The Promise and Perils of Infrastructure Privatization: The Macquarie Model

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Author: Lewis D. Solomon

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Th e P rom i se a n d P e r i l s of I n f r a st ruc t u r e P r i vat i z at ion Th e M acqua r i e Mode l

Le w is D. Solomon

THE PROMISE AND PERILS OF INFRASTRUCTURE PRIVATIZATION

Copyright © Lewis D. Solomon, 2009. All rights reserved. First published in 2009 by PALGRAVE MACMILLAN® in the United States—a division of St. Martin’s Press LLC, 175 Fifth Avenue, New York, NY 10010. Where this book is distributed in the UK, Europe and the rest of the world, this is by Palgrave Macmillan, a division of Macmillan Publishers Limited, registered in England, company number 785998, of Houndmills, Basingstoke, Hampshire RG21 6XS. Palgrave Macmillan is the global academic imprint of the above companies and has companies and representatives throughout the world. Palgrave® and Macmillan® are registered trademarks in the United States, the United Kingdom, Europe and other countries. ISBN: 978–0–230–61930–2 Library of Congress Cataloging-in-Publication Data Solomon, Lewis D. The promise and perils of infrastructure privatization : the Macquarie model / Lewis D. Solomon. p. cm. ISBN 978–0–230–61930–2 (alk. paper) 1. Infrastructure (Economics)—Management. 2. Privatization. I. Title. HC79.C3S64 2009 338.9⬘25—dc22

2009009523

A catalogue record of the book is available from the British Library. Design by Newgen Imaging Systems (P) Ltd., Chennai, India. First edition: December 2009 10 9 8 7 6 5 4 3 2 1 Printed in the United States of America.

Con t e n t s

Acknowledgments

vi

1 Introduction

1

2 The Rationale for Privatizing Infrastructure Assets

11

3 Macquarie: The Early Years, Its Culture, and Its Growth

25

4 Macquarie: Its Current Operations and Its Growth Strategy

37

5 Macquarie: The Creation of Its Infrastructure Funds

53

6 Macquarie and the Privatization of Highways in the United States

83

7 Macquarie and the Privatization of Airports Globally

109

8 The Macquarie Model: Looking to the Future

137

Notes

153

Index

193

Ac k now l ed gm e n t s

As is the case with most books one person is listed as the author, but many made it happen. Without the tireless efforts of Jason J. Hawkins, Reference Librarian, The Jacob Burns Law Library, The George Washington University Law School, this work would not have come to fruition. Stephen Syski, J.D. 2009, The George Washington University Law School, assisted with research and citation checking. Nell Taylor-Christy diligently inputted the manuscript and helped with the index.

Ch a p t e r O n e I n t roduc t ion

This is the corporate biography of the Macquarie Group Ltd., an extraordinary Australian firm, set in the context of the global privatization of infrastructure. It also provides a policy analysis of promise and perils of infrastructure privatization, focusing on toll roads and bridges as well as airports, worldwide and particularly in the United States. Beyond the scope of the book is the privatization of social infrastructure (healthcare, long-term care, educational, and correctional facilities), communications infrastructure (broadcast transmission networks and mobile telephone towers), and regulated utilities (gas, water and electricity transmission, storage, and distribution). Highways, bridges, and airports may appear boring, rather prosaic, but they are the heart of a nation’s capitalist economy—past, present, and future. As an Urban Land Institute report concluded, “Sound infrastructure forms the backbone that is critical to maintaining and enhancing regional economic growth, competitiveness, productivity, and quality of life.”1 The global economy pressures nations to upgrade their infrastructure to remain competitive and gain advantages. Moving goods and people internally with efficient access to global pathways, such as airports, is essential in the twenty-first century. Macquarie has become one of Australia’s greatest corporate successes, a model for a company managing to compete spectacularly on the world stage. From its modest beginnings as the downunder outpost of a British merchant banking company, Macquarie, through its various investment funds, achieved preeminence as the world’s leading nongovernmental owner or lessee of infrastructure assets. It has made a significant difference in how we view infrastructure, its ownership, management, and operation. The infrastructure fund model, pioneered by the Macquarie, has spread around the globe.

2 / infrastructure privatization

One of the biggest drivers of the firm’s business is its securitization of infrastructure assets. Macquarie bundles steady-return infrastructure assets across the world into investment funds, both listed on stock exchanges and unlisted. The firm now manages more than A$239 billion of assets with approximately A$149 billion devoted to infrastructure assets.2 It manages thirty-five infrastructure funds, covering the investment spectrum.3 Looking to equity markets to provide liquidity for investors, nine of its infrastructure funds are listed on five stock exchanges, the New York, Australian, Toronto, Korean, and Singapore exchanges. It also manages twenty-six unlisted infrastructure funds open only to pension funds, other institutions, and accredited investors (those with certain asset and income levels). Through the funds it controls, Macquarie owns or leases 118 nonreal estate businesses around the world, in 26 countries.4 These include highways (Chicago Skyway and the Indiana Toll Road), airports in Sydney and Brussels, seaports (Changshu Xinghua in China), water distribution (Thames Water Co. [Southeastern U.K.]), and parking lots (in Manhattan). It has become the biggest toll road operator in the globe and the second largest private investor in airports. Macquarie infrastructure assets affect people’s lives. Each day more than 100 million people use essential services provided by Macquarie funds, approximately 2.3 million cars drive on Macquarie managed toll roads, each year 81 million people pass through its airports, and some 82,000 people work at its businesses.5 Despite its aggressive reputation, today Macquarie is cognizant of its responsibilities. As Allan E. Moss, then Macquarie’s CEO and Managing Director put it, “The big difference between the 1980s and the period we’re in now [2007] is that it is far more important to us that we be conscious of our community responsibility.”6 The firm realizes the importance of the infrastructure it owns or leases. One disaster could well end the entire privatization party, not only for Macquarie but also for other infrastructure privatization players, such as Goldman Sachs, a leading U.S. investment bank. Once labeled by Financial Times and Barron’s, respectively, as the “upstart bank run by Australians,”7 and the “Aussie Upstart,”8 today as a financial services phenomenon, Macquarie has exported its unique model around the world. Admirers have come up with a noun “Macquisitions” to describe its forays into a toll road in Chicago or an airport in Brussels. To succeed in investment banking in Australia,

introduction / 3

a small domestic market compared to the United States or Europe, Macquarie needed to be innovative. In searching the globe for deals, it operates from a simple assumption: there is money to be made at every step of a transaction, not just one step. Macquarie was among the world’s first financial institutions to recognize infrastructure investments as an asset class and create funds to hold them. Infrastructure assets generally are monopoly or quasimonopoly businesses and the investment funds it sets up and manages are loaded up with debt. It takes the funds public or privately sells shares in them. In short, Macquarie has pioneered the bundling and securitizing of infrastructure into diversified portfolios and figured out how to take new fees at every step of the process. Macquarie developed an integrated model, a one-stop shop, with its units advising, arranging, securing funding, executing, and managing as many parts as possible and taking care of each step of every complex deal. This model allows Macquarie to pick up multiple-fee streams along the way. The potential for fees in infrastructure deals, even if market-based, at arm’s length and approved by independent directors, is astounding. Macquarie advises public sector bodies that are considering the construction of a new facility or the privatization of an existing asset. It takes fees for originating, advising, underwriting, and serving as the lead manager of a deal. It takes more fees for helping arrange the financing for an asset acquisition and raising funds that others invest. Once an asset is packaged into a fund, it earns management fees, say 1.0 to 1.5 percent of a fund’s value, and incentive fees. The firm takes a healthy (typically 20 percent), hedge fund-type, performance fee on a fund’s profits above a specified threshold level that varies based on benchmarks appropriate to the assets in a fund and whether a fund is listed on a stock exchange or not. The Macquarie Model focuses on yield-oriented infrastructure assets as investments that meet the needs of pension funds and other financial institutions with long-term liabilities. The assets possess the following attributes: highly predictable, stable, long-term cash flows; slight competitive pressures with relatively high barriers to entry, preferably having a monopoly or nearly so; and high revenue certainties with low risk and volatility. Predictable cash flows are based on relatively fixed operating costs, reasonably low ongoing capital expenditure requirements, and contractual mechanisms for rate increases. As virtual monopolies, with


competition limited because of the difficulties of building a competing highway, for instance, and with captive customers, the infrastructure assets generate dependable, nearly guaranteed, long-term cash flows. Macquarie pools the assets into funds it manages and sells shares in these funds. It groups the assets into specialized funds, which offer moderate but predictable dividend yields to both institutional and retail investors. These assets are securitizable, that is, they are easily converted into shares of a listed fund that are bought and sold on a stock exchange. The strategy brings together the capital amassed initially by Australia’s forced savings plan, and now more generally globally, with the world’s infrastructure needs. Unlike private equity funds that aim for returns of 20 to 30 percent per year, Macquarie recognized that global investors have a seemingly insatiable appetite for dependable, annual returns of 8 to 12 percent. Regulated infrastructure assets, such as highways, generally do not lend themselves to an operational turnaround or financial restructuring within the three-to-five year investment period typically adopted by private equity firms. Rather, infrastructure deals typically run for decades. Infrastructure assets offer stable, long-term cash flows that enable Macquarie funds to use debt to boost their returns. Infrastructure investments provide nearly guaranteed revenue streams and to a large extent, returns protected against inflation. They are utility-like investments with a reasonable yield and are not too volatile. They offer regular cash flows, which translate into healthy dividend distributions to investors, while providing a hedge against inflation through the ability to increase user fees. Because infrastructure assets typically provide essential services that are necessities, demand is relatively unresponsive (more technically, inelastic) to the heightened user fees. For example, the income from a toll road grows slowly but steadily with substantial growth from rate increases and the installation of new systems, such as electronic toll collection. As pioneered by Macquarie and its model, infrastructure became a new asset class for investors worldwide, alongside bonds, stocks, and real estate, offering relatively low risk, secure, long-term cash flows and inflation protection. Bonds provide a low-risk profile to investors, but have a limited upside and are vulnerable to inflation. Equities are volatile; real estate is exposed to interest rate and other risks. Infrastructure is not immune to these negatives, but it is relatively less affected by inflation,

introduction / 5

volatility, or interest rate risk, among other disadvantages. Not linked to the equity markets and less cyclical than real estate, infrastructure offers relatively stable, low-risk returns. The returns generated from infrastructure assets are generally superior to those provided by real estate investments. For example, Western European office investments typically yield an annual average yield of 4 to 5 percent; while yields on retail store investments are approximately 5.5 percent. (The term “yield” connotes the annual percentage return, expressed as the ratio of annual net income to a property’s capital value.) In contrast, for example, a toll road in Europe will likely yield an annual a return in excess of 8 percent during the first half of a twenty-five-year operating concession. Likewise, airports typically produce annual yields of 8 to 9 percent.9 Pension funds, life insurance companies, and other institutional investors have come to think of infrastructure as a substitute for longduration, fixed income bonds. Infrastructure represents a high quality, long-term, income-oriented investment generating stable returns, with an upside potential, relatively uncorrelated with equities or business cycle fluctuations, but positively correlated with inflation. The income flows from infrastructure investments match these institutions’ actuarial liabilities for payments to retirees and life insurance beneficiaries. With political risk perhaps the greatest threat to the success of most infrastructure investments, using the fund format enables investors to diversify across sectors, such as toll roads and airports, and geographies to mitigate the consequences of political risk at the portfolio level. Investing in nations with well-developed legal systems, where concession agreements are binding and legally enforceable, further minimizes any political risk. Overview of the Book

Chapter two discusses concession agreements, entered into by lessees such as Macquarie, and analyzes the advantages and disadvantages of infrastructure privatization. It concludes that private entities can use equity ownership structures to reduce the cost of capital. Private managers generally can attain efficiencies that public managers cannot. Incentives also exist for private operators to improve service and increase an asset’s utilization. In sum, innovative public-private partnerships offer the public sector the opportunity to retain controls through carefully negotiated


and structured concession agreements but gain efficiencies and innovation from private operators. Chapter three provides an overview of Macquarie’s early days. It surveys Macquarie’s humble beginnings in 1969 as a tiny antipodean offshoot of a British merchant bank that grew relatively slowly in its first twenty-five years. The chapter examines the role played by a key executive, Allan E. Moss, the firm’s head from 1993 until May 2008, in shaping the firm’s culture. Moss promoted entrepreneurship within strict risk boundaries, producing a corporate culture that facilitated Macquarie’s remarkable growth and success over the years. Chapter four provides an overview of Macquarie’s current operations. In the long takeover boom of the 1970s and 1980s as corporate Australia was reorganized, it moved from serving as a specialist money market operator and corporate advisor to a successful, but small, full-fledged investment bank, taking advantage of successive waves of domestic financial sector deregulation. Macquarie prospered with its reputation for innovation. It led the way with the launch of the first Australian cash management trust. Then in the mid-1990s it hit upon a model of infrastructure funds, which gave it a major leg up and enabled the firm to become a global financial player. Since the mid-1990s, it transformed itself first into a leading Australian investment banking firm and then into a force to be reckoned with on the world financial stage. It became a global financial institution based in Sydney, Australia, rather than an Australian firm that operated overseas. The chapter focuses on the importance Macquarie attaches to risk management, something other commercial and investment banks became painfully aware of in 2007–2008 credit crisis. Although maintaining a decentralized entrepreneurial culture, Macquarie centrally controls a small number of key risks, including credit, finance, operational, and compliance standards. Also examined are Macquarie’s 2007 restructuring that will enable the firm to commit more capital for its continued expansion overseas and, at least in the near term, free its specialized infrastructure funds from the strict requirements that the Australian financial regulator sets for domestic commercial banks. As developed in chapter five, three key ingredients propelled Macquarie’s interest in infrastructure assets. A wide-scale Australian privatization program, coupled with strong equity markets and inexpensive debt, helped Macquarie’s infrastructure model flourish under near perfect conditions. Beginning in the early 1990s, it has had an ample availability of Australian investors willing to buy its

introduction / 7

yield-oriented products. New Australian pension rules, introduced in 1992, mandated that employees set aside part of their salary into privately managed retirement funds. Australian tax changes also facilitated Macquarie’s involvement in infrastructure, beginning with the construction of a toll road in Sydney that it financed through an initial public offering. From that tollway came the first and the oldest of its funds, the Australian-listed Macquarie Infrastructure Group (formerly called the Infrastructure Trust of Australia Group), which now manages highways, bridges, and tunnels throughout the world. Beginning with the Macquarie Infrastructure Group, Macquarie came to play a leading role in bundling and securitizing large, diversified portfolios of infrastructure assets packaged into various funds. As developed in chapters five, six, and seven, Macquarie focused its attention on infrastructure assets, which as virtual monopolies, generate dependable, long-term cash flows. Its specialized infrastructure funds hold toll roads worldwide and in the United States, as examined in chapters five and six, respectively, and airports globally as analyzed in chapter seven. The predictable cash flows from toll roads and bridges, for example, particularly older ones with established rates of traffic growth and the prospects of future rate increases, morphed into attractive long-term investments with quantifiable risks. As developed in these chapters, financial engineering, specifically, asset revaluations and debt refinancing, play a key role in maximizing fund distributions to shareholders. Timely asset sales also enter in the picture. The Macquarie Infrastructure Group benefited from access to a flow of deals. As discussed in chapter five, Macquarie was an early mover in the Australian toll road market. It also developed the first modern toll road in the United Kingdom and purchased the concession for a Canadian motorway, the largest, privately owned infrastructure leasehold in North America. Foreign nations, such as Australia, France, Italy, and Spain, pioneered in perfecting the concession model for investor-operated highways, thereby mobilizing private capital to develop and operate high quality motorways, both urban and intercity. Although the United States trails other developed nations in privatizing highways, chapter six analyzes the privatization of U.S. toll roads by Macquarie. The firm built the South Bay Expressway and snatched up some of America’s trophy highways, including the Chicago Skyway, the Indiana Toll Road, and the Dulles Greenway. To meet future U.S. highway and bridge needs, other public


sector officials may discover the benefits of long-term concessions and may take a closer look at converting existing publicly run toll roads into privately managed ones and allowing the private sector to construct and manage new toll roads. Toll-financed new capacity likely represents the far larger potential for the privatization of U.S. highways. Chapter seven focuses on Macquarie’s worldwide privatization of airports, beginning with the Sydney Airport. As with toll roads, the rest of the world has long accepted airport privatization as a sensible policy. However, airports in the United States remain a public sector enterprise. The chapter considers the legal barriers to privatizing U.S. airports and the need to revamp the American approach. The Macquarie Model is based on creating specialized infrastructure funds, listing many of them on stock exchanges, and obtaining management and other fees. Chapter eight critiques this model, analyzing the doubts that exist about its sustainability, and looks to the future of the firm and its infrastructure funds. Although Macquarie Group avoided the subprime mortgage and other debt problems that plagued many global investment bankers beginning in mid-2007, new challenges exist. Others are horning in on deals Macquarie once had nearly to itself. The firm possesses a first mover advantage globally with its specialized infrastructure fund business. As a pioneer, Macquarie funds have posted strong returns but others are jumping on the bandwagon. However, because of its expertise the firm continues to be more willing and able to take more risks than others. Having its specialized funds lease (or buy) infrastructure assets represented a brilliant strategy, especially when debt money was both cheap and available. The book concludes that as the world’s leader in infrastructure privatization the Macquarie Model will continue to have considerable potential in developed nations, particularly the United States. In face of the worldwide need for infrastructure maintenance, repair, and construction, which cash-strapped or debt-burdened governments generally fund only with difficulty, the moment has arrived for private sector investment in and management of these projects. The globe’s massive infrastructure funding needs will likely attract ever larger pools of private capital. Pension funds and other financial intermediaries, among other investors, will continue to pour money into infrastructure funds, attracted by predictable, income-oriented returns and the potential for appreciation and will continue to serve as a ready source of private capital. *

*

*

introduction / 9

Australia, Canada, the United Kingdom, and other countries in Western Europe, such as France, Spain, and Italy, race ahead of the United States in facing their infrastructure needs and using private financing to fund and manage new construction and improvements to existing facilities. The United States continues to put off the day of reckoning. New public sector spending has failed to keep pace with traffic growth. The federal government as well as states and localities postpone infrastructure improvements, but they are running out of time. Congestion on roads and in the air is ever increasing, delaying the shipment of goods and lengthening commutes. Apart from massive federal infrastructure spending designed as an economic stimulus and a jobs creation program, $ 27.5 billion out of the $787 billion allocated to highway construction as part of the American Recovery and Reinvestment Act of 2009, new ways of financing much needed infrastructure maintenance and construction in the United States will evolve, including innovative public-private partnerships, based on the Macquarie Model of its funds leasing existing (or construction new) assets. The U.S. Department of Transportation broadly defines a publicprivate partnership as “a contractual agreement formed between public and private sector partners, which allows more private sector participation than is traditional.”10 We may see the public sector using economic stimulus money to leverage private sector equity capital to tackle large infrastructure challenges. Government will tap not only private capital but also private expertise. In coming years, attracting billions of dollars in global private capital to modernize America’s infrastructure— highways, bridges, and airports—will represent a significant net gain of the United States. Privatization offers not only a financial tool but also a powerful management technique as well, with a demonstrated track record, for instance, of getting new highway projects built on time and on-budget and allocating capital to projects that provide a high ratio of benefits to cost.11 In short, in the future, American highways, bridges, and even airports may become another category of investor-owned utility, similar to gas and electric utilities. In the first decade of the twenty-first century, infrastructure moved from an arcane corner of the capital markets to almost center stage. Increasingly and with gusto, financial institutions and other investors have embraced infrastructure as an asset class. The next chapter analyzes why the public sector turned to infrastructure privatization.


Ch a p t e r Two Th e R at iona l e for P r i vat i z i ng I n f r a st ruc t u r e Asse t s

Public sector officials thinking big about cost of maintaining, if not improving, aging infrastructure and facing huge budget deficits and an inability to raise taxes or access capital markets often turn to privatizing these assets. To fill the funding gap, government has discovered the long-term concession model. Under this model, in exchange for a long-term license to operate and maintain an infrastructure asset, an investor-owned firm may either: finance, design, and build a new asset, or takeover existing asset and modernize it. In either case, it will operate and maintain the project, financing its expenditures from the user fees it charges. Organizing the construction, operation, and management, or just the operation and management, of an infrastructure asset by the private sector in return for user fees represents a business undertaking. As a management model, investor-owned businesses generally perform many activities better than governments. To attract capital, a for-profit business must price and market the asset that provides a specific service in return for a fee, and manage the asset to cover its costs and provide a competitive rate of return on funds invested in the project. In managing a business, the private sector thus devotes itself to serving its customers and maximizing its revenues and minimizing its costs. It must generate a return on its owners’ investment in a competitive environment. It does this by meeting the wants of people who use and pay for its product. In the twentieth century, the United States showed the world that investor-owned utilities, network industries such as electric, gas, and landline telephone, far exceeded state-owned utilities in carrying out these functions. Learning from the examples in the United States, nearly every developed nation has privatized these network-type utilities.


The long-term concession model extends the investor-owned utility concept from electricity, gas, and telecommunications to limited access highways, bridges, and airports analyzed in this book. Just as utilities are vital industries affected with the public interest, so too are these infrastructure assets. In the twenty-first century, policy goals, whether to raise cash or fill funding gaps, among other objectives, will drive public-private infrastructure transactions. The public sector protects the public interest in infrastructure assets and strives to fulfill policy objectives through detailed provisions and requirements in long-term concession agreements. Whether an agreement involves leasing an existing asset or developing a new one, each contract addresses a basic set of issues. However, an agreement for an existing facility involves lease payments to the public body and a smaller, future construction commitment; while an agreement for a new asset involves higher levels of initial risk for the private partner, including a large construction commitment. After providing an overview of concession agreements, this chapter analyzes the advantages of privatizing an infrastructure asset, including lease payments to the public sector, new sources of funding for infrastructure maintenance and improvements, increased managerial efficiency, and market-based user fees. The chapter also considers disadvantages of market-based user fees and potential disadvantages of privatization, including future windfalls, competition provisions, length of a concession, foreign firms as concession operators, and the possibility of the concessionaire’s bankruptcy or default. The chapter concludes that a carefully negotiated, drafted, and closely enforced concession agreement can maximize the advantages and minimize the disadvantages of an infrastructure privatization. Concession Agreements

A well-drafted concession agreement protects the public interest. The contract spells out the obligations of the concessionaire and the asset owner, the public sector body or agency granting the concession. An agreement for an existing toll road contains, for example, detailed provisions dealing with numerous issues, including the lease payments by the private sector, who pays for future expansion and reconstruction, how the contract will be amended without unfairness to either party, limits on toll rate increases, the degree of protection for the concessionaire from competition from taxpayer-funded roads, and an early

privatizing infrastructure assets / 13

termination of the concession before the expiration date that is fair to both sides. Typically, the fair market value of a long-term concession agreement is the net present value of its net revenues over the remaining years of its term based on an independent, third-party valuation study. The contract spells out the concessionaire’s performance standards, including maintenance, repair, and replacement, as well as providing for monitoring and compliance mechanisms. For a highway concession, maintenance standards typically include requirements pertaining to the response to accidents and other problems, such as snowfall and road kill removal, and levels of service. The rigorous performance standards that must be met as a condition of retaining the concession create incentives for the private operator to maintain the road in the condition stipulated in the contract. However, the public sector must actively and intelligently manage the contract to enforce the specified operating standards. Defining operating and performance standards, including the frequency of inspections and the methods of enforcement, are key aspects of any concession contract. They provide the mechanism through which the public sector monitors the infrastructure’s ongoing soundness and ensures that the concessionaire is maintaining the asset properly. Although the concessionaire generally has sufficient incentives to maintain the facility to maximize revenues for debt repayment and disbursements to its equity investors, as with any contract a risk of nonperformance or underperformance exists. As a long-term agreement, a concession arrangement cannot anticipate all possible issues. An agreement must provide the basis for a sound long-term public-private partnership as well as a mechanism for working out new issues in ways agreeable to both sides. The contract typically contains an arbitration mechanism to deal with disagreements about interpreting the contract’s provisions and whether its terms are being met, provisions for correcting any deficiencies or handling a default by either party, and handback requirements that come into play on the concession’s premature termination or at the end of the concession term. It is important to note that concession agreements give limited control of an infrastructure asset to the private sector. They are not a blanket handover of total control. Furthermore, modern concessions are typically awarded as part of a competitive bidding process. After hiring an expert consultant in bidding procedures, the public body assembles comprehensive information on the project and spells out the selection


process. A request for qualifications enables the public sector to winnow the potential bidders and drop from competition those less capable of fulfilling the contract. Thereafter, the short list of the best-qualified parties submit detailed proposals. If one bid is clearly superior, it is generally accepted. Bidding in the United States for a concession on an existing toll road facility typically is based on the party offering the maximum lease payments. Another approach focuses on the lowest toll rates, among other provisions, over the concession’s term. Contractual controls and limitations placed on a concessionaire reduce a concession’s value. Some controls are necessary to protect the public interest; others are more marginal in their safeguards. Advantages of Privatization

The privatization of infrastructure assets provides four major benefits: lease payments; new capital sources; increased efficiency; and marketbased user fees.1 Lease Payments. The public sector receives lease payments, in the form of an up-front payment, revenue-sharing, or annual lease payments, it can use to balance budgets, retire debt, fund social programs, including state spending for Medicaid, or meet retiree liabilities faced by state and local governments. The payments received by a government may also help accelerate public sector transportation projects that may otherwise be stalled because of a lack of funding. Concern exists about the public sector taking payments from a concession company up-front, as a onetime lump sum payment. This type of payment is often used, entirely or largely, for debt retirement and/or capital expenditures. The public sector must weigh the trade-off between an up-front payment and ongoing lease payments or revenue-sharing arrangements over the agreement’s life. In entering into a concession deal, the public body must carefully assess both its current capital needs versus its long-term capital requirements as well as the certainty of an up-front payment (or fixed, annual lease payments) versus the degree of risk with respect to sharing future revenues. New Capital Sources. With federal and state fuel tax-based funding and debt-financing no longer able to meet the rapidly growing highway, bridge, and airport needs in the United States, we are increasingly frustrated with congested highways and airport delays. As developed in chapters six and seven, the United States faces a major shortfall in


highway, bridge, and airport investments for both maintenance and expansion purposes. Traditionally, the public sector used tax revenues and, to a lesser degree, tax-exempt bonds to finance the development and modernization of infrastructure assets in the United States. Because they cannot share in profits, municipal bond investors receive no upside advantage. They focus on the downside risk of their fixed, debt service interest entitlements not being met and their principal not being returned in a timely manner. To obtain an investment grade bond rating, municipal bond issuers (and ultimately investors) look to a project’s debt coverage ratio, that is, its annual revenues must significantly exceed its annual debt service obligations. Because a project’s annual revenues must be between 25 and 100 percent more than its annual debt service burden, a significant limit exists on the amount of capital that can be raised for infrastructure costs in the U.S. tax-exempt bond market. The concession model provides access to a large, new capital source. It opens the door to equity investors as well as lenders, including institutional investors, such as tax-exempt pension funds and university endowments, that do not purchase municipal bonds. A private concessionaire can provide additional capital through the equity funds provided by the firm or its outside investors. Concession companies have greater flexibility in their use of leverage, that is, the amount of debt in relation to the equity provided. Also, while bond financing aims to recover investors’ capital entirely over the twenty-five to thirty-year term of the bonds; concessions can be structured for seventy-five or more years. The longterm nature of concession deals can make a big difference in the ability to raise capital and fund a project. Increased Efficiency. In addition to privatization serving as a financial tool, it provides a powerful management tool. The private sector generally can more efficiently manage infrastructure assets. For example, in a review of fifty-two empirical studies of infrastructure privatization, thirty-two of these studies concluded that performance of the privatized firms was significantly superior to that of the public entities.2 For-profit operators bring efficiencies and shift operating risks away from the government. In any long-term highway lease, for example, risks exist. Traffic and revenues may be far below projections. Recessions in the national or a regional economy may depress driving and accordingly revenues.


Public sector toll authorities are often inefficient. Weak incentives generally exist for public sector innovation. Profit maximization usually is not a top priority for public authorities. Patronage can be problem.3 Many public sector toll agencies are run by political appointees, who often serve short-terms. Some agencies are constrained to deal with politically favored contractors. Offering limited career paths, they often cannot attract the best talent or pay executives market-rate salaries. They may be slow to adopt cost-saving, customer-friendly technology, such as electronic toll collection, which minimizes delays and enhances safety at toll plazas, while offering environmental benefits through the reduction of noise and exhaust pollution from vehicle stops and starts. Public authorities evidence difficulty in devoting capital to technological upgrades. As indicative of public sector inefficiencies, on taking office in January 2005, Indiana Governor Mitchell E. (Mitch) Daniels (R) asked how much it cost to collect a fifteen-cent toll on the Indiana Toll Road. Daniels said, “This being government, nobody knew, and they finally came back to me and said it was 34 cents. My response was that we’d be better off on the honor system.”4 Apart from debt service obligations, payroll represents the largest operating expense of toll roads. Public sector toll road jobs often include above-market wages and benefits, such as generous base rate pay, overtime opportunities, automatic seniority pay increases, health insurance and retirement benefits, and job security. In other words, public toll authorities generally overpay employees for the services rendered. Furthermore, public agencies cannot easily adjust staffing levels as technology and needs change. They are often overstaffed. Legal, engineering, janitorial, and security services may go to politically connected firms. In contrast, for-profit managers generally are more customeroriented, more innovative, more business-like. Private operators are generally more aggressive in attracting traffic and decreasing expenses. Private concessionaires reduce costs by moving from politically dictated to competitive, market-driven purchases of goods and services. Private firms unhesitatingly upgrade if a new technology will pay for itself through better customer service and reduced costs. One new technology, electronic toll collection, leads to the phasing out of toll collectors, a negative from the viewpoint of politically powerful unions. Fearful of widespread layoffs and/or reductions in benefits if employees are transferred from the public to the private sector, unions


in the United States generally oppose the privatization of infrastructure assets. The impact of job loss can, however, be dealt with in the concession agreement. Market-Based User Fees. Leasing infrastructure assets generally is the best way to ensure that the user pays to maintain and improve these facilities. Private operation of infrastructure assets includes the ability to raise rates without fear of being penalized at the voting booth. In other words, private sector lessees will be less prone to keep rates artificially low to placate voters. Annual toll increases for the life of the concession are needed to service the large amount of debt typically used in a privatization transaction. Private lessees can also experiment with peak pricing, a market-based approach designed to relieve traffic jams on highways and bridges. Concessions remove many of the obstacles to raising rates. Under public sector operation, the manager generally starts out by setting fees at market levels. Over the years, if the public body can service the debt with the existing rates, it generally foregoes the opportunity to raise fees, even though the market could bear the increases. Thus, because of a fear of the political response to an increase user fees, public agencies typically undercharge. Political considerations mean that increases in user fees do not keep pace with the rate of inflation for infrastructure operation and maintenance costs, let alone improvements. This gap contributes to funding shortfalls, deferred maintenance, and for a highway or a bridge, congestion, because prices do not adjust to keep the traffic flowing smoothly. Because public authorities are reluctant to raise tolls as more cars and trucks use a road, for example, highways become congested and are of less benefit to users. Ultimately, when the crisis point arrives, the implementation of a huge toll increase is painful to motorists. Privatization moves the question of fee increases away from the political realm so that market considerations guide rate increases, subject to the terms of a concession agreement. By allowing a public agency to enter into a concession agreement, a legally enforceable contract, a legislative or regulatory body limits its future ability to intervene in rate-setting decisions. User fees are set at what the market will bear, not the price set by politicians determined to win votes. Also, concession agreements typically have provisions that do not permit deferred maintenance. The high valuation accorded toll road concession deals centers, in part, on the certainty of raising rates over the life of a long-term


agreement. Private firms strive to adjust tolls modestly, typically annually, knowing it is a business-like approach. With private sector operators, users face steady, annual, inflationadjusted toll rates. There is a sound case for small, regular toll increases. Inflation impacts a toll road’s costs, such as wages and maintenance expenditures. Prices need to keep pace with these increases. It is more customer-friendly to implement modest price increases, which people generally expect (and more willingly accept) for goods and services, rather than wait ten or fifteen years and seek to overcome political opposition to a massive 30 to 50 percent onetime increase to catch up with current costs. Concession agreements typically incorporate annual caps on the amount user fees can be increased, using one of several inflation indices or some other predetermined measure. These caps represent ceilings; the actual rates charged depend on market conditions. Some agreements use a negotiated ceiling on the concessionaire’s rate of return instead of price caps to leave the pricing free to be adjusted as needed to control traffic congestion. The rate increases built into a concession contract face what economists call the elasticity of demand. Although many drivers lack flexibility in the route they travel, enough customers have options and will balk at paying rates they feel exceed the value they receive from using a toll road. In other words, the user fee must be attractive to the customers for the value they receive in using the product. The amount a company can charge will only equal what people are willing to pay and thus private sector operators will set rates at about their market levels. Most toll roads serve as high-speed alternatives to existing highways. If a toll road becomes too expensive, however, its private operator risks losing business. Too high a rate, especially in recession years, whether throughout a nation or regionally, means fewer users, which generally results in lower total revenues. The private firm will generally select a rate that maximizes its total revenues. The rate may be less than the cap set forth in the concession agreement. Although these arguments are theoretically sound, the viability of continuous, annual toll increases on highways has not, however, been tested in the United States. Cognizant that the toll increases provided for in a concession agreement will lead to sharply higher tolls over a period of year, a public body may select a cap designed to give lower annual rate increases. Privatization deals will get done; however, as a consequence, either the up-front or lease


payments to (or future revenue-sharing payments with) the government will be lower. To deal with concerns about future rate increases, the public sector may link the payment to a user’s ability to pay. To offset the hardship that low income groups may experience from highway or bridges tolls, for example, public officials could implement a transportation voucher system or provide subsidies to ease the financial burden. Occasionally, some toll road agreements will not directly restrict rates. If the main purpose of the user fee exists to manage the traffic flow through what is called value-priced tolling, the concession agreement will not contain toll rate ceilings. Under this approach, the rates must be allowed to vary to keep the traffic flowing at the specified performance levels. With value-priced lanes, the contract typically limits the private operator’s rate of return, with surplus revenues going into a public sector highway or transportation fund. Potential Disadvantages of Privatization

Disadvantages exist, of course, leading to the opposition to privatization. There are six major, potential disadvantages: future windfalls; competition provisions; viewing a concession as a sale of assets; length of the concession; foreigners as concession-operators; and bankruptcy or default. Future Windfalls. After taking over an asset, the private sector often receives big windfalls from debt refinancing and the attendant fees. Concession holders typically refinance their indebtedness on more favorable terms. If a government is concerned about this happening, it can negotiate to share in the refinancing gains. A contract could include a gain clause, enabling the public sector to receive a lump sum cash payment at the time of the refinancing. Although this type of clawback mechanism may make the privatization deal more politically acceptable, it will likely result in smaller lease payments. Competition Provisions. Concession contracts may limit the extent of public sector competition by new, “free” (non-toll) taxpayer-provided roads serving the same market. However, these provisions rarely ban all forms of parallel, “free” roads, whether additions to or new highways. Rather, they usually offer the concessionaire compensation for the reduced traffic, if it can prove a loss of revenue. The agreements typically provide that only certain types of competing roads are subject to compensation, such as motorways that divert traffic from the toll


road and thus reduce its revenues. Often excluded are roads that comprise part of a region’s official, current, long-range transportation plan as well as highways more than a specified number of miles on either side of the toll road. These competition details are negotiable as part of the concession contract. Occasionally, the public sector may receive the right to extra revenues attributable to positive impacts on the toll road from the state’s own roadway improvements. Contract provisions that limit the prospect of competition will increase the value of a lease, by helping the concessionaire protect its investment, but may run counter to the public interest if this type of provision is not commensurate with the risks borne by the private sector. Stringent noncompete clauses may create future political pressures to modify the provision or terminate the concession. Conversely, provisions offering little protection will likely reduce the lease payments, however structured. A trend exists to include a limited competition protection clause or no provision at all. Viewing a Concession as a Sale of Assets. Xenophobics, such as CNN’s Lou Dobbs, decry the sale of tax-funded highways to foreign companies. In one broadcast, Dobbs stated, “I mean . . . , it’s incredible. . . . [T]he idea that a state government or an authority of any kind could sell infrastructure, highways, [to private interests] it just boggles the imagination. . . . Foreigners could take over some of our busiest highways with the Bush administration’s blessing—foreign companies. Those roads, by the way, were built by the taxpayers.”5 However, a long-term concession of an infrastructure asset represents a lease, not a sale, with stringent provisions to protect the public interest. The public sector retains ownership of the roadway, bridge, or airport, establishes maintenance and operating standards, holds oversight responsibility and step-in rights. As noted earlier in this chapter, the government protects taxpayers by demanding accountability in an infrastructure contract with the private sector. Length of the Concession. With leases of highways, bridges, and airports extending to more than fifty years, changing circumstances will likely require modifications to the contracts. Concession agreements contain detailed provisions allowing changes during their term. Subject to the limitation that contractual terms cannot normally be changed to disadvantage either side financially, these contracts contain procedures for negotiating changes, employing independent experts to make fair financial estimates, and arbitrating disputes.


