Infrastructure traffic builds

States eye sell-offs of toll roads, lotteries to save money — creating new investment opportunities

April 16, 2007

By Arleen Jacobius

If you sell it, they will come.

State legislatures are contemplating two dozen bills that would sell some of their crown jewels to private investors — everything from toll roads to state lotteries. If approved, those privatizations could encourage the growth of the nascent infrastructure asset class in the U.S.

Infrastructure investing is already a growing asset class in Europe, Canada and Australia. But in the U.S., with its well-developed municipal bond markets, the need for external financing has been less pressing.

“We’re in the first inning of a nine-inning ball game,” said Mike Dudkowski, vice president, Wilshire Consulting, Santa Monica, Calif.

Right now, there is more than $25.7 billion in public to private proposals for toll roads alone. Overall, an estimated $1.6 trillion is needed to repair and rebuild U.S. infrastructure, according to a recent paper by Deutsche Bank’s RREEF Real Estate Research.

Managers are eyeing a golden opportunity. Carlyle Group is raising a $1 billion infrastructure fund. JPMorgan Asset Management, Goldman Sachs & Co., Merrill Lynch & Co. Inc. and Morgan Stanley Investment Management are also moving into the area.

Real estate firms Starwood Capital Group LLC and RREEF Infrastructure, private equity firm AIG Highstar Capital LP and bond manager Nuveen Investments Inc. are also entering the fray.

Global investment management firms Macquarie Global Infrastructure Group, Babcock & Brown Ltd., UBS Global Asset Management and Global Infrastructure Partners, a joint venture between GE Infrastructure and Credit Suisse Group, are also offering infrastructure funds.

Early interest

U.S. investors are just starting to flirt with the investments, and so far only a smattering have taken the plunge. Among investors that have added either a first-time allocation or increased an existing allocation this year are the $11.8 billion Illinois State Board of Investment, Chicago, the $5.8 billion San Bernardino County (Calif.) Employees’ Retirement Association and $2.6 billion Cincinnati Retirement System.

The $100 billion New York City Retirement Systems, the $25 billion Arizona State Retirement System, Phoenix, and the $5.6 billion Michigan Municipal Employees’ Retirement System, Lansing, are also considering initial allocations.

Managers are betting that state governments will open the floodgates and offer public infrastructure projects for private investment. And some states are attempting to oblige. Pennsylvania Gov. Ed Rendell who asked state legislators this month to approve a bill to privatize the Pennsylvania Turnpike by June. Virginia and Utah passed legislation last year allowing the states to enter into concession agreements for private tollway operations and private road maintenance. Indiana and California are also entertaining privatization plans.

Also, three states — New Jersey, Illinois and Indiana — are considering using proceeds from privatized infrastructure projects to pay down pension debt.

49% leased

• The New Jersey bills, supported by Gov. Jon Corzine, would lease 49% of the New Jersey Turnpike, Garden State Expressway and the state lottery to private firms. Turnpike revenue would be contributed to the state’s pension funds, which have $79 billion in combined assets and $24.6 billion in unfunded liabilities.

• Illinois’ plan was announced by Gov. Rod Blagojevich earlier this month and a bill is now before the Legislature that would use proceeds from the sale or lease of the state lottery to pay down the state’s $41 billion pension liability.

• In Indiana, a bill that would authorize the privatization of the state’s lottery and use the proceeds to fund the state pension system passed the Senate and is in a House committee. So far, it has not received a hearing in the House. Last year, the state leased the Indiana Toll Road for 75 years in a $4.8 billion deal to a consortium led by Macquarie Infrastructure Group and Spain’s Cintra, Concesiones de Infraestructuras de Transporte SA.

And it’s not just states that are outsourcing the construction and maintenance of their infrastructure. A small number of municipalities are looking into privatization as well.

In Chicago, Mayor Richard M. Daley is behind a move to privatize Midway Airport. This month, Mr. Daley also proposed selling parts of the Chicago Transit Authority, the city’s mass transit system, to provide the cash needed to fund the CTA’s pension fund, which is 33% funded.

This is not Mr. Daley’s first move in this area. In 2005, Cintra Concesiones de Infraestructuras de Transporte and Australia’s Macquarie Infrastructure Group paid the city of Chicago $1.8 billion for a 99-year lease giving the consortium the right to run and receive tolls from the Chicago Skyway, a 7.8-mile elevated highway running from the city’s South Side to the Indiana border.

Federal backing

The federal government appears to be backing these moves. Mary Peters, the U.S. transportation secretary, has appeared in a number of states, most recently Pennsylvania, to support turning public infrastructure over to private operators. Earlier this month, she flew to Harrisburg to support the privatization of the 359-mile Pennsylvania Turnpike, which stretches from Ohio to New Jersey.

Privatization is not a new concept in the United States, said Leola Ross, portfolio strategist for Russell Investment Group¸ Tacoma, Wash., The federal railroad system, telecommunications systems, some water systems in California and utilities in Connecticut and New York are run by private operators, Ms. Ross said.

What’s changed is that co-investment opportunities and infrastructure funds are sprouting up while governments seek new sources of capital, according to a recent report Ms. Ross wrote with John Osborn, senior consultant at Russell.

Large public and corporate pension funds are attracted to the asset class because of its cash flow and relatively stable returns, Mr. Osborn said in an interview. Infrastructure also serves as an inflation hedge because most privatization contracts are linked to inflation, he said.

However, there are risks. “One big risk is political risk,” Wilshire’s Mr. Dudkowski said. Outside developed countries, the political risk is that the lease might be revoked. In the U.S., the risk is that politicians backing the privatization deal will be seen as giving away revenue-generating assets that could be used to defray costs and lower taxes, he said.

Another risk is potential revenue shortfall, Mr. Dudkowski said. Because initial analysis on volume and usage is typically for long periods — between 50 and 99 years — “small changes will have a huge impact on the value of the asset and the price,” he said.

What’s more, the first investors moving into a new asset class generally reap the largest returns. Subsequent returns stabilize over time with increased flow of investment dollars and investors, he said. “Investors in U.S. infrastructure are going to want to see that there are a number of opportunities within the U.S. in the years to come,” Mr. Dudkowski said.