Public Private Partnership/Concession ModelA Fad or a Wave of the Future California Municipal Treasurer's Association April 27, 2006
Public-Private Partnerships can provide a new source of capital for State and Local Governments. New OptionPublic-Private Partnership • Traditionally allows conservative amount of debt to fund projects • Perceived financial obligation of sponsoring entities Historical Option Issue tax-exempt bonds • Can be structured to minimize impacts on customers and/or sponsors • More capital for given project (debt and equity) • Operating risk shifted to private party • A long-term agreement under which a private firm designs, builds, manages and/or operates a publicly-owned asset
Oregon Evaluating private concessions on three separate greenfield projects An increasing number of State and Local Governments are utilizing Public-Private Partnerships for their financing needs. Utah P3 Legislation in place Illinois Concession sale of Chicago Skyway for $1.83 Bn New York P3 Legislation in process Colorado Evaluating P3 opportunities for future toll roads Indiana Sale of a Concession in Indiana Toll Road with outstanding bid of $3.85 Bn • New Jersey • P3 Legislation in process • Potential Concession sale of the NJ Turnpike and Garden State Parkway • California • New P3 Legislation being considered • BART OAC Project • Delaware • P3 Legislation in place • Potential sale of State Route 1, Route 301 & I-95 • Virginia • Dulles Toll Road Concession • Capital Beltway HOT Lanes • Pocahantas Parkway concession • Texas • Trans Texas Corridor Project; Six 50-yearconcessions for greenfield projects • Harris County considering private Concession sale of its Toll Road System North Carolina P3 Legislation in place South Carolina P3 Legislation in place • The $3.85 Bn Indiana Toll Road and $1.83 Bn Chicago Skyway transactions have created an increased focus on alternative infrastructure investment strategies Goldman Sachs has had dialogue with key decision makers on P3
Public-Private Partnerships are very common in Europe and Asia. Light Railway Water & Waterway (incl. Solid Waste) European PPP Activity Airports Ports Roads Austria Belgium Denmark Finland France Germany Greece Ireland Italy Netherlands Norway Portugal Spain Sweden UK China Hong Kong Japan South Korea Asian PPP Activity
Target Infrastructure Sectors Investment Characteristics Recent US Infrastructure Activity Leveraged Equity Investment Steady, predictable, low-risk cash flows to match long-dated insurance and pension liabilities The emerging infrastructure market offers an alternative source of funds via the equity capital of insurance and pension funds. • Transportation • Toll Roads • Airports • Ports • Regulated Utilities • Electricity • Gas • Water • Government Infrastructure • Schools • Hospitals • Prisons Total Buying Power: $189 Billion Potential Existing Asset Leases • Essential social infrastructure • Insulation from business cycle • Natural inflation hedge • Ability to support high leverage Potential Greenfield Projects Completed P3 Transactions
Infrastructure Assets European Toll Roads European Ports Real Estate Assets European Airports European Properties European Regulated Utilities US Reits (Apartments) US Reits(Shopping Centres) US Reits(Office Properties) Relative to real estate, an asset class with similar investment characteristics, infrastructure is undervalued. Commercial Real Estate Cash Flow Characteristics • Exposure to over development • Valuation compared to replacement cost (suburban office, retail) • Exposure to supply demand characteristics of real estate - weakness in net effective rents with vacancy rates above 7%-8% • Real estate assets discounted with long-term DCF, five year exit assumes growth in perpetuity of limited life asset Valuation Differences in Infrastructure • Infrastructure valued over long time period, with realistic capital expenditure assumption • Returns calculated over long life, return is driven by long-term refinancing and dividend capacity • Finite life of concessions 25 to 100 years, similar to a ground lease High Medium Source: Goldman Sachs estimates
Toll Roads Regulated Utilities Airports The United States market represents an area of potential growth for infrastructure investors. Future Privatisation (e.g. UK, Germany) 42% Future Privatisation 28% Europe Government 21% Private Sector 45% Private Sector 43% Private Sector 37% Government 55% Government 29% EV = €170 – 250bn EV = €50 – 100bn EV = €500bn Private Sector 2% Government 10% United States Government 98% Government 100% Private Sector 90% EV = $300 – 400bn(a) EV = $75 – 125bn EV = $400bn • Based on a GDP multiplier vs. Europe of 1.7x • Source: Goldman Sachs estimates
The profile of a typical infrastructure investment is significantly different from a traditional private equity investment. Traditional Private Equity Infrastructure Investment • Discounted cash flow and exit • Long term (ten year plus) forecast of cash flow/ dividend yield • No exit assumed/desired by institutional investors or listed funds – critical to return • Operating improvements are often mild and relatively straightforward • Regulated assets return operating improvements every five years • Most assets are simple in operation (increasing electronic tolling, cost reduction, yield management) • Financing is long-term and investment grade • Tremendous value created through financing • “Mini-perm” to long-term • Bullet structures • Dividend flexibility • Tenor of financing hedges risk of changes in real rates • Target high single-digit to mid-teens long-term returns • More similar to long-term mezzanine – no prepayment risk • Returns very sensitive to changes in inflation • Tax optimization critical • Discounted cash flow and exit • Five year forecast • Exit assumption tested based on exit alternatives, IPO or trade sale – critical to return • Transactions often driven by operating improvements, performance • Cost reductions, synergies, turn-around strategies • Add on acquisitions, roll-ups, consolidation plays • Financing through conventional bank and mezzanine or high yield markets • Relatively short-term bank debt • Amortizing debt • Mezzanine or high yield paper increases leverage • Second lien paper or lower cost mezzanine increase exit flexibility • Target returns of 20+% IRRs • Tax optimization critical
