In my August/September column I chronicled recent U.S. advances for the European/Australian model of long-term concessions with equity investments, describing this as a kind of paradigm shift for U.S. highways in the 21st century.
Since I wrote those words, this new model has won several victories, with proposals based on it winning out over traditional toll financing models. But it has also been challenged by a leading investment banker skilled in doing traditional toll financing.
First, let’s look at where this new model has made the difference in the selection process. Earlier this year, it proved decisive in Virginia DOT’s selection of the Fluor/Transurban team to add four HOT lanes to the southwestern quadrant of the Washington Beltway (I-495). What had been a $700 million project requiring about $100 million of state funding has evolved into a nearly $900 million project with all private funding. The difference is Transurban’s equity investment in the project.
That same team was selected in October for a $914 million project to develop HOT lanes on I-95 and I-395, all the way from Spotsylvania County, VA to the Potomac River (56 miles). Once again, the key competitive difference between the Fluor/Transurban proposal and the competing Clark/Shirley/Cofiroute bid was equity; the latter proposed all-debt financing via a 63-20 nonprofit corporation. “[Fluor] were prepared to put skin in the game,” selection panel chair John Rollison told Tollroadsnews.com. “That was attractive for many of us.”
Also in October, Oregon DOT picked Macquarie Infrastructure Group (MIG) for a billion-dollar project in the Portland area to develop three new toll projects. A group led by Bechtel proposed a nonprofit financing model, using a 63-20 corporation. They also bid for only one of the three toll roads, the Dundee-Newberg Bypass, while MIG proposed doing all three. MIG is proposing a concession model with equity investment. (Because traffic does not appear sufficient to support fully toll-based financing, Oregon DOT expects there to be a mix of state highway funds and toll financing.)
Finally, by the time you read this, Transurban may have completed ongoing negotiations with VDOT to lease and refinance the troubled Pocahontas Parkway, a new toll road that was developed using traditional 100% debt toll financing and a 63-20 corporation.
Despite this series of wins for the equity/concession model, my investment-banker friend has challenged it on several grounds. Let’s review them one by one.
First, he says equity is not needed to remedy any lack of investment in highways, since there is plenty of demand for toll road debt. It’s true that the world is awash with capital; a recent Wall Street Journal article (Nov. 3, 2005) puts total global pension fund, insurance company, and mutual fund capital in excess of $40 trillion. But it’s also true that traditional toll-road finance models can finance less of a given project’s cost than a debt plus equity model-as the recent Virginia cases illustrate.
Next, he challenges my point that you need equity to get “patient capital” willing to wait for its return in the out years, in contrast to toll revenue bondholders who must be paid on schedule from year one. To illustrate, he described a planned issue of 40-year, zero coupon subordinated debt for a western U.S. toll road. Buyers of that debt will receive no payments during the 40-year term (but do have the possibility of early payoff after 10 years). So clearly, this is a kind of patient capital that is available for non-concession toll road financing.
Third, he says that what concession deals are really doing is persuading DOTs to accept more aggressive toll rates than would otherwise be politically feasible-because the resulting deals avoid the need for tax funding of the road (in the case of new projects) or liberate frozen capital for other uses (in the case of leasing existing projects like the Chicago Skyway). But he laments that with the (for-profit) concession model, excess cash flow that could have been used to build more infrastructure will instead be used to provide dividends to pension fund holders.
This last point really gets to the nub of the issue. Yes, as my banker friend says, the investors who fund projects with equity do require a higher return, on average, than those who provide debt financing. But what he ignores is the value provided in exchange for that higher return. This is most obvious in the case of new toll roads, where the concession company and its backers take on both construction risk and revenue risk. The track record of “public-private” toll roads using 63-20 nonprofit corporations is so far zero for two: both the Pocahontas Parkway and the Southern Connector are financially shaky, and the world is not exactly flocking to this model. There is a global problem of wildly over-optimistic forecasts regarding costs and revenues of transportation mega-projects. Shifting these kinds of risks to toll road owners and their sophisticated investors is a major benefit of the concession model.
What about the lease of existing toll roads? While the risk-transfer point is not so obvious in these cases, there will clearly be a need to rebuild and expand just about any toll road over the life of a 50 to 99-year concession period, so the value of transferring construction risk will still be there. And there are many other benefits to be gained from shifting major portions of the highway sector from the state bureaucracy model to the investor-owned utility model. Reason’s recent policy paper, “Should States Sell Their Toll Roads?”, goes into this point at some length (www.reason.org/ps334.pdf).
In short, this debate is about far more than financing. It concerns how best to own, operate, and manage 21st century highways-as well as how best to finance them. America needs a lot more debate and discussion on this potential paradigm shift.
Robert W. Poole Jr. is director of transportation studies and founder of the Reason Foundation.