Longterm lease of Turnpike likely best value for Pennsylvania - Gov Rendell seeking law for a concession

Pennsylvania Turnpike Governor Edward Rendell is now going all out to garner legislative support to complete a longterm lease concession of the Pennsylvania Turnpike, today releasing the results of analysis by Morgan Stanley showing a concession provides way more value for the state than the "public-public" plan the Turnpike Commission has been peddling.

The Turnpike has an intrinsic value of $12 billion to $18b and a concession is likely to produce an annual $840m to $1,620m per year in perpetuity according to calculations by Morgan Stanley. Borrowing against the value of the Turnpike Mainline as proposed by the Pennsylvania Turnpike Commission (PTC) will only yield $222m/year though the Commission has also proposed borrowing against the motor license fees, putting tolls on I-80 and a $1 congestion charge to bulk up the revenue.

A not-for-profit (NFP) public corporation (based on IRS 63-20) structured on the same assumptions as a for-profit concession would yield less ($900m to $1,400m/year) than a private concession because of a higher cost of capital, but considerably more than the PTC proposal in all but the lowest range of projections. (Cost of capital is lower for private concessionaires because of their flexibility in funding, their ability to use tax breaks and to range internationally for sources of capital that will accept low interest rates).

Governor Rendell said today: "The Morgan Stanley analysis makes it clear that (a concession on) the turnpike can be the key to solving our transportation funding crisis today and for generations to come."

The Rendell administration is seeking support from the legislature for an enabling bill to call bids, select a concessionaire and complete a toll concession. Officials said they are hopeful the a private concessionaire can be selected before the end of the year for a financial close probably early in 2008.

We traveled to the Capitol in Harrisburg where the announcements were made early this afternoon, briefings given, and printed summaries handed out.

The major presentation to the press was by Roy Kienitz, Rendell's deputy chief of staff and transportation adviser, and by two top officers of Morgan Stanley's Chicago office, Robert Collins (Infrastructure Mergers & Acquisitions) and Stratford Shields (Public Finance).

Kienitz said the takeaway quote was that the Turnpike as a concession is a "significantly valuable asset which can generate sufficient revenue to fund all the ongoing highway needs and much of the state's transit needs as well."

He said the only way to get certainty about the precise value of a toll concession is to go into the market and see what bids it brings.

Traffic and revenue modeling by Morgan Stanley assumed:
- the east-west mainline and northeast extension concessioned (omitting western TRs)
- no toll increase until 2010,
- then annual toll cap increases the greater of 2%, CPI or GDP/capita
- one percent annual increase in traffic
- no reduction in operating costs
- concessionaire to defease PTC debt and carry out PTC's 10 year capital plan
- target internal rate of return of 10% to 15% (return on equity)
- 80% debt / 20% equity funding, debt at 6%, 3.6% after tax for waited average cost of capital of 5.38%

The Rendell plan is to put the proceeds into a dedicated transportation investment fund to generate an annual income for the state. This shows concession fees $12b to $18b and annual rates of return to the transport investment fund of 7% to 9%. The high 9% rate of return on the state's investment of the high range concession fee of $18b generates $1.62b/yr and low 7% return on $12b low fee generates $840m/yr in perpetuity for transport needs.

Kienitz and the Morgan Stanley analysts said it was possible that bidders might assume higher traffic growth, lower costs, and lower cost of capital or some combination in which case their bids would be significantly higher. For example 2% annual growth in traffic versus the 1% assumed could increase the value of the concession by $4b to $5b.

Kienitz said they believed the value of the concession was unlikely to be less than the $12b to $18b range and was quite likely to be more. If it was more the state would have the option to fund both highway and transit needs from the concession proceeds without having to invoke an oil company tax.

Morgan Stanley's Robert Collins noted that in both the Skyway and the Indiana Toll Road the top bidder paid about a billion dollars more than the second bidder, and in the case of the ITR a billion more than the analysts prior estimate of intrinsic value so forecasting the bid with precision is impossible.

The Turnpike Commission proposal was not viable because it does not raise nearly enough revenue, Kientiz said.

Kienitz said that the modeled toll concession has several advantages over the Turnpike Commission proposal apart from generating far larger revenues for the state. It would mean lower tolls for motorists on the Turnpike until 2036, saving them a total of $8.2b discounted to present value.

Third, there was less political risk once a concession is signed.

Said Kienitz: "While the longterm lease (concession) model has many uncertainties now, we can be certain that on the day you get paid (the upfront concession fee) that you've got a guaranteed revenue stream. With the Turnpike Commission model and any public model you have to have the will to increase tolls as planned and carry out the program over many years. There is a real difference in the degree to which the numbers can be locked in (between a concession and the Turnpike Commission model). You may get changes of intentions, changes of mind about following the (Turnpike Commission) plan."

