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CIPFA Scotland Asset Management Workshop Investing in ...

  1. 1. CIPFA Scotland Asset Management Workshop Investing in Infrastructure Larry Kohn, Managing Director 212.648.2227 March 1, 2007 Today’s presenter Larry A. Kohn is a managing director for JPMorgan Asset Management’s Infrastructure Investments group responsible for advising clients on the opportunities and risks associated with Infrastructure Investing. Larry is a member of the Infrastructure Investments Committee. Larry brings 30-plus years of investment management experience to the group, including almost 10 years of advising institutional clients on alternative investments, from his previous position working with JPMorgan Alternative Asset Management clients on their hedge fund strategies. Recently, Larry was selected by Transportation Secretary Mary E. Peters to serve on a Blue Ribbon Panel of Technical Experts that has been formed by the national Surface Transportation Policy and Revenue Study Commission. The Commission was created by Congress to provide recommendations on the future needs and funding of the Nation’s transportation system. Prior to joining JPMorgan, Larry was a managing director of Quellos Capital Management, a hedge fund of funds, responsible for advising clients on alternative investments, absolute return strategies and hedge fund research. Previously, Larry was a partner with Lazard Freres & Co., overseeing product and business development for the institutional asset management business. Larry spent ten years with Goldman Sachs as vice president in the investment banking division and was one of the founding professionals of Goldman Sachs Asset Management, where he focused on large pension funds, endowments and foundations. Additionally, he held various positions at SBC Communications during his 11 year tenure, including senior investment officer of their pension fund. Larry holds a B.S. from the University of Missouri 1 1
  2. 2. What is infrastructure? Essential facilities and services, upon which the economic productivity of a community depends Assets involved in the movement of goods, people, water and energy Transportation Communications Regulated Social Assets Assets Assets Infrastructure Radio/TV broadcast Bridges and tunnels Electricity transmission Schools towers Toll roads Wireless towers Oil and gas pipelines Hospitals Electricity and gas Railroads Cable systems Prisons distribution Rapid transit links Satellite networks Water distribution Courthouses Waste water collection Airports, Seaports and processing systems 2 Why consider infrastructure? Ideal match for pension liabilities, endowment and foundation obligations: – long term assets – inelastic user demand, monopolistic / quasi-monopolistic assets – generate growing cash flow – return profile similar to core real estate: largely cash yield with a lesser amount of capital appreciation – low correlation to traditional asset class returns – attractive inflation protection characteristics; a real return asset Risk and return characteristics are compelling Infrastructure can support more debt / leverage without incurring more risk than real estate Premium returns may be available to “early movers” 3 2
  3. 3. Golden Gate Bridge: An example of demand inelasticity Following the internet bust, approximately 400,000 Bay area jobs were lost on a base of 3.2 million between March of 2001 and September of 2003 — a 12% decline. This amounts to one of the worst post-war regional recessions in the U.S. Traffic over the Golden Gate Bridge was down 3.5% and 4.6% in FY2002 and FY2003, respectively Despite the regional recession, a 66.6% toll increase was implemented in FY2003 and revenues grew by 34% Golden Gate Bridge: Demand and price inelasticity Traffic / Crossings # of Crossings / Revenue $ Revenue ($) 90,000,000 Employment 3,300,000 80,000,000 3,200,000 Employment Figures 70,000,000 3,100,000 60,000,000 50,000,000 3,000,000 40,000,000 2,900,000 30,000,000 2,800,000 20,000,000 10,000,000 2,700,000 0 2,600,000 2000 2001 2002 2003 2004 2005 Year Source: 4 Illustrative Risk-Return Spectrum Assets in the core to value-added areas of the risk-return spectrum represent approximately three-quarters of the opportunities in OECD countries Core and Core Plus Value-Added Opportunistic Bridges, tunnels, toll roads Airports, seaports Development projects Pipelines, energy transmission Rail links Satellite networks and distribution Contracted power generation Merchant power generation Water and waste-water Rapid rail transit Non-OECD country systems infrastructure Less risk More risk Less return More return 5 3
