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INFRASTRUCTURE INVESTOR

INFRASTRUCTURE VALUATION

A guide to the valuation of privately held infrastructure equity and debt

By Frederic Blanc-Brude and Majid Hasan EDHEC.:Risk Institute

Contents

Figures and tables

About the authors

1 lntroduction 1.1 Why infrastructure? 1.2 The demand for benchmarks 1.3 A roadmap 1.4 This book

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PART 1: UNDERSTANDING PRIVATELY HELD INFRASTRUCTURE INVESTMENTS

2 The nature of investable infrastructure 11 2.1 Existence of investable infrastructure 11 2.2 The role of long-term contracts 11 2.3 The role of commitment 13 2.4 The contractual nature of underlying infrastructure investments 13 2.5 Creating and regulating investable infrastructure 15 2.6 Monopoly privatisation and regulation 16 2.7 Project finance and corporate governance 18 2.8 Conclusion: lnfrastructure assets are not real assets 19

3 lnfrastructure project financing 21 3.1 Investment delegation and project financing 21 3.2 Definition 22 3.3 Agency and monitoring in project finance 27 3.4 A response to the long-term investment problem 32 3.5 Project financing as risk optimisation 33 3.6 Conclusion: lnfrastructure project finance as a reference asset 35

4 Risk and the cost of capital in infrastructure projects 37 4.1 Construction risk 38 4.2 Leverage 40 4.3 Revenue risk 42 4.4 Contract renegotiation 43 4.5 Political risk 45 4.6 Conclusion: Systematic sources of risk in project finance 47

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Contents

PART II: ISSUES WITH LONG-TERM INVESTMENT PERFORMANCE MEASURES

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Benchmarking infrastructure investments: Objectives and challenges 5.1 Why benchmark infrastructure investments?

5.2 Two challenges

Addressing the challenges of long-term investment benchmarking 6.1 Bayesian inference for long-term investment benchmarking 6.2 Towards intersubjective pricing measures 6.3 Families of generic infrastructure projects

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PART III: MEASURING THE PERFORMANCE OF INFRASTRUCTURE PROJECT DEBT

7 Objectives and characteristics of infrastructure project debt 73

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7.1 Objectives 74 7.2 Defining infrastructure debt 74 7.3 Observable asset values 75 7.4 Covenants and embedded options 7.5 ldentifying default triggers 7 .6 Reorganisations 7. 7 llliquidity and lumpiness 7 .8 Documented performance 7.9 Conclusion

Approaching the valuation of infrastructure debt 8.1 Asset-pricing models 8.2 Corporate debt valuation models 8.3 Proposed approach 8.4 Conclusion

Valuation framework 9.1 Intuition 9.2 Cash flow dynamics 9.3 Structural framework

Debt restructuring model 10.1 Restructuring upon a technical default 10.2 Restructuring upon a hard default

Model implementation 11.1 Cash flow model 11.2 Risk-neutral measure

11.3 Debt rescheduling upon default

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Contents

11 .4 Algorithm 11.5 Results

PART IV: VALUING EQUITY INVESTMENTS IN INFRASTRUCTURE PROJECTS

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Objectives and approaches 12.1 Objectives 12.2 Existing approaches to private equity valuation 12.3 Proposed approach

Expected dividend model 13.1 A Bayesian framework 13.2 Cash flow metrics and risk measures 13.3 Dividend state transitions 13.4 (Conditional) dividend payment distribution 13.5 Prior elicitation

Valuation framework 14.1 Modern asset-pricing theory 14.2 A state-space framework

Observation (pricing) equation 15.1 Pricing equation 15.2 Matrix formulation 15.3 Observation equation

State (discounting) equation 16.1 Term structure model 16.2 Matrix formulation 16.3 State equation

Filtering of the term structure 17 .1 State-space model 17.2 Filtering and updating 17 .3 Parameter estimation 17.4 Model outputs 17.5 Conclusion

Model implementation 18.1 Prior elicitation 18.2 Equity cash flow projections 18.3 Results 18.4 Return measures 18.5 Risk measures 18.6 Market dynamics 18. 7 Sensitivity to conditional dividend volatility estimates

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Contents

PART V: CONCLUSIONS

19 Conclusions 19.1 Key points 19.2 Data collection and standardisation 19.3 Next steps

PART VI: TECHNICAL APPENDICES

A Debt valuation A.1 Risk-neutral measure A.2 Risk measures A.3 Return measures

B Equity valuation B.1 Cash-flow metrics B.2 Bayesian estimates B.3 Pricing equation

Bibliography

About PEI

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