public private partnership/concession model a fad or a wave of the future california municipal...

Public Private Partnership/Concession ModelA Fad or a Wave of the Future

California Municipal Treasurer's Association

April 27, 2006

I. Public Private Partnerships: An Alternative Source of Capital

California Municipal Treasurer's Association 3

Public-Private Partnerships can provide a new source of capital for State and Local Governments.

New Option

Public-Private Partnership

Can be structured to minimize impacts on customers and/or sponsors

More capital for given project (debt and equity)

Operating risk shifted to private party

A long-term agreement under which a private firm designs, builds, manages and/or operates a publicly-owned asset

Historical Option

Issue tax-exempt bonds

Traditionally allows conservative amount of debt to fund projects

Perceived financial obligation of sponsoring entities


An increasing number of State and Local Governments are utilizing Public-Private Partnerships for their financing needs.

The $3.85 Bn Indiana Toll Road and $1.83 Bn Chicago Skyway transactions have created an increased focus on alternative infrastructure investment strategies

Goldman Sachs has had dialogue with key decision makers on P3

Oregon

Evaluating private concessions on three separate greenfield

projects

Texas

Trans Texas Corridor Project; Six 50-yearconcessions for greenfield projects

Harris County considering private Concession sale of its Toll Road System

Utah

P3 Legislation in place

Colorado

Evaluating P3 opportunities for future toll roads

Illinois

Concession sale of Chicago Skyway for $1.83 Bn

Indiana

Sale of a Concession in Indiana Toll Road with

outstanding bid of $3.85 Bn

New York

P3 Legislation in process

Delaware


Potential sale of State Route 1, Route 301 & I-95

Virginia

Dulles Toll Road Concession

Capital Beltway HOT Lanes

Pocahantas Parkway concession

North Carolina


South Carolina


New Jersey

P3 Legislation in process

Potential Concession sale of the NJ Turnpike and Garden State Parkway

California

New P3 Legislation being considered

BART OAC Project


Public-Private Partnerships are very common in Europe and Asia.European PPP Activity

Austria

Belgium

Denmark

Finland

France

Germany

Greece

Ireland

Italy

Netherlands

Norway

Portugal

Spain

Sweden

UK

China

Hong Kong

Japan

South Korea

Water & Waterway (incl. Solid Waste)

Light RailwayPortsAirports Roads

Asian PPP Activity


The emerging infrastructure market offers an alternative source of funds via the equity capital of insurance and pension funds.

Transportation Toll Roads Airports Ports

Regulated Utilities Electricity Gas Water

Government Infrastructure Schools Hospitals Prisons

$152 Bn80% Debt

$37 Bn 20% Equity

Essential social infrastructure Insulation from business cycle Natural inflation hedge Ability to support high leverage

Steady, predictable, low-risk cash flows to matchlong-dated insurance and pension liabilities

Investment Characteristics Recent US Infrastructure Activity

Target Infrastructure Sectors Leveraged Equity Investment

Total Buying Power:

$189 Billion

Potential Existing Asset LeasesPotential Greenfield ProjectsCompleted P3 Transactions


Relative to real estate, an asset class with similar investment characteristics, infrastructure is undervalued.

Commercial Real Estate Cash Flow Characteristics

Exposure to over development

Valuation compared to replacement cost (suburban office, retail)

Exposure to supply demand characteristics of real estate - weakness in net effective rents with vacancy rates above 7%-8%

Real estate assets discounted with long-term DCF, five year exit assumes growth in perpetuity of limited life asset

Valuation Differences in Infrastructure

Infrastructure valued over long time period, with realistic capital expenditure assumption

Returns calculated over long life, return is driven by long-term refinancing and dividend capacity

Finite life of concessions 25 to 100 years, similar to a ground lease

0

1

2

3

4

5

6

7

8

9

10

4x 6x 8x 10x 12x 14x 16x 18x 20x 22x 24x

EV/EBITDA

Ear

nin

gs

Pre

dic

tab

ilit

y

Hig

hM

ediu

m

Infrastructure Assets

Real Estate Assets

European Toll Roads

European Ports

European Airports

European Regulated

Utilities

European Properties

US Reits (Apartments)

US Reits(Office Properties)

US Reits(Shopping Centres)

Source: Goldman Sachs estimates


The United States market represents an area of potential growth for infrastructure investors.