  4. 4. Illustrative returns1 Capital Avg. cash yield Avg. leveraged appreciation Asset segment Risk (years 1–5)2 IRR3 potential Toll roads (Operating) Low 4–9% 8–12% Limited Private Finance Initiatives Low – Medium 6–12% 9–11% Extremely limited Regulated assets Low – Medium 6–10% 10–15% Limited Rail Medium 8–12% 14–18% Yes Airports / Seaports Medium 5–10% 15–18% Yes Toll roads (Development) Medium – High 3–5% 12–20% Yes Communications networks Medium – High 8–10% 15–20% Yes Power generation High 4–12% 12–25% Yes 1 The returns set forth above for certain infrastructure asset segments are for illustrative purposes only. The returns are estimates calculated from market information available to JPMorgan, which may not be accurate or complete and returns shown may not represent actual historical returns. These Returns should not be relied upon as an indicator of Returns which may be achieved in the future, which will be a function of a variety of factors, including, without limitation, the specific assets, their location, the economic, interest rate, competitive, and in the case of regulated assets, the regulatory environment, at the time. Past performance is not indicative of future results. 2 Cash distribution to equity holders as a percentage of equity investment. 3 Assumes debt of 50% to 85% and investment periods of not less than five (5) to seven (7) years. 6 Concessions are structured to provide a real return The City of Chicago granted price-setting autonomy to the private sector within authorized toll limits stipulated in the 99-year Skyway Concession Agreement Passenger $2.00 $2.50 $3.00 $3.50 $4.00 $4.50 $5.00 + greater of 2% or CPI or nominal GDP/capita1 Cars 2005 2008 2011 2013 2015 2017 2020 2023 2026 2029 Favorable urban traffic profile: from 1999-2004, annual average vehicle-miles on urban U.S. highways increased by 3.5% (vs. 2.2% growth for urban and non- urban combined)2 Debt represents 84% of Skyway’s $1.83 billion concession price3 Under a concession structure, the private sector concessionaire captures projected revenue growth in exchange for assuming operating risk Toll rates as per Chicago Skyway Concession Agreement, City of Chicago. 1 U.S. nominal GDP per capita average growth for the 20 years ending December 31, 2005 was 5.5%. 2U.S. DOT. 3 Infra-News. 7 4
  5. 5. Comparing fixed income to infrastructure A coupon for a fixed rate bond is constant, without inflation-protection characteristics. Cash flows for an infrastructure concession, however, are not fixed and tend to rise through a combination of both traffic growth and adjustment for inflation. Comparison of a Fixed Bond Coupon and Concession Project Cash Flows £29.00 Toll / rate increases = 2% p.a. £27.00 Traffic / population growth = 1.5% p.a. Bond coupon £25.00 £23.00 £21.00 £19.00 £17.00 £15.00 £13.00 £11.00 £9.00 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 Years Source: JPMorgan Asset Management 8 Comparing fixed income to infrastructure We have compared changes in the value of infrastructure assets to the value of a long- term fixed-rate bond in response to changes in interest rates. – A 30-yr bond shows duration of approximately 15, i.e. a 1% change in yield will result in a 15% change in price. Contrary to a fixed coupon bond, infrastructure assets with cash flows that adjust for inflation will have a duration approaching zero or even negative duration, allowing them to maintain (or increase in) value. Impact of Changes in Interest Rates on Valuation 2.00 1.80 30-year concession project 30-year bond 1.60 Price index 1.40 1.20 1.00 0.80 0.60 0.40 0.20 - -3% -2% -1% 0% 1% 2% 3% 4% 5% Interest rate change Source: JPMorgan Asset Management 9 5
