HAVE A LOOK at recent US transportation infrastructure deals and a distinct pattern emerges: a 99-year lease on the Chicago Skyway, 75 years on the Indiana Toll Road, a potential 60 year deal on the Port of Virginia, 52 years on the three big Texas toll road concessions.
Another interesting trend is the rising tide of hostility toward the Skyway and Indiana Toll Road deals because of their size, their leverage – and the length of their concessions. At the recent Infrastructure Investor forum in New York (see page 14), for example, one speaker said they were “two black eyes” for the US’ public-private partnership sector because they set the wrong example for the industry.
Combine this with the bills introduced by US Senators Bingaman and Grassley in April that seek to take away a favorable tax provision for such deals, and one can’t help but wonder: is it just mere coincidence, or have concession lengths been getting shorter – and will they get shorter still?
Indeed, several transactions that are in the market right now feature significantly shorter concession lengths than the blockbuster Skyway and Indiana Toll Road deals in 2004 and 2006. But in the case of the Skyway, as any insiders will recall, there were many compelling reasons to go with 99 years. And while any decision on how long the lease should be is ultimately a combination of deal circumstances and the economics required to make it work, critics eager to eschew longer-term leases would do well to learn why they were actually structured that way in the first place.
In the year leading up to the announcement of Chicago’s lease of the Skyway for 99 years in return for $1.83 billion, there was a weekly gathering every Friday around noon at the city’s offices or Mayer Brown in downtown Chicago.
There, amid stacks of documents and catered lunch, representatives from the city’s budget office met to debate various aspects of the aptly code-named ‘Project Rainbow’ with a phalanx of advisors, including teams led by Mayer Brown’s John Schmidt, Chicago’s legal counsel on the deal, and Goldman’s Florian and Rob Collins, the city’s financial advisors. Sometimes, the crowd reached as many as 30 people, all weighing in on topics ranging from seemingly cosmetic details (‘Should we open the bids in public?’) to altogether more fundamental considerations such as, ‘How long should the concession be?’
It took months to resolve the second point, which required decisions on how to structure the lease so that the concessionaire could get ownership of the 7.8-mile toll road for tax purposes, and how to get the most money out of any potential lease.
It also required dealing with the fact that part of the Skyway is a steel truss bridge over Chicago’s Calumet River, and bridges are eligible for accelerated depreciation under IRS code. So instead of depreciating eligible portions of the upfront cost over the useful life of the Skyway, the concessionaire could take advantage of an accelerated 15-year cost recovery period that could provide huge income tax savings. But there was one catch: “To capture the depreciation, the lease has to have a term that exceeds the useful life of the asset. And bridges have a very long useful life,” says Mayer Brown’s Schmidt.
Schmidt says basic bridge structure had a life of 75 years, based on an engineering study conducted by URS Corporation. URS eventually settled on a remaining useful life of 56 years after doing a weighted average of the various components of the entire facility. But Mayer Brown’s tax lawyers knew this wouldn’t fly with the IRS: someone could still point to the major component – the bridge itself – and easily argue that he lease had to be longer if they settled for 60 or 65 years. Go to 99 years, Schmidt says, and the bidders could be “confident for tax purposes” that their savings were locked-in for sure
THERE’S SOMETHING IN IT FOR THE BIDDERS, TOO
There was another important reason why the city decided to go for 99 years. Collins, now the head of infrastructure advisory for the Americas at independent investment bank Greenhill & Co. in Chicago, recalls that bidder preferences made the longer lengths more desirable for the city. “Ultimately, we talked to all the bidders about what they valued and why and it turned out the bidders really valued the much longer, 99-year lease for financing reasons,” he notes.
The present value of the cashflows 99 years out were negligible, Collins says, but the financing reasons were compelling: ratings agencies, which would have to evaluate the debt that bidders put on the asset, wanted a longer-term lease to ensure that the Skyway would be able to ride out economic cycles. This lessened refinancing risk and made the deal more bankable,
It also changed the economics of the transaction – materially. The advisory team estimates that going from 75 to 99 years added between $100 to $150 million to the upfront fee for the Skyway. For Chicago, which had big plans for the proceeds and hoped to squeeze every penny out of the concession, this made perfect sense.
