The US infrastructure market is at an inflection point and it is poised for growth. It is expected to attract significant private capital in the coming years after decades of underinvestment.
Analysis of the 50 US state budgets shows that public spending on transport infrastructure is set to grow 11.6% over the next two years, up from 4.2% over the last two years. Infrastructure reinvestment is also expected to grow for the first time since the financial crisis. More states than ever now have public-private partnership (or P3) legislation and are opening dedicated P3 offices. States are increasingly publishing their infrastructure pipelines. They are moving forward with infrastructure and taking cues from Canada, Australia, the UK and Europe. Efforts are underway to streamline federal regulatory approvals.
The market in the United States is poised to attract new capital from institutional investors in the US and from abroad. There are proposals to broaden P3 regulations to allow more private capital into the market and investors are increasing their allocations to infrastructure. The sectors most likely to receive incremental private investment first are those that have clear user fees, are critical to the economy and are operating at a low standard. These include highways, airports and ports. Air traffic control is also high on the list because efforts are already underway for it to be privatized.
The electricity grid is facing many challenges from new sources and uses of power and has been identified by Congress and the administration as a priority. We expect continued near-record capital expenditures by utilities and additional government incentives to increase investment in the smart grid. Renewables have a well-functioning incentive plan in place by the states and the federal government and we do not anticipate any material changes. The freight rail industry is investing near record levels to prepare for future transportation growth.
Infrastructure is an essential part of the economy. People use transportation infrastructure every day to commute to work, travel freely, and visit their friends and family. Businesses depend on a well-functioning infrastructure system to obtain supplies, manage inventories and deliver goods and services to market. This is true for US companies whose businesses rely directly on the infrastructure system, such as UPS and CSX. It is also true for businesses that indirectly rely on the infrastructure system, such as farmers who use publicly funded infrastructure to ship crops to buyers and dot.com companies that send goods purchased online to customers throughout the world.
A modern transportation infrastructure network is necessary for an economy to function, and there is substantial empirical research that links the quality and quantity of infrastructure to competitiveness, productivity, economic growth and quality of life. In 1955 during his State of the Union address, President Eisenhower expressed his vision that “A modern, efficient highway system is essential to meet the needs of our growing population, our expanding economy and our national security.” This vision is even more relevant now than it was then. Today it would include making US highways and the nation’s entire transportation, telecommunication and power infrastructure more efficient and effective.
This three-part series will focus on the state of the US infrastructure market. We will look at the amount of infrastructure spending taking place now and the amount that is needed. We will assess new initiatives being discussed to finance infrastructure with public and private capital and the sectors most likely to attract new investment.
The US is at an inflection point on infrastructure and it has an extraordinary opportunity ahead of it
For much of the last century America’s infrastructure has supported and enabled innovation and has been a driver of US growth. During the Great Depression, federal funding supported construction of thousands of roads, bridges, airports and dams. During the 1950s, President Eisenhower spearheaded the National System of Interstate and Defense Highways. Under this 35-year program, 41,000 miles of critical roads were built by the states and funded mostly from fuel tax.
These massive federal programs are a thing of the past. Public officials lack the wherewithal to modernize US infrastructure. State and local governments still face funding gaps and tax revenues have not reached pre-crisis levels, although they are rising. The same is true of the federal government. What is needed now is a new way to plan for, pay for and deliver infrastructure. It is an opportune time for the US to pursue infrastructure because interest rates are low and funding is inexpensive. Economic growth is relatively strong and the availability of private capital looking for long-term steady returns is high. The challenge is enormous but the US has the resources to do it.
