Unyoking the Cash Cow: Who Should Own the New Jersey Turnpike?

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Derrick Leung, Class of 2008 Advisor: Professor Alain Kornhauser 6 December 2010. Unyoking the Cash Cow: Who Should Own the New Jersey Turnpike?. ORFE Senior Thesis Presentation. 1: Introduction. The New Jersey Turnpike. Interstate 95; 148 miles Opened in 1951-1952 - PowerPoint PPT Presentation

Transcript of Unyoking the Cash Cow: Who Should Own the New Jersey Turnpike?

  • Unyoking the Cash Cow: Who Should Own the New Jersey Turnpike?

    Derrick Leung, Class of 2008Advisor: Professor Alain Kornhauser6 December 2010ORFE Senior Thesis Presentation

  • 1: Introduction

  • The New Jersey TurnpikeInterstate 95; 148 milesOpened in 1951-1952FY06 toll revenues: $533.4 millionFY06 ridership: 250 million trips5th most traveled highway (IBTTA)

    Current valuation$6 billion (Lesniak, Mar. 2006)$30 billion (Villaluz, July 2005)$40 billion (Edwards, Feb. 2008)1

  • Public Benefit Company (PBC)Privatization Debate2For PrivatizationAgainst PrivatizationImproved operational efficiencyInnovative tollingPublic sector needs for fresh capitalIncentives to use private equity (leverage)

    Uncertain private sector advantageConflicting public/private goalsTransaction costs ($30 million to $200 million)

  • Motivation3Public Benefit Company (PBC)Private sector managementPublic sector controlProposed structure of toll increases

    Chicago Skyway, Jan. 2005$1.83 billion, 99-year leaseIndiana Toll Road, June 2006$3.85 billion, 75-year lease

    $29.7 billion as of June 30, 2007$2.6 billion annual charge

    Previous Asset MonetizationsNew Jersey State Debt

  • 2: New Jersey Turnpike Valuation Model

  • FormulationModified DCF formulation

    Free Cash Flow (FCF) formulation


  • Model ParametersValuation timeframe:75 years (2007-2081)Inflation measure:3% increase in CPI

    Revenues:Projected using regression of growth rates over past 9 yearsFive (5) different tolling scenariosPrice elasticity of traffic:

    0 (inelasticity), -0.19 (average), -0.15 (low bound), -0.31 (high bound)

    Expenses:Projected using regression of growth rates over past 9 years

    Interest and principal payments; capital expenditures


  • Tolling StrategiesCase 1: Status QuoCurrent real toll maintainedCase 2: Leung-Kornhauser PlanInitial real toll doublingCase 3: Break-even Toll PlanCalculation of real toll such that net present valuation yields 0Case 4: Governor Corzines Plan (PBC)50% maximum real toll increases in 2010, 2014, 2018, and 2022 plus annual increases, based on CPI, levied to capture the prior 4 years, starting in 2010 and every 4th year thereafter.Case 5: Private Entity PlanInitial real toll increase that yields optimal (maximum) valuation


  • Data and Projections7

  • 3: Results

  • Case 4: Governor Corzines Plan (PBC) 8Functional form of solutionValuation sensitive to more inelastic traffic

  • PBC EquivalentPBC Equivalent Cash Flow structureTolling structure of current plan inefficientInspired by Leung-Kornhauser plan

    Gains to setting initial three-time (quadrupling) real toll increaseGreater cash flow in earlier time periods9

  • Case 5: Private Entity Valuation10Functional form of solutionPrivate Entity Valuation unbounded for elasticity of 0

  • Valuation Sensitivity to Line-Item Costs11Valuation insensitive to individual line-item costs (5%)

  • Valuation Sensitivity to Cost Basket12Material benefit due to cost reductions seen from reduction in cost basket (20%)

  • 4: Conclusion

  • Valuation Drivers13Valuation driven by increased tolls when traffic is price inelasticValuation driven by cost reductions when traffic is price elastic

  • The Motorists Perspective14

  • Arbitrage Gain15Arbitrage Gain = High Valuation Current ValuationCase 1: Status QuoArbitrage Gain = $0Case 2: Leung-Kornhauser PlanArbitrage Gain = $9.1 billionCase 3: Break-even Toll PlanArbitrage Gain = N/A

    Case 4: Governor Corzines Plan (PBC)Arbitrage Gain = $31.5 billionCase 5: Private Entity PlanArbitrage Gain =

  • Recommendation: The Buyers Perspective16Implement PBC Equivalent: 3x initial increase of real toll

  • 5: Case Study: Pennsylvania Turnpike

  • BackgroundPennsylvania Turnpike is Americas oldest toll toad (1937), 537-mile routeOperated by Pennsylvania Turnpike CommissionPowers to construct, operate, and maintain the Turnpike System and issue revenue bonds, repayable solely from tolls and other Commission revenuesPennsylvania population: ~12 millionVehicle trips (May 2007)Passenger: 160 millionCommercial: 25 millionTotal: 185 millionGross fare revenue (May 2007)Passenger: $323 millionCommercial: $295 millionTotal: $618 million17

  • Operations (FYE May)18Source: Pennsylvania Turnpike Commission 2007 Comprehensive Annual Financial ReportVehicle TripsGross Fare RevenueVehicle Trips (% Split)Gross Fare Revenue (% Split)(in $mm)

  • Toll HistoryErosion of real toll value over the years has led to severe lack of profitability of the Turnpike (like many toll roads)Variable costs and interest rates increase every year by inflation, so tolls should also increase by inflation to preserve the integrity of the toll roads cash flowsBut the act of raising tolls is difficult from a political perspective

    19Source: www.InflationData.comIllustrative Value of $1.00 from 1940

  • TimelineNovember 2006: Study by the Pennsylvania Transportation Funding and Reform Commission (PTFRC) note critical need for annual investment of $1.725 billion to fund maintenance, repair and expansion of state roads May 2007: Morgan Stanley report analyzes various alternatives including a long-term lease, public corporation/leverage, and a PTC proposalSources indicate $12-18 billion as an indicative valuation range for a leaseSeptember 2007: Governor Ed Rendell solicits qualifications for potential bidders for the Turnpike in anticipation of a leaseMay 2008: Final winning bid announcedAbertis / Citi consortium offers $12.8 billionGoldman Sachs / Transurban consortium offers $12.1 billionSeptember 2008: Financial crisis deepens with collapse of Lehman Brothers

    20Source: For Whom the Road Tolls: Corporate Asset or Public Good (An Analysis of Financial and Strategic Alternatives for The Pennsylvania Turnpike

  • ValuationWinning bid of $12.8 billion also contemplates an additional $1.7 billion to fund the beginning of operations (total consideration of $14.5 billion)Purchase price funded by mixture of equity and debtCritics noted the use of leverage for the investment was more conservative than structures typically used at the time (ex. 80% or even 90% debt for infrastructure assets like the Turnpike)Capital structure of winning bid:$8.5 billion of debt, includinga $250 million capex facility$6.0 billion of equityBid perceived to fall short of goalValuation = 35x EBITDA365 million (2007)Relatively low compared toSkyway and ITR transactions

    21Source: InfraNews

  • CriticismWinning bid anchored by foreign investorAbertis is a Spanish transportation and telecommunications firm (founded in 2003 after a merger of two companies founded in 1967 and 1971)Operate 6,700 km of motorways in Europe, and several international airportsPublic company traded on the Bolsa de Madrid (BMAD: ABE)Earned 3.9 billion Euros of revenue (2009); over 12,000 employeesValuation not as high as previously contemplatedFinal bids were around $12 billion, the low end of valuation range originally indicatedGovernor Rendell indicated later that the $18 billion range contemplated tolls being increased 5.5% annually (not possible since tolls would be capped to the greater of 2.5% or CPI)State Assembly vote would face opposition from publicBid expiration was extended twice by the consortium to facilitate discussion22Source: InfraNews, Abertis

  • Decision23What Would You Do?If you were a State Congressman...

  • OutcomeState Assembly ultimately did not hold voteSome members of Congress were offended by low valuation, although some confessed that the vote would not have been favorable in any caseUnforeseen issues:Credit crisis eroded debt markets for financingEquity sponsors less willing to make investments due to uncertaintyState finances eroded as tax revenues were lower due to high unemploymentMunicipalities unable to refinance debt (and break out-of-the-money interest rate swaps) or issue lower cost debt due to credit riskCiti Infrastructure Investors moved on soon after to bid on Midway Airport (large hub airport in Chicago area)Bid also failed since acquisition was contingent on securing financingClosed credit markets provided challenge24

  • 6: Thesis Application in the Real World

  • Goldman SachsInvestment BankingMergers and AcquisitionsIndustry coverage groups (Technology, Media and Telecom (TMT), Natural Resources, Financial Institutions, Industrials, Consumer/Retail, Real Estate)Product group (Leveraged Finance, Equity Capital Markets, Derivatives)Asset ManagementAsset Management (GSAM) and Private Wealth Management (PWM)Trading and Principal InvestmentsEquitiesFixed Income, Currency, Commodities (includes Special Situations Group)Merchant Banking/Private Equity DivisionPrincipal Investment Area (Corporate Equity, Corporate Debt, Mezzanine, Real Estate, Infrastructure)


  • What is Private Equity?Acquisition through leveraged buyout (LBO) of mature, stable cash flow businesses with free cash flow generation used to support debt serviceReasonable growth, defensive business model, strong management team, low capital expenditures, over-equitized capital structureLeverage used to increase purchase price in auctions2004-2007: 75% debt / 25% equity, low cost of debt (low credit spreads)2008 and after: at most 50% debt / 50% equity

    Private Equity Firm (General Partner)Investors (Limited Partners)Private Equity Fund(Limited Partnership)Investment AInvestment BInvestment C26

  • Characteristics of Infrastructure InvestmentsStabilityProvision of essential services to communitiesInsulated from business cycles, high barriers to entryDuration