Sitting down with Ross Israel for an in-depth discussion about Queensland Investment Corporation (QIC) and the infrastructure platform he heads, it would have been difficult not to get things underway with some reflection on the Queensland Motorways deal QIC closed in April.
There were several elements to the transaction that were attention-grabbing. The first was its price tag. QIC sold the 70-kilometre road network for A$7.057 billion (€4.9 billion; $6.6 billion) to a consortium comprising Transurban, AustralianSuper and Tawreed Investments, exceeding even the highest estimates and becoming the largest toll road transaction in Australia’s history.
The other headline-generating fact was that QIC had paid A$3.088 billion to acquire the asset in May 2011.
Asked whether the success of the sale surprised even him, Israel replied: “I think it was a very high-quality collection of assets that doesn’t come around that often, in our view.”
In 2011, the state of Queensland decided to vest the asset into its defined benefit fund in order to offset the fund’s liabilities.
“So this was not just contributing cash from the government side but actually contributing an asset that could perhaps be improved or enhanced and then monetised thus improving the funding position of the Queensland Public Sector Defined Benefit Fund,” he explains.
Indeed, there are several ways in which QIC Global Infrastructure added value to the initial assets it acquired. All three – Gateway Motorway, the Gateway Extension Motorway and Logan Motorway – are tolling concessions that expire in 2051.
“The asset was very much under-commercialised,” Israel says. “We had a task to commercialise the business towards best practice industry performance levels, so we established a business plan and transition plan to really overhaul the business.”
The overhaul included finding a new chief executive and implementing other changes at the management level.
“In terms of the senior management team, only two of the top 20 people who were in the business when the Queensland Government announced it was transferring the asset in late 2010, remained there when we sold the asset in 2014. So there was a significant change programme around the leadership of the company.”
Another transition involved the company’s governance. QIC reconstituted the board with independent directors who had specific toll road and commercial experience.
“We went into a process of significantly reviewing the management controls, the risk environments, the procurement methods within the company,” Israel says, summing it up as a ‘cultural’ change in how the business operated.
The result was a focus on growth and improved operational efficiency in the form of a 37 percent increase in growth between 2011 and 2014 and EBITDA (earnings before interest, tax, depreciation and amortisation) margins climbing from 67 percent to more than 75 percent.
While QIC owned the asset, it also focused on improving relations between the two main stakeholders: the Brisbane City Council and the Department of Transport and Main Roads, the state agency which oversees roads.
“Those two relationships were not as constructive as they should have been in terms of trust and exchange,” Israel notes.
But what really transformed the original three assets into a unique network was the addition of the Go Between Bridge, Legacy Way and Clem 7 Tunnel. Queensland Motorways acquired the right to toll, operate and maintain the first two assets under a formal agreement it entered into with the Brisbane City Council in September 2013. The company also formally reached agreement to acquire the Clem 7 Tunnel concession, which at the time was in receivership. Legacy Way is the only asset that is currently under construction and is scheduled to open in 2016.
To demonstrate how each asset complements the other, Israel grabs a piece of paper and draws a schematic, in the process demonstrating his own enthusiasm and passion for his work.
Two of the three initial assets – Gateway Motorway and the Gateway Extension run north to south, with the latter connecting to Logan Motorway, which runs east to west.
By acquiring the three other assets, “we were able to add a couple of roads that were within the inner city ring, which were decongesting roads. So by adding those three, you captured the majority of growth corridors in the city from a traffic perspective, providing a diversification benefit for the portfolio as a whole as well as extracting economies of scale,” Israel says.
“There haven't been a lot of networks that have come to market,” he continues. “You think about the Indiana Toll Road, the Chicago Skyway, they’re predominantly point to point roads. An example of a network would have been the Pennsylvania Turnpike,” he says, referring to a proposed privatisation that never came to pass due to public opposition and the state legislature killing the proposal put forward by then Governor Ed Rendell.