From a private operator’s viewpoint, various risks exist in a seventyfive-year deal for an existing facility, for example the seventy-five-year lease for the Indiana toll road, then fifty years old. The concessionaire must plan to add the necessary capacity to meet the service level requirements spelled out in the concession agreement. Apart from the required future expansion, through privatization the public sector transfers to the private operator other risks, including technology shifts, changes in business conditions, and uncertainties of population and economic growth. The private sector also assumes other risks, such as alterations in travel patterns and modes of transportation. Shorter agreements can be negotiated. Reducing the number of years during which investors can recover their investment significantly lowers revenues received by the public sector, whether in terms of upfront payments, annual lease payments, or future revenue sharing (or all three). Whatever the term of the concession, it is important to remember that the public sector generally makes commitments, for example, employee pension benefits lasting decades into the future, impacting on taxpayers for more than fifty years. Foreigners as Concession-Operators. In the first decade of the twentyfirst century, only European and Australian firms possess the worldclass expertise, competence, and track record with respect to the long-term development, operation, and management of infrastructure, such as toll roads. In these nations, governmental policy has encouraged private sector operators. Desirous of an experienced, professional manager, a responsible public sector agency must weigh successful prior experience in its selection criteria. Because of the American tradition of building and operating toll roads by public sector agencies, no domestic, private sector toll road industry currently exists in the United States. With time, domestic American private sector operators will likely develop. As discussed in chapter eight, we are witnessing a proliferation of U.S.-based infrastructure funds. Initially, they will do joint venture deals, combining the U.S.-firm’s knowledge of the local market and its funding capabilities with a foreign company’s hands-on experience in managing and operating a toll road. Until American firms gain the requisite expertise, some fear a greater risk of a security breach when foreigners manage and operate infrastructure assets in the United States. Wherever their shareholders may reside, foreign firms will always possess a strong self-interest in the security and safety of the leased roads, bridges, and airports they


manage and operate. The financial viability of a project depends on an asset remaining open without interruption. Real, rather than emotional, issues can be dealt with by contract. A concession agreement subjects a foreign firm to the same legal and security agreements as any domestic entity or public agency. For example, the toll road contracts typically provide for state police to continue to monitor the roadway. Agreements could provide for improved surveillance systems and enhanced security vetting of employees. Bankruptcy or Default. Bankruptcy (or a default on the concession contract) by the concessionaire could place operating burdens on the public sector, whether in terms of a government bailout or takeover. The outcome of a lessee’s bankruptcy depends on the terms of a concession and the applicable bankruptcy laws. With a debt-financing concession, the project’s bondholders may have what are called step-in rights to prevent a bankruptcy from happening. If a bankruptcy does occur, a government may benefit if it can terminate the concession and lease the asset again, but retain the lease payments. In any event, the public sector must be prepared to assume control of the asset during the concession’s life and have the requisite staffing and capital to ensure a smooth transition in the event of a contract termination. The government always retains the risk as the owner of the facility and as the manager of last resort. *

*

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To protect the public interest, the public sector negotiates and enforces the terms of the concession contract, which incorporates detailed provisions dealing with numerous issues. In negotiating the concession, the government needs a clear picture of the public objectives so that the contract can strive to achieve these goals. The public sector must specifically ask whether it is retaining an adequate share of an asset’s value. The government wants to make certain that a facility is run well and at the same time that the privatization transaction represents an interesting business opportunity. Getting the price right is a difficult, sensitive task. Contractual terms providing a concessionaire with substantial pricing power and protection from competition increase the discounted present value of the revenue stream associated with an asset. Other key assumptions go into toll road valuation, including traffic growth projections and the cost of long-term borrowing. In negotiating a


contract, public agencies must be cognizant of a facility’s cost and its risk profile, as well as the degree to which competing facilities (or the threat of competing facilities) will constrain a concessionaire’s pricing power. In addition to its own internal expertise, the public sector body must retain outside entities to provide additional advice on a variety of financial and managerial issues. In sum, the vital components of a mutually successful, beneficial, long-term infrastructure arrangement include a detailed agreement, well-chosen partners, and expert advice. High-quality contract monitoring is essential over the concession’s term. If an asset changes hands over the decades, each buyer may, in turn, feel increasing pressure to make the deal work financially to its benefit. The public sector must remain vigilant so that service does not suffer. Over the past decade or so, Macquarie has played a significant role in the worldwide privatization of infrastructure. Before analyzing these privatization transactions in chapters five, six, and seven, we turn and examine in chapters three and four how Macquarie transformed itself from a small outpost of a British merchant banking firm into the leader in the Australian investment banking market, and then into its current position a force to be reckoned with on the world stage. The next chapter analyzes Macquarie’s early years, it culture, and its growth.


Ch a p t e r Th r e e M acqua r i e: Th e Ea r ly Ye a r s, It s Cu lt u r e, a n d It s Grow t h

From its inauspicious beginnings four decades ago, Macquarie transformed itself from a small, but successful, Australian banking firm into a global force in a number of financial services fields, achieving preeminence through its real estate and infrastructure, among its funds. After tracing the firm’s early years, this chapter examines the role of a key executive, Allan E. Moss, in shaping its culture. Moss promoted entrepreneurship within strict risk boundaries, producing a corporate culture that facilitated Macquarie’s remarkable growth and success over the years. Also summarized are its mistakes and failures as well as the firm’s emphasis on human capital. Macquarie’s Beginnings as Hill Samuel Australia

Founded in December 1969, Macquarie began as a small, wholly owned Australian subsidiary, Hill Samuel Australia Ltd., of a large British merchant banking firm, Hill Samuel & Co., which is now part of Lloyds TSB Group PLC.1 It initially operated out of a two-room office in Sydney.Shortly after the establishment of its Australian subsidiary, Hill Samuel recruited two young Harvard MBAs to run it, David S. Clarke and Mark R.G. Johnson. When Clarke and Johnson joined the firm, it had some twelve employees. Well-connected and debonair, Clarke served as the joint managing director of Hill Samuel Australia Ltd. (HSA) from 1971 to 1977, its sole managing director from 1977 to 1984, and as Executive Chairman of HSA and then the Macquarie Bank Ltd. from 1984 to 2007. He currently is the nonexecutive chairman of both the bank and its nonoperating holding company, the Macquarie Group Ltd. Johnson was the joint managing director of HSA from 1971 to 1977 and an executive director of


Hill Samuel & Co. (London) from 1977 until 1980. He rejoined the Macquarie Bank in 1986, serving as an executive board member of the firm from 1987 to 2007 and deputy chairman during those years. Hill Samuel established a merchant bank subsidiary in Australia for several reasons.2 Until the early 1980s, Australian controls restricted the operations of trading (commercial) banks to short-term borrowing and lending. Corporations looking for large-scale, longer-term lending had to turn to merchant banks to satisfy their needs. Legislation barred foreign entities from operating as commercial banks in Australia, although they could create merchant bank subsidiaries there. The legal structure, along with resource boom of the late 1960s, led foreign merchant banks, such as Hill Samuel, into the Australian capital market. From 1969 until the mid-1980s, the unit offered a limited range of services, including corporate lending, as a result of Australian regulatory restrictions on trading (commercial) bank lending operations. It engaged mainly in cash management trust activities, a type of money market fund that invested in short-term debt instruments, long dominating that business in Australia. It engendered astonishing employee loyalty; not only were they the pick of the bunch, they were also well compensated. Competitors found it impossible to recruit from HSA. Hill Samuel Becomes Macquarie

In 1985, the subsidiary split off from Hill Samuel in a management buyout, orchestrated by Allan E. Moss.3 As part of a move to obtain an Australian banking license, Hill Samuel cut its ownership stake to roughly 30 percent, 9.9 percent in the form of voting shares and 20 percent in nonvoting shares, the latter then reduced to 15 percent in 1992. The divestment was necessary because under Australian banking law, one shareholder could not own 10 percent or more of a bank’s voting shares.4 As part of the restructuring plan, Hill Samuel received a cash payment of A$24.2 million (£17 million). The new bank’s executives and staff owned 9.9 percent of its voting shares, with twelve Australian institutional investors holding the remaining roughly 80 percent. The move occurred in the context of a rapidly changing Australian financial environment. Hill Samuel realized that its subsidiary’s prospects would be dim without a full banking license. The British firm concluded that it would rather own a major interest in a trading (commercial) bank than a controlling interest in a merchant bank. Hill Samuel expected, correctly in hindsight, that the deregulation of

early years, its culture, and its growth / 27

banking in Australia would hold major opportunities for licensed trading banks to become fully competitive financial services organizations. The spin-off and the creation of the Macquarie Bank Ltd. occurred in the context of the deregulation of the Australian financial system. The Campbell Committee, set up in January 1979 to investigate all aspects of the nation’s financial system, provided a forum for deregulation advocates. The Campbell Committee’s terms of reference required it to make recommendations to improve the Australian financial system in light of “the Government’s free enterprise objectives.”5 The Committee’s report “start[ed] from the view that the most efficient way to organise economic activity is through a competitive market system which is subject to a minimum of regulation and government intervention.”6 In recommending a far-reaching deregulation of the Australian financial system, its recommendations included the removal of controls on bank deposits and lending interest rates; the abolition of maturity controls on interest-bearing bank deposits; the removal of quantitative and qualitative lending controls; the deregulation of the foreign exchange market and the floating of the Australian dollar; and the removal of barriers of entry into the nation’s financial system.7 After the defeat of the Liberal government at the polls in early 1983, the incoming Labor government set up the Martin Committee to review the Campbell Committee’s findings in light of the new government’s social and economic objectives. Before the Martin Committee handed down its report, the new government abolished most controls over foreign exchange transactions and took steps to float the Australian dollar. In its report released to the public in February 1984, the Martin Committee reported favorably on the Campbell Report,8 thereby opening the way for financial reforms to proceed. After obtaining its own banking license from the Australian federal government as an authorized deposit-taking institution in February 1985,9 Macquarie Bank Ltd. opened a private trading bank business the next month. Macquarie became a mixture of a commercial bank and an investment bank, offering financial and takeover advice, underwriting and placement of securities, foreign currency management, bullion trading, futures brokerage and interest rate hedging services. As a licensed bank, its activities became subject to regulation under rules overseen by the Australian Prudential Regulatory Authority (APRA). APRA’s banking regulations restricted the financial risk exposure of certain subsidiaries of authorized, deposit-taking institutions, such as Macquarie Bank, a topic that we will return to in chapter four.


Adopting a new identity, the new firm renamed itself for Lachlan Macquarie (1761–1824), an early governor of New South Wales. He transformed the British penal colony into a more free market economy by encouraging the development of commerce and agriculture.10 Macquarie, who served as governor from 1810 to 1821, became famous for a feat of financial engineering he performed in late 1813 and early 1814. Faced with an acute currency shortage in the colony, Macquarie, a person of action, did not wait on London for a solution. To establish a regular currency, in place of illicit rum, he bought Spanish silver dollars worth five British shillings each. Emulating administrators in the West Indies, Macquarie ordered the punching out of their centers. He thereby created two new sets of coins. The two pieces consisted of the donut silver dollar with a hole, called the “Holey Dollar,” Australia’s first currency, then valued at five shillings, and the “Dump,” formed from the hole, which was worth one shilling and three pence.11 The strategy doubled the number of coins in circulation and increased their worth by over 25 percent. Lachlan Macquarie is still admired in Australia for his simple, but ingenious, act of financial engineering, a creative solution to a difficult problem. The Holey Dollar became the Macquarie Bank’s logo on its formation in 1985. It represents innovative financial thinking. Since its founding more than two decades ago, the Macquarie Bank, now the Macquarie Group, has fostered an aggressive, entrepreneurial spirit, within the context of prudent risk management. Allan Moss’s Role in Shaping Macquarie’s Culture

Prior to Macquarie taking its new name, beginning in 1983 Allan E. Moss, an Australian born in 1949, led the team responsible for preparing the submission to the Australian government for forming the bank and obtaining its banking license. Right out of Harvard Business School, where he graduated at the very top of his class, Moss joined Hill Samuel Australia in 1977, in its Corporate Services Group, when the firm had some fifty employees. In 1984, he founded and was appointed head of the bank’s Financial Management Division, now called its Risk Management Group. From risk management, he moved to other parts of the business. In 1986, he was made responsible for the firm’s Corporate Banking Group. Continuing his rapid rise, he was appointed head of the Financial Markets Group in 1988, and named


Deputy Managing Director and board member the following year. He became the firm’s Managing Director in 1993. After the corporate restructuring in 2007, analyzed in chapter four, he became Managing Director and CEO of Macquarie Group Ltd., the firm’s new holding company, and Managing Director and CEO of Macquarie Bank. He held these posts until his retirement in late May 2008. Moss, described by journalists as quiet-spoken, and low-key, personally very understated, came across as a university professor or a rather cautious banker. Inside the bank, he was respected for his intellect, and liked for his genial, unassuming manner. Brainy but seen as bumbling, there was something of an absent-minded professor about him. He had a reputation for being clumsy. Yet for all his affability, Moss could be coolly detached, with an uncanny ability to come up with bold initiatives with big payoffs and to know what was going on in every corner of Macquarie’s increasingly far flung business empire. Seemingly egoless, Moss sought to guide and expand the firm that, he maintained, he never aspired to run.12 Prior to his retirement, Moss was regarded as one of the world’s great business leaders of the late twentieth and early twenty-first centuries. In 2006 and 2007, Barron’s named him as one of the thirty best CEOs in the world.13 For over two decades, Macquarie’s board has believed that the risk management function, created by Moss, is increasingly vital to the bank. By focusing on how much money the firm could lose in any transaction, the risk management group seeks to make certain that it is ready for any financial catastrophe that might unfold, whether in Australia, any other part of the world, or globally, a lesson many other commercial and investment banks wished they had learned before 2007.14 Under Moss’s leadership, the firm tried (and continues to strive) to strike what it regards as the right balance between risk control and entrepreneurship. In introducing a new product or undertaking a new activity, the firm continues to run various scenarios to test its potential harm to the entire entity. As Moss stated before his retirement, “Risk management has to be a priority, so I try to ensure I provide an environment in which entrepreneurial talent can thrive, but within a framework of strong controls.”15 Moss used the phrase “freedom within boundaries” to characterize the balance between the pursuit of profit and the avoidance of risk. He had previously called it “loose tight,”16 an infamous phrase associated with Enron’s Jeffrey Skilling,17 who learned the phrase from one


of the world’s preeminent consulting firms, McKinsey, when it served as an Enron consultant. Moss believed his concept of “freedom within boundaries” allowed Macquarie to “maintain that smaller business entrepreneurial culture within a much larger organisation.”18 Moss explained his overarching approach as follows: We have a philosophy—freedom within boundaries—which means that we seek to control a relatively small number of parameters, and they are mostly about risk: credit risk, market risk, brand and reputation risk and operational risk. We seek to give as much operational freedom as we can, and we try to provide an environment that is conducive and supportive of entrepreneurial activity. It’s not an environment where a lot of black-andwhite direction is given, but we work hard to control risk.19

Within the firm-wide context of risk management, a silo structure exists. Each unit has the power to be entrepreneurial. Moss stated, “Managing key things and delegating as much as we can has encouraged entrepreneurial activity while controlling significant risk.”20 According to Moss, It’s a collaborative process and when we think of our culture, the best way to explain it is that it’s a small business culture within a larger organisation and those of us who are in the leadership all remember what it was like to be a part of a smaller business, and so we’ve organised ourselves to maintain that smaller business entrepreneurial culture within a much larger organisation. The way we foster that is through a philosophy we call freedom within boundaries and what that means is that we seek to centrally control a small number of key risks but we leave as much as we possibly can to the people who are involved in the relevant business, and that even extends to looking to them to recommend their own strategies.21

Macquarie’s banking and property group founder, William J. (Bill) Moss, no relation to Allan Moss, who retired in 2007 after twenty-two years with the firm, summarized its corporate culture as follows: Macquarie somehow has been able to get people to believe in a culture, where, if you build a business, you will be rewarded. If you just have a culture where you get paid quickly, then people will just go out and buy things and hope they go up in value. I think the creativity comes out of a culture that will support you.22

The entrepreneurial culture creates intense internal competition that sets Macquarie apart from many other investment banks. As Allan Moss once told a former Macquarie executive, “. . . [T]he day you realise


that your biggest competitors are more likely inside Macquarie . . . than outside is the day you understand Macquarie. . . .”23 Macquarie’s Growth

Macquarie’s growth into a full-service, rather plain vanilla, investment bank was steady, but unremarkable, competing successfully against local subsidiaries of Wall Street and European giants. Then in July 1996, the firm listed its shares on the Australian Stock Exchange to provide enhanced liquidity for its shareholders. Hill Samuel sold its 15 percent interest in the firm to the Sultan of Brunei, who, in turn, disposed of most of his stake in 1998. Macquarie’s entrepreneurial approach made the firm innovative and very good at reinventing itself, within the established risk management parameters. Its infrastructure fund business took root beginning in the mid-1990s. In 1996, as considered in chapter five, it launched its first fund, Infrastructure Trust of Australia Group, subsequently renamed Macquarie Infrastructure Group, following the successful financing of the construction of the M2 Motorway, a Sydney toll road. It then packaged a variety of infrastructure assets into funds, which it sold to yield-hungry investors. The steady-return, low risk infrastructure investments melded perfectly with pension funds’ and other institutions’ long-term obligations and investment horizons. By 2001, Macquarie embarked on a full-scale transition to infrastructure fund manager. On September 11, 2001, Macquarie commenced raising A$500 million of new capital, representing about a 50 percent expansion of its capital base to support its strategic development plan, focused on specialized funds. Moss disliked corporate labels. He once stated, “If a label exists, it does so because there is an existing business model that it describes. We really don’t want to be doing things that others are already doing. We want to do something different.”24 In the past decade or so, Macquarie has done things differently. Most notably, it controls and operates a global portfolio of infrastructure assets, roads, bridges, and airports, dozens and dozens of facilities around the world; diversified by asset class and geography. As of the end of September 2008, it had 118 infrastructure and infrastructure-like investments worldwide.25 It provides an essential range of services, including land, air, and sea transport, car parks, electricity, gas, water, broadcast communications to millions and millions of people in


Australia, New Zealand, Asia, Africa, Europe, the Middle East, and North America. Reflecting the firm’s global reach and its scrappy, entrepreneurial culture, Moss noted in October 2005, “If I were running one of the major Wall Street firms, I wouldn’t be toiling for difficult transactions in challenging industries in every corner of the globe.” “We have,” he added with a chuckle, “the advantage of desperation.”26 Macquarie’s Failures, Mistakes, and Successes

Over the years, Macquarie made its mistakes and had its failures, which were few in number. Its mistakes include a power station and a fiber optic network, both in Australia, which it sold.27 In 1997, the privately held Horizon Energy Investment Group, of which the Infrastructure Trust of Australia Group (ITA), renamed the Macquarie Infrastructure Group (MIG), was a member, purchased the Loy Yang, a power station and coal mine from the State of Victoria government. With Horizon contributing some 25 percent of the equity to the Loy Yang Power Partnership, ITA invested A$170 million for a 50.7 percent equity interest in Horizon, giving it 12.7 percent of the equity in the power station and mine.28 Thereafter, the power generating facility faced an unexpected decline in electricity prices. After Horizon’s sale of the power plant in 2004, MIG received some A$16.2 million for its interest in Horizon, suffering a near wipeout of its investment.29 Macquarie has encountered several high profile setbacks. It failed to buy various icons, such as its £1.5 billion bid for the London Stock Exchange Group Plc. in 2006 and the A$11.1 billion deal for Qantas Airways Ltd. in 2007. Macquarie viewed the exchange as a financialinfrastructure asset. However, when it balked at upping an offer, the stock exchange responded with a dismissal of its bid. Macquarie had been hatching a deal for Qantas for a decade that evaporated in May 2007. With its botched bid went A$140 million in advisory fees (some 1.5 percent of the transaction’s value) as well as fees from any refinancings and taking Qantas public again. Qantas wanted to be bought, a majority of its shareholders wanted to sell, but Macquarie could not get the transaction done.30 Macquarie also failed in its bid to take private Alinta Ltd., Australia’s largest energy infrastructure firm. In 2007, Macquarie switched from being Alinta’s internal adviser to participating with Alinta’s managers in


an A$8 billion buyout. The switch resulted in the bank being publicly dismissed from its position as Alinta’s internal adviser. Babcock & Brown Ltd., an upstart rival and a Macquarie-clone, won approval to buy Alinta, beating out Macquarie’s bid. Other mishaps dented the firm’s aura of invincibility. In late 2006, Macquarie may have suffered a security breach on an Australian Defense Department contract. This led Canberra to snub it for a role in the further privatization of Telstra Corp., Australia’s largest telecommunications group.31 Despite these mistakes and failures, Macquarie’s overall track record is unexcelled. From fiscal year 1996 through fiscal year 2008, it reported twelve successive years of record profits and growth, with the firm’s profits hitting A$1.8 billion in the year ending March 31, 2008.32 The gains continued during the dot.com bust of 2000–2002 and through the early part of the 2007–2008 credit crunch, including a more than 20 percent increase in fiscal year 2008 in a market where few financial institutions globally reported profit gains over the corresponding annual period. During Moss’s term (1993–2008) as Macquarie’s head, the firm’s profits grew thirtyfold. By the end of its 2008 fiscal year, the firm had a staff of 10,000 strong, operating in 60 offices in 25 countries,33 offering a full range of investment, financial market, and advisory products and services. Over the years, Macquarie has fostered a strong sense of camaraderie with autonomy and high salaries (and bonuses) serving as key elements. The Importance of Macquarie’s Intellectual Capital

The firm bets on its intellectual capital. Today, it is the employer of choice for Australia’s “best and brightest.” Known as the “Millionaires Factory”34 for the large sums of money its senior executives have made over the years, it attracts top talent with market-rate salaries and generous bonuses for employees at its top performing units. Its compensation packages are broadly in line with its Wall Street competitors and, more generally, global investment banking standards. As part of its compensation model, about 50 percent of Macquarie’s profits go into compensation, consistent with investment banking worldwide. It is also a meritocracy where winners, not just the top bosses, are rewarded for stellar performance. The hiring of ex-politicians and bureaucrats to help win and manage acquisitions has proven a successful, if controversial, strategy.35


Its sky-high remuneration numbers have drawn the most attention. Macquarie regularly has had the highest paid executives in Australia, who annually receive huge cash bonuses. The furor over executive compensation boiled over in 2007. Macquarie reported that for its 2007 fiscal year, ending in March 2007, the firm paid seven of its top executives more than A$10 million a year, with Allan Moss, receiving A$33.5 million, and Nicholas W. Moore, then the head of the firm’s investment banking group, now renamed its Capital Group, A$32.9 million.36 A leading proxy advisory firm, Institutional Shareholder Services (ISS), which provides proxy-voting services for institutional investors globally, in July 2007 recommended that Macquarie shareholders vote against the company’s proposed Remuneration Report in a nonbinding poll. In reaching this conclusion, ISS reasoned that executive remuneration largely in the form of annual cash bonuses, as opposed to equity awards, such as stock options, did not sufficiently provide a long-term alignment of management and shareholder interests, even if as part of its remuneration strategy for senior executives, 20 percent of any annual bonus must be deferred for up to ten years. It noted that top executives took home too much of the firm’s total earnings, receiving a disproportionate share of the profits generated by the use of shareholders’ capital. ISS also asserted that the compensation plan was rigged to provide executives with big windfalls from short-term gains, such as asset sales, that had nothing to do with the sustainability of the firm’s profits.37 Although more than 25 percent of the shares voted at the company’s annual meeting in July 2007 failed to endorse the board’s position on executive pay,38 the firm’s senior executive team remuneration structure appeared to provide a strong linkage between compensation and longterm shareholder returns with strategic business decision making made over a ten-year horizon. Perhaps in response to critics, such as ISS, in February 2008, Macquarie group modified its remuneration arrangements, including an increase in the portion of performance-based profit share deferred and allocated as equity for its chief executive officer and other members of the firm’s executive committee. Then in March 2009, Macquarie proposed further changes to its remuneration arrangements for its senior executives and employees. In brief, the profit share paid in cash would be reduced and the percentage of retained profit share would be increased.39 Macquarie executives wear their salaries and bonuses as badges of the bank, and accordingly, their own international standing. Its pay scales


enable the firm to retain and motivate senior executives, fostering loyalty and providing continuity. Salaries are huge, but so is shareholder wealth in terms of dividends and share value. From July 1996 to the end of March 2007, the Macquarie Bank and its Australian-listed specialized funds generated an aggregate of more than A$40 billion for their shareholders from dividends and the appreciation in value of shares. During this period, the firm delivered a total shareholder return of 1,814 percent, a better return than any other company listed in the Australian Stock Exchange Top 50 listed companies during that period.40 *

*

*

Macquarie’s entrepreneurial spirit within strict risk parameters, as fostered by Allan Moss during his tenure as head of the firm, allowed the company to be flexible and ambitious, yet secure, and to produce such extraordinary results. Chapters five, six, and seven delve into a key source of this success: the Macquarie infrastructure model. Before considering the Macquarie Model, the next chapter provides an overview of the various units that comprise the firm.


Ch a p t e r Fou r M acqua r i e: It s Cu r r e n t O p e r at ions a n d It s Grow t h St r at e g y

Today, Macquarie, part investment bank, part fund manager, part facilities operator, is the world’s biggest toll road lessee and manager and the globe’s second largest private airport lessee and manager. It operates a diversified financial services institution, providing a full range of investment, financial market, and advisory services in Australia and Asia, and having a focused, selective presence in other international markets. Macquarie is what Allan Moss described as a “federation of entities”1 in which managers work freely within strictly defined risk criteria. According to Moss, “In many respects it is a federation because we do work to provide a home for entrepreneurial activity, and there are some rules along with being part of the federation, particularly the observance of risk management.”2 Moss indicated that his approach encourages an entrepreneurial spirit backed by the resources and support of a large institution. The risk control framework allows executives to manage as they see fit. As a federation of businesses, each unit strives to bring in more profits than the others. The greater a profit a particular division makes, the larger the chunk of the bonus pool it is allocated and the more money it has to distribute to its staff and managers. After summarizing Macquarie’s operations, this chapter provides an overview of its Risk Management Group and the firm’s 2007 restructuring. The chapter concludes with an analysis of Macquarie’s current growth strategy. Macquarie’s Operations

As Macquarie grew after 1996, prior to its restructuring in 2007, it evolved into seven units: Investment Banking; Treasury and Commodities;


Real Estate; Equity Markets; Banking and Securitization; Financial Services; and Funds Management.3 Its independent, but centralized Risk Management Group, discussed in the next section of this chapter, assumes responsibility for ensuring that all risks are appropriately assessed and managed across the firm. Investment Banking. As the engine driving profitability, the group delivers more than one half of the firm’s total profits. For example, in fiscal year 2007, it contributed 58 percent of the entity’s overall profits.4 In Australia, Macquarie, through the Investment Banking group’s Corporate Finance division, still bears the hallmarks of a traditional investment bank. It is Australia’s largest investment bank, constantly ranking number one as an advisor in announced and completed mergers and acquisitions.5 Its Corporate Finance division initiates, structures, and executes a broad spectrum of transactions for corporate, institutional, and governmental clients. It is a global provider of corporate advice and services with respect to mergers and acquisitions, divestitures, takeovers, corporate restructuring, listed and unlisted debt, equity and hybrid financing, capital management, leasing and asset financing, and project financing, among other strategic financial matters. The separate Investment Banking Funds (IBF) business within the Corporate Finance division houses a range of specialized infrastructure and infrastructure-like funds that comprise an important part of the overall division’s strategy. The division’s ability to acquire assets has allowed it to develop a number of specialized funds, globally. As of the end of March 2007, IBF had a portfolio of assets under management of some A$109 billion.6 In addition to deriving fees from its fund management activities, it also obtains fees as the advisor to its funds in their asset acquisitions and sales as well as debt refinancings. Beyond its involvement in the specialized funds that the firm manages, the Corporate Finance division conducts a number of investments on behalf of the firm, including asset acquisitions, minority equity stakes, and stakes in IBF-managed funds. Several acquisitions are noteworthy. In June 1999, the firm acquired Bankers Trust’s (BT’s) Australian investment banking business, an arch rival, from the U.S.-based Principal Finance Group, which had previously purchased Bankers Trust Australia Ltd. from Deutsche Bank AG.7 Noting at the time that it was an “enormous step forward”

current operations and growth strategy / 39

for the bank, Moss stated, “This is a fantastic business—very high quality in its characteristics—and it’s astonishing it should be available in this way, at this price.”8 The firm acquired BT’s large scale, market-leading businesses, such as BT’s debt markets business, allowing Macquarie to reenter the Australian government bond market as a leading player. The roughly A$100 million acquisition helped, in part, propel the investment banking group to its preeminent position. In April 2007, Macquarie acquired Giuliani Capital Advisors LLC as the first step in a campaign to build its investment banking presence in North America.9 The Giuliani group, a boutique firm, specialized in providing advisory services to financially distressed companies. Even before the onset of the mid-2007 credit crunch, Macquarie was keen to develop its corporate restructuring business, both the advisory side and the principal side. The Giuliani acquisition also strengthened Macquarie’s merger and acquisition advisory business. The Investment Banking group’s other divisions include Macquarie Securities, Financial Products, and Capital Finance. Macquarie Securities, a leading Asia-Pacific equities business, provides retail, institutional and corporate brokerage services in Australia and Asia and equities research coverage to institutional investors, globally. Making a strategic acquisition of a struggling firm in May 2004, Macquarie purchased the Dutch ING Group’s Asian equities business, the old Barings business that ING had taken over in 1995 when the UK bank collapsed, for about A$145 million. Through its operations in nine nations, the acquisition provided a needed pan-Asian platform and a critical mass from which Macquarie could grow in that region.10 Doubling Macquarie’s staff in South Asia and giving it an onthe-ground presence and bank licenses in various markets for the first time, the purchase gave Macquarie an equities distribution capacity in the Asian retail investor markets, along with an advisory and securities origination side. Thus, the ING Group acquisition enabled the firm to enhance its corporate finance as well as its infrastructure and real estate fund businesses. The firm thereafter relaunched its regional operations under the Macquarie Securities Asia brand, focusing on equities as well as infrastructure and real estate fund management. It came to derive more income in its securities business in Asia than it does in Australia. The Financial Products division offers a structured product business across a range of asset classes. It originates and distributes a number of its retail and high net worth funds in Australia and internationally.


It works with the Corporate Finance division in structuring financial solutions for a variety of transactions. The Macquarie Capital Finance division provides capital, finance, and other services to clients’ operations in a range of selected industries. It uses its capital to purchase financial assets and to acquire, manage, and sell niche assets through their life cycle. Treasury and Commodities. Through its six divisions, this group is involved in a broad range of financial trading and related activities in a number of markets. As a recognized leader in various markets, it provides clients with both over-the-counter and structured hedging and financing solutions. It contributed 14 percent of the firm’s total profits in fiscal year 2007.11 The group’s Metals and Energy Capital division offers derivative trading and financing in various metals and other selected commodities as well as financing to the oil and gas industry. Its Foreign Exchange division provides services across all currency pairs and structured term hedging currency solutions for Australian and international clients. The Debt Market division originates, arranges, and places debt for clients and is active in primary and secondary markets for governmental, inflation-linked, corporate, global, and asset-backed securities. It provides credit and interest rate risk management solutions through structured securities and derivative instruments. Its Energy Markets division operates in North America, the United Kingdom, Europe, Asia and Australia, providing risk management financing and selected physical commodity solutions to a broad customer base across the energy sector. The Agricultural Commodities and Investor Products division provides tailored risk management, structured finance, commodity index, and selected physical commodity solutions to a global client base across the agricultural industry. Its Futures division offers a full range of brokerage and clearing services for Australian and international exchangetraded derivatives markets. Real Estate. This group has emerged as a global property behemoth. Together with the Banking and Securitization group, the real estate group contributed 15 percent of the firm’s profits in fiscal year 2007.12 It is a diverse, international business with a blend of real estate and financial expertise across a number of locations and markets. The range of services offered include funds management, wholesale equity raising,


investment and development finance, development management, property securitization, and asset management. The Real Estate group consists of two divisions. Its Real Estate Structured Finance division is a leading provider of finance solutions for clients, actively participating and investing with clients as well as managing and sharing project risks. This division’s services encompass development finance, acquisition and repositioning, and tailored financing and structuring of complex transactions. The Real Estate Capital division is a market leader in real estate management, development, and fund management through its stock exchange listed real estate management trusts and funds as well as its unlisted funds, deal sourcing, advisory, structuring and financing, real estate securitization, and equity capital raising. It has properties located in Australia, New Zealand, Asia, the United States, Africa, the Middle East, and Europe, ranging across all sectors, from marinas and bowling alleys to shopping centers and office buildings. There is nothing like Macquarie Real Estate, which manages over 700 properties worldwide, with an aggregate value of more than A$36 billion at the end of September 2008.13 Although a discussion of the Real Estate Capital Division’s thirtyone property vehicles, including seven listed and twenty-four unlisted funds and trusts, is beyond the scope of this book, its major property vehicles in alphabetical order are as follows:14 ●

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Macquarie Central Office CR-REIT, listed on the Korean Stock Exchange, owns a twenty-two-story building in the Seoul central business district. Macquarie CountryWide Trust, listed on the Australian Stock Exchange, invests in retail properties across Australia, New Zealand, the United States, and Europe, focusing on food and nondiscretionary retailers, such as supermarkets and groceryanchored neighborhood shopping centers. Macquarie DDR Trust, listed on the Australian Stock Exchange, invests in U.S. shopping centers. It is the largest owner and manager of value- and convenience-oriented retail properties in the United States. Macquarie Direct Property Fund, an unlisted, open-ended fund, invests in global properties, Australian and overseas property funds, and listed property securities.

42 / infrastructure privatization ●

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Macquarie Goodman Hong Kong Logistics Fund, an unlisted fund, invests in industrial property in Hong Kong. Macquarie Leisure Trust Group, listed on the Australian Stock Exchange, invests in tourism and leisure-based property in Australia, New Zealand, and the United States. Macquarie NPS REIT, an unlisted fund, invests in office and retail properties in Korea. Macquarie Office Trust, listed on the Australian Stock Exchange, invests in commercial office property in Australia, Western Europe, the United States, and Japan. Macquarie Property Income Fund, an unlisted, open-ended fund, invests in listed property securities. Macquarie Real Estate Equity Funds, a series of unlisted, real estate development funds, invest in the main real estate sectors.