Infrastructure investment is poised for growth
As shown in Exhibit 1, US public construction spending, a proxy for infrastructure reinvestment rates, reached a 20-year low of 21% of total tax receipts in 2016.(1) This is expected to change in the next two years. Goldman Sachs’ most recent analysis of the Department of Transportation (DOT) budgets for the 50 US states points to higher public construction spending for the first time since the financial crisis (see Exhibit 2). It is being driven by 24 states that passed legislation in 2016 and 2017, adding new funding sources for transport infrastructure investment. Goldman Sachs expects growth of 5.5% and 6.1% in 2017 and 2018 (11.6% collectively), up from 0.1% and 4.1% for 2015 and 2016 (4.2% collectively). This represents a 175% increase for 2017 and 2018 vs. 2015 and 2016.
Exhibit 1. Public construction reinvestment rates coming off 20-year lows
California is leading the charge in new construction spending with a recent increase of 54% in its 2018 transport budget, which passed in April 2017 with 100% of the democratic majority voting to pass it. The bill calls to raise $52.4 billion over the next decade to pay for a massive program of rebuilding California’s highways and bridges and improving public transit. It will be paid for by a combination of revenue measures, including an increase in the state’s excise tax on gasoline from 28 cents to 40 cents per gallon, increased vehicle registration fees and a new $100 annual charge on emission-free vehicles.
Exhibit 2. State transportation investment picking up
Growth in state transportation investment (year-over-year %)
The US is ripe for new private investment. Budget constraints, past underinvestment, and more states than ever having P3-enabling legislation will drive state and local governments to provide incentives to investors. More state and local governments are publishing their pipelines and opening government infrastructure offices. Investors are increasing their allocations to infrastructure. All of these factors suggest the US is at an inflection point.
Continued progress in the public-private partnership (P3) market
The primary way for the government to tap private capital, other than through the municipal bond market, is through P3s. Private companies have long been involved in the construction of infrastructure, but their role has usually been that of a contractor with the ultimate responsibility for financing and delivering projects resting with a state or local agency. We believe this is on the cusp of changing.
The P3 contract was first introduced in the US in 1995 when State Route 91 was constructed in Southern California. Since then, 56 P3 projects have been funded with loans under the Transportation Infrastructure Finance and Innovation Act (TIFIA) and the number of projects has accelerated over the last 10 years (Exhibit 3).
Exhibit 3. TIFIA financing drives acceleration in P3 spending
All About Public-Private Partnerships
Public-private partnerships are referred to as P3s in the US, public-finance initiatives (PFIs) in the UK and PPPs elsewhere.
Availability-payment P3s. Once construction is completed, the private developer is entitled to payments from the government, as long as contract conditions are fulfilled. Availability payments are sized to cover operating and maintenance costs, debt service costs and equity returns as a private entity operates the project. Availability payments are not subject to swings in demand such as traffic levels and are typically adjusted downward only for lack of performance or lack of availability of the asset to the public. The availability-payment P3 is prevalent in the UK, where they are also called private finance initiatives (or PFIs), and in Canada, Australia, France, the Netherlands and Portugal.
Demand risk P3s. Demand risk P3s, or concessions, have a long history of public-private financing and have been used in many European countries and in Latin America, particularly for toll roads. Under a concession or demand risk P3, the project is largely financed by user fees and the government takes on no or only limited demand risk. This model is often used for toll roads, airports, public transport, and water, gas and electricity P3s.
Hybrid forms. P3 arrangements can have characteristics of both an availability-payment and a demand risk P3, exposing the government to a variety of potential liabilities: (1) explicit obligations such as availability payments; (2) contingent obligations, such as financial guarantees, termination payments and subsidies, if demand falls under certain thresholds; and (3) more remote contingent obligations, such as the risk of contract renegotiations or takeover of the project in the case of default of the special purpose vehicle
We expect 2018 to usher in the launch of several significant P3 projects. It will also see the early impacts of the current administration, which has called for increased private investment in public projects and has hinted at changes to the legislative and regulatory framework that would lower the barriers of private capital looking to finance infrastructure.
Despite the growing adoption, only $80 billion of TIFIA projects reached financial close in the last 12 years, with $8.9 billion in P3s reaching financial close in 2016. This represents only 0.05% of US GDP and is 74% lower than the median of 0.19% for other countries that use P3s. If the US used the same spending rate as the median, it would add $411 billion to incremental spending over 10 years.
