could deal a major blow to the privatization model. The
scuttling of the Penn Turnpike deal and the delays in the
Midway deal can be attributed to several factors, which are
instructive for private investors evaluating infrastructure
opportunities.
Political Opposition. Privatizing infrastructure is politically sensitive. Political opposition often derives from
suspicion of turning over public goods to profit-making
entities. In this respect, local government budgetary
shortfalls are a double-edged sword: even as they prompt
governments to pursue privatization, they fuel arguments
of opponents who wonder why governments do not
simply find a way to reap for themselves the returns
expected by private investors.
One Illinois politician has
compared infrastructure privatization to “selling the furniture to pay the mortgage.”
The immediate precipitating factor behind the Penn
Turnpike deal’s collapse was the Pennsylvania Legislature’s
failure to grant necessary legislative authorizations. The
deal met heavy opposition from Pennsylvania legislators
and the Pennsylvania Turnpike Commission. After extending its bid twice to accommodate the legislature, the
investor consortium allowed its bid to expire on October 1,
2008. Likewise, in Chicago, the Midway privatization
recently met opposition from candidates for a newly-vacant congressional seat.
Credit Conditions. Infrastructure investments are not
immune from the factors, such as the credit crunch,
wreaking havoc on other deals throughout the economy.
For example, with the Penn Turnpike deal structured as
50% equity and 50% bank debt, it is widely speculated that
the uncertain credit markets were the most important
factor in the investors’ decision to let their bid expire. The
Midway transaction, which was originally expected to close
by the end of 2008, was put on hold after the investor
consortium announced in January 2009 that it was
seeking additional equity capital, a move that may have
been prompted by the need to replace expensive or
unavailable debt.
Valuation Difficulties. Infrastructure is a relatively new
asset class for private investors, and valuing these assets is
still more of an art than a science. To illustrate, the
Commonwealth of Pennsylvania’s financial advisers and
the media estimated the value of the assets would range
from $20 billion to upwards of $30 billion, but the winning
bid for the Penn Turnpike was only $12.8 billion. For the
Midway project, pre-bidding estimates ranged from $1.5
to $3 billion. The winning bid, at $2.52 billion, was within
this range, but the range itself was sizable. The novelty of
valuing infrastructure assets partially explains the wide
fluctuations. Dramatic swings in cost of capital and
economic forecasts over the past several years are also
factors. What is clear is that wide disparities in valuation,
coupled with the lengthy time frames involved in getting
privatization deals completed, can derail deals.
Regulatory Approvals. Various regulatory requirements also create obstacles for private investors
underwriting and completing these deals. A failure to
obtain one of the many required approvals can derail a
project in which substantial investment has already been
made. Additionally, approval delays afford equity and debt
investors opportunities to revalue, renegotiate, and
reconsider transactions — a
dangerous prospect in the
current investment environ-
ment. Finally, concessions required to obtain these
approvals can affect (generally for the worse) the underwriting of the project.
The Midway transaction, for instance, required the
approval not just of Chicago city authorities but also of
certain neighboring cities. The privatization is being done
pursuant to a national program spearheaded by the Federal
Aviation Administration, which must approve the financial
terms of the deal. Under the program’s terms, 65% of airline
tenants also need to approve the transaction. To gain the
approval of Southwest Airlines, the investor consortium
agreed to freeze carrier charges at 2008 levels for its first six
years of operation, followed by limiting fee increases to the
rate of inflation for the next 19 years.
“Who will bridge the capital gap?”
Mind the Gap
The future demand for infrastructure capital will outstrip
the supply available from public sources. Who will fill this
capital gap? While it is undeniable that infrastructure is a
highly attractive asset class, that the political momentum is
moving toward more infrastructure deals, and that there
are successful precedents, investors are well advised to
recognize the risks and hurdles presented. Capital alone
will not be sufficient to address these obstacles. Success is
achievable only with a thorough understanding of both
generic and asset-specific obstacles to private infrastructure
transactions in today’s environment.
Tuan A. Pham is a partner in the San Francisco
office of Goodwin Procter, and can be reached at
(415) 733-6062 or tpham@goodwinprocter.com.
Valerie J. Washburn is an associate in the San Francisco
office of Goodwin Procter, and can be reached at
(415) 733-6089 or vwashburn@goodwinprocter.com.
