unyoking the cash cow: who should own the new jersey turnpike?
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Derrick Leung, Class of 2008 Advisor: Professor Alain Kornhauser 6 December 2010. Unyoking the Cash Cow: Who Should Own the New Jersey Turnpike?. ORFE Senior Thesis Presentation. 1: Introduction. The New Jersey Turnpike. Interstate 95; 148 miles Opened in 1951-1952 - PowerPoint PPT PresentationTRANSCRIPT
Unyoking the Cash Cow: Who Should Own the New Jersey Turnpike?
Derrick Leung, Class of 2008
Advisor: Professor Alain Kornhauser
6 December 2010
ORFE Senior Thesis Presentation
1: Introduction
The New Jersey Turnpike
Interstate 95; 148 miles
Opened in 1951-1952
FY06 toll revenues: $533.4 million
FY06 ridership: 250 million trips
5th most traveled highway (IBTTA)
Current valuation
– $6 billion (Lesniak, Mar. 2006)
– $30 billion (Villaluz, July 2005)
– $40 billion (Edwards, Feb. 2008)
1
Public Benefit Company (PBC)
Privatization Debate
2
For Privatization
Against Privatization
Improved operational efficiency
Innovative tolling
Public sector needs for fresh capital
Incentives to use private equity (leverage)
Uncertain private sector advantage
Conflicting public/private goals
Transaction costs ($30 million to $200 million)
Motivation
3
Public Benefit Company (PBC) Private sector management
Public sector control
Proposed structure of toll increases
Chicago Skyway, Jan. 2005
– $1.83 billion, 99-year lease
Indiana Toll Road, June 2006
– $3.85 billion, 75-year lease
$29.7 billion as of June 30, 2007
– $2.6 billion annual charge
Previous Asset Monetizations
New Jersey State Debt
2: New Jersey Turnpike Valuation Model
Formulation
Modified DCF formulation
Free Cash Flow (FCF) formulation
4
Model Parameters
Valuation timeframe: 75 years (2007-2081)
Inflation measure:3% increase in CPI
Revenues:– Projected using regression of growth rates over past 9 years– Five (5) different tolling scenarios– Price elasticity of traffic:
0 (inelasticity), -0.19 (average), -0.15 (low bound), -0.31 (high bound)
Expenses:– Projected using regression of growth rates over past 9 years
Interest and principal payments; capital expenditures
5
xp
Traffic
Tolling Strategies
Case 1: Status Quo
– Current real toll maintained
Case 2: Leung-Kornhauser Plan
– Initial real toll doubling
Case 3: Break-even Toll Plan
– Calculation of real toll such that net present valuation yields 0
Case 4: Governor Corzine’s Plan (PBC)
– “50% maximum real toll increases in 2010, 2014, 2018, and 2022 plus annual increases, based on CPI, levied to capture the prior 4 years, starting in 2010 and every 4th year thereafter.”
Case 5: Private Entity Plan
– Initial real toll increase that yields optimal (maximum) valuation
6
Data and Projections
7
3: Results
Case 4: Governor Corzine’s Plan (PBC)
8
Functional form of solutionValuation sensitive to more inelastic traffic
PBC Equivalent
PBC Equivalent Cash Flow structure
– Tolling structure of current plan inefficient
– Inspired by Leung-Kornhauser plan
Gains to setting initial three-time (quadrupling) real toll increase
– Greater cash flow in earlier time periods
9
Case 5: Private Entity Valuation
10
Functional form of solutionPrivate Entity Valuation unbounded for elasticity of 0
Valuation Sensitivity to Line-Item Costs
11
Valuation insensitive to individual line-item costs (5%)
Valuation Sensitivity to Cost Basket
12
Material benefit due to cost reductions seen from reduction in cost basket (20%)
4: Conclusion
Valuation Drivers
13
Valuation driven by increased tolls when traffic is price inelastic
High
Valuation driven by cost reductions when traffic is price elastic
The Motorist’s Perspective
14
Relative Toll over Valuation Period
0.0
0.5
1.0
1.5
2.0
2.5
2006 2007 2008 2009 2010 2011
Year
Rel
ativ
e T
oll
Status Quo Leung-Kornhauser PBC
Relative Toll over Valuation Period
0
5
10
15
20
25
30
35
40
45
2006 2011 2016 2021 2026 2031 2036 2041 2046 2051 2056 2061 2066 2071 2076 2081
Year
Rel
ativ
e T
oll
Status Quo Leung-Kornhauser PBC
Arbitrage Gain
15
Arbitrage Gain = High Valuation – Current Valuation
Case 1: Status Quo
– Arbitrage Gain = $0
Case 2: Leung-Kornhauser Plan
– Arbitrage Gain = $9.1 billion
Case 3: Break-even Toll Plan
– Arbitrage Gain = N/A
High
Case 4: Governor Corzine’s Plan (PBC)
– Arbitrage Gain = $31.5 billion
Case 5: Private Entity Plan– Arbitrage Gain = ∞
Recommendation: The Buyer’s Perspective
16
Implement PBC Equivalent: 3x initial increase of real toll
5: Case Study: Pennsylvania Turnpike
Background
Pennsylvania Turnpike is America’s oldest toll toad (1937), 537-mile route
Operated by Pennsylvania Turnpike Commission