(a) Based on a GDP multiplier vs. Europe of 1.7xSource: Goldman Sachs estimates

EV = €170 – 250bn EV = €50 – 100bn EV = €500bn

EV = $300 – 400bn(a) EV = $75 – 125bn EV = $400bn

Toll Roads Regulated UtilitiesAirports

Europe

Private Sector 2%

Government 98%

Government 100% Private

Sector 90%

Government 10%

Government 21%

Private Sector 37%

Future Privatisation

(e.g. UK, Germany)

42%

Future Privatisation

28%Private Sector 43%

Government 29%

Private Sector 45%

Government 55%

United States


The profile of a typical infrastructure investment is significantly different from a traditional private equity investment.

Discounted cash flow and exit Five year forecast Exit assumption tested based on exit

alternatives, IPO or trade sale – critical to return Transactions often driven by operating

improvements, performance Cost reductions, synergies, turn-around

strategies Add on acquisitions, roll-ups, consolidation

plays Financing through conventional bank and

mezzanine or high yield markets Relatively short-term bank debt Amortizing debt Mezzanine or high yield paper increases

leverage Second lien paper or lower cost mezzanine

increase exit flexibility Target returns of 20+% IRRs Tax optimization critical

Discounted cash flow and exit Long term (ten year plus) forecast of cash flow/

dividend yield No exit assumed/desired by institutional investors or

listed funds – critical to return Operating improvements are often mild and relatively

straightforward Regulated assets return operating improvements

every five years Most assets are simple in operation (increasing

electronic tolling, cost reduction, yield management) Financing is long-term and investment grade

Tremendous value created through financing “Mini-perm” to long-term Bullet structures Dividend flexibility

Tenor of financing hedges risk of changes in real rates

Target high single-digit to mid-teens long-term returns More similar to long-term mezzanine – no prepayment

risk Returns very sensitive to changes in inflation

Tax optimization critical

Traditional Private EquityInfrastructure Investment

II. Concession Agreements Overview


1

What is a Private Operator Concession Agreement?

Concession Agreement – A legal document that evidences a long-term lease of a public asset by a private operator.

Public Body Retains Private Operator Accepts

Up-front Payment by Private Operator

Oversight of Operations and Rate Setting Methodology

Rights to mandate operating performance under the agreement

Rights to expand/enhance asset beyond those specified in agreement

Right to cancel agreement if Private Operator doesn’t perform

All operating responsibilities and costs

Construction duties and related construction risk

Requirements to expand/enhance the asset and related costs

Reporting responsibilities to public body

Asset’s revenues throughout life of agreement; return asset in original condition at end of lease


2

Public policy shapes the form of the concession.

ConsiderationsPolicy Decision

Manual of specific operation conditions and rules to which a concession partner must adhere

Description

Operating and Maintenance Standards

What are operating and maintenance conditions that are most important?

Potential compensation if future development causes competition issues.

Non-Compete Is this good public policy? What are future capital plans that could have

an impact if any?

Responsibility for law enforcement Enforcement

Toll limits can be mandated in Concession Agreement

Tolls Public appetite for future increases What is the elasticity of demand?

Length of time that a concession partner will be allowed to lease and operate the road

Length of Concession What is political sensitivity to length of concession?

What is value of incremental term length?

Status of existing employees Conditions for new concession company

employees

Labor Will the concessionaire be held to the State’s employment standards?

How is police force currently compensated for existing duties?

Responsibility for existing potential environmental liabilities (if any)

Environmental Are there any known environmental liabilities?

Will the State allow or mandate future expansion / enhancements

Expansion / Enhancements What enhancements are necessary Future expansion if capacity constrained

Capacity constraints if any and other requirements

Materials and methods

Construction Requirements Allowance for phasing could enhance feasibility

What construction factors are important?


3

Key Policy Considerations and Questions for Public-Private Partnerships

The Franchise/Concession Agreement provides governmental control over tolls/pricing, operating standards and other key parameters.

After some opportunities to cure the problems, the government can take back the asset and keep the up-front payment.

Huge pools of pension fund and other investor monies are being allocated to the infrastructure space.

Low equity return hurdles, interest expense tax shields and depreciation benefits, create a cost of capital which is competitive with municipal bonds.

Do we lose control?

What if the private operator doesn’t perform?

Why is there demand for these assets now?

Isn’t it a higher cost of capital than tax-exempt debt?

AnswerQuestion


4

Concession Agreements offer an alternative to finance projects.

Strategy Description

1) Public Ownership Traditional toll/revenue system – design, construction, O&M, governance, etc. remain with the State

Same as above except certain activities may be contracted for – i.e., design / construction, etc.

