (Atlanta) 3.69 4.02 (.33)

HOU (Houston Hobby) 9.65 10.70 (1.05)

MSY (New Orleans) 9.96 11.60 (1.64)

DAL (Dallas Love Field) 2.99 7.42 (4.43)

DFW (Dallas/Fort Worth) 8.56 13.64 (5.08)

SAT (San Antonio) 7.25 13.22 (5.97)

RSW (Fort Meyers) 9.99 16.26 (6.27)

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improvement in these areas, the low level of income for food and beverage should not be

justification for the airport privatization either.

The Study also indicates that LMM has poor performance in the area of vehicle rentals and

parking. With regard to vehicle rentals, the Study states that “while many tourists visiting the island

rely on taxis to get to their respective hotels/cruise ships, increased awareness of tourist activities

on the island could lead to improved car rental revenue. Obviously, an “increased awareness of

tourist activities on the island” is not a factor that depends of or can be controlled by airport

management. Besides what the Study recognizes, i.e., that many tourists do not need to rent

vehicles in Puerto Rico, other factors affect this area. Airports such as JFK, ATL and ORD have car

rental revenue which is less than that of LMM, obviously due to the fact that the passengers at

those airports are either in transit or use public transportation. At LMM, many of the passengers

are Puerto Ricans who are returning from or coming to visit relatives, and do not need to need to

rent vehicles. Furthermore, the Study fails to indicate if the revenues (and availability) that are

counted for purposes of the Study are those of on-airport car rental companies (which are a few,

and generally the most expensive ones) or those of all the companies that provide car rental

services off-airport in the Isla Verde and Los Angeles neighborhoods, only a few minutes outside the

airport. If the statistics included in the Study are only those of the on-airport companies, the

numbers are misleading. In any event, given that LMM is well served by the rental car companies

established on and off airport, it does not appear that car rental revenue is not a factor that

requires privatization of the airport.

With regard to parking revenues, the Study states that there is a per enplanement revenue

much smaller than that of the other mentioned airports. The Study indicates that the reason for this

reduced revenue is “poor management leading to mis-pricing and inadequate record keeping”.

Obviously, those are problems that are solved with better administration, not with privatization.

With regard to prices, it is clear that parking prices in Puerto Rico are generally less than in the US

(even at luxury hotels), so the income reflected will also be less. Furthermore, the parking revenue

statistic is also misleading, because it fails to take into consideration the fact that LMM parking is

strictly short-term (less than one day), while the remaining airports have medium and long-term

parking facilities that are heavily used. In fact, the cities mentioned in the Study as having the

highest parking fees are cities served by Southwest Airlines, whose passengers tend to be day-

trippers who depend heavily on those services. In Puerto Rico, the concept of long-term parking is

privately offered in a limited way (there is a lot at the Los Angeles neighborhood) and it is now

when, little by little, is starting to gain popularity. Finally, with the availability of cellular phones and

the cell phone parking area, the need for short term parking has also been reduced. In the end, this

area by itself is not a justification for privatizing the airport.

2.3 The LMM “opportunities”

Section 3.5 of the Study discusses the “LMM opportunities”. Many of them have been previously

discussed in this paper; however, there are two areas that are worth mentioning. First, with regard

8

to the cargo facilities, the Study indicates that the cargo revenue at LMM has increased significantly

since 2002. However, with regard to this increase, the only thing the Study says is that “the PRPA is

evaluating options regarding its cargo facilities”. Second, the Study emphasizes the possibility of

establishing LMM as an international hub.

Although LMM already has the facilities and the potential to become an international hub, our

political situation as part of the US customs and immigration system limits this potential. That is

because since 2003, the US suspended the Transit Without Visa Program (‘TWOV”). This program

allowed passengers to change flights at US airports to reach other countries without the need to

obtain a US entry visa. Once the TWOV program was eliminated, most passengers (including the

passengers from all countries in the Western Hemisphere) need some kind of visa to travel through

the US, something that would make LMM impractical as a transit hub. Presently, only the nationals

of 36 countries in the world (the EU, Japan, Korea, Singapore, Brunei, Australia and New Zealand)

are exempt from US visa requirements; it is obvious that these are not enough to create an effective

transit hub in Puerto Rico.

