The Next Frontier - Listed Infrastructure in America
Q&A with RARE Infrastructure CO-CEO Richard Elmslie
Monday, June 5, 2017, President Trump announced plans for a week‑long focus on infrastructure, starting with privatizing air traffic control. In general, what are the requirements for infrastructure investment in America?
Richard Elmslie: The first requirement is that you need bipartisan support. The Trump administration has that – because the Democrats are interested in doing some privatization of infrastructure.
The second requirement is a President who wants to do something with assets, and he's identified 50 assets that he thinks are prime candidates for infrastructure. Many of those assets have been privatized elsewhere in the world without tax incentives, and have been privatized with private debt and equity supporting those assets and bringing them from government ownership to private ownership, so there's no reason why the Trump assets can't do the same.
Many of the assets, though, that Trump has identified are not owned by the federal government. They're owned by state governments, so the federal government needs to provide incentives for the state’s governments to want to dispose of those assets.
That's not dissimilar to what's happened in Australia, where many of the assets are earned by the state governments. The federal government put in place a program whereby if the state government sold an infrastructure asset and then used the proceeds to go back into infrastructure, they provided a 15 percent boost to the sale price. I understand that Gary Cohn, one of Trump's advisors, is actually talking with Joe Hockey, who is the treasurer of the federal government in Australia, about the Australian process.
Americans have traditionally not wanted to pay for their infrastructure. What has traditionally happened is the government has built the infrastructure, and they never maintained it. That's the problem we have at the moment, because it's in very poor condition because it wasn't maintained.
The third requirement is a framework that's put in place that will attract private equity and debt to build these new assets and maintain these assets. I mentioned the 50 assets. Many of them can be financed through the private sector without tax benefits. The framework, which has been put in place in many other parts of the world, is generally a concession‑type framework. The government would award a concession to a private consortium to build or rebuild a road or a piece of infrastructure, and then to maintain that piece of infrastructure at a certain level for a 20‑year period, or 30‑year period, a set period of time.
That operator, over that period of time, would have earned a reasonable return commensurate for the risk. An operator doesn't really care how he or she gets the return, so long as over the defined period he or she gets that return.
Historically, the American public doesn't really like to pay for these assets. One way to introduce such a cost, say a toll, is to make the initial toll quite cheap and then increase it gradually year after year with inflation. Then every five years maybe it will go up by 20 percent, so that over a 20‑year life the operator gets the nine percent return, sufficient for him or her to put equity capital to use to rebuild the road. Debt gets paid out over that 20‑year period, and the public actually think it's a good deal because they're not paying a lot initially.
We have seen that before. Again, I come back to Australia. One of our largest pieces of infrastructure, which is still owned by the government, is the Harbour Bridge in Sydney. It was 20 cents for nearly 60 years and then in 1987 they put it up to a dollar. There was quite a large amount of public outcry, going from 20 cents to a dollar. Today it's about four dollars and nobody cares about it. They got used to it. Americans will accept the cost and get used to it.
What you really need out if this framework is for the consumers to think it's a good deal, for the vendor, being the government, to think it's a good deal, and for private enterprise to walk away thinking they've got a return commensurate for the risk, both for their debt and equity.
If you can successfully roll out one project, there will be others that follow because it will be a winning model. That is the model that's applied in Europe, Australia, and other parts of the world. It's been very successful. It could be applied to many of the 50 assets identified by president Trump.
What incentives are required for owners of assets to recycle capital to fund new projects? Do you have any examples where privatization or incentivization has been example?
Richard: The governments know that they've got assets that have dilapidated, and they need to be restored, and they don't have the money to do it. In order to get private capital involved, private capital really needs to know that there is a framework in place and that framework will be adhered to by the government.
That means that if I'm going to bid to rebuild a road, or to build a new road, or fix an airport, I need to know that if I'm going to spend the money on responding to an RFP, that that RFP is going to be adhered to, that there is a proper process for assessing the bids, and that the party will be awarded that asset on an unfettered basis, as outlined in the RFP, so that they can go about in rebuilding the road, or the airport, or whatever they have to do.
That way you'll attract private capital, because there's a framework and a process in place and that the private capital will bid on the basis that they get a return for their equity and debt. If you have a number of parties bidding, it should be a competitive process so that they're not gouging.
There are many examples all around the world where it's been successful. It depends how you define a success, because in some cases assets might have been sold too poorly, so very successful for the people who came in, and maybe the government didn't get the best price.