  6. 6. An example of transparent and fair regulation The U.S. Energy Act of 2005 has required the Federal Energy Regulatory Commission (FERC) to establish new rules which promote capital investment in electricity transmission 18.00% Electric utility regulated 16.00% returns on equity Energy Act (includes FERC and effective 14.00% state regulators) 02/06 12.00% 10.00% 8.00% ~6% spread 6.00% 4.00% Five year 2.00% Treasury Rate 0.00% 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 Refer to page 34 for an example of an electricity transmission investment opportunity. Source: Electric Utility ROE – America's Electric Utilities, 8th edition, Leonard S. Hyman. Regulatory Research Associates. Treasury Rate – Federal Reserve Statistical Release, Selected Interest Rates 10 ITC Holdings: An example of electricity transmission investment opportunities By paring their annual outlays for transmission capacity in the past 25 years, utilities have failed to keep pace with the public’s seemingly unquenchable power demands Created in 2003 to acquire the transmission assets of Detroit Edison for $610 million ITC exclusively focused on transporting electric power to ~10 million customers in Michigan The Energy Policy Act of 2005 gave FERC a mandate to use price incentives to attract investment capital. Regulators have allowed for an exceedingly generous 13.88% return on equity for ITC. In addition, it was noted that, “favorable rate treatment must be long term and certain in order to call forth investment in the grid.” In May 2006 the transmission assets of METC, a former subsidiary of CMS Energy (Consumers Energy) were purchased by ITC Source: Barron’s, July 24, 2006. 11 6
  7. 7. Infrastructure — unique risks Unique risks (and mitigating factors) Regulatory risk (due diligence and transparent regulatory process) Political risk (non-monopoly assets, labor support, enforceable contracts, commercial law) Liability issues (insurance and appropriate risk allocation among stakeholders) Liquidity (not as liquid as real estate, but neither is timber, agriculture) Varying sub-sector risks along a spectrum from operating toll roads, water/gas distribution, airports through to development (similar to real estate) An emerging investment strategy: inefficiencies, lacking robust data 12 A common concern with infrastructure investing… The perception: there is too much money chasing too few deals. Our belief: recent headline-making deals represent outlying data points, not long- term trends. Rationale… Given the amount of deferred maintenance and the shortage of government funding to maintain (let alone improve) infrastructure, the number of opportunities will only continue to grow – over the next 20 years, modernizing water and sewer systems, and the construction and repair of roads, bridges and tunnels alone will cost in excess of $1.1 trillion1 The long-term investor will see a plethora of activity; currently serious discussions involve: – Pennsylvania Turnpike – Illinois Tollway – New Jersey Turnpike – Chicago Midway Airport – Dutch utility network – Electric transmission opportunities – Schiphol Airport (Holland) – Lisbon Airport – etc… 1 National Chamber Foundation study commissioned by the U.S. Chamber of Commerce (2005); Environmental Protection Agency (2006). 13 7
  8. 8. Tolls increase in order to maintain roads and ease congestion, regardless of whether assets are held publicly or privately 91 Express Lanes New Jersey Turnpike The 91 Express Lanes opened in 1995 under The New Jersey Turnpike is a government- a private operator in Orange County, CA with owned asset a peak toll of $2.50. To increase revenues during a The peak toll rose to $4.75 in August 2003, recessionary period in 1991, New Jersey when Orange County reacquired the asset. implemented a sharp toll increase: The state implemented “congestion – 100% increase for commercial vehicles management pricing”, and the current peak – 70% increase for passenger vehicles toll has jumped to $9.25, a 95% increase since the asset was held privately. UK toll scheme A government-proposed UK road-pricing scheme could cost motorists £30bn a year1. The “pay as you go” user fees would range up to £1.28p per mile at peak times. The resultant revenue would equate to an extra 8p on the pound on income tax. Source:, 2007. 1Source: Eddington Transport Study, published Jan. 2007. 14 An attractive potential partner to operators and investment consortia A sample of operators, developers, and maintenance providers that represent potential partners: Global multi-sector development, construction, engineering Bechtel Parsons Fluor Kiewit Ferrovial Eiffage SNC-Lavalin Skanska Zachry Vinci Construction Transfield Services Bouygues ACS AECOM Construction Strabag Balfour Beatty Shaw URS Sector focused — operations, maintenance, equipment supply and ownership Toll roads and highways Power and energy Airports, seaports Railways, mass transit Cintra Foster Wheeler BAA ALSTOM Transurban Technip Fraport Bombardier Autostrade SpA Halliburton P&O Transdev Abertis Washington Group ABP Keolis International 15 8