Staying on the theme of public opposition, the conversation turns to Australia’s success in recycling assets. While Israel has heard of similar privatisation attributes in other geographies, he admits it hasn’t been enunciated or expressed as explicitly as it has in Australia.
“It's certainly been a very good way in which [Australian state] governments have explained the sale and lease of assets and I think there’s a number of successful attributes that we’ve seen from the government side,” he notes.
Those attributes include the government not actually selling the assets. “You’re providing them on a long-term lease or concession and at the end of that the assets revert back to the government.”
Equally important is that the government does not give up control of the assets. They’re either regulated or have a concession agreement in place that ensures the private owner/operator continues to provide a high standard of service.
“The third thing that they've been mindful to say is ‘I’m monetising the asset and I’m recycling the proceeds back into the structure’. In some cases they've even been more specific by reinvesting in the communities and the geographic regions where the asset is located. So that’s quite astute politics,” he concludes.
One such instance is the 99-year leases the New South Wales (NSW) government sold in April 2013 to a consortium led by Australian fund manager IFM Investors for the Ports of Kembla and Botany. The NSW government committed to reinvesting the A$5.07 billion it received from the sale in new infrastructure.
Another similar and more recent transaction was the 98-year lease of Port of Newcastle that NSW sold to Hastings Funds Management and China Merchants for A$1.75 billion. A large chunk of those proceeds will go towards revitalising the city of Newcastle, Hastings’ executive Peter Taylor said at the time.
These deals, as well as that of the Queensland Motorways transaction, have prompted many to speak of a tipping point in the Australian market. Asked whether this claim is justified in his view, Israel responds: “It’s certainly a tipping point in providing government with a high degree of confidence that there is private capital attracted to assets in the infrastructure space.”
In his opinion, this confidence will translate into Australian governments – both on the federal and state levels – to bring more assets to market in the next three to five years.
But the confidence gains are two-fold. “It’s certainly positive, giving us – the private sector – confidence that governments see the private sector, and the pension sector in particular, as a viable funding base for further infrastructure investment; and that’s a positive development, I think, for everyone.”
While the Queensland Motorways deal has taken up a good part of the conversation, QIC’s story doesn’t end – and it certainly doesn’t begin – there.
The Queensland government established QIC in 1991 to manage and invest its public sector employees’ fund. It was around that time that compulsory superannuation was introduced in Australia, which required employers to contribute three percent of employees’ salaries to a superannuation fund.
Today, QIC serves more than 90 institutional investors – including half of the top 25 superannuation funds in the country – as well as pension plans, sovereign wealth funds, and insurance companies in Australia, Europe, Asia, the Middle East and the US.
QIC’s infrastructure business came into existence more than a decade later, in 2006.
“The Queensland Public Sector Defined Benefit Fund was a slow mover relative to its Australasian peers in allocating to infrastructure and so they decided to establish the capability in-house,” Israel recounts. “They had successfully done that in other asset classes, so I think it was somewhat of a well-worn path.”
Real estate is QIC’s oldest asset class, established almost at the same time the fund manager was founded. The private equity platform was launched in late 2005, shortly before infrastructure.
“In the ‘90s we invested across all asset classes including equities and fixed interest. But over time, we've narrowed our focus on asset classes we manage in-house, which are predominantly infrastructure, real estate and private equity,” he explains.
“We also have a global liquids strategy which is a fixed interest, hedge fund strategy, while the Defined Benefit Fund for the state [of Queensland] is managed within QIC.”
Israel joined QIC to launch the infrastructure platform, along with Matina Papathanasiou, now deputy head of QIC Global Infrastructure.
“There was nothing when we started,” Israel remembers.
Asked what prompted him to take on the challenge, he says: “The motivation was really to start something from scratch with a clean sheet of paper. The opportunity to come and establish a team to build out a globally diversified portfolio with an initial allocation of A$1 billion from the Queensland Public Sector Defined Benefit Fund and to leverage the experience from other places, was very inviting.”
