MACQUARIE CAPITALSOUTH AUSTRALIA TRANSPORT 2012June 2012
AGENDA1 STATE OF PLAY2 POSSIBLE SOLUTIONS3 IS DEMAND RISK MODEL DEAD?
Projects impacted by political constraintsSTATE OF PLAY – BALANCE SHEETCONSTRAINTSMantra Debt reduction Budget surplusReal...
Large backlog of projectsOutcome: absent changes, needed projects are not getting done Various estimates of national infr...
Short term hump or long term trend? Public debt rebalancing is a global issue and will take significant timeLOOKING TO TH...
Not a shortage of capital, but a shortage of projects Superannuation industry has $1.4 trillion of assets under managemen...
Productivity and competitiveness under threat Productivity has plateaued and is beginning to decline Poor / weak product...
Perceptions of infrastructure investment Alternative – redeploy government capital from existing assets to new assets Po...
-$60-$40-$20$0$20$40$60Tax losses Infrastructure projects typically generate large tax losses during constructionAN ALTER...
Utilisation of tax losses by investors (current) Tax losses are carried forward and investors don’t pay tax for a number ...
$0$5$10$15Utilisation of tax losses by investors (proposal) Tax losses become claimable immediately by investors to offse...
Net positive for tax revenues Reduces funding gaps Allows some marginal projects to proceed with private financing Cons...
Recent project failures have led some to proclaim that the traditional demand-risk based PPP model is nolonger acceptableS...
Despite these claims and the challenging market conditions, patronage-risk deals are still being completedboth globally an...
Overview HighlightsMIDTOWN TUNNEL CASE STUDYFinancial Close April 2012Deal Size (USD) $2,092mTotal Debt (USD) $1,097mConce...
Forecasting demand accurately, particularly during ramp-up, can be challenging• Li & Hensher (2010) found that actual firs...
Research shows that the forecast error – the difference between actual and forecast traffic – decreases overthe life of th...
Not all failed PPP projects have resulted in public bailouts• When the Cross City Tunnel became insolvent in Dec 2006,the ...
1. The patronage-risk PPP model is not obsolete• On the contrary, economic infrastructure PPPs continue to be required by ...
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Taking a fresh approach to transport infrastructure financing

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With governments reaching their borrowing capacity for big-ticket infrastructure, the need to examine alternative ways of funding transport projects is paramount to ensuring a productive and prosperous future for South Australia. Andrew Newman, Associate Director, Macquarie Capital explored techniques to encourage the private sector to further invest in infrastructure at the 2012 South Australia Transport Infrastructure Summit. For more information on the annual event, please visit the conference website http://goo.gl/tX8g5.

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Taking a fresh approach to transport infrastructure financing

  1. 1. MACQUARIE CAPITALSOUTH AUSTRALIA TRANSPORT 2012June 2012
  2. 2. AGENDA1 STATE OF PLAY2 POSSIBLE SOLUTIONS3 IS DEMAND RISK MODEL DEAD?
  3. 3. Projects impacted by political constraintsSTATE OF PLAY – BALANCE SHEETCONSTRAINTSMantra Debt reduction Budget surplusRealityDowngraded toAA+ post budgetState 50% net debtmetric under threatSource: South Australia Budget Paper 2012 – 2013, S&P Credit Rating Report October 201150%60%70%80%90%100%110%120%130%140%0100020003000400050006000700080009000100002011A 2012A 2013F 2014F 2015F 2016FNetFinancialLiabilitiestorevenue(%)NetDebt($m)Net Debt S&P Credit Rating Limit Net FinancialLiabilitiesto Revenue
  4. 4. Large backlog of projectsOutcome: absent changes, needed projects are not getting done Various estimates of national infrastructure spending requirements exist— $770 billion to 2018 (Citigroup, June 2008)— $455 billion over the next decade (ABN AMRO, May 2008) Gap between infrastructure supply and demand exists across most asset classes,including road, electricity, gas, water and rail1 Backlog growing New financing structures required to incentives private sector involvementSTATE OF PLAY – CONCLUSION1. See Infrastructure Australia, ‘Infrastructure Finance Reform’ (Issues Paper), July 2011
  5. 5. Short term hump or long term trend? Public debt rebalancing is a global issue and will take significant timeLOOKING TO THE FUTUREGovernment net debt forecast 2011-15 (% of GDP)Source: Commonwealth Government, MYEFO 2010-11; IMF, ‘Fiscal Monitor’, April 20110%40%80%120%160%Australia Canada Germany US UK France Italy Japan
  6. 6. Not a shortage of capital, but a shortage of projects Superannuation industry has $1.4 trillion of assets under management1 Forecast to increase to $5 trillion over the next 15 years2 Need a transparent pipeline of infrastructure investments to promote efficient projectdeliveryLOOKING TO THE FUTURE1. APRA, ‘Statistics: Quarterly Superannuation Performance’, March 20112. Association of Superannuation Funds of Australia, ‘Challenges of Financing Infrastructure’ (ASFA Paper), May 2011