Lowering barriers to investment
There are barriers preventing more investment of private capital into the P3 market. One is the lack of an infrastructure pipeline. Many federal governments, such as in the EU, UK and Canada, and the new Asian Infrastructure Bank, publish their pipelines but the US does not.
Another barrier is that some US policies limit the scope with which public agencies can work with private investors. For example, 11 of the 35 states that have P3 legislation limit the types of projects that qualify for P3s. Much of this is due to a perception of political risk to incumbent politicians if a project does poorly.
More states publishing infrastructure pipelines and opening infrastructure offices
These barriers are beginning to subside. Some states are now publishing their infrastructure pipelines (e.g., Virginia and California) and the administration is suggesting a US federal pipeline. A recent survey by JD Power showed US consumer attitudes toward P3s have become more favorable, and this will in turn decrease the perception of political risk. States also are increasingly turning to P3s because of concern over their bond ratings should they borrow in the public markets.
There are proposals for more US states to open offices of infrastructure investment that can serve as single points of contact where interested investors could begin a dialogue with a state or locality. These offices could also provide information to the public about P3 projects, thereby increasing transparency, countering misperceptions that might exist and increasing local political support. Currently seven states and Washington, DC, have P3 offices and the number is expected to grow. There is also a multi-state office on the West Coast, the West Coast Infrastructure Exchange (WCX), which serves California, Oregon, Washington and British Columbia.
What is infrastructure?
Infrastructure consists of economic infrastructure, social infrastructure and commercial infrastructure:
Economic infrastructure consists of fixed, tangible assets that make up physical capital, one of the three factors of production. These assets are required for economic growth and are important in the capital formation and final consumption stages of GDP. Broad sectors include transportation, utilities, power and telecommunications. Characteristic of economic infrastructure projects is that they earn their revenues from demand, usage, volume and sometimes a partial availability payment from the government. Example of projects are toll roads, airports, ports, utilities and power generation plants.
Social infrastructure includes the system of networks and facilities that support people and the community. These assets are often operated by the private sector and are used to support and provide public services, such as public schools, parks, housing and large dams.
Commercial infrastructure is a recent offshoot of the asset class and comprises assets for which the benefits of sharing infrastructure outweigh the competitive advantage of owning and operating one’s own infrastructure. Often characterized by a high degree of competition, this category includes assets such as satellites, cable networks and mobile phone towers. Often commercial infrastructure is included in economic infrastructure.
Common characteristics of infrastructure are high barriers-to-entry, high capital costs, essential services, inelastic demand, diversified end-user base and long-term customer contracts.
Federal financing programs
There are a small but growing number of federal programs in the US that help certain infrastructure projects address credit needs.
The Transportation Infrastructure Finance and Innovation Act (TIFIA) offers letter of credit to surface infrastructure projects. TIFIA has an enviable track record. It is estimated that the federal government will get back 99.9% of its money from the $21.8 billion of current letters of credit it has issued, and P3s have been the main recipient of TIFIA financing. There are suggestions to expand TIFIA given its strong performance and to consolidate it into similar federal programs for the water and railroad sectors (WIFIA and RRIF, respectively). Transportation P3s would benefit from TIFIA expansion.
PABs and MABs offer inexpensive funding
Private Activity Bonds (PABs) are a federally supported program that can be a catalyst for P3s. PABs are issued by a public entity (e.g., a state or local government) on behalf of a private partner and they are aimed at projects that serve some public purpose, such as airport improvements, water facility upgrades and toll roads.
Interest is tax-exempt for many PABs thus lowering the cost of debt. As a result, PABs are quite popular and many P3s take advantage of PABs as part of their overall finance package. There is a cap, however, on the amount of PABs that can be issued in each state. As of January 2016, there had been 21 P3s that used the PAB model. The Obama administration proposed a modified PAB in 2016 called a Qualified Public Infrastructure Bond (QPIB), which would not be subject to a cap and be available for a broader range of project types. Congress has recently made proposals for other types of innovative, federally sponsored financing programs such as Move America Bonds (MABs), an expanded version of PABs.
