Progressing in millimetres

One decade after the first road privatisation in the US, the market appears to be progressing, albeit slowly.

Fear of traffic slowdowns and flagging concessions had some wondering last year if the US transportation privatisation market would remain viable, especially when combined with the somewhat chilling effect of the municipal bond market and not entirely friendly public opinion.

Fortunately, there is good news. The latest US roads analysis by Fitch Ratings showed “sustained and improved growth” in the first half of 2015 in terms of traffic and revenues. Though Fitch expects growth to slow to a more moderate pace in the second half of 2015, rating outlooks in the toll road sector remain stable. 

In addition, the market continues to show some depth, even if it doesn't quite deliver on the deal flow front. Sure, there is a greater investor preference for mature operating toll roads, but greenfields are far from dead and hybrid structures are gaining in importance, helping to make toll road concessions more palatable for both the public and the private sectors. Lastly, pension funds are taking a shine to the sector, making a strong case for being the ideal private sector partners for many of these assets.

THE EXAGGERATED DEMISE OF GREENFIELDS 

While the greenfield toll road space has not been without its false starts, Mayer Brown partner Joe Seliga, who has been advising in the North American transportation space for the past 15 years, believes “the demise of greenfield toll revenue concessions is exaggerated”, citing several examples that show strong market interest. 

The first he mentioned was the State Highway 288 project, a deal he advised on for the Texas Department of Transportation. “With State Highway 288 there were three proposers that were shortlisted and all three submitted proposals for a toll revenue concession project. The selected proposers ultimately agreed to a concession payment to the DOT of a little over $26 million for the right to construct the facility and operate it as a toll lane revenue concession for 52 years,” Seliga says.

He then pointed to North Carolina, which recently completed its first greenfield public-private partnership (P3) toll road deal for the addition of 26 miles of managed lanes to the I-77 as an example of not only activity, but innovation in the space. 

“They included on that project what they called a developer ratio adjustment mechanism (DRAM) and what they attempted to do there was address the risk to the lenders – so basically this is the public authority – and addressing the risk to the lenders in the early years of the concession,” he explains. 

David Tyeryar, chief financial officer at the North Carolina Department of Transportation (NCDOT), said at our recent Infrastructure Investor LP Summit (IILP15) that while the I-77 deal is quite complex, it is also, in many respects, the state's “perfect P3”.

“It's a fixed amount of money up front – $95 million – with contingent liability over the life of the project of $75 million and we're done,” Tyeryar states. “If something happens to equity, that's non-recourse to the state. With $170 million in our capital we get a $660 million asset.”

According to  Seliga, “the I-77 project demonstrates that there are tools available to the public sector to address some of the revenue risk that's out there, particularly from a lender perspective, that allow the public sector to transfer the bulk of the risk as opposed to retaining that risk, as they do in an availability payment transaction.”  

RISE OF THE HYBRIDS

While both availability payment and revenue-risk arrangements have their benefits and drawbacks, hybrid models are now emerging to capture the combined benefits of both concession types. 

In Colorado, availability payment structures are taking root. Michael Cheroutes, executive director of the Colorado Center for Infrastructure Investment said at IILP15 that the availability concession arrangement that was conceived for the I-70 project is one that will likely be utilised as a model for future concessions in that state.

“[The I-70 project] has proceeded on an availability payment basis primarily because there is no revenue protection for that corridor,” Cheroutes explains. “It was a struggle for the public side to come to grips with the notion of availability payments, the notion of the higher costs associated with availability payments, but I think it is a model that's been accepted. Something that we think will be a model for a number of other projects.” 

But while availability payment concessions have made headway in Colorado, North Carolina avoids these deals since they provide few of the P3 benefits sought by the public side. 

“Availability payment concessions in North Carolina are considered debt, simply because if you're making payments to the concessionaire or to the bondholders after substantial completion of the project, it's the same as if you had financed the project, so we don't use them much,” Tyeryar argues. “We're not going to issue debt if you're going to count it against our capacity.” 

Revenue-risk deals, on the other hand, are quite attractive for their risk-shifting characteristics, he offers. “They're actually really good for us because they shift the entire burden to the private sector.” 

Robert Poole, director of transportation policy at the Reason Foundation, points out that the I-70 project is, in some ways, a hybrid of the two models since part of the plan calls for a managed lane on the eastern end of the highway. He also notes that Florida is employing a hybrid structure for the I-4 project that is being developed through an availability payment concession and which also includes tolled managed lanes in the median: “Those are availability payment deals, but the state is going to be collecting toll revenue that will cover a portion of the cost of the availability payments, so I envision that as a hybrid of the two models.” 

Seliga believes that while the area of hybrid concessions has not yet been fully explored, there is a precedent for such arrangements in one of the US' strongest transportation concession markets: Texas. In some Texas projects, Seliga explains, subsidies are being combined with revenue-risk concession models in cases where the project developer is being asked to not only build managed lanes, but to also rebuild or expand general purpose lanes or build frontage roads.

SEEKING MATURITY 

Perhaps unsurprisingly, though, mature operating toll roads are attracting the lion's share of investor attention. That is perfectly exemplified by the recently auctioned Skyway project, which achieved a multiple of more than 35 times its annual earnings before interest, tax, depreciation and amortisation (EBITDA) on revenues of $80.7 million annually, when it was sold to the Canada Pension Plan Investment Board (CPPIB), the Ontario Municipal Employees Retirement System and Ontario Teachers' Pension Plan for $2.84 billion.

Each of the pension investors in the Skyway concession came to the table with $512 million equity cheques, which brought the roughly $2.3 billion project debt down below a one-to-one ratio with equity. Still, some critics question whether the new concessionaires, even with their long-term view, will be able to turn a profit on the toll road, which largely services commuter traffic.

IFM Investors , who acquired the Indiana Toll Road (ITR), the only other mature toll road asset to come to market in recent times, was said to have eyed the Skyway transaction, but declined to pursue when it became clear that original concession partners Ferrovial and Macquarie would be seeking a multiple in the mid-30s. On the $5.7 billion ITR acquisition, however, IFM showed that it was willing to step into the arena while multiples are high, accepting a multiple of 32 times annual EBITDA on that asset.  

In the original Skyway deal, Ferrovial and Macquarie provided $880 million in equity on the $1.83 billion concession. Then, one year later, the project was further leveraged through a $370 million refinancing. Ferrovial reported that it would recover $269 million for its 55 percent equity share in the $2.84 billion transaction, with Macquarie Atlas reportedly expecting $100 million in gross revenues from the sale of its 22.5 percent stake. 

In the ITR deal, while some argue that overly-ambitious traffic forecasts were responsible for the failure of the project to generate sufficient revenue, Mayer Brown's Seliga, who worked on the original concession, tells us that it was more likely the debt-to-equity ratio in the original concession that was the problem. On the new deal, Selina says “IFM has weighted it more toward equity, [with] the relative proportion of equity-to-debt [being] substantially higher.”  

There have been murmurings that the Skyway and the ITR deals, with their mid-30 multiples, are a sign that the toll road sector may be experiencing a bubble. But only time will tell if the sale of the assets to long-term investors will provide more stability than the original debt-heavy transactions.

PENSIONS SHOW PROMISE

Long-term investors, especially pension funds, certainly think so and are keen to present themselves as strong partners in these concessions, perhaps hoping to assuage some of the concerns the public sector has when offering existing assets to the private sector. 

IFM Investors' US executive director for infrastructure, Michael Kulper, argues that pensions and their fund managers approach investments with a mind toward being a “responsible fiduciary that manages assets from an enlightened perspective [to] maximise the lifetime value of these assets, because that's how pension funds match their long-term liabilities to pensioners”.

IFM wasn't alone in this view. Ross Israel, co-founding head of infrastructure for pension manager Queensland Investment Corporation (QIC) Global Infrastructure, says he sees a “virtuous circle” in local pension-managed mature toll road assets.

“If the pension fund invests in a toll road in their local area and continues to maintain it for good utility, the members are getting the productivity in their local area as a result and the virtuous circle is closed in terms of better economic performance in the geography in which they live,” highlights Israel, who led QIC on its successful acquisition and commercialisation of Australia's Queensland Motorways (QML) project.

“They are a good custodian and a good source of capital with patience and a desire for good, stable, predictable cash flows that are attracted to inflation-hedged assets, which certain concessions do provide with the right structure on tolls.”

PROGRESSING IN MILLIMETRES 

Roughly 15 months ago, Israel told Infrastructure Investor that in his view, the US transportation privatisation market was progressing in inches, naming the municipal bond market as the market's most significant “chilling factor” at the time. And while there have been recent successes in bringing projects to market, he remains conservative in his growth estimates for the coming years. “It's growing by millimeters, inches aside,” he said.  

QIC partner Leisel Moorhead added that while the municipal bond market is one of the many factors contributing to the lack of toll road asset privatisations, public perception remains a key detractor.  “I think there is this perception in the public that only the public can operate a toll road and I think QML, and clearly  a number of other motorways, show that it can be done [by the private sector] and it can be done well.”