– Powers to construct, operate, and maintain the Turnpike System and issue revenue bonds, repayable solely from tolls and other Commission revenues
Pennsylvania population: ~12 million
Vehicle trips (May 2007)
– Passenger: 160 million
– Commercial: 25 million
– Total: 185 million
Gross fare revenue (May 2007)
– Passenger: $323 million
– Commercial: $295 million
– Total: $618 million
17
Operations (FYE May)
18
132 136 139 141 150 156 164 163 161 160
19 20 21 2322 23 24 25 25 25
0
50
100
150
200
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Veh
icle
Tri
ps (
in 0
00s)
Passenger Commercial
151 156 160 163 173 179 188 188 186 185
$186 $192 $195 $200 $213 $219 $230$303 $329 $323
$160 $170 $184 $178 $175 $180 $190
$258$279 $295
$0
$100
$200
$300
$400
$500
$600
$700
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Gro
ss F
are
Reve
nue
(in 0
00s)
Passenger Commercial
$346 $362 $380 $378 $388 $400 $420
$561$607 $618
88 87 87 86 87 87 87 87 86 86
12 13 13 14 13 13 13 13 14 14
0 %
25 %
50 %
75 %
100 %
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Veh
icle
Tri
ps (
% S
plit
)
Passenger Commercial
54 53 51 53 55 55 55 54 54 52
46 47 49 47 45 45 45 46 46 48
0 %
25 %
50 %
75 %
100 %
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Gro
ss F
are
Reve
nue
(% S
plit
)
Passenger Commercial
Source: Pennsylvania Turnpike Commission 2007 Comprehensive Annual Financial Report
Vehicle Trips Gross Fare Revenue
Vehicle Trips (% Split) Gross Fare Revenue (% Split)
(in
$m
m)
Toll History
Erosion of real toll value over the years has led to severe lack of profitability of the Turnpike (like many toll roads)
Variable costs and interest rates increase every year by inflation, so tolls should also increase by inflation to preserve the integrity of the toll road’s cash flows
But the act of raising tolls is difficult from a political perspective
19
$15.31
$6.69
$0.00
$2.00
$4.00
$6.00
$8.00
$10.00
$12.00
$14.00
$16.00
1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005
Nominal Dollar Nominal Toll
Source: www.InflationData.com
Illustrative Value of $1.00 from 1940
Timeline
November 2006: Study by the Pennsylvania Transportation Funding and Reform Commission (PTFRC) note critical need for annual investment of $1.725 billion to fund maintenance, repair and expansion of state roads
May 2007: Morgan Stanley report analyzes various alternatives including a long-term lease, public corporation/leverage, and a PTC proposal
– Sources indicate $12-18 billion as an indicative valuation range for a lease
September 2007: Governor Ed Rendell solicits qualifications for potential bidders for the Turnpike in anticipation of a lease
May 2008: Final winning bid announced
– Abertis / Citi consortium offers $12.8 billion
– Goldman Sachs / Transurban consortium offers $12.1 billion
September 2008: Financial crisis deepens with collapse of Lehman Brothers
20 Source: For Whom the Road Tolls: Corporate Asset or Public Good (An Analysis of Financial and Strategic Alternatives for The Pennsylvania Turnpike
Valuation
Winning bid of $12.8 billion also contemplates an additional $1.7 billion to fund the beginning of operations (total consideration of $14.5 billion)
Purchase price funded by mixture of equity and debt
– Critics noted the use of leverage for the investment was more conservative than structures typically used at the time (ex. 80% or even 90% debt for infrastructure assets like the Turnpike)
Capital structure of winning bid:
– $8.5 billion of debt, including
a $250 million capex facility
– $6.0 billion of equity
Bid perceived to fall short of goal
Valuation = 35x EBITDA
– 365 million (2007)
– Relatively low compared to
Skyway and ITR transactions21 Source: InfraNews
Criticism
Winning bid anchored by foreign investor
– Abertis is a Spanish transportation and telecommunications firm (founded in 2003 after a merger of two companies founded in 1967 and 1971)
– Operate 6,700 km of motorways in Europe, and several international airports
– Public company traded on the Bolsa de Madrid (BMAD: ABE)
– Earned 3.9 billion Euros of revenue (2009); over 12,000 employees
Valuation not as high as previously contemplated
– Final bids were around $12 billion, the low end of valuation range originally indicated
– Governor Rendell indicated later that the $18 billion range contemplated tolls being increased 5.5% annually (not possible since tolls would be capped to the greater of 2.5% or CPI)
State Assembly vote would face opposition from public
– Bid expiration was extended twice by the consortium to facilitate discussion
22 Source: InfraNews, Abertis
Decision
23
What Would You Do?
