When Indiana leaders inked a deal in 2006 to lease a 157-mile toll road to private investors, many in the state balked. In exchange for a $3.8 billion, lump-sum payment, the investors would get to keep toll road revenue for 75 years. Critics claimed state leaders had given up a valuable revenue stream in exchange for a one-time cash infusion and that they had given little regard to the long-term implications. “Governments,” wrote B. Patrick Bauer, the Democratic leader of the state House at the time, “should not be in the business of enriching private companies at the expense of those they serve.”
Fast-forward five years, and it’s clear that the deal was anything but a giveaway. The investors, not the state, are suffering under the expense of the deal. One report from the business news service Debtwire suggests that, by next year, the project’s partners -- Australian bank Macquarie and Spanish firm Cintra -- may not be able to make the debt payments tied to the deal. In a prospectus for investors, Macquarie notes that the Indiana Toll Road revenues are expected to remain insufficient to cover debt service in the medium term, and without an improved economic outlook and a boost in toll revenues, there’s a risk that its reserves won’t be sufficient to pay the debt when it matures in 2015. “Should this occur, any default under the loan documents may lead to lender actions which may include foreclosure of the project assets or bankruptcy,” Macquarie wrote. The project had net losses in excess of $260 million last year, according to Macquarie’s financials.
The situation has prompted Gov. Mitch Daniels, who helped negotiate the deal, to brag that the investors overpaid. “That’s why you hold an auction,” Daniels has said. “Sometimes, you hit the jackpot.” In 2009, he famously told Barron’s that the arrangement was the “best deal since Manhattan was sold for beads.”
By most accounts, the project has been a windfall for Indiana, with little downside to taxpayers. “They got more than they should have gotten,” says Peter Samuel, who runs the trade publication TOLLROADSnews. “They wouldn’t get that today.”
There has been some speculation that the deal might have been too good. Indiana’s gain may be a loss for other states pursuing similar projects. Investors are likely to notice that a project that, at one time, was the poster child for public-private partnerships now looks more like a dubious deal.
Take the case of Ohio, which is considering a similar arrangement with its turnpike. Gov. John Kasich has speculated that the deal could be worth as much as $3 billion. That may, however, be an overly optimistic figure, given what’s happened to the Indiana Toll Road (ITR). Financial experts say they expect private investors to take a more conservative approach to public-private partnerships and insist that their public partners take on a greater share of the risk. “They realize they have government entities over a barrel,” says Indiana state Rep. Terri Austin. “They’re saying, ‘You want our money? We’re going to dictate some of the rules.’”
The problem for the ITR’s investors -- and one that can potentially unravel similar deals -- is the imprecise nature of traffic projections. They are, transportation officials admit, notoriously unreliable and more of an art form than a science. If investors guess too high, they could lose big sums. But if they guess too low, they might wind up losing out on a good deal. The ITR deal was a case of especially bad timing, since there’s no way Macquarie and Cintra could have predicted that the worst economic downturn since the Great Depression would strike so soon after the ink dried on the contract. The ITR “was bought during a bubble and the [new owners are] trying to operate during a recession,” says David Ellis, a research economist with the Texas Transportation Institute. “To expect for this to be a rosy time might be a little bit contrary to logic.”
Americans, still suffering the effects of a recession while facing elevating gas prices, aren’t driving as much as they used to. Moreover, the volume of commercial truck traffic -- key to the success or failure of the ITR -- is tied directly to the state of the economy at large. With those trucks not hauling the volume of products they once did, it’s no surprise the investors are struggling.
The ITR isn’t the only deal that’s giving its private partners financial fits. In San Diego, the regional planning agency is considering buying the lease to the South Bay Expressway toll road after the previous operator -- a Macquarie subsidiary -- went bankrupt. And the landmark deal for Chicago’s Skyway, another Macquarie and Cintra venture, is also highly leveraged, with $439 million in debt maturing in 2017. The ability to refinance that debt will depend on continued traffic and revenue growth, according to a Macquarie prospectus. Though revenues are climbing, traffic on the Skyway is down 5 percent from this time a year ago.
