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Derrick Leung, Class of 2008 Advisor: Professor Alain Kornhauser 6 December 2010. Unyoking the Cash Cow: Who Should Own the New Jersey Turnpike?. ORFE Senior Thesis Presentation. 1: Introduction. The New Jersey Turnpike. Interstate 95; 148 miles Opened in 1951-1952

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Unyoking the Cash Cow: Who Should Own the New Jersey Turnpike?


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    1. Derrick Leung, Class of 2008 Advisor: Professor Alain Kornhauser 6 December 2010 Unyoking the Cash Cow: Who Should Own the New Jersey Turnpike? ORFE Senior Thesis Presentation

    2. 1: Introduction

    3. The New Jersey Turnpike • Interstate 95; 148 miles • Opened in 1951-1952 • FY06 toll revenues: $533.4 million • FY06 ridership: 250 million trips • 5th most traveled highway (IBTTA) • Current valuation • $6 billion (Lesniak, Mar. 2006) • $30 billion (Villaluz, July 2005) • $40 billion (Edwards, Feb. 2008) 1

    4. Privatization Debate • Improved operational efficiency • Innovative tolling • Public sector needs for fresh capital • Incentives to use private equity (leverage) • Uncertain private sector advantage • Conflicting public/private goals • Transaction costs ($30 million to $200 million) Public Benefit Company (PBC) For Privatization Against Privatization 2

    5. Motivation • Private sector management • Public sector control • Proposed structure of toll increases • Chicago Skyway, Jan. 2005 • $1.83 billion, 99-year lease • Indiana Toll Road, June 2006 • $3.85 billion, 75-year lease • $29.7 billion as of June 30, 2007 • $2.6 billion annual charge Public Benefit Company (PBC) Previous Asset Monetizations New Jersey State Debt 3

    6. 2: New Jersey Turnpike Valuation Model

    7. Formulation • Modified DCF formulation • Free Cash Flow (FCF) formulation 4

    8. p x Traffic Model Parameters • Valuation timeframe: 75 years (2007-2081) • Inflation measure: 3% increase in CPI • Revenues: • Projected using regression of growth rates over past 9 years • Five (5) different tolling scenarios • Price elasticity of traffic: • 0 (inelasticity), -0.19 (average), -0.15 (low bound), -0.31 (high bound) • Expenses: • Projected using regression of growth rates over past 9 years • Interest and principal payments; capital expenditures 5

    9. Tolling Strategies • Case 1: Status Quo • Current real toll maintained • Case 2: Leung-Kornhauser Plan • Initial real toll doubling • Case 3: Break-even Toll Plan • Calculation of real toll such that net present valuation yields 0 • Case 4: Governor Corzine’s Plan (PBC) • “50% maximum real toll increases in 2010, 2014, 2018, and 2022 plus annual increases, based on CPI, levied to capture the prior 4 years, starting in 2010 and every 4th year thereafter.” • Case 5: Private Entity Plan • Initial real toll increase that yields optimal (maximum) valuation 6

    10. Data and Projections 7

    11. 3: Results

    12. Case 4: Governor Corzine’s Plan (PBC) Functional form of solution Valuation sensitive to more inelastic traffic 8

    13. PBC Equivalent • PBC Equivalent Cash Flow structure • Tolling structure of current plan inefficient • Inspired by Leung-Kornhauser plan • Gains to setting initial three-time (quadrupling) real toll increase • Greater cash flow in earlier time periods 9

    14. Case 5: Private Entity Valuation Functional form of solution Private Entity Valuation unbounded for elasticity of 0 10

    15. Valuation Sensitivity to Line-Item Costs Valuation insensitive to individual line-item costs (5%) 11

    16. Valuation Sensitivity to Cost Basket Material benefit due to cost reductions seen from reduction in cost basket (20%) 12

    17. 4: Conclusion

    18. High Valuation Drivers Valuation driven by increased tolls when traffic is price inelastic Valuation driven by cost reductions when traffic is price elastic 13

