Public Private Partnership/Concession ModelA Fad or a Wave of the Future
California Municipal Treasurer's Association
April 27, 2006
I. Public Private Partnerships: An Alternative Source of Capital
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Public-Private Partnerships can provide a new source of capital for State and Local Governments.
New Option
Public-Private Partnership
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
Historical Option
Issue tax-exempt bonds
Traditionally allows conservative amount of debt to fund projects
Perceived financial obligation of sponsoring entities
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An increasing number of State and Local Governments are utilizing Public-Private Partnerships for their financing needs.
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
Oregon
Evaluating private concessions on three separate greenfield
projects
Texas
Trans Texas Corridor Project; Six 50-yearconcessions for greenfield projects
Harris County considering private Concession sale of its Toll Road System
Utah
P3 Legislation in place
Colorado
Evaluating P3 opportunities for future toll roads
Illinois
Concession sale of Chicago Skyway for $1.83 Bn
Indiana
Sale of a Concession in Indiana Toll Road with
outstanding bid of $3.85 Bn
New York
P3 Legislation in process
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
North Carolina
P3 Legislation in place
South Carolina
P3 Legislation in place
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
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Public-Private Partnerships are very common in Europe and Asia.European PPP Activity
Austria
Belgium
Denmark
Finland
France
Germany
Greece
Ireland
Italy
Netherlands
Norway
Portugal
Spain
Sweden
UK
China
Hong Kong
Japan
South Korea
Water & Waterway (incl. Solid Waste)
Light RailwayPortsAirports Roads
Asian PPP Activity
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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
$152 Bn80% Debt
$37 Bn 20% Equity
Essential social infrastructure Insulation from business cycle Natural inflation hedge Ability to support high leverage
Steady, predictable, low-risk cash flows to matchlong-dated insurance and pension liabilities
Investment Characteristics Recent US Infrastructure Activity
Target Infrastructure Sectors Leveraged Equity Investment
Total Buying Power:
$189 Billion
Potential Existing Asset LeasesPotential Greenfield ProjectsCompleted P3 Transactions
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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
0
1
2
3
4
5
6
7
8
9
10
4x 6x 8x 10x 12x 14x 16x 18x 20x 22x 24x
EV/EBITDA
Ear
nin
gs
Pre
dic
tab
ilit
y
Hig
hM
ediu
m
Infrastructure Assets
Real Estate Assets
European Toll Roads
European Ports
European Airports
European Regulated
Utilities
European Properties
US Reits (Apartments)
US Reits(Office Properties)
US Reits(Shopping Centres)
Source: Goldman Sachs estimates
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The United States market represents an area of potential growth for infrastructure investors.
(a) Based on a GDP multiplier vs. Europe of 1.7xSource: Goldman Sachs estimates
EV = €170 – 250bn EV = €50 – 100bn EV = €500bn
EV = $300 – 400bn(a) EV = $75 – 125bn EV = $400bn
Toll Roads Regulated UtilitiesAirports
Europe
Private Sector 2%
Government 98%
Government 100% Private
Sector 90%
Government 10%
Government 21%
Private Sector 37%
Future Privatisation
(e.g. UK, Germany)
42%
Future Privatisation
28%Private Sector 43%
Government 29%
Private Sector 45%
Government 55%
United States
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The profile of a typical infrastructure investment is significantly different from a traditional private equity investment.
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
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
Traditional Private EquityInfrastructure Investment
II. Concession Agreements Overview
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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.
Public Body Retains Private Operator Accepts
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
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Public policy shapes the form of the concession.
ConsiderationsPolicy Decision
Manual of specific operation conditions and rules to which a concession partner must adhere
Description
Operating and Maintenance Standards
What are operating and maintenance conditions that are most important?
Potential compensation if future development causes competition issues.
Non-Compete Is this good public policy? What are future capital plans that could have
an impact if any?