In the long term, public-private partnership (P3) contracts in the U.S. may start to adopt characteristics of deals structured abroad, including more flexibility and risk sharing, says Art Smith, vice chair of a United Nations panel that examines P3 issues. Some projects in Spain are structured with “contract balancing” that allows the government to extend the length of a contract if the contractor is performing well but traffic is lower than projected. If volume exceeds expectations, the government can end the deal prematurely. Similarly, a technique in South Korea sets a floor in the contract, and if traffic falls below that level, the government will step in and assist the contractor with a portion of that lost revenue. If traffic rises above a threshold, the investor would share a portion of those profits with the government. Availability payments, in which a public entity agrees to make regular payments to the private entity based on the quality of service, as opposed to actual traffic volume, may become increasingly common too. A Florida project is poised to be the first in the U.S. to use that technique.
Meanwhile, the losses in Indiana aren’t dampening the interest of investors. A partnership led by an arm of Goldman Sachs won a P3 bid in Puerto Rico earlier this summer, paying $1.4 billion to operate two toll roads over the next 40 years. It beat out a Morgan Stanley-led team to secure the deal. Moreover, governments’ desire for P3s is on the rise. With state and federal highway budgets stretched, lawmakers are reluctant to supplement them with higher gas taxes or general fund revenue. That makes P3s an attractive option, and in some circles they have been portrayed as a miracle cure for the country’s crumbling infrastructure.
States have been acting to put the right pieces in place to make P3s possible. Thirty-one have passed legislation that enable P3s, according to the National Conference of State Legislatures. This year, Arizona, Arkansas, Indiana and Ohio created or expanded their P3 authority. At the federal level, while the House and Senate have introduced wildly different highway bills, there is broad agreement from both sides on a plan to increase funding for a federal program called TIFIA (Transportation Infrastructure Finance and Innovation Act), which allows state and local governments to borrow federal funds for their projects. Transportation leaders say TIFIA is especially useful for financing public-private partnerships.
Investors, aware that many governments view P3s as a solution to their budget woes, are poised to take advantage of these opportunities. They’ll be careful not to repeat the mistakes of the ITR. It isn’t just investors who suffer if a deal goes bad. There’s a possible downside for governments as well. If the private partner goes bankrupt, the state could be on the hook for its debt payments, state Rep. Austin says, although officials from the Indiana Department of Transportation insist that isn’t the case.
Most experts believe that the best P3s are those that provide a fair return to all sides, and the goal shouldn’t be to break either party. Will Wingfield, a spokesman for the Indiana Department of Transportation, says that if the ITR project defaults or declares bankruptcy, Macquarie and Cintra would have the opportunity to find new investors. If that effort fails, tolling authority would return to the state, and Indiana would keep its lump-sum payment.
Troubled though the project is, it’s important to distinguish between the high levels of debt hurting the investors and the actual operations of the road. “We knew at the outset that they were taking advantage of a lot of debt to finance the deal that was made,” Wingfield says. “We still believe that the toll road itself is in pretty solid shape in terms of the revenue coming in and its condition.” Cintra, for its part, released a statement defending the project, saying it would continue to make its debt payments and remain solvent, although it acknowledged there’s a chance, as with any project, that there could be a default if net toll revenues fall below projections in the long term. “But it is worth noting that although default would be extremely unpleasant for investors, it would allow the state to take over a much-needed project at a fraction of its cost,” Patrick Rhode, vice president of corporate affairs for Cintra US, said in a statement.
Some experts view the hype about ITR losses as much ado about nothing. “If a toll road had two or three bad years in years 31 or 32, nobody would probably notice,” says Ellis, the Texas economist. “Because we went into this recession at the time shortly after the toll road was purchased, everyone says the concept might not work. I’d argue we’ll have to give it a lot more time.”