    19. The Motorist’s Perspective 14

    20. High Arbitrage Gain • Case 1: Status Quo • Arbitrage Gain = $0 • Case 2: Leung-Kornhauser Plan • Arbitrage Gain = $9.1 billion • Case 3: Break-even Toll Plan • Arbitrage Gain = N/A Arbitrage Gain = High Valuation – Current Valuation • Case 4: Governor Corzine’s Plan (PBC) • Arbitrage Gain = $31.5 billion • Case 5: Private Entity Plan • Arbitrage Gain = ∞ 15

    21. Recommendation: The Buyer’s Perspective Implement PBC Equivalent: 3x initial increase of real toll 16

    22. 5: Case Study: Pennsylvania Turnpike

    23. Background • Pennsylvania Turnpike is America’s oldest toll toad (1937), 537-mile route • Operated by Pennsylvania Turnpike Commission • Powers to construct, operate, and maintain the Turnpike System and issue revenue bonds, repayable solely from tolls and other Commission revenues • Pennsylvania population: ~12 million • Vehicle trips (May 2007) • Passenger: 160 million • Commercial: 25 million • Total: 185 million • Gross fare revenue (May 2007) • Passenger: $323 million • Commercial: $295 million • Total: $618 million 17

    24. Operations (FYE May) Vehicle Trips Gross Fare Revenue (in $mm) Vehicle Trips (% Split) Gross Fare Revenue (% Split) Source: Pennsylvania Turnpike Commission 2007 Comprehensive Annual Financial Report 18

    25. Toll History Illustrative Value of $1.00 from 1940 • Erosion of real toll value over the years has led to severe lack of profitability of the Turnpike (like many toll roads) • Variable costs and interest rates increase every year by inflation, so tolls should also increase by inflation to preserve the integrity of the toll road’s cash flows • But the act of raising tolls is difficult from a political perspective Source: www.InflationData.com 19

    26. Timeline • November 2006: Study by the Pennsylvania Transportation Funding and Reform Commission (PTFRC) note critical need for annual investment of $1.725 billion to fund maintenance, repair and expansion of state roads • May 2007: Morgan Stanley report analyzes various alternatives including a long-term lease, public corporation/leverage, and a PTC proposal • Sources indicate $12-18 billion as an indicative valuation range for a lease • September 2007: Governor Ed Rendell solicits qualifications for potential bidders for the Turnpike in anticipation of a lease • May 2008: Final winning bid announced • Abertis / Citi consortium offers $12.8 billion • Goldman Sachs / Transurban consortium offers $12.1 billion • September 2008: Financial crisis deepens with collapse of Lehman Brothers Source: For Whom the Road Tolls: Corporate Asset or Public Good (An Analysis of Financial and Strategic Alternatives for The Pennsylvania Turnpike 20

    27. Valuation • Winning bid of $12.8 billion also contemplates an additional $1.7 billion to fund the beginning of operations (total consideration of $14.5 billion) • Purchase price funded by mixture of equity and debt • Critics noted the use of leverage for the investment was more conservative than structures typically used at the time (ex. 80% or even 90% debt for infrastructure assets like the Turnpike) • Capital structure of winning bid: • $8.5 billion of debt, including a $250 million capex facility • $6.0 billion of equity • Bid perceived to fall short of goal • Valuation = 35x EBITDA • 365 million (2007) • Relatively low compared to Skyway and ITR transactions Source: InfraNews 21

    28. Criticism • Winning bid anchored by foreign investor • Abertis is a Spanish transportation and telecommunications firm (founded in 2003 after a merger of two companies founded in 1967 and 1971) • Operate 6,700 km of motorways in Europe, and several international airports • Public company traded on the Bolsa de Madrid (BMAD: ABE) • Earned 3.9 billion Euros of revenue (2009); over 12,000 employees • Valuation not as high as previously contemplated • Final bids were around $12 billion, the low end of valuation range originally indicated • Governor Rendell indicated later that the $18 billion range contemplated tolls being increased 5.5% annually (not possible since tolls would be capped to the greater of 2.5% or CPI) • State Assembly vote would face opposition from public • Bid expiration was extended twice by the consortium to facilitate discussion Source: InfraNews, Abertis 22