Responsibility for law enforcement Enforcement
Toll limits can be mandated in Concession Agreement
Tolls Public appetite for future increases What is the elasticity of demand?
Length of time that a concession partner will be allowed to lease and operate the road
Length of Concession What is political sensitivity to length of concession?
What is value of incremental term length?
Status of existing employees Conditions for new concession company
employees
Labor Will the concessionaire be held to the State’s employment standards?
How is police force currently compensated for existing duties?
Responsibility for existing potential environmental liabilities (if any)
Environmental Are there any known environmental liabilities?
Will the State allow or mandate future expansion / enhancements
Expansion / Enhancements What enhancements are necessary Future expansion if capacity constrained
Capacity constraints if any and other requirements
Materials and methods
Construction Requirements Allowance for phasing could enhance feasibility
What construction factors are important?
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Key Policy Considerations and Questions for Public-Private Partnerships
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?
AnswerQuestion
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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
Same as above except certain activities may be contracted for – i.e., design / construction, etc.
2) Public Ownership / Private Contracting
All activities, including the setting of rates, are controlled by a private entity
4) Private Ownership
The State “owns” facilities and maintains governance, enters into lease agreement with a private entity that is responsible for operations, maintenance, construction
3) Concession AgreementStrategies 2-4 are variations
of PPP alternatives
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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
Private Equity
Transfer of
Revenue Risk
3) Concession Agreement
4) Private Ownership
1) Public Ownership
2) Public Ownership/Private Outsourcing
= Yes = Partial = No
Public Control
= >Partial
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Impact on ValueValue 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
Concession Agreement structuring decisions will ultimately determine the price of an asset.
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
III. Concession Value Generation
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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
Net Revenues
Municipal Bond Concession Sale
Today 40 yrsPast
Debt1.25-2.00x Coverage
99 yrs
Conservative Projections
Today 40 yrsPast 99 yrs
Equity InvestorDebt
Net Revenues
Conservative Projections
Chicago Skyway Example
$800 Million $1.83 Billion
Vs.
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Despite a similar capital cost, a concession produces a higher value via more aggressive growth estimates.
Tax benefits, aggressive debt structures, and low interest rates have allowed Private Concessionaires to achieve an after-tax cost of capital similar to the tax-exempt rates.
However, when the Concessionaire establishes a capital structure, it bonds against a long-term Concession Agreement that unambiguously defines future toll increases.
Municipalities do not typically predefine multiple future toll increases and have minimal incentive to publish aggressive projections.
Indiana had not raised tolls since 1985 and Chicago Skyway had not raised tolls since 1993.
Municipal capital markets are cautious of future political risk (i.e., reversal of planned toll increases, failure to enact) necessitating conservative revenue projections and debt service coverage.
Tax-exempt arbitrage rules prevent borrowing unless proceeds can be spent within a set period of time.
On the other hand, Private Concessionaires have incentive to maximize revenues to create consistent or improving margins to validate large purchase prices.
Capital markets have greater confidence that for-profit operators will raise tolls at the pre-defined rate to meet investor expectations.
Unlike municipal entities that borrow to meet a set capital need, Private Concessionaires strive to optimize capital structure and maximize Equity IRR.
IV. Indiana Toll Road vs. Chicago Skyway
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($Mn, unless otherwise noted)
OperationsYear 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 TermsPurchase 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
ProcessTime 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
Chicago Skyway vs. Indiana Toll Road ComparisonComparing the First Two U.S. Public-Private Partnership Transactions
Key Transaction Highlights Comments
(a) AADT for Western end of Indiana Toll Road; Eastern end AADT is 25,000
Goldman Sachs served as financial advisor to the government on both the Skyway and ITR transactions.
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Table of Contents
Public Private Partnerships: An Alternative Source of Capital I
Concession Agreements Overview II
Concession Value Generation III
Indiana Toll Road vs. Chicago Skyway IV
Tab
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