Equity Markets. Undertaking the firm’s equity derivatives activities and its trading as a principal in global equity markets as well as its equity finance and hedge fund operations, the Equity Markets group contributed 9 percent of the firm’s profits in fiscal year 2007.15 This group consists of four divisions. The Equity Products division offers equity-linked investments, trading, and risk management products to wholesale and retail clients in Australia, Asia, Europe, the United States, and Latin America. Its MQ Specialist Investment Management division manages and delivers a range of single strategy and multistrategy funds and structured fund products to retail clients in Australia and to institutional clients, globally. The Equity Finance division provides securities borrowing and lending as well as structured equity finance to institutional clients in Australia, Asia, Europe, and the United States. In conjunction with Macquarie Securities, its Alternative Strategies division offers equity derivatives and financing, mainly to Macquarie’s hedge fund clients. Banking and Securitization. This group brings together the firm’s retail lending and banking businesses. It engages in mortgage lending in the United States and Canada as well as consumer lending and credit card services in Australia. Through its relationship banking services, the group offers banking services to successful small and medium-sized businesses, professionals, and high net worth individuals in Australia, Canada, and the United Kingdom. Financial Services. This group, which contributes 3 percent of the firm’s profits in fiscal year 2007,16 serves as the primary relationship


manager for the firm’s retail client base in Australia, New Zealand, and Thailand. The group consists of two divisions. The Macquarie Adviser Services division provides sales and product management services to its in-house and external products, including retail pension funds, the Macquarie Cash Management Trust, and various insurance products. The Macquarie Private Wealth division, the number one full-service retail securities broker in Australia, maintains direct relationships with clients and offers a range of services, including securities brokerage, investment planning, online securities brokerage, strategic financial planning, executive wealth management, private banking, and private portfolio management. Funds Management. This group, one of Australia’s largest fund managers, manages various equity and debt funds as well as fund-of-funds in Australia and internationally, including Korea, Hong Kong, Taiwan, and Europe. Providing a range of services to pension funds, corporations, financial advisers, and retail investors, it contributed 1 percent of the firm’s total profits in fiscal year 2007.17 Risk Management Group

This independent, centralized group has responsibility for ensuring that all risks are appropriately analyzed and managed across the firm.18 These risks are quantified and aggregated using an economic capital model that assesses projected returns relative to risks on new business approvals, new product approvals, and significant individual transactions. The aggregate risk is then subject to a global risk limit, specifically, the financial resources available to the firm to absorb risk. For Macquarie, the effective management of risk is critical to its continued growth and profitability. The Risk Management Group reports directly to the Managing Director and the board of the Macquarie Bank, now the Macquarie Group, the umbrella holding company as of late 2007. Its responsibility covers the entire range of the firm’s operations, assessing risk from a group-wide perspective and ensuring a consistent approach across all areas. It approves each group’s new businesses or activities, the offering of new products, the entry into new markets, and the undertaking of significant changes in existing products or processes. It monitors various risks daily so if any limit breaches occur, they are immediately addressed. The Risk Management Group consists of four functions: credit, finance, operational, and compliance. The credit function seeks to


minimize the risk of loss that might arise from the failure by counterparties to repay loans or honor trading contracts. Material credit exposures are not assumed without appropriate analysis. All limits are reviewed at least yearly, or more frequently, if needed, to ensure that the most current information available on counterparties is taken into account. All of the firm’s credit exposures are monitored regularly against limits, including daily monitoring of credit exposures that fluctuate through time. To mitigate credit risks, Macquarie uses collateral or credit enhancing techniques, including guarantees, letters of credit, and the purchase of credit default swaps. Policies to control credit risk also include avoiding the unacceptable concentrations of risk to any economic sector or to any one counterparty. Because of the global nature of the firm’s business, the analysis of country risk is increasingly important to credit risk. Where appropriate, Macquarie uses political risk insurance to cover its country risk. The finance function strives to ensure that each of the firm’s groups appropriately manages market, funding, and liquidity risks. Market risk is the risk of loss associated with changes in the level of volatility or prices in markets to which each group is exposed. These market risks include foreign exchange, interest rate, equity, bullion, and commodities. The group sets limits for all exposures in all markets. Limits are set for individual markets and trading areas and for each group as a whole. Equity-like risks are taken into account. These exposures include holdings in the specialized funds it manages, direct investments in entities external to the bank, real property, lease residuals, and holdings of seed assets for its new trusts and funds. The exposures arising from each of these positions are regularly calculated on a worst case basis, depending on the nature of the asset, and are aggregated to determine total portfolio risk. For significant seed asset acquisitions, a comprehensive identification and assessment of all risks and potential losses is undertaken. The group’s finance function also ensures that the aggregate risks, across all types of risks, do not exceed the firm’s economic capability to bear the risks. A report of market exposures is provided daily to senior managers. The function also has responsibility for ensuring that the bank discharges its obligations to the Australian Prudential Regulation Authority, including compliance with existing prudent standards. The operational risk function assesses operational risks from a firmwide perspective. It strives to ensure that an appropriate framework exists to identify, assess, and manage these risks.


With each of the bank’s businesses assuming responsibility for developing and implementing its own legal risk management and compliance procedures, the compliance function seeks to assess the legal, regulatory, and reputational risks from a firm-wide perspective. The function minimizes and manages compliance risk by overseeing the management of these risks by the various groups to ensure that they are identified in an appropriate manner and that appropriate standards are consistently applied to these risks. In sum, risk management for Macquarie reflects the principle of separating prudent controls, through an assessment of various risks, from the firm’s operational management. Moss’s Role as Managing Director

Prior to his retirement in late May 2008, Allan Moss, as Managing Director, assumed two basic roles: risk oversight and external relationship building and maintenance. He kept the business rolling in, but increasingly, he spent the largest part of his day, every day, cogitating about risk, using the reports generated by the Risk Management Group and watching how the firm invested its money. Moss noted that risk management is “the top priority for everyone in the organization. Every day we run scenarios that show what would happen to Macquarie . . . if today a once-in-a-lifetime event happened.”19 Risks were (and continue to be) assessed daily, with computers number crunching a series of “bad” scenarios. Each day, Moss received a report on how Macquarie would fare if world equity markets suddenly dropped 40 percent or adverse currency movements occurred, among other possibilities. According to Moss, “On some scenarios we would make a lot of money. On others we would lose a lot, but well within our capacity as an organisation.”20 The aggressive, independent risk analysis team watches over the shoulders of the firm’s operational groups to ensure the deals they put together meet acceptable risk criteria. This approach is not popular within the firm, but the risk management team kept the wheels on Moss’s vision for the firm and its growth strategy. Corporate Restructuring

In July 2006, Macquarie Bank announced its intention to restructure its activities and create a nonoperating holding company that would own its banking and nonbanking businesses. The plan, consummated


in November 2007, provides the firm with the flexibility to continue the growth of its noncommercial banking and diverse international operations. By the end of its fiscal year 2007, international activities had contributed 55 percent of its income.21 A nonoperating holding company structure is relatively common among major banking and financial service groups in the United States and Europe. These groups typically have a holding company that, in turn, owns a number of subsidiaries undertaking various activities. Regulatory constraints triggered Macquarie’s restructuring plan. As a licensed Australian bank, all of the activities of the Macquarie Bank, the parent entity of both its commercial banking and noncommercial banking units, were regulated by the Australian Prudential Regulation Authority (APRA) as banking activities. An investment bank regulated as a trading (commercial) bank presented challenges for Macquarie. The bank found that the APRA’s rules, particularly its restrictive capital adequacy regulations, did not readily accommodate its significant, diversified noncommercial banking activities. In particular, APRA’s rules restricted the dealings in certain of its nonbank subsidiaries, such as those undertaking securities brokerage, investment banking, and funds management, as well as the firm’s activities as an investing principal. Because these activities were not traditional commercial banking in nature, they were not always readily accommodated within APRA’s banking regulations. With most of the firm’s growth coming from its nonbanking operations, particularly its investment banking business as well as its international activities and overseas funds management, the need to conform to Australian prudential standards governing financial conglomerates inhibited growth. APRA imposed limits on risk exposures to related entities at both individual and aggregate levels, meaning Macquarie had to increase its banking businesses at least in line with the growth of its nonbanking activities or meet a regulatory brake on the rate its nonbanking operations could grow. This restriction on its nonbanking businesses proved unpalatable. The firm needed to remove its funds management and investment banking, among other activities, from the Australian prudential regulatory regime. These rules had become punitive. Reflecting the view that APRA banking rules restricted the ability of Macquarie Bank, as then structured, to conduct the activities of its key subsidiaries and would have constrained their future growth, Macquarie Chairman, David S. Clarke, stated, “We have effectively outgrown the conventional banking regulatory model. The NOHC


[nonoperating holding company] structure would provide Macquarie with the flexibility to continue to pursue growth in the regions and markets in which we operate.”22 Allan Moss added, “The creation of the NOHC will facilitate Macquarie’s continued international expansion in our investment banking, stockbroking, specialized funds management, trading, and other activities.”23 Restructuring using a nonoperating holding company would provide Macquarie more strategic and operational flexibility than its prior structure. The structure would also allow the firm to respond more readily to developments in its business activities and the markets in which it operates. Furthermore, the move to the holding company structure reflected a decision by Macquarie that the Australian regulator allocated capital inappropriately for the firm and that the market would allocate capital more efficiently, with less of a regulatory compliance burden. The legal regime for a holding company structure in Australia evolved over a decade. In 1997, the Australian Financial System Inquiry, the Wallis Report,24 concluded, among other things, that the nonbank holding company structure should be the preferred corporate form for financial conglomerates. It recommended that the nonbank holding company structure be permitted for financial conglomerates, provided these organizations meet a number of prudential requirements, including those in the areas of capital, management, firewall adequacy, and governance.25 With the passage of a decade, the recommendations of the Wallis Report led to legislative changes permitting the formation of nonoperating holding companies in the financial sector. In July 2007, the Australian Parliament, through the enactment of the Financial Sector Legislation Amendment (Restructures) Act of 2007,26 amended the Financial Sector (Transfers of Business) Act of 1999,27 now called the Financial Sector (Business Transfer and Group Restructure) Act of 1999. In brief, the 2007 legislation facilitates the implementation of a nonbank holding company structure by financial groups by permitting a NOHC to be the parent of an Australian Authorised Deposit-Taking Institution (ADI), among other entities. The 2007 amendments provide the Australian Federal Treasurer with the power to grant ADIs, such as the Macquarie Bank, relief from specific impediments under the Australian Corporations Act of 2001 that previously blocked the adoption of a NOHC structure and to give approval for an ADI to become a subsidiary of the NOHC. The amendments also


addressed what would otherwise be certain adverse tax consequences of a restructuring for a financial group and its shareholders. After receiving all necessary approvals for the restructuring, including those by the APRA 28 and the Federal Treasurer29 as well as shareholder30 and court approvals,31 Macquarie consummated its plans for restructuring under a nonoperating holding company structure. Under the new structure, as implemented in November 2007, the nonoperating holding company, the Macquarie Group Ltd., became the firm’s parent, with its shares listed on the Australian Stock Exchange. Two groups sit under the holding company, first, a banking group, and second, a nonbanking unit. The bank group retains the firm’s more traditional operations, including banking and securitization, with the Macquarie Bank Ltd., continuing as a licensed Australian bank, as the principal operating entity, together with its financial services (subsequently merged with banking and securitization in February 2008 to form the banking and financial services group), funds management, real estate, almost all of the operations from the equity markets and the Treasury and commodities groups, and a limited number of investment banking loans and leases. The banking operations of the bank group remain governed by the strict Australian capital requirements. Most of Macquarie’s investment banking group, renamed its Capital Group, including its infrastructure and infrastructure-like funds as well as its merger and advisory business, together with certain operations from the Treasury and Commodities Group and the Equity Markets Group form the nonbank group. The Capital Group initially consisted of five divisions, Capital Advisers, Capital Finance, Capital Funds, Capital Products, and Capital Securities. In 2008, Macquarie combined the activities of Capital Securities and the Equity Markets groups into a new operating group called Macquarie Securities Group.32 It also combined the funds management and funds-based structural product businesses offered by the Funds Management Group, Equity Markets Group, and Macquarie Capital Products into a new group, Macquarie Funds Group, and placed the new group in the Banking and Financial Services Group.33 Group-wide services, such as risk management, continue to be held by the Macquarie Group, the nonoperating holding company. Outside the Risk Management Group, each group has its own experts working on risk management issues. Thus, the 2007 restructuring allows the nonbanking group to continue its growth trajectory, free from the previous, regulatory


limitations, particularly the burdensome capital constraints, at least in the near term. Although the APRA is developing its policy framework for regulating nonbank holding companies, new prudential standards, including those for investment banking activities, are not expected until 2009, at the earliest, with Macquarie facing a possible increase in regulatory capital requirements for its noncommercial banking endeavors. The transaction also enabled Macquarie to free up funds it had previously held as part of its capital adequacy obligations. Experts estimate that upward of A$500 million was unlocked. Also, the firm could add an additional A$2.5 billion in debt to its balance sheet, funding several years of growth.34 Macquarie was one of the few financial institutions in the world with lots of spare capital. By late 2007, it was felt that Macquarie’s capital would enable the firm to take advantage of future opportunities. In addition, through the end of March 2008, the Macquarie Group continued to access the short-term issued paper market, particularly in Australia, obtaining A$10.9 in asset secured or nonrecourse financing and A$4.6 billion in term funding mainly through private placements. The initial financing of the transfer of nonbanking assets and businesses from the Macquarie Bank and its subsidiaries to the nonbanking group was achieved through a combination of external credit facilities and funding from Macquarie Bank, including a capital reduction.35 The Macquarie Group obtained A$19 billion in funding, consisting of a senior unsecured debt loan from a syndicate of Australian and international banks and a two-year senior bridge loan from Macquarie Bank. In addition to these funds paying the Macquarie Bank for assets transferred from the bank to the nonbanking group, the latter unit will also use the funds to pay for the growth of its nonbanking businesses. The senior unsecured bank debt financing, totaling A$8 billion, consisted of three elements: first, up to A$1.6 billion in standby loan facilities with a term of 364 days, with four optional 180-day extension periods; second, up to A$2.4 billion in revolving loan facilities with a minimum term of three years and with two optional one-year extension periods; third, up to A$4.0 billion loan facilities with a minimum term of three years and with two optional one-year extension periods. As a result of the strong support from the banks participating in the syndication, the facility was subsequently increased from A$8 billion to A$9 billion. The senior bridge loan, initially set at A$10.1 billion and later reduced to A$9 billion, provided transitional funding designed to facilitate the


nonoperating holding company’s external financing and its funding profile in the global capital markets. It was expected that this bridge facility would be fully repaid over twenty-four months either through refinancing or using the nonbanking surplus capital. As part of the implementation of the restructuring, Macquarie Bank reduced its capital by A$3.0 billion. The capital, which was deducted from its capital base, was transferred to Macquarie Group Ltd. to help capitalize the operations of the nonbanking group and finance the nonbanking group’s acquisition of assets and businesses from Macquarie Bank. All the debt previously issued by the Macquarie Bank remained in the bank group. In other words, the restructure did not affect the existing Macquarie Bank term borrowings. Macquarie’s Current Growth Strategy

After the 2007 restructuring, the key factors that led to Macquarie’s success remain unchanged. No significant alterations were made in its business model or its business approach. The firm-wide risk management framework, a key feature of its success, continues to apply across the entire entity, as restructured. Moss created not only the firm’s current culture but also its strategic model, centered on opportunistic innovation. The contributions of the investment banking group’s, now its Capital Group’s, founding head, Nicholas W. Moore, have been crucial. For over a decade, the firm has conceived of an idea and then realized it. Macquarie and its various units have been there every step of the way, as adviser, underwriter, manager, and seller. Macquarie takes advisory fees for the deal, more fees for the underwriting if there is a public float, and if things go well, a performance fee from the fund or trust, in addition to a management fee. In describing the approach that transformed Macquarie from an outpost of a British merchant bank to a global player in twenty years, Moss stated, “It’s been a step-by-step process. We haven’t tried to construct grand, long-term visions, we’ve just been trying to do what we do well and add value by taking the incremental steps.”36 The firm sought niches that others have not exploited. Moss gave divisional managers considerable autonomy and responsibility for the growth of their units. He noted, “We don’t have a big chart on the wall that says this is exactly where Macquarie Bank is going to go. We have business leaders. Their responsibility is not just to execute.


Their responsibility is to make recommendations about our strategy as well.”37 Nicholas Moore, who became head of the Macquarie Group on Moss’s retirement in May 2008, put it this way, “The main bank sets the broad parameters and centrally controls risk and reputational issues. The divisions then operate as semi-autonomous entrepreneurial businesses which are expected to generate ideas. Decisions [to invest] are made as close to the ground as possible. We flourished because we did not have a rigid structure or vision of the world.”38 Macquarie’s success is based on adjacency and competency. Its strategy follows an incremental approach, growing by “stepping in to adjacent spaces,” Moss noted. In innovating by increments, he continued, “It does not involve grand visions. The strength of this approach is you know where you are going. It allows you to control risk. Sometimes you end up down a path you wouldn’t have anticipated if you’d tried to look too far ahead.”39 The concept of competency comes in when Macquarie enters a new sector in which to apply its infrastructure model, for example. In preparing to enter a new field, it hires experts to advise and form teams with Macquarie staff who apply the firm’s existing financial expertise to create a new specialized fund or trust. Beyond infrastructure, when its comes to a new business or acquisition assessment, each time Macquarie tests whether it has the competency in-house or whether it needs to make use of joint ventures or acquire expertise from outside companies. In selecting new infrastructure-like assets, Macquarie continues to be driven by a criteria Moss called “privilege,”40 more specifically, the delivery of safe cash flows and risk minimization. He advised managers and staff to look for assets isolated from what he called “the full rigours of competition.”41 The rubric of privileged assets now includes communications infrastructure, such as broadcast transmission services, transmission and distribution utilities, and hospital and long-term care facilities, topics beyond the scope of this book. *

*

*

The move to infrastructure around the world made sense to Macquarie executives. Australia did not (and does not) have the same volume of big fee-making investment banking opportunities, whether initial public offerings or mergers and acquisitions, accorded those firms in the United States and Europe.


Beginning in the mid-1990s, the firm focused on infrastructure assets, initially toll roads in Australia, virtual monopolies that generate dependable cash flows. Macquarie stumbled almost by accident into infrastructure funds when it came up with the idea to list the Hills Motorway Group, the operator of a Sydney toll road, in 1994.

Ch a p t e r Fi v e M acqua r i e: Th e Cr e at ion of It s I n f r a st ruc t u r e Fu n d s

In 1994, Macquarie got into infrastructure investing. In that year, the firm initiated a funding breakthrough in Australia through its innovative private sector financing of an infrastructure project, with neither a controlling core owner-operator nor a governmental guarantee of the project (or its return). As the initial infrastructure project to be listed on a stock exchange, the Hills Motorway Group served to test the viability of a secondary market for such securities. To bring infrastructure projects into the investment mainstream, Macquarie realized it was necessary to have broad participation from investors and to create liquidity for their investments. As structured, a publicly traded fund was not an investment in a construction project or in a motorway’s operations, but rather in the cash flows that toll roads would generate during their concession periods, typically thirty-six to forty-five years. As a model for future infrastructure funds, the investors would take risks and reap the rewards. The public sector would get the infrastructure back at the end of the concession period without having to underwrite any of the future risks. With strong equity markets, inexpensive debt, and widescale privatization programs globally, Macquarie’s infrastructure model flourished in near perfect conditions. By constantly recycling its capital and bidding for new assets in conjunction with its funds, Macquarie used a relatively small amount of capital to operate and manage an enormous sum of infrastructure assets globally. This chapter begins with an analysis of the three factors that led Macquarie to pioneer in infrastructure investing and the creation of funds for these assets. In the context of the firm’s evolving culture, it focuses on Macquarie’s first venture, the Hills Motorway Group, a single-project investment. The multi-project Infrastructure Trust of


Australia Group is then considered, followed by an examination of its global successor, the Macquarie Infrastructure Group. The chapter provides a brief history of the two funds’ major acquisitions and then focuses particular attention on the template—including asset revaluations, debt refinancing, sale of assets, corporate restructuring, and fee arrangements—provided by these two funds for the Macquarie infrastructure model. Factors Propelling Macquarie Into Infrastructure Investing

Besides an entrepreneurial culture, do not discount good timing and extraordinary luck in Macquarie’s rise to global prominence through its infrastructure funds. Three factors—first, the privatization of public sector infrastructure assets, in Australia and globally; second, a change in the Australian pension (superannuation) system; and third, tax benefits provided by Australia—propelled Macquarie’s new direction. The Privatization Wave. The firm rode the global wave of the privatization of public assets as it washed over Australia, starting in the early 1990s. Decades before, European governments began looking to the private sector for help with highway infrastructure. With the public sector unable to provide the funding to build new roads, private capital became an important source. Spain in the 1960s had private concessionaires build its road network; France followed with private concessions in the early 1970s.1 These concessionaires consisted of consortiums of construction firms and banks. In the early 1990s, cash-strapped governments in Australia started to sell or lease infrastructure to private firms. The public sector realized it could not only raise funds but also modernize its crumbling infrastructure. The rise of private infrastructure investing in Australia corresponded with reduced public sector spending on infrastructure. Australia witnessed a shift away from the public sector’s traditional role in providing and financing infrastructure. By the 2006, Australian public sector spending on infrastructure as a percentage of the nation’s Gross Domestic Product was half that of 1970, declining from 7.2 percent of GDP in 1970 to 3.6 percent in 2006.2 In the decade of the 1960s, a booming Australian economy had funded new roads, railways, and power stations, all government-built, owned, and operated. Thereafter, however, the increasingly heavy demands for spending on health, education, and welfare forced governments, both at the federal and state levels in Australia, to ask the private sector to fund (or

creation of its infrastructure funds / 55

take over) projects the public sector had previously paid for and run as a matter of course. In the early 1990s, a bank collapse left the State of South Australia A$5 billion in debt. The South Australian government sold its stateowned water and electricity companies to retire the debt, thereby allowing the state to attract new capital for projects, such as the redevelopment of the Adelaide Airport. In the 1990s, private interests subsequently took over responsibility for major gas pipelines in Western Australia and South Australia, water treatment works in New South Wales, Melbourne’s East Swanson Dock, and most of Victoria’s power industry.3 Emblematic of these changes, in November 1994, the Australian government requested the Economic Planning Advisory Commission to establish a task force to investigate and report on private sector involvement in the funding, control, and management of infrastructure in Australia. The task force’s final report, issued in September 1995, noted, “The private sector has an important role to play”4 in helping to meet Australia’s future infrastructure needs. The report indicated, “Significant domestic opportunities exist for further private involvement in infrastructure provision.”5 At both the state and federal levels, Australia spurred private sector involvement in infrastructure assets. In the United States, where federal funding, state fuel tax revenues, and a flourishing market for tax-exempt toll revenue bonds issued by public sector toll agencies made alternative sources of capital less necessary, the privatization of infrastructure assets began much later. In the first decade of the twenty-first century, budgetary pressures forced the U.S. public sector to explore alternatives to the traditional public sector financing of infrastructure. As discussed in chapter six, in 2005, a Macquarie-led partnership paid $1.83 billion for the right to operate the Chicago Skyway toll road for ninety-nine years, the first lease of an existing highway in the United States. Previously, as discussed in chapter six, in 2002, Macquarie became involved in the development of a new toll road, SR 125 South, outside of San Diego, California. The Transformation of Australia’s Retirement System. Besides the domestic and global privatization trend, Macquarie cashed in on a revamped, Australian government-mandated retirement system set up in 1992. To create a credible retirement system for its aging population, Australia passed a law requiring most employers to divert 5 percent of their employees’ salaries into investments designed to fund their retirement.6 Contributions were (and currently are) directed to


individual accounts in funds invested by private sector managers. Over time, the contribution percentage increased to 9 percent. Currently, the mandated pension strategy grows by more than A$160 billion a year, providing a huge capital base for Australian financial institutions. The retirement pool, which totaled A$750 billion in 2006, is expected to hit A$1.5 trillion by 2015.7 The new retirement system created a huge demand for fixed-incomelike vehicles, especially in a time when the bond market offered skimpy returns. Initially in Australia, and then globally, pension and other retirement funds drove the demand for infrastructure assets, attracted by their long-term nature, strong competitive position, and stable and relatively good returns. The long-life, inflation-indexed returns provided a good match for long-dated liabilities of pension and other retirement funds as well as life insurance companies. Increases in global economic growth and the changing demographics created massive pools of savings worldwide that, in part, drove down long-term interest rates and raised the attractiveness of medium-to-lowrisk and medium-return infrastructure assets, such as highways. With low yields from bonds, global investors came to have a seemingly insatiable appetite for dependable returns of from 6 to 12 percent offered by infrastructure funds. Tax Benefits. In 1992, the Australian federal government introduced tax concessions to encourage private investors into the infrastructure market. Under the Infrastructure Borrowings Scheme,8 which was closed to new projects in February 1997, the emergence of infrastructure bonds allowed project developments to pass tax benefits earned during the construction phase onto those financing the project, thereby assisting in the development of key facilities. In brief, the Develop Australia Bond Program provided a tax-free income for approved infrastructure projects to resident infrastructure lenders. In return, the borrower, a company that was not a trust, enjoyed reduced finance costs basically in the form of lower interest costs, but gave up the income tax deduction on the interest payments associated with the loan. In the early years of operation, tax losses are of limited value to a toll road project. The ability to exchange these losses for lower debt costs increased the efficiency of project financing. The infrastructure bonds did not, however, represent an additional source of risk to a project. They were fully backed by cash held in escrow, which could be used to repay the loan in the event of a default. Thus, while not providing a source of funding, infrastructure bonds allowed a greater amount of debt to be used. Through the 1997


Infrastructure Borrowing Tax Offset Scheme,9 which replaced the 1992 Infrastructure Borrowing Scheme, the Australian Government continued its support for qualifying domestic infrastructure investments. The Impact of These Factors

Nicholas W. Moore, an accountant by profession, joined Macquarie in the 1980s. He rose to head its project and structured finance division by 1986 and to lead its asset and infrastructure group in 1998. He became the deal-driven head of its Investment Banking Group (then renamed its Corporate Finance Group and now its Capital Group) in 2001, prior to becoming CEO of the Macquarie Group in 2008. Observers characterize Moore as brash, whereas Moss was reserved; charismatic but abrasive, Moore had an earthy way of talking.10 Moore served as the originator and driving force behind Macquarie’s infrastructure business. He had the idea of buying an existing toll road from the public sector, a brownfield facility, or, as Macquarie initially did, building one from scratch, a greenfield facility, and using an initial public offering to sell the highway to finance the project. The marketing pitch: because a toll road produces a steady cash flow relatively unaffected by economic downturns or competition, an investment in a toll road would provide a good way to save for retirement. Moore spearheaded the firm’s move into infrastructure assets and funds, with Macquarie-backed infrastructure projects becoming a key component of Australians’ retirement investment strategy by providing stable, longterm returns from inflation-linked, yield-based investments. Because Australia’s economy was (and is) not big enough to absorb the cash generated by its pension system, investment managers had to find ways to spend funds elsewhere. This led Macquarie, among others, to specialize in an often overlooked niche: big-ticket infrastructure projects, such as roads and airports, around the globe. Macquarie soon sought investment opportunities abroad, but that would take us ahead of our story. The Hills Motorway Group

Macquarie’s first venture into infrastructure projects involved a socalled greenfield project. Unlike one type of privatization, which involves the transfer, typically by means of a long-term lease, of the operation and management of an existing asset from the public sector


to the private sector, in a greenfield deal private investors buy the rights to develop an asset that does not exist. More specifically, they acquire the rights from the public sector to build, operate, and manage a particular asset for a specified time period, at the end of which the asset will revert to the government. The firm’s first infrastructure project, the Hills Motorway located in Sydney’s suburbs, illustrated Allan Moss’s concept of adjacency, discussed in chapter four. Moss put it this way: The adjacency is best illustrated by how we got involved in the infrastructure funds management business a decade ago. We decided to compete for the private financing of a toll road in northwest Sydney and came up with a novel idea of financing it through an IPO [initial public offering], and to our knowledge no one had done that before with a new road. From there, it was a relatively modest step to establish a fund that might own more than one road, or to do the same in other industries, and to broaden the mandate to international roads.11

After providing an overview of the Hills Motorway project, this section discusses the terms of the concession, its financing, the project’s risk factors, and Macquarie’s fees. Overview of the Project. Over the opposition of environmental groups, in August 1994, the Hills Motorway Group, a private consortium led by Macquarie, finalized the contractual arrangements with the New South Wales Roads and Traffic Authority (RTA) to build and operate the M2 Motorway, a single infrastructure project.12 The M2 Motorway is a four-lane, twenty-one kilometer tollway linking the lower northern shore of Sydney to the northwestern region of Sydney. The project cut driving times from Sydney’s northwest to the city by about twenty minutes and reduced traffic on local roads.13 It formed part of a larger program of road transport improvements for the Sydney region called the Sydney Regional Orbital Strategy. One of the aims of the orbital strategy was to support the policies of two reports, Integrated Transport Strategy and Cities for the 21st Century, prepared, respectively, by the New South Wales Department of Transport and the New South Wales Department of Planning.14 The various individual road projects, including the M2 Motorway, which formed the orbital strategy were designed to assist in the demand management of the roads around Sydney and to support an efficient public transportation system in the metropolitan Sydney region. The


completion of the orbital strategy would be staged, taking as long as a decade and a half. Construction of the M2 Motorway was originally scheduled for completion by November 30, 1997. Surmounting one of the risks of a new construction project, namely, completion delays, the Hills Motorway Group opened the M2 Motorway six months early, on May 26, 1997. Terms of the Concession. The RTA granted the M2 Motorway a maximum concession period of forty-five years from its completion.15 A long-dated concession enhances the opportunity for realizing an asset’s value in the future; amplifies the benefits of active management initiatives that increase revenues, reduce costs, or lower risks; and heightens the potential for financial refinancings and restructurings. At the conclusion of the concession, the motorway would be returned to the RTA and public ownership at no cost. In other words, the equity investment in the Hills Motorway Group would have no value at the end of the concession period. If the traffic flow were to increase at a level to provide the initial Hills Motorway Group investors with a specified, real (inflation-adjusted), after-tax internal rate of return, the concession period could be shortened to as little as thirty-six years. Analysts, however, indicated that a reduced concession period would likely not occur as the real, after-tax internal rate of return thresholds were unlikely to be achieved.16 The internal rate of return concept is a commonly used measure for evaluating limited-life projects. It projects the likely cash flows and resulting cash distributions during the life of the investment and applies a discount rate to these returns. Future toll rates (and thus revenues) from the project are closely linked to inflation. Under the toll calculation schedule, detailed in the Project Deed, tolls will annually increase at the greater of 4 percent or the consumer price index, in incremental units of A$0.50.17 Although the incremental unit increases will result in the toll rates slightly lagging inflation, the toll income will be highly correlated with inflation. In short, with toll charges increasing in line with inflation, the equity part of the project evolved into something akin to an inflation-linked bond with cash flows influenced by traffic growth and the Australian Consumer Price Index. The concession agreement contains an anticompetition provision. The Hills Motorway Group is protected against losses if any governmental unit builds a nearby road that has the potential to impact negatively on its returns.18 The government, however, does not get to share


in any benefits that might flow to the tollway in the event a new road enhances the M2’s earning potential. Financing the Project. The financial structure for the M2 Motorway, a roughly A$500 million project, consisted of two types of securities issued by the Hills Motorway Group, which are “stapled” and thus inseparable. The two are units in Hills Motorway Trust (the Trust) and an equal number of shares in Hills Motorway Ltd. (the Company).19 The deal had a tax-driven financing and corporate structure. The Trust, managed by Hills Motorway Management Ltd., a wholly owned subsidiary of Macquarie Bank Ltd., was responsible for obtaining the funding for the construction of the M2 Motorway. The Trust, a conduit for tax purposes, leased the M2 land from the Roads and Traffic Authority (RTA) at a specified annual base rental fee of A$7 million, indexed for inflation, making the RTA carry a significant, potential exposure of some A$315 million for the project. The actual payment of this rental fee was deferred toward the end of the concession period until the real (inflation-adjusted), after-tax, annual internal rate of return for the Trust’s investors (more specifically, the hypothetical initial trust investors) would reach a 12.25 percent and would accrue without payment of any interest.20 At the end of the concession period, estimates indicated over A$700 million would accrue and be payable to the Roads and Traffic Authority.21 Repayment of the rentals that would accrue over the last five years of the concession period would, therefore, substantially reduce any equity distributions by the fund during this period. Other trust-operating costs include a trustee fee, a trust management fee, a debt management fee, and miscellaneous costs. The Trust issued two types (more technically, tranches) of inflationindexed bonds, with future toll rates (and thus the project’s revenues) highly (but not exactly) correlated with inflation.22 This form of debt financing well suited the M2 Motorway Project. With the first tranche of A$100 million issued in December 1994 and the second, of A$103 million, in June 1996, and with both tranches maturing in December 2021, the inflation-linked bonds took the pressure off the project’s cash flow in the early years. This form of debt financing enabled the equity returns to be leveraged without introducing risk levels associated with an equivalent amount of conventional debt. In addition to the inflation-linked bonds, the Motorway floated about A$111 million of term debt through bank loans, maturing in December 2009, at an interest rate of approximately 10 percent per year.


The Company, which subleased the land from the Trust, was responsible for supervising the design and the construction of the motorway. To guard against cost overruns, the Company contracted out construction to Abigroup Ltd. and Japan’s Obayashi Corp. on a predominately fixed-price, fixed-completion-date basis.23 Each contractor agreed to invest A$15 million in the project or a total of A$30 million. The Company entered into an operating agreement with Tollaust Pty Ltd., a 60–40 joint venture between Abigroup Ltd. and Transroute International S.A., a large European motorway operator, for the ongoing operation and maintenance of the motorway. The operating and maintenance contract provides for a base, annual fee of A$5.69 million indexed for inflation, plus a variable fee and a bonus fee in certain circumstances, for running and maintaining the motorway.24 To pay for the motorway’s construction, the Trust made an A$153.45 million infrastructure loan to the Company. Interest on this loan was prepaid to the Trust, which took advantage of the special tax treatment accorded the infrastructure loans, as noted earlier in this chapter, with the interest payment distributed, generally tax free, to the Trust’s investors.25 In June 1996, the Company refinanced this loan with a zero coupon bond due in 2009.26 The stapled securities issued by Hills Motorway Group were listed on the Australian Stock Exchange in December 1994. It was Australia’s first publicly listed toll road. The Project’s Risk Factors. Distributions from the Hills Motorway Group would depend almost entirely on the number of toll-paying vehicles traveling on the motorway. Other income sources would include fees derived from advertising signage and rent from service centers. For investors, following the completion of construction, the major risk focused on the traffic volume the motorway would attract.27 When a toll road project becomes operational, it faces risks similar to any other business. In the case of a highway, traffic flows may not live up to forecasts and more motorists than anticipated may alter their customary routes to avoid paying a toll. Once the traffic volume becomes known, however, the uncertainty risk for investors would basically disappear and a toll road would become a steady, predictable, yield-driven, long-term investment over the concession period. Macquarie’s Fees. Characteristic of future infrastructure deals, Macquarie and its units obtained various fees in connection with the Hills Motorway project. The group received fees for structuring the venture and its financing, including an underwriting fee payable to


Macquarie Underwriting Ltd. As the trust manager, Hill Motorway Management Ltd., another Macquarie Bank subsidiary, received an annual trust management fee, initially A$350,000. Following the completion of construction, this fee was indexed for inflation. The Trust also paid advisory fees to Macquarie Corporate Finance Ltd. For the 1998 fiscal year, these advisory fees equaled A$25,000.28 Infrastructure Trust of Australia Group

The M2 Motorway’s successful initial public offering triggered Macquarie’s first infrastructure fund, the Infrastructure Trust of Australia Group (ITA Group), launched in 1996. The ITA Group supplied the schematic for a new type of business strategy, one that allowed Macquarie to garner new, lucrative fees for originating, underwriting, financing, and advising on a deal and reap more fees for managing an asset through a fund. Also, by listing an infrastructure fund on a stock exchange, Macquarie opened a gateway to a broader base of investors, enabling retail investors to participate in infrastructure, an emerging asset class. In October 1996, Macquarie brought its Infrastructure Trust of Australia Group, a retail infrastructure fund, to the market, raising A$300 million, and in December of that year listed it on the Australian Stock Exchange. An investment in the ITA Group took the form of stapled securities, consisting of one unit each of two trusts, ITA (I) and ITA(II). The income generated by ITA(I) would be derived from assets in which the fund did not have a controlling interest, while ITA(II) would have a controlling (or a potentially controlling) interest in certain assets. In the early years of operating a toll road, a project may generate cash flows but record substantial accounting and tax losses as a result of significant depreciation deductions. Thus, the dual entity stapled structure facilitated the release of cash flows to investors via dividends without a need for accounting profits. The ITA Group’s four initial “seed” toll road assets, with acquisition costs totaling about A$231.4 million, were as follows29 : 1. Fifty percent of the shares (at a cost of A$61.6 million) in Interlink Roads Pty Ltd., plus the assumption of subordinated debt with a balance of about A$8.7 million held by Macquarie Bank. Interlink Roads Pty Ltd. was the private sector operator of the M5 Motorway in the southwestern Sydney suburbs.


