Are Toll Roads Too Risky For Pensions?
Toll roads aren’t the cash cows they used to be. The assumption that the roads will “pay for themselves” is no longer a reliable one, and credit rating agencies are taking notice.Toll roads aren't the cash cows they used to be. Many are struggling and the grim news of rising toll road bankruptcies confirms the fundamentals are very weak in this sector.
In Orange County, California, traffic on the San Joaquín Hills toll road is half what was projected. A recent toll road extension outside of Austin, Texas, is also seeing just half the expected traffic volume, leading the company that oversees the road to cut toll prices in hopes of attracting more “customers.” Moody’s Investor Services has downgraded the company’s credit rating. In the DC suburbs, the Inter-County Connector and new high-occupancy toll lanes along the famously congested Capitol Beltway are both getting far less than half the use that was projected. In San Diego County, the private company that built and operated the South Bay Expressway went into bankruptcy when the cars failed to materialize.
The federal loan program for transportation, TIFIA, now looks at only one criterion when choosing projects. Prohibited from considering public benefit, regional significance, or environmental impact, U.S. DOT staff chooses projects on the basis of credit-worthiness alone. The conventional wisdom holds that toll roads are the natural beneficiaries of this approach, since they include a mechanism for paying the loan back — but stories like those above indicate that that assumption should be re-examined.
Fitch Ratings, one of the Big Three credit rating agencies, warned investors in June that it was concerned about the future profitability of toll roads, given that “Americans have driven less each year since 2004 and those ages 16 to 34 have reduced their driving more than any other age group.”
Fitch analysts cited the groundbreaking report, “A New Direction,” by U.S. PIRG and stated their own belief that “the recession and increase in gas prices only partially explain this broad trend.” They think the shift from suburban to urban living and changes in technology and work patterns mean a more lasting reduction in driving. As such, they state, “caution remains warranted when future projections are the basis for investment.”
“In our view, these trends could have an impact given the U.S.’s current dependence on the user-fee infrastructure development model,” Fitch analysts wrote. “If these reductions persist, greater public subsidies would be required to fund still-needed new projects and provide credit stability.”
Of course, road projects have always required subsidies. Nearly 50 percent of road spending is covered by general taxpayer funds.
Reading the comments above got me thinking about pension funds investing in toll roads as part of their infrastructure investments. Last year, CPPIB paid $1.14-billion for stakes in five major Chilean toll roads as it boosted its exposure to both infrastructure and emerging markets.
The relatively stable and long-term returns that toll roads provide have made them sought-after investments for pension funds and other institutional investors, and Chile has become a hot spot for Canadian investors like CPPIB, AIMCo, and Brookfield Asset Management.
But toll roads aren't always profitable and taking a stake in an established toll road isn't the same as taking on construction risk building a new one. I raise this issue because the Indiana Finance Authority (IFA) and Indiana Department of Transportation (INDOT) recently selected four private developer teams which will compete to design, build, finance, operate and maintain the I-69 Section 5 project from Bloomington to Martinsville.
Among the finalists was a consortium led by Isolux Infrastructure where PSP Investments is taking an equity stake. Last year, Isolux Corsán reached an agreement with PSP Investments for a €500 million investment in Isolux Infrastructure with an additional €100 million being contributed by Isolux Corsán:
This investment will strengthen Isolux Infrastructure’s global leading position in its businesses operating the Group's concessions in toll roads, high-voltage power lines, and photovoltaic electricity generation. Isolux Infrastructure, led by its CEO Santiago Varela, has major capital investment projects totalling approximately €7.5 billion.Clearly Isolux Infrastructure is a global player and this deal demonstrates the confidence PSP Investments has partnering up with them expand their infrastructure investments.
This transaction, which forms part of the global development and diversification strategy rolled out by Isolux Corsán over the last five years, will boost Isolux Infrastructure's capacity to expand. Isolux Infrastructure is the subsidiary of Isolux Corsán that has grown strongest in recent years.
For Isolux Infrastructure, the agreement is a testament to its success in positioning itself as a global player in its field, and demonstrates confidence in its capacity to manage major road and power infrastructure projects.
