real payoff

COPYRIGHT INDUSTREAMS LTD.

REAL PAYOFFAN INDUSTREAMS INITIATIVE

TO EXPLORE BETTER WAYS OF WORKING WITH AND GAINING FROM VOLATILITY

(for strategy setting, decision-making and value creation in port and infrastructure investment and portfolio management)


Why this initiative? The central challenge is variability in world markets and of

course world trade and by extension infrastructure and port markets.

Through many cases in the ports sector and subsequently in the wider infrastructure field it is clear to us that the solution cannot be in prediction alone.

Precision forecasting is increasingly being debunked - the limitations are too great and one of the key reasons why many projects and acquisitions do not deliver the expected returns.

So the starting point is that payoffs (say in the form of returns) are distributed and cannot be reduced to very specific payoff points (e.g. estimating an IRR to be a specific percentage point such as 15% for a 40 year concession).

That suggests that we must accept much wider variance in the market variables we work with and greatly increases the importance of the factors in our control and the function or business model that turn market variables into payoff (such as concession agreements, operating model, partnership model, gearing etc. as well as optionality and flexibility).

This presents both a great challenge and opportunity for decision-making and value creation in investing and portfolio management.

Ultimately this is about shareholder value creation.

Shareholders are starting to intuit that returns are distributed over a much wider spectrum than previously conceived and with that are going to demand a better understanding of the down side exposures and how you limit them as well as your ability to expose yourself to upsides.

Robustness and upside will increasingly become the focus of shareholders

The fragile will sooner or later leave the market place

Note: Return on investment spread.


What this is about and the potential This is about embracing variability and about creating

value from variability. To do that we need new tools and ways of dealing with

variability in decision-making and value creation in investing and portfolio management.

With this initiative we will explore various solutions. In this presentation we introduce a few of the many options including simple heuristics and the payoff function to address central issues in decision-making and what we for now are calling the “value leap” as outlined to the right.

Very simply put it is about creating robustness and upside in asset and portfolio value as outlined below (for more see the case).

For decision-making: Providing the means to fully understanding our up and downward exposure also in the face of skewness and with that how we make smart tradeoffs as well as utilize or create free options that substantially shift our asset value.

Value leap: Many operators have by now honed their skills at creating value through understanding and influencing the market place. Most, however, are not using their business model to fully leverage and protect against market uncertainty. This is where we see some of the greatest un-tapped value in todays market place for operators.Note: From case outlined later in this presentation (changing NPV

range in USD from -1bn / +1.7bn to -0.3bn / +3.4bn).


Exploring a few of the components

1. BackdropEmbracing variability and moving from single payoff point paradigm to a payoff distribution and with that moving to real investment strategies (payoff as expressed in e.g. IRR or NPV).

2. FrameworkExploring ways of moving from payoff distribution to payoff function and utilizing that to working with and creating value from market variability.

3. CaseA simulated case showing how we use levers at our disposal to substantially shift our payoff distribution and thereby investment returns (for inspiration purposes only).

In the following we will walk through the preliminary backdrop and framework and a specific case to lay out frameworks and solutions for illustration purposes. It is not meant to be exhaustive in any way – it is purely meant as an introduction and to spur ideas.


BACKDROP(embracing variability)


Variability in port investing and assetsSTATING THE OBVIOUS…The Compounded Annual Growth Rate (CAGR) for a sample country was 4.7% over a 20 years historical period (here simulated using partial US ports data). But for the individual ports the range was between 0.5% to 10.2% CAGR for 97.5% of the ports (weighted by volume – see the y axis for one port share of total). The obvious is that even on a very aggregate level we face substantial variability.

…AND IT GETS MUCH WORSE…Our payoff (or lack of) is exposed to numerous factors including the volume distribution in a port among terminals (our terminal vs all the others), average revenue, operating costs etc. And the more factors we add the fatter the tails to either side and the greater the possible future outcome for our payoff (say IRR or NPV). And this is before even introducing any “skewness” which complicate matters further.


Real payoff (or return) distributions

In real life the payoff distributions are, well, distributed over a larger spectrum (of e.g. potential returns or net present values). Examples are given to the right which are some of the potential real distributions and of course any mix thereof.

Symmetrical payoffs with more or less variance.

Skewed payoffs either right or left tail.


Real and false investment objectives

It may well be that there are only two real non-narrative investment objectives. One is decreasing the overall variance through market structure selection, deal frames etc. (and willingness to tradeoff upside for less downside). The other is creating investments with high payoff upsides and little downside.

The diagrams to the left illustrate narrative positions in investments where the expected singly point payoff is very different from the real possible payoffs. One in which payoff is symmetrical and where the upside is welcome but the downside might prove detrimental to the company in question and thus not what they really wanted. The other a pure loosing position where the potential downside is big and the upside capped (sometimes seen in acquisitions).


FRAMEWORK(exploration of concepts for working

with and gaining from volatility)


From distribution to function

Consider the payoff distribution as a result of market variables and the function (or business model) that translates these variables into payoff. Left some of the most obvious examples.

We cannot compute probabilities to any single point of payoff (or return).

But we know much about how our function works at different market variables and thus how these translate into payoff.

Using the payoff function is a means to working with variability.

Another way to think of the difference is as market variables being “x” and the function being “f(x)”.

Market variables or x

Payoff (or return)

MARKET VARIABLES

Volume Rates Unit costs Currency exposure Interest rates Etc.

FUNCTION

Operating model Concession terms Expansion, phasing and

other options Funding and ownership

model Insurance Etc.

Payoff function or f(x)


The function we wish to achieve and avoid

Very simplified when we translate real payoff distributions into payoff functions they roughly match up as laid out below. This gives us a broad idea of what we wish to achieve and avoid for our payoff function (or business model).


