Financing Port Infrastructure

MARTIN BYRNE, HELEN SIPSAS, AND TESS THOMPSON*

ABSTRACT

Port infrastructure is essential for the conduct of trade and tourism between countries. This paper aims at investigating the financial strategies used for port projects, project financing, and cash flow techniques used by Los Angeles Airport and Seaport and Long Beach Seaport and European airports and seaports in England, The Netherlands, Belgium, Germany, Greece, and Turkey. (JEL L60)

INTRODUCTION

A major influence on financial strategy in the ports industry is the ownership and management of a given port. The most widely adopted port ownership involves some form of governmental body, whether national, regional, or municipal. In some countries, there is a move toward privatization options which provides for varying degrees of public and private participation. This may be due to the recognition that close ties to local governments may cause large inefficiencies in time, personnel, and decision making. The World Development Report [World Bank, 1994] indicates a variety of ownership and management situations including corporatization, leasing, management contracts, performance agreements, and service contracts.

Corporatization transforms a state-owned enterprise into a legal entity subject to company law which includes a board of directors with decision making responsibility. Privatization involves the transfer of port property and management to a publicly recognized business entity. Privatization can be achieved through management buyouts which allow workers and management to purchase a facility at a negotiated price. The sale transfers 100 percent of ownership from public to private auspices [Ashford and Moore, 1992]. Other types of ownership and management such as agreements to build-operate-transfer, build-own-operate- transfer, and build-own-operate are contractual and may be limited in duration. It should also be noted that whether ownership is public or private, input from local interest groups will influence infrastructure projects.

Management contracts allow private contractors to perform a variety of port services. This arrangement provides for competition within the port operation without a change in ownership. Third-party facility development, akin to a joint venture, allows a private contractor a financial interest in a port in exchange for project construction and financing. Germany's Hochtief

*Loyola Marymount University--U.S.A. Research assistance was provided by Kelly Calabio, Danny Davis, Adam Harita, Carina Lim Dancer, Mary Mulligan, James Nakamura, Evelyn Sellers, and Patty Vajda.

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Company will build a $2.3 billion airport for Greece in exchange for a 45 percent stake for 30 years. Britain's Associated Seaports and British Airports Association (BAA) manage several ports. BAA is the operator of seven airports in Great Britain and is a public corporation with share ownership traded on the London Stock Exchange.

In the U.S., the majority of ports are owned and managed by counties and municipalities. Privatization of airports is possible as a result of President Bush's executive order in April 1992. Until then, private sector involvement was limited to management contracts at general aviation facilities.

Ports can also be classified as either operating ports, which own and operate their facilities charging fees based on a variety of services supplied, or landlord ports, which lease their facilities to others to run [Hershman, 1988, p. 218]. Airport leasing produces revenue from rentals of ground, cargo areas, office, check-in and ticket counters, hangars, operational and maintenance areas, and terminal area concessions. Revenue is also obtained from landing area and other flight fees based on gross landing weight or take-off weight or as a percentage of total airline revenue. The Los Angeles Airport (LAX) management indicated that its landing fee based on loaded take-off weight equates to about $1,000 per Boeing 747. Determination of charges for landing fees can vary [Ashford and Moore, 1992, p. 4]. European airports may charge a passenger load supplement fee which is based on the number of passengers. Since October 1990, legislation allows federally aided U.S. airports to collect a per passenger facility charge (PFC) to help cover costs for terminal and land operations.

Landlord seaports obtain revenues from leasing land and facilities and from provision of services such as dockage, wharfage, and demurrage. Cruise liners are expected to pay a port tax per passenger. Ports must generate enough revenue to cover expenses, maintenance, and expansion projects to maintain a viable and growing organization. Some ports rely heavily on tax exemptions and subsidies to supplement earned revenues [Hershman, 1988, p. 220]. The Port of Antwerp, Belgium, relies on government subsidies while the privately owned Port of Tilbury, England receives no subsidies and pays an annual fee to the Port of London Authority for Thames river dredging.

PORT FINANCIAL STRATEGY

Strategy is a continuous process affected by internal and external constraints which focuses on what needs to be done [Ring, 1988, p. 69]. External factors include the environment, regulatory agencies, government interests, the local community, and supporting infrastructure for trade development. User demand at Heathrow has caused BAA to consider adding a fifth terminal. The project is meeting opposition from environmentalists. Heathrow, considered to be of national importance to trade, fears losing air traffic to European competitor airports.