Who owns infrastructure?
Infrastructure is owned by the private sector or by the public sector (i.e., federal, state or local governments). The private sector tends to own demand-based infrastructure in which it can earn a required rate of return. This often includes economic infrastructure or projects that earn revenues from usage and volume. The public sector owns infrastructure that does not necessarily earn an explicit return but gives society a positive externality, e.g., a school affording someone an education. This often includes social infrastructure. Highways that do not have tolling are normally owned by the state unless they make an availability payment to the sponsor, in which case they are privately operated through a long-term concession agreement. However, the state retains ultimate ownership. The term “sponsor” means an infrastructure equity investor.
Efforts to reinstitute BABs
Build America Bonds (BABs) is another successful program for federal financing of infrastructure. Authorized only for the period 2009-2010, BABs utilized the municipal bond market but offered taxable bonds, in which either the issuer received a federal subsidy of 35% of the interest paid to bondholders (Direct Payment BABs) or the bondholder received a 35% federal tax credit (Tax Credit BABs). These subsidies brought the effective cost of debt to the issuer close to that of tax-exempt bonds.
Direct Payment BABs were very successful and $181 billion were issued in 20 months, which financed one-third of all new state and local government long-term borrowings during this brief period. Unlike tax-exempt municipals, BABs were popular with investors who did not have a federal tax liability, such as foreign investors and US pension funds. There are recommendations to the administration that the BABs program be re-instituted given its past success.
Asset recycling and privatization could unlock hundreds of billions
Asset recycling, a form of privatization or divestiture, is the leasing of existing infrastructure assets to private investors to raise funds for new investment. These assets have user-fee revenue streams, e.g., from toll roads and airports, and appeal to institutional investors that seek infrastructure investments that are both low risk and likely to generate stable returns. The proceeds are then reinvested into projects that do not have user fees and need direct government funding. Asset recycling has been popular in Australia, where the phrase was coined. Between 2013 and 2016, New South Wales leased A$15 billion of infrastructure assets to investors and allocated A$6 billion to new projects.
US may follow the Australian recycling model
The administration has voiced its desire to emulate the Australian model as part of its $1 trillion infrastructure stimulus plan released on May 23, 2017. The plan included leasing specific assets such as the Power Marketing Administrations’ transmission assets to the private sector. The plan also included the creation of an Air Traffic Control Corporation to manage the air traffic control system, and the expansion of the US Department of Veterans Affairs Administration’s ability to lease out vacant assets. Other single-name assets that are prime candidates for privatization include TVA and Amtrak.
Privatization could play an important role in the US push to invest more in infrastructure. As of 2015, there were $52.3 trillion in fixed assets in the US, as shown in Exhibit 4. Although 78% of these are owned by the private sector, there are still $11.6 trillion owned by the government. This represents a large pool of assets, some of which could be leased or sold to help fund new infrastructure.
Exhibit 4. Net stock of public fixed assets
USD trillions (2015)
The idea behind privatization is that the shift from public to private management will produce improvements because the profit-seeking behavior of new, private sector managers will lead to cost cutting and greater attention to user satisfaction. It works best when firms can run assets or services more efficiently than the government or when competition between firms can bring down costs over time. Sometimes it is also easier for private companies to set prices properly. For example, America’s airports charge planes to land in proportion to their weight, but if airports were privately owned it is likely that these tolls would be based on runway congestion, which small planes are prone to cause. Transportation economists have argued for years for a more efficient price mechanism to allocate existing runway capacity.
What could the US government earn from asset recycling and privatization?