Puerto Rico’s limited viability as a transit hub under present rules becomes obvious when observing

American Airline’s decision of moving its Latin American hub from San Juan to Miami, although LMM

is a less expensive airport, and although AA incurred in a long term commitment with regard to its

LMM terminal, which is now almost abandoned.

2.4 The LMM capital improvement plan

According to the Study, there is a capital improvement plan at LMM that, during the years 2012-

2014 would cost about $89.6 million. At page 25 of the Study, it is stated that these projects would

be financed by Passenger Facility Charges (“PFC’s”)8. The Study then attempted to create doubt as

to the plan’s viability, indicating that “if PFC’s are not available to fund projects for any reason, the

operator will be forced to find alternative financing. In that case, the cost of financing is likely to be

much less by a concessionaire than PRPA’s.

The Study conveniently failed to mention that, by the time of its publication, the FAA had already

authorized PRPA to collect at least $520 million in PFC’s until 2033, so the concern expressed in the

Study is unfounded9. Furthermore, the Study fails to indicate that there are previously approved

grants from the federal government to perform the projects indicated on page 25 of the study,

which should reduce the cost of the capital improvement plan. For example, there are grants in the

amount of $82,992.00 for security measures, and $6,327, 354 for construction of the southern

general aviation access road and wildlife evaluation10. The omission is not casual; if the airport is

privatized, all of these funds would be available to the private operator.

8 An indirect tax on “consumption” of goods and services at the airport, paid by passengers.

9 PFC Approved Locations (as of 11/1/10), www.faa.gov/airports/pfc/monthly_reports.

10 Pre-application package, page 153.

9

2.5 The Desirability and Convenience Study-Conclusion

As detailed in this evaluation, most of the premises articulated in the “Desirability and Convenience

Study” as justification for the privatization project was not valid then and are not valid now. Had the

Study been performed in an honest manner, it would have concluded that, although the PRPA has

challenges regarding LMM’s performance, and there is much ground for improvement, a better

administration, and a better effort at improving tourism on the part of the Puerto Rico government

are the keys to a more successful PRPA. Even Caribbean Business, a weekly newspaper that has

strongly supported the public-private partnership process, had the following to say about the LMM

privatization on September 9, 2010:

Airport PPP Not a Magical Solution

Government officials interviewed for our front-page story consistently point to the

fact that both passenger and cargo traffic have declined at LMMIA. Their

complaints about the adequacy of the LMMIA may lead some to believe that this

reduction in traffic is the result of poor management and outdated facilities, and

that these shortcomings can be fixed by entering into a PPP to bring in a private

company to take over the management and operation of the airport through a long-

term contract.

We have no doubt that a private company will run the airport more efficiently and

will provide better services than those we receive under the management of the

Puerto Rico Ports Authority. As a result, entering into a PPP to upgrade the LMMIA

is a good move on the part of the administration. However, entering into a PPP

alone will not solve the real problems that are causing the decline in traffic at

LMMIA.

We should clarify at the outset that despite its current shortcomings, the LMMIA is

far superior to the airports of Santo Domingo, Cancun or any other island

destination in the Caribbean. In fact, from a passenger’s perspective, the LMMIA

is certainly more user-friendly than the huge and poorly organized Miami

International Airport.

The main cause of diminishing traffic is not our airport—it’s the fact that fewer

people want to travel to Puerto Rico. It’s the fact that there are fewer airlines

flying to Puerto Rico. It’s the fact that most of the airlines that are left have cut

back drastically on flights in and out of Puerto Rico because there is less demand.

Fewer people want to come to Puerto Rico because our hotel room inventory over

the years has hardly grown. Seven thousand rooms in 1970, 13,000 rooms today.

Cancun, about 400 rooms in 1970, more than 30,000 rooms today. Dominican

Republic, 3,000 rooms in 1970, more than 65,000 rooms today. Puerto Rico has lost

its ability to grow and attract visitors. Our marketing and branding changes

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completely every four years. The reasons why traffic at the airport has declined are

many.

In pursuing these P3 projects, it is essential that the government secure a sizable upfront payment

from the private entity that will receive the concession to operate the airport. After all, the entity

that is awarded the contract will be taking over a well-developed airport, where the government has

invested hundreds of millions of dollars in the past 10 years alone.

3. Financial Analysis of the proposal P3A project: LMM International Airport.

During the period 2001-2011 the annual average Operating Income of SJU-Airport was $54.6 million.