Last year, the company increased its international networks of power lines managed under concession after winning the largest power contract in India (in Uttar Pradesh, with total capex of €815m). It currently manages 5,533 kilometers world-wide and has since won further tenders in Brazil. Isolux Infrastructure is a world leader in this business, also operating in the United States, where it has 605 km of power lines in Texas.
Isolux Infrastructure manages 1,610 km of toll roads in India, Mexico, Brazil and Spain, of which 1,400 km are already under operation. In the photovoltaic power business, the company (through T-Solar) develops and manages 286 MWp in Italy, Spain, India, Peru and the USA.
But it's extremely rare that a pension fund will take an equity stake and construction risk in a greenfield infrastructure project like this, especially in a state where previous private-public toll road partnerships ran into trouble:
Eleven million trucks. That’s how many 18-wheelers needed to rumble across northern Indiana in 2010 for the state’s 157-mile toll road to break even. Unfortunately, only about half that many did and the road came up $209 million short. This sounds like the beginning of yet another story about recession-ravaged states bleeding cash. And it is, sort of. The twist is that the Indiana Toll Road is managed not by the state but by a group of corporate investors, part of a public-private partnership experiment intended to show how businesses can help government run more efficiently and save taxpayers money—all while turning a profit.
President Barack Obama and politicians from both parties have held up such private sector alliances as a model for the future, as cities and states find it increasingly difficult to shoulder the enormous cost of building and maintaining roads and bridges. California, Illinois, Michigan, Kentucky, and Georgia are all courting investors, hoping to strike deals in which corporations will assume some of the expense and risk in exchange for a share in the profits. This money loser in Indiana shows how difficult it can be to apply business principles to sprawling public projects.
Now five years old, the Indiana deal has yet to turn a profit, or break even. Two overseas companies—Cintra Concesiones de Infraestructuras de Transporte, a unit of Madrid-based Ferrovial, and Macquarie Infrastructure Partners, an investment fund managed by Macquarie Group (MQG) of Sydney, won the right to run the road with a daring $3.8 billion bid—$1 billion more than the next-highest offer. The companies each owned a 50 percent stake of the project, which was backed by several overseas banks. The group then attracted other investors who bought pieces of the deal.
It turned out to be a bargain for the taxpayers of Indiana. The state received the upfront payment and has avoided more than $100 million a year in operating costs. “The state got a great deal,” says Jane Jankowski, a spokeswoman for Indiana Republican Governor Mitch Daniels. “The lease agreement contains numerous protections for the taxpayer and travelers and ensures the continued successful operation of the road.”
The private investors haven’t made out so well. Had the road been profitable, they stood to make millions per year over the life of the 75-year project. As it is, they have not been able to get past the debt they incurred winning the bid. They have met their annual debt payments only by borrowing money and may default before loans mature in 2015, according to disclosure documents from Macquarie Atlas Roads, one of the investors. The project’s 2010 prospectus said that revenue from the highway is “expected to remain insufficient to cover debt service obligations over the medium term.” The document cautions that “any default under the loan documents may lead to lender actions which may include foreclosure of the project assets or bankruptcy.” Even Governor Daniels, who had enthusiastically backed the venture, recently said that the foreign investors had overpaid.
In an e-mail, Macquarie spokeswoman Paula Chirhart said the prospectus was prepared in 2009 during the global financial crisis and “was never stated as a forecast or an expectation.” She added that “we expect the Indiana Toll Road to continue to meet its debt service payments as they fall due.” Patrick Rhode, a Cintra spokesman, said in an e-mail that more vehicles are using the Indiana road as the economy recovers. A reserve account was created to cover financial gaps that occur over long periods of time, he said. “We do not expect a default.”All over the world, toll reads are running into trouble, especially in recession-ravaged countries. Scott Wilson of Road Pricing recently commented on Spain's growing network of bankrupt toll roads:
Even so, the poor results could dampen enthusiasm for similar projects elsewhere. In Ohio, which faces a budget shortfall of as much as $8 billion over two years, lawmakers are considering a bill that would give Republican Governor John Kasich the authority to seek a sale or lease of the Ohio Turnpike. Kasich has optimistically suggested the road might be worth $3 billion. Given the way things are going next door, he may have a hard time finding takers willing to plunk down that kind of cash.