  7. 7. Productivity and competitiveness under threat Productivity has plateaued and is beginning to decline Poor / weak productivity growth by international standards Australia exposed post resources boomIMPLICATIONS FOR AUSTRALIAMultifactor productivity indexSource: ABS, ‘Measures of Australia’s Progress’, 2010; OECD,‘Compendium of Productivity Indicators’, 2008Average multifactor productivity growth (2001-06)-1%0%1%2%3%SwedenIrelandJapanBelgiumFinlandUSUKFranceGermanyAustraliaNetherlandsDenmarkAustriaCanadaPortugalSpainNewZealandSwitzerlandItaly7080901001101992 1994 1996 1998 2000 2002 2004 2006 2008 2010
  8. 8. Perceptions of infrastructure investment Alternative – redeploy government capital from existing assets to new assets Political challenges in arguing these cases Possible additional solution to address political issues…POSSIBLE SOLUTIONSINFRASTRUCTURE=INVESTMENTINFRASTRUCTURE≠DEBT
  9. 9. -$60-$40-$20$0$20$40$60Tax losses Infrastructure projects typically generate large tax losses during constructionAN ALTERNATIVE SOLUTIONAnnual income for tax purposes (rebased to $100 of equity)Construction Operations
  10. 10. Utilisation of tax losses by investors (current) Tax losses are carried forward and investors don’t pay tax for a number of yearsAN ALTERNATIVE SOLUTION1. Assumes marginal tax rate of 15% for investors (eg super funds)$0$5$10$15Annual tax paid (rebased to $100 of equity)1
  11. 11. $0$5$10$15Utilisation of tax losses by investors (proposal) Tax losses become claimable immediately by investors to offset other income Timing benefit worth 15 - 25% of equity requirement depending on marginal tax ratesAN ALTERNATIVE SOLUTIONAnnual tax paid (rebased to $100 of equity)ConstructionTax creditsclaimedimmediatelyby investors11. Assumes top marginal tax rate of 46.5% for investors during construction2. Assumes marginal tax rate of 15% for investors during operationsEarly operationsTax losses have been used tax paid by investors2Late operationsNo difference as tax would be payable under both cases2
  12. 12. Net positive for tax revenues Reduces funding gaps Allows some marginal projects to proceed with private financing Construction and operations of the new projects will generate incremental taxrevenues (income, payroll, GST)For $100 equity, p.a. Construction period Early operations period Late operations periodInvestor tax Foregone revenue fromtax credits ~$151~$3 tax paid by investors astax credits have been used3No change once timingbenefit is exhaustedAdditional taxrevenues~$100 D&C spend ~$25 of tax revenue2~$20 O&M spend ~$5 of tax revenue2~$20 O&M spend ~$5 of tax revenue2Net revenue4 + ~$10 + ~$8 + ~$5AN ALTERNATIVE SOLUTION1. Assumes top marginal tax rate of 46.5% for investors during construction2. Assumes 25% average tax rate from incremental infrastructure spending3. Assumes marginal tax rate of 15% for investors during operations4. Benefits exclude multiplier effect of infrastructure investment
  13. 13. Recent project failures have led some to proclaim that the traditional demand-risk based PPP model is nolonger acceptableSTATEMENT: THE DEMAND-RISK PPP MODEL ISDEAD“The PPP toll road model is dead... the extent of risktransfer and because the unending stream of extra demandsplaced on concessionaires have made roads so expensivemotorists won’t use them.”Construction Industry Executive“Governments have been greedy... and this has contributedto the financial collapse of projects such as Sydney’s LaneCove Tunnel... There isn’t a one-size-fits-all template”Government Official“Over time, patronage models have become more complex,sophisticated and more expensive... Currently, the privatesector will not willingly accept greenfield patronageforecasting risk.”Construction Industry Group• The financial failures of high-profile PPP projects (e.g. LaneCove / Cross City Tunnels in NSW, CLEM7 tunnel in QLD)have led many investors to become highly sceptical• Bidders with the most aggressive assumptions werepreviously selected by the government to win bids, which ledthe market to respond with increasingly biased forecasts oftraffic• Critics argue that PPP bids fundamentally rest onquestionable ramp-up curves, initial patronage and a host ofother expansion factors which are subject to significantoptimism bias
  14. 14. Despite these claims and the challenging market conditions, patronage-risk deals are still being completedboth globally and in AustraliaSource: Queensland Health, RF Annual Privatisation Report 2011, French Ministre de lÉquipement, Virginia Department of TransportationREALITY: PATRONAGE DEALS ARE STILL BEINGDONECountryYear ofFinancialClose ProjectInfrastructuretypeConcessionlength Enterprise valueAustralia 2010 Gold Coast University Hospital Car Park Car park 30 years ~A$80mAustralia 2011 Queen Elizabeth II Medical Center Car Park Car Park 26 years ~A$100mAustralia Pending Sunshine Coast University Hospital Car Park Car park 25 years TBDArgentina 2011 Corredor Vial del Atlantico Toll road 30 years US$1.9bnBrazil 2011 Rio de Janeiro – Bahia highway Toll road 25 years US$1.14bnChile 2011 Autopistas de la Region de Antofagasta Toll road 35 years US$320mFrance 2011 Tours-Bordeaux High Speed Rail Rail 50 years €7.8bnItaly 2010 Milan East Ring Road Toll road 50 years €2.0nUnited States 2009 North Tarrant Tunnel Toll road 52 years US$2.0bnUnited States 2010 LBJ Managed Lanes Toll road 52 years US$2.78bnUnited States 2011 Virginia Midtown Tunnel construction and Downtown Tunnel renovation Toll road 58 years US$1.47bn