Toll road asset recycling: $120 billion of potential infrastructure investment
Goldman estimates that state and local governments could unlock up to $120 billion of potential infrastructure investment if state-owned toll roads were divested and the proceeds were used for new projects (the Australian recycling model). This valuation excludes capital that could be unlocked by liberalizing tolling restrictions more generally, such as on Interstate highways that do not have tolls.
One impediment to this is that the 1956 law that created the Interstate highway system bans tolls on most Interstate highways. These roads are at the end of their useful lives and there is little appetite among politicians to raise gasoline taxes, so lifting the ban now seems appealing. A second impediment is that current laws require that all bonds on an asset to be recycled be refinanced from tax-exempt municipal bonds to taxable bonds, substantially raising the cost of capital for the private entity involved. Asset recycling would be more viable in the US if the government relaxed these regulations and allowed outstanding bonds on recycled assets to remain tax-exempt.
Airport privatization: $50 billion of incremental capital for improved airport productivity
Another set of assets at the disposal of US local and state governments is the airport system. Over the past two decades, countries such as Italy, France and Spain have privatized their airports, while the US has almost exclusively maintained publicly owned and operated airports. In 2012, a pilot program was reauthorized for airport privatization but limits the number of private commercial airports to 10 vs. over 500 commercial airports in the US. As of April 2017, there were four airports in the program although several applications are pending. Like toll roads, airports are attractive to infrastructure investors for their consistent revenue generation and strong margins (40% EBITDA margins on average in Europe). Privatized airports in Europe rank significantly higher in customer satisfaction than do US public airports.
Port privatization: $23 billion of incremental investment for improved operating efficiency
Similar to airports, ports in the US tend to be owned by the public sector. They represent another opportunity for asset divestitures to the private sector to generate additional capital for infrastructure investment. In addition to unlocking capital for reinvestment, privatization of ports could lead to increased operating efficiency. This is particularly important for US ports which rank in the lower quartile on both portfolio flow and port cost. Based on 2014 capacity, US ports generated an estimated $3.8 billion in sales in 2014, implying $23 billion in valuation using a similar multiple as used in airports.
Highways, airports and ports alone could bring in an estimated $190 billion for US infrastructure. Other prime candidates for privatization are the air traffic control system, TVA and the four Power Marketing Administrations.
See Appendix 1 for more in-depth toll road, airport and port valuations.
What does all this mean?
We believe there is movement in the US infrastructure market. The US P3 market will get a boost over the next few years as barriers to infrastructure investment are lowered, existing financing tools are expanded, new financing tools are developed and current federal financing programs are built upon. There is a push for privatization and asset recycling of the air traffic control system, toll roads and airports and, if it is successful, other sectors would likely follow over the coming years.
Administration’s efforts thus far on infrastructure
The White House released details in May 2017 on its plan to incentivize $1 trillion in new investment. It included $200 billion of proposed federal financing with incentives for states and private investment for the remaining $800 billion. The proposal would expand existing credit guarantee programs, such as TIFIA and WIFA, and would lift the cap on PABs and restrictions on P3s. It would encourage privatization and liberalizing tolling restrictions, an important key to unlocking a large amount of capital. The is largely what was announced in the State of the Union address and what has recently been reported in the press.
Streamlining of regulatory approvals to follow the Canadian model
There are two components to modernizing US infrastructure: money and permits. There needs to be a dramatic reduction in red tape so that infrastructure can be approved in two years or less, not 10 years or more as it often takes now. No one deliberately designed America’s infrastructure approval system. It is an accident of legal accretion occurring over 50 years. This may be about to change. In an August 2017 press conference, the administration announced its intent to roll back the regulatory and permitting process. It included a two-year limit for federal environmental reviews in order to allow major projects to move forward. The intention is to follow the Canadian model, a move to reduce political risk that would be welcomed by investors. The US has a higher rate of project cancellations than other countries, which puts off investors, so this reform is an important component of attracting capital. It can be accomplished by consolidating decisions within a simplified framework with set deadlines and clear lines of accountability. Germany’s approval process to air issues and get to a final decision is simple and effective. Canada recently overhauled its rules, by clearing a path to a two-year process for certain federal projects and by delegating other projects to the provinces. Australia is also working on an overhaul.
