Turning Asphalt to Gold

By JENNY ANDERSON, New York Times

January 20, 2006

In late 2004, Goldman Sachs advised the city of Chicago on the $1.83 billion sale of a 99-year concession for its Skyway toll road. For its work, the firm received a nice $9 million fee. More important, Goldman also got inspiration.

Across the negotiating table was an Australian bank that until recently was little known outside its home country: Macquarie Bank. In recent years, Macquarie has become the envy of Wall Street by buying the rights to operate infrastructure projects including ports, tunnels and airports, as well as toll roads, packaging them in funds and reselling the stock in those funds to the public, minting money at each stage along the way.

Now Goldman is raising a $3 billion fund to invest in similar public infrastructure deals. Another unit of the bank recently bid on a public-private partnership to run the Dulles Toll Road outside Washington. Mark B. Florian, the municipal finance banker who advised Chicago on the Skyway deal, has moved to New York to oversee the bank's efforts to advise on, invest in and better understand infrastructure assets.

And Goldman is not alone. If imitation is the sincerest form of flattery, the best and brightest of Wall Street are for once not complimenting each other, but an outsider on the rise. Credit Suisse, Merrill Lynch, Morgan Stanley and UBS are all in different stages of exploring how to make money on public infrastructure, both as an adviser to others and as a principal in investing in the deals.

Credit Suisse is looking at how to leverage its expertise in buying real estate and advising on the sale of airports; both UBS and Credit Suisse are trying to gauge whether their big private banking clients would be interested in the assets.

"Before anyone else, Macquarie saw the potential of the U.S. market," said Robert W. Poole Jr., the director of transportation studies at the Reason Foundation, a libertarian research group. "They have the most robust model of highways as a new utility that can be an investor-owned utility like gas and electric utilities."

With local and state governments in the United States in search of ways to increase revenue without raising taxes or issuing bonds, public-private partnerships have recently become a hot-ticket investment idea.

During the last 12 months, more than $20 billion worth of private sector proposals have been submitted to transportation departments from Georgia to Oregon, according to a study by Mr. Poole. Just last night, bankers from Wall Street firms were working late to polish bids for the Indiana Toll Road.

"There's opportunity popping up all over the U.S.," said Greg Hulsizer, chief executive of California Transportation Ventures. In 1991, the company won a concession to build the South Bay Expressway, a 10-mile tollway in San Diego, and it is now owned by a Macquarie fund.

"It's not uncommon to see public-private partnerships for infrastructure around the world, especially in Europe," he said, "Here in the States, it's a new, emerging trend."

Macquarie came into its own only in 1985, when, as a subsidiary of Hill Samuel & Company, a British merchant bank, it received an Australian banking license. It is now a deal powerhouse; in 2004 and 2005, it bought $17 billion worth of global infrastructure assets, according to Thomson Financial.

Its model looks particularly alluring to Wall Street. Using a small capital base, Macquarie acquires giant assets by borrowing other people's money, then packages the assets into funds, which are sold to investors through public offerings or as unlisted funds. Along the way, it makes a killing on fees.

"It's an obvious gold mine," said one competitor who asked not to be named because his bank is working on its own infrastructure strategy.

The pitch to governments is simple: Macquarie will look after the assets - maintaining the roads or ports, raising toll road fees to make the investment more profitable - then give them back, in 99 years or so.

"It's not a sell-off of the family silverware," says Murray Bleach, head of Macquarie's North American infrastructure advisory business. "You leave it with someone who can polish it up and earn more money for the use of it."

Unlike private equity funds, which look for rates of return of 20 to 30 percent, these funds expect returns in the low to high teens, according to Macquarie officials, or 6 to 12 percent, according to competitors.

Macquarie has recognized that global investors have a seemingly insatiable appetite for dependable returns of 5 to 10 percent, especially since government bond yields have been lower of late.

The potential for fees in these public infrastructure deals is astounding, even by Wall Street's obsessive and excessive fee standards. Bankers can make advisory fees on the sale of the often-large assets. Then, once packaged into funds, the assets earn Macquarie management fees (1 to 1.5 percent) as well as incentive fees: 20 percent on profits above a certain threshold. The thresholds vary, based on benchmarks appropriate to the assets in the funds.

The model has risks. Low interest rates have provided flush financing for Macquarie. In essence, its deals are like leveraged buyouts: it provides the equity, borrows the debt and rakes in rich fees. Higher interest rates would make debt financing less attractive and could affect returns across the board.