Grants and Passenger Facilities charges (PFC) annual average for the same period was $25.7 million.

This amount corresponds to non-operating income. Thus, total annual average of the SJU-Airport

financial resources is $89.8 million (64.1+25.7, operating income + PFC’s)11,12

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84.7=64.1+20.6, where $64.1 million is Operating Income plus Depreciation, plus Insurance claims paid plus other residual

costs, on a cash basis. On the other side, the $20.6 million corresponds to Grants from the federal governments ($3.2 millions)

and a tax paid by users of the airport facility, PFC (17.4 million). For the period 2001-2011 the annual average of Grants was

$10.0 million per year and P.F.C. was $15.7 million per year. 12

Source: FAA/CAT5/RPT127 fiscal years (P.R.) 2001-2011.

11

3.1 The analytical model and valuation

3.1.1 Present Value of the stream of Operating Income including Depreciation and cash

payment:

PV(Yop)=PV(n, iR Yopt)

PV(40,(0.05-0.03)),64.1=1,753.5

PV(Yop)=1,753.5 million

Yop: Operating

Income+Depreciation+others+insurance

claims

t=1, 2, 3………39, 40

i, interest rate

iR at constant 2011 prices

im at current prices

iR=im-π

π, inflation rate =0.03

The flow of income of $64.1 million per year, discounted at a monetary rate of interest equal to

5% and an expected rate of inflation equal to 3%, which implies a real rate of interest equal to

2%, during a period of 40 years, generates a stuck of wealth equal to $1,753.5 million.

3.1.2 PV of payment for the acquisition of absolute control of SJU(LMM)

In exchange for $1,753.5 million, the counterpart to P3A pays to $615.0 million up front for the

liquidation of debt of GDB-PRIFA-PRPA for the amount of $669.2 million. The counterpart

accepts the payment schedule for amortization of such debt AFI=AFI1+AFI2+AFI3. According

with the official statement of the debt issued by PRAFI (a subsidiary of GDB) the payment of the

debt is scheduled in three (3) series (AFI1, AFI2 and AFI3). The PV of the payments is $518.6

million PV (AFI1=320.5, AFI2=105.1 and AFI3=93.0). Note that in this arrangement the

counterpart receives a capital gain of $96.4 million (615.0-518.6)

The counterpart has to pay Rent for the current utilization of the assets of the airport. The PV of

the future stream of rents in 40 years is $128.9 million13. Note that this rent is the maximum

expected rent according to foot note 13.

13

Rent. ∑�

����.���∗�.�+ ∑

�

����.���∗ �.�∗�.��+∑

�

����.���∗ �.�∗�.�= 11.8 + 75.0 + 42.1 = 128.9����

�����������

������ . This is the PV of

the rent in which $2.5 million are paid annually during the first five (5) years, $4.25 million is paid during the period year six (6)

to thirty (30) and $8.9 million is paid during the period year thirty one (31) to year forty (40).

There are two (2) other definitions of the rent. A) Section 2.1 (c) of the Lease Agreement reads as follows:

(c) The Lessee shall pay to the Authority, in cash, an amount (the “Annual Authority Revenue Share”) equal to (i) for the sixth

full Reporting Year through and including the thirtieth fill Reporting Year, 5% of the gross Airport Revenues earned by the

Lessee in such Reporting Year or (ii) for the thirty-first full Reporting Year and each succeeding Reporting Year, 10% of the gross

Airport Revenues earned by the Lessee in such Reporting Year. In this case the counterpart can choose between paying 15.1 or

42.1 million.

The partnership report considers that the rent includes both periods from 6 to 30 and 31 to 40 which mean that the total

payment of rent is $116.84 million according with the partnership report.

12

3.1.3 Other Transactions

a. Present Value at formalization of the P3A of the SJU (LMM): 0.05*615=$30.8 million, paid by

counterpart. However, such payment is subject to full payment of long term debt of PRPA,

including lines of credit with GDB, loan with Wells Fargo, et al.

3.1.4 Summary

P3A generates a deficit:

DEFICIT=1,753.5-518.6-128.9-30.8

DEFICIT=1,075.2 million.

NOTE: If FAA accept the transfer of money associated with Grants and PFC, the

additional loss to PRPA/GDB is PV (40,0.02,25.7)=703.0 million.

