MACQUARIE CAPITALSOUTH AUSTRALIA TRANSPORT 2012
June 2012
AGENDA1 STATE OF PLAY2 POSSIBLE SOLUTIONS3 IS DEMAND RISK MODEL DEAD?
Projects impacted by political constraints
STATE OF PLAY – BALANCE SHEET
CONSTRAINTS
Mantra Debt reduction Budget surplus
RealityDowngraded to
AA+ post budget
State 50% net debt
metric under threat
Source: South Australia Budget Paper 2012 – 2013, S&P Credit Rating Report October 2011
50%
60%
70%
80%
90%
100%
110%
120%
130%
140%
0
1000
2000
3000
4000
5000
6000
7000
8000
9000
10000
2011A 2012A 2013F 2014F 2015F 2016F
Net F
inan
cia
l Lia
bilitie
s to re
venue (%
)
Net D
ebt (
$m
)
Net Debt S&P Credit Rating Limit Net Financial Liabilities to Revenue
Large backlog of projects
Outcome: 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 involvement
STATE OF PLAY – CONCLUSION
1. See Infrastructure Australia, ‘Infrastructure Finance Reform’ (Issues Paper), July 2011
Short term hump or long term trend?
Public debt rebalancing is a global issue and will take significant time
LOOKING TO THE FUTURE
Government net debt forecast 2011-15 (% of GDP)
Source: Commonwealth Government, MYEFO 2010-11; IMF, ‘Fiscal Monitor’, April 2011
0%
40%
80%
120%
160%
Australia Canada Germany US UK France Italy Japan
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 project
delivery
LOOKING TO THE FUTURE
1. APRA, ‘Statistics: Quarterly Superannuation Performance’, March 2011
2. Association of Superannuation Funds of Australia, ‘Challenges of Financing Infrastructure’ (ASFA Paper), May 2011
Productivity and competitiveness under threat
Productivity has plateaued and is beginning to decline
Poor / weak productivity growth by international standards
Australia exposed post resources boom
IMPLICATIONS FOR AUSTRALIA
Multifactor productivity index
Source: ABS, ‘Measures of Australia’s Progress’, 2010; OECD,
‘Compendium of Productivity Indicators’, 2008
Average multifactor productivity growth (2001-06)
-1%
0%
1%
2%
3%
Sw
ed
en
Ire
lan
d
Ja
pa
n
Belg
ium
Fin
lan
d
US
UK
Fra
nc
e
Ge
rma
ny
Au
str
ali
a
Neth
erl
an
ds
Den
ma
rk
Au
str
ia
Ca
na
da
Po
rtu
ga
l
Sp
ain
New
Ze
ala
nd
Sw
itze
rla
nd
Ita
ly
70
80
90
100
110
1992 1994 1996 1998 2000 2002 2004 2006 2008 2010
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 SOLUTIONS
INFRASTRUCTURE
=
INVESTMENT
INFRASTRUCTURE
≠
DEBT
-$60
-$40
-$20
$0
$20
$40
$60
Tax losses
Infrastructure projects typically generate large tax losses during construction
AN ALTERNATIVE SOLUTION
Annual income for tax purposes (rebased to $100 of equity)
Construction Operations
Utilisation of tax losses by investors (current)
Tax losses are carried forward and investors don’t pay tax for a number of years
AN ALTERNATIVE SOLUTION
1. Assumes marginal tax rate of 15% for investors (eg super funds)
$0
$5
$10
$15
Annual tax paid (rebased to $100 of equity)1
$0
$5
$10
$15
Utilisation 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 rates
AN ALTERNATIVE SOLUTION
Annual tax paid (rebased to $100 of equity)
Construction
Tax credits
claimed
immediately
by investors1
1. Assumes top marginal tax rate of 46.5% for investors during construction
2. Assumes marginal tax rate of 15% for investors during operations
Early operations
Tax losses have been used
tax paid by investors2
Late operations
No difference as tax would be payable under both cases2
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 tax
revenues (income, payroll, GST)
For $100 equity, p.a. Construction period Early operations period Late operations period
Investor tax Foregone revenue from
tax credits ~$151
~$3 tax paid by investors as
tax credits have been used3
No change once timing
benefit is exhausted
Additional tax
revenues
~$100 D&C spend
~$25 of tax revenue2
~$20 O&M spend
~$5 of tax revenue2
~$20 O&M spend
~$5 of tax revenue2
Net revenue4 + ~$10 + ~$8 + ~$5
AN ALTERNATIVE SOLUTION
1. Assumes top marginal tax rate of 46.5% for investors during construction
2. Assumes 25% average tax rate from incremental infrastructure spending
3. Assumes marginal tax rate of 15% for investors during operations
4. Benefits exclude multiplier effect of infrastructure investment
Recent project failures have led some to proclaim that the traditional demand-risk based PPP model is no
longer acceptable
STATEMENT: THE DEMAND-RISK PPP MODEL IS
DEAD
“The PPP toll road model is dead... the extent of risk
transfer and because the unending stream of extra demands
placed on concessionaires have made roads so expensive
motorists won’t use them.”
Construction Industry Executive
“Governments have been greedy... and this has contributed
to the financial collapse of projects such as Sydney’s Lane
Cove 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 private
sector will not willingly accept greenfield patronage
forecasting risk.”
