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Corporate Road Warriors on the Move

Washington Post

Washington, DC (06/19/2006)—A burgeoning trend kicked off when private foreign firms started leasing toll roads from state and local governments around the nation has sent U.S. transportation infrastructure finance players scrambling—including funneling billions of dollars into infrastructure investment funds and rethinking their traditional roles—to get a piece of the action.

It all started with the Chicago Skyway, which was leased for 99 years by the city of Chicago to a consortium led by Australia-based Macquarie Infrastructure Group and Spain-based Cintra Concesiones de Infraestructuras de Transporte SA. The deal closed in January 2005.

The 7.8-mile toll road was built in 1958 and connects the Dan Ryan Expressway on the west end to the Indiana Toll Road on the east end.

Under the deal, Chicago received a $1.83 billion cash payment from the Cintra-Macquarie group, which took over operation and maintenance of the road and keeps the toll revenue collected through 2104. The deal allows the private group to raise the tolls on a schedule negotiated with the city. Tolls for passenger cars are capped at $2.50 until 2008 and rise incrementally to $5.00 starting in 2017.

This transaction between the consortium and Chicago was the first privatization of an existing toll road anywhere in the United States.

Most recently, the same pair of companies is close to closing a deal with Indiana on a 75-year lease deal for its toll road, a 157-mile highway that runs east to west along the state’s northern boarder, in exchange for a $3.8 billion upfront payment.

While it is too early to declare that the nation is in a new era of transportation infrastructure finance, several traditional transportation finance firms are betting that if we aren’t yet, we ultimately will be.

Many companies, including investment banks Goldman, Sachs & Co., JPMorgan Chase & Co., Morgan Stanley, as well as the giant construction and engineering firm Parsons, are actively seeking out concession deals, and Macquarie is exploring the possibility of leasing U.S. airports, according to recent interviews with company officials and representatives.

Their interest also comes as the Virginia Department of Transportation last month agreed in principle to a 99-year concession deal—including operations, maintenance, and collection of toll revenue—with Transurban Ltd., an Australia-based toll road operator, for the Richmond-area Pocahontas Parkway. Under the deal Transurban would pay VDOT $525 million.

Traditionally states and localities have relied on federal, state, and local gas taxes vehicle fees and other revenues, along with municipal bonds to finance transportation infrastructure. But those sources have not kept pace with the nation’s growing infrastructure needs.

The private sector capital now interested in public infrastructure provides a third financing option “that should be considered as part of any funding process,” said Mark Florian, chief operating officer of Goldman’s municipal finance and infrastructure group.

“The gist of this business really grew up out of need, in places such as Europe and Australia, and other parts of the world where there is not a big, deep municipal bond market,” he said. “Governments needed to build projects, but didn’t necessarily have access to the very liquid municipal bond market that we have in the United States. What they would do is ask the private sector to come in and build facilities and give the private sector the ability to collect revenue as an enticement to get them to build it in the first place.”

Following the Macquarie-Cintra group’s execution of the Skyway concession in January 2005, Goldman reorganized its municipal finance group in March 2006. As part of the reorganization, Tracy Wolstencroft was brought in to head the group from Goldman’s corporate investment banking team.

“The reorganization at Goldman Sachs took place with a couple of things in mind for the future,” Florian said. “One is to grow our existing municipal finance business, which is a debt and derivatives business. The second is to focus on public-private partnerships and how can we grow that as well.”

The change was “is really about growing the existing business and as well as this new initiative,” he said.

Henry M. Paulson Jr., Goldman’s chairman and chief executive, was “very supportive” of the change towards moving into the private concession sector, according to Florian. Paulson was nominated late last month by President Bush to become Treasury secretary.

Florian does not believe that there are any tax rules or regulations that Paulson could change in order to help the private concession market grow.

“The federal government has been relatively accommodating to date—this administration has been supportive,” he said. “There is nothing that the federal government needs to do in order to push the business forward.”

A sign of the administration’s general support came last month when Transportation Secretary Norman Y. Mineta spoke before opening the day’s trading at the Nasdaq stock exchange. He urged investment and engineering firms to lead the privatization charge.

“The time is now for United States investors—including our financial, construction, and engineering institutions—to get involved in transportation investments,” Mineta said. “Their involvement will be crucial if we ever hope to have the funds necessary to build the transportation network required by our rapidly growing economy. Private capital will give those communities willing to embrace it an opportunity to augment public funds in order to complete critical transit and highway projects.”

Florian did, however, point out that loosening tolling restrictions on the Interstate highway system would be beneficial to expanding the public infrastructure privatization market.

One initiative local governments could take that might attract private investment is to build new high-occupancy toll lanes on existing free roads, he suggested. HOT lanes, which are actively being planned in Virginia, Maryland, and other states, would increase capacity on the road and relieve congestion, while leaving a drive-for-free option.

Meanwhile, Goldman Sachs, the Carlyle Group, a private equity firm, and other investment companies are putting together funds—Goldman’s is estimated to be worth about $3 billion and Carlyle’s roughly $1 billion—that are designed to acquire transportation infrastructure assets around the nation, according to published reports.

In March, around the same time as the Goldman reorganization, Carlyle announced that it established a team to conduct investments in the infrastructure sector.

“Carlyle’s Infrastructure team will invest primarily in U.S. infrastructure in transactions ranging from $100 million to more than $1 billion,” the firm said in a release. “The team will engage in public-private partnerships with governments at all levels as well as purchase projects outright or through long term concessions.”

Morgan Stanley is putting together an infrastructure fund, which is part of its asset management business, firm officials said in an interview. But they did not provide any other details citing restrictions during fund raising.

Their interest in privatization comes as the firms increasingly see municipalities look to corporate finance frameworks to solve public finance problems, according to Robert Collins, a Chicago-based Morgan Stanley executive director who heads the mergers and acquisition group.

“We are having dialogues with those clients that have underfunded pension plans or vast budget deficits to explore unlocking any latent equity value within non-core assets,” he said. “These kinds of dialogues have been increasingly active across different sectors and across the country.”

The firm is exploring private deals for both existing infrastructure, sometimes referred to a brownfields, and to build new infrastructure, known as greenfields.

“We are looking at both sides of it, the greenfield and the brownfield, we are looking at working with municipal entities to advise them on all alternatives across all asset classes,” said Eugene Devlin, a Morgan Stanley managing director and head of the firms public finance department.

Devlin also noted that he was skeptical that the privatization trend would reduce the overall amount of tax-exempt debt that is issued. “I think this will supplement the projects that would not normally get done,” he said.

Banks are typically raising dollars primarily from foreign pension funds and insurance companies, which are seeking investments that yield more than municipal bonds, but are not as volatile as stocks and equities.

“These types of investments make a lot of sense for pension funds because a lot of these pension funds have very long liabilities where they are going to be paying out a lot of money for the next 30, 40, 50 years,” said one observe. “For them to have a long duration asset that is generating cash flow that is pretty steady cash flow over a long period of time is perfect. It is a great vehicle for pension funds.”

“A lot of insurance companies have investment pools that last for a long, long time as well,” the observer added. “They have reserves they need to invest and they want steady investments as well.”

The recent influx of available capital is coming from nations like Australia, where Macquarie and TransUrban are based. Australia introduced compulsory pensions 15 years ago.

“The Australians have an awful lot of pension money to put to work and they are looking for stable long-term investments that produce stable returns that match their investments goals and horizons,” said Michael C. Finnegan, a managing director with JPMorgan.

JPMorgan is building a fund, but Finnegan did not have any other details about it. He noted that the bank’s leaders keep Finnegan’s group—which advises state and local governments on concession deals—separate from the side of the business that raises private dollars.

With capital in hand, the investment firms are actively seeking out concession projects.

For example, Goldman is currently working on several concession projects, including seven Texas greenfield toll road facilities.

JPMorgan has submitted a study to Harris County, which includes Houston, that explores a sale of its extensive toll network. The county is considering other financing studies and deciding what avenues to pursue.

Also in Texas, two groups of private firms last week submitted proposals to finance the extension of Interstate 69 through the state. Each one of the groups includes one of the two firms that worked together on the Chicago and Indiana deals.

Morgan Stanley is part of a consortium led by Spain-based FCC Construccion S.A. that is bidding to design, build operate and finance a tunnel that will improve access to the Port of Miami. The other two bidders include a group led by French firm Bouygues Travaux Publics, of which ABN AMRO Bank NV is a partner, and a team led by Spanish firm Dragados Concesiones de Infraestructuras SA.

Under the proposed deal, the Florida Department of Transportation, once the tunnel is built, would pay the winning team an annual payment over 35 years, instead of requiring drivers to pay a toll when using the tunnel. However, the so-called annual “availability payment” would be reduced by the number of hours that lanes are closed or the tunnel does not meet negotiated operating requirements. The technique has been used primarily in Europe.

Parsons is traditionally known as an engineering, design, and construction firm, but, as the privatization of the public infrastructure sector has appeared on the horizon, they too intend to branch out from project design, development, and delivery.

“We are trying to stay current with new approaches to financing and ownership and operations,” said Jeff Squires, a vice president with Parsons. “At this stage we are starting to talk to concessionaires about being a full partner, not just in the delivery of the project, but also in the long-term operation and management—having a financial stake.”

Squires—a former aide to Sen. Jim Jeffords, I-Vt., on the Senate Environment and Public Works Committee and the Senate Finance Committee—stressed that discussions are still in their early stages. He also did not specify what firms are involved or what projects were being considered.

“We are open to exploring a wide range of roles” beyond project delivery,” he reiterated. But “as we expand the nature of our participation, it is going to have to be appropriate to what we do.”

As an example of the firm’s interest in the growing business, Squires pointed out that Parsons is part of a consortium building the Kicking Horse Canyon project in British Columbia.

The project involves phase two of the construction of the Kicking Horse Canyon roadway and bridge, and a 25-year concession for the operation, maintenance and rehabilitation of approximately 26 kilometers of the Trans-Canada Highway between the Highway 95 intersection in Golden, British Columbia, and the western boundary of Yoho National Park.

Squires noted that while foreign firms currently are the leaders private concession sector, “I think there are a lot of familiar domestic [firms] that think they need to get into this business.”

He pointed out that the established foreign firms have an advantage because they have a portfolio of assets that allows them to mitigate risk associated with taking on these deals.

“Each of these projects has a different performance curve with different points in time that are expected to yield different outcomes and if you can blend that it helps you to advance more comfortably,” Squires said.

Efforts by Congress to limit how states or cities could spend private concession dollars or protect consumers from unreasonable toll increase schedules could also pose risks for the fledgling business, sources said.

Sources said that Democrats on the House Transportation and Infrastructure Committee have been meeting with experts, but that it is unclear if the lawmakers will draft or introduce legislation that would regulate infrastructure privatization.

At a hearing last month on private transportation infrastructure financing before the committee’s highway subcommittee, Rep. Peter DeFazio, D-Ore., raised concerns over allowing private firms to profit from the use of public infrastructure.

During the hearing, Gov. Mitch Daniels, who appeared before the panel, said that tolls on the Indiana Toll Road, which is run by the state, had not been raised since 1985, in part because no Indiana politicians wanted to back such a politically unpopular move.

DeFazio argued that by leasing the Indiana Toll Road, Daniels was “outsourcing political will” to raise tolls to the private sector.

In response, Daniels stressed that the $3.8 billion Indiana Toll Road concession deal would allow the state to finance nearly $5 billion of other badly needed road projects that it could not have done otherwise. The $5 billion figure includes the $3.8 billion upfront payment plus $900 million in interest the state expects to earn.

Opponents to the toll road deal last week argued before the state Supreme Court that the planned use of proceeds from the lease is unconstitutional and that the money should instead be used to pay off debt. A lower state court recently ruled that under state law the opponents would have to post a $1.9 billion bond in order to pursue the case on its merits. The lease deal is expected to close by June 30.

More recently, another observer raised the possibility that congressional partisan divisiveness could also rear its head in conjunction with privately financed greenfield projects because those projects would not have requirements that come with using federal dollars, for example, compliance with the Davis-Bacon Act requirements on prevailing wages.

“I think that the ability to do major projects without federal funding could represents a concern in some quarters that maybe some of the protections that are built into the federal program would be absent,” the observer said. “As I listen to the early discussions I think it portends the potential for regulation.”

Davis-Bacon is a Depression-era labor law that requires payment of prevailing wages on projects financed with federal funds.

The issue is controversial in Congress and often pits labor against management and the interests of Northern and Northeastern states, which have a heavily unionized labor forces, against Southern and Western states, where unions are not as entrenched.

Macquarie manages a $24 billion investment portfolio, which includes investments in more than 90 infrastructure facilities in more than 20 countries. The firm specializes in different types of infrastructure, including toll roads, airports and airport-related assets, telecommunications, water, rail, port, energy generation, transmission and distribution assets, as well as water and wastewater.

Given the scope of the types of infrastructure that have been privatized around the world, some are looking to expand the phenomenon in this country beyond toll roads.

For example “everyone is starting to look at power generation assets, health care assets, surplus real estate, and water and sewer facilities” JPMorgan’s Finnegan said.

One area that the Macquarie hopes to develop in the U.S. is airport privatization, according to John Cline, a lobbyist with C2 Group, which represents the firm.

Macquarie believes that now is the right time to explore that avenue because the Vision 100—Century of Aviation Reauthorization Act expires at the end of fiscal 2007. Debate on renewing the law, which governs the Federal Aviation Administration and authorizes funding for its programs, is expected to intensify as lawmakers focus on the issue next year.

Cline said that the hurdles are higher for airport privatization than for highways. He cites language in current law that mandates that revenues generated from an airport have to be used on the airport. While a few airports have deals with private operators to run their facilities, such as Indianapolis International Airport with airport firm BAA, the language in current law prevents private firms from owning or leasing U.S. airports on a long-term basis.“It makes it very difficult for a private entity to come in earn a profit, and not be able to take the money off of the airport,” he said. “That provision is a major barrier.”

However, the firm sees an opportunity because airport infrastructure is crumbling and traditional financing sources—federal dollars and bonds—will not be adequate to make the needed improvements.

“The landscape is also changing on the airport side, there are insufficient resources for the capital investment that is needed, both for airport runway redesign and additions, as well as terminal developments, but then also the airspace,” Cline said. “[The FAA wants] to move from a ground-based radar system to a satellite-based system, which is a $10 billion to $15 billion investment. There are lots of investments in the aviation world for which there are no obvious source of public money.”

Cline said that Macquarie, which owns shares in airports in Copenhagen, Rome, Sydney, and Brussels, is well-positioned to privatize U.S. airports. The lobbyist said discussions with lawmakers and the U.S. Department of Transportation about the issue are underway.

One issue that has concerned some public airport operators and airlines over the prospect, according to Cline, is that cities would use the funds they make from a long-term lease deal to pay for pension or post-pension costs at the expense of growing airport and other transportation-related needs.

But restricting the use of proceeds from a concession deal to reinvestment in infrastructure could alleviate the issue. Along with seeking airport deregulation, Macquarie plans to continue to seek out concessions for highways, Cline said.

“Certainly this [privatization movement] cannot be depicted yet as a tidal wave of change that is occurring,” he said. The majority of “infrastructure projects are going forward as publicly financed traditional government supported projects.” “But there is no doubt that with the Skyway and the Indiana toll road transactions there are people out looking at all sort of deals,” Cline said.

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