In this case, the total deficit of the transaction of SJU (LMM) is:

DEFICIT(1)=1,075.2+703 million

DEFICIT(1)=1,778.2 million.

The rate of value to money in favor of the counterpart in the case of no transfers of

grants and PFC is equal to: VM=1,075.2/518.6=2.07. Meaning that for each dollar of

investment in cash the transactions generates $2 in value.

In the case of the transfer of grants and PFC’s is included then the rate of value to

money is: VM=1,778.2/518.6=3.43.

Another interpretation of these parameters is by observing the value of the inverse of

the parameters. For example if the value to money is 3.43 then the parameter of

money to value is = 1/3.43=0.292 which implies that for every dollar of wealth conceded

by the government, only $0.29 is receive in exchange.

4 The Allocation, Distribution of Risk

The “Study of Desirability and Convenience for Luis Muñoz Marín” repeats fifty (50) times the word risk

in the space of twenty five (25) pages-net. A ratio of two times the word risk per page-net.

To study the possible events of risk is necessary to study the documents which configure the entity

under analysis.

4.1 The “Operating Standards”

One of the P3A’s most commonly used selling points to convince the Puerto Rican people of the

convenience of the LMM privatization is the adoption of new “Operating Standards”. As stated in Part

III (A) of the Final Application:

Another critical element is the requirement under both the Lease Agreement and the Airport Use

Agreement that Aerostar comply with detailed Operating Standards that are an exhibit to both

agreements. These Operating Standards set out standards for ongoing maintenance and operations,

both within the terminals and on the airfield. The Operating Standards also require an annual review by

an independent engineering firm to assure that all operations are being maintained at the legally-

13

required levels and require Aerostar to propose and implement a plan to respond in a timely way to any

material issues that are identified.

So important are these “Operating Standards” as a selling point, that even Governor Fortuño, when

announcing the selection of Aerostar as the winner of the bidding process, emphasized their

importance, focusing on the many daily times that the private operator would be required to, among

other things, clean the airport bathrooms. However, when evaluating the applicable clauses of the lease

agreement, it becomes obvious that adherence to such standards is practically voluntary on the part of

the private operator.

Section 6.1 of the Lease Agreement establishes the “obligation” to comply with the

Operating Standards. Immediately after establishing that “obligation”, however, the

lease removes all possibility of enforcing such Operating Standards by permitting (i) long

periods to cure noncompliance, (ii) flexibility at the time of compliance, and (iii)

clarification that the Operating Standards are not violated by occasional acts. In fact,

Section 6.1 states “any non-recurring failure to meet specific time limits shall not

constitute a violation”. With that language, any hope that the operator would feel

obligated to “clean the bathrooms 16 times daily” shall cease to exist.

The voluntary nature of these Operating Standards becomes even clearer when examining Section 16.1

of the lease agreement. Under that section, in order to be considered an event of default by the lessee,

any violation of the Operating Standards would require that (i) there was a failure to comply 3 times

within a calendar month, (ii) the failures would have to continue unremedied for 30 days after notice,

and there would have to be 12 months of persistent breach. This arrangement is so cumbersome that

the lessee would have to work extremely hard to deserve having its failure to comply be considered an

event of default.

Finally, nowhere in the lease agreement or the operating standards is there any discussion of how does

the PRPA intend to monitor daily compliance with the operating standards. The only review mechanism

is an annual review by an “independent” engineering firm paid for by the lessee. As with any set of

laws, rules, regulations or standards, if there’s no enforcement mechanism, they become a simple wish

list.

4.2 Environmental Liabilities

Section 3.2(c) of the lease agreement exempts the private operator from any liability regarding

environmental conditions existing at the time of closing. Among those pre-existing environmental

liabilities, there is a large potential liability for the damage caused to the airport land due to leakage in

the operation of the fuel system. This potential liability remains with the PRPA.

Section 4.5 of the Desirability and Convenience Study indicates that, through the years, this potential

liability has been charged to the airlines through the rate-setting methodology. Once the privatization

takes place, the PRPA will not be able to charge this liability to the airlines and, as we have explained

14

before, will not have the ability to obtain funds for this purpose. Thus, the PRPA will have a great

exposure to this potential liability, without a clear mechanism to provide funds to resolve it. When

cleanup time comes, as it eventually will, it will probably be necessary to obtain US taxpayer funds,

through mechanisms as the Superfund, to perform this cleanup, while the private operator will be

happily enjoying its profits.