    29. Decision • If you were a State Congressman... What Would You Do? 23

    30. Outcome • State Assembly ultimately did not hold vote • Some members of Congress were offended by “low” valuation, although some confessed that the vote would not have been favorable in any case • Unforeseen issues: • Credit crisis eroded debt markets for financing • Equity sponsors less willing to make investments due to uncertainty • State finances eroded as tax revenues were lower due to high unemployment • Municipalities unable to refinance debt (and break out-of-the-money interest rate swaps) or issue lower cost debt due to credit risk • Citi Infrastructure Investors moved on soon after to bid on Midway Airport (large hub airport in Chicago area) • Bid also failed since acquisition was contingent on securing financing • Closed credit markets provided challenge 24

    31. 6: Thesis Application in the Real World

    32. Goldman Sachs • Investment Banking • Mergers and Acquisitions • Industry coverage groups (Technology, Media and Telecom (TMT), Natural Resources, Financial Institutions, Industrials, Consumer/Retail, Real Estate) • Product group (Leveraged Finance, Equity Capital Markets, Derivatives) • Asset Management • Asset Management (GSAM) and Private Wealth Management (PWM) • Trading and Principal Investments • Equities • Fixed Income, Currency, Commodities (includes Special Situations Group) • Merchant Banking/Private Equity Division • Principal Investment Area (Corporate Equity, Corporate Debt, Mezzanine, Real Estate, Infrastructure) 25

    33. What is Private Equity? • Acquisition through leveraged buyout (LBO) of mature, stable cash flow businesses with free cash flow generation used to support debt service • Reasonable growth, defensive business model, strong management team, low capital expenditures, over-equitized capital structure • Leverage used to increase purchase price in auctions • 2004-2007: 75% debt / 25% equity, low cost of debt (low credit spreads) • 2008 and after: at most 50% debt / 50% equity Private Equity Firm (General Partner) Investors (Limited Partners) Private Equity Fund (Limited Partnership) Investment B Investment C Investment A 26

    34. Characteristics of Infrastructure Investments • Stability • Provision of essential services to communities • Insulated from business cycles, high barriers to entry • Duration • Nature of services supports asset longevity • Long-term cash flows support long-term investment horizon • Inflation • Regulation or concession determines pricing (inflation-linked cash flows) • Yield • Current yield through free cash flow • Diversification • Low correlation with other asset classes • Alternative to other investments (including traditional private equity) 27

    35. Competitive Landscape • Competitors • Private equity firms • KKR, TPG, Carlyle, Blackstone, Bain Capital, Apollo • Boutique infrastructure investment firms • Global Infrastructure Partners, Alinda, Macquarie, Babcock & Brown • Investment Banks • Morgan Stanley • Insurance companies / pension funds • Sovereign wealth funds 28

    36. Selected Transactions • Sea Ports • Restructuring of $5 billion North American terminal operator • Distressed LBO of $5 billion international port and rail company • Toll Roads • LBO of Florida toll road through P3 auction; approx. $1 billion transaction • Proprietary recapitalization strategy for select North American toll roads • Airports • LBO of regional airport through P3 auction • Natural Resources, Energy and Power • Equity investment in one of the largest natural gas pipelines in the U.S. • Investment in natural gas storage facility in Wyoming (development) • Investment in water storage facility in southern California (development) • Carve-out of regional electric utility • Fundraising • Raised $3.1 billion of equity capital for new infrastructure fund 29

    37. Then and Now • Mega funds • Diversification of investor base • Auctions accepted • Use of leverage • Cheap cost of debt (low spreads) • Long tenor (7-10 years) • Steep growth profile underwritten • Stable, solvent companies Pre-Credit Crisis Post-Credit Crisis • Smaller funds • Limited Partners want to exit • Negotiated transactions • More equity required • High cost of debt (debtor risk) • Short tenor (3-5 years) • Low base, moderate growth • Restructuring strategies through debt or equity investments 30

    38. 7: Q&A