What we know and what we control…

What we know……is that market variables can vary much and have a lot of inherent volatility in particular over long time horizons.

What we control……is how our function (or business model) translates that volatility into payoff.

We have all seen outcomes that we thought were extreme at time of conception of both ends of the market spectrum in numerous investment cases across the sector. What has never been observed is an investment case turning into the exact expected return values.

We chose and design our own payoff function. We chose whether to hardcode it to be robust with substantial upside or fragile.

Conceivable return scenarios

This never happens


…using it for decision-making

Exposure Where are we? We need to understand our upward and downward exposure – a single payoff point won’t give us any information about that. This get’s even worse and much more critical when there is any form of skewness involved which occurs in all investment cases one way or the other.

Value creation Some of the levers at our disposure including very much optionality (such as investment phasing or expansions) have the potential to simply improve our payoff function by limiting down side and increasing upside (but hidden if only considering single payoff points).

TradeoffsOthers situations may be more complex with tradeoffs. Good examples include concession terms or operating models. In such circumstances the payoff function help us understand what we are trading off and would often lead to very different conclusions than a single payoff point paradigm would. In the example to the right we think we have made a decision that provides a small gain seemingly for free, but in reality has provided much more downside and less upside.


…and value leap through f(x)

Value creation through x

Value creation through x and f(x)

Best of both worlds

The leading operators in general have great insight to the market place and how to impact it. But the biggest area of untapped value creation and most overlooked may well lie in the function itself (including optionality).

So one way to look at x versus f(x) and value creation would be to consider value creation through x as mainly market selection focused. That is to say select an opportunity that has reasonable likelihood of delivering a positive return from an average point of view.

f(x) value creation then takes place within a given market setting in terms of how best to transform the payoff distribution by limiting the down side (or left tail) and expanding the upside as much as possible (right tail).

Pre- and post-investment

This analogy works both for investing as well as asset and portfolio management.

Whereas x value creation pre-investment is centered around market selection a good example post-investment would be capturing higher market share or securing higher rates.

For f(x) value creation post-investment would include all the factors pre-investment (although a number more from a tradeoff perspective) and also include the development of new options as well as more operational levers (including contracting aspects of commercial, operations and procurement).


CASE(what this could look like

for a sample investment case)


Introduction The following case has been made purely for the purpose of illustrating how a real

view of payoff can enable us to vastly alter our payoff function and thereby distribution.

It showcases a greenfield investment and how we can use levers to change our payoff distribution from a range of -968mn / +1,707mn to -293mn / +3,438mn changing the potential max gain from 1.76 times to 11.75 times that of our potential loss (the case was simulated for NPV in USD, but could of course be applied to any metrics used to measure payoff or returns).

The base case scenario has by intention been kept the same throughout the simulation to show how knowledge of one payoff point provides very little information of our real payoff distribution.

Whereas this shows an investment case the same methodology is applicable to investment and portfolio management and decision-making in general.

In the case we use a few of the obvious levers that can be used to transform our payoff distribution but they are just a few of what is conceivably a vast array of levers.


Base case (greenfield sample)

Base case assumptions 20 year concession 1,500 meters of quay and 100ha at cost of 500mn USD Capacity 1.5mn TEU (ramp-up period of 6 years) Average rate at 200 USD per TEU, average variable cost

at 50 USD per TEU Fixed cost at 5mn USD per year Concession cost at 50mn USD per year (fixed) 25% corporate tax rate 10% discount rate

Simulation methodology Base case at index 100 for volume and

average rate (scenario 11) Payoff function tested for index 0 (scenario

1) through to 200 (scenario 21) Average price and volume thus tested for

data sets 0/0, 10/10, 20/20 etc. up to index 200/200 of base case (21 scenarios in total)

All other items kept constant

Note: NPV values in million USD

Comments As capacity is capped at

1,5mn TEU volume only has an impact up to the base scenario thereafter only avg. rate increase make a difference

Lowest payoff point mainly consisting of investment and concession liabilities

Return spread (NPV in USD)

Base case 241mn

Minimum -968mn

Maximum 1,707mn

Max./Min. 1.76 times

Base case


Changing the function (just a few of the levers)


Base case 241mn

Minimum -543mn

Maximum 1,703mn


Concession structure Previous fee $50mn per

year New fee $44.25 per TEU PV value of concession

fee remains $426mn (at 10% discount rate) as per base case

Investment phasing Previous commitment at

500mn USD Option introduced to

phase in 2 parts of $250mn per phase

Expansion option Capacity capped at

1.5mn TEU in base case Option introduced to

double capacity by investing additional $500mn USD


Base case 241mn

Minimum -718mn

Maximum 1,707mn



Base case 241mn

Minimum -968mn

Maximum 3,766mn



Transformed payoff (function and distribution)

Combined Changed concession

structure Investment phasing in

two parts Expansion option to

increase capacity


Base case 241mn

Minimum -293mn

Maximum 3,438mn



DisclaimerThis presentation is issued for information purposes only and does not constitute an agreement, offer, obligation or invitation to enter into transactions or investment business.

With this presentation, INDUSTREAMS LIMITED does not act in any way as your advisor. This presentation is not intended as, nor should it be, a substitute for consulting with INDUSTREAMS LIMITED.

Whilst this presentation has been produced from sources believed to be reliable, the information, views and opinions expressed in this presentation are provided as of the date of this presentation and remain subject to verification, completion and change without notice. No representation or warranty whatsoever (whether express or implied) is or will be made as to, or in relation to, the accuracy, reliability or completeness of the information contained herein or in the appendices to this presentation.

INDUSTREAMS LIMITED will not be liable towards you or any third party for any eventual damage you may incur, caused by the information contained in this presentation and its appendices.

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