To be most effective, streamlining the approval process would need to be part of a larger reform effort, as many regulatory reviews are at the state level. The August press conference echoed the administration’s earlier executive order in January 2017 to streamline and expedite environmental reviews and approvals, “especially for projects that are a high priority such as improving the electric grid and telecommunications systems and repairing and upgrading critical port facilities, airports, pipelines, bridges and highways.”
What is project finance?
Project finance is the method of financing infrastructure, industrial or public assets using limited recourse long-term debt, typically raised by a special purpose vehicle (SPV) created solely to complete the infrastructure project. Principal and interest payments are funded entirely from cash flows generated by the SPV, while the scope and duration of the project is defined in the SPV’s contractual arrangements. Project finance debt can be an efficient way to fund long-term capital-intensive projects in which the underlying revenues are relatively stable and predictable. Project finance has also come to mean a sector in which issuers use this type of finance. In this regard, infrastructure is a subset of the larger project finance sector.
Washington’s effect on infrastructure
There is a great need for investment and a very large amount of capital within and outside of the US looking for suitable projects. Although the federal government plays a very important role, this opportunity is not completely dependent on the politics of Washington. State and local governments account for 75% of infrastructure spending and own 87% of public infrastructure (Exhibit 4). They own 98% of highways, including the entire US Interstate system. They own bridges, seaports, water and sewer systems, transit systems, schools, and police and fire stations. The federal government dominates in ownership of intellectual property, R&D assets and conservation, such as parks and recreation. It also owns the air traffic control system, most of Amtrak, postal buildings, large dams and other single name assets.
The federal government influences infrastructure at the state, local and private level – where most investment occurs – through incentives, taxation and regulations, not only by direct federal spending. Infrastructure in the US is much more decentralized than in many countries because the US is a large federation, similar to Canada and Australia, both of which have strong models of decentralized infrastructure coordination. The current politics of Washington will not derail the long-term trend of increased state, local and private capital investment in US infrastructure.
What a new US infrastructure bill could look like
In his January 30, 2018 State of the Union address, the US President announced the administration’s infrastructure plan. The plan broadly fit with previous announcements and press releases by the administration. Below are the key take-aways from the plan and then recent news reports:
- $200 million in federal spending mostly through grants, and plans to incentivize state, local and private spending of $1.3 billion for a total of $1.5 billion over 10 years.
- Encourages PPP. Covers most main economic and social infrastructure sectors.
- Makes securing some funding means tested through a cost-benefit analysis to avoid boondoggle projects. This has been widely suggested.
- Strong emphasis on rural investment. Up to 25% of total federal spending expected.
- Adds to existing federal financing programs (TIFIA, RRIF, WIFIA, etc.).
- Creation of a new fund for public lands infrastructure. This will be funded by revenues due to the US government from mineral and energy development on federal lands and waters.
- Executive order allowing for disposal of federal assets to improve overall allocation of economic resources in infrastructure investment. This could be a precursor to asset recycling and/or privatization through asset disposals or the leasing of publicly-owned assets to the private sector. This could release a significant amount of capital.
- Elimination of some of the important caps on PABs (e.g., volume by state and maximum amount allowed in transportation). Extends PABs eligibility to other sectors, e.g., ports and airports. This mirrors the Obama administration’s 2016 proposal for a modified PAB called a Qualified Public Infrastructure Bond (QPIB).
- Liberalize tolling restrictions on Interstate highways and allow for commercialization of roadside rest areas. This could also release a significant amount of capital.
- Apply fast act streamlining on all rail projects and subsidize short-line and passenger rail. There has been little emphasis on additional intercity passenger rail capacity in the US for years. Amtrak is used almost exclusively for this service.
- Expand federal credit assistance to state infrastructure banks.