  9. 9. Illustrative opportunities across sectors (U.S.)* Value Sector Opportunity Location (bn) Description Status Roads TTC-35 Texas $7.2 Initial phase of a 50-year construction Cintra-Zachry signed development agreement plan to build 600-mile rail, road and with TxDOT. Construction of SH 130 will be utility corridor from Mexico border the first facility developed under the TTC-35 through northeast Texas Comprehensive Development Agreement. SH 121 Texas $2.0 Concession to complete remaining Four bidders have been short-listed; final bids construction and operate/maintain are due at the end of January 2007. the 24-mile road. Hampton Roads Virginia $3.6 Construction of a third crossing Detailed proposals submitted by two teams in Crossing August 2006; Panel to review and consider proceeding with negotiations Illinois Tollway Illinois $14.0 Potential lease of 274-mile Illinois toll Credit Suisse presented a feasibility and system valuation report to the State; awaiting tolling decision Mountain View Utah $2.5 Construction of a 35-mile toll road for Legislative approval signed in March 2006; Corridor southwest of the Salt Lake City area awaiting tolling decision by the Utah Transportation Commission in late 2007. Bridges Miami Port Miami, FL $2.0 Construction of tunnel between the Three qualified bidders announced; Proposals & tunnels Tunnel MacArthur Causeway / I-395 and the are due in February 2007, with the contract to Port of Miami be awarded in early spring 2007. Mississippi River Missouri / $0.9 Construction of an 8-lane bridge and Initial approval granted in April 2006, awaiting Toll Bridge Illinois relocation of I-70 in Illinois final approval from House, Senate and decision on tolling Rail BART Airport San $0.2 3.4 mile extension of the BART light They have shortlisted three teams; awaiting the Connector Francisco, rail system under an up to 35-year release of an RFP CA concession Airports Midway Airport Chicago, IL TBD Potential sale or lease of Midway Financial Advisors engaged; awaiting financial Airport study of lease structure to be completed. Preliminary application approved by FAA. Electricity & gas Private utility U.S. TBD Potential sale of regulated assets Information Memorandum distributed distribution US$32.4+ Sources: JPMorgan Asset Management, Infra-news, Project Finance Magazine, Reuters, BART company site. *Shown for illustrative purposes only. 16 Illustrative opportunities across sectors (Europe) Value Sector Opportunity Location (bn) Description Status Roads Fehmarn Germany €4.0 ($5.1) Construction of a bridge, tunnel or both Series of technical studies and financing Belt to form a fixed road and rail link plans have been completed – awaiting spanning the 19km wide Fehmarn adoption of technical standards – expected in Straight between Germany and 2007 Denmark Local road Italy €7.8 ANAS (state-owned road authority) The first tranche of the Termoli to San Vittore networks ($10.0) seeks to privatize an extensive existing highway, in south-eastern Italy, is to be road system and convert portion into toll financed through a PPP arrangement. roads Airports Schiphol Holland TBD Potential private placement of 20% Dutch Government considering sale of up to equity interest to long-term investors 49% equity interest (20% to long-term investors and 29% via IPO) Lisbon Airport Portugal €3.6 ($4.6) ANA Aeroportos (state-owned) is ANA is currently considering financing considering privatization and concurrent structure of new airport and seeking financial construction and lease of new airport in advisors Lisbon Ports Forth Ports U.K. £0.8 ($1.4) Listed U.K. ports company May split company into a property and ports business to maximize value Rail Brenner Tunnel Austria-Italy €7.4 ($9.5) Extension of the Brenner rail axis from Recent proposal to extend axis to Naples. EC Munich to Verona. Part of north-south has announced potential funding €1bn Euro rail link for high-speed train Metro North Dublin, TBD Development of 15 train stations, 17km Ireland’s Railway Procurement Agency (RPA) Ireland route around the Dublin area; expecting has given notice of forthcoming contract 34 million passengers a year opportunities on the Metro North project. PFI Portfolio PFI Portfolio U.K. £0.7 ($1.3) Potential sale of a 65 asset portfolio, Awaiting bid selection which includes health, education, accommodations Waste Essex Waste PFI U.K. £0.3 ($0.4) Potential 25-30 year concession for Essex Waste PFI scheme is moving forward management waste management scheme in Essex with a soft market test event County US$32.3+ Sources: JPMorgan Asset Management, Infra-news, Project Finance Magazine. 17 9