The bottom line: A toll road held up as an example of public-private partnerships shows no signs of breaking even for its conglomerate.
Spain was once lauded for having a large network of first class privately financed toll roads. Now it looks like many of those roads were commissioned by government, and built by the private sector based on overly optimistic forecasts of growth off of the back of Spain's property led boom, that was a bubble which has popped.I just came back from Greece where I saw firsthand road traffic on major (tolled) highways and bridges was down considerably from previous years. Greeks are cutting costs, getting rid of second cars and traveling much less. The recession and dumb austerity measures like hiking the fuel tax had a huge impact on Greek toll roads. On a brighter note, tourism is booming this year, which is good for PSP Investments as they took a concession stake in Athens airport as part of their big bet on airports.
Phys.Org reports from AFP on the debacle of the roads heading for bankruptcy, and it isn't just rural highways, but big urban highways near Madrid:
Two highways, Radial 3 and Radial 5, opened in 2004 at the height of Spain's construction boom. Now the company owes 660 million euros ($850 million) to the bank, 340 million to the builders and 400 million to residents evicted to build it.
Six toll roads have entered bankruptcy proceedings since May 2012, when the Madrid-Toledo (AP-41) toll road was the first. It was managed by Grupo Isolux Corsan SA, Comsa SA, Azvi and Banco Espiritu Santo SA, and owed over US$646 million in debt.
Many more more are also heading for bankruptcy.
It isn't just roads, as Spain built high speed railways and airports, with some of both of those now looking like woeful investments.
The craze drove Spain to break records: it became the country in Europe with the most kilometres of motorways and the most commercial international airports, and was second only to China in the world for the length of its high-speed train lines.
Meanwhile, the government already upgraded existing roads as well, untolled roads. At a time of deep recession, it is clear that Spaniards are preferring to save money over time, so are avoiding the toll roads in favour of the untolled government roads.
Motorway traffic is now at levels not seen for over 15 years.
The report continues:
On the Accesos de Madrid roads, "where there were supposed to be 35,000 vehicles a day, there are 10,000," said Jose Antonio Lopez Casas, director of Accesos de Madrid, the company that manages two major highways around the capital.
What is the lesson?
That road projects should be driven not by political imperatives, but commercial ones. The private sector assumed that perpetual growth would continue and that forecasts of growth were robust, but ignored the bubble economy (like so many others did). Instead of project led concessions, it may have made more sense to commercialise parts of the network, letting the private sector manage existing highways and decide on the merits of upgrading them instead of building new tolled roads.
However, there is a bright side in that the risk has been born by the private sector. The roads are built, and the cost to maintain them is a fraction of the capital cost to build them, which in most cases will be wiped out and born by the creditors.
Spain is obviously "overbuilt" for toll roads, and bankrupt toll roads may see prices cut to encourage demand, but may also put pressure on government to change how it charges its untolled network (through fuel tax). The bigger issue is whether the sheer scale of this bankruptcy overwhelms, and is likely to create mergers and require more fundamental reform of the highway sector, or if government feels pressured to nationalise the roads (unnecessary and unwise in my view).
But as far as toll roads, one expert shared these comments with me:
A lot can go wrong when the private sector takes on revenue risk. Most projects now are being financed using availability payments. Unfortunately, too many revenue projects closed with completely over optimistic traffic forecasts.And on Isolux and PSP's bid to build an extension to I-69 in Indiana, he added:
If they win the bid, they become an owner building a construction project. In this structure, PSP's principle interest is getting the project done on time and on budget. There is no doubt PSP will get it right eventually but they will get a few lumps along the way.This comment highlights some of the "lumps" many private investors have experienced building and managing toll roads around the world. Is now the time to take on the risk, including construction risk, investing in toll roads? Clearly PSP thinks so and while they may be right, the fundamentals for this sector remain weak, especially in recession-ravaged countries.
Below, Bitexco Group's Nguyen Tien Dzung discusses the $757 million Dau Giay-Phan Thiet Expressway Project in Viet Nam. Bitexco will take a 60% stake in the highway, the nation's first private-public infrastructure project. He speaks with Susan Li on Bloomberg Television's "First Up."