And so the number 99 was written into the standard concession and lease agreement that was handed out to the prospective bidders. They then made their bids based on what they thought leasing the asset for 99 years would be worth. The outcome is already part of infrastructure folklore: Spanish concessionaire Abertis bid $500 million, a consortium comprising ABN, OMERS and Cofiroute offered $700 million – and Cintra and Macquarie Infrastructure Group came in with the legendary $1.83 billion.
After the number behind the Cintra/Macquarie bid was read out loud, the people in the room asked for it to be repeated just to make sure they had heard right. “We were looking for anything with a ‘b’ behind it,” recalls Florian – but no one on the City of Chicago team had considered anywhere near $1.83 billion.
THE CASE FOR 60
Tax savings aren’t always a key driver behind lease lengths. In Virginia, CenterPoint Properties, an industrial real estate developer ultimately owned by the $202 billion California Public Employees’ Retirement System (CalPERS), had other things on its mind when it made an unsolicited 60-year concession bid for the Port of Virginia in March.
“We’re not buying this as a tax play,” says CenterPoint general counsel Daniel Hemmer. CenterPoint is organised as a pass-through entity for tax purposes and its key backer, CalPERS, is exempt from paying income taxes. So the company focused on economic variables rather than tax savings in determining what lease length to propose to the Virginia Port Authority.
“In the initial part of the lease, we have 10-15 years of significant investment, and you want to have enough time to recoup that,” Hemmer says.
CenterPoint felt that 99 years was too long, but a 60-year concession made sense. It was long enough so that the company could earn back its investment but not so short that it would put pressure on the private partner to spike rates early on. Doing so would not be in the public partner’s interest since dramatic increases in fees would harm volumes and make the port less competitive. “It’s good public policy,” Hemmer says, adding that determining the length is “more of an art than a science”.
INTO THE 50S
Elsewhere in the US, investors find themselves not having much of a choice with regard to concession lengths. In Texas, for instance, it’s no coincidence that the three toll road developments involving private investment – the $1.35 billion SH 130 in Austin, the $1.6 billion North Tarrant and the $2.7 billion ‘New LBJ’ projects in Dallas – all feature 52-year long concessions.
“In Texas, you are limited to the 52-year maximum,” says Tom Moore, a partner at law firm Bracewell & Giuliani in Houston, which did the legal work on the deals for Cintra, the winning bidder for all three. The useful life of a road, according to the Bureau of Economic Analysis, is 45 years and all three projects involve a new-build component. So Cintra will be able to capture an accelerated depreciation “tax shield” on the projects, Moore says.
Moore concedes the industry would prefer a longer term, but 52 years was “a judgment by the legislature on what would be needed to bring private equity to these deals”. Until the rule changes, investors will likely be capped at that length – if not shorter. “There’s been some discussion [in the legislature] about shorter terms. I’m not sure where that’s going,” he says.
Investors in California may find themselves in a similar situation. A state law there prohibits leases beyond 55 years in length with very few exceptions. So any potential lease of parking assets currently owned by the City of Los Angeles – a PPP that has been in the making since last year – may end up being limited to 55 years, though a person familiar with the situation says a longer length may be feasible, depending on the deal structure.
And nationally, there remains pressure from Washington to eliminate the tax savings currently allowed under the law for deals like the Skyway. Senators Bingaman and Grassley’s bill is a case in point. While a spokesperson for Senator Bingaman declined to make the Senator available for an interview, she said Bingaman “remains concerned that the tax code’s cost-recovery periods for privatised highways do not reflect economic reality”. Therefore, the Senator will continue to press for his measure – Senate Bill 885 – that would eliminate the favorable tax code if enacted into law.
Whatever the outcome of the legislative process, and regardless of the locality of a US infrastructure asset, one thing’s for certain: the length of a concession isn’t the most important aspect in any transaction of this kind. “What should be a much more major concern of the state and local governments, who are the lessors of these assets, is that they have the right agreement in place,” says Dana Levenson of Royal Bank of Scotland, who is the former Chicago chief financial officer who during his tenure saw the City close Skyway and a $563 million transaction involving underground parking facilities.