Today, of the approximately A$75 billion QIC has under management, its infrastructure team of 22 professionals manages A$5.1 billion of infrastructure assets with an additional A$6.6 billion in sale proceeds related to the Queensland Motorways sale.
“We've got three core sectors we focus on – transportation, energy and utilities, and public-private partnerships (PPP; P3),” Israel says, adding that QIC will only do P3s that involve availability payment structures.
When the infrastructure business started out, the pension fund’s allocation to infrastructure was only three percent.
“That's increased with confidence over time as they basically got more familiar, more comfortable with the rules and the nature of the asset class,” Israel says. The allocation is now between eight and 12 percent.
QIC Global Infrastructure currently has 18 direct and indirect investments globally. The majority of the business – 60 percent – is in Australia, while the remaining 40 percent is abroad.
“We’ve been able to do transactions in Europe and in the US, we are predominantly OECD [Organisation for Economic Cooperation and Development]-centric,” he notes.
One transaction QIC’s infrastructure team completed in the US was Ohio State University (OSU) Parking in 2012; a transaction Israel describes as ‘interesting’.
“The car parking was a division within the University. So we acquired the concession but then we had to establish the company which would run the concession. We had to bring together a management team, we had to create the IT systems, we had to create a brand,” he says. “And we had to do all that so when the keys were handed over and the gates went up it would be the same as when the University owned the car parks.”
The facilities include garages and surface lots comprising a total of 37,000 car spaces. QIC established QIC Park to manage the OSU facilities, known as Campus Park.
QIC Park, however, which is based in Columbus, Ohio, is not the only presence QIC has established Stateside. The Australian fund manager also has offices in San Francisco and Los Angeles staffed with members of its real estate and private equity business units.
“The QIC Global Infrastructure business is planning to have people situated in these offshore offices, perhaps by the end of the year,” Israel says. “So we will be expanding the scope of our team to include London and probably San Francisco.”
US MARKET ‘INCHING’ FORWARD
Asked whether he’s witnessed any changes in the US infrastructure market since joining QIC, Israel sounds guardedly optimistic.
“We’re inching closer to more movement, perhaps more embracing of private investment,” he says, identifying the energy sector as an area that will see significant private backing. The energy sub-sectors of gas and electricity have already seen this, while “unconventional shale gas will create enormous opportunity and already has for the purposes of midstream assets,” he comments.
Transportation is another big sector in terms of opportunities with private investment having already been realised in rail. “I think in terms of roads – and airports in particular – there hasn’t been as much [private investment] in the US, but we anticipate that in the next five to eight years this will grow,” Israel notes.
Citing the increasing number of states that have adopted enabling legislation, Israel says: “That’s clearly been a progression from 2006 to 2014. These things take time. There are layers of stakeholders to move through.”
One way to do that is to be conscious of the stakeholders around assets that Israel terms ‘privileged.’
“They are privileged assets because in many cases, they’re essential services that people feel they have a dedicated right to and which they have paid for through their tax dollars,” he says. “From our point of view, it's really important that you [the private sector partner] are perceived and actually are a strong steward of the asset.”
Australia has plenty of examples of assets that have become more efficient, have delivered on service standards and been enhanced after having passed to private hands – which Israel describes as a ‘win-win’.
While Australia and the US are quite different, Israel is hopeful the US will continue to progress. “It’s just moving at a different pace,” he acknowledges.
Having touched on the US market and the opportunities it presents, Israel proceeds to identify other sources of investment opportunity.
“With government balance sheets significantly stretched there’s really a key role for pension money and private investment to augment the renewal of that infrastructure and we think that’s going to be a powerful thing.”
Another promising development Israel sees is in secondary assets. These arise either from strategic businesses looking to become more core-focused, assets that become distressed due to market cycles, or closed-end funds approaching their exit deadline.
“We feel very optimistic that there are good investments out there; it's just a matter of finding relative value amongst them,” he concludes.