  15. 15. Overview HighlightsMIDTOWN TUNNEL CASE STUDYFinancial Close April 2012Deal Size (USD) $2,092mTotal Debt (USD) $1,097mConcession Type Design, Build, Finance, Operate & TollConcession Period 58 yearsConcessionaire Elizabeth River Crossings Opco, LLCExpected ConstructionCompletionDecember 2016Value $675mRatings S&P BBB-; Fitch BBB-Coupon 4.45% - 5.50% paAll-in yield 5.47% paAmortisation 2022-2042Public Activity BondsMarket appetite for pure demand risk projects, both for debt and equity, remain strong• The Midtown Tunnel project was a PPP concession for thedesign, build, finance, operation, maintenance and tolling oftwo crossings of the Elizabeth River between Portsmouth andNorfolk, Virginia.• The consortium ran a multi-source debt process whichincluded banks and Public-Activity-Bonds (PABs)• Project represents the largest capital markets issue for aprivate US toll road since GFC• PABs were over-subscribed 4X, enabling underwriters totighten final pricing to an all-in rate of 100bps below thebenchmark infrastructure project borrowing rate
  16. 16. Forecasting demand accurately, particularly during ramp-up, can be challenging• Li & Hensher (2010) found that actual first-year traffic for thelast five Australian toll road projects were, on average, 45%below bid forecasts• A similar international study by Standard & Poor’s (2004) of 87European and Australasian toll roads reported a similarover-estimation of 20-30%STATEMENT: FORECASTING INITIAL PATRONAGEIS IMPOSSIBLEYear 1 traffic forecasting performanceToll Road Error (%)M2 (32.8%)M7 (51.8%)Cross City Tunnel (51.1%)Lane Cove Tunnel (37.0%)Eastlink (45.0%)Source: Li & Hensher (2010)
  17. 17. Research shows that the forecast error – the difference between actual and forecast traffic – decreases overthe life of the assetREALITY: ACTUAL TRAFFIC TENDS TOCONVERGE TO FORECAST TRAFFIC OVER TIMEActual versus forecast traffic (AADT) for CityLinkOverview4505005506006507007502001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011AverageAnnualDailyTransactions(000sAADT)Actual traffic Forecast TrafficSource: Transurban• Li & Hensher (2010) found that the forecast error decreasesby 2.5 percentage points per annum• The Year 1 forecasting error for the M2 was-32.8% in 1998, but ten years later in 2007, the actuallevel of traffic was almost exactly the same as the initialforecasts• The Year 1 forecasting error for Eastlink was -45.0% in2008, but 3 years later in 2011, the forecasting error haddecreased to -28.0%.• Similar results are reported both globally and in the UnitedStates (US Transportation Research Board, 2006; Vasallo,2007; Phibbs, 2007)
  18. 18. Not all failed PPP projects have resulted in public bailouts• When the Cross City Tunnel became insolvent in Dec 2006,the NSW Government was not required to provide financialassistance• Instead, the tollway was subsequently sold to a syndicate,with the original equity investors realising considerablefinancial losses• This example demonstrate that the risk transfer mechanism isefficient, with the private sector bearing the project risks inreturn for the rewards• Various structures exist which can rebalance the riskallocation between the private and public sectorREALITY: VARIOUS STRUCTURES EXIST WHICH CANMITIGATE RISK OF FAILURE IN ECONOMIC PPPSVariable concession length• Private sector bids a fixed level of tolls and the governmentadjusts the concession length to allow a reasonable return onfacility construction costs, taking into account traffic levelsPublic Sector Development Company• Government takes responsibility for projects duringdevelopment and refinances with private sector capital afterrevenues have stabilised• Previously used by QLD Government to fund Gateway BridgeUpgradeDownside protection and upside capping• Government provides downside protection in the event of trafficunderperformance but caps the possible upside in the event oftraffic outperforming forecasts
  19. 19. 1. The patronage-risk PPP model is not obsolete• On the contrary, economic infrastructure PPPs continue to be required by governments to fund infrastructuredevelopment2. Forecasting initial patronage will always be challenging, however:• Where traffic has initially underperformed, in most instances, actual traffic has converged to forecast levels afterdemand ramp-up and infrastructure establishment has occurred• Structures exist to mitigate the risk of poor revenue modelling3. Myriad opportunities exist for the government to collaborate with the private sector to deliver and meet the nation’sinfrastructure funding requirementsCONCLUSION
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