- Eliminate constraints on public transit PPP. Allow non-federal construction and operation of inland waterways. Currently dominated by the US Army Corps of Engineers.
Missing from recent press reports on the administration’s infrastructure plan:
- Airport privatization and air traffic control
- Power grid (except in the new rural infrastructure program)
- Tax credit plan as suggested before the 2016 election by campaign senior policy advisors Peter Navarro and Wilber Ross
The administration’s plans have not come to fruition so far in 2018 but it is possible a plan will come together after the mid-term elections. Meanwhile, the private sector continues to invest, with non-bank investors increasingly taking up the slack.
A further proposal for re-patriation of off-shore profits
An innovative proposal by Senator Delaney (D-Maryland) is to start an American Infrastructure Fund (AIF) that issues 50-year 1% coupon bonds through a reverse Dutch auction. Companies would be incentivised to repatriate by competing for a low tax rate. This would be achieved through a competitive bidding process where the ‘price’ would be a ratio of bond investment-to-repatriated profits. As companies bid the ratio decreases, i.e., the effective tax rate increases, until the target size is raised. The funds are then used as infrastructure investment. The early price talk, should AIF become a reality, is an offer of around 1-to-4 but some economists expect companies will bid in the 1-to-7 area.
Another plausible way repatriated profits could be put to work in infrastructure is through the US tax-equity market, which provides capital for a broad array of renewable projects in the US. This amounted to $13 billion in wind alone in 2016.
Combining infrastructure with the Tax Cuts and Jobs Act of 2017 was expected by some analysts because historically Democrats have supported infrastructure spending and Republicans have supported tax cuts. Since it was omitted from tax reform, it seems likely to slip to 2019. At that point, it could be considered as a standalone issue, perhaps with the goal of attracting bipartisan support. It is possible that some infrastructure-focused initiatives could be addressed in the next 6-12 months, while leaving a broader infrastructure package until after the mid-term elections in November 2018.
See Appendix 2 on infrastructure elasticity for an explanation of how infrastructure quality can rank higher than its condition would suggest.
Appendix 1. US toll road, airport and port valuations
Toll road valuation $120 billion: Highway toll revenue generated $14.4 billion in 2014 from publicly owned toll roads according to the Federal Highway Administration. EBITDA margins are estimated by Goldman Sachs to be 65% based on a sample of the 12 largest toll roads. Precedent transactions in Europe and Australia have been at a 24 EV/EBITDA multiple. This values existing US toll roads at $120 billion after estimated debt of $110 billion (5.7x sales). Seventy-five percent of toll revenues come from only six states. In order, these are New York, New Jersey, Texas, Florida, California and Illinois. They would stand to benefit the most from an asset recycling program.
Airport valuation $50 billion: According to the FAA, the Airports and Airways Trust Fund (AATF) earned $14.4 billion in revenues in 2016. EBITDA margins at the 25 largest airports are 40% and are comparable to privatized airports outside of the US (e.g., best-in-class privatized airports in Europe have EBITDA margins of 55%). Implied EV/EBITDA multiples are 20x based on historical IRRs. This gives a valuation of $50 billion after estimated debt of $65 billion.
Port valuation $23 billion: Based on 2014 capacity, it is estimated that ports generated $3.8 billion in sales in 2014. Using a slightly higher multiple than airports (i.e., 21x), gives a valuation of $23 billion after estimated debt of $13 billion. Ports get a small premium on the multiple because their EBITDA margins are estimated at 45% vs. airports at 40%.
Appendix 2. Good quality and average satisfaction, so why so much required investment?
There is an inconsistency when analyzing the quality of US infrastructure compared to the need for so much investment. The World Economic Forum (WEF) ranks US infrastructure eleventh globally out of 138 countries, and Americans have not expressed a high level of dissatisfaction with their infrastructure: 69% are satisfied with US highways and roads and 61% are satisfied with public transport. This is about the median of other countries. There are two explanations for this inconsistency: greater O&M spending vs. capital spending and high infrastructure elasticity.