Morgan Stanley's role

Kientiz faced sharp questions from several journalists about Morgan Stanley's role, and whether there was any conflict of interest.

He said Morgan Stanley was not going to make any decisions.

"They (Morgan Stanley) don't have the power. People in this building, the general assembly and the governor, they will set the terms."

He said Morgan Stanley are strictly prohibited under the terms of their employment by the state from working for any bidder and from bidding. He said their compensation is proportional to the value of any deal consummated to give them an incentive to work to maximize benefits to the state. If they were paid a fixed fee they wouldn't have that incentive.

Secrecy in the state's interest

He also faced questions about the secrecy surrounding the responses to expressions of interest. He said there had been sharp internal debate on this issue but it was decided to hold all responses confidential because this would maximize the state's earnings. Although the bids did not contain precise numbers, many of the responses by potential bidders to the request for expressions of interest did describe the methodology and approach they would use when making the actual bid.

"We got strong advice to not to release the responses. It is of vital interest to bidders. If they know the other bids then they can bid that plus one dollar. Uncertainty about the other bids is of great value to the state in getting the maximum bids. After the selection is made and after the whole thing is done then we can release everything."

Law needed to demonstrate this is real

Legislation was needed Kienitz said to show the state's seriousness. Given that there were some loud voices being raised against a concession it would be "problematic" to attempt it without a clear legislative mandate.

"The (private capital) market would be very uncomfortable" without a clear vote and clear legislative authority to seek bids, develop one or more alternatives and then to implement (the concession," Kientiz said.

The Turnpike Commission would not be given the right to "top" the selection after the event, Kienitz said and the legislation would not allow the legislature to approve or disapprove the deal.

The legislation would need to give the administration "carte blanche" to finalize a concession deal within the terms of legislation, Kienitz said. There could be no legislative intervention after the deal was negotiated.

Bidders are likely to spend "three million, four million, five million dollars" on a serious bid, Kienitz said and they won't do this "unless they think this is for real." Having the authority to follow through and consummate the deal with the selected bidder was essential to getting serious bids.

Legislation

At time of writing no bill is written but there is a PennDOT Transportation Finance Legislation Summary and an Overview.

The legislation it says will provide for public-private transportation arrangements (PPTAs) across the state, allowing state agencies and the DOT to enter into PPTAs including specifically the Pennsylvania Turnpike's "monetization." It also allows arrangements with non-profits.

Labor protection, toll rate moderation, maintenance

The concessionaire will be required to honor existing labor agreements through their term (most are three years) and in addition PennDOT in selecting a concessionaire will consider, "among other things, the extent of the private entity's commitment to offer appropriate protections to workers then employed," to limit increases in tolls, and to maintain the facility properly.

Other features of the legislation:

- proceeds of concessions must go to transportation, not to general fund
- unsolicited proposals and solicited allowed
- PennDOT must approve
- plan for minorities, women, veterans and disabled part of assessment
- all submissions to be held confidential until completion when must be made public
- state may pay for environmental cleanup for existing conditions at project sites
- caps on toll increases and formulae for toll raises may be included
- public entities may get authority for federal program support for projects
- local authorities not to have any veto power to stop projects
- no geographic limit on Ps (except the state's boundaries, we guess)
- no legislative approval to be required for individual projects or agreements
- exemption from low bid provisions of procurement law
- state prevailing wage, reciprocal limitations, steel products procurement and trade practices acts to apply to concessions

Another interesting aspect of the bill will transfer control of the Pennsylvania Turnpike from the Turnpike Commission to PennDOT. Roy Kienitz the governor's deputy said "not to read too much into this."

This is proposed to be enacted "to make 100 percent sure" the state is able to take control of the Turnpike from the present Turnpike Commission when it comes to handing over the facility to a concessionaire.

Otherwise this might require a vote of the Turnpike Commission which in theory might refuse to let go.

Tense situation with Commission

Kienitz said that although the administration has been "working reasonably well" there is "a somewhat tense situation with the (Turnpike) Commission." The state's lawyers wanted that power to transfer the Turnpike to a department of state to be enacted just in case they stage a sit-in.

Text of Gov Rendell's statement

May 21, 2007

GOVERNOR RENDELL SAYS TRANSPORTATION FUNDING ANALYSIS DETERMINES HIGHEST VALUE LIKELY FROM LONG-TERM LEASE

HARRISBURG – An analysis of options to address Pennsylvania’s massive transportation funding needs has determined that a lease of the Pennsylvania Turnpike is likely to generate the highest level of funding to repair roads and bridges and avert drastic public transit cuts, Governor Edward G. Rendell announced today.

The report, which was released today, said other options studied are feasible, but are unlikely to bring enough revenue to tackle all road, bridge and transit needs. The other options would likely need to be supplemented by other revenue sources to fully fund all transportation needs, the analysis concluded.