4.3 The Effect of Privatization on the Regional Airports

As the FAA is aware, besides LMM, the PRPA owns 11 other airports in Puerto Rico, all of which to some

extent receives FAA approved funds, be either pfc’s or grants. None of these airports is profitable;

however, they provide a valuable public service to Puerto Rico by permitting air service to reach

locations on all corners of the island. In recent years, the government of Puerto Rico has made an effort

to expand passenger service to the Aguadilla and Ponce airports, and has announced plans to use those

airports as key elements of the economic development strategy for those areas. Furthermore, the PRPA

has moved the operations of the Fajardo airport to the Ceiba airport (the former Roosevelt Roads Naval

Center, now known as José Aponte de la Torre Airport), a facility with enormous untapped potential. All

of these efforts, however, will come to a sudden halt if the LMM privatization process is allowed to

occur, and these airports will become “white elephants” which neither the government of Puerto Rico

nor the US government will be able to maintain.

Section 3.22 of the lease agreement establishes that the PRPA will pay “leasehold compensation” (i.e.

penalties) if any government entity obtains a 14 C.F.R Part 139 operating certificate for (i) any airport in

Ceiba during the next 20 years, or (ii) any airport anywhere else in the island during the next 15 years.

Furthermore, the PRPA will be required to pay “leasehold compensation” if, at an airport that has a Part

139 certificate, there is an addition of new passenger service that is not the expansion of present service

(i.e., new airlines).

With regard to the Ceiba airport, Section 3.22 has the effect of making its development impossible for

the next 20 years. Following the LMM privatization, the PRPA (and the Federal government) will have

the obligation of maintaining this airport, with its 11,000 feet runway and its 1700 acre grounds, as an

airport to serve the small planes that serve Vieques and Culebra. Given the size of its runway, it is not

even efficient for that purpose, as the planes have to spend much more time taxiing that at the old

Fajardo airport.

With regard to the Aguadilla and Ponce airports, the situation is just as difficult. These are airports that

could potentially handle higher commercial passenger service. However, if the privatization is

permitted, there will be no possibility of bringing new airlines for the next 15 years, and that potential

will remain untapped.

On July 30, 2012, Representative Charlie Hernández made a public denunciation of the nefarious effects

of Section 3.22. Following that announcement, the P3A has gone to great lengths to deny the

accusations, claiming, among other things, that this is a common clause and that it has FAA approval. If

the FAA has really reviewed and approved that clause, it should take a closer look at its effects,

particularly in light of the Regional Airports Operational Plan (‘RAOP’) proposed by the P3A/PRPA.

15

The RAOP (Appendix F to the Final Application), although directed to the Regional Airports, starts by

adopting a basic (and contradictory) premise: Ensuring Enhancement of LMM is Critical for Puerto Rico.

Under that premise, it is claimed that LMM’s potential as an economic generator has not been fully

realized. It is also claimed that the regional airports, which handle 11% of the passenger service in

Puerto Rico, have the potential to “increase frequency, provide cargo services, and develop other

services”.

The RAOP consists of five types of measures: (i) managerial measures, (ii) support measures for regional

airports, (iii) capital improvements, (iv) efficiency and expenses, and (v) revenues and opportunities.

The ‘managerial measures’ consist of naming a ‘revenue manager’ to evaluate the revenues and the

lease agreements, in a way that the PRPA can maximize revenues (read: increase lease costs).

Furthermore, the RAOP proposes the consolidation and restructuring of the PRPA’s Engineering and

Planning departments, in a way that these departments handle the capital improvements at both the air

and the maritime divisions (read: reduce headcount).

The discussion of ‘support measures for regional airports’ goes back to the basic premise, by indicating

that “rather than a diluted aviation system, the P3 for LMM facilitates a robust International Airport

capable of serving all Puerto Rico, and promotes the optimization of the regional airports”. As a support

measure, it proposes to use the $25 million fund to be established as part of the privatization agreement

in the following order: (i) payment of operational expenses, and (ii) capital improvements. This clearly

shows that the intention is to invest the least amount possible in capital improvements to the regional

airports.