We show the amount of required US investment in our second piece “Outlook for United States infrastructure: US infrastructure market analysis,” Autumn 2018.
Falling capital spending but steady O&M spending
It is widely reported in the press that US infrastructure spending is insufficient. Headline public spending has dropped 9% in real terms since 2003. When dissecting that number, however, it becomes clear that US capital spending has dropped 23% but operation and maintenance (O&M) spending has actually increased by 6% (Exhibit 5). In fact, O&M spending has grown steadily at about 5% per annum since 1956.
O&M spending is key to overall longevity and efficiency and has helped to maintain existing infrastructure performance. This explains why existing infrastructure gets good quality scores by Americans surveyed by the WEF despite large infrastructure needs estimated by the American Society of Civil Engineers (ASCE). We benchmarked 2014 numbers vs. 2003 in Exhibit 5 because real infrastructure spending dropped post 2003 due to a rapid increase in infrastructure-related input costs.
Exhibit 5. Capital investment compared to O&M spending
2014 constant dollars
|US infrastructure investment (USD billions)||Capital||O&M||Total|
|State & local||50||130||180|
|State & local||140||196||336|
|% increase vs 1985||104%||52%||75%|
|State & local||112||208||320|
|% increase vs 1985||57%||62%||60%|
|% increase vs 2000||(23%)||6%||(9%)|
High state of US infrastructure elasticity preserves performance
Infrastructure is considered to be highly elastic between the extremes of condition (Exhibit 6). It is similar in concept to the price elasticity of demand (Ped), where Ped is > 1.0, except here it is the performance elasticity of condition (Pec), where Pec is > 1.0 and changes in condition (the independent variable) lead to changes in performance (the dependant variable). This high elasticity helps to explain the relatively good US quality scores. In this context condition can be thought of as age and performance as perceived quality.
By most accounts, existing infrastructure condition is below average but stable O&M spending has maintained it. This would put its condition in the middle-right part of the horizontal x-axis in Exhibit 6. This high elasticity also helps explain why its age has been able to increase over the years without a corresponding drop in quality. It also shows that infrastructure condition can only worsen to a certain degree until quality drops off rapidly.
Even though infrastructure performance is considered elastic, the price elasticity of demand for the use of infrastructure (an entirely different matter) is typically inelastic. This is because often there are not substitutes, many infrastructure services are considered essential, and the user fees are often a small portion of disposable income and not discretionary (e.g., tolls on roads and bridges, user electricity bills and user fees on mass transit).
Exhibit 6. Infrastructure elasticity
Regular O&M spending can maintain infrastructure similar to other assets. On aircraft, for example, proper maintenance can significantly extend an airplane’s service life but it gets more expensive with age, flying time and the number of take-offs and landings (or cycles). The serviceable lifespan of the 747 was thought to be 40 years when PanAm took to the skies with its first Jumbo Jet flight in 1970 and many older 747s are still in service today, especially in the military and firefighting units. Industry experts now estimate the 747 airframe can fly over 60 years because of today’s improved inspection and maintenance programs.
In many cases the decision to retire an airframe is based on economics rather than age. America’s infrastructure is similar: At some point it cannot be repaired anymore and just needs to be replaced.
Acknowledgment, sources and endnotes
Sequoia would like to thank Michael Verhoeven for his assistance in preparing this report.
Primary sources: American Society of Civil Engineers, Bipartisan Policy Center, Bureau of Economic Analysis, Cato Institute, Common Good, Congressional Budget Office, Congressional Research Service, Council of Economic Advisors, Department of the Treasury, Federal Highway Administration, Goldman Sachs Global Investment Research, IMF Fiscal Monitor Database, Moody’s Investors Service, National Council on Public Works Improvement, Preqin, US Department of Transportation and World Economic Forum.
(1) Public construction spending as a percentage of total tax receipts. Tax receipts equal to total property, sales, income and corporate taxes from the US Census Bureau’s quarterly summary.