CHICAGO — The Indiana Toll Road, bankruptcy and all, continues to show the benefits of privatization and the lessons for investors and governments interested in privatizing U.S. infrastructure, Wells Fargo says in a recent report.
"The Indiana Toll Road transaction was a landmark deal in 2006 and we believe it will continue to be enlightening for U.S. market participants in public private partnerships in 2015 and beyond," Wells Fargo senior analyst Randy Gerardes wrote in the April 1 report, titled "Indiana Toll Road: Lessons Learned for the U.S. P3 Market."
"Going forward, we think more states will consider long-term leases of infrastructure assets as they grapple with ways to rebuild and reinvest in infrastructure," Gerardes wrote.
Toll roads generally offer stable cash flow and high operating margins, even when traffic is down, according to Gerardes.
Indiana Toll Road Concessions Inc., filed for bankruptcy last September. The firm, a Macquarie subsidiary, paid Indiana $3.8 billion in cash for a 75-year lease of the road in 2006, the largest privatization at the time.
The company was driven to insolvency largely by overoptimistic traffic projects and a debt-heavy capital structure burdened by interest-rate swaps that became costly.
Australian fund manager IFM Investor submitted the winning bid for the asset last month, agreeing to pay $5.7 billion the remaining 66-year lease of the road. It's the largest bid for an existing public asset in the U.S., according to several market participants. The bid marks the first time that major U.S. pension funds have invested in American infrastructure.
Despite a price nearly 50% over the original bid, the new financing should prove favorable to investors because it features significantly more equity than the current debt-laden structure, according to Wells.
The bid includes $3.2 billion in equity, or 57% of the transaction, according to Wells.
A "bull" analysis of the financing shows an equity rate of return of 12% over the life of the lease. A "bear" analysis- with much lower toll revenue growth among other factors - assumes a 6.9% return on equity over the life of the concession. The final terms and debt structure will be "critically important," Gerardes said.
There are several reasons for "rich" toll road valuations, his report said: low interest rates, a limited supply of toll roads and, in the case of ITR, aggressive rate increases built into the concession contract with the Indiana state government.
As illustrated in the case of the Australian fund manager, pension funds are increasingly looking to U.S. infrastructure for a place to invest their money.
"Pension funds in particular with big investment mandates and longer investment horizons are looking for long-lived 'alternative' investments with steady cash flow," Gerardes wrote. "U.S. pension funds may like the optics (and currency diversification) of an international fund investing in U.S. based infrastructure and are willing to pay management fees to fund sponsors for exposure to assets, such as the ITR."
Traffic projections and revenue forecasting are key to valuing toll roads. But accurate projections can be difficult, Gerardes said.
"Toll revenues, even for brownfield toll roads with a long operating history such as ITR, can be difficult to estimate given the lack of a contractual agreement and individual driver demand elasticity," he said.
The uncertainty of traffic projections may lead to more availability-based P3 models. The structure - recently used by Indiana and Ohio in their new privatizations - calls for the private operators to receive a guaranteed rate of return from governments as long as the operators meet various criteria.
The value of the ITR could jump again, Gerardes said.
"We think investors can expect another refinancing prior to the concession's end date in 2081," Wells wrote. "However, like any option, the value of the concession and the ability to refinance becomes less as the length of the remaining concession gets shorter. This is of particular concern for lenders (bond holders) who remain with the asset even when the equity value is zero."
