For all the controversies surrounding infrastructure asset monetisations, perhaps no single issue touches more raw nerves than the question of whether vendors of assets get fair price at auction. Leave any inkling of doubt that a toll road or a bridge wasn’t sold for an appropriate sum and charges of foul play are sure to follow – along with committee hearings and all the fun that comes with getting grilled by angry politicians.
That’s precisely what happened in Chicago, when the city’s inspector general, David Hoffman, published a scathing report in early June asserting that, at a price tag of $1.15 billion, the city leased its metered parking system for about $1 billion less than what it was worth.
Coming on the heels of widespread anger and vandalism resulting from meter malfunctions during the handover process from the city to the lessee, Morgan Stanley Infrastructure Partners, the report didn’t help much in restoring calm. It did, however, provoke an interest in the financial mathematics used to arrive at valuations in deals of this kind.
“We want to know. I think people deserve to know and I want to know – my interest has been piqued,” Chicago alderman Manuel Flores told Infrastructure Investor in June. He said he would call William Blair and Company, the city’s financial advisor on the transaction, to testify how their valuation methodologies reached such vastly different conclusions from the Chicago Inspector General.
On 2 July, that hearing was held, but it came and went with a whimper rather than a bang. Taking place on the Thursday before the 4 July holiday weekend, the meeting was attended by Blair’s principal on the deal, Thomas Lanctot, and several high-ranking members of the Chicago City Council Committee on Finance – but not the Inspector General himself.
Among the testimony prepared for the meeting was a 12 page document from Blair explaining where the Inspector General went wrong in his analysis. He’d concluded that the meter system was worth between $1.7 billion and $2.56 billion, versus Blair’s indicative range of between $650 million to $1.2 billion.
The most obvious flaw in the analysis, Blair argued, was that the inspector general confused the concept of revenue with free cash-flow. The former represents the top-line receipts from the operation of the parking meters, whereas the latter nets out operating expenses, corporate taxes, capital expenditures and other cash items that might take away from what would otherwise flow to the equity-holder. By merely discounting net revenue, the inspector general overstated the free cash-flow by about $9 million per year over the 75-year lease, Blair argued.
Secondly, said the firm, the Inspector General used a discount rate of 7 percent based on a study of discount rates for municipal infrastructure projects prepared by Partnerships Victoria, the oversight body for public-private partnerships in the state of Victoria, Australia. Blair argued there was “no stated logic behind that decision” other than “an obscure report produced over four years ago by an Australian state government” that was “readily available for download on the internet”.
But given that the report recommended discounting regulated water utilities at a higher discount rate of 8.26 percent, it was clear that the parking meter system deserved a higher discount rate, Blair argued. Using the 10.4 percent rate recommended in the report for assets of “medium” risk, Blair arrived at a range of $848 million to $1.295 billion, which “clearly reflects the soundness of the winning bid – even when evaluating it using the report’s selected source”.
Quod erat demonstrandum? Sure – for a finance audience or anyone with a Wharton degree, the logic of Blair’s analysis is spotless.
But as those who listen to talk radio in Chicago will know that “discount rate” and “free cash-flow” remained opaque concepts to the public even after Lanctot testified in front of city council members. What resonated a lot more was the Inspector General had published, and angry listeners talked about “robbery” and “rip-off”.
Infrastructure investors will ignore this imbalance of perception at their peril. In a recent KPMG survey of infrastructure providers, Stanford University professor Ryan Orr provided one potential option: “Political, social, environmental and regulatory gridlock is suffocating the infrastructure deal flow pipeline—not just in the US but globally. This raises questions in my mind like: Why is the private sector continuing to offer a legal, financing, and technical solution, when the most severe roadblocks are fundamentally institutional in nature? Could the private sector do more to invest in public relations, coalition building, and strategic communications skills?”
Now there is a challenge.