Again, I'll come back to Australia because they've been quite a large supporter of privatizing infrastructure assets. The most recent one is New South Wales' government sold most of its electricity assets and has used the proceeds to go back into infrastructure. They got a 15 percent bonus from the federal government. And one of the big projects they put the money back into was a very large road project called WestConnex. It's a nearly $20‑billion project. The government is now going to sell off stage one and stage two, which is worth around $15 billion, maybe a bit more, to some parties. They'll use some of the funding for that to complete stage three.
They're putting those proceeds back in to build to very large, $15, $120‑billion road for Sydney, and now they're going to sell of the rights to that road over a 20 to 25‑year period to a party to complete the development of the road, and then to maintain the road for the period of that concession.
From an investment perspective, once privatization occurs in the United States, who do you think will participate?
Richard: If they get the framework right, like I said, and they get one project completed and it's seen to be successful, I think you'll get many, many different parties wanting to be involved. You'll get many of the international banks wanting to be involved by providing debt finance.
You will get many of the infrastructure funds and infrastructure companies wanting to be involved on the equity end, also on being operators. That will be both listed and unlisted infrastructure companies.
On the listed front, the three largest operators of toll roads, as opposed to financiers, are all listed toll road companies around the world. You have Transurban in Australia. You have VINCI in France, Atlantia and Abertis in Italy and Spain. All of them would like to have some involvement if it's successful. Except for VINCI, each of them have actually had a look in America, but America's gone two steps forward, three steps backwards.
Obviously, there will be a side effect for consultants around the world who will be involved ‑‑ traffic consultants, and financial consultants, and engineers. Actually, it's a big spin‑off if they did the privatization successfully for many different businesses, but it will benefit both the listed and the unlisted participants.
What are some of the challenges that you see Trump facing?
Richard: The biggest challenge is, as I said before, he's got bipartisan support. He wants to do it, but he doesn't own the assets. He needs to find a Republican Governor who is very keen to improve the infrastructure in his or her State, who is aligned with Trump.
Trump’s team has identified an asset it thinks would be a good infrastructure asset to dispose of first. Air traffic control, to be honest, is an unusual asset to sell first, as many roads that could be resurfaced to be improved.
Nevertheless, the administration needs to establish a framework that gives private investors both debt and equity to the comfort that that framework going to an RFP period will be upheld and that, if they spend the money on submitting an RFP, which is very expensive, there will be a conclusion and there will be a party that will be awarded the right to build or modernize the particular asset for a period of time. That framework needs to be robust enough to provide the private equity and debt sufficient comfort that, over the life of that concession, they're actually going to receive the funds they believe, based on their concession model.
To sum it all up, the biggest risks to Trump are:
- Finding a Republican Governor that's of like mind to him
- Identifying the right asset
- Establish the right framework and ensure that framework isn’t changed during the RFP period
- The framework has to be able to survive the period of the concession without interference by government
About Richard Elmslie
As a founder, Co-Chief Executive and Co-Chief Investment Officer, Richard is a member of the Management and Investment Leadership Teams at RARE. As a member of the Investment Leadership Team, Richard is responsible for the governance and management of the investment team and the investment process. As a Portfolio Manager, Richard is a member of the investment committees responsible for the investment performance across all strategies.
Prior to founding RARE in 2006, Richard spent 19 years in the global infrastructure sector, including five years as Head of Power and Joint Head of Infrastructure at UBS Investment Bank. Highlights of Richard’s career include being part of the advisory team on the privatisation of the UK / Scottish and New Zealand Telecom, as well as team leader on the privatisation of major Australian airports in Sydney, Melbourne and Brisbane. Richard holds a Bachelor of Commerce from the University of New South Wales, is a member of the Institute of Chartered Accountants and is a Fellow of FINSIA.
About RARE Infrastructure Limited
Established in 2006, RARE is a dedicated infrastructure investment manager focused on global listed infrastructure. Headquartered in Sydney, with offices in Melbourne, London and Chicago, RARE became an affiliate of Legg Mason Inc. in 2015. RARE provides investors with high quality portfolios of listed infrastructure securities, focused around three key areas: global value, emerging markets and yield.
About Legg Mason, Inc,
Legg Mason, Inc. is a global asset management firm, with $731 billion in assets under management as of April 30, 2017. The company provides active asset management in many major investment centers throughout the world. Legg Mason is headquartered in Baltimore, Maryland, and its common stock is listed on the New York Stock Exchange (symbol: LM).
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