Construction of the existing 19.7 kilometer M5 tollroad was completed in 1994. 2. About 70.1 percent of the equity (at a cost of A$93.8 million) in the Airport Motorway Group, the New South Wales Government’s “preferred proponent” to build, own, and operate Sydney’s Eastern Distributor (or M1 Motorway, as it was renamed) from the central business district to the airport. The first stage of this greenfield project opened in 1999; the second, in 2000. Other Macquarie members of the Airport Motorway Group included Macquarie Corporate Finance Ltd. (as financial adviser), Macquarie Underwriting Ltd. (as equity underwriter), and Macquarie Bank (as joint debt underwriter). 3. About 8.1 percent of the equity (at a cost of A$15.72 million) in the listed Hills Motorway Group, the operator of the M2 tollroad, a greenfield project initiated by Macquarie and then under construction. 4. About 9.8 percent of the equity (at a cost of at least A$51.5 million) in the listed Transurban Group Ltd., the builder and operator of Melbourne’s City Link, an A$1.8 billion greenfield project, connecting three of that city’s major freeways, which were then under construction and completed later in 2000. The ITA Group acquired its ownership interest in Interlink Roads, the first of its assets, in August 1996. Stakes in the other three assets were purchased subsequently, with the interest in Airport Motorway acquired in August 1997. The Hills Motorway and Transurban interests came from deals between ITA(I) and Obayashi Corp., the Japanese construction company then building the M2 and City Link projects, with the securities transferred in June 1997 and December 1999, respectively.30 The ITA Group deal provided the template for subsequent Macquarie funds with respect to the fee structure and asset revaluations. Fee Structure. A Macquarie Bank subsidiary, Macquarie Infrastructure Investment Management Ltd. (MIIML), managed the ITA Group. It received an annual management fee of 1.25 percent of the fund’s net investment value. It also received a performance fee equal to 15 percent of the annual return of the ITA Group above a specified benchmark index, the Australian All Industrials Accumulation Index, with any underperformance carried forward. The performance fee is payable in three annual installments, with one-third payable at the end of the year for which the fee is calculated, and the second and third installments,


twelve and twenty-four months, respectively, after the payment of the first installment. The second and third installments are payable only if the fund maintains its performance in excess of the benchmark.31 ITA Group paid base fees of A$2.42 million and A$6.23 million in fiscal years 1997 and 1998, respectively. Performance fees equaled A$5.94 million in both of these fiscal years.32 MIIML also received 18 million ITA Group stapled securities out of a total of 318 million stapled securities for which it paid A$200.33 Another Macquarie Bank subsidiary, Macquarie Underwriting Ltd., received an underwriting fee of 2 percent and a lead manager fee of 1.33 percent of the total amount raised by the ITA Group in its IPO. These fees totaled about A$10.8 million.34 Macquarie Bank also received interest on the loan it provided to the ITA Group to fund the acquisition of the equity interest in Interlink Roads.35 Macquarie Corporate Finance Ltd. received advisory fees from the Airport Motorway Group on the Eastern Distributor (M1) project.36 Subsequently, Macquarie Underwriting Ltd. received fees of A$2.6 million as underwriter and lead manager for the ITA Group stapled securities issued pursuant to a rights offering in October 1997. During fiscal year 1998, Macquarie Bank received letter of credit fees of A$386,375, and SPAL Ltd., a wholly owned subsidiary of Macquarie Bank, received letter of credit fees of A$42,356 and an interest payment of A$454,011.37 Asset Revaluations. Because the ITA Group was not expected to earn income from the bulk of its toll road assets for several years, the fund’s initial distributions to investors relied, in part, on annual asset revaluations as the benchmark (but not the source) for these payments. In projecting an annualized cash yield of 9.1 percent on ITA Group’s stapled securities from November 1996 to June 30, 1997, the entity’s prospectus stated, “The distribution is based upon the returns forecast from the Seed Assets, which will largely comprise asset revaluations, and interest on cash invested in money market securities.”38 Although a detailed discussion of Australian accounting standards is beyond the scope of this book, some background is helpful. As exemplified by the ITA Group, unlisted assets held in the Macquarie infrastructure funds are generally “marked to model,” in accordance with Australian accounting standards. Specifically, Australian accounting standard AASB 1030 allowed the ITA Group to recognize profit and loss amounts in its Statement of Financial Performance relating to the revaluation of noncontrolled assets as long as: “(a) the financial assets are measured at net market value as at the reporting date;


and (b) any changes in net market value are recognised as revenues or expenses in the financial year in which the changes occur.”39 Thus for its unlisted, noncontrolled assets, the ITA Group calculated the present value of the cash flows that a road was expected to generate over the life of the concession. These cash flows were discounted to a present value amount using a discounted cash flows model. This model applies a discount rate to the expected cash flows to determine how much less a future dollar is worth than a dollar today.40 The discounted cash flow method provides the preferred (and commonly used) valuation technique for an infrastructure asset because it best takes into account the long-term nature of an asset’s cash flows. Under this approach, the asset values are not based on actual market prices, but on what a model, using estimates of future profits (more specifically, the discounted cash flows) say they are worth. The discount rate is the risk free interest rate for the country where the asset is located, plus a risk premium that reflects the uncertainty as to the accuracy of these future cash flow estimates, based on traffic and toll levels. Revaluation gains involve, in part, reducing the discount rate applied to future cash flows generated by an asset. By starting with a large risk premium and reducing it in successive years, a fund could generate a reliable stream of revaluation gains. Macquarie based its approach on the premise that as infrastructure assets mature, their earnings become less volatile and more predictable. The cost of debt service, including interest and principal payments, another factor in the revaluation model, depends on both the existing financing arrangement and any assumed future arrangements. Changes in inflation assumptions also impact on an asset’s valuation. Higher inflation assumptions result in a higher valuation for an asset. As the ITA Group revaluated its unlisted, noncontrolled assets higher, the fund reported the gains as revenues. In effect, this approach generated “profits” based on future asset values and enabled the distribution of these profits currently, often using borrowed money to do so. With base management fees payable as a percentage of the fund’s net investment value, asset revaluations also raised these fees. Using this approved accounting approach, the ITA Group’s unlisted interest in Interlink Roads Pty Ltd. was initially valued and subsequently revalued as follows: 41 August 21, 1996

June 30, 1997

June 30, 1998

A$61.6 million

A$68.6 million

A$74.2 million


Although paying distributions out of asset revaluations was (and remains) controversial, early in the history of its infrastructure funds, Macquarie maintained that the inclusion of these asset revaluations in revenues gave the best picture of a fund’s progress. According to John Caldon, then managing director of Macquarie Infrastructure Investment Management Ltd. (the ITA Group’s manager), “[ITA is] a developer which will realise value when assets are mature. We are not an infinite holder of assets.”42 From the cleaver idea of the Hills Motorway project to the A$231 million worth of seed assets that formed the initial fund, the ITA Group grew quickly and provided its managers with valuable experience in the world of infrastructure assets. The Macquarie group’s expertise in the selection of the proper assets, the payment of multiple fees, and the use of asset revaluations would not only become very profitable as the fund expanded worldwide but also would serve as the template for Macquarie infrastructure model. Macquarie Infrastructure Group

In 1999, as the ITA Group began to acquire assets outside Australia, the fund was renamed the Macquarie Infrastructure Group (MIG), becoming a prominent investor in a number of surface transportation projects. Over the years, MIG acquired a worldwide stable of roads, bridges, and tunnels. Each of these assets in which MIG has an interest is set up as a separate legal entity in which MIG (or an MIG-controlled entity) is a shareholder. In each case, the debt borrowed by these separate entities is nonrecourse debt as to MIG, that is, MIG provides no guarantees to the lenders. The creditors only have recourse to the cash flows from a project, with MIG having no potential liabilities to the lenders. MIG’s Infrastructure Assets

This section provides a brief overview of MIG’s major infrastructure assets and their acquisition. They include the following: October 1999. MIG, through a wholly owned U.K. subsidiary, bought 100 percent of the shares of Kvaerner Corporate Development Ltd. and Kvaerner Investments Ltd., which owned infrastructure projects and developments in the United Kingdom and Western Europe. Through Macquarie Infrastructure (U.K.) Ltd., a 100 percent owned subsidiary of Macquarie European Infrastructure plc., as the result


of the Kvaerner purchase, MIG acquired a 50 percent interest in Yorkshire Link Holdings Ltd., the concession holder of the M1/A1 Link, linking the M1 Motorway south of Leeds with the A1 Truck Road in the U.K., which opened in 1999. This motorway derived revenues under a shadow toll system based on variable distance charges for different classes of vehicles. The users were not charged directly, but a government agency paid the concessionaire an amount based on agreed formula for vehicle usage. Through the Kvaerner purchase, MIG also acquired 24.8 percent stake in Lusoponte Concessionária para a Travessia do Tejo S.A. (Lusoponte), which held the concession for two existing Tagus River toll bridges in Lisbon, Portugal. MIG’s stake in Lusoponte was increased to 30.6 percent in November 2002 and January 2003.43 March 2000. MIG acquired a 70 percent interest in Warnowquerung GmbH and Co. KG, a limited partnership holding the rights to build, own, and operate a greenfield tunnel under the Warnow River in Rostock, Germany, then under construction and subsequently opened in 2003.44 September 2000. MIG, through Macquarie Midland Holdings Ltd., acquired a 75 percent interest in Midland Expressway Ltd., the concessionaire of the M6 Toll Road, the first privately developed tollway in the United Kingdom then under construction, and subsequently opened in 2003. MIG increased its interest in Midland Expressway Ltd. to 100 percent in June 2005. Subsequently, in 2006, Macquarie Motorways Group Ltd., a 100 percent-owned subsidiary of Macquarie Infrastructure Group International Ltd. (in turn, owned by MIG), acquired all the shares of Midland Expressway Ltd. from Macquarie Midland Holdings.45 December 2000. MIG acquired a 50.6 percent interest in Statewide Roads Ltd., the concessionaire for the existing M4 Motorway in Sydney. The M4 Motorway opened in 1992, linking Sydney’s western residential districts with its inner western suburbs.46 January 2002. MIG acquired a 40 percent interest in Cintra Concesiones de Infraestructuras de Transporte (Cintra), which owned, among other assets, the concessions for toll roads in Spain and a 67.1 percent stake in 407 International Inc., the holder of the concession for Highway 407 (now 407 ETR) in Toronto, Canada.47 The highway was developed by the Ontario Government and opened to traffic in 1997. The 407 International Inc. acquired the 407 ETR concession in mid-1999.


Grupo Ferrovial S. A. (Ferrovial) was (and remains) Cintra’s corporate parent. As discussed in chapter seven, Macquarie had previously teamed with Ferrovial to acquire the Bristol (U.K.) Airport in January 2001. In April 2002, through Macquarie Infrastructure (Toll Route) S. A., MIG acquired an additional 16.13 percent direct interest in 407 International, Inc. Through its investment in Cintra, MIG had a 26.84 percent indirect interest in the roadway for a total interest of 42.97 percent. Through an asset swap with Cintra prior to its initial public offering in October 2004, MIG’s interest in the concessionaire for the 407 ETR toll road was reduced to a direct 30 percent interest,48 with Macquarie Infrastructure Canada, Inc., a wholly owned subsidiary of Macquarie Infrastructure (Luxembourg) S.A., holding a 13.87 percent interest and Macquarie European Infrastructure plc (a subsidiary of one of MIG’s trust components) holding MIG’s original 16.13 percent interest.49 February 2003. MIG acquired a 40 percent stake in the Westlink Motorway Group (renamed the Westlink Consortium), the concessionaire and operator of the M7 in Sydney, which links the M2, M4, and M5. The M7 was then under construction and subsequently opened in 2005. MIG thereafter increased its interest in the Westlink Consortium to 45 percent in December 2005 and to 47.5 percent in September 2006, and to 50 percent in September 2008.50 February and April 2006. MIG, through Macquarie Autoroutes de France SA, a company owned 50 percent plus one share by MIG, acquired a 25 percent interest in Financière Eiffarie SA, the holder of the concession for Autoroutes Paris-Rhin-Rhône (APRR), an existing toll road in the east of France, giving it a 20.37 percent interest in APRR.51 As analyzed in chapter six, MIG in September 2002, through Macquarie 125 Holdings Inc., a wholly owned subsidiary of one of MIG’s trust components, acquired an 81.6 percent interest in the San Diego Expressway Limited Partnership (SDELP), the holder of the thirty-five-year concession to develop and operate State Route 125 South, a greenfield project near San Diego, California, that subsequently opened in November 2007. In May 2003, MIG increased its ownership of SDELP to 100 percent.52 MIG also acquired a major stake in three existing (brownfield) U.S. toll roads: a 45 percent stake in the Chicago Skyway in January 2005; a 100 percent interest in the Dulles Greenway, in Northern Virginia, in September 2005; and a 50 percent interest in the Indiana Toll Road in June 2006.53


MIG’s Financial Engineering

Building on the techniques of ITA Group, MIG established the fivefold infrastructure fund template next examined, namely, asset revaluations, asset sales, corporate restructuring, asset refinancing, and fees paid to Macquarie units. MIG made infrastructure assets attractive to investors through asset revaluations as well as borrowing (or refinancing) using cheaper debt and asset sales fund distributions. Governance questions are then considered. Asset Revaluations. For purposes of asset revaluations, Australian accounting standards differentiate noncontrolled assets from controlled assets. The Australian accounting standard mentioned earlier in this chapter (AASB 1030) continued to govern the revaluation of unlisted, noncontrolled assets until December 31, 2004. Under AASB 1030, MIG revalued the following unlisted, noncontrolled assets and included the revaluations in its revenues (or expenses): Lusoponte:54 June 30, 2001

June 30, 2002

June 30, 2003

A$48.6 million

A$130.9 million

A$221.2 million

June 30, 2004 revaluated downward by A$10.2 million to A$211.0 million

Cintra (excluding Highway 407):55 June 30, 2002

June 30, 2003

June 30, 2004

A$ 675.7 million

A$1.05 billion

revalued slightly downward to A$1.04 billion

Then, beginning on January 1, 2005, under Australian accounting standard AASB 139 MIG had to designate its noncontrolled asset investments as financial assets “at fair value through profit and or loss” in its Income Statement.56 A financial asset is any asset that is “an equity instrument of another entity.”57 An equity instrument is “any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities.”58 Fair value is defined as “the amount for which an asset could be exchanged . . . between knowledgeable, willing parties in an arm’s length transaction.”59 In short, MIG could (and did) recognize changes in the fair value of unlisted, noncontrolled investments in its


financial assets in its Income Statement. Under this approach, MIG revalued its major unlisted, noncontrolled assets as follows: 407 International, Inc.: 60 June 30, 2005

June 30, 2006

June 30, 2007

A$2.55 billion

A$2.96 billion

A$3.04 billion

June 30, 2005

June 30, 2006

June 30, 2007

A$236.6 million

A$234.7 million

revalued downward by A$17.7 million to A$217.0 million

June 30, 2008 A$3.30 billion

Lusoponte: 61

June 30, 2008 revalued downward by A$30.6 million to A$188 million

Financière Eiffarie SA: 62 June 30, 2006

June 30, 2007

June 30, 2008

A$534.8 million

A$1.34 billion

A$1.47 billion

Another Australian accounting standard, AASB 1041, which was in force from July 1, 2000 through June 2005, required MIG to value its controlled assets on a fair value basis.63 Fair value was again defined as “the amount for which an asset could be exchanged . . . between knowledgeable, willing parties in an arm’s length transaction.”64 Similar to noncontrolled assets, the assessment of fair value is made on the basis of a discounted cash flow analysis. However, unlike noncontrolled assets, revaluation increments for controlled assets are generally credited to the asset revaluation reserve, which is part of the owner’s equity, in the consolidated entity.65 In short, MIG could not include in its revenues the revaluations of its controlled assets: M1 and M4 in Australia as well as the M6 Toll in the U.K.66 Under the entity concept for consolidated groups, Australian accounting standard, AASB 1024, requires the inclusion of all assets and liabilities of the parent entity and its subsidiaries in parent’s consolidated financial statements.67 The requirement to consolidate is based on the


existence of control. Control is defined as “the capacity of an entity to dominate decision-making, directly or indirectly, in relation to the financial and operating policies of another entity so as to enable that other entity to operate with it in pursuing the objectives of the controlling entity.”68 Before establishing the existence of a group for consolidated return purposes, the capacity to control must exist. Substance-overform considerations are employed in determining the existence of control. The commentary to AASB 1024 provides: “Whether an entity has control of another entity will always be a question to be decided in the light of the prevailing circumstances. The definition of control depends upon substance rather than form. . . . ”69 A number of factors may indicate the existence of control including: (1) the capacity to dominate the composition of the controlled entity’s board of directors; (2) the capacity to appoint or remove all or a majority of its directors; (3) the capacity to control the casting of the majority of the votes at a meeting of the board of directors; (4) the existence of a statute, agreement, or any other scheme, arrangement, or device, which, in substance, gives one entity the capacity to enjoy the majority of the benefits and to be exposed to the majority of the risks of another entity, notwithstanding that control may appear to be vested in another party.70 AASB 127, which replaced AASB 1024 on January 1, 2005, continues these provisions.71 Under these accounting principles, despite its 50 percent ownership interest in Interlink Roads Pty Ltd., MIG regarded its stake as a noncontrolling interest, apparently because it did not have the power over more than half of Interlink’s voting rights. Furthermore, MIG could only place two directors on Interlink’s four-person board and thus it did not control a majority of the board.72 MIG revalued its unlisted interest in Interlink Roads stake and included the revaluations in revenues (or expenses) as follows:73 June 30, 1999

June 30, 2000

June 30, 2001

A$192.1 million

A$240.9 million

A$255.8 million

June 30, 2002

June 30, 2003

June 30, 2004

A$372.1 million

A$493.9 million

revalued downward by A$4.2 million to A$489.7 million

June 30, 2005 A$540.8 million


In sum, the revaluation of unlisted, noncontrolled assets contributed the following amounts to MIG’s revenues: Year Ending June 30, 2000: A$131.3 million; June 30, 2001: A$105.5 million; June 30, 2002: A$910.2 million; June 30, 2003: A$1.12 billion; June 30, 2004: A$147 million; June 30, 2005: A$785.9 million; June 30, 2006: A$424.6 million; June 30, 2007: A$1.6 billion; June 30, 2008: A$757.8 million.74 Because MIG’s base fees are keyed to asset values, these asset revaluations increased MIG’s management fees. Moreover, MIG used these revaluations, and the accompanying revenue gains, to make greater distributions to its security holders. As a legal benchmark for the payment of dividends, Australian corporate law requires that dividends be paid only out of “profits.”75 Asset revaluations increase a firm’s profits but not its cash flow. To maintain solvency upon making distributions, MIG had to look for cash from other sources, namely, asset sales and debt refinancings. Refinancings, in particular, allowed MIG to realize increased asset values as its assets matured and were operated more efficiently. For example, in October 2007, MIG told its security holders that the fund expected to cover 55 percent to 65 percent of its fiscal year 2008 distributions with cash flows from the operation of its assets, leaving 35 percent to 45 percent to be covered by asset sales or debt refinancings.76 In fact, MIG covered 54 percent of its fiscal year distribution from its operating cash flows.77 Asset Sales. Following the sale of two minor U.K. non-toll road assets in February 2001,78 from 2003 onward, MIG began to divest itself of its assets and securities holdings. From 2003 through 2006, MIG realized about A$3.7 billion in the sale of infrastructure assets and securities as follows: December 2003. MIG sold its entire interest in the Transurban Group for A$230.4 million, representing a compound annual return since its acquisition in 1996 of 25.4 percent per year.79 The sale represented the harvesting of a noncore asset. October 2004. MIG received A$1.74 billion interest in cash for its shares in Cintra’s initial public offering. As part of the agreement with Ferrovial (the majority shareholder in Cintra), Cintra’s 13.87 percent direct shareholding in 407 International Inc. was transferred to MIG in exchange for 11.99 percent of MIG’s investment in Cintra. MIG’s 28.01 percent remaining stake in Cintra was sold in the latter firm’s IPO. Through the Cintra investment, MIG realized an internal rate of return of 22 percent per year.80 The internal rate of return compares


cash inflows, including distributions received and asset appreciation, with the cash expended to acquire an asset. A review of the Ferrovial-Macquarie alliance occurred in mid-2004 as part of the deal in which Macquarie acquired its interest in Cintra in 2002. The review concluded that Macquarie’s departure would best serve Cintra. Apparently Macquarie and Ferrovial had major disagreements about Cintra’s future; Ferrovial, holding a controlling interest, prevailed. December 2004. MIG sold the 50 percent interest Macquarie Yorkshire Ltd. held in Connect M1-A1 Holdings Ltd. (formerly Yorkshire Link Holdings Ltd.), the holder of the concession for the Yorkshire Link, to a Macquarie-related entity, the Macquarie Infrastructure Company Trust, a company listed on the New York Stock Exchange, for A$107.2 million.81 MIG viewed the Yorkshire Link, a noncore asset, as a mature road with a limited upside potential, on which it had realized an internal rate of return of 42 percent per year.82 April and May 2005. MIG exchanged its entire interest in the Hills Motorway Group, another noncore asset, and received Transurban Group securities and A$3.75 million in cash, realizing an internal rate of return in excess of 38 percent per year on this holding. MIG subsequently sold the Transurban Group securities in March 2006 for A$151 million.83 August 2006. Consistent with its overall strategy and previous divestment activity, MIG spun off its mature Australian assets, the M1, M4, and M5 toll roads, to the separately listed Sydney Roads Group (SRG), receiving 825 million SRG stapled securities, which it distributed to MIG security holders, and cash payment of A$125 million. As part of this transaction, SRG also assumed debts totaling A$275 million. On these assets, which prior to their sale represented about 13.7 percent of MIG’s portfolio, the fund had quintupled the value of the capital originally invested in these toll roads, generating an annual internal rate of return of 27 percent per year on them in the process.84 The divestiture and sale of these assets to SRG represented a “winwin” situation for MIG investors and Macquarie, especially the latter. Australian investors may not have been as comfortable with the new geographical areas, especially the United States, into which MIG was expanding. Also, the Sydney Roads Group, when separated from MIG’s other assets and offered to Australian investors, likely achieved a greater value for these toll roads than would be attributed to them within MIG. The Sydney tollways comprised the most mature assets


in MIG’s portfolio. MIG had added about as much value as it could to these assets, thereby limiting their upside potential and undermining the case for Macquarie continuing to extract fees. Furthermore, Macquarie was not collecting any performance fee streams from the trio of highways.85 December 2006. As will be discussed in chapter six, MIG reduced its exposure to its U.S. assets by selling 50 percent of its interests in all four of its U.S. assets, the Chicago Skyway, the Dulles Greenway, the Indiana Toll Road, and the South Bay Expressway, to another Macquarie entity, the unlisted Macquarie Infrastructure Partners, for $824.6 million (A$1.06 billion).86 Prior to the partial divestment, MIG had realized an internal rate of return of 21 percent per year on these U.S. assets.87 After 2006, MIG continued its asset sales. In January 2009, MIG sold its 30.6 percent interest in Lusoponte for €112 million (A$227 million). The sale price represented an annual 15 percent internal rate of return for MIG.88 In December 2008, MIG announced the sale of its 50 percent interest in Westlink M7 for A$805 million, which it completed in February 2009. The sale delivered to MIG investors an annual internal rate of return of 25.9 percent.89 In sum, through these sale transactions MIG generally sought to dispose of investments where it had optimized an asset’s performance. By buying low, adding value, and selling high, the sales uniformly produced strong returns for MIG security holders. Corporate Restructuring. Prior to September 21, 2000, the listed MIG securities consisted of stapled securities of two Australian trusts, Macquarie Infrastructure Trust (I) (MIT(I)) and Macquarie Infrastructure Trust (II) (MIT(II)). On September 21, 2000, MIG was reconfigured into a triple-stapled structure, following the distribution of shares in Macquarie European Infrastructure plc (MEI) (previously a wholly owned subsidiary of MIT(II)) to MIG investors. After the restructuring, Macquarie Infrastructure Investment Management Ltd. (MIIML), a wholly owned subsidiary of Macquarie Bank, managed all three entities. Then on May 10, 2001, Macquarie Infrastructure Investment Management (U.K.) Ltd. (MIMUK), a wholly owned subsidiary of the Macquarie Bank, became the manager of MEI.90 This arrangement lasted until January 2005, when Macquarie Infrastructure Bermuda Ltd. (MIBL) (renamed Macquarie Infrastructure Group International Ltd. (MIGIL) in November 2005) was inserted above MEI in the corporate structure, with Macquarie Capital Funds


(Europe) Ltd., a Macquarie Group subsidiary, serving as the advisor to MIGIL. The accompanying capital restructuring enabled the return to MIG of £340 million from MEI, thereby facilitating a £90 million distribution of the proceeds from the sale of Cintra shares. By permitting a £250 million internal restructuring of MEI’s funding arrangements, the revamping enabled a more appropriate mix of debt and equity for MIBL. The recapitalization of MEI also enabled the flow of funds from investments back to MIG security holders in a more timely and efficient manner because MIBL, as a Bermuda company, unlike MEI, was not subject to distributable reserve restrictions on the payment of dividends, but only a solvency test. A solvent company has adequate cash to pay its debts, or its assets exceed its liabilities. Unlike the U.K. tax system, Bermuda, furthermore, does not impose any taxes on capital gains or dividends.91 Asset Refinancings. Beginning in 2004, MIG embarked on an aggressive refinancing campaign. Debt restructuring is a common phenomenon in the management of toll roads and results in the release of cash that can be used to fund distributions. In November 2004, MIG refinanced the Airport Motorway Group debt facilities. A$515.5 million in new loans replaced an A$474.3 million credit facility, resulting in some A$12 million for MIG. In June 2005, MIG refinanced Interlink Roads loans with a new A$540 million interest-only facility, replacing an existing A$485 million facility. In August 2005, as discussed in chapter six, it completed the Chicago Skyway refinancing, releasing $168.2 million (A$221.7 million) to the fund.92 In a major financial restructuring, MIG completed the refinancing of the M6 U.K. toll road in August 2006. Existing facilities of £619.9 million (A$1.54 billion) were replaced with new nine-year facilities of £1.03 billion (A$2.55 billion) due for repayment in 2015, thereby better matching the road’s capital structure and future, ramped-up interest rates to its cash flows over the concession’s life. After repaying the previous debt facility and incurring debt arranging and refinancing fees, the refinancing generated £358 million (A$887.5 million) for MIG. An additional £34 million (A$84.3 million) of restricted cash assets were released from the refinancing, with a total distribution of £392.1 million (A$972.3 million) to MIG. Out of the distributions received, MIG used A$500 million to repay the standby facilities drawn in connection with the acquisition of the Indiana Toll Road in June 2006, with the remainder applied, along with the proceeds from the sale of its U.S. assets, to buy back A$1 billion of its securities.93


In sum, the M6 refinancing generated value to MIG security holders by enabling investors to receive cash earlier, reducing the financing costs on this asset, and leveraging investment returns. The new loans not only generated cash MIG could distribute to its security holders but also provided greater flexibility in their terms and conditions. As an MIG spokeswoman noted, “We consider refinancing [part of] our core business.”94 MIG continued to remain active in refinancing and debt raising transactions. In August 2007, MIG refinanced a €500 million loan for the APRR on better terms than the existing facility.95 In October 2007, MIG refinanced $625 million of 407 ETR’s senior debt, generating annual interest cost savings of approximately 1.3 percent per year. In January 2008, MIG refinanced an additional C$550 million of the road’s debt.96 In 2008, APRR completed a number of debt raising transactions, including a €200-million seven-year inflation-linked commercial paper issue in October 2008 and a €200-million four-year bank facility in December 2008. In January 2009, 407 ETR borrowed C$500 million through a bank syndicate. Even before the 2004–2008 refinancings, MIG had implemented significant financing innovations. In February 2003, it pioneered using Reset Convertible Notes (ReCNs) to fund its investment in Westlink M7 road. MIG’s investment in the M7 was funded by the Ontario Teachers Pension Plan (OTPP), which subscribed to ReCNs issued by Western Sydney Orbital Funding Trust (WSOFT), a wholly owned subsidiary of MIT(I). WSOFT then invested in Westlink. This funding arrangement permitted MIG to delay the injection of its equity capital into Westlink, thus allowing the fund to improve its investors’ returns. The ReCNs allowed the holder to convert them at a discount into MIG stapled securities within five years after issuance, with a maximum term of ten years, subjected to certain events triggering an early redemption. At the option of the issuer, interest could be paid or added to the outstanding loan principal. After the initial five year period, MIG could change the conversion discount rate and the interest rate on the ReCNs. After five or ten years, if the holders do not elect to convert, they have the option to convert or redeem the ReCNs at face value plus any capitalized, but unpaid, interest.97 In November 2006, the OTPP exercised its rights to convert all ReCNs into MIG stapled securities. In 2005, MIG securitized part of the expected cash flows from three Australian toll roads. MIG assigned its entitlement to future cash


flows generated by tolls in exchange for cash. In July 2005, the fund received A$150 million from the securitization of part of the expected future Airport Motorway Group distributions. Then in December 2005, it received A$125 million from the securitization of part of the expected future Interlink Roads and Statewide Roads distributions.98 Securitization involves packaging these cash flows and distributions into securities that were sold to investors. Macquarie Fees. In addition to base and performance fees, Macquarie and its various units extracted millions of dollars in other fees from MIG. Fees paid by MIG in these related party transactions with other Macquarie units were externally benchmarked and/or reviewed by independent experts who provided an opinion as to their arm’s length nature to the fund’s independent directors. Despite these safeguards, Macquarie and its other units (not external providers) received these fees. The following is a year-by-year summary: Fiscal year 2000 (year ending June 30, 2000): base fee: A$9.71 million.99 Fiscal year 2001 (year ending June 30, 2001): base fee: A$28.77 million and performance fee: A$72.58 million, with in specie distribution costs: A$5.66 million. The performance fee paid in fiscal year 2001 was the first installment (of three) of the A$207.7 million fee earned in that year.100 Fiscal year 2002 (year ending June 30, 2002): base fee: A$53.5 million and performance fee: A$76.25 million. This performance fee payment included the second installment of the 2001 performance fee as well as the first installment of the A$18.3 million fee earned in fiscal year 2002. Macquarie Bank Ltd. also received an underwriting fee of about A$11.0 million (1.375 percent of the underwritten amount (A$800 million)) in connection with the Priority Entitlement Offer of 250 million new MIG stapled securities.101 In fiscal year 2002 the base fee was revised and set as follows: 1.25 percent per year of MIG’s net market value of up to A$3 billion and 1.00 percent per year of MIG’s net market value in excess of A$3 billion. Effective June 30, 2002, the performance fees paid by MIG were restructured, with MIG’s nonexecutive directors given the option to pay these fees in new MIG stapled securities rather than in cash.102 Fiscal year 2003 (year ending June 30, 2003): base fee: A$70.74 million and performance fee: A$148.28 million. This performance fee payment included the third installment of the 2001 fee, the second installment of the 2002 fee, and the first installment of the A$197 million fee earned in fiscal year 2003.103


Fiscal year 2004 (year ending June 30, 2004): base fee: A$73.98 million and performance fee: A$6.15 million. While the performance criteria for the third installment of the 2002 performance fee were met, the criteria were not met for the second installment of the 2003 fee. No performance fee was earned for fiscal year 2004. Therefore, the performance fee paid in 2004 consisted only of the third installment of the 2002 fee.104 Fiscal year 2005 (year ending June 30, 2005): base fee: A$83.28 million and performance fee: A$92.52 million. This performance fee payment, which was reinvested in MIG stapled securities, included the third installment of the 2003 performance fee as well as the first installment of the A$77.7 million fee earned in fiscal year 2005. Macquarie Bank received a fee of A$4.6 million from MIG for financial advisory work in relation to Cintra’s IPO. Macquarie Securities (USA), Inc. billed Skyway Concession Company Holdings LLC $19 million for financial advisory services performed in relation to the acquisition of the Chicago Skyway. MIG Holdings (US) LLC entered into an arrangement with Macquarie Bank, under which it could elect to put (sell) 49 percent of its interest in MIG Chicago Holdings LLC to Macquarie Bank at par value. The premium paid was $6.5 million. The option was not exercised. On normal commercial terms, MIG also entered into certain interest rate swaps with Macquarie Bank and sold a portion of the debt securities issued by Transurban Group (received in exchange for the fund’s interest in the Hills Motorway Group) through Macquarie Equity Capital Markets Ltd.105 Fiscal year 2006 (year ending June 30, 2006): base fee: A$97.96 million. No performance fee was earned in fiscal year 2006; likewise, the second installment of the 2005 fee was not earned, thus, no performance fee was paid in 2006. Macquarie Securities (USA), Inc. earned advisory fees of $16 million (A$21.52 million) for work performed on the Dulles Greenway acquisition and $1.58 million (A$2.11 million) from the refinancing of the Chicago Skyway indebtedness. Macquarie Bank earned the following advisory fees: A$2.95 million from MIG for work performed on the APRR acquisition and A$81.76 million from Financierè Eiffarie SA relating to debt financing in connection with the APRR transaction; A$1.5 million from MIG for work performed on the securitization of future Airport Motorway Group cash flows; A$0.94 million from MIG for work performed on the securitization of future Interlink Roads Pty Ltd. and Statewide Roads Ltd. cash flows; and A$5.47 million for MIG for work performed


in relation to the Westlink M7 refinancing. Macquarie Securities (Australia) Ltd. earned brokerage fees of A$0.3 million from MIG’s sale of Transurban Group stapled securities. Macquarie Equity Capital Markets Ltd. earned underwriting fees of A$3.4 million from MIG with respect to the institutional placement of its securities.106 Fiscal year 2007 (year ending June 30, 2007): base fee: A$81.96 million. As in 2006, the performance fee criteria were not met to allow a performance fee for 2007 or the payment of the third installment of the 2005 fee; thus, no performance fee was paid in 2007. Macquarie Bank earned advisory fees of A$5.81 million for work performed on the sale of MIG’s interest in its four U.S. assets. MIG paid an advisory fee of A$4.95 million to Macquarie Bank and underwriting fees of A$1.11 million to Macquarie Equity Capital Markets and UBS in connection with the divestiture to the Sydney Roads Group. Macquarie Bank earned advisory fees from MIG of A$15.41 million for work performed in relation to the M6 debt refinancing. Brokerage fees of A$1.05 million were paid to Macquarie Securities (Australia) Ltd. in connection with MIG’s security buyback.107 In November 2007, MIG security holders approved giving the fund’s independent directors the option, until October 2009, to pay base fees in cash or allow that cash to be reinvested in the fund’s securities. The option to pay the fee in MIG securities may only be exercised with the case-bycase approval of MIG’s independent directors. This flexible arrangement will increase MIG’s operating cash flows in the medium term and provide some breathing room for assets to grow their cash flows.108 Fiscal year 2008 (year ending June 30, 2008): base fee: A$67.03 million.109 No new performance fee was payable. Macquarie Capital Advisors Ltd., a subsidiary of the Macquarie Group, received an advisory fee of A$3.85 million relating to the establishment of the MIG Westlink Funding Trust. Brokerage fees of A$0.6 million were paid to Macquarie Securities (Australia) Ltd. in connection with MIG’s security buyback.110 Governance Issues. With a multiplicity of related party transactions raising the possibility of conflicts of interest, governance provisions became important to MIG investors. As noted, the Macquarie Bank and its various units undertook transactions with and performed numerous services for MIG. Prior to November 2002, the fees for these transactions and services were approved by the nonexecutive directors of Macquarie Infrastructure Investment Management Ltd. (MIIML) (the manager of MIT(I) and MIT(II)) and the nonexecutive directors


of Macquarie European Infrastructure plc (MEI).111 These nonexecutive directors need not, however, have been independent of Macquarie. On March 31, 2003, the Australian Stock Exchange Corporate Governance Council released its Principles of Good Corporate Governance and Best Practice Recommendations (the Standards)112 designed to maximize corporate performance and accountability in the interests of a firm’s shareholders and the broader domestic economy. Beginning in 2004, listed companies, including MIG, had to disclose the extent of compliance with the Standards and explain why they did not adopt a standard. To safeguard the interests of each of its fund’s security holders, in November 2002, the Macquarie Bank’s board previously had adopted its Funds Management Activity Policy (Fund Policy)113 to address the fact that the Macquarie Bank’s interests may conflict with the interests of its funds’ investors. In accordance with the Fund Policy, independent directors now comprise a majority of MIIML’s board, with MEI (as of 2005, Macquarie Infrastructure Group International Ltd. (MIGIL)) having a board composed of 50 percent independent directors, but not a majority of independent directors. Macquarie adopted this approach because no significant decision could be made by one board without the consultation and approval of the other board. Related party transactions and services must be approved by MIIML’s or MEI’s (now MIGIL’s) independent directors. All related party transactions are tested by whether they meet market standards. Macquarie executive directors who are employed by Macquarie do not vote or, unless invited by the independent directors, participate in discussion on related party matters. The detailed standards of independence go far beyond not being a member of management (a nonexecutive director).114 In response to criticism by governance consultants calling for Macquarie to be more open in relation to its funds, in 2009 MIG implemented further changes in its corporate governance framework. In brief, these changes give the Macquarie Group Ltd. a less direct role in MIG’s management. Under the new arrangement, MIG security holders can nominate and vote on directors to the boards of MIIML and MIGIL. Previously, the Macquarie Group nominated and appointed most of the fund’s directors. Macquarie also intends to abstain from voting the securities it holds with respect to the appointment of MIG’s directors and financing decisions, such as securities issuances and buybacks.115 *

*

*


By cutting costs and raising user fees on its infrastructure assets, the Macquarie Infrastructure Group posted top-notch returns for its investors. Since the fund’s 1996 inception as the ITA Group, MIG achieved an internal rate of return of 11.4 percent annually based on all capital raised, distributions paid, and market capitalization through September 2008.116 In addition to the fund’s expertise in selecting assets to lease and operate, whether greenfield projects or existing facilities, MIG’s continued success has rested on extraordinary financial engineering, focusing on asset revaluations, debt refinancings, and asset sales. MIG understands the growth phases of its toll roads and uses that knowledge to time the sale of its assets. Moreover, MIG adjusted its holdings, such as in the divestment of the M1, M4, and M5 motorway and the partial sale of its interest in four U.S. toll roads, in response to its investors’ tastes. We next turn and focus on MIG’s construction of a greenfield toll road, SR125 South—the South Bay Expressway, the privatization of two publicly owned and operated U.S. toll roads, the Chicago Skyway and the Indiana Toll Road, and its acquisition of an existing, privately operated U.S. toll road, the Dulles Greenway.