2) Public Ownership / Private Contracting

All activities, including the setting of rates, are controlled by a private entity

4) Private Ownership

The State “owns” facilities and maintains governance, enters into lease agreement with a private entity that is responsible for operations, maintenance, construction

3) Concession AgreementStrategies 2-4 are variations

of PPP alternatives


5

A transfer of risk and use of private equity for the Local Governments can be achieved via a well-structuredConcession Agreement.

Transfer of Design/

Build/Other Risk

Private Equity

Transfer of

Revenue Risk

3) Concession Agreement

4) Private Ownership

1) Public Ownership

2) Public Ownership/Private Outsourcing

= Yes = Partial = No

Public Control

= >Partial


6

Impact on ValueValue Driver Examples

Future Revenue Growth Rate/Price Increases Variable Pricing Volume Increases Potential for Asset Expansion Increase Use of Electronic

Tolling/Billing

Rate increases provide visibility into future cash flows Time of day pricing adjustments can improve volume flow Increased volume drives growth without raising rates Increased capacity generates more volume Increases price/demand inelasticity

Longer Term of Concession

Shift Tax Benefits Extend Principal Amortization

Provide More Years of CashFlow to Concessionaire

Longer term allows greater flexibility for depreciation Allows for new debt to be amortized over additional

years, which adds value More years = increased up-front payment

Expense Reduction Worldwide Expertise Create Operating Efficiencies

Streamlined construction and other operational costs Streamlined operations can reduce operating costs

Concession Agreement structuring decisions will ultimately determine the price of an asset.

Capital Expenditures /Congestion Limits

Mandated Capital Expenditures Options to Expand Asset

Congestion Limits

Deduction for value received up front Ability to expand asset can enhance value by

increasing volume, but costs must be considered Overly restrictive limits on volume may trigger

unneeded capital expenditures and lower value

III. Concession Value Generation


8

Concession leases provide an opportunity to capture the “growth wedge” in volume and revenue increases.

Municipal bond investors rely on historical revenues to determine the leverage levels which constrains total value for the owner

Equity investors look for future returns based on growth

Debt + Equity = Greater Proceeds for Owner of Asset

Net Revenues

Municipal Bond Concession Sale

Today 40 yrsPast

Debt1.25-2.00x Coverage

99 yrs

Conservative Projections

Today 40 yrsPast 99 yrs

Equity InvestorDebt

Net Revenues

Conservative Projections

Chicago Skyway Example

$800 Million $1.83 Billion

Vs.


9

Despite a similar capital cost, a concession produces a higher value via more aggressive growth estimates.

Tax benefits, aggressive debt structures, and low interest rates have allowed Private Concessionaires to achieve an after-tax cost of capital similar to the tax-exempt rates.

However, when the Concessionaire establishes a capital structure, it bonds against a long-term Concession Agreement that unambiguously defines future toll increases.

Municipalities do not typically predefine multiple future toll increases and have minimal incentive to publish aggressive projections.

Indiana had not raised tolls since 1985 and Chicago Skyway had not raised tolls since 1993.

Municipal capital markets are cautious of future political risk (i.e., reversal of planned toll increases, failure to enact) necessitating conservative revenue projections and debt service coverage.

Tax-exempt arbitrage rules prevent borrowing unless proceeds can be spent within a set period of time.

On the other hand, Private Concessionaires have incentive to maximize revenues to create consistent or improving margins to validate large purchase prices.

Capital markets have greater confidence that for-profit operators will raise tolls at the pre-defined rate to meet investor expectations.

Unlike municipal entities that borrow to meet a set capital need, Private Concessionaires strive to optimize capital structure and maximize Equity IRR.

IV. Indiana Toll Road vs. Chicago Skyway


1

($Mn, unless otherwise noted)

OperationsYear Opened 1958 1956 – Skyway defaulted on tax-exempt debt in 1970s / ITR has steady historical growth

Road Length (in miles) 7.8 157.0 – Longer road necessitates more cap ex / higher operating budget

# of Toll Plazas 1 22 – ITR divided between ticket & barrier system

Number of Lanes 6 4 to 6 – Bridge widening difficult to accomplish on Skyway

Existing ETC (Y/N) N N – Concessionaire ability to increase throughput with ETC

Last Toll Increase 1993 1985 – Pre-deal toll rates below national median for both roads

Revenues (Yr Preceding Sale) $39.8 $87.7 – Skyway traffic fell due lane closures from Capital Improvement Program (CIP)