“The Morgan Stanley analysis makes it clear that the turnpike can be the key to solving our transportation funding crisis today and for generations to come,” said Governor Rendell.

The financial analysis, completed over the last month by Morgan Stanley & Co., which is serving as the commonwealth’s independent financial advisor on transportation funding alternatives, looked at three options:
• A long-term lease of the turnpike;
• Creation of a new, tax-exempt, public benefit corporation under IRS code 63-20, which would allow for private management of the turnpike; and
• A proposal by the Pennsylvania Turnpike Commission that includes new tolls on Interstate 80 and a new “congestion tax” that would be collected at the most heavily used turnpike exits.
The report concludes that each proposal could likely deliver the $965 million per year required to meet the state’s highway and bridge investment needs. Two of the options — a long-term lease and a new public corporation — could also provide significant funding for the state’s transit needs. Estimates are that the long-term lease option could meet all highway needs and all transit needs. This could eliminate the need to fund transit from other sources, such as Governor Rendell’s proposal for a new Oil Company Gross Profits Tax.

“The lease option would almost certainly provide the most money and, for that reason, we have to take it seriously,” the Governor said. “We need $1.7 billion to repair our roads and bridges and keep public transportation going in all 67 counties. This analysis shows we can achieve this goal in a way that protects against excessive toll hikes and maintains state control of the turnpike.

“A tightly controlled lease – one that maintains the commonwealth’s ownership of the turnpike, includes strong protections against excessive toll hikes, and protects turnpike workers – provides a unique opportunity to meet our transportation funding needs,” said Governor Rendell. “As it reviews this report, the legislature will no doubt consider other options, too. Any final transportation funding plan, whether it includes a turnpike lease or one of the other options, will need to fund both roads and transit at adequate levels.

“This analysis shows that a turnpike lease could do that by itself. The other options would likely need to include other revenues to meet all our investment needs.”

The Turnpike Commission plan would require the passage of three separate tax or toll hikes; higher turnpike tolls; tolling Interstate 80; and a new, $1 Congestion Tax surcharge on turnpike motorists in metropolitan areas. In addition, selection of this option would require a fourth revenue source for transit, such as the Oil Corporations Gross Profits Tax. The other options would also see turnpike tolls rise but they might not require any revenue from other sources.

“My goal continues to be to raise funds to invest in our roads, bridges and transit systems in a way that has the least affect on Pennsylvania drivers,” the Governor said. “Today’s report confirms that tapping the value of the turnpike is the best way to do this. Pennsylvanians built and paid for this road, and now the toll road can help us repair roads and bridges and fund transit all over the state.

“We must find a way to meet our transportation infrastructure needs without asking taxpayers and motorists to shoulder a disproportionate share of the cost,” he said.

Morgan Stanley’s findings included:
• Each of the three new toll hikes identified in the Turnpike Commission plan would require the approval of the General Assembly and the Governor.
• Even if the General Assembly would agree to enact the toll hikes proposed in the Turnpike Commission’s plan, the other two alternatives — turnpike lease and the 63-20 public benefit corporation leveraging model — would still generate significantly higher proceeds in future years than the commission’s proposal.
• Toll increases are inevitable under all of the three proposals and the Turnpike Commission proposal would cost turnpike drivers $8.3 billion more in toll increases than the other two options over the next 28 years. The total amount paid by motorists every year under the Turnpike Commission option is projected to be higher than under the other two options until 2036: 73 percent higher after 10 years, and 32.5 percent higher after 20 years. And,
• The value of a lease for the Pennsylvania Turnpike cannot be fully measured unless, and until, a bidding process is completed. According to Morgan Stanley’s analysis, the actual leasehold value of roadways in Indiana and Chicago far exceeded initial estimates.
The experience in Chicago and Indiana, where leases have already been signed, makes a compelling case for allowing the commonwealth to test the market to determine the actual value of the Pennsylvania Turnpike. The process requires that bidders not be publicly identified until the completion of the process to create greater competition for the bid.

As Morgan Stanley notes in its analysis, the experience in other states and cities indicates that uncertainty over political support for leasing “is likely to depress bid values.” Accordingly, the report concludes that enactment of broad authorizing legislation “will provide the best environment for maximizing revenue.”

The ultimate decision on the competing proposals rests with Governor Rendell and the General Assembly. Governor Rendell has made it clear the primary objective of a funding solution must be to raise adequate revenue to solve Pennsylvania’s most pressing transportation funding needs while obtaining the very best possible deal for taxpayers and the driving public.

More information about solving the state’s transportation crisis is available online at www.Rideonpa.org

TOLLROADSnews 2007-05-21 first posting, completed 2007-05-22