Financing strategies depend on the mix and degree of private and public involvement in port ownership and management. Publicly owned enterprises tend to be more severely constrained in terms of sources than are privately owned entities. Regardless of ownership, public interest barriers require that ports analyze the economic and environmental impact of expansion and improvement projects. Constraints on the primary goals of maximizing income and minimizing risk include maximizing employment, stabilizing the regional economy, and minimizing the environmental impact [Dowd, 1988, p. 217].

For our interviews with port management, we prepared a short list of questions relative to the three strategy areas under consideration. For cash management strategy, we asked, "Is

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excess cash invested in short-term governments or alternative instruments? Is foreign exchange risk hedged?" For infrastructure project strategy, we asked, "Is discounted cash flow analysis used? What other factors are considered?" For long-term financing strategy, we asked, "Are subsidies the main source of project financing?"

CASH MANAGEMENT

Treasury management, cash management, or working capital management strategy is governed by an important planning tool, the cash budget. Strategy includes speeding cash inflows, slowing cash outflows, and minimizing idle cash, transaction costs, borrowing costs, and administrative costs related to cash flows [Hill and Satoris, 1988, p. 11]. When receivables or payables are denominated in foreign currencies, strategy to minimize exchange rate risk must also be considered. Strategy is concerned with maximizing returns with minimum risk [Kelly, 1986, p. 7].

Ownership and policy constraints allow limited leeway in the choice of short-term investments. Some publicly owned ports, like the ports of Los Angeles, Long Beach, and Antwerp were required to deposit cash receipts with the city treasurer who is responsible for investments and voucher disbursements. A city treasurer's pooled investment programs may be constrained by government regulations and limited primarily to investments in low-risk, low-yield government obligations and high-grade money market instruments.

Private port managers may have fewer restrictions and may be able to use financial instruments which will maximize their returns with acceptable risks. Private ports can use aggressive or conservative cash management strategies since they have internal control of cash assets. Cash management strategy tended to be conservative or slightly aggressive at the ports visited.

Ports with payables, receivables, loans, and investments only in domestic currency are not likely to have direct foreign exchange risk. In this case, foreign users of the port assume the foreign exchange risk associated with currency conversion. However, long delays in payment of receivables may indicate the conversion difficulties of some port users and may increase port operation costs.

Ports accepting payment in foreign currencies or making investments or loans in foreign currencies will have transactions subject to exchange rate risk. Accounting rules in the port's home country may also cause such ports to have translation exposure [O'Conner and Bueso, 1990, p. 134]. Our findings were that U.S. ports and European ports required payment in their domestic currency. In a few instances, European ports, notably Stansted and the seaport and airport in Istanbul, Turkey, indicated that they had accepted some foreign currency contracts. Foreign currency received was immediately converted at the going spot rate to minimize exchange rate risk.

LONG-TERM FINANCIAL STRATEGIES

Financing of port capital projects requires both internal and external long-term funds. The overall goal is to obtain funds for planned long-term needs at the lowest possible cost and the highest amount of certainty that the financing will be successful. Ports, whether public or private, are entities with a public interest.

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Strategy begins with the port justifying the need for expansion of its own or supporting infrastructure. It has been said that in the port industry, "the goal is sustainable development" [Layman, 1993, p. 13]. Ports and facilities planning is future-oriented and entails varying degrees of uncertainty [Agerschou and Lundgren, 1983, p. 1]. Ports must consider the needs of their current and future user pools and make improvements that are technologically viable in order not to lose business to competing ports. Benchmark required returns in excess of cost of capital may be established, but usually the returns are much lower over the project life. The ports visited indicated that return on investment was not the major criteria for projects. Ports develop facilities master plans, which are based on forecasts of cargo movements and passenger capacity. Both in the U.S. and Europe, airports face a capacity crisis due to overwhelming growth in demand. Heathrow is estimated to be running at between 96.8 percent and 98.5 percent of capacity and Gatwick between 95.2 percent and 95.9 percent of capacity.

Expansion plans must also meet a variety of environmental and community requirements. Aircraft noise, increased highway traffic, pollution, sea life damage, and other environmental factors may have a substantial impact on airport and seaport expansion and infrastructure development. Mitigation projects to curb adverse environmental damage can add significant costs to expansion projects.

DEVELOPMENT AND FINANCING STRATEGY

In terms of strategy, the relative openness of decision making affecting port infrastructure projects creates greater constraints for public sector expenditures and managers than for their private sector counterparts [Ring, 1988, p. 279]. Projects involving the public sector have more time constraints than purely private sector projects.

Competitive bidding for large development projects is usual. The Richard Rogers Partnership won the international design competition for the development of a fifth terminal at Heathrow [Shifrin, 1992, p. 33]. BAA's commercial services, usually operated by private fnans, are often awarded on the basis of competitive bidding [Gomez-Ibanez and Meyer, 1993, p. 213].

Construction, operation, and maintenance costs of infrastructure result in the ports industry being both capital-intensive and monopolistic. Heathrow's fifth terminal is expected to cost about US $1.5-1.6 billion. Airport de Paris plans to spend nearly $2 billion between 1994 and 1998 to increase capacity [Crumley, 1994, p. 77].

A substantial up-front contribution to expansion costs is provided from internal sources. Airport de Paris finances approximately 70 percent of all its development investments internally with the remaining amount financed by bank loans [Crumley, 1994, p. 77]. The Ports of Los Angeles and Long Beach fund approximately 50 percent of their capital projects through internally generated funds. LAX funds one-third of its long-term projects using internally generated funds. Funds generated internally reduced the borrowing needs of the Dallas-Fort Worth airport by two-thirds [Kyle, 1994, p. 18].

In Britain, the Monopolies and Mergers Commission established a reasonable level for profits based on the cost of capital for BAA. As a stock company, BAA pays dividends on its shares and argues that it is a high risk business. "The MMC set the maximum charges for the London airports on the assumption that BAA needed a return on the current cost of its capital of 8 percent" [Darwall, 1994, p. 15]. BAA's internally generated revenue is earmarked for dividends and investment financing.

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The added advantage of restricting revenues is the possibility of earning interest income on unexpended accumulated funds. It is also possible for a port to borrow at a low rate in anticipation of needs and invest in government securities at a higher rate. The interest differential is another source of funds [Ashford and Moore, 1992, p. 37]. Associated British Ports in 1993 earned 10.9 million pounds in interest income or approximately 11 percent of its gross profit [Associated British Ports, 1993].

U.S. airports depend upon governmental grants in aid financed by the Airport and Airway Trust Fund established in 1954. The grants are part of the Airport Improvement Program which is designed to allocate funds among competing demands [Fetdman, 1992, p. 91]. At LAX, as much as one-third of a project has been financed from Airway Trust Grants. The major stipulation is that the grant funds cannot be used for projects designed purely for the purpose of generating revenue or for the benefit of private users [Kluckhohn, 1984, p. 32]. Other grants include enplanement entitlements and discretionary grants from the federal government.

The European Union has a structural aid package designed "to help its poor members achieve economic convergence" by providing up to 80 percent of funding [Hope, 1994, p. 4]. A grant from the European Union is expected to aid in the financing of port infrastructure improvement in Greece.

Public ports' use of the capital markets as a source of financing is usually limited to issues of competitive bid revenue bonds under municipal auspices. U.S. federal tax legislation provides favorable tax treatment for holders of these bonds allowing for lower interest rates, a sizable advantage for port financing. The bonds are repaid from port earnings. The Port of Los Angeles planned a $200 million revenue bond issue to aid in the funding of a $145 million dredging project [Glover, 1994, p. 8].

Although grants, federal funds, and revenue-type bonds may be available financing sources for private ports, equity financing from new issues of shares and rights offerings are additional alternatives. BAA, responsible for seven airports, has had successful share and rights issues. However, equity financing is the most costly of financing options available to ports. The long- term financing challenge is to choose the alternative or combination of alternatives that will minimize the cost of capital and assure the success of the capital projects.

CONCLUSION

Publicly owned ports have less flexibility in selecting alternative financial strategies both in the short run and in the long run. Cash management is frequently handled by a city treasurer with little input from the port financial manager. Short-term investments of cash are usually limited by city regulations to high-grade, low-yield governments and money market instruments. Sources of long-term financing are primarily no- or low-cost grants and loans and revenue bonds. Port management financial strategy is concerned with minimizing costs and risks rather than maximizing returns.

Privately owned or managed ports have the advantage of greater treasury management control. Financial managers are able to select higher risk, higher return investments with appropriate maturities and may have to manage foreign exchange risk. Long-term f'mancing alternatives include equity as well as debt financing and grants. Private ports may need to require a higher return on projects to meet shareholders expectations.

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Whether ports are public or private, they are part of a country ' s infrastructure. As such, it is in the country's interest that the infrastructure be adequately maintained and expanded as necessary to meet increased needs.

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