This week, Macquarie's chief financial officer told Bloomberg News that the bank would earn no performance fees for any of its infrastructure or specialized funds for the six months that ended Dec. 31, which will reduce the bank's revenues.

"The rush into this will create some opacity around risk," said one Wall Street executive who is also looking at this strategy and insisted on anonymity because his bank did not yet have its strategy developed. "There will be other shoes to drop on this."

For its part, Macquarie welcomes Wall Street's crashing its party. "We've been saying it's a great asset class and now some of our dear friends are joining," Mr. Bleach of Macquarie said. "The market is not static. There will be plenty of assets to buy."

The Australian bank's model is a result of national circumstances. A 1992 law required employers to set aside a percentage of their employees' income for retirement. Today, workers are required to set aside at least 9 percent, which has helped build a national retirement nest egg of $591 billion, with $70 billion to $80 billion added every year - providing a huge cushion of capital to Australian banks.

Macquarie bankers had been advising the Australian government on the sale of public assets when it started a privatization drive in the early 1990's. Nicholas Moore, the head of investment banking in Sydney, decided the bank should get in on the action. In 1996, a Macquarie fund made an investment in an Australian toll road.

Today, Macquarie has roughly $23 billion invested in what the bank calls specialized infrastructure funds. The specialist funds have contributed heavily to the bank's bottom line. For the half-year that ended September 2005, corporate finance, which includes the specialist funds as well as advisory and financing work, contributed 41 percent of the bank's profit of 482 million Australian dollars ($360.5 million). Macquarie shares have risen more than 900 percent since they made their debut on the Australian Stock Exchange in July 1996. Macquarie's funds are invested all over the world and trade on various global exchanges: Macquarie Infrastructure Company Trust trades on the New York Stock Exchange, for example.

Macquarie's name is everywhere - its deals have been called Macquisitions - including a listing as a lead bidder for the London Stock Exchange. Recently, Macquarie has bought cooling systems in Chicago, satellite parking lots at various American airports and, most recently, with Black Diamond Capital Management, the Smart Carte Corporation, the concessionaire for baggage carts and strollers at airports across the United States.

The bank is frequently accused of overpaying. When it bid $1.83 billion for the Chicago Skyway with Cintra, a Spanish private sector developer of transportation infrastructure, the next closest bid was $700 million.

"Our view was we didn't overpay," Mr. Bleach said. "The market says we didn't." The bank refinanced about $1 billion of the debt in 2005, recouping about half of that for the equity partners.

The Chicago Skyway deal sheds some light on why such a concession might be attractive to governments. When Macquarie, together with Cintra, won the 99-year concession to run the Skyway, the city set aside a rainy day fund of $500 million, paid down $855 million in Skyway and city debt, set up an eight-year $375 million annuity and even had some money left over, which it will use to deliver heat to the city's neediest people.

In exchange, Macquarie and Cintra will operate the toll road, which generates about $20 million in cash flow a year, for 35 years. The concessionaires will be able to raise tolls and will be required to maintain the tollway.

"The economic analysis in favor of doing the deal was overwhelming." said John R. Schmidt, a lawyer from Mayer Brown Rowe & Maw who represented the city.

California has also seen advantages in doing a deal with Macquarie. In 1991, California Transportation Ventures won the right to build Route 125, a 10-mile toll road connecting one of the fastest-growing cities in the country, Chula Vista, to a major thoroughfare. But it took more than a decade to have environmental permits approved - the Quino checkerspot butterfly was discovered on the land - forcing the company to look for an infusion of capital. In two deals, Macquarie bought 100 percent of the partnership rights to the concession, and the toll road is under construction.

"We get a much-needed facility without having to divert funds from other projects to build it," said Laurie Berman, deputy district director for the California Department of Transportation.

Now that most of Wall Street is rushing in, it is unclear whether there will be enough investors who want to put their money in public infrastructure funds. And more competitors may just raise the prices of available assets.

As it grows, Macquarie will face its own challenges. It has had only two major mistakes, investments it has since sold: a power station and a fiber optic network, both in Australia. It cannot afford many more.

"It's not like we will make 50 percent on one asset and zero on another," Mr. Bleach of Macquarie said. "It's more like 13, 14, 15. We can't have any zeros."