What is a Private Operator Concession Agreement? • Concession Agreement – A legal document that evidences a long-term lease of a public asset by a private operator. Private Operator Accepts Public Body Retains • Up-front Payment by Private Operator • Oversight of Operations and Rate Setting Methodology • Rights to mandate operating performance under the agreement • Rights to expand/enhance asset beyond those specified in agreement • Right to cancel agreement if Private Operator doesn’t perform • All operating responsibilities and costs • Construction duties and related construction risk • Requirements to expand/enhance the asset and related costs • Reporting responsibilities to public body • Asset’s revenues throughout life of agreement; return asset in original condition at end of lease
Public policy shapes the form of the concession. Policy Decision Description Considerations • Length of Concession • Length of time that a concession partner will be allowed to lease and operate the road • What is political sensitivity to length of concession? • What is value of incremental term length? • Tolls • Toll limits can be mandated in Concession Agreement • Public appetite for future increases • What is the elasticity of demand? • What enhancements are necessary • Future expansion if capacity constrained • Expansion / Enhancements • Will the State allow or mandate future expansion / enhancements • Is this good public policy? • What are future capital plans that could have an impact if any? • Non-Compete • Potential compensation if future development causes competition issues. • Construction Requirements • Capacity constraints if any and other requirements • Materials and methods • Allowance for phasing could enhance feasibility • What construction factors are important? • Operating and Maintenance Standards • Manual of specific operation conditions and rules to which a concession partner must adhere • What are operating and maintenance conditions that are most important? • Status of existing employees • Conditions for new concession company employees • Will the concessionaire be held to the State’s employment standards? • Labor • Environmental • Responsibility for existing potential environmental liabilities (if any) • Are there any known environmental liabilities? • Enforcement • Responsibility for law enforcement • How is police force currently compensated for existing duties?
Key Policy Considerations and Questions for Public-Private Partnerships Question Answer • The Franchise/Concession Agreement provides governmental control over tolls/pricing, operating standards and other key parameters. • After some opportunities to cure the problems, the government can take back the asset and keep the up-front payment. • Huge pools of pension fund and other investor monies are being allocated to the infrastructure space. • Low equity return hurdles, interest expense tax shields and depreciation benefits, create a cost of capital which is competitive with municipal bonds. • Do we lose control? • What if the private operator doesn’t perform? • Why is there demand for these assets now? • Isn’t it a higher cost of capital than tax-exempt debt?
Concession Agreements offer an alternative to finance projects. Strategy Description 1) Public Ownership Traditional toll/revenue system – design, construction, O&M, governance, etc. remain with the State 2) Public Ownership / Private Contracting Same as above except certain activities may be contracted for – i.e., design / construction, etc. 3) Concession Agreement The State “owns” facilities and maintains governance, enters into lease agreement with a private entity that is responsible for operations, maintenance, construction Strategies 2-4 are variations of PPP alternatives 4) Private Ownership All activities, including the setting of rates, are controlled by a private entity
= Yes = No A transfer of risk and use of private equity for the Local Governments can be achieved via a well-structuredConcession Agreement. Transfer of Design/Build/Other Risk Transfer ofRevenue Risk Private Equity Public Control 1) Public Ownership 2) Public Ownership/Private Outsourcing 3) Concession Agreement 4) Private Ownership = >Partial = Partial