Ch a p t e r Si x M acqua r i e a n d t h e P r i vat i z at ion of H ig h ways i n t h e Un i t e d Stat e s

Privatization of highways through long-term concession deals represents a new and important phenomenon for U.S. transportation finance and operations. As its first investment in the United States, in 2002 the Macquarie Infrastructure Group (MIG) acquired a majority interest in a Southern California greenfield project, the South Bay Expressway, which it built and opened in 2007. Although, the United States had a long history of private toll roads in the nineteenth century, the privatization of existing American highways began in 2005. In that year, a Macquarie-led group leased the Chicago Skyway. Then in 2006, a Macquarie-led joint venture obtained the concession to operate and maintain the Indiana Toll Road. In addition to leasing these two publicly funded toll roads, previously, in 2005, MIG took over an existing private toll road, the Dulles Greenway, in Northern Virginia. America, however, lags far behind the rest of the world in the privatization of greenfield and brownfield highways. As considered in this chapter, the public sector—federal, state, and local—lacks the resources to maintain and construct all the U.S. road and bridge projects that need to be funded. The nation faces ever worsening urban traffic congestion, fast-growing truck traffic, and an inability of fuel taxes to fund much more than maintenance of the existing highways and bridge systems. All of this adds up to an enormous and growing highway and bridge funding gap between investment needs and what that available funding sources will produce. Based on Macquarie’s initial success in the United States, this chapter concludes that given the magnitude of spending required, private capital markets will increasingly become a realistic source of funds through infrastructure privatizations and various types of public-private partnerships. Private sector participation can help ensure that infrastructure planning, construction, and operation are rooted in sound cost-benefit analysis.


The History of U.S. Highways: A Brief Overview

Private enterprise has a long history of owning and operating highways in the United States. Following independence from Great Britain, there began a great push to develop the interior of the United States and a significant expansion of interstate trade, with the private sector dominating the financing of highways in the eighteenth and nineteenth centuries.1 In this era of private turnpikes, road building and operation by forprofit investors dwarfed corresponding governmental efforts. From 1792, when turnpikes were first chartered by states, until 1902, some five thousand companies built and operated between thirty to fifty-two thousand miles of highways nationwide.2 Private toll roads went through two basic phases. From 1792 to 1845, over eight hundred private turnpikes were built, mainly in the northeast, but also in Virginia, Maryland, and Ohio. The next phase focused on California and the more mountainous areas of the west, where there were many places railroads could not reach. Toll regulation in the west was more favorable than in the east. From 1850 to 1902, over one thousand toll roads were incorporated in the west, particularly in California and Colorado. Nationwide, some private turnpikes prospered, while others struggled. Ultimately all private turnpikes either succumbed to competition from the railroads, which offered travelers a faster route to distant points, or were taken over by the public sector. During the twentieth century, roads and interstate highways extended auto and truck transportation across the continent. With the popularity of automobiles, modern American toll roads were launched in the 1940s and 1950s. States looking to build limited-access highways borrowed funds for construction and agreed to pay interest and repay the principal with the tolls charged to motorists. Connecticut took the lead by opening the Merritt Parkway, an auto-only toll road, followed by Pennsylvania, which opened the Pennsylvania Turnpike to auto and truck traffic in 1940. Thereafter, a number of states in the East and Midwest, including New York, New Hampshire, New Jersey, Indiana, Ohio, Kansas, Illinois, and West Virginia, built toll expressways. In the ensuing decades, some fast-expanding metropolitan areas created their own toll roads, with municipal or state funding. Governmental entities built and operated all of these toll roads. Private toll roads did not reappear until the last decade of the twentieth century. In the 1990s, two new private toll roads were developed,

macquarie and privatization of highways / 85

specifically, the State Route 91 express lanes in Orange County, California, and the Dulles Greenway project in Virginia. A discussion of SR 91 is beyond the scope of this book. The Dulles Greenway is considered later in this chapter. Over the past fifty years, road construction in the United States has focused on the development of the Interstate Highway System, more formally, the Dwight D. Eisenhower National System of Interstate and Defense Highways, which Congress authorized in 1956.3 Today, the interstate highway system connects people nationwide via nearly a 47,000-mile network of roads. This system changed the way Americans live. The system helped create the backbone of U.S. economic growth, gave people unprecedented mobility, allowed greater choices in where to live and work, significantly increased highway safety, reduced congestion on local roads, and made possible the modern trucking industry. A pet project of President Dwight D. Eisenhower (R), the system put the United States on the road to being the world’s most motorized society. The interstate highway system was never an exercise in central planning, with the federal government planning and building a unified system. Although the initial, general plan for the interstates was worked out jointly by the federal government and state transportation departments, in reality what we call the “interstate highway system” is a patchwork of roadways owned and operated by separate state governments plus numerous other highway, bridge, and tunnel agencies. In some fourteen states, a mix of fuel and other taxes, tax-exempt debt, and toll revenue financing, not federal aid, developed major interstate highways. In addition to a variety of taxes, states and various transportation authorities had ready access to the large, well-established municipal bond market in the United States, which proved a plentiful, reliable source of relatively inexpensive financing for motorways. However, both the non-toll road portions of the system and the toll road parts had to meet a number of federally mandated standards set by the Federal Highway Administration. During the interstate highway boom era, roughly 1956 to 1980, the federal government financed much of the nation’s highway construction using the Federal Highway Trust Fund. The fund was created by Congress to help build the interstate highway system and is supported by federal taxes on gasoline and diesel motor fuels.4 Prior to the creation of the fund, federal motor vehicles and fuel taxes were deposited into the U.S. General Fund. At the same time, Congress barred states from imposing tolls on the portions of the interstate highway


system financed with federal funds.5 However, under the 1956 Act, federal funds could be used to construct approaches to toll roads in the system. Also, some 2,500 miles of existing toll highways were incorporated into the proposed system. Under another long-standing exception, Congress permitted federal funding of toll bridges and their approaches as part of the pre-1956 federal-aid highway system. In addition, Congress periodically allowed states to repay the federal aid used to build highways so that tolls could be imposed on the roadways.6 Subsequently, in 1978, Congress authorized the use of federal funds to build interstate system toll roads, provided the states receiving the aid pledged to remove the tolls when the highway construction debt was retired.7 Few states made such a pledge. As a general matter, because the states could levy tolls on parts of the system not financed with federal aid, there developed a network of toll roads in the Northeast and in Florida, with pockets of toll roads throughout the Midwest. Many of these highways were incorporated into the interstate system and permitted to retain their tolls to pay off outstanding bonds. In a few cases, such as Connecticut, tolls were removed at some point after the original bonds were paid off. However, in most other states, such as Pennsylvania, Indiana, Illinois, and Oklahoma, the tolls remained and were used to maintain and expand the original expressways. With the previous exceptions outlined above and certain limited exceptions set forth in the reauthorization of the Federal Highway Trust Fund in 2005,8 the U.S. government continues to bar the imposition of tolls on the federally funded portions of the interstate highway system. Today, the federal government encourages a limited degree of experimentation with tolls in six programmatic areas. First, the new Express Lanes Demonstration Program9 directs the U.S. Secretary of Transportation to carry out fifteen demonstration projects from fiscal year 2005 through 2009 to permit the collection of tolls on facilities in the interstate system in order to manage high levels of congestion, among other objectives. It was assumed that most of the funding would go to open high occupancy toll (HOT) lanes to encourage car pooling. In other words, cars with passengers that paid tolls would use the new HOT lanes. Second, the Interstate System Construction Toll Pilot Program allows three facilities on the interstate system, whether highways, bridges, or tunnels, to impose tolls to pay for the construction of new projects.10 Third, an existing pilot program, the Value Pricing Pilot Program,11 which continued under the 2005 act, allows up to


fifteen state tolling programs to experiment with congestion pricing, where tolls are set, from hour to hour, based on the number of cars on the road at any time. The traffic is constantly monitored and the feed are adjusted accordingly. Using variable pricing, these roads seek to prevent overloading by finely tuned pricing, limiting the traffic to what a road can bear. Finally, the U.S. Department of Transportation has three other toll project areas, the high occupancy vehicle (HOV) lane conversions, the Interstate System Reconstruction and Rehabilitation Pilot Program, and Section 129 Toll Agreements.12 Also, to encourage private investment, the 2005 reauthorization provides for the issuance of up to $15 billion in tax-exempt private activity bonds (PABs) through September 2009 to finance the construction of new highways and rail-truck transfer freight facilities.13 State or local governments typically issue private activity bonds to provide debt financing for a project used by a private entity. These bonds were previously not permitted for highway projects. In addition to providing low, tax-exempt interest rates, PABs eliminate the difference in interest costs between debt issued by the private and public sectors. The 2005 act allows the U.S. Secretary of Transportation to allocate this private activity bond capacity. After the Department of Transportation solicited requests in January 2006 for such allocations, opening the possibility that the financing could be used for new toll facilities or improvements to privatized toll roads, it approved the Port of Miami Tunnel and the Missouri Safe and Sound Bridge Improvement projects, two public sector initiatives.14 The 2005 act reflects the current need to tap global capital for the U.S. highway market and the state of affairs in which Macquarie discovered the U.S. road sector. In quick succession, in the first decade of this century, the firm built a greenfield project and took over the operation and maintenance of two existing public sector roads and a private one. Macquarie and the South Bay Expressway

The Macquarie Infrastructure Group built the South Bay Expressway, formerly known as SR 125 South, a greenfield project. This toll road represented MIG’s first investment in the United States. This section provides background on the project and its financing.15 The South Bay Expressway (SBX) is a 13.9 kilometer (9.3 mile) fourlane toll road that runs north in Southern California from adjacent to


the Mexican border to just south of Route 54 in Bonita, California. In conjunction with the construction of the SBX, two sections of untolled, public sector-funded road were constructed to link the SBX into the greater San Diego highway network. In 1991, the California Department of Transportation awarded the SBX concession to the South Bay Expressway Limited Partnership (SBXLP). After years of delays, mainly with respect to not-in-mybackyard, environmental, and endangered species issues, in September 2002, MIG acquired an 81.6 percent stake in the SBXLP, and thus the concession. MIG purchased the remaining 15.7 percent of SBXLP in May 2003. After acquiring total ownership of SBXLP, Macquarie commenced construction of the SBX in July 2003. The road opened to traffic in November 2007. The concession runs for forty-five years until 2052.16 MIG financed the SBX construction through a combination of senior debt, a U.S. Government Transportation Infrastructure Finance and Innovation Act of 1988 (TIFIA)17 debt facility, and equity contributions by MIG. A senior debt facility of $400 million helped fund the construction, with MIG equity contributions reducing the facility to a maximum of $340 million. In 2003, the U.S. Department of Transportation selected SBX for financial support under the TIFIA program. This program is designed to encourage private investment in transportation infrastructure with a major national impact. SBX was the first private toll road to receive a low-interest loan under the TIFIA program. During the SBX construction, MIG drew down the TIFIA facility to meet some 33 percent of eligible TIFIA project costs. This limitation helps ensure that the TIFIA attracts, but does not displace, co-investment. The term of the SBX TIFIA debt facility is 38 years, including the construction period. The loan limit was $140 million, excluding capitalized interest. The interest is fixed at a below-market rate of 4.46 percent per year, a rate then comparable to long-term U.S. Treasury securities, for the facility’s life. U.S. Department of Transportation policy requires a borrower to repay a TIFIA loan facility in order to reallocate these subsidized loans from mature projects to new transportation lending projects, thereby stretching federal money. The TIFIA loan agreement for the SBX requires the repayment of the facility through a cash sharing mechanism. After MIG has received $32 million in distributions from the SBX project, cash flow sharing begins. The sharing percentage starts at


25 percent of the cash flow available to the equity interest and increases by 5 percent each year until the loan is repaid. Also, 50 percent each year until the loan is repaid. Also, 50 percent of any refinancing proceeds in excess of the initial senior loan must be used to repay the TIFIA facility. MIG executed an Equity Funding Agreement in 2003 that requires $133.4 million of equity be contributed to the project. In addition to the subordinated TIFIA loan, SBX has some $321 million of senior debt. The concession limits the total, real return on invested capital (both debt and equity) to 18.5 percent per year. According to MIG’s analysis, this limit would not pose a constraint even under significant, upside traffic growth scenarios. Under the concession agreement, SBXLP is freely able to set market-based toll rates throughout the concession period. Macquarie and the Chicago Skyway

The 2005 takeover of the Chicago Skyway by a Macquarie-Cintra joint venture marked the first-of-its-kind privatization of an existing toll road in the United States, and it raised Macquarie Infrastructure Group’s recognition in the United States. The Skyway (more formally, the Chicago Skyway Toll Bridge System), a 7.8-mile elevated road, runs from downtown skyscrapers and I-94 (the Dan Ryan Expressway) to old steel mills in northwest Indiana and I-90 (Indiana Toll Road). It is the most convenient route between central Chicago and the northwest suburbs of Indiana. The Skyway’s Background. Opened in January 1959, the Skyway, a toll road gateway to Chicago, repeatedly encountered financial difficulties during decades of public sector management.18 For years, it could not compete with the I-94 expressway, a toll-free road. From 1963 to 1974, the Skyway’s net revenues were insufficient to pay bond interest on a current basis. With one exception, the city did not make scheduled deposits into a sinking fund account. As the result of these interest payment and sinking fund deficiencies, a class action lawsuit, filed in 1972 against the city on behalf of all the bondholders, led a federal district count to order numerous toll increases on the Skyway. As of 1989, all interest in arrears was paid and the Skyway began paying interest on a current basis. The city refinanced the Skyway’s outstanding bonds in 1994. As traffic increased on the free expressway, motorists came to appreciate the substantial time savings offered by the Skyway.


In 2004, the City of Chicago entered into a bidding process to lease the Skyway, which was not a core municipal asset. Mayor Richard M. Daley (D), a key proponent of the leasing transaction, had unusually wide latitude in implementing decisions regarding the city’s infrastructure. The city had done its homework. It overcame a major legal hurdle in 2002. Illinois law regarding leaseholds would have required the new private operator-lessee to pay real estate taxes on the asset and right of way. The city won an exemption to the ongoing leasehold tax in the spring of 2002 through carefully worded legislation that only impacted the Skyway.19 An agreement with the federal government relating to federal funds used on a connector road would have made a lease transaction impossible. Chicago officials renegotiated the agreement with the U.S. government. The Skyway was in good condition after the city had spent some $260 million in major capital improvements.20 Most of these improvements, which were completed by January 2005, enhanced the road’s value. In undertaking the transaction, the city sought to secure its longterm financial future. It faced a $220 million deficit in its $5 billion 2005 budget. Rating agency analysts issued warnings about the city’s razor-thin cash situation and its minuscule operating expense reserve. The Concession Agreement. In October 2004, the City of Chicago entered into a concession and lease agreement with the Skyway Concession Company LLC (SCC).21 SCC is owned by a holding company, Skyway Concession Company Holdings LLC, which in turn is owned by Macquarie Infrastructure Group, 45 percent, and Cintra Concesiones de Infraestructuras de Transporte SA (Cintra), 55 percent, a Spanish company discussed in chapter five. The Macquarie-led group received a ninety-nine-year lease to operate and maintain the toll road in exchange for a January 2005 cash payment of $1.83 billion to the City of Chicago. As part of the deal, the concessionaire received the right to collect and retain all toll revenues during the term of the lease. The agreement included a schedule of toll increases, with specified periodic step increases beginning in January 2005 through 2017. Tolls for passenger vehicles were limited to $2.50 until 2008, $3.00 until 2011, $3.50 until 2013, $4.00 until 2015, $4.50 until 2017, and $5.00 in 2017, unless inflation is higher during these periods. After 2017, the maximum annual increases were capped at 2 percent, or the increase in the U.S. Consumer Price


Index, or per capita nominal U.S. Gross Domestic Product growth, whichever was greater.22 These future toll increases, which are legally binding and subject to market forces, cannot be suspended as a result of popular disquiet or influenced by political debate. The consortium assumed responsibility for running the road, with the SCC taking over the maintenance and operation of the Skyway from the City of Chicago Department of Streets and Sanitation. Both the maintenance manual and the operations and procedures manuals spell out requirements in mind-numbing detail. For example, these standards include how quickly potholes must be filled: continuously, every 24 hours.23 The specified operating standards are, however, to be “construed flexibly” so that occasional or incidental acts (or omissions) will not be deemed a violation of the concession contract.24 The agreement also requires the SCC to carry out and pay for specific capital improvements totaling $80 million to enhance the Skyway’s operational efficiency.25 Because the area around the Skyway is heavily developed, thereby making new roadways extremely unlikely, the contract does not include any protection from competition. If the new operator fails to meet any material obligation of the agreement, subject to an opportunity to cure the default, the city possesses a number of remedies. Among other alternatives, the city can terminate the lease and take the toll road back.26 Reaction to the Transaction. It was the price paid in the sealed-bid auction that left rival bidders and city officials “dumbstruck.” The latter had hoped for $1.2 billion at the very most for a toll road that produced some $43 million a year in revenues. The winning bid was $1.1 billion more than that offered by the nearest other bidder, with the next closest bid of some $701 million. Aldermen Edward Burke (D), Chicago City Council’s finance committee chairman, described the deal as “the greatest single financial coup in the history of Chicago.”27 Political leaders saw the deal as an attractive way to obtain cash without raising taxes. Chicago used the proceeds from the agreement in the following manner: $463 million to repay the Skyway’s outstanding indebtedness; $392 million to repay the city’s general obligation debt; $375 million to fund an operating budget shortfall account that the city could use to smooth impact of economic cycles and stabilize the need for additional revenues; $500 million to fund a “permanent” rainy day reserve fund; and $100 million to fund various “visible” programs, such as winter heating assistance and shelters for the homeless.28 The cash infusion led Moody’s to upgrade Chicago’s general obligation


bond rating to Aa3 from A1 in February 2006.29 As an attorney with the law firm that served as the transaction counsel to the city put it, the deal helped shore up Chicago’s finances “in a way that really has made Chicago probably financially the strongest major city in America.”30 However, the city did not invest any of the proceeds to fund new infrastructure. Post-Takeover Changes. After the takeover, the consortium upped tolls, cut operating expenses, and introduced electronic tolling. In February 2005, passenger car tolls went from $2.00 to $2.50, the first increase since 1993. Previously, Skyway toll takers and maintenance personnel were fulltime, unionized Chicago city employees, with generous salaries and benefits. In January 2005, almost all of the road’s workers left, most for other city of Chicago jobs. Although exodus temporarily left the partnership short-staffed, they were replaced by nonunion toll takers and maintenance workers, who could be deployed in whatever activity was most urgent. Within six months of the takeover, the partnership installed electronic toll collection equipment, thereby improving traffic flow, reducing backups, and encouraging more users. It also assigned additional toll collectors during rush hours to reduce wait times and expand the use of the road. As a result of these changes, for the final six months of 2005, traffic on the Skyway rose 5 percent and revenues increased 33 percent (boosted by the fifty-cent toll hike) from the similar period in 2004.31 For the six months that ended in December 2005, the Skyway’s earnings (before interest, taxes, depreciation, and amortization) were ahead 40 percent from the same period in 2004.32 Macquarie’s Bid. With minimal economic and population growth in the area served by the Skyway and jobs moving west of Chicago’s downtown Loop, some experts asserted that Macquarie-Cintra overpaid for the facility.33 Macquarie often pays far more than other bidders because it understands infrastructure better. After putting some forty investment bankers on the deal, it analyzed all the risk aspects and priced them into its bid. As Macquarie’s Allan Moss put it, “Industry knowledge is of absolutely fundamental importance and the key to our success.”34 Several factors, notably financial engineering, entered into Macquarie’s bid. The deal relied, in the past, on an aggressive view of toll revenue growth based on steadily indexed toll increases. The group estimated that Skyway traffic would aggressively grow annually


by about 3 percent; the city’s own study used a modest 1 percent yearly growth rate.35 The 2 percent annual difference, stretched out over decades, when combined with toll increases that would produce strong revenue growth, helped result in a much higher valuation. Refinancing the Skyway Transaction. The ability to refinance the project’s debt played an important role in Macquarie’s high bid.36 To finance the $1.83 billion purchase price, in December 2004, Macquarie-Cintra initially raised $1.19 billion as a bridge loan, including a $1.0 billion acquisition facility, fully drawn down to fund the concession agreement, a liquidity facility of $110 million, designed to make early period interest payments, and $80 million to fund ongoing capital expenditure requirements, from a consortium of European banks. Eight months later, in August 2005, the group cut its exposure on the Skyway debt by refinancing that indebtedness in the bond market, allowing it to repay its outstanding bank loans and to remove about 40 percent of its equity investment from the project. The August 2005 refinancing incorporated many innovative features. It was designed so that the project would pay as little interest, at the most stable rate, over the longest possible period. It used interest rate swaps to make the bonds placed in the floating interest rate market confirm as closely as possible to this ideal. A swap occurs when a borrower exchanges aspects of its loan obligation with a counterparty. With an interest rate swap, using a derivative financial instrument, the borrower swaps its variable interest rate obligation and obtains a fixed interest rate obligation. The structure facilitated the issuance of floating interest rate securities, which enhanced to marketability of the senior debt and enabled the project sponsors to achieve a lower interest rate than would have been possible with fixed interest rate financing. The structure also enabled the deferral of, first, the principal amortization on the debt through balloon principal payments and back-end loaded maturities and, second, fixed interest rate payments to the swap counterparties from the early year to the later years, when higher toll rates would take effect. The refinancing structure featured two senior, secured bond slices (more technically, tranches) totaling $1.4 billion issued by the Skyway Concession Company LLC and a $150 million, thirty-year subordinated debt at holding company level, specifically, the Skyway Concession Company Holdings LLC. The subordinated debt, provided by three banks, was at a level below that of the two consortium shareholders and was thus dependent on distributions from the project for repayment.


The first of the two senior tranches consists of $439 million of series A floating interest rate bonds with a bullet maturity after twelve years in 2017. Through the use of a derivative financial instrument, interest on the series A obligation is swapped into a fixed interest rate obligation until maturity, thereby eliminating the debtor’s variable interest rate risk. The second tranche consists of $961 million of series B floating interest rate bonds that pay interest only for the first fourteen years and then begin to amortize the added-on (more technically, accreting) swap interest and bond principal in 2019, with a final maturity in twentyone years (2026). Financial Security Assurance, Inc., a bond insurer then rated triple-A by Moody’s Investors Service, Inc. and Standard and Poor’s Ratings Services, is on the hook for $1.4 billion of the senior indebtedness, backed only by the Skyway lease. It insured the senior secured debt and provided a forward commitment to guarantee refinancing the debt in the later years of the concession. Thus, both the Series A and B tranches can be refinanced at maturity into a subsequent Series C issue, thereby eliminating the risk of future refinancing. Because bond insurers traditionally have been adverse to a future refinancing (more technically rollover) risk, the Skyway deal marked a groundbreaking event. The issuer paid a price, however, in terms of a higher senior debt coverage requirement, which limited the amount of leverage provided by the senior indebtedness. To increase the leverage on the series B bonds to the desired level, the group structured a deferred payment interest swap structure and a repayment profile similar to a series of zero coupon bonds. In effect, as a result of the refinancing, with a significant hedging of interest rates, the initial interest payments were set at below-market rates with the indebtedness principal increasing over time, thereby better matching the project’s operating cash flows. Less cash flows were diverted to creditors, leaving more to be paid to investors, at least over the short term. The refinancing caused a jump in the project’s internal rate of return to around 12–13 percent,37 without the Macquarie-led group guaranteeing any of the indebtedness. MIG’s initial investment in the Skyway was $397 million, consisting of an equity contribution of $373.5 million and a contribution to development costs of $23.5 million. In less than eight months after the acquisition closed, refinancing provided a cash distribution to Macquarie-Cintra of $373 million, of which MIG’s share was $168 million.38 With improved cash flows to Macquarie-Cintra over the


near- and longer term, the payback period on the equity used to fund the acquisition dropped to fourteen years. Thereafter, the toll road operator is in the deal for the remaining term with no equity at risk. The refinancing also pre-funded the $80 million capital improvement program and created a $36 million reserve fund. Macquarie and the Indiana Toll Road

On taking office in January 2005, Governor Mitchell E. (Mitch) Daniels Jr. (R) faced a $3 billion gap in Indiana’s highway budget, equal to ten years of new road construction.39 Privatization of the Indiana Toll Road, which runs between the border with Illinois, just south of Chicago, and the border with Ohio, gave Daniels the opportunity to improve the state’s roads without blowing apart the state’s budget. The Politics of Privatization. Unlike Chicago’s plan for the Skyway privatization, which unanimously passed the City Council, Daniels’ plan for the Indiana Toll Road encountered considerable political backlash. Indiana Democrats bitterly fought the agreement and the authorizing legislation, only to see it pass the state House of Representatives by a 51 to 48 vote on March 14, 2006, the last day of the session, with Senate approval (31 to 19) minutes ahead of a midnight deadline.40 Nearly united in their opposition, Democrats basically saw it as a “bad deal.” Even before the critical March votes, the then House Minority Leader B. Patrick Bauer (D-South Bend) commented, “This is a 75-year surrender of an interstate highway and all the revenue it could have brought in (over decades).”41 Subsequently, Bauer called the toll road agreement a “fiscal disaster,” stating “It’s short-sighted, shortfunded and the money we lost will be apparent, but it’ll be after this governor’s gone. So it’s all about him, and right now, and nothing about the future.”42 Besides financial concerns, xenophobia fueled the opposition, reflecting a political climate of increasing protectionism and opposition to globalization. With a Spanish-Australian partnership in charge of the toll road, many Hoosiers became concerned about the loss of control of an infrastructure asset to foreign entities. Taking a slightly different tack and viewing the interstate highway concept as a national security route for carrying military vehicles and personnel (as it was sold to Congress in the mid-1950s), Bauer asserted, “There is a security question of having interstate roads in foreign hands.”43


When the political dust settled, Daniels prevailed. He won votes from key lawmakers by assuring them that no toll road workers would lose their jobs. The lease generated immediate cash to launch major construction projects in every transportation corridor of Indiana, a politically astute ploy, without raising the state’s gas tax or taking on more debt. Daniels called the transaction a “Louisiana Purchase of our time,” enabling the Hoosier State to move forward on a host of highway and other projects “that would have remained on the drawing board for decades.”44 In June 2006, the State of Indiana, specifically the Indiana Finance Authority that held legal title to the toll road, closed a seventy-fiveyear lease deal with ITR Concession Company LLC (ITR), a subsidiary of Statewide Mobility Partners LLC, in turn a consortium owned by MIG-Cintra, for operation and maintenance of the Indiana Toll Road.45 The concession fee, called “rent,” for the lease of the fifty-yearold, 157-mile toll road, which opened in 1956 and is an important link in the U.S. interstate highway system, equaled $3.8 billion. The ITR outbid three other groups by at least $1 billion, with the only American bidder, Morgan Stanley, offering $1.9 billion, one half of the winning up-front payment. Indiana likely benefited from Macquarie-Cintra’s desire to avoid dealing with a rival operator next to the Skyway.46 Use of the Proceeds. Unlike Chicago, which used the lease proceeds for non-transportation related projects, Indiana directed the funds obtained from the concession to highway projects. It allocated the upfront payment as follows: $200 million to retire outstanding toll road bonds; $500 million to establish a “Next Generation Trust Fund,” a charitable trust, with the interest generated by the fund distributed every five years to the Major Moves Construction Fund beginning in 2011; and $3.1 billion to fund the “Major Moves Construction Fund,” a trust fund, to build transportation projects, such as I-69 connecting Evansville and Indianapolis.47 In short, nearly all of the proceeds will go to a program to modernize the state’s highway system. At present, Indiana is the only state in the United States with a fully funded, tenyear state highway plan. Furthermore, the state earns interest on the unexpended funds. Subsequent to the Indiana transaction, in August 2006, Moody’s revised the rating outlook for Indiana to stable from negative, because of the state’s gradually improving economy and its strong fiscal management that for fiscal year 2006 led to Indiana’s first balanced budget in eight years.48 The longer-term prospects for continued balanced


budgets increased, in part, due to funding of the state’s transportation capital plan and moderation of the state’s debt burden. The Indiana Toll Road Concession Agreement. The Indiana Toll Road concession agreement basically follows the Chicago Skyway model with a few differences. The concessionaire is allowed to collect and retain all toll and concession revenues during the term of the lease. While the lease negotiations were underway, Governor Daniels administratively raised the tolls on the road for cars for the first time in twenty years.49 Pursuant to a toll freeze provision in the concession contract, the higher rates for cars were postponed until the ITR installed an electronic tolling system on the road.50 With the implementation of an electronic tolling system along the road’s full length in April 2008, motorists faced a 72 percent fare hike to $8 for the full 157 miles, but passenger vehicles using transponders receive a multiyear, 40 percent discount on the higher tolls through mid-2016.51 The state set aside $60 million to compensate the concessionaire for lost revenue as a result of the nearly two-year toll freeze.52 The state-subsidized discount was a concession offered by Daniels to get the privatization legislation passed. Beginning in mid-2010, new rates come into effect. On July 1, 2010, the maximum toll for passenger cars may increase by the greater of 8.2 percent, or the percentage increase, compounded annually, of the CPI or per capita nominal GDP, whichever is greater, during specified measuring periods. On July 1, 2011 and thereafter, the ITR may increase the maximum toll level for cars by a percentage increase each year for the remainder of the lease term. The maximum toll may increase by two percent, the pace of U.S. inflation, or the rate of U.S. economic growth, whichever is the highest.53 The actual tolls will be subject to varying degrees of competition, with users able to judge the value they get from the toll road in comparison to alternative routes. A provision also exists for charging different toll levels for various segments of the toll road. Motorists will not like the higher tolls, but they probably will like the infrastructure projects that the deal will help finance. Furthermore, investors will not lease roads without assurance that they can raise tolls over the years. Indiana officials, similar to those in Chicago, cognizant of a potential, future backlash from voters, negotiated contracts that permit toll increases at predetermined dates or based on measures of inflation or economic growth. The operating standards manual impose detailed requirements on the concessionaire, which includes everything from pavement


smoothness to landscaping the road drainage. For example, ITR is required to replace dead trees within seven days, pick up litter every seven days, and wash toll booth windows three times a week.54 Similar to the Skyway agreement, the specified operating standards are to be “construed flexibly” so that occasional departures from the standards will not be deemed a violation of the concession contract.55 Unlike the Chicago deal, the Indiana agreement contains a fiftyfive-year non-compete clause to protect the concessionaire from losing traffic to a taxpayer-financed roadway. Subject to paying the concessionaire compensation for the decrease in net income suffered each year as a direct result of a “competing highway,” the non-compete clause prohibits the state from building or improving any limited-access highway spanning more than twenty miles within a ten-mile corridor on either side of the toll road.56 An adverse action clause prohibits any action by the state or a local government that imposes costs on the concessionaire and materially depresses the fair market value of the concession. If triggered, an adverse action could result in a substantial payment from the government to the concessionaire or the termination of the concession and the payment to Macquarie-Cintra by the state of the fair market value of the concession at such time.57 Opening a competing free highway is a compensation event, not an adverse action.58 If the concessionaire fails to perform and comply with the terms of the agreement, a provision exists for a cure period and dispute resolution, before the concession becomes void, among other remedies. The concession is also void if the concessionaire admits in writing that it is unable to pay its debts or otherwise moves to bankruptcy.59 The agreement imposes mandatory capital improvement obligations (in addition to the electronic tolling system) of some $300 million on the concessionaire within the first four years of the concession. ITR agreed to add relief lanes between designated mile markers by specified dates to improve traffic flow and alleviate congestion. It must also pay for future added lanes or make other improvements if traffic volumes reach certain specified levels, provided land is available for expansion.60 Financing The Concession. With a total cost of the deal at $3.996 billion (including $196.3 million for reserves and other costs), Macquarie and Cintra together made a $748 million equity investment in the project, each contributing $374 million, with the remainder financed by $3.248 billion in loans from a syndicate of seven banks.61 MIG funded its equity investment by drawing on standby loan facilities.


In addition to the acquisition debt facility of $3.248 billion, the bank syndicate provided a capital expense facility of $665 million and a liquidity facility of $150 million. The liquidity facility pays the current interest expenses on the other two facilities and provides a buffer against any fluctuations in operating cash flows. To make the transaction work, the financing involved what is called a step-up interest rate swap with a counterparty, under which most interest payments on the acquisition and capital expense indebtedness are deferred until maturity and added to principal over that period. The swap arrangement, which allows prearranged interest rates increases over the twenty-yearperiod from 2006 to 2026, provides significant long-term interest rate protection. The financing also defers principal amortization to later years, when toll revenues and thus the project’s cash flows likely will be much higher. In sum, the financing increased the amount of debt the project could support. As structured, it was anticipated that the deal would generate a 13 percent internal rate of return and that Macquarie-Cintra would receive their equity investments back in fifteen years.62 Chicago Skyway and Indiana Toll Road Synergies. The MacquarieCintra team integrated the operations of the Chicago Skyway and the Indiana Toll Road, both part of I-90, across state lines to operate as a single system. Through joint marketing and customer service as well as spreading operations and maintenance crews over the two facilities, the group received some synergies out of operating both of them. Because they attract more traffic, improvements on one facility benefit the other. However, the Skyway and the Indiana Toll Road have separate staffs and separate accounts because they are separate companies with separate concession obligations. Did Macquarie Overpay?