EBITDA (Yr Preceding Sale) $28.4 $60.6 – Skyway EBITDA Margin = 71% / ITR EBITDA Margin = 69%

10 Yr. Traffic CAGR 6.2% 3.0% – Urban concentration drives higher growth rate on Skyway

3 Yr. Avg. Capital Ex $95.0 $32.2 – Skyway completed $300 mn CIP prior to deal / ITR facing depleted reserve fund

% Commercial Traffic / Revenue 8% / 19% 18% / 58% – Significant long-haul truck traffic on ITR

% Passenger Traffic / Revenue 92% / 81% 82% / 42% – Work and vacation commuters drive traffic on Skyway

AADT 48,000 46,000 (a) – Western ITR traffic flows into Skyway / Eastern ITR traffic flows into rural Ohio

Employees 105 590 – Significant personnel infrastructure in ITR

Concession TermsPurchase Price $1,830.0 $3,850.0 – Skyway = 64.4x EBITDA / 46.0x Revenue; ITR = 63.5x EBITDA / 43.9x Revenue

Length of Concession (yrs) 99 75 – Both terms structured to exceed remaining useful life of road asset

Committed Cap Ex (1st 3 yrs) $60.2 $226.0 – ITR mandates accelerated completion of existing Toll Road projects

Congestion Management (Y/N) No Yes – ITR has lane widening targets that require expansion when reached

Proposed Toll Schedule (Y/N) Yes Yes – Skyway fixed increases until 2017; ITR fixed increases until 2010; Both allow annual increases = to greater of 2%, CPI or GDP per capita after fixed period

ProcessTime of Process (in days) 240 117 – ITR fastest concession sale process to date

Number of Qualified Bidders 5 10 – Indication that appetite for U.S. infrastructure assets is increasing

Number of Submitted Bids 3 4 – Binding bids backed by $75 mn LOC in ITR / $55 mn LOC in Skyway

Chicago Skyway vs. Indiana Toll Road ComparisonComparing the First Two U.S. Public-Private Partnership Transactions

Key Transaction Highlights Comments

(a) AADT for Western end of Indiana Toll Road; Eastern end AADT is 25,000

Goldman Sachs served as financial advisor to the government on both the Skyway and ITR transactions.


2

Table of Contents

Public Private Partnerships: An Alternative Source of Capital I

Concession Agreements Overview II

Concession Value Generation III

Indiana Toll Road vs. Chicago Skyway IV

Tab


3

Disclaimer

This material is not a product of the Fixed Income Research Department. It is not a research report and it should not be construed as such. All materials, including proposed terms and conditions, are indicative and for discussion purposes only. Finalized terms and conditions are subject to further discussion and negotiation and will be evidenced by a formal agreement. Opinions expressed are our present opinions only and are subject to change without further notice. The information contained herein is confidential. By accepting this information, the recipient agrees that it will, and it will cause its directors, partners, officers, employees and representatives to use the information only to evaluate its potential interest in the strategies described herein and for no other purpose and will not divulge any such information to any other party. Any reproduction of this information, in whole or in part, is prohibited. Except in so far as required to do so to comply with applicable law or regulation, express or implied, no warranty whatsoever, including but not limited to, warranties as to quality, accuracy, performance, timeliness, continued availability or completeness of any information contained herein is made. Opinions expressed herein are current opinions only as of the date indicated. Any historical price(s) or value(s) are also only as of the date indicated. We are under no obligation to update opinions or other information. The information contained herein has been prepared solely for informational purposes and is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or instrument or to participate in any trading strategy. The Goldman Sachs Group, Inc. does not provide accounting, tax or legal advice; however, you should be aware that any proposed indicative transaction could have accounting, tax, legal or other implications that should be discussed with your advisors and or counsel. The materials should not be relied upon for the maintenance of your books and records or for any tax, accounting, legal or other purposes. In addition, we mutually agree that, subject to applicable law, you may disclose any and all aspects of any potential transaction or structure described herein that are necessary to support any U.S. federal income tax benefits, without the Goldman Sachs Group, Inc. imposing any limitation of any kind. The Goldman Sachs Group, Inc. and affiliates, officers, directors, and employees, including persons involved in the preparation or issuance of this material, may from time to time have "long" or "short" positions in, and buy or sell, the securities, derivatives (including options) or other financial products thereof, of entities mentioned herein. In addition, the Goldman Sachs Group, Inc. and/or affiliates may have served as manager or co-manager of a public offering of securities by any such entity. Further information regarding this material may be obtained upon request.

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