Construction Industry Group
• The financial failures of high-profile PPP projects (e.g. Lane
Cove / Cross City Tunnels in NSW, CLEM7 tunnel in QLD)
have led many investors to become highly sceptical
• Bidders with the most aggressive assumptions were
previously selected by the government to win bids, which led
the market to respond with increasingly biased forecasts of
traffic
• Critics argue that PPP bids fundamentally rest on
questionable ramp-up curves, initial patronage and a host of
other expansion factors which are subject to significant
optimism bias
Despite these claims and the challenging market conditions, patronage-risk deals are still being completed
both globally and in Australia
Source: Queensland Health, RF Annual Privatisation Report 2011, French Ministre de l'Équipement, Virginia Department of Transportation
REALITY: PATRONAGE DEALS ARE STILL BEING
DONE
Country
Year of
Financial
Close Project
Infrastructure
type
Concession
length Enterprise value
Australia 2010 Gold Coast University Hospital Car Park Car park 30 years ~A$80m
Australia 2011 Queen Elizabeth II Medical Center Car Park Car Park 26 years ~A$100m
Australia Pending Sunshine Coast University Hospital Car Park Car park 25 years TBD
Argentina 2011 Corredor Vial del Atlantico Toll road 30 years US$1.9bn
Brazil 2011 Rio de Janeiro – Bahia highway Toll road 25 years US$1.14bn
Chile 2011 Autopistas de la Region de Antofagasta Toll road 35 years US$320m
France 2011 Tours-Bordeaux High Speed Rail Rail 50 years €7.8bn
Italy 2010 Milan East Ring Road Toll road 50 years €2.0n
United States 2009 North Tarrant Tunnel Toll road 52 years US$2.0bn
United States 2010 LBJ Managed Lanes Toll road 52 years US$2.78bn
United States 2011 Virginia Midtown Tunnel construction and Downtown Tunnel renovation Toll road 58 years US$1.47bn
Overview Highlights
MIDTOWN TUNNEL CASE STUDY
Financial Close April 2012
Deal Size (USD) $2,092m
Total Debt (USD) $1,097m
Concession Type Design, Build, Finance, Operate & Toll
Concession Period 58 years
Concessionaire Elizabeth River Crossings Opco, LLC
Expected Construction
Completion
December 2016
Value $675m
Ratings S&P BBB-; Fitch BBB-
Coupon 4.45% - 5.50% pa
All-in yield 5.47% pa
Amortisation 2022-2042
Public Activity Bonds
Market appetite for pure demand risk projects, both for debt and equity, remain strong
• The Midtown Tunnel project was a PPP concession for the
design, build, finance, operation, maintenance and tolling of
two crossings of the Elizabeth River between Portsmouth and
Norfolk, Virginia.
• The consortium ran a multi-source debt process which
included banks and Public-Activity-Bonds (PABs)
• Project represents the largest capital markets issue for a
private US toll road since GFC
• PABs were over-subscribed 4X, enabling underwriters to
tighten final pricing to an all-in rate of 100bps below the
benchmark infrastructure project borrowing rate
Forecasting demand accurately, particularly during ramp-up, can be challenging
• Li & Hensher (2010) found that actual first-year traffic for the
last five Australian toll road projects were, on average, 45%
below bid forecasts
• A similar international study by Standard & Poor’s (2004) of 87
European and Australasian toll roads reported a similar
over-estimation of 20-30%
STATEMENT: FORECASTING INITIAL PATRONAGE
IS IMPOSSIBLE
Year 1 traffic forecasting performance
Toll 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)
Research shows that the forecast error – the difference between actual and forecast traffic – decreases over
the life of the asset
REALITY: ACTUAL TRAFFIC TENDS TO
CONVERGE TO FORECAST TRAFFIC OVER TIME
Actual versus forecast traffic (AADT) for CityLinkOverview
450
500
550
600
650
700
750
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Avera
ge A
nnual D
aily
Tra
nsactio
ns (
000's
A
AD
T)
Actual traffic Forecast Traffic
Source: Transurban
• Li & Hensher (2010) found that the forecast error decreases
by 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 actual
level of traffic was almost exactly the same as the initial
forecasts
• The Year 1 forecasting error for Eastlink was -45.0% in
2008, but 3 years later in 2011, the forecasting error had
decreased to -28.0%.
• Similar results are reported both globally and in the United
States (US Transportation Research Board, 2006; Vasallo,
2007; Phibbs, 2007)
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 financial
assistance
• Instead, the tollway was subsequently sold to a syndicate,
with the original equity investors realising considerable
financial losses
• This example demonstrate that the risk transfer mechanism is
efficient, with the private sector bearing the project risks in
return for the rewards
• Various structures exist which can rebalance the risk
allocation between the private and public sector
REALITY: VARIOUS STRUCTURES EXIST WHICH CAN
MITIGATE RISK OF FAILURE IN ECONOMIC PPPS
Variable concession length
• Private sector bids a fixed level of tolls and the government
adjusts the concession length to allow a reasonable return on
facility construction costs, taking into account traffic levels
Public Sector Development Company
• Government takes responsibility for projects during
development and refinances with private sector capital after
revenues have stabilised
• Previously used by QLD Government to fund Gateway Bridge
Upgrade
Downside protection and upside capping
• Government provides downside protection in the event of traffic
underperformance but caps the possible upside in the event of
traffic outperforming forecasts
1. The patronage-risk PPP model is not obsolete
• On the contrary, economic infrastructure PPPs continue to be required by governments to fund infrastructure
development
2. Forecasting initial patronage will always be challenging, however:
• Where traffic has initially underperformed, in most instances, actual traffic has converged to forecast levels after
demand ramp-up and infrastructure establishment has occurred
• Structures exist to mitigate the risk of poor revenue modelling
3. Myriad opportunities exist for the government to collaborate with the private sector to deliver and meet the nation’s
infrastructure funding requirements
CONCLUSION