Initially it was felt that Macquarie had overpaid for both privatized facilities. The Chicago Skyway and the Indiana Toll Road each fetched a staggering forty times trailing annual revenues and sixty times annual pretax cash flows.63 To make the transactions work required careful financial engineering. To support huge amounts of debt, the Chicago and Indiana deals used nonconventional financial structures that relied on escalating debt service payments, back-ended principal repayments, and interest rate derivatives. As noted, the initial Chicago Skyway funding was


refinanced, which brought immediate financial benefits to MIG and Cintra. The lessees of the Chicago and Indiana roads are betting they will earn about 12–13 percent annually on their equity investments through toll increases, higher traffic volumes, and better management over their leases’ long lives. As noted in chapter two, both roads should be better run under experienced, for-profit operators who recognize that drivers will seek alternate routes if they are unhappy. For example, in 2007, ITR quickly offered the E-Z Pass, which is popular in the Northeast.64 Then, the complaints started. Some asserted that Macquarie-Cintra made out like bandits. One critic, Dennis J. Enright, a principal with the NW Financial Group, LLC, wrote that by retaining public control, public financing could have generated “the same (or even greater) monetization levels” from the future revenue streams of the Chicago Skyway and the Indiana Toll Road.65 He concluded, “Public monetization produces the upfront economic benefit but leaves the control of the road and future cash flows in the hands of the public sector to fund transportation needs.”66 In other words, according to this critic, as a theoretical matter, public control provides lower cost capital that would result in smaller toll increases for the same asset. However, the government’s ability to borrow cheaply turns on its capacity to levy taxes. Also, the risks of a project determine the public sector’s real costs of capital. If the government operates and maintains a highway, the taxpayer ultimately bears these risks. A public sector usually is a less adroit manager than a private operator. Apart from Enright’s assertion regarding the availability of capital provided by public financing, the two privatization deals evidence trade-offs. The long-term leases limit future flexibility with respect to changes in public policy. With the up-front payment, the city and the state gave up any upside potential. Greater equity returns than expected may pose future political risks. Termination could be expensive. In both cases, however, the public sector received substantial up-front payments and more efficient operations and maintenance, with the concession agreements minimizing the political risk from future toll increases. Tax Aspects of Long-Term Concessions

In some instances, a very long-term lease may be functionally equivalent to a sale of a facility for federal income tax purposes. Similar to the concessions in Australia, the toll road lease agreements in the United


States provide for long durations, for example, ninety-nine years for the Chicago Skyway, then forty-six years old, and seventy-five years for the Indiana Toll Road, then fifty years old. From a private operator’s viewpoint, various risks exist in a seventy-five- or a ninety-nine-year deal for an existing facility. These risks include adding the necessary capacity to meet the service level requirements spelled out in the concession agreement. Apart from the required future expansion, through privatization the public sector transfers various risks, including technology shifts and business condition changes, to the private sector. The private sector bears other risks. Who knows what will be the main means of moving goods and people seventy-five or ninety-nine years from now? In short, by entering into a concession, the private sector takes the risk that its road may have less (or more) value in the future. Cognizant of these risks, a long-term agreement in the United States provides one tangible benefit to a private operator, namely, federal income tax savings. These tax benefits contribute to reducing the real cost of the concession and increasing the value of the lease payments, particularly an up-front payment. If the term of the lease exceeds an asset’s remaining design life at the time of the transaction, the Internal Revenue Service treats the concessionaire as the acquirer-owner for federal income tax purposes. With the terms for the Chicago Skyway and Indiana Toll Road concessions almost certainly exceeding their respective remaining design lives, both concessionaires qualified as the tax acquirers-owners. Thus, the part of the up-front payment allocated by the governmental unit—for example, the Indiana Finance Authority—to the right to impose and collect tolls is amortized over fifteen years from the inception of the concession, on the straight line basis, pro rata each year.67 To qualify for amortization as a Section 197 intangible under the Internal Revenue Code, which applies to a broad class of intangible assets, the tolling right must be a government-granted right, separate from the leasehold, and not an interest in land.68 The remaining portion of the up-front payment is treated as prepaid rent amortized over the full concession term. Thus, both transactions were structured as seventy-five- and ninety-nine-year leases, with the concessionaires claiming ownership of the toll road for federal income tax purposes so they could take the beneficial amortization deductions. The concessionaires could, in turn, sell these amortization deductions to U.S. companies that would use them to reduce their tax liabilities.


Macquarie and the Dulles Greenway

Although not a privatization transaction, in 2005 the Macquarie Infrastructure Group acquired the concession for the privately financed Dulles Greenway in Northern Virginia. This section briefly summarizes the history and MIG’s acquisition of the lease for this existing U.S. toll road. In 1988, the Commonwealth of Virginia enacted legislation enabling the private development of highways, thereby permitting private toll roads.69 Previously, the Virginia Department of Transportation (VDOT) had built the Dulles Toll Road, a state owned facility, which opened in 1984 and proved to be an instant success. VDOT then considered extending the toll road from the Dulles International Airport to Leesburg, Virginia. A consortium, the Toll Road Investors Partnership II, L.P. (TRIP II), consisting of Shenandoah Greenway Corp. of Virginia, Autostrade International SpA (an Italian toll road operator), and Brown and Root (a Texas-based engineering and construction firm), made an unsolicited proposal to develop the extension, using private financing. In 1993, VDOT awarded the 42.5-year design-build-operate-transfer concession to TRIP II for the fourteenmile, $350 million project.70 In September 1995, construction of the private toll road was completed, six months ahead of schedule. With tolls initially set at $1.75 each way for cars, initial traffic volume fell considerably short of preconstruction projections, with some 10,000 vehicles, not 30,000 to 35,000 vehicles as projected, using the facility each day. Tolls were reduced to one dollar each way, which generated more traffic but less revenue, and then raised to $1.15. By 1999, TRIP II’s creditors restructured the project’s debt, thereby avoiding a default.71 With the addition of more entrance ramps that allowed more drivers to use the facility, revenues grew. Use of the road steadily increased over the years, paralleling the region’s explosive population growth. In 2001, the Virginia State Corporation Commission extended the concession for an additional twenty years, to 2056.72 Thereafter, the concessionaire began a program of major new capital expenditures to upgrade capacity, including additional lanes, improved connections to the Dulles International Airport, new interchanges, and toll plaza expansions. A further refinancing occurred in 2005, including a fund for capital improvements. In 2005, Macquarie Infrastructure Group acquired the concession for $ 617.5 million.73 In September 2005, MIG, through MIG Investments 2_(US) LLC, now the Dulles Greenway Partnership,


spent $532.7 million to buy 86.7 percent of the interests in the TRIP II held by AIE Holdings LLC and Shenandoah Holdings LLC and 100 percent of the limited partnership’s general partner, Shenandoah Greenway Corp. of Virginia, the entity that holds the sole right to operate and manage the concession. MIG provided two subordinated loans secured against the 86.7 percent of the limited partners’ interests and acquired two long-dated call options to acquire these limited partnership interests. Each call option has a strike (acquisition) price of $60 million. At a compound interest rate of 8 percent, the strike price will increase to $111 million in 2013, the earliest exercise date, or to $190 million in 2020, the last exercise date. That same month, MIG, again through MIG Investments 2_(US) LLC, purchased the remaining 13.3 percent of TRIP II held by Kellogg, Brown and Root for $84.5 million. Through an institutional private placement of its stapled securities, MIG raised the capital to fund the transaction. In July 2006, after MIG assumed responsibility for the operation of the road, TRIP II, now controlled by MIG, sought permission from the Virginia State Corporation Commission to raise the tolls on the Dulles Greenway. The commission approved the toll increases in September 2007, and also permitted the implementation of congestion management price premiums, that is, variably priced tolls.74 MIG Transfers Part of Its Four U.S. Toll Roads

By the end of 2006, MIG had stakes in four U.S. assets: South Bay Expressway (not yet completed), Chicago Skyway, Indiana Toll Road, and Dulles Greenway. Reducing its exposure to these assets, in December 2006, MIG sold one half of its stake in each to Macquarie Infrastructure Partners (MIP) for $825 million. Earlier that year, Macquarie established Macquarie Infrastructure Partners, an unlisted, diversified investment fund, focusing on infrastructure and infrastructure-type investments in the United States and Canada. The interests sold were valued at $762 million at the end of June 2006, rolled forward to the close of the transaction, and represented about 11 percent of MIG’s portfolio.75 MIG received from MIP $771.9 million (A$987.8 million) in cash, $7.1 million (A$9.1 million) in deferred cash consideration, and $45.7 million (A$58.5 million) as the present value of future, required equity contributions to South Bay Expressway’s Equity Funding Agreement that MIP will make on MIG’s behalf.76 Beyond the bottom line reduction in MIG’s U.S. assets, the fund entered into the transaction perhaps


to offset U.S. angst about key infrastructure sales to foreign firms as well as non-U.S. investors anxious about owning U.S. assets. Macquarie created MIP partially as a U.S.-domiciled investor to overcome xenophobic concerns about leasing American infrastructure assets to foreigners.77 MIG used A$500 million from the partial sale transaction to increase its share buyback program from about 6 percent to up to 17.5 percent of its stapled securities.78 From an accounting perspective, MIG no longer held a controlling interest in the Dulles Greenway and the South Bay Expressway projects. With the loss of control over these assets, MIG’s remaining interests in these two facilities were recognized as investment acquisitions based on the applicable percentage of the net book value of these two assets it still held. MIG recognized the difference between this acquisition value and the fair market value as a revaluation gain. For the fiscal year 2007, ending June 30, 2007, the Dulles Greenway thus provided a revaluation gain to MIG of A$64.7 million, and the South Bay Expressway, A$65.3 million.79 Macquarie and the Future of Highway Privatization in the United States

The United States has long neglected its highways and bridges. U.S. roads and bridges are crumbling, as a result of inadequate maintenance and overuse. This was brought home by the August 2007 bridge collapse of the I-35W bridge over the Mississippi River in Minnesota. As a result, there is growing realization that the United States faces massive infrastructure needs and that these needs cannot all be funded through public financing. The mature U.S. economy, with an established but aging infrastructure, faces huge bills. The U.S. Interstate Highway System, which turned fifty years in 2006, forms the backbone of modern American’s economic growth. Deteriorating roads pose problems in many parts of the United States. Congestion will increasingly overwhelm roads designed for lower traffic volumes. Estimates placed the cost of wasted time and fuel for travelers at $60 billion annually in 2003, about five times the 1982 level. The economic costs increased much higher, to roughly $170 billion per year, when the costs of uncertainty and lost productivity were included. These costs have been growing at about 8 percent per year, almost triple the rate of the U.S. economy’s growth (prior to the 2007–2008


recession).80 The U.S. private sector’s ability to generate future economic benefits depends, in part, on how well highways are maintained, operated, and, where bottlenecks impede mobility and productivity, expanded. Reducing traffic congestion is critical. Pavements in the U.S. interstate and primary road systems were designed on the basis of a fifty-year initial service life. As these major arterials approach the end of their typical life cycles, they will need expensive overhauls. According to one federal commission, 15 percent of America’s roads are now in poor shape. About 27 percent of U.S. bridges are “structurally deficient” or “functionally obsolete.”81 With the original design life of many of these assets long past, an ever growing percentage of federal and state resources is directed to maintenance activities. Experts agree that the United States faces an enormous shortfall in highway and bridge capital investment over the next several decades, with serious negative consequences for the movement of goods and people. Two examples, a federal government report and research estimates by professional association, illustrate this shortfall. A U.S. Department of Transportation report on highway conditions and performance found that of the total $147.5 billion spent on highways and bridges by all governmental levels in the United States in 2004, the most recent year for which data is available, $70.3 billion went for capital expenditure. These included $36.4 billion for the rehabilitation, resurfacing, and reconstruction of existing roads and bridges; $14.7 billion for building new roads and bridges; $12.8 billion to add new lanes to existing roads; $6.4 billion for system enhancements, such as safety, operational, or environment measures.82 To maintain pavement and current congestion levels on U.S. highways and bridges would require $78.8 billion per year (in 2004 dollars) over the twenty-year period from 2005 to 2024. The tab grows far larger when you add in the needed new infrastructure. To improve conditions and reduce congestion would require a total annual investment of $131.7 billion (in 2004 dollars) for rehabilitation, expansion, and enhancement over twenty years through 2024 or $61.4 billion per year more than current levels.83 The American Association of State Highway and Transportation Officials, in cooperation with the Federal Highway Administration, funded research conducted by the National Cooperative Highway Research Program, which is administered by the Transportation Research Board of the National Academies. This research concluded


that the United States would require roughly $109.7 billion in 2007, growing to $145.9 billion by 2017 and $166.3 billion in 2021, to maintain average conditions on the increasingly congested U.S. highways and bridges. It could cost a total of $154.8 billion in 2007, increasing to $205.8 billion by 2017 and $234.6 billion in 2021, to improve these conditions.84 In sum, the United States faces significant annual deficits for the maintenance of existing highways and bridges for meeting its transportation needs and enhancements to that system to mitigate congestion and better move goods and people, despite $27.5 billion allocated to highway construction in the 2009 economic stimulus package. The United States faces these crumbling and congested highways and bridges just as the nation faces the most significant economic downturn since the Great Depression. The traditional fuel tax model is falling short of the financial needs generated by aging infrastructure and increasing traffic demands. States rely on funds generated by federal (plus their own) fuel taxes for highway capital and operating expenses. Although a majority of the twelve-member commission created by Congress to study surface transportation policy and revenue recommended in December 2007 that the current federal 18.4-cent per gallon gasoline tax be hiked over a five-year period, by five to eight cents each year, to forty cents a gallon (and after that, adjusted for inflation),85 increasing fuel taxes are politically unpopular. Economic uncertainties and soaring gas prices (for a time) resulting in less driving, more fuel efficient cars (and the possibility of plug-in vehicles) that will further erode the revenue stream from gasoline taxes, and congressional resistance to tax increases, among other factors,86 lead to the conclusion that various types of public-private partnerships will likely assume a larger role in meeting future U.S. highway and bridge needs. Although in the past decade some states have supplemented fuel taxes by issuing general obligation bonds backed by general-fund revenues or bonds backed by an allocated portion of future gas tax funds, these remain the exceptions. Many state budgets are groaning under the weight of decades of borrowing, making massive new debt offerings more difficult. With the credit ratings of many states weakening, they are unwilling to take on additional debt. The growth of entitlement programs, such as Medicaid and the need to fund and/or replenish pension programs, will place increasing pressure on state budgets. Only about twelve states have significant public sector toll agencies, which


issue tax-exempt toll revenue bonds. In short, beyond public spending on infrastructure as an economic stimulus and a jobs creation program, new funding sources must be used. America’s highways and bridges may become a public utility, more like electricity, increasingly funded by prices charged to customers, that is, tolls, not by fuel taxes or bonds backed by general-fund revenues. Long-term, for-profit concessionaires, paid by user charges, may assume more responsibility for meeting motorist needs. These providers will respond to the demand for better services by investing in improved capacity. Thus, given the massive needs and the availability of upward of $400 billion in capital87 for high-priority projects, more U.S. highways and bridges in major American urban areas may attract privatization, particularly, truck-only toll lanes that would enable trucks to carry more goods faster. In the United States, public-private infrastructure partnerships, however, face resistance. As exemplified by the Indiana experience,88 public scrutiny will intensify over the need for privatization and the appropriate terms for concessions. Many fret that the private sector will take unfair advantage and deprive the public of its patrimony. Public unease will likely persist with respect to turning existing public highways, for example, over to private operators, particularly foreign firms, that can annually raise tolls under long-term concession contracts. However, the main arena for the privatization of U.S. highways will likely focus on toll-financed new capacity. Privatization is not a complete panacea to America’s highway and bridge crisis, requiring well-maintained existing roads and bridges and new surface transportation facilities. Privatization is a powerful management tool with a demonstrated track record of getting greenfield highway projects built on time and within budget, and allocating resources to projects that provide a high ratio of benefits to costs. Also, it is a financial tool, one of several options, along with, perhaps, more consistent, financially rigorous federal involvement. Although a topic beyond the scope of this book, some have suggested a National Investment Bank, an independent federal entity for infrastructure financing, which would have the authority to finance infrastructure projects by issuing long-term, federally guaranteed bonds.89 It would allocate funds to these projects based on various factors, such as location, type, regional and national significance, reduction in traffic congestion, and environmental benefits. The bank concept focuses on making more rational public sector decisions about


spending for highways and bridges on their merits and removing some of the politics inherent in the current scattershot system. Today, unlike private firms, governmental agencies typically do not rigorously analyze a project, including how it would impact on traffic or the environment relative to its cost, before deciding whether to proceed. *

*

*

Despite the American public’s misgivings about long-term concessions and its unease with foreign operator-providers, Macquarie, among other firms, may play a significant role in meeting future U.S. highway and bridge needs. Macquarie has the global experience to privatize more American highways and bridges, including greenfield and brownfield projects. Moreover, Macquarie’s successful development of the South Bay Expressway and takeovers of the Chicago Skyway, the Indiana Toll Road, and the Dulles Greenway give it a competitive advantage in the United States. With the help of Macquarie and other private sector capital providers and operators, a paradigm shift may occur with respect to how limited-access highways will be built, maintained, and operated in the United States. Having examined Macquarie’s success in privatizing toll roads, we now turn and examine Macquarie’s privatization of airports around the world.

Ch a p t e r Se v e n M acqua r i e a n d t h e P r i vat i z at ion of A i r ports Globa lly

Building on the success of the Macquarie Infrastructure Group, Macquarie soon turned to securing concessions to operate and manage airports, another infrastructure asset. Established in 2002, Macquarie Airports (MAp), a publicly held fund, is one of the world’s leading airport operators, with a diversified portfolio of high quality airport assets. The management of MAp works with onsite managers of its airports to identify and implement various operational and commercial initiatives, striving to position each airport for long-term growth. After providing an overview of the global airport privatization trend, this chapter analyzes Macquarie’s entry into the airport business and its creation of a listed infrastructure fund, Macquarie Airports, focusing on airports. Particular attention is devoted to Macquarie Airports’ acquisition of the concession to manage and operate the Sydney Airport, including the initial skepticism of the deal, a second look at how the takeover flourished, and its financial aspects. Then, three of Macquarie’s other airport ventures, Rome, Brussels, and Copenhagen, are examined. The chapter also analyzes Macquarie Airports’ use of asset revaluations, as well as management, performance, and other fees it paid to various Macquarie units. The chapter concludes with a brief look at the privatization of airports in the United States and the future of U.S. airports. Some Background on the Privatization of Airports Globally

Divesting airports to the private sector was unknown until 1987. Then a pioneering departure from tradition became a major global trend. In 1987, Prime Minister Margaret Thatcher’s government sold the British Airports Authority, a public agency that operated London’s


three major airports (Heathrow, Gatwick, and Stansted) and Scotland’s four principal airports (Prestwick, Glasgow, Edinburgh, and Aberdeen) via an initial public offering of its shares.1 Investors paid £1.23 billion (about $1.98 billion) to acquire the entity, renamed BAA plc. Thereafter, a number of other U.K. airports were privatized, including Liverpool in 1990 (sale of a majority interest), Belfast in 1994, and Birmingham in 1997 (sale of a majority interest). Austria sold 27 percent of the Vienna Airport in 1992. Then Denmark followed, selling a minority (25 percent) stake in the Copenhagen Airport in 1994. Germany sold a 50 percent interest in the Dusseldorf Airport in 1997 and a minority (36 percent) interest in the Hamburg Airport in 2000. Italy followed with the sale of a minority interest in the Rome airports in 1997.2 Other nations outside Western Europe also turned to long-term leases, that is so-called concessions, for their airports. In July 1997, Australia entered into fifty-year concessions for three airports, Brisbane, Melbourne, and Perth, with various consortia. Prior to privatization, in most nations, except in the United States, public-owned airports operated following a shopping center model. The public sector airport company, as the landlord, leased space to airlines, as tenants. The airport owned and controlled all the space and assigned the gates (and other space) to the airlines as needed, through a system of common-use gates. Airlines paid landing fees and space rentals at agreed upon, preset rates, based on how much of the facility they used. This businesslike, landlord-tenant model continued under privatization with little change to the airlines. Macquarie Enters the Airport Business

Before venturing into the privatization of airports, Macquarie understood that modern airport management was a specialized field, with income streams and opportunities ranging from aeronautical in character to retailing, property development, garages, and airline services. However, that diversity and a relative lack of competition made the sector less volatile and, in some ways, more appealing than other infrastructure investments. Seeing the opportunity to privatize airports globally, in October 2000, the Macquarie Bank acquired The Portland Group, a U.K.based boutique consulting firm. Portland specialized in the airport and air transportation industry, focusing on the development of airport business plans to maximize commercial revenues, including retail,

macquarie and privatization of airports / 111

parking, and property development. The group was considered to be at the leading edge of the commercial (nonaeronautical) development of airports.3 Then, in January 2001, with checkbook in hand, Macquarie Bank bought 50 percent of the Bristol International Airport, one of the fastest growing airports in Europe for A$94.6 million. Cintra Concesiones de Infraestructuras de Transporte, SA (Cintra), a division of Spain’s Grupo Ferrovial, acquired the balance, which it then transferred to Ferrovial Aeropuertos. The acquisition would serve as a seed asset for Macquarie’s airport fund.4 Macquarie launched its unlisted Macquarie Airports Group Ltd. (MAG) fund in August 2001 to make equity investments in investment grade, developed-world airports, particularly in Europe. MAG was established with initial investments totaling €365 million (A$632 million) by blue chip financial institutions from the United Kingdom, Europe, North America, and Australia. The Macquarie Bank invested A$98.3 million in MAG.5 Later in 2001, Macquarie found additional interest from the capital market in investing in a listed airport fund that would provide liquidity to investors. The idea of the listed Macquarie Airports as an equity participant in the unlisted MAG soon unfolded. At the same time as Macquarie contemplated a publicly held airport fund, MAG purchased interests in September and December 2001, respectively, in two regional airports in the United States: 50 percent of the Bristol International Airport for A$105.7 million from the Macquarie Bank, and 24.1 percent of the Birmingham International Airport, the fifth largest airport in the United Kingdom, for £84 million (A$227 million).6 The purchase price for the interest in the Bristol Airport represented Macquarie Bank’s original cost plus an agreed upon amount for holding costs and stamp duty. Macquarie Airports: A Listed Infrastructure Fund

As organized in 2002, Macquarie Airports consists of three entities: two Australian trusts and a Bermuda limited liability company. MAp securities consist of shares or units in these three separate entities that are stapled together and trade as one entity.7 Through Macquarie Airports Trusts No. 1 and 2 (MAT1 and MAT2), Macquarie Airports acquires, respectively, noncontrolling and controlling interests in Australian airports. The third entity, Macquarie Airports Holdings (Bermuda) Ltd.


(MAHBL), renamed Macquarie Airports Ltd. in 2006, acquires nonAustralian airports. Macquarie Airports Management Ltd. (MAML), a wholly owned subsidiary of the Macquarie Bank, manages the two Australian-registered management investment vehicles and serves as MAp’s Responsible Entity. Macquarie Investment Management (UK) Ltd. (renamed Macquarie Capital Funds (Europe) Ltd. in 2007), another wholly owned subsidiary of the Macquarie Bank, advises the Bermuda entity, MAHBL. In March 2002, the newly formed Macquarie Airports’ first investment was the acquisition of a 36.7 percent stake in the unlisted Macquarie Airports Group for an up-front payment of A$136 million, together with a provision for an additional A$246 million for future calls on MAG securities, with its last investment made in March 2003. The investment gave MAp an 18.35 percent indirect interest in the Bristol Airport at a cost of A$38.8 million (subsequently increased to 35.5 percent as a result of MAp acquiring additional MAG shares, as discussed later in this chapter) and an 8.85 percent indirect interest in the Birmingham Airport at a cost of A$83.2 million. Macquarie Airports acquired these shares through wholly owned subsidiaries of MAHBL.8 In September 2007, thwarted in its hopes of gaining a controlling interest in the Birmingham Airport, the Macquarie Airports Group sold its stake in the underperforming airport for £210 million (A$491 million).9 Then, in May 2008, MAG was restructured from a limited life investment fund into a holding company. The restructuring removed the risk of a potential sale of its investment in the Bristol Airport on the winding up of MAG, which would have been required by 2011. Macquarie and the Sydney Airport

Following the privatization of most other major Australian airports in 1997, in July 1998 the ownership of the Sydney Airport was transferred under a fifty-year lease to Sydney Airports Corp. Ltd. (SACL), a public sector company, wholly owned by the Commonwealth Government. In December 2000, the Australian government announced its intention to privatize the Sydney Airport through the sale of shares in SACL. Following the events of September 11, 2001, and the financial collapse of Ansett, Australia’s second-ranking airline later that month, the Minister for Finance and Administration deferred the sale until early 2002. In March 2002, the sale process recommenced. In June


2002, a Macquarie-led consortium paid A$5.6 billion for the Sydney (Kingsford Smith) Airport, the city’s main international and domestic gateway, with most international travelers to Australia landing in Sydney.10 In the privatization transaction, the consortium’s firm Southern Cross Airports Corp. Pty Ltd. (Southern Cross) acquired all of the shares in Sydney Airports Corp. Ltd. from the Australian government. At the time, SACL had forty-six years remaining on its lease from the Commonwealth Government to operate and manage the airport, with an option to renew for another forty-nine years. The Sydney Airport deal represented one of the last stages in the Liberal government’s ongoing privatization program, led by Prime Minister John Howard. The funds received for the concession paid off A$4.2 billion of the Australian government’s A$40 billion debt. The consortium bid some A$600 million above its nearest competitor. At the time, skeptics derided the purchase as vastly overpriced in light of terrorism, the SARS outbreaks in Asia, and the global recession that then rattled the airline industry. The stock market initially agreed with this assessment. Macquarie Airports publicly issued shares in March 2002 and was listed on the Australian Stock Exchange in April 2002, only to see its share price decline about 60 percent to a low in October 2002. From March 2002 to September 2002, Macquarie Bank’s share price slumped by more than half, as a result of an overissuance of Macquarie-related securities and concerns about the Sydney Airport deal. Australian investors were up to their ears with Macquarie-branded securities. In the ten months ending June 2002, Macquarie and its various funds tapped the Australian market for about A$6 billion in capital. Investors also feared that Macquarie paid too much for the airport concession and that the firm could not sustain its fee-driven business model (concerns that would surface again in 2007 and 2008 as discussed in chapter eight).11 The acquisition of Sydney Airport, a conspicuous asset, directed the media spotlight on Macquarie. However, Allan Moss smoothly, almost glibly, noted: It’s natural and appropriate that we should be subject to public scrutiny. Each stage of growth brings with it different challenges. Those challenges aren’t necessarily harder; they’re inevitably different. It’s important for us to recognise that dialogue with the community is now more important, and we recognise that that’s going to be a much more important part of our future.12


In July 2002, Moss, humbled by a collapse in the price of Macquarie Bank’s shares that threatened to cause a staff revolt, kowtowed to shareholders at the bank’s annual meeting. He patiently explained to stockholders where the bank had gone wrong and what it would do prospectively. Although Macquarie had raised A$6 billion in less than one year, Moss conceded that the bank had “strained the capacity of the Australian market.” In the future, Macquarie would “pace” the raising of its capital more carefully, he noted. With the bank struggling to float another infrastructure fund, Macquarie Communications Infrastructure Group (MCIG), focusing on broadcast transmission services, more specifically television towers, Moss stated that the bank would work hard to “establish a dialogue with investors on fees and key fund decisions.”13 To implement the MCIG offering, which investors did not take to, Macquarie scaled it back from A$500 million to A$310 million, and kept one-third of the shares on its books. MCIG shares were listed at A$1.69, a steep discount from its A$2 per share offering price.14 The MAp deal was structured so retail investors paid the first dollar for each share at its listing in April 2002 and the second dollar some six months later. As Moss explained in September 2002: There were a lot of retail investors who perhaps weren’t expecting to be paying the second dollar when they made their original investment. By that I mean they expected to sell their shares between then and there. So we had a huge turnover of stock for the last number of months which is probably more tied into the stock structure than anything else.15

To quell investor unrest in 2002, the Macquarie Bank took up shares in the placements by both MCIG and Macquarie Airports, further tying up its capital. This would have been easy to do in a bull market; it was more difficult in the 2001–2002 bear market. The Macquarie Bank ended up with some ninety-three million shares in Macquarie Airports from the initial share issue debacle. In January 2003, it disposed of some fifty-eight million of these securities to institutional and retail investors, at A$1.15 per security, a huge discount from the original offering price of A$2 per share.16 A Second Look at the Sydney Airport Deal

Despite the initial criticism, Macquarie knew what it was doing. Airports are not as sensitive to economic cycles as airlines. Aircraft takeoff and


landing fees, although important, were not the Sydney Airport’s only income source. The airport also drew income from parking, rents paid by retail stores, and airport advertising. Macquarie saw that private companies had revolutionized airport retail operations. Improved customer amenities included a focus on doubling or tripling the space devoted to retailing. Brand-name retailers, offering a much wider variety of goods at competitive prices rather than the traditional higher airport prices, were courted. To generate additional revenues, private airport operators also adopted a modern, businesslike approach to real estate management. They set rents and other charges at market levels. They sought higher and better uses for airport land, consistent with airport operations. Cognizant of these trends, Macquarie’s Nicholas Moore, the person then responsible for the bank’s infrastructure investments, outlined the firm’s approach at the time of the 2002 privatization transaction: We would see the step up, going forward, in the retail, commercial side. What you can recover on the aeronautical side depends on your physical facility. You can’t be charging monopoly rent. In the long-term view of the cash flow, aeronautical revenue is relatively flat. You see the growth taking place in the retail, car parking and commercial activities. That comes from a 5 percent increase every year in people passing through the facilities.17

Even in the midst of the aviation slump, Macquarie extracted double-digit profit growth from the Sydney Airport by cutting operating expenses and lifting revenues from various ancillary businesses, including rents paid by retail stores, parking lot operations, and onsite property development. Flying into Sydney quickly became like visiting a shopping mall with airplanes, not a place where plane journeys begin and end. According to experts, the airport soon became the second-best performing airport retailer in the world behind the privately operated Heathrow. Although the Sydney Airport was the thirty-second-busiest in the world in 2004 in terms of passenger traffic, it already ranked sixth in terms of retail floor space.18 In addition to the implementation of a modern business plan for airport operations, the Southern Cross consortium wisely hired top executives to run the airport, one of the most politically sensitive positions in Sydney. In January 2003, SACL installed a former top Australian bureaucrat, Max Moore-Wilton, as its chief executive officer and executive chairman. The previous month Moore-Wilton had left his post as


secretary to the Department of Prime Minister and Cabinet, the nation’s most powerful bureaucrat, serving as Prime Minister John Howard’s “right-hand” man. Moore-Wilton had also previously held several powerful posts in the New South Wales bureaucracy. He came with a mandate to establish a new vision for growth at the airport. Having attained these goals, in April 2006, he became SACL’s nonexecutive chairman and the Chairman/Director of the MAp boards.19 Aviation aspects also flourished. The Macquarie-led consortium saw the Sydney Airport as set for a traffic growth spurt. In July 2002, after the implementation of the concession deal, SACL acquired the Ansett terminal building for A$192 million. The acquisition of that terminal, left largely empty after Ansett’s collapse, provided greater flexibility for domestic flights. This growth was further boosted when, in November 2002, SACL and Sir Richard Branson’s Virgin Blue sealed an access deal with Virgin Blue largely taking over the terminal. Virgin Blue agreed to drop all pending litigation against the Sydney Airport over the cost of access, specifically, the gate fees at the terminal, and allegations regarding SACL’s reneging on agreements. In exchange, Virgin Blue took over six of the Ansett terminal’s eighteen gates on a priority basis in December 2002, with access to up to another six common-use gates.20 The Macquarie-led consortium encountered some bumps, however, in running the Sydney Airport, particularly with respect to Virgin Blue. Some background is in order. In 2002, the Australian government deregulated aeronautical charges at the nation’s biggest airports. It allowed these airports to set their own prices, and gave the Australian Competition and Consumer Commission (ACCC) a price monitoring role but no direct control over aeronautical charges. Thus, the Sydney Airport, which had received approval for 97 percent increase in airport charges by the ACCC just prior to privatization, was free to set its own prices, subject to contractual constraints and the disclosure of information pursuant to the price monitoring regime as well as general competition and consumer legislation. In December 2005, Macquarie’s reputation suffered a setback when the Australian Competition Tribunal (ACT) concluded that the Sydney Airport had abused its monopoly power over domestic airline landing and associated charges by changing its fee structure to suit Qantas. The Australian Federal Court subsequently dismissed the airport’s appeal of the ACT’s decision.21 Virgin Blue took legal action claiming the airport’s decision to charge fees according to passenger numbers, not weight, unfairly discriminated


against its budget-oriented operation. Virgin Blue’s all-economy flights typically have higher passenger loads than Qantas. With the aeronautical charges at the Sydney Airport “declared,” the ACT’s decision gave the ACCC power to regulate domestic landing and associated fees at the airport, with the ACCC acting as arbitrator (or through legally binding private arbitration) if the airport and the airlines could not strike a deal on fees. Virgin Blue then reached an agreement with the airport on aviation charges. Subsequently, a 2007 report by the Australian Government Productivity Commission concluded that the nation’s privatized airports were not price-gouging monopolists, but the federal government should keep monitoring aviation charges at the country’s biggest airports, including Sydney, for another six years.22 Once again, in hindsight, Macquarie had outsmarted its skeptics. From June 2002 to June 2007, an increase in air traffic, coupled with rising parking charges and retail store rents following the privatization, led to a nearly 60 percent gain in revenues. During this period, the airport’s earnings before borrowing costs, taxes, depreciation and amortization increased by over 75 percent.23 Looking back, Allan Moss evidenced satisfaction, but not surprise, by the success of the Sydney Airport venture. “Despite the challenges and skepticism,” he noted, the airport “performed pretty much as we expected, and it is recognized by analysts everywhere as an outstanding investment. Some people reacted to the high price, but their knowledge of the asset was superficial.”24 Macquarie and the Sydney Airport: Financial Aspects

During the first decade of this century, MAp developed and displayed its expertise in capital management and investment structuring— financial engineering—of its airports, as exemplified by what it did in Sydney. In addition to increasing MAp’s ownership stake in an airport, for Macquarie financial engineering focuses on debt refinancing to reduce interest costs and provide additional capital. Increasing MAp’s Ownership Stake. Over the years, Macquarie Airports increased its stake in the Sydney Airport. As part of the 2002 privatization transaction, Southern Cross Airports Corp. Pty Ltd. (Southern Cross) acquired all of the shares of SACL for A$4.23 billion in a rather complex manner.25 MAp, through its wholly owned subsidiary Macquarie Airports (Sydney Holdings) Pty Ltd. (MASH), acquired a 72.8 percent controlling interest in the Southern Cross Australian


Airports Trust (SCAAT) by purchasing 815 million units in SCAAT at a cost of A$815 million. SCAAT then subscribed to 55.6 percent of the securities issued by Southern Cross Airports Corp. Holdings Ltd. (Southern Cross Holdings), which became, in turn, the parent entity of Southern Cross. This chain of ownership gave MAp a 40.4 percent direct interest in the Sydney Airport. Moreover, Macquarie-managed funds together held a 53 percent initial interest in Southern Cross Holdings and thus in the Sydney Airport. In addition to MAp’s 72.8 percent interest in SCAAT, Macquarie Airports Group (MAG) acquired 21 percent and Macquarie Global Infrastructure Fund (MGIF) 2.2 percent, respectively, of SCAAT. With SCAAT holding a 55.6 percent interest in the Sydney Airport, MAG and MGIF’s respective interests in the airport were 11.7 percent and 1.2 percent. Because MAp owned 37 percent of MAG, MAp had another 4.3 percent indirect interest in the Sydney Airport, giving it a total beneficial interest of 44.7 percent. In the aggregate, Macquarie affiliates provided some A$1.1 billion of the equity funding for the 2002 privatization transaction. Beginning in 2003, Macquarie Airports raised its ownership stake in Southern Cross Holdings so that by the end of 2007 it held a 72.1 percent interest in that firm. In July 2003, MAp bought an additional 2.9 percent interest in Southern Cross Holdings from Abbey National Bank for A$48.5 million. It financed this acquisition via an A$54 million placement of its stapled securities to institutional investors. The next month, it increased its interest in MAG to over 40 percent by acquiring a 3.43 percent interest in MAG from the Abbey National Bank for €17.15 million (A$29.7 million). Funded from its working capital, this purchase raised MAp’s beneficial interest in Southern Cross Holdings by 0.4 percent.26 In November and December 2003, Macquarie Airports again increased its stake in Southern Cross Holdings through the purchase of the 4.96 percent interest owned by Germany’s Hochtief Airport GmbH. The purchase was funded through A$119 million placement of MAp’s stapled securities to institutional investors.27 MAp had a 48.3 percent direct interest and a 4.7 percent indirect interest (through MAG) for a total beneficial interest of 53 percent in the Sydney Airport by the end of December 2003. In February 2004, MAp made an offer to MAG’s shareholders to exchange their MAG shares for MAp securities.28 MAG’s board was required to consider a listing proposal within twelve months of MAG


becoming 75 percent invested, which it did in March 2003. Rather than securing a separate listing, a number of MAG shareholders accepted MAp’s offer to obtain liquidity for their holdings. For MAp’s shareholders, the exchange transaction increased the beneficial ownership of MAp’s existing investments, provided a higher weighting in MAp’s portfolio to the rapidly growing U.K. airports, and increased the overall size and scale of MAp. As a result of this transaction, in May 2004, MAp acquired, through Macquarie Airports Feeder Trust, an additional 17.6 percent direct interest and a 3.9 percent indirect interest (for a total of 21.5 percent) in MAG for a total cost of A$256.6 million, excluding transaction costs. MAp came to hold a 61.6 percent controlling interest in MAG, with the acquisition of MAG shares funded through the issuance of 138.7 million new MAp stapled securities. Then, in September 2005 and May 2008, MAp acquired additional interests in MAG of 2.6 and 6.7 percent, respectively, thereby raising its total interest in MAG to 70.9 percent (and thus the Bristol Airport to 35.5 percent).29 After acquiring an additional 2.1 percent interest from Global Infrastructure (Sydney Holdings) Pty Ltd. in February 2007, Macquarie Airports exercised a call option to purchase a 15.1 percent interest in the Sydney Airport consortium from Ferrovial Infraestructuras SA for A$663 million. The previous year, MAp had acquired Ferrovial’s 50 percent interest in the Bristol Airport, which MAp subsequently transferred to the Macquarie European Infrastructure Fund and the Macquarie European Infrastructure Fund II. Ferrovial sold its stakes in the Sydney and Bristol airports to help cut its debt after leading a consortium to buy the British airport operator BAA plc that runs the Heathrow, Gatwick, and Stansted airports, among other U.K. airports. The 2007 transactions increased MAp’s ownership interest in the Sydney Airport to 72.1 percent and its voting rights to 78.7 percent.30 Debt Refinancing Transactions. Besides increasing its ownership stake in the Sydney Airport, MAp actively pursued refinancing deals. It took advantage of the existing bank appetite and capital markets to refinance loans to improve their terms and provide additional funds for airport improvements and expansion.31 The total amount of capital raised to fund the 2002 share purchase was A$6.365 billion. Southern Cross Airports Corp. Pty Ltd. (Southern Cross), a wholly owned subsidiary of Southern Cross Holdings, issued A$3.744 billion in senior debt. Southern Cross


Holdings issued A$2.02 billion in equity (consisting of A$504 million of common shares and A$1.511 billion of redeemable preferred shares) and A$600 million in a convertible, subordinated debt instrument, dubbed FLIERS (Floating IPO Exchangeable Reset Securities), which could be converted to equity. It then lent A$2.439 billion to Southern Cross, in turn, as noted above, issued A$3.744 billion in senior debt. Southern Cross then used the aggregate of these funds as follows: A$4.233 billion to acquire all the shares of SACL; lent A$1.449 billion to SACL to repay its existing debt and establish reserves of A$140 million; and approximately A$299 million to pay transaction and debt issue costs.32 Shortly after the consummation of the privatization transaction, in October 2002, A$1.5 billion of medium-term notes were issued to refinance the bridge loan facility of a corresponding amount. The notes, which were floated on more favorable terms than the bank debt, covered a range of maturities from eight to ten years and were about 80 percent hedged to protect against adverse moves in interest rates. This refinancing lowered the overall cost of the consortium’s debt structure.33 A pattern of nearly annual debt refinancings then occurred. In September 2004, MAp refinanced A$2.5 billion in senior bank loans and established A$655 million in increased debt facilities, primarily for Sydney Airport’s capital expenditures and general working capital purposes. A total of A$1.585 billion in bank debt facilities was established. Capital markets debt totaling A$1.570 billion was issued, all of which was wrapped, that is, guaranteed, by MBIA Insurance Corp. (MBIA). The refinancing demonstrated MAp’s expertise in reducing interest payments, improving credit terms, and establishing additional debt facilities for future capital purposes.34 In July 2005, the Sydney Airport completed an A$200 million capital indexed bond issue, thereby refinancing a corresponding amount of bank debt. Capital indexed bonds are a type of inflation-linked bonds. The refinancing reduced interest costs and extended the maturity date of the indebtedness to 2020, but did not change the consortium’s overall debt position.35 In December 2006, Southern Cross implemented a massive A$3.683 billion senior debt refinancing.36 In addition to bank debt facilities of A$959 million, including capital expenditure, liquidity, and working capital facilities, it simultaneously sold seven bond slices, or tranches, totaling A$2.724 billion, using a variety of maturities and structures.