If you were a State Congressman...
Outcome
State Assembly ultimately did not hold vote
– Some members of Congress were offended by “low” valuation, although some confessed that the vote would not have been favorable in any case
Unforeseen issues:
– Credit crisis eroded debt markets for financing
– Equity sponsors less willing to make investments due to uncertainty
– State finances eroded as tax revenues were lower due to high unemployment
– Municipalities unable to refinance debt (and break out-of-the-money interest rate swaps) or issue lower cost debt due to credit risk
Citi Infrastructure Investors moved on soon after to bid on Midway Airport (large hub airport in Chicago area)
– Bid also failed since acquisition was contingent on securing financing
– Closed credit markets provided challenge
24
6: Thesis Application in the Real World
Goldman Sachs
Investment Banking
– Mergers and Acquisitions
– Industry coverage groups (Technology, Media and Telecom (TMT), Natural Resources, Financial Institutions, Industrials, Consumer/Retail, Real Estate)
– Product group (Leveraged Finance, Equity Capital Markets, Derivatives)
Asset Management
– Asset Management (GSAM) and Private Wealth Management (PWM)
Trading and Principal Investments
– Equities
– Fixed Income, Currency, Commodities (includes Special Situations Group)
– Merchant Banking/Private Equity Division Principal Investment Area (Corporate Equity, Corporate Debt, Mezzanine,
Real Estate, Infrastructure)
25
What is Private Equity?
Acquisition through leveraged buyout (LBO) of mature, stable cash flow businesses with free cash flow generation used to support debt service
– Reasonable growth, defensive business model, strong management team, low capital expenditures, over-equitized capital structure
Leverage used to increase purchase price in auctions
– 2004-2007: 75% debt / 25% equity, low cost of debt (low credit spreads)
– 2008 and after: at most 50% debt / 50% equity
Private Equity Firm (General Partner) Investors (Limited Partners)
Private Equity Fund(Limited Partnership)
Investment A Investment B Investment C
26
Characteristics of Infrastructure Investments
Stability
– Provision of essential services to communities
– Insulated from business cycles, high barriers to entry
Duration
– Nature of services supports asset longevity
– Long-term cash flows support long-term investment horizon
Inflation
– Regulation or concession determines pricing (inflation-linked cash flows)
Yield
– Current yield through free cash flow
Diversification
– Low correlation with other asset classes
– Alternative to other investments (including traditional private equity)
27
Competitive Landscape
Competitors
– Private equity firms KKR, TPG, Carlyle, Blackstone, Bain Capital, Apollo
– Boutique infrastructure investment firms Global Infrastructure Partners, Alinda, Macquarie, Babcock & Brown
– Investment Banks Morgan Stanley
– Insurance companies / pension funds
– Sovereign wealth funds
28
Selected Transactions
Sea Ports
– Restructuring of $5 billion North American terminal operator
– Distressed LBO of $5 billion international port and rail company
Toll Roads
– LBO of Florida toll road through P3 auction; approx. $1 billion transaction
– Proprietary recapitalization strategy for select North American toll roads
Airports
– LBO of regional airport through P3 auction
Natural Resources, Energy and Power
– Equity investment in one of the largest natural gas pipelines in the U.S.
– Investment in natural gas storage facility in Wyoming (development)
– Investment in water storage facility in southern California (development)
– Carve-out of regional electric utility
Fundraising
– Raised $3.1 billion of equity capital for new infrastructure fund29
Then and Now
30
Mega funds
– Diversification of investor base
Auctions accepted
Use of leverage
Cheap cost of debt (low spreads)
Long tenor (7-10 years)
Steep growth profile underwritten
Stable, solvent companies
Pre-Credit Crisis
Smaller funds
– Limited Partners want to exit
Negotiated transactions
More equity required
High cost of debt (debtor risk)
Short tenor (3-5 years)
Low base, moderate growth
Restructuring strategies through debt or equity investments
Post-Credit Crisis
7: Q&A