  10. 10. Potential transactions currently in the news Estimated Opportunity Location value (bn)1 Status New Jersey Turnpike NJ $20.0 New Jersey legislators have called for the sale of 49% interest in the 148-mile toll road. The State’s transportation trust fund is depleting and legislators are reluctant to raise gasoline taxes. Asset report has been completed; Corzine to decide on Turnpike by April 2007. Atlantic City Expressway NJ $4.0 The 44-mile expressway from Philadelphia to Atlantic City, New Jersey’s casino region, has been cited by NJ Senator William Gormley as a potential sale candidate Tappan Zee Bridge NY $2.0-$12.0 Toll bridge is currently in poor operating condition and state legislators and transportation authorities are evaluating refurbishment or completely rebuilding the toll bridge. Cost estimates for refurbishing could be more than $2 billion and rebuilding could cost $4-$12 billion depending on the size and whether it carries a railway I-95 (North/South Carolina SC TBD South Carolina Department of Transportation (SCDOT) has applied to the Federal segments) Highway Administration (FHWA) to toll the existing Interstate 95. If given the go-ahead, SCDOT will likely enter into a PPP agreement to fund an upgrade of the route Pennsylvania Turnpike PA $18.0+ Governor Ed Rendell said his administration has had discussions in recent months with private groups about such groups paying the state to take control of highways or railroads Forth Road Bridge U.K. £0.7 ($1.1) The new suspension bridge being proposed to replace the 40-year old crossing of the Forth would form part of the A90 Edinburgh - Dundee corridor. The Scottish road authority FETA has reviewed a feasibility study and is currently considering financing plans Nimes-Montpellier bypass France €1.2 ($1.4) Réseau Ferré de France (RFF), which owns and manages the French rail network with responsibility for upgrading and development, is publishing a tender for financial advisors to assist with this project and other planned rail PPPs A1 - Santo Tomé del Puerto Spain €0.4 ($0.5) Shadow toll PPP - part of the €2bn country-wide renovation and maintenance program to Burgos that the Ministry of Public Works launched in 2006. The program will see 1,521km of roadways bid out for renovation and maintenance in return for shadow toll collection Rome Ring Road Italy €5.7 ($6.8) Italian road authority is considering PPP involving redevelopment and upgrade of existing Rome Ring Road US$53.8+ Sources: 1. Values reflect publicly stated figures or estimated based on the valuation multiples of Chicago Skyway and Indiana Toll Road; Barron’s (5/8/06), Infra-news, Factiva. 18 Historical PPP Activity in Europe PPP Investment in European Countries, 2003-2006 The Netherlands Denmark 7% Germany 2% 8% France Other 9% 8% Spain Belgium 11% 9% Italy UK 20% 26% Total est. value: $164bn Source: Standard & Poor's, Dealogic 19 10
  11. 11. Potential PPP Activity in Europe European Infrastructure Investment Market by Country Central and Eastern Europe Germany 13% 15% Rest of Europe 5% Baltic states France 2% 12% Nordic states 9% Benelux Spain 6% 10% Austria 3% UK Greece Italy 9% Portugal 4% 9% Total est. value: Eur 4 - 5 trillion 3% Source: Deutsche Bank 20 Potential PPP Activity in Europe European Infrastructure Investment Market by Sector Gas pipelines Water 11% 11% Telecom 15% Electricity 20% Airports 3% Seaports Oil pipelines 3% 3% Railways Roads 17% 17% Total est. value: Eur 4 - 5 trillion Source: Deutsche Bank 21 11
  12. 12. Recent PPP example: UK Exeter International Airport Owned by Devon County Council from 1974 One of the fastest-growing airports in the UK, growing at an average annual rate of 10% since 1990 Will handle over 1,000,000 passengers in 2007 Was purchased by Regional and City Airports (Exeter) Ltd (RCA) for £60 million (£31 million equity) in December 2006 Airport will be substantially redeveloped with new terminal facilities, new aircraft stands, and further terminal capacity New departures building will be constructed by 2010 22 Recent PPP example: France A65 Motorway Eiffage/Sanef consortium won the bid for the Eu1 billion, 65-year A65 Motorway real toll concession in 2006 Design, Build, Finance and Operate (DBFO) project 4-year construction period for a 152km motorway between Bordeaux and Pau in southwestern France Occurred in the wake of the Bouygues-led consortium’s successful bid for the 55-year concession of A41 in late 2005 23 12
  13. 13. BAA: the largest airport privatization in history British Airports Authority In 1987, the UK government conducted a public share offering of the former BAA, valuing the company at $2.5 billion At the time, BAA owned and operated 3 main London airports and 4 main Scottish airports By 1990, market value had risen to $4 billion In 2006, Ferrovial acquired BAA, which then owned 7 UK airports serving 141 million passengers per year and valued at over $18 billion 24 A growing sense of urgency for transportation infrastructure investment in the U.S. “Each year, Americans lose 3.7 billion hours and 2.3 billion gallons of fuel sitting in traffic jams and waste $9.4 billion as a result of airline delays. Worse, congestion is affecting the quality of Americans lives by robbing them of time that could be spent with families and friends.” “There is a growing consensus among transportation policymakers and economists that existing financing mechanisms for highway and aviation infrastructure are unsustainable in the long term and will be unable to keep pace with projected demands on the transportation network.” “Unleash private sector investment resources. The Department will work to reduce or remove barriers to private sector investment in the construction, ownership, and operation of transportation infrastructure…” - National Strategy to Reduce Congestion On America’s Transportation Network: Department of Transportation, United States of America, May 2006 25 13
  14. 14. Power infrastructure investment in the U.S. is also drawing significant attention “Under prior established law, FERC was required to allow a return which provides an opportunity to earn ‘enough revenue not only for operating expenses but also for the capital costs of the business… That return should be sufficient to assure confidence in the financial integrity of the enterprise, so as to maintain its credit and attract capital.’ … The new Energy Act, by contrast, arguably requires a return high enough to expand the business, by investing in more transmission and new transmission technologies. There is thus a strong argument that the new statute requires something higher than the traditional rate of return.” - LeBoeuf, Lamb, Greene & MacRae LLP, in an August 2005 memo “The huge blackout that hit the Northeast, the Midwest and Canada so hard three years ago… was nonetheless a forceful demonstration of the problems this nation will face if we fail to make timely investments in the system to modernize it to meet increasing demand and increase electricity production and delivery capabilities.” “’Critical Congestion Areas’ [(Southern California and the Atlantic coastal area)] are of most urgent concern… Both areas are large, densely populated, economically vital to the nation, and adversely affected by transmission congestion that increases electricity prices and threatens reliability.” “Now, it is time to create the transmission equivalent of the interstate highway network. Regional electric power delivery systems must be upgraded and woven together…” - National Electric Transmission Congestion Study: U.S. Department of Energy, August 2006 26 JPMorgan’s view of core plus infrastructure investments Long-term assets with low risk of obsolescence Frequently have relatively low operating risk and operating Predictable Cash Flow costs Inelastic user demand Infrastructure is a real return asset, comparable to real estate Diversification Low correlation of returns to equity and fixed income Diversification relative to real estate, timber, commodities Typically, stable returns and potential for growing cash flow Majority of return from cash yield, with opportunity for Return Profile modest capital appreciation Premium returns may be available to early investors Debt ranges from 50% to 85% of total capital Leverage and Liquidity Secondary market exists but less liquid than real estate Liquidity trade-off: cash flow profile vs. capital appreciation Attractive alternative to long-term fixed income Portfolio Management Favorable risk-adjusted returns relative to equity Inflation-protection, demographic-hedging characteristics 27 14
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