The seven bond tranches were as follows: First, an A$185 million issue of fourteen-year fixed interest rate capital indexed bonds. The bonds are due in 2020 and are wrapped by MBIA, thereby presumably offering investors greater security but a lower interest rate. Second, A$300 million of new twenty-four-year fixed interest rate capital indexed bonds due in 2030 and wrapped by Ambac Assurance Corp. (Ambac). Third, A$750 million of sixteen-year floating interest rate notes to mature in 2022 and wrapped by MBIA. Fourth, A$400 million of five-year bonds wrapped by Ambac. These fixed and floating interest rate notes will mature in 2011. Fifth, A$217 million of seven-year bonds wrapped by Ambac. These floating interest rate notes will mature in 2013. Sixth, A$659 million of twenty-one-year floating interest rate notes to mature in 2027 and wrapped by Financial Security Assurance, Inc. Seventh, A$200 million of fifteen-year floating interest rate notes wrapped by MBIA. As part of the 2006 debt refinancing package, Southern Cross Holdings issued A$650 million of notes called Sydney Kingsford Smith Interest Earning Securities (SKIES). By floating 6.5 million SKIES at A$100 each, Southern Cross Holdings refinanced A$600 million of FLIERS convertible notes it issued in 2002. SKIES are ten-year, noncallable, cumulative, subordinated, unsecured notes. If not called, the SKIES will pay additional interest after five years. Because they were issued directly by Southern Cross Holdings instead of involving an intermediate trust as did FLIERS, SKIES offered a simpler capital structure than FLIERS. After the completion of the 2006 debt refinancing, in 2007, the Sydney Airport consortium distributed approximately A$900 million of the proceeds to its shareholders. MAp used its share of these proceeds to repay a bridge loan that was drawn down to fund its acquisition that year of an additional interest in the Sydney Airport from Ferrovial.37 In November 2008, the Sydney Airport refinanced A$485 million of existing capital expense facilities and funded A$859 million of new capital expenses to accommodate future growth until the end of 2012. The first phase of the funding included A$776 million in new bank debt facilities, largely received from existing banks, and a shareholder contribution of A$513 million. In the second phase, supported by an additional shareholder equity contribution and implemented in the first quarter of 2009, the Sydney Airport repaid A$870 million in term debt that would have matured later in 2009, thereby deleveraging the company’s capital structure.38


Other Macquarie Airports’ Ventures

Under the terms of the sale agreement for the Sydney Airport, Macquarie Airports cannot take a controlling stake in most other Australian airports. Thus, its future growth must come from offshore. In addition to the Bristol Airport, the Macquarie Airports portfolio now includes the Brussels and Copenhagen airports. It acquired and then disposed of its interest in the Rome Airports. In 2007, MAp made a long-term strategic investment in Japan Airport Terminal Co., Ltd., a company listed on the Tokyo Stock Exchange, a topic beyond the scope of this book. This section considers MAp’s three major non-Australian airport holdings: Rome, Brussels, and Copenhagen. Rome. The Rome Airport System consists of two airports, Fiumicino (Leonardo da Vinci) and Ciampino (G.B. Pastine). Aeroporti di Roma S.p.A. (AdR) controls the two airports under concessions to operate, maintain, manage, and develop them until 2044. In March 2003, after the 2002 Sydney Airport deal, Macquarie Airports consummated the purchase of 28 percent stake in AdR for A$542 million (including transaction costs) from Leonardo Holding S.A. (Leonardo), a wholly owned subsidiary of Gemina S.p.A. (Gemina), which owned 95.9 percent of AdR.39 The 2003 deal involved several Macquarie funds that formed a consortium to invest in AdR through a special purpose entity, Macquarie Airports Luxembourg S.A. (MALSA). Through MALSA, MAp, MAG, and Macquarie Global Infrastructure Fund acquired a minority 44.7 percent shareholding in AdR for A$842 million. MAp, acting through Macquarie Airports Holdings (Bermuda) Ltd., acquired a 44.3 percent stake in MALSA for A$382 million, including transaction costs, representing a direct interest in AdR of 19.8 percent. Macquarie Airports Group acquired 50.1 percent of MALSA, giving MAp an additional 8.2 percent indirect interest in AdR and a total beneficial interest in AdR of 28 percent.40 To fund the purchase of its stake in AdR and repay the short-term borrowings used to purchase the Sydney Airport, MAp raised A$670 million through the following three techniques: first, a priority entitlement offer of A$562.5 million to its existing security holders; second, a private placement consisting of A$82.5 million in MAp securities to institutional shareholders; and third, a placement of MAp securities to the Macquarie Bank for A$25 million. MAp acquired additional shares


in MALSA for A$58.6 million and lent A$290.2 million to MALSA under convertible loan arrangements. The convertible loans effectively entitled MAp to all of MALSA’s income and had a term of forty-two years, unless terminated earlier. MAp could, at any time prior to a specified date, have converted these loans into MALSA redeemable preference shares.41 In July 2005, AdR refinanced €490 million of revolving and term loan facilities on better terms. This refinancing resulted in a significant reduction in interest charges.42 Over the years, by acquiring additional stakes in MAG, MAp boosted its interest in the Rome Airport System. At the end of 2006, MAp held a 34.2 percent beneficial interest in the two Rome airports.43 In July 2007, MALSA sold its interest in AdR back to Leonardo for A$1.95 billion (€1.237 billion) with MAp’s share coming to about A$1.1 billion. Rather than taking full control of an underperforming asset, Macquarie decided to sell its stake in the Rome airports. Macquarie concluded that MALSA’s minority (44.7 percent) holding prevented it from unlocking the airports’ full earning potential. Macquarie and Gemina, Leonardo’s parent, butted heads over the type of investments needed at the Rome Airport System. MAp opposed Gemina’s plans to spend billions on AdR, which reported a 1.7 percent drop in its 2006 earnings. In any event, the Italians, particularly the Rome political establishment, feared that Macquarie would gain control of AdR and wanted the Australians out.44 Brussels. In December 2004, Macquarie Airports led a group of two Macquarie-managed unlisted infrastructure funds, Macquarie European Infrastructure Fund and Macquarie Global Infrastructure Fund II as well as the Macquarie Bank to pay A$1.26 billion, through Macquarie Airports (Brussels) S.A. (MABSA), for a 70 percent stake in the Brussels International Airport Corp. NV/SA (BIAC), renamed The Brussels Airport Co.45 With a 76.1 percent interest (decreased to 74.2 percent in 2005) in the consortium, MAp acquired 52 percent beneficial interest in the airport for A$895 million. The Belgian government retained a 30 percent interest in the corporation, which holds the license to operate the Brussels Airport indefinitely. MAp’s A$895 million investment in MABSA was made in the form of convertible debt of A$761 million and shareholder loans of A$134.3 million. The convertible loans effectively entitle MAp to all of the income from MABSA and have a term of fifty-one years. MAp


may, at any time prior to a specified date, convert the outstanding loan balance into preferred shares of MABSA. The shareholder loans have a ten-year term and are noninterest bearing.46 To fund its investment in BIAC, MAp successfully offered its existing security holders A$465 million of a new hybrid security, Tradeable Interest-bearing Convertible to Equity Trust Securities (TICkETS) and made a private placement of its stapled securities of about A$510 million. Macquarie structured TICkETS, which were issued by the Macquarie Airports Reset Exchange Securities Trust (MAREST), to pay a fixed interest rate until January 1, 2010. On that date (or earlier under certain circumstances), TICkETS holders could request an exchange into MAp securities (or a cash equivalent) at a discount to the market price. Specifically, in December 2004, MAp entered into a loan agreement with MAREST under which MAp borrowed A$465 million from MAREST to fund a portion of the Brussels Airport acquisition. Thereafter, in August 2006, MAp entered into another loan agreement with MAREST that issued additional TICkETS securities and, in turn, lent MAp A$439.2 million of the funds it raised.47 MAp then followed the familiar pattern of increasing its ownership stake and engaging in debt refinancings. In 2006 and 2007, MAp acquired additional interests of 1.9 percent and 8.2 percent, respectively, in the Brussels Airport. At the end of 2007, it held a 62.1 percent interest in the airport.48 Also in 2007, the Brussels Airport entered into a syndicated bank loan facility of €1.636 billion, with the term facility maturing in 2015. The refinancing enabled the airport to repay its existing bank debt, while reducing interest rate payments, improving the debt maturity profile, and making a special distribution of €310 million to its security holders. Also, the refinancing provided funds for future capital expenditures and working capital requirements.49 In November 2008, MAp sold a 26.1 percent interest in the Brussels Airport to the unlisted Macquarie European Infrastructure Fund 3 at a 47 percent premium over its acquisition cost. MAp retained a 36 percent interest in the airport that continued to be managed by MABSA.50 Copenhagen. In late 2004 and early 2005, MAp began purchasing shares in Copenhagen Airports A/S (Københavns Lufthavne A/S), a listed company, and, by February 2005, it had acquired an 11.3 percent interest in the company for approximately A$282 million.51 MAp funded its purchases through to a letter of credit facility and a bridge


loan of approximately A$160 million that was repaid after the successful completion of a private placement of MAp securities in May 2005. Up until 2007–2008, Macquarie’s strategy generally focused on taking control of, and not just investing in, an infrastructure asset. After acquiring an additional 3.4 percent interest from February through October 2005, MAp purchased another 38.1 percent stake in December 2005, through a tender offer by Macquarie Airports Copenhagen ApS, a subsidiary of MAp.52 The 38.1 percent acquisition was funded by twelve-month bridge loan and a seven-year term loan, the latter arranged at the holding company level with a completely hedged interest rate. Then, in 2006 and 2007, MAp acquired additional interests of 0.6 percent and 0.3 percent, respectively, in the Copenhagen Airports, increasing its ownership to 53.7 percent. To date, the Danish government has not sold its 39.2 percent stake in the airport operator. In 2005, Copenhagen Airports’ international investments included: a 49 percent interest in Newcastle International Airport (UK); a 20 percent interest in Hainan Meilan Airports Co. Ltd. (China); and a 9.85 percent interest in Grupo Aeroportuario del Sureste de Mexico S.A. de C.V. (ASUR), which owns and operates nine airports in Mexico, including the Cancun Airport (Mexico’s second largest airport) and is listed on the New York and Mexican Stock Exchanges. In 2007, with MAp in control, Copenhagen Airports sold its entire interest in Hainan Meilan and about two-thirds of its interest in ASUR.53 Then, in 2008, MAp bought a 5.6 percent interest (subsequently increased to 6.7 percent and then 7.8 percent) in the B shares of ASUR for about $85 million and through a series of swap agreements obtained an economic exposure to changes in the price of ASUR shares equaling about 8.6 percent of the B shares.54 In November 2008, MAp sold 50 percent of its interest in the Copenhagen Airports to the unlisted Macquarie European Infrastructure Fund 3 at a 49 percent premium over its acquisition cost. With MAp retaining a 26.9 percent interest, the airport was managed as part of a 50:50 joint venture between MAp and the unlisted fund.55 Asset Revaluations

Similar to the technique used by the Macquarie Infrastructure Group, asset revaluations assumed importance for MAp. For example, in 2005, MAp reported total revenues of A$1.448 billion of which A$1.420 billion was from asset revaluations.56


MAp revalues its investments in the unlisted securities of its various airports, using a discounted cash flow model, discussed in chapter five.57 These valuations are also periodically benchmarked to other sources, such as recent market transactions in similar assets and independent valuations. Revaluations of noncontrolling and controlling interests in unlisted securities must be distinguished. MAp revalued its noncontrolling stakes in the Birmingham, Bristol, and Rome airports as follows58 : Airport

2003 (in million)

2004 (in million)

2005 (in million)

2006 (in million)

Birmingham

A$132.7

A$192.2

A$194.9

A$205.5

Bristol

A$90.9

$213.1

A$158.5

A$176.9

Rome

A$553.3

A$810.3

A$827.7

A$844.3

In 2007, MAp revalued its interest in the Bristol Airport to A$350.5 million.59 Under Australian accounting standards analyzed in chapter five, MAp included these revaluations annually in its revenues, thereby increasing its yearly profits. MAp owns a majority of the voting interests in the Sydney Airport, and until November 2008, in the Brussels and Copenhagen airports. If one company (the parent) owns more than 50 percent of the voting shares of another company (the subsidiary), typically indicating control of the subsidiary and resulting in the preparation of financial reports under consolidated accounting, the consolidation standard requires the combination, or more technically, the consolidation, of the financial accounts of both companies. As discussed in chapter five, the consolidation standard prevents the parent company, such as MAp, from recognizing the gains in the value of assets, such as airports, as income. Despite its majority ownership of the Sydney and Brussels airports (the latter until November 2008), MAp took the position that it did not control the financial and operational decision-making of these entities. Shareholder agreements for both airports require supermajorities to approve any significant financing and operating decisions. For the Sydney airport, 75 percent of the shareholder votes must approve significant financial and operating decisions; for the Brussels airport a twothirds supermajority of shareholders must pass resolutions concerning these significant decisions.60


MAp also makes use of minigroups. For example, at the end of 2005, MAp had a 74.2 percent beneficial interest in the Brussels Airport, giving it the right to dividends, for example, but it held only 52.8 percent of the voting interests.61 The difference between MAp’s percentage of the beneficial interests and the voting interests exists because another Macquarie entity, Macquarie European Infrastructure Fund (MEIF), owns some of the voting interests in the Brussels Airport. Because MEIF is a separate entity from MAp, MAp took the position that it need not have included the shares held by MEIF in determining its voting interests in the airport. However, at the end of 2007, an amendment to the MABSA Shareholders Agreement resulted in MAp gaining voting control of the airport, only to lose its control position as a result of the partial divestiture of its interest to another Macquarie entity in 2008.62 In sum, through the use of various mini groups and the boundaries that define consolidated groups, MAp avoids the requirements of consolidated accounting. Thus, prior to assuming control of the Sydney and Brussels airports, MAp treated these investment airports as financial assets for profit and loss purposes. These techniques allowed MAp to revalue its investment in the Sydney Airport by a total of A$1.36 billion between 2003 and 2005. MAp revalued its Sydney Airport investment as follows: 2003— A$1,332.4 million; 2004—A$2,373.8 million; 2005—A$2,695.3 million.63 These revaluations resulted in revenues to MAp of A$1.04 billion in 2004 and A$322 million in 2005. MAp also revalued its interests in the Brussels Airport as follows: 2004—A$933.7 million; 2005—A$1,352.3 million; 2006—A$1,431.9 million.64 As discussed in chapter five, Australian corporate law allows dividends to be paid out of “profits.” Because asset revaluations increase profits, MAp has used the revaluations as a benchmark by which it could make distributions to its security holders. However, because the asset revaluations did not increase its cash flow, MAp relied on asset sales and debt refinancings to cover part of its dividend payments. For 2007, for example, the cash flow from MAp’s airports covered about 75 percent of its dividend distributions, leaving about 25 percent to be covered by asset sales and refinancings.65 By 2008, MAp had upped its operating cash coverage of its dividends to 79 percent.66 Besides increasing the benchmark for the payment of dividends, the asset revaluations also facilitated to the transfer of cash from MAp to


various units of the Macquarie Bank, now the Macquarie Group, in the form of management fees and presumably, performance fees. Management and Performance Fees Paid by Macquarie Airports

Macquarie Airports annually pays a base (management) fee and a performance fee to its responsible entity, Macquarie Airports Management Ltd. (MAML) and its advisor, Macquarie Investment Management (UK) Ltd. (MIMUK) (renamed Macquarie Capital Funds (Europe) Ltd. in 2007), both wholly owned subsidiaries of the Macquarie Bank (now the Macquarie Group). The base fee equals: 1.5 percent per year of the first A$500 million of MAp’s net investment value; 1.25 percent per year of the next A$500 million of its net investment value; and 1.00 percent per year of its net investment value in excess of A$1 billion.67 Although the base fee is not payable on amounts MAp invested in MAG or its cash (or cash equivalents) holdings, the base fee structure depends on how much Macquarie Airports believes each of its airports is worth, not whether it recognizes the revaluation gain as revenue. In other words, because MAp pays the base fee on the value of its assets, the higher the asset valuation, the higher the base fee paid. Over the years, MAp paid the following management fees to MAML and MIMUK: 2002—A$4.29 million; 2003—A$13.8 million; 2004— A$28.9 million; 2005—A$54.3 million; 2006—A$57.7 million; 2007—A$75.4 million.68 In September 2002, MAp managers agreed to take their management fees in MAp stapled securities at the issue price, rather than in cash, until its share price exceeded the original offering price. Thus MAp issued securities at A$2.00 per share to pay the following portions of its base fees: 2002—A$1.1 million; 2003—A$9.4 million; 2004—A$9.0 million. This arrangement continued until 2004, when MAp’s price on the Australian Stock Exchange exceeded its original offering price.69 When MAp acquired a controlling interest in MAG in 2004, it consolidated MAG’s assets, liabilities, and financial results, including fees paid to MAG’s advisor, into the MAp financial report. Thus, in addition to the above fees, MAp reported the following management fees paid to MAG’s advisor: 2004—A$10.1 million; 2005—A$14.5 million; 2006—A$14.7 million; 2007—A$7.5 million.70 MAp also pays a performance fee to its responsible entity and its advisor, Macquarie units, if the performance of the MAp securities exceeds a benchmark index, specifically the Morgan Stanley Capital International World Transportation Infrastructure Accumulation Index (excluding


MAG and MAp). The performance fee equals 20 percent of the return above the benchmark return for any period. If the return is less than the benchmark return in any period, the deficit is carried forward and is included in calculating whether the return exceeds the benchmark return for any subsequent periods. Detailed provisions exist with respect to MAp investments in MAG. Although the performance fee is payable in cash, MAp’s managers may take it in MAp’s stapled securities.71 Tying back to asset revaluations and increased revenues, the higher MAp’s reported profits, which presumably translate into price gains for its shares, the more likely are higher performance fees for Macquarie. MAp paid the following performance fees to its managers: 2002— none; 2003—A$764,706; 2004—A$217.4 million; 2005—A$37.3 million; 2006—none; 2007—none.72 All of the performance fees were applied to subscriptions of MAp stapled securities. In addition to the performance fees it paid to MAML and MIMUK, MAp also reported performance fees of A$147.4 million paid to MAG’s advisor in 2007.73 Other Fees Paid by Macquarie Airports

In addition to management and performance fees, MAp paid various Macquarie companies other fees. Although approved by the independent directors who comprise a majority of the board of MAp’s Responsible Entity (MAML),74 these arm’s-length fees went to Macquarie entities. These other fees paid, totaling A$188.2 million from 2002 through 2007, were as follows: 2002—A$36.8 million in underwriting and management fees paid to Macquarie Equity Capital Markets Ltd. (MECM); A$5.5 million in selling fees to MECM; A$2.65 million for interest on a letter of credit to Macquarie Bank.75 2003—A$1.7 million in placement fees for capital offerings to MECM; A$4.8 million in advisory fees in connection with the acquisition of an interest in AdR to Macquarie Bank companies.76 2004—A$6.4 million placement fee to MECM; A$13.8 million advisory fee in connection with completion of the acquisition of the Brussels Airport by MABSA to Macquarie Bank companies.77 2005—A$1.74 million placement fee to MECM; A$15.3 million advisory fee in connection with the Copenhagen Airports acquisition to Macquarie Bank companies; A$3.7 million fee for the bridge facility to partially fund the acquisition of a controlling interest in


the Copenhagen Airports to Macquarie Bank; A$1.97 million fee in relation to a letter of credit facility and A$3.3 million interest expense in relation to that facility to Macquarie Bank.78 2006—A$6.18 million for interest and fees for a bridge funding facility to Macquarie Bank; A$28.2 million for advisory services in connection with the Sydney Airport to Macquarie Bank; A$4.9 million for underwriting and advisory fees in connection with TICkETS paid by MAREST to MECM.79 2007—A$19.5 million advisory fee in connection with the sale of its investment in the Rome Airport System to Macquarie Group; A$4.04 million advisory fee in connection with the sale of Birmingham Airports Holdings Ltd. to Macquarie Group; A$8.8 million advisory fee in connection with the refinancing of the Brussels Airport to Macquarie Group; A$13.6 million in advisory fees in connection with the refinancing of the Sydney Airport to Macquarie Group; A$5.3 million in interest and fees for a bridge funding facility to Macquarie Group.80 Over the past two decades, airports around the world have been privatized. However, privatization of American airports using the Macquarie Model faces legal and practical barriers. Privatization of Airports in the United States

Current federal law constricts the privatization of U.S. airports, whether owned by a state or local airport agency or a regional authority. A unique joint venture approach to airport governance serves as an additional barrier to privatization. In 1996, Congress enacted legislation permitting up to five U.S. airports to be sold or leased to a private sector operator as a means to generate capital for improvements and increase operating efficiencies.81 At least one of these had to be a general aviation (noncommercial service) airport and not more than one could be a large hub airport, that is, handling 1 percent or more of total U.S. passenger boardings. For general aviation airport, privatization could take the form of a sale or lease. For a commercial air carrier facilities, only a lease was permitted. Under the Airport Privatization Pilot Program, a public sector agency that owns a commercial and/or general aviation airport may apply to the Federal Aviation Administration for waivers from federal aviation law provisions that might otherwise forbid the retention


of the sale or lease proceeds by the sponsoring agency or from other provisions requiring the repayment of previous federal grants or the return of land provided by the federal government. Subsequently, in September 1997, the FAA published its final guidelines and application procedures for this pilot program.82 Until 1996, three major legal barriers prevented the sale or longterm lease of airports in the United States. First, in general, any federal grants previously received by the public sector owner had to be repaid if an airport were sold or leased.83 The 1996 act exempts airports privatized under its provisions from the requirement that federal grants be repaid or land received from the U.S. government be returned.84 Second, in general, federal law prohibits revenue diversion thereby blocking the current public sector owner from receiving any profits from the sale or lease of an airport and the new owner from providing any reward to its shareholders from profitable operations. In other words, revenues must stay on the airport.85 The 1996 act provides for an administrative exemption to permit the public sector sponsor under the pilot program to use offsite the proceeds from the sale or lease of an airport. In order to make use of sale or lease proceeds away from the airport, the public sector privatization sponsor must get the approval of a supermajority (at least 65 percent) of the air carriers serving the airport, among other requirements. Furthermore, through another administrative exemption, the act allows the new owner or lessee under the pilot program to receive compensation (and thus profits) from its airport operation efforts which it may distribute to its shareholders.86 Third, in general, federal law prevents private airport owners from receiving federal Airport Improvement Program (AIP) entitlement grants or assessing passenger facility charges (PFCs). The 1996 act permits airports privatized under the pilot program to receive federal AIP entitlement grants up to a specified maximum amount and charge PFCs.87 Under the 1996 legislation, the FAA Administrator may grant an exemption for the sale or lease of an airport if the privatization plan contains nine basic features.88 The airport must continue to be available for public use in a nondiscriminatory manner. The airport’s operations cannot be interrupted in the event of the private operator’s financial difficulties or bankruptcy. The private operator must maintain, improve, and modernize the airport. Charges to airlines for gate fees cannot increase greater than the rate of inflation unless at least 65 percent of the airlines using the facility approve a higher amount,


among other requirements. Fee increases for general aviation airplanes cannot exceed those for commercial airlines. Airport safety and security must be maintained “at the highest possible levels.” Noise impact must be mitigated to the same extent as at a public sector airport. Adverse environmental impacts must be mitigated to the same extent as at a public sector airport. The transaction cannot abrogate any collective bargaining agreements in effect on the date of the sale or lease. To date, one airport, Stewart International Airport, was privatized under the 1996 pilot program. In March 2000, the National Express Group PLC, a publicly traded British firm, through a wholly owned subsidiary, SWF Airport Acquisition, Inc., entered into a ninety-nineyear lease with the New York State Department of Transportation for the Stewart International Airport in New Windsor (Newburgh), New York.89 Under the terms of the agreement, National Express made an initial payment of $24 million for the lease, and agreed to pay an additional $11 million over the next ten years, plus a percentage of the airport’s gross income. However, the firm did not obtain the airlines’ approval waiving the restricted use of the airport revenues, so it could not profit directly from the airport’s operations. Also, New York State could use its lease revenues only for improvements to Stewart and other state-owned airports. After National Express decided to focus on its bus and rail operations, Stewart became expendable. In November 2007, the firm sold its lease to the Port Authority of New York and New Jersey for $78.5 million, returning the airport to public control.90 In attempting the first privatization of a major American airport, the city of Chicago in October 2008 announced the 99-year lease of the Chicago Midway International Airport.91 In addition to a desire to increase operating efficiencies and make the city more financially sound in light of recurring budget deficits, Chicago’s interest stemmed, in part, from the successful 2005 privatization of the Chicago Skyway, discussed in chapter six. In May 2006, the Illinois legislature preserved the property tax exemption for the airport if it were leased to a private operator.92 After the repayment of Midway Airport revenue bonds, legislation also enacted in May 2006, requires the city to spend 90 percent of lease proceeds on local infrastructure projects and/or to strengthen its underfunded pension funds created for municipal employees. Furthermore, when the airport is leased, to overcome potential union opposition, the legislation provides that Midway employees will either get a job with the new operator-lessee or elsewhere in the city government.93 The deal collapsed in April 2009 when the winning


group Midway Investment and Development Co. consisting of two U.S. companies, John Hancock Life Insurance Co. and Citigroup’s Citi Infrastructure Investors, and one Canadian firm, YVR Airport Services Ltd. could not secure financing for its $2.52 billion bid, amid tight credit market conditions. The rich price, roughly thirty times annual cash flow, might have led banks to decline funding the transaction even if credit were more freely available. The 1996 pilot program gives veto power over a privatization plan’s success to an airport’s airlines. For both the public sector sponsor and the private sector owner (or lessee) to gain the full benefits from privatization, the legislation requires the approval of a supermajority of an airport’s incumbent airlines, a major barrier. Because airlines generally oppose the privatization of U.S. airports especially where they would face higher charges under a private operator, prior to the Midway Airport deal, public sector officials generally considered it a battle not worth fighting. Besides Stewart, only four other privatization proposals were submitted to the FAA. One for Niagara Falls was rejected and two for San Diego Brown Field and Rafael Hernandez in Aguadilla, Puerto Rico, were withdrawn. Another for the New Orleans Lakefront Airport has languished at the FAA since 2002. Apart from the legal barriers to privatization and the potential for imposing higher charges air carriers, the opposition of airlines may stem from the rather unique joint venture approach to airport governance.94 In the United States, anchor-tenant airlines traditionally enter into a long-term lease-and-use agreement, which gives them the exclusive use of a terminal (or a concourse) and the right to approve (or veto) the airport’s capital spending plans. Under a typical residual cost lease agreement, the airport’s prior-year’s budget outcome determines what each airline pays each year in landing fees and space rentals. The annual residual cost equals the difference between total, non-airline revenues and total expenses. The airport recovers the residual cost out of landing charges and space rentals the airlines pay the next year. Thus, these signatory airlines become joint venturers with the public sector airport owner. With an abundance of passengers, an airport derives considerable revenues from retail sales, parking, and auto rentals, leaving a small residual cost for the airlines to pay. Conversely, if an airport does poorly on its non-airline revenues, the airlines face a higher residual cost. In exchange for sharing these risks, the airlines gain the ability to veto capital spending plans for terminal (or concourse) expansions that otherwise would permit new competitors to add service.


If the privatization of U.S. airports goes forward, it is unclear whether this joint venture approach will continue. The new owner or lessee may seek to renegotiate residual cost lease agreements that do not allow the airport to retain any profits or implement a landlord-tenant model, generally used worldwide, except in the United States. Airlines hesitate to renegotiate airport agreements that would result in cost increases. Looking to the Future of U.S. Airports

In the United States, gridlock continues on America’s runways, especially in the New York metropolitan area. Across the nation, airlines continue to struggle to shoehorn flights. Delays increase. Bad weather can throw airline schedules off for days. Airports face the challenge of accommodating increasing numbers of regional jets and new super-jumbo jets. The new super-jumbo jets will require re-engineered runways. Maintaining the integrity of the U.S. national airport system requires continual updates and a predictable flow of capital. The Federal Aviation Administration estimates indicate that capital development funds in excess of $8 billion annually are needed to meet the expanding demand.95 The Airport Council International puts that number at $17.5 billion annually.96 In the United States, airport funding has come from five major sources tax-exempt: airport bonds (some 59 percent); the federal Airport Improvement Program grants (21 percent); passenger facility charges (13 percent); state and local funding (4 percent); and airport revenues (4 percent).97 Traditional airport financing sources, particularly taxexempt bonds and federal funds, are inadequate to make the needed improvements, such as airports runway redesign and additions, as well as terminal development. Beyond these traditional sources of capital for improvements and expansions, similar to highways and bridges, privatization provides a financial tool and a proven management tool and a proven management tool. As one study concluded: We would expect private airports to introduce some form of rational pricing to make efficient use of available taxiing areas and runway capacity, to make efficient investments in terminals and runways to reduce delays, and to allow access to any carrier that is willing to pay the cost of using its facilities. . . . Generally, we would expect efficiencies to accrue to the traveling public as airlines and airports develop theirbuyer-seller relationship without governmental interference or contractual mandates. In a more competitive environment, airlines would be more forthcoming about their performances of

macquarie and privatization of airports / 135 the type of airport services that would reduce operating costs and improve service to passengers, while airports would have an incentive to respond to these preferences and introduce new services.98

The Macquarie Model and Future Airport Privatizations

MAp’s team combines airport management experience in a range of areas, including airport commercial development and operations, traffic forecasting, and aeronautical regulation, with specialized investment banking expertise, including investing in and financing airport infrastructure and increasing the value of airports over time. As an active manager, MAp works closely with the local management at each of its airports, using its experience and expertise to develop and implement strategies to attract new airlines and services. MAp executives possess significant skills and experience in capital management, an important area in the MAp investment model.99 From April 2002 through the end of September 2008, MAp achieved an enviable record. It generated an internal rate of return of 13.9 percent annually based on all the equity capital it raised, distributions, and market capitalization.100 Up until mid-2008, as Macquarie Airports looked to the future, it continued to seek to invest in airports with a dominant market position in an area with strong underlying demand for air travel and marked by underdeveloped retail, garage, and property activities. It sought airports with above-average passenger growth, which serve as origin and destination airports, with strong population centers around them, and a capacity to expand services. It wanted to take a significant stake only where it could influence key strategic, financial, and commercial decisions and increase returns by optimizing an airport’s capital structure. However, in August 2008, reflecting a net loss of A$274.3 million for the first six months to June 30, 2008 (compared to a profit of A$939.2 million for the same period in the prior year) and a less benign environment for listed infrastructure funds, marked by a significant discount of MAp’s security price to its directors’ valuation of its airport businesses, the fund unveiled a far-reaching plan to enhance security holder value.101 It announced the partial sales of its stakes in the Copenhagen Airports and the Brussels Airport, designed to raise about A$1.5 billion, the buy-back of up to A$1 billion of MAp securities over twelve months, and the redemption of the TICkETS hybrid securities issued in connection with the purchase of its stake in the Brussels Airport. Consummated in November 2008, MAp’s partial divestment


of is interest in the two airports achieved the fund’s valuation objective. It received cash consistent with MAp directors’ valuation of these two assets, reflecting a nearly 50 percent premium to the original acquisition costs. The sale of these interests to another Macquarie fund ensured that MAp would continue to exercise joint control over and retain an upside exposure to these airports. Furthermore, MAp did not pay any advisory fees in connection with the two divestitures. The partial sale also facilitated the buy-back plan, which, in turn, was expected to help the fund’s share price and validate the credibility of the net asset backing of MAp securities by demonstrating the fund’s belief its portfolio value and confidence in its existing airport businesses. The buy-back would also enhance the sustainability of the fund’s future distributions from cash flows, not from asset sales and debt refinancings, thereby achieving a convergence between distributions and earnings, hopefully by 2010. The sale transaction funded the TICkETS redemption that reduced MAp’s leverage, simplified its capital structure, and enhanced its flexibility due to the release of security backing the hybrid instrument. MAp further indicated that as a result of its capital and portfolio overhaul plans, coupled with the major drop in travel, especially in Europe, following the onset of the global economic downturn, it would not participate in any significant acquisitions, at least in the short term. Although remaining confident that its airports will deliver strong, long-term growth, with the Sydney Airport making up more than 60 percent of its portfolio, MAp became ever more reliant on its crown jewel. In July 2009, the Macquarie group agreed to give up its management role at MAp in an effort to close the gap between the value of MAp’s airports and the price of its shares. In exchange for Macquarie giving up management and performance fees from MAp, it will receive 150 million newly issued securities in the fund, valued at A$345 million. The new shares will boost Macquarie’s stake in MAp to more than 27 percent, keeping it as the fund’s largest shareholder.