With regard to the capital improvements, the RAOP indicates that all future projects should include a

financial cost/benefit analysis. It is emphasized that capital improvement projects should focus

primarily on general aviation and commuter aircraft (as opposed to commercial aviation). Also, it

indicates that the PRPA should develop a capital improvement program based on its ability to obtain

funding, which, as we have previously seen, will be questionable at best following LMM’s privatization.

The discussion of “efficiency and expenses” the report indicates that the PRPA will investigate and

evaluate all options available to reduce utility expenses, including recouping such expenses from the

airport tenants (read: increase lease costs at the regional airports). It is also emphasized that, although

regional airports handle only 11% of the passenger traffic, their payroll expenses amount to 33% of the

PRPA payroll. As a remedy to that, the report mentions the possibility of having the regional airport

employees become employees of the LMM private operator, or that they take early retirement through

the fund to be established with funds from the LMM upfront payment.

With regard to the ‘revenues and opportunities’, the report states that the PRPA will establish a plan to

maximize revenue by reviewing all contracts such as concessions, car rentals, etc. The report

emphasizes that the landing fees and other fees at the regional airports have historically been “below

cost recovery”, and that the PRPA should revise them until they reach cost recovery.

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All of the measures contained in the RAOP, if adopted, will have one certain result: to eliminate

whatever incentive there may be for commercial airlines such as JetBlue and Spirit to continue flying to

Aguadilla and Ponce. Particularly for JetBlue, which has a new terminal available at LMM, there is no

reason to keep a separate operation at Aguadilla and Ponce if there is no cost incentive. Once these

airlines decide not to fly to the regional airports, Section 3.22 of the LMM lease agreement will make it

impossible for the PRPA to find substitutes at the regional airports.

A further nail in the regional airports’ coffin is Section 4.9 of the proposed Use Agreement, which

creates the “Puerto Rico Air Travel Promotion and Support Fund”. As explained previously, this fund

grants monetary incentives to any airlines operating at LMM that brings to LMM a higher number of

passengers than it brought to that airport in 2011. Obviously, given the stagnant economy, the only

probable way of reaching a quick increase in the number of passengers to LMM is for the airlines to stop

flying to the regional airports. Once those flights leave the regional airports, pursuant to Section 3.22 of

the LMM lease agreement, it will be impossible to substitute them without penalty.

Finally, it is important to notice that, although the LMM lease agreement places limits on the PRPA’s

ability to bring passenger service to the regional airports, and there is much talk about developing cargo

service in those airports, there is absolutely nothing in the contract that limits or impedes LMM’s ability

to increase its cargo operations. In fact, the LMM growth plan includes ‘growing cargo operations at the

airport14. Given its already developed cargo facilities, and the immense potential created by the

availability of Terminals D and E (American Airlines’ terminals, which Aerostar plans to mothball in the

short run), compared to the need to develop cargo facilities from the ground up at the regional airports,

what are the chances that the regional airports will be able to count on cargo business to survive (even

with the certification of Aguadilla as a Free Trade Zone)?

Reality cannot be avoided: should the LMM privatization be allowed to occur, the regional airports will

be doomed to underdevelopment and inefficiency. While the residents of the Western and Southern

parts of Puerto Rico will lose the convenience of what little passenger service they have now, the PRPA

will have to continue carrying these unproductive assets, which will become absolutely dependent upon

federal funds for their continued existence.

4.4 PRPA’s Viability Post-LMM Privatization

One important question that we had asked ourselves since the filing of the Preliminary Application for

the LMM privatization is: what will happen to the PRPA if LMM is privatized and removed from its

portfolio? As part of its effort to justify the LMM privatization, the RAOP contains a financial pro-forma

which attempts to paint a positive picture of the PRPA without the LMM. Upon close examination,

however, the effort fails.

14

See, Public-Private Partnership Luis Muñoz Marín Airport: Selection of Preferred Bidder, presentation prepared by the

PRPA/P3A, July 19, 2012, page 6.

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In case there was any doubt that the PRPA is not counting on developing the regional airports, it should

be noticed that the pro-forma assumes the following: (i) minor increases in passenger traffic; (ii) modest

cargo growth at Aguadilla; (iii) regional airport capital expenditures funded through grants, pfc’s,

proceeds from the privatization or property sales; (iv) increases in ground leases; (v) increases in

aeronautical rates; and (vi) the transfer or at least 10-11% of the PRPA employees to the private

operator. After making those assumptions, the pro-forma makes some outlandish financial projections,

upon which it builds the conclusion that the PRPA will be able to survive after privatizing LMM. The

regional airports’ income and the maritime income are projected as follows:

It appears clearly from the above table that, while a modest increase is projected for airport income, a

fabulous increase is projected for maritime income. On the basis of that fabulous increase in maritime

income, it is projected that the PRPA would only have losses in 2012, and would return to profitability

from 2013 on. Against that projection, it is necessary to look at reality-based numbers:

Nowhere in the pro-forma is there a justification for the optimistic projections for years 2012-2014.

Given the PRPA’s historic reality, the data contained in the pro-forma lacks credibility, and appear to be

a simple process of inflation to justify the result desired in the pro-forma.

On March 2009, Standard & Poor’s issued its most recent rating of the PRPA debt15. At the time, the

rating agency downgraded the PRPA debt to BBB-, and indicated that the rating reflected weaknesses

such as (i) the fact that the Authority’s financial performance is integrally related to the Commonwealth

of Puerto Rico and the GDB, (ii) significant volatility in airport enplanements and cruise ship passengers

and, (iii) relatively high dependency on American Airlines and American Eagle passengers. On the other

hand, the credit weaknesses were partly mitigated by (i) strong support from the GDB, (ii) monopolistic

control over all of Puerto Rico’s airports and most of Puerto Rico’s ports, (iii) operational and financial

diversity from the authority’s two principal facilities: LMM and the Port of San Juan, and (iv) relatively

high proportion of origin and destination passengers. Furthermore, S&P indicated that, if the ratings on

the Commonwealth or the GDB were lowered, the ratings on the PRPA would have to be lowered.

15

Preliminary Application package, pages 177 et seq

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PRPA post LMM P3A

Proforma Income Statement

2008-2017 (000$)

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

(a)

Aero Income Non-LMM

Growth Factor

4,522

5,127

1.1338

5,962

1.1629

6,585

1.1045

7,288

1.1068

8,219

1.1277

(b) Non Aero Income Non-LMM

Growth Factor

3,380 3,613

1.0689

3,719

1.0293

3,792

1.0196

3,900

1.0285

3,971

1.0182

(c) Maritime Income

Growth Factor

Source: P3A

67,943 62,833

.9248

73,250

1.1658

60,156

.8212

76,620

1.2737

83,034

1.0837

91,285

1.0994

92,184

1.0098

93,098

1.0099

94,027

1.0100

Note: No explanation for the extraordinary growth of Maritime Income: 51.8% for 3 years 2012-2014

Assume instead that growth is positive: 1.01, then,

(d) Maritime Income 60,156 60,758 61,365 61,979 62,599 63,225 63,857

(c)-(d)=(e) 15,862 21,669 29,356 29,585 29,873 30,170

End Balance

(f) As per P3A (27,121) 53 160 145 158 235

(f)-(e)=(g) As per growth consistent with

actual conditions

(42,983) (21,616) (29154) (29,040) (29,715) (29,935)

Note: By just adjusting the rate of growth of Maritime Income to a more reasonable rate the Balance change for the worst. Compare (c) with (d) and (f) with (g).

Then, look for Maritime Income of PRPA for the period 2000-2011. Or, simply compare 76,620 with the audited value. In the original prepared by PRPA the

reported value of 76,620 is unaudited

Note1: Growth Factor – 1 = Rate of Growth

Note2: It’s interesting to observe that by being prudent in the estimation of the growth of maritime income for the years 2012, 2013 and 2014

the Balance for PRPA immediately reflects a deficit of approximately 30 million per year. This implies that a calamity for PRPA. One wonders if

the maritime income will grow by 52% in the period 2012 to 2014. This percentage comes from 1.2737*1.0837*1.0994=1.5175.

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Were this privatization process allowed to proceed, the post-privatization PRPA would still have most of

the weaknesses listed above, but would not have the monopolistic control over the airports that was

considered a strength. Under those circumstances, the post-privatization PRPA would be hindered in

any effort to issue new debt, even if it was left debt-free at the time of the privatization. Given the

overextended situation in which the GDB and the Commonwealth find themselves at the present, the

PRPA may lose its viability, putting at risk the extensive investment in grants, pfc’s and other funds that

the U.S. government has made up until now.

5 Summary and Conclusion

Starting with the study and analysis of the project, which is based on a peculiar appreciation of a Public

Private Partnership, as expose in the Study of Desirability and Convenience for Luis Muñoz Marín

International Airport.

The financial analysis of the project as structured produces a loss to PRPA of $1,084.2 million valued at

Present Value, for forty (40) year at a 5 percent of interest nominal and 2 percent in real term. An

annuity of $64.1 million, during the period produced by the airport operation is what the counterpart to

P3A receives. An upfront payment of $615 million is converted into a payments plan to pay back a $669

million debt previously issued, to pay back debt of PRPA. The present value of the payment plan has

value of $494.1 million. The counterpart obtains a capital gain of $121 (615-494) million thanks to GDB.

The loss to the government of Puerto Rico is $1,084.2 million without the Grants and PCF transfers.

Including the value of the transfer the loss is $1,787.2 million.

To analyze the risk events of the project a study was made of the Lease Agreement16, the airport use

Agreement on the (NEW) operating standards. Section 6.1 and 16.1 of the lease Agreement, jointly with

the fact that there is not description in the agreement as to how PRPA is going to monitor the

compliance of the counterpart with the operating standard. Then, with no monitoring by PRPA and the

cumbersome procedures defined in 6.1 and 16.1, construct a moral hazard by facilitating the voluntary

nature of the operating standards. However, there is an annual monitoring performed by an

independent engineering firm paid for by the counterpart (The Lessee).

In this manner all risk of the operation are transferred to PRPA. The only risk of the operation of the

airport which is faced by the lessee is the one associated with the annual monitoring, the cost of which

is paid by the lessee.

It is abundantly clear that the voluntary compliance, of the lessee, with the operating standard plus the

passivity of PRPA, converts this so called Public Private Partnership, risk wise, and is the opposite of

Privatization. By privatization all risk is transferred to the counterpart (the buyer) in this P3 no risk is

allocated to the counterpart (the lessee)17.

It is a heavy burden, and unnecessary, to accept this P3A project. The government of Puerto Rico has

other options before John Galt.

16

Schedule A12 of the Lease Agreement pp1225-1321 of PAA Docket 2009-1144 Final application 17

See Bibliography 1

20

Bibliography

1 Engel, Eduardo Ronald Fisher and Alexander Galetovic, The Basic Public

Finance of Public-Private-Partnerships, National Bureau of

Economic Research, WP-13284, July 2007, 62pp

2 FAA CATS, Rpt 127, various years, various airports 2000-2011

3 Herrero, José Antonio Concesión del aeropuerto LMM, San Juan, Puerto Rico: un

ejercicio de “crony capitalism”, sept 2012 5pp.

Jaherr01@gmail.com

4 Leiringer, Roine Technological Innovation in PPPs: incentives, opportunities

and actions, Construction Management and Economic,

Reading U.K. March 2006, pp. 301-308

5 OECD Public Private Partnerships: in pursuit of risk sharing and

Value for Money, www.oecd.org/publishing, 2008 pp 35-88

6 P.R. Ports Authority Airport Use Agreement, San Juan, PR, July 5, 2012,

97pp+Schedules

7 P.R. Ports Authority Basic Financial Statements 2002-2011 San Juan, PR, various

dates

8 P.R. Ports Authority Final Application under 49 U.S.C. SS47134 for the Long

Term Lease of Luis Muñoz Marín International Airport,

Docket No. FAA 2009-1144, updated, San Juan, PR, 44pp +

appendices

9 P.R. Ports Authority Luis Muñoz Marín International Airport, Lease Agreement,

San Juan, PR, July 24, 2012, 150pp+Schedules.

10 P3A Ensuring Enhancement of LMM is critical for Puerto Rico,

San Juan, PR. Undated

11 P3A Partnership Report for the Procurement to acquire a lease

to finance, operate, maintain and improve Luis Muñoz

Marín International Airport San Juan, PR, July 2012, 25pp +

appendices

12 P3A Schedule A- Operating Standards Luis Muñoz Marín

International Airport, July 24, 2012, 76pp+ appendices

13 P3A Study of Desirability and Convenience for Luis Muñoz Marín

International Airport, San Juan, PR June 2010, 44pp

14 Pabón Rosario, Mario The Luis Muñoz Marín International Airport Privatization;

San Juan, PR, Sept 2012 22pp mpabon@justice.com

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