Concession Agreement structuring decisions will ultimately determine the price of an asset. Impact on Value Value Driver Examples Future Revenue Growth • Rate/Price Increases • Variable Pricing • Volume Increases • Potential for Asset Expansion • Increase Use of Electronic Tolling/Billing • Rate increases provide visibility into future cash flows • Time of day pricing adjustments can improve volume flow • Increased volume drives growth without raising rates • Increased capacity generates more volume • Increases price/demand inelasticity Longer Term of Concession • Shift Tax Benefits • Extend Principal Amortization • Provide More Years of CashFlow to Concessionaire • Longer term allows greater flexibility for depreciation • Allows for new debt to be amortized over additional years, which adds value • More years = increased up-front payment Expense Reduction • Worldwide Expertise • Create Operating Efficiencies • Streamlined construction and other operational costs • Streamlined operations can reduce operating costs Capital Expenditures /Congestion Limits • Mandated Capital Expenditures • Options to Expand Asset • Congestion Limits • Deduction for value received up front • Ability to expand asset can enhance value by increasing volume, but costs must be considered • Overly restrictive limits on volume may trigger unneeded capital expenditures and lower value
Concession Sale Concession leases provide an opportunity to capture the “growth wedge” in volume and revenue increases. • Municipal bond investors rely on historical revenues to determine the leverage levels which constrains total value for the owner • Equity investors look for future returns based on growth • Debt + Equity = Greater Proceeds for Owner of Asset Chicago Skyway Example Municipal Bond Vs. Net Revenues Net Revenues Conservative Projections Conservative Projections Debt 1.25-2.00x Coverage Equity Investor Debt Past Today 40 yrs 99 yrs Past Today 40 yrs 99 yrs $1.83 Billion $800 Million
Despite a similar capital cost, a concession produces a higher value via more aggressive growth estimates. • Tax benefits, aggressive debt structures, and low interest rates have allowed Private Concessionaires to achieve an after-tax cost of capital similar to the tax-exempt rates. • However, when the Concessionaire establishes a capital structure, it bonds against a long-term Concession Agreement that unambiguously defines future toll increases. • Municipalities do not typically predefine multiple future toll increases and have minimal incentive to publish aggressive projections. • Indiana had not raised tolls since 1985 and Chicago Skyway had not raised tolls since 1993. • Municipal capital markets are cautious of future political risk (i.e., reversal of planned toll increases, failure to enact) necessitating conservative revenue projections and debt service coverage. • Tax-exempt arbitrage rules prevent borrowing unless proceeds can be spent within a set period of time. • On the other hand, Private Concessionaires have incentive to maximize revenues to create consistent or improving margins to validate large purchase prices. • Capital markets have greater confidence that for-profit operators will raise tolls at the pre-defined rate to meet investor expectations. • Unlike municipal entities that borrow to meet a set capital need, Private Concessionaires strive to optimize capital structure and maximize Equity IRR.
Chicago Skyway vs. Indiana Toll Road ComparisonComparing the First Two U.S. Public-Private Partnership Transactions Key Transaction Highlights Goldman Sachs served as financial advisor to the government on both the Skyway and ITR transactions. Comments ($Mn, unless otherwise noted) Operations Year Opened 1958 1956 – Skyway defaulted on tax-exempt debt in 1970s / ITR has steady historical growth Road Length (in miles) 7.8 157.0 – Longer road necessitates more cap ex / higher operating budget # of Toll Plazas 1 22 – ITR divided between ticket & barrier system Number of Lanes 6 4 to 6 – Bridge widening difficult to accomplish on Skyway Existing ETC (Y/N) N N – Concessionaire ability to increase throughput with ETC Last Toll Increase 1993 1985 – Pre-deal toll rates below national median for both roads Revenues (Yr Preceding Sale) $39.8 $87.7 – Skyway traffic fell due lane closures from Capital Improvement Program (CIP) EBITDA (Yr Preceding Sale) $28.4 $60.6 – Skyway EBITDA Margin = 71% / ITR EBITDA Margin = 69% 10 Yr. Traffic CAGR 6.2% 3.0% – Urban concentration drives higher growth rate on Skyway 3 Yr. Avg. Capital Ex $95.0 $32.2 – Skyway completed $300 mn CIP prior to deal / ITR facing depleted reserve fund % Commercial Traffic / Revenue 8% / 19% 18% / 58% – Significant long-haul truck traffic on ITR % Passenger Traffic / Revenue 92% / 81% 82% / 42% – Work and vacation commuters drive traffic on Skyway AADT 48,000 46,000 (a)– Western ITR traffic flows into Skyway / Eastern ITR traffic flows into rural Ohio Employees 105 590 – Significant personnel infrastructure in ITR Concession Terms Purchase Price $1,830.0 $3,850.0– Skyway = 64.4x EBITDA / 46.0x Revenue; ITR = 63.5x EBITDA / 43.9x Revenue Length of Concession (yrs) 99 75 – Both terms structured to exceed remaining useful life of road asset Committed Cap Ex (1st 3 yrs) $60.2 $226.0 – ITR mandates accelerated completion of existing Toll Road projects Congestion Management (Y/N) No Yes – ITR has lane widening targets that require expansion when reached Proposed Toll Schedule (Y/N) Yes Yes – Skyway fixed increases until 2017; ITR fixed increases until 2010; Both allow annual increases = to greater of 2%, CPI or GDP per capita after fixed period Process Time of Process (in days) 240 117 – ITR fastest concession sale process to date Number of Qualified Bidders 5 10 – Indication that appetite for U.S. infrastructure assets is increasing Number of Submitted Bids 3 4 – Binding bids backed by $75 mn LOC in ITR / $55 mn LOC in Skyway (a) AADT for Western end of Indiana Toll Road; Eastern end AADT is 25,000
Tab Public Private Partnerships: An Alternative Source of Capital I Concession Agreements Overview II Concession Value Generation III Indiana Toll Road vs. Chicago Skyway IV Table of Contents
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