Ch a p t e r Eig h t Th e M acqua r i e Mode l: Look i ng to t h e Fu t u r e

Even before the global credit crunch that began in the summer of 2007, triggered by the U.S. subprime mortgage crisis, observers had cast doubt on the Macquarie Model. As developed in this book, that model involves combing the globe for infrastructure assets exposed to no (or limited) competition, such as toll roads and airports, bundling them into Macquarie-managed funds, and taking a variety of fees along the way. The Macquarie Model came under fire in May 2007 from several well-known short sellers, notably James (Jim) Chanos of Kynikos Associates, a hedge fund. Known for predicting the collapse of Enron (a U.S. energy trader and a one-time market darling), Chanos put the Macquarie Bank (now the Macquarie Group) on a list of publicly held shares to sell short.1 (Short sellers borrow a stock, betting its price will fall. When they return the shares to the lender at the original price, if the stock has declined in value, they profit from the difference.) In reaching this conclusion, he reasoned that the infrastructure funds Macquarie managed were excessively leveraged, that is, they used too much debt in relation to the equity provided by investors, and that the Macquarie Model worked only in an era of inexpensive debt and rising asset prices. Chanos told an investors’ conference in May 2007 that he believed that the Macquarie Model was an “inherently unstable platform,” particularly in view of the policy of some of its funds to borrow in order to pay dividends. “This only works in a world of cheap credit and asset inflation,” he observed.2 Chanos further stated, “If you look at the financial accounts from the trusts, you’ll see that in almost all the cases the companies are using Australian revaluation accounting to write up the value of the asset annually and putting that through


operating income and into equity.”3 In addition, Chanos attacked Macquarie’s method of valuing assets, alleging that its funds routinely overpaid for their holdings and paid distributions from debt, particularly, by refinancing loans. A less-benign environment, which arrived in July 2007, he asserted, would end the party. Other critics, such as Dr. John L. Goldberg, an Honorary Associate, School of Architecture, Design, Science and Planning, University of Sydney, had launched an even harsher attack on the Macquarie Model. In 2006, Goldberg concluded: [T]he probability of financial failure [in three Sydney toll roads, including Macquarie Infrastructure Group’s M2 Motorway] has been shown to be 100 percent in every case, in the sense that cash flow will be insufficient to amortize debt. Not only do the models specify unattainable rates of return to investors but the true financial position of the projects is being masked by financial engineering leaning to increased debt out of which equity dividends are being paid.”4

Beyond the attacks on its infrastructure funds, with the onset of the credit crisis in the summer of 2007 Macquarie Bank shares fell some 37 percent from their May 17, 2007 peak of A$98.64 to a low of A$61.90 on August 16, 2007. At its peak, the bank boasted a priceearnings ratio of 20:1, that is, its share price equaled twenty times its earnings, versus the average of 12:1 for other Wall Street players. It became a prime target for profit-taking. Macquarie shares were caught in the global sell-off impacting financial institutions more generally, giving fresh voice to critics of the Macquarie Model. In particular, investors sold investment banks on worries about possible exposure to subprime mortgages or collateralized debt obligations. A collateralized debt obligation (CDO) represents the securitization of a portfolio of financial assets, such as corporate bonds or mortgage-backed securities. The purchase of the portfolio is financed by the sale to investors of multiple classes of debt securities, typically in the form of notes, and a class of equity securities, typically preferred stock. Generally, the amounts owed with respect to a more senior class of CDO securities are required to be paid before amounts owed with respect to the more junior classes. The subordination of classes of debt securities (referred to as tranching) allows the classes of notes secured by the same asset pool to receive different credit ratings by one or more rating agencies. Macquarie Bank shares were not helped by the announcement in late July 2007 that two Macquarie Fortress Investments Ltd. funds

macquarie model / 139

were hurt by the meltdown in corporate bond markets.5 The two funds, one listed and the other unlisted, which invested in high yield, senior, secured U.S. corporate loans, initially faced losses of 25 percent of their asset values. Their portfolios of corporate loans were originated by banks and sold to institutional investors. Similar to residential mortgage loans, secured loans, as the term indicates, are secured by a priority, that is, a senior lien on a borrower’s assets and the accompanying right to any cash obtained from the sale of collateral, if the borrower experiences financial difficulty. Beginning in July 2007, problems in the U.S. subprime mortgage markets pushed down the value of investments in credit markets more generally. Heavily leveraged, as the value of the two Macquarie Fortress funds’ loans fell, they had to sell some of their assets to meet the loan conditions, more technically, covenants, on their borrowings, with the firesale resulting in a significant loss of principal that only accelerated in 2008. By the end of February 2008, the net asset value of the listed Macquarie Fortress fund had declined by two-thirds from its end of June 2007 value, only to collapse and become worthless in October 2008, as a result of the impact of the global credit crisis on the prices of its U.S. senior, secured loans. Under an April 2008 refinancing agreement, the fund’s investors could receive, on various scenarios, most, but not all, of their investments back when the securities underlying the notes mature. Investors must, however, wait at least four years, because the income generated by the securities will first be used to payoff the fund’s leveraged financing.6 Although a Macquarie unit, Macquarie Financial Products Management Ltd., was the funds’ responsible entity, the Macquarie Bank (now the Macquarie Group) had no direct exposure to the two funds. It owned 66.7 percent of the Los Angelesbased firm, Four Corners Capital Management LLC, which managed the two funds’ portfolios. In the context of the unprecedented turmoil in global financial markets in 2008 which sharply intensified beginning in mid-September 2008 with the bankruptcy of Lehman Brothers and worries about the sustainability of its infrastructure funds’ business, Macquarie Group shares plummeted. Its shares first declined to A$42.95 on March 17, 2008, at the time of the collapse of Bear Stearns, before climbing to above A$66.0, on May 19, 2008, then falling to a low of A$22.0 on November 17, 2008, before rebounding to A$30.70 on December 1, 2008, and closing at A$28.81 on December 31, 2008. This chapter begins by analyzing the prospects for the Macquarie Group, especially with regard to the global credit meltdown of


2007–2008. It then examines the general outlook for its sponsored infrastructure funds, built on the Macquarie Model, and the primary challenges those funds face, including asset valuations and revaluations, use of debt, and new competition. The chapter concludes by considering the impact of increased public sector savvy in the area of infrastructure privatization, which may lead to public-private partnerships with greater degrees of shared benefits. The Macquarie Group

Even with stringent risk management tools, no financial institution was immune from the impact of adverse economic conditions in 2008. For the six months ending September 30, 2008, the Macquarie Group’s net profits fell 43 percent to A$604 million from A$1.06 billion a year earlier. Write-downs totaling A$1.14 billion sliced A$395 million from the firm’s bottom line. These write-offs, which stemmed from a variety of sharply deteriorating markets, included costs relating to the sale of its Italian mortgages portfolio, the write-down of its funds’ assets and other co-investments, the impact of loan impairment provisions, and certain impairments on its trading asset positions.7 In the future, a number of equity investments by Macquarie classified as available for sale will likely require impairment charges because of a “significant or prolonged decline in fair value below”8 costs. These write-downs will negatively impact the Macquarie Group’s future profits. With various charges totaling A$2.5 billion, for its fiscal year ending March 31, 2009, the firm reported a 52 percent drop in its net profits to A$871 million from a year earlier earnings of A$1.8 billion. Despite these write-downs, the Macquarie Group continues to be well capitalized and well-funded. At the end of September 2008, it had capital of A$10.3 billion, 40 percent (A$3.3 billion) in excess of its minimum regulatory capital requirements. It had A$26.3 billion in cash and liquid assets well in excess of its short-term issued debt of A$18.9 billion. During the six months ending September 30, 2008, it raised term funding of A$7.8 billion from a variety of sources and had an undrawn A$3.8 billion senior credit facility. Despite months of denials in 2009 that it did not plan to raise new capital, the firm raised A$540 million from institutional investors by the end of April 2009.9 In the midst of the worldwide financial meltdown, Macquarie, unlike other well-known organizations, such as Citigroup and Merrill Lynch, did not experience massive losses or write-downs of the debt


inventory. Macquarie was spared billions in losses because its main business focused on providing services to clients rather than trading for its own account. In contrast, proprietary trading represented a big chunk of the earnings of many global investment banks. For Macquarie, this type of activity did not represent a big proportion of its profits. Unlike many global investment banks, Macquarie did not face the problem of having large amounts of debt that it could not sell to others. It did very little underwriting of corporate debt and no underwriting of the leveraged loans that financed and fueled the private equity buyout boom prior to 2008. It had only modest credit exposures to hedge funds. As of September 30, 2007, for example, its portfolio had only minor holdings of collateralized debt obligations and collateralized loan obligations, all of which were rated AAA or AA. These holdings, totaling some A$300 million, constituted a small fraction of its then A$224 billion in assets.10 Although it did no subprime lending, it had about A$200 million in assets backed or partially backed by pools of subprime mortgages. The firm recorded a relatively small loss of some A$30 million on these assets, as defaults were minimal.11 Macquarie’s business continues to be diversified by geography and by product. Two-thirds of its earnings are concentrated in the Australian and Asian markets, which were generally less impacted, at least initially, by the 2007–2008 financial crisis. The group is very active in Asia and for a considerable period, Asia remained insulated from the U.S. subprime mortgage difficulties. Because of Macquarie’s position as a market maker, it also benefited from increased volatility in the financial markets that characterized the second half of 2007 and all of 2008, producing improved trading opportunities, a widening of market-making spreads, and increased demand for its hedging services.12 Although the Macquarie Group had sufficient financial and staffing resources to weather the 2007–2008 financial storm, three items are noteworthy: possible future write-offs; alleged reliance on management and performance fees received from its infrastructure funds; and increased offerings of its unlisted infrastructure funds. First, the likelihood exists of future write-offs in its equity investments in its infrastructure and real estate funds and other assets.13 Not unexpectedly, real estate investments proved troublesome for Macquarie. For example, the write-down in the value of investments in its listed real estate funds in the firm’s fiscal year ended March 31, 2008 hurt its bottom line. Its real estate group’s income moved from a profit of A$507 million in the 2007 fiscal year (including a one-time


A$302 million asset sale gain) to a loss of A$81 million in fiscal year 2008, following a A$293 million write-down in the value of its real property fund investments.14 In addition to likely future real estate write-downs, at least in the near term, a prolonged downturn in real estate and other markets will also result in fewer opportunities to generate profits from the sale of investments and other assets in coming years. Doubts exist about how the firm values its 17 percent stake in MIG and its 22 percent of MAp. Instead of continuously marking assets to market value, directors of these funds determine their respective values every six months, using market prices and cash generated. When economic conditions rapidly deteriorates, critics maintain, this valuation approach fails to offer sufficient transparency. Second, with respect to the role of performance and management fees in relation to the firm’s profits, it is important to note that in fiscal year 2008, about 20 percent of the Macquarie Group’s operating income came from its infrastructure and real property funds or managed asset arrangements, with approximately 10.8 percent from management and performance fees from these sources, about 5.3 percent from advisory and underwriting fees paid by its infrastructure and real estate funds, and approximately 4.2 percent from the sale of assets from the Macquarie Group to its infrastructure and real funds.15 For the first half of fiscal year 2009, the Macquarie Group generated 21 percent of its operating income from these sources.16 Performance fees generated by its Capital Funds group, which houses its infrastructure funds, equaled A$210 million for the six month period ending September 30, 2008, out of firm-wide, total net profits of A$604 million for this period, with a significant contributor to performance fees for this period resulting from the termination of the advisory agreement with Bristol Airports Bermuda Ltd.17 In short, the Macquarie Group remains vulnerable to a decline in the performance fees it receives from its infrastructure funds if they begin to underperform in comparison to their respective benchmarks. As noted in chapters five and seven, since 2005, neither Macquarie Infrastructure Group (MIG) nor Macquarie Airports (MAp) has generated any performance fees for the parent entity. However, management fees are charged regardless of performance. These management fees produced by the infrastructure funds keep rolling in with A$27.7 million and A$21.4 in base fees generated by the Macquarie Infrastructure Group and Macquarie Airports in the first half of fiscal year 2009.18 As long as the value of assets under management holds up, these fees will not decrease.


Third, by listing its infrastructure funds on stock exchanges in Australia, the United States, Canada, Korea, and Singapore, Macquarie opened a gateway not only to a broader base of investors but also to lucrative new fee streams. It also has developed unlisted funds, such as Macquarie Infrastructure Partners. Although continuing to develop listed and unlisted funds in response to investor demands,19 Macquarie increasingly relies on the unlisted market to raise capital. By tapping the unlisted fund market, which looks to the rising terminal value of infrastructure assets, as opposed to the illusion of regular dividends, to fuel continued growth, pension funds and other institutional investors have less of an appetite for Macquarie’s highly leveraged structures or its internal fee generating practices, for example, selling assets from one of its funds to another. However, these investors have a longer investment horizon and dislike the extreme volatility in market values associated with listed infrastructure funds. Generally, Macquarie earns lower performance fees but higher management fees from unlisted funds than from its listed units. Similar to its listed funds, the performance fee structure for its unlisted funds provides for a 20 percent outperformance fee. In contrast to an equity index performance benchmark for its listed funds, the unlisted funds typically use an absolute return hurdle, for instance, 20 percent of the total return above 8 percent per year. Its listed funds typically calculate the performance fee annually or biannually. For an unlisted fund, unlike a listed fund, the performance fee calculation occurs only where there is a liquidity event, such as a sale of assets with a return of capital to investors, thereby delaying the payment of performance fees.20 This accommodation to market trends reflects, however, the firm’s commitment to innovation. With respect to base fees, its unlisted infrastructure funds pay a 1.5 percent annual management fee in comparison to a weighted average of 1.1 percent for its listed funds.21 In sum, the creeping rot in the global financial markets resulting from the U.S. subprime mortgage meltdown, the ensuing credit crunch, the pain of deleveraging, and the global economic deceleration and recession, among other factors, adversely impacted the Macquarie Group. The slowdown in deal flows, as well as the 2007–2008 credit crisis and the various write-downs, put the brakes on Macquarie, at least temporarily, and prevented the firm from growing with the same rapidity as it had for so many years.


Macquarie Infrastructure Funds

Critics allege that the Macquarie infrastructure funds face five major challenges: overpayment for assets; overuse of debt; use of debt to fund distributions; reliance of asset revaluations; and new competition. This section analyzes each of these allegations. Although trading in line with plunging global stock markets and other listed infrastructure players, in 2007–2008, the stock market agreed with these negative allegations. Macquarie Airports shares plummeted from a high of A$4.64 on October 18, 2007, to a low of A$1.83 on November 26, 2008, only to rebound to A$2.40 by December 31, 2008. Similarly, Macquarie Infrastructure Group shares dropped from A$3.95 on April 10, 2007, to A$1.38 on November 17, 2008, and closed 2008 at A$1.71. At the end of 2008, shares of both funds traded at significant discounts to their respective book values, reflecting the impact of the global economic slowdown on the value of infrastructure assets. Do Macquarie funds overpay for infrastructure asset acquisitions? Critics assert that Macquarie funds overpay for infrastructure assets because they have an incentive to overpay.22 Shareholders in its infrastructure funds pay Macquarie management fees based on the size of assets in each fund as well as fees with respect to various transactions, including debt refinancings and asset sales. However, as analyzed in chapters five, six, and seven, Macquarie did not overpay for its highway and airport assets. Within eight months of its acquisition, for example, MIG refinanced the Chicago Skyway debt, returning $168 million (A$218 million) to the fund. The sale of assets by Macquarie funds to third parties resulted in a stream of substantial profits. In 2007, for instance, Macquarie funds sold nine assets, including a stake in the Rome Airport System, to third parties for more than A$8 billion, or 2.3 times the original equity invested in these assets.23 In 2008, as noted in chapter seven, MAp completed a partial divestiture of its interest in the Copenhagen and Brussels airports to another Macquarie fund at a premium of nearly 50 percent in excess of acquisition costs. As evidence of its acquisition discipline, Macquarie Infrastructure Group walks away from four out of every five deals it reviews (128 out of 160).24 Given its expertise in asset acquisition and its skillful use of debt and financial engineering, more generally, Macquarie can pay higher prices for any asset it acquires. This strategy relies, of course, on Macquarie convincing lenders to provide the necessary funds for asset acquisitions and subsequent refinancings.


Do Macquarie funds overuse debt? Critics assert that the Macquarie funds overuse debt and thus are too highly leveraged, thereby betting on a continued flow of easy credit to finance asset acquisitions and refinance indebtedness.25 A period of low interest rates for most of the decade after 9/11 provided bountiful financing for infrastructure acquisitions and debt refinancings. Macquarie also benefited from the loosening of credit market conditions to use more debt for its asset purchases. However, it is difficult to conclude that most of Macquarie’s infrastructure asset deals were significantly overleveraged. According to Allan Moss, “[T]he average leverage in our infrastructure funds is less than 60 per cent, which is reasonably conservative for very high-quality assets and these are very high-quality assets with very, very reliable income streams.”26 Although the level of leverage within Macquarie infrastructure funds is based on the firm’s internal asset valuations, which likely exceed market valuations, the reliance on debt by Macquarie funds is now decreasing. For example, across the Macquarie Infrastructure Group’s asset portfolio, as of June 30, 2008, its net debt equaled only 50.5 percent of these assets’ enterprise value.27 Macquarie funds have implemented initiatives to reduce debt levels given the difficult market conditions existing in 2008. As noted in chapter seven, Macquarie Airports deleveraged its business by redeeming its TICkETS hybrid instruments in 2008; the Sydney airport repaid A$870 million in debt in early 2009 that would have matured later that year. Macquarie has acted cautiously by hedging its infrastructure funds’ interest rates on borrowings and avoiding short-term debt maturities. Interest rate hedging protects investors against the risk of rising interest rates. As an example of its interest hedging, MIG was 87 percent interest rate hedged across its portfolio to end of its 2010 fiscal year, with 100 percent, 99 percent, and 99 percent hedging on, respectively, the 407 ETR, the M6 Toll Road, and its U.S. toll roads.28 As an example of its avoidance of short-term debt, only 8 percent of MIG’s debt will mature by the end of the third quarter of 2010.29 Also, as noted in chapter five, MIG avoids recourse financing with payments of interest and principal exclusively from each of its asset’s cash flows. Macquarie maintains that infrastructure represents a new asset class.30 A toll road acquisition, for example, may require a heavy upfront capital expenditure and produce little free cash, but as spending decreases and tolls rise, the cash-rich asset can meet the interest


payments and pay off the debt. With increasing cash flows, debt service capacity increases. In short, Macquarie regards the use of debt by its infrastructure funds as “both prudent and efficient.”31 Furthermore, the infrastructure assets deliver essential services to communities. They seemingly will produce substantial future cash flows, Macquarie asserts, that underpin its funds ability to sustain appropriate debt levels over the long-term.32 The impact of a severe recession on cash flows remains, however, uncertain. During the third quarter of 2008, evidence supported Macquarie’s optimism. During this period, MIG showed a weighted portfolio average traffic decline of 2.4 percent, but toll revenues rose 2.8 percent. As a result of global economic conditions, MIG’s diverse holdings experienced traffic downturns, but its overall portfolio continued to deliver revenue growth. For the six months to December 2008, MIG reported its major asset performance in comparison to the same period in 2007 as follows: 407 ETR, traffic decrease of 2.2 percent but a revenue increase of 1.8 percent; M6 Toll Road, 11.8 percent traffic decrease and 0.3 percent revenue decline; APPR, 3.3 percent traffic drop and 0.9 percent revenue decline.33 Still analysts question the premise that Macquarie infrastructure funds would be immune to the economic downturn. Apart from debt levels, critics also point to Macquarie’s back-ending of interest payments, which increase (or accrete) over time.34 As discussed in chapter six, instead of constant, fixed interest rates, the Indiana Toll Road financing and refinancing of the Chicago Skyway, among its toll road financing transactions, used a stepped-up interest rate profile to better match rising future interest expenses with increasing future revenues. For example, the interest on the Chicago Skyway debt amounted to $89.7 million in 2007, but it will rise to $145.0 million annually by 2018.35 This technique improved MIG’s interest coverage ratios and boosted the weak initial free cash flow yield from projects, thereby enabling better dividend coverage. The stepped-up interest rates, with lower, initial interest rates, also made it easier for MIG to pay higher prices for assets, under the guise of future cash flow accretion. Stepped-up interest rates are a two-edged sword. A lower initial interest rates reduce the traffic risk associated with projects in their growth stage. This strategy more evenly spreads risk over a project’s life. However, traffic risk is extended beyond an asset’s opening and ramp up periods. With interest rates stepping up in the medium term,


traffic numbers accordingly must increase. Because cash is released to shareholders more quickly than under higher initial interest rates, stepped-up interest rates increase the investors’ internal rate of return, especially where IRRs are sensitive to the time value of money. There’s a cost to stepping-up, namely, the payment of a fee to hedge providers. By paying a high up-front fee to the hedge providers, interest rates can be set at a very low level, at least initially. Do Macquarie funds increase their debt obligations partly to pay fund shareholders their promised dividends? Dividends some Macquarie infrastructure funds pay to investors have been funded by debt taken on, not the cash flows generated by the assets held. Criticizing the use of debt to pay promised dividends to fund shareholders, Chanos stated, “Borrowing future growth to pay investors today bears the hallmarks of a Ponzi scheme.”36 Cash flows do not currently cover the dividends paid by Macquarie Airports and Macquarie Infrastructure Group. In 2008, MAp’s operating cash covered about 79 percent of its distributions.37 As noted in chapter seven, MAp intends to align its distributions with its operating cash by 2010. In its 2009 fiscal year, MIG expects to cover 55 to 65 percent of its distributions from earnings, up from 54 percent in fiscal year 2008.38 Macquarie uses debt restructuring and asset sales to pay part of these funds’ distributions, also relying on a future stepped-up interest rate profiles. In other words, Macquarie funds borrow more initially, often refinance with cheaper debt, and use part of the proceeds to pay dividends now. In a less certain debt environment, this strategy may be far more difficult to implement. Thus, the stock market remains doubtful that Macquarie Infrastructure Group can continually refinance (or sell) assets to fund distributions. Many of Macquarie funds’ infrastructure assets are monopolies (or near monopolies) facing limited competition and high barriers to entry, and these can sustain high debt levels as long as the funds have the ability to charge more for their services in the future, even if, for MIG, traffic declines as the result of a recessionary environment. Because of this cash flow pattern, distributions by Macquarie funds to their shareholders are often out of debt in the early years. The ability to raise more money by refinancing debt is driven by the credit quality of an asset, which typically improves over time as the risk decreases. The ability to refinance debt also assumes that the credit markets will not shut down, as they did during the fall of 2008, and that short-term bank loans can


be refinanced advantageously. In the near term, it is unclear whether Macquarie infrastructure funds will be able to refinance portions of their indebtedness, at least as favorably as in the past. If capital markets remain tight, the value of infrastructure assets (and funds’ shares) will likely adjust downward. The dividends Macquarie funds pay currently are rewarded, to some degree, in their share prices. In addition to share buybacks by MIG and MAp, using debt to pay dividends helps maintain the value of a fund’s equity securities. The Macquarie approach assumes no disruptions in current distributions as a result of adverse capital structure changes, capital market tightness, or unsustainable cash flows. Fund share prices, in other words, are sensitive to assumptions about capital structure, capital markets, interest coverage, and operating revenues, with inexpensive debt underpinning the Macquarie Model.39 These debt- (and asset sale-) funded distributions form a key component of the Macquarie Model. The use of borrowed money is only possible when asset prices are increasing and cheap debt is available. To continue to grow and pay dividends, at least in the short term, Macquarie funds need access to inexpensive debt to finance asset acquisitions and refinance its debt obligations. If interest rates move up in the future, the funding costs for the types of leveraged deals in which Macquarie participates will increase. Interest rate rises make traditional bond markets more attractive to both pension funds and retail investors. Higher interest rates (or the collapse of credit markets in the fall of 2008, a more extreme situation) make debt financing (and refinancing) less attractive (or nearly impossible), adversely affecting the returns infrastructure funds generate, thereby reducing their benefits to fund investors. Macquarie funds may, however, be largely insulated from the impact of rising interest rates. For example, tolls on MIG’s roads are linked to inflation. If interest rates increase, so do a highway’s revenues. In the future, however, rising real interest rates, that is, in excess of inflationprotected revenues, may make the Macquarie Model more difficult to replicate. But rising inflation impacts all asset classes, and investors’ cash still needs a home. Does the Macquarie Model rest on the revaluation of infrastructure assets? Critics charge the Macquarie funds with generating revenues by revaluing assets and changing the assumptions in their valuation models.40 For example, for fiscal year 2007, Macquarie Infrastructure Group reported revenues of A$2.74 billion and profits of A$2.11 billion.


Its actual revenues were just A$967 million with the bulk of its earnings coming from the revaluation of its assets.41 Fortunately for Macquarie, its funds’ debt binge occurred in conjunction with rising asset prices that facilitated asset revaluations. As discussed in chapter five, revaluation gains involve, in part, reducing the risk premium applied to future cash flows generated by a fund’s assets. The discounted cash flow method to value assets relies on applying a discount rate to estimates of future cash flows. The discount rate is the risk-free interest rate for the country where the asset is located, plus a risk premium that reflects the uncertainty as to the accuracy of these future cash flow estimates. By starting with a large risk premium and reducing it in successive years, Macquarie can generate a reliable stream of revaluation gains. Macquarie’s logic is based on the premise that as infrastructure assets mature, their earnings become less volatile and more predictable. Thus, the risk premiums should fall. However, in the future, risk premiums may rise, as a result of a global recession, higher assumed financing costs, and macroeconomic factors, such as long-term inflationary expectations, negating easy, upward asset revaluations and leading to downward asset revaluations. Reflecting the negative economic environment, as of June 30, 2008, in comparison to December 30, 2007, MIG wrote down the value of its assets as follows: M6 Toll Road 28 percent, Chicago Skyway 23 percent, South Bay Expressway 29 percent, Dulles Greenway 15 percent, 407 ETR 13 percent, and APRR 9 percent.42 What will be the impact of new competition? Critics maintain that the “supernormal” returns generated by Macquarie funds will moderate as competition increases, particularly from other investment banks as well as private equity funds. Increased competition may also lead Macquarie and its competitors to overpay for assets. In other words, the infrastructure sector may suffer from an overvaluation of assets as a result of more buyers willing to pay high multiples and use excessive leverage.43 Macquarie generally aims for returns in the low teens from its infrastructure assets. Macquarie’s success drew competition from other financial institutions. Although Macquarie set the pace throughout the globe, a number of new players, including Goldman Sachs Group (GS Infrastructure Partners Fund) and Morgan Stanley (Morgan Stanley Global Infrastructure Fund), to name a few, entered the market. These financial buyers have the requisite financial muscle and can hire infrastructure experts to counter Macquarie’s track record, the depth of its global expertise, and its ability structure and distribute debt and equity


instruments. Macquarie funds have drawn fire because of their fee structures, which are less defensible in economic downturns and in markets where new entrants, such as Goldman Sachs, are luring investors. In 2007, new funds searching for their first infrastructure deal drove up asset prices and drove down yields. In the future, competition for assets, especially mature core assets in Europe, will, arguably, bring the returns down. Mature infrastructure assets will more likely provide high single-digit performance, more akin to real estate, albeit with lower volatility. There is room for more competitors, however, because of the growing popularity of infrastructure as an asset class. Institutional investors searching for higher-yielding stable investments have flocked to infrastructure assets. Despite the turbulent capital market environment, in the first nine months of 2008, infrastructure funds worldwide raised more than $21 billion.44 For pension funds, in particular, the long duration, inflation hedging, and steady cash flow nature of infrastructure investments hold considerable appeal. Pension funds in the United States are themselves tax exempt, so they do not purchase tax-exempt bonds. Thus, what is attractive to such funds is equity in privatized toll road projects, or more commonly, participation in infrastructure funds. Investment opportunities are multiplying as more governments globally seek private sector financial and managerial involvement. The public sector, facing budgetary constraints such as the city of Chicago in 2005 and 2008, and tight credit markets, can raise capital through monetizing existing infrastructure assets, thereby increasing their supply. Other drivers for increased infrastructure privatizations include years of deferred maintenance and the growing need for governments to find alternative capital sources to fund greenfield projects and repair brownfield assets as well as the growing recognition of the benefits of privatizations as a management tool. In short, with the growing demand for infrastructure assets may come an increased supply, with the supply likely growing faster than the demand. Macquarie’s increasing reliance on more opaque unlisted funds will prove beneficial as these funds will likely be less impacted by the scrutiny attached to the public sector leasing assets to the private sector. On balance, it is uncertain whether more competitors will raise the price of assets. Macquarie may not be pushed into bidding ever-higher prices for assets to maintain its growth trajectory. As a result of the 2007 subprime shakeout and the 2008 credit crunch, it became harder for all potential bidders, including Macquarie, to conduct acquisitions


reliant on debt financing. The global credit crisis likely has in some ways enhanced Macquarie’s long-term positioning. The firm’s funds have billions in investable capital and are in the process of raising more money in the near term. Many of its competitors were more adversely impacted by the financial meltdown. Impact of Increased Public Sector Savvy on Infrastructure Funds

At least in the United States, if more greenfield and brownfield privatization highway and bridge deals are done, the public sector will likely be far more savvy. Infrastructure asset lessors, typically state governments and municipal authorities, will likely focus on attaining the ideal blend of up-front (or annual lease) payments, future toll hikes, and revenue sharing. In the future, state and local governments may require lessees to share toll-hike revenues with the public sector that built a highway or a bridge. A move may occur away from entering into long-term concessions with the highest bidder, as exemplified by the Chicago Skyway and the Indiana Toll Road transactions, to various types of revenue-sharing arrangements as a form of partial privatization. Rather than getting the most dollars up-front for a concession, the public sector may select the bidder that will provide the best service and offer revenue sharing derived from future efficiency gains. Under this type of arrangement, a private operator would receive compensation for its efforts in running the concession better with both the concessionaire and the public sector enjoying a stake in the ongoing benefits, including windfall gains, such as refinancing. Thus, future concessions may include provisions for sharing of the gains from debt refinancings as well as revenues, based on the length of deal, the potential limits on returns to investors, the amount of the lease payments, and the possibility of terminating a concession when specified returns have been achieved by the private sector operator. The public sector may also seek to retain some ongoing discretion over toll rates and may look to compensate private operators through future payments based on performance standards, such as traffic growth. In sum, future public sector decision makers will consider the need to maintain flexibility and a degree of control for future generations. To benefit from the upside, the public sector will need to reduce the upfront benefit it receives. Also, it may require a continued private sector commitment through the retention of adequate levels of equity and the sharing of refinancing gains.


Infrastructure asset transaction are often enormously complex.45 Beyond the financial details, the social, legal, and technical complexities exist. Even in developed nations, these assets are embedded within a country’s societal context. Citizens and politicians hold emotional attachments that not only influence how infrastructure assets obtain funding and are constructed, operated, and maintained, but also constantly shift with the ebb and flow of social mores and political pressures. Sovereign risk in the form of the nature and extent of future public sector regulation and intervention is an important risk consideration. Infrastructure funds must not only be savvy enough to build and operate (or lease and operate) assets, paying careful attention to the financing, management, and marketing aspects, but artfully engage in the dynamics of the never-ending public policy debates, as exemplified in the Indiana Toll Road transaction. Given these complexities and the ongoing political pressures, a need exists to negotiate a “fair” deal at the outset. In exchange for taking significant financial risks, the private sector wants to obtain proportionate future financial gains. In return for providing an infrastructure asset to the private sector to build and operate (or lease and operate), a governmental body wants sufficient tangible and intangible public benefits. Negotiating a fair deal structure requires both sides to do their homework and evaluate their respective risks and expected returns. Establishing mutual trust over time goes a long way in bridging difficult negotiating issues. Compromise represents a necessary requirement for achieving a “fair” transaction.46 *

*

*

Innovation remains a hallmark for Macquarie. It looks to expand into other fields such as running retirement homes and casinos that have investment profiles similar to more traditional infrastructure assets, such as highways and airports. The firm may also move away from assets whose value is linked to interest rates, such as infrastructure, and more into growth-style assets. In the future, bidders may look to new assets to privatize, such as lotteries.47 Or, in the future, Macquarie may go in an entirely new direction. As Allan Moss put it, “I hope [Macquarie’s future] develops in an unpredictable way, because one of the secrets of success is doing things that are different and therefore difficult to predict.”48

No t e s

1

Introduction

1. Urban Land Institute and Ernst & Young, Infrastructure 2007: A Global Perspective (Washington, DC: Urban Land Institute, 2007), 4. 2. Macquarie Specialist Funds Quarterly, September 2008, 6 (Introduction to Macquarie Specialist Funds) and 27 (Macquarie Capital Funds Snapshots). 3. Ibid., 27 (Macquarie Capital Funds Snapshot). 4. Ibid., 27 (Macquarie Capital Funds Snapshot) and 30 (Global Presence). 5. Ibid., 21 (Specialist Funds—Serving the Community Everyday). 6. Quoted in Bethany McLean, “Would You Buy a Bridge from This Man?” Fortune 156:7 (October 1, 2007): 138–150, at 150. 7. Financial Times (London), “The LSE does not need Macquarie,” December 15, 2005, 18. 8. Leslie P. Norton, “Aussie Upstart,” Barron’s 86:31 (August 7, 2006): 19–21. 9. Sara Seddon Kilbinger, “Investors, Seeking Roads to Riches, Turn to Infrastructure,” Wall Street Journal, May 3, 2006, Marketplace Section, B6. 10. United States Department of Transportation, Report to Congress on Public-Private Partnerships, December 2004, viii. 11. Ibid., 41–59. 2 The Rationale for Privatizing Infrastructure Assets 1. For the analysis of the advantages and disadvantages of privatization, I have drawn on Robert Poole, Director of Transportation Studies, Reason Foundation, Testimony, Public-Private Partnerships: Innovative Financing and Protecting the Public Interest, Hearing before the Subcommittee on Highways and Transit of the Committee on

154 / notes

2.

3. 4. 5.

Transportation and Infrastructure, House of Representatives, 110th Congress, 1st Session, February 13, 2007, 38–40; Robert W. Poole, Jr., “Public-Private Partnerships for Toll Highways,” Ibid., 119–125; Tyler D. Duvall, Assistant Secretary for Transportation Policy, U.S. Department of Transportation, Statement, Ibid., 72–76; Peter Samuel, “The Role of Tolls in Financing 21st Century Highways,” Reason Foundation, Policy Study No. 359 (May 2007), 28–34; Peter Samuel, “Should States Sell Their Toll Roads?” Reason Foundation, Policy Study No. 334 (May 2005); Peter Samuel, “Leasing State Toll Roads: Frequently Asked Questions,” Reason Foundation, Policy Brief No. 60 (March 2007); Leonard C. Gilroy et al., “Building New Roads through Public-Private Partnerships: Frequently Asked Questions,” Reason Foundation, Policy Brief No. 58 (March 2007); RREEF Research, “U.S. Infrastructure Privatization and Public Policy Issues,” September 2006; Maria Matesanz and Joshua Schaff, “Deep impacts,” Project Finance 276 (December 2006/January 2007): 40–43. See also William L. Megginson and Jeffry M. Netter, “From State to Market: A Survey of Empirical Studies on Privatization,” Journal of Economic Literature 39:2 (June 2001): 321–389 and E. S. Savas, Privatization and PublicPrivate Partnerships (New York: Seven Bridges, 2000). Mary Shirley and Patrick Walsh, “Public versus Private Ownership: The Current State of the Debate,” The World Bank, Development Research Group, Regulation and Competition Policy, Policy Research Working Paper 2420 (August 2000), 48–52. John D. Donahue, The Privatization Decision: Public Ends, Private Means (New York: Basic Books, 1989), 57–78, provided a summary of the empirical evidence. He concluded, “In sum, when a well-specified contract in a competitive context can enforce accountability, the presumption of superior private efficiency in delivering public services holds true.” Ibid., 78. See also Eytan Sheshinski and Luis F. López-Calva, “Privatization and Its Benefits: Theory and Evidence,” CESifo Economic Studies 49 (3/2003): 429–459 and Tae H. Oum, Nicole Adler, and Chunyan Yu, “Privatization, Corporatization, Ownership Forms and Their Effects on the Performance of the World’s Major Airports,” Journal of Air Transport Management 12 (2006): 109–121. Florencio López-de-Silanes, Andrei Shleifer, and Robert W. Vishny, “Privatization in the United States,” RAND Journal of Economics 28:3 (Autumn 1997): 447–471. Quoted in Andrew Bary, “Toll-Road Sales,” