MACQUARIE CAPITALSOUTH AUSTRALIA TRANSPORT 2012

June 2012

AGENDA1 STATE OF PLAY2 POSSIBLE SOLUTIONS3 IS DEMAND RISK MODEL DEAD?

Projects impacted by political constraints

STATE OF PLAY – BALANCE SHEET

CONSTRAINTS

Mantra Debt reduction Budget surplus

RealityDowngraded to

AA+ post budget

State 50% net debt

metric under threat

Source: South Australia Budget Paper 2012 – 2013, S&P Credit Rating Report October 2011

50%

60%

70%

80%

90%

100%

110%

120%

130%

140%

0

1000

2000

3000

4000

5000

6000

7000

8000

9000

10000

2011A 2012A 2013F 2014F 2015F 2016F

Net F

inan

cia

l Lia

bilitie

s to re

venue (%

)

Net D

ebt (

$m

)

Net Debt S&P Credit Rating Limit Net Financial Liabilities to Revenue

Large backlog of projects

Outcome: absent changes, needed projects are not getting done

Various estimates of national infrastructure spending requirements exist

— $770 billion to 2018 (Citigroup, June 2008)

— $455 billion over the next decade (ABN AMRO, May 2008)

Gap between infrastructure supply and demand exists across most asset classes,

including road, electricity, gas, water and rail1

Backlog growing

New financing structures required to incentives private sector involvement

STATE OF PLAY – CONCLUSION

1. See Infrastructure Australia, ‘Infrastructure Finance Reform’ (Issues Paper), July 2011

Short term hump or long term trend?

Public debt rebalancing is a global issue and will take significant time

LOOKING TO THE FUTURE

Government net debt forecast 2011-15 (% of GDP)

Source: Commonwealth Government, MYEFO 2010-11; IMF, ‘Fiscal Monitor’, April 2011

0%

40%

80%

120%

160%

Australia Canada Germany US UK France Italy Japan

Not a shortage of capital, but a shortage of projects

Superannuation industry has $1.4 trillion of assets under management1

Forecast to increase to $5 trillion over the next 15 years2

Need a transparent pipeline of infrastructure investments to promote efficient project

delivery

LOOKING TO THE FUTURE

1. APRA, ‘Statistics: Quarterly Superannuation Performance’, March 2011

2. Association of Superannuation Funds of Australia, ‘Challenges of Financing Infrastructure’ (ASFA Paper), May 2011

Productivity and competitiveness under threat

Productivity has plateaued and is beginning to decline

Poor / weak productivity growth by international standards

Australia exposed post resources boom

IMPLICATIONS FOR AUSTRALIA

Multifactor productivity index

Source: ABS, ‘Measures of Australia’s Progress’, 2010; OECD,

‘Compendium of Productivity Indicators’, 2008

Average multifactor productivity growth (2001-06)

-1%

0%

1%

2%

3%

Sw

ed

en

Ire

lan

d

Ja

pa

n

Belg

ium

Fin

lan

d

US

UK

Fra

nc

e

Ge

rma

ny

Au

str

ali

a

Neth

erl

an

ds

Den

ma

rk

Au

str

ia

Ca

na

da

Po

rtu

ga

l

Sp

ain

New

Ze

ala

nd

Sw

itze

rla

nd

Ita

ly

70

80

90

100

110

1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

Perceptions of infrastructure investment

Alternative – redeploy government capital from existing assets to new assets

Political challenges in arguing these cases

Possible additional solution to address political issues…

POSSIBLE SOLUTIONS

INFRASTRUCTURE

=

INVESTMENT

INFRASTRUCTURE

≠

DEBT

-$60

-$40

-$20

$0

$20

$40

$60

Tax losses

Infrastructure projects typically generate large tax losses during construction

AN ALTERNATIVE SOLUTION

Annual income for tax purposes (rebased to $100 of equity)

Construction Operations

Utilisation of tax losses by investors (current)

Tax losses are carried forward and investors don’t pay tax for a number of years

AN ALTERNATIVE SOLUTION

1. Assumes marginal tax rate of 15% for investors (eg super funds)

$0

$5

$10

$15

Annual tax paid (rebased to $100 of equity)1

$0

$5

$10

$15

Utilisation of tax losses by investors (proposal)

Tax losses become claimable immediately by investors to offset other income

Timing benefit worth 15 - 25% of equity requirement depending on marginal tax rates

AN ALTERNATIVE SOLUTION

Annual tax paid (rebased to $100 of equity)

Construction

Tax credits

claimed

immediately

by investors1

1. Assumes top marginal tax rate of 46.5% for investors during construction

2. Assumes marginal tax rate of 15% for investors during operations

Early operations

Tax losses have been used

tax paid by investors2

Late operations

No difference as tax would be payable under both cases2

Net positive for tax revenues

Reduces funding gaps

Allows some marginal projects to proceed with private financing

Construction and operations of the new projects will generate incremental tax

revenues (income, payroll, GST)

For $100 equity, p.a. Construction period Early operations period Late operations period

Investor tax Foregone revenue from

tax credits ~$151

~$3 tax paid by investors as

tax credits have been used3

No change once timing

benefit is exhausted

Additional tax

revenues

~$100 D&C spend

~$25 of tax revenue2

~$20 O&M spend

~$5 of tax revenue2

~$20 O&M spend

~$5 of tax revenue2

Net revenue4 + ~$10 + ~$8 + ~$5

AN ALTERNATIVE SOLUTION

1. Assumes top marginal tax rate of 46.5% for investors during construction

2. Assumes 25% average tax rate from incremental infrastructure spending

3. Assumes marginal tax rate of 15% for investors during operations

4. Benefits exclude multiplier effect of infrastructure investment

Recent project failures have led some to proclaim that the traditional demand-risk based PPP model is no

longer acceptable

STATEMENT: THE DEMAND-RISK PPP MODEL IS

DEAD

“The PPP toll road model is dead... the extent of risk

transfer and because the unending stream of extra demands

placed on concessionaires have made roads so expensive

motorists won’t use them.”

Construction Industry Executive

“Governments have been greedy... and this has contributed

to the financial collapse of projects such as Sydney’s Lane

Cove Tunnel... There isn’t a one-size-fits-all template”

Government Official

“Over time, patronage models have become more complex,

sophisticated and more expensive... Currently, the private

sector will not willingly accept greenfield patronage

forecasting risk.”

Construction Industry Group

• The financial failures of high-profile PPP projects (e.g. Lane

Cove / Cross City Tunnels in NSW, CLEM7 tunnel in QLD)

have led many investors to become highly sceptical

• Bidders with the most aggressive assumptions were

previously selected by the government to win bids, which led

the market to respond with increasingly biased forecasts of

traffic

• Critics argue that PPP bids fundamentally rest on

questionable ramp-up curves, initial patronage and a host of

other expansion factors which are subject to significant

optimism bias

Despite these claims and the challenging market conditions, patronage-risk deals are still being completed

both globally and in Australia

Source: Queensland Health, RF Annual Privatisation Report 2011, French Ministre de l'Équipement, Virginia Department of Transportation

REALITY: PATRONAGE DEALS ARE STILL BEING

DONE

Country

Year of

Financial

Close Project

Infrastructure

type

Concession

length Enterprise value

Australia 2010 Gold Coast University Hospital Car Park Car park 30 years ~A$80m

Australia 2011 Queen Elizabeth II Medical Center Car Park Car Park 26 years ~A$100m

Australia Pending Sunshine Coast University Hospital Car Park Car park 25 years TBD

Argentina 2011 Corredor Vial del Atlantico Toll road 30 years US$1.9bn

Brazil 2011 Rio de Janeiro – Bahia highway Toll road 25 years US$1.14bn

Chile 2011 Autopistas de la Region de Antofagasta Toll road 35 years US$320m

France 2011 Tours-Bordeaux High Speed Rail Rail 50 years €7.8bn

Italy 2010 Milan East Ring Road Toll road 50 years €2.0n

United States 2009 North Tarrant Tunnel Toll road 52 years US$2.0bn

United States 2010 LBJ Managed Lanes Toll road 52 years US$2.78bn

United States 2011 Virginia Midtown Tunnel construction and Downtown Tunnel renovation Toll road 58 years US$1.47bn

Overview Highlights

MIDTOWN TUNNEL CASE STUDY

Financial Close April 2012

Deal Size (USD) $2,092m

Total Debt (USD) $1,097m

Concession Type Design, Build, Finance, Operate & Toll

Concession Period 58 years

Concessionaire Elizabeth River Crossings Opco, LLC

Expected Construction

Completion

December 2016

Value $675m

Ratings S&P BBB-; Fitch BBB-

Coupon 4.45% - 5.50% pa

All-in yield 5.47% pa

Amortisation 2022-2042

Public Activity Bonds

Market appetite for pure demand risk projects, both for debt and equity, remain strong

• The Midtown Tunnel project was a PPP concession for the

design, build, finance, operation, maintenance and tolling of

two crossings of the Elizabeth River between Portsmouth and

Norfolk, Virginia.

• The consortium ran a multi-source debt process which

included banks and Public-Activity-Bonds (PABs)

• Project represents the largest capital markets issue for a

private US toll road since GFC

• PABs were over-subscribed 4X, enabling underwriters to

tighten final pricing to an all-in rate of 100bps below the

benchmark infrastructure project borrowing rate

Forecasting demand accurately, particularly during ramp-up, can be challenging

• Li & Hensher (2010) found that actual first-year traffic for the

last five Australian toll road projects were, on average, 45%

below bid forecasts

• A similar international study by Standard & Poor’s (2004) of 87

European and Australasian toll roads reported a similar

over-estimation of 20-30%

STATEMENT: FORECASTING INITIAL PATRONAGE

IS IMPOSSIBLE

Year 1 traffic forecasting performance

Toll Road Error (%)

M2 (32.8%)

M7 (51.8%)

Cross City Tunnel (51.1%)

Lane Cove Tunnel (37.0%)

Eastlink (45.0%)

Source: Li & Hensher (2010)

Research shows that the forecast error – the difference between actual and forecast traffic – decreases over

the life of the asset

REALITY: ACTUAL TRAFFIC TENDS TO

CONVERGE TO FORECAST TRAFFIC OVER TIME

Actual versus forecast traffic (AADT) for CityLinkOverview

450

500

550

600

650

700

750

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Avera

ge A

nnual D

aily

Tra

nsactio

ns (

000's

A

AD

T)

Actual traffic Forecast Traffic

Source: Transurban

• Li & Hensher (2010) found that the forecast error decreases

by 2.5 percentage points per annum

• The Year 1 forecasting error for the M2 was

-32.8% in 1998, but ten years later in 2007, the actual

level of traffic was almost exactly the same as the initial

forecasts

• The Year 1 forecasting error for Eastlink was -45.0% in

2008, but 3 years later in 2011, the forecasting error had

decreased to -28.0%.

• Similar results are reported both globally and in the United

States (US Transportation Research Board, 2006; Vasallo,

2007; Phibbs, 2007)

Not all failed PPP projects have resulted in public bailouts

• When the Cross City Tunnel became insolvent in Dec 2006,

the NSW Government was not required to provide financial

assistance

• Instead, the tollway was subsequently sold to a syndicate,

with the original equity investors realising considerable

financial losses

• This example demonstrate that the risk transfer mechanism is

efficient, with the private sector bearing the project risks in

return for the rewards

• Various structures exist which can rebalance the risk

allocation between the private and public sector

REALITY: VARIOUS STRUCTURES EXIST WHICH CAN

MITIGATE RISK OF FAILURE IN ECONOMIC PPPS

Variable concession length

• Private sector bids a fixed level of tolls and the government

adjusts the concession length to allow a reasonable return on

facility construction costs, taking into account traffic levels

Public Sector Development Company

• Government takes responsibility for projects during

development and refinances with private sector capital after

revenues have stabilised

• Previously used by QLD Government to fund Gateway Bridge

Upgrade

Downside protection and upside capping

• Government provides downside protection in the event of traffic

underperformance but caps the possible upside in the event of

traffic outperforming forecasts

1. The patronage-risk PPP model is not obsolete

• On the contrary, economic infrastructure PPPs continue to be required by governments to fund infrastructure

development

2. Forecasting initial patronage will always be challenging, however:

• Where traffic has initially underperformed, in most instances, actual traffic has converged to forecast levels after

demand ramp-up and infrastructure establishment has occurred

• Structures exist to mitigate the risk of poor revenue modelling

3. Myriad opportunities exist for the government to collaborate with the private sector to deliver and meet the nation’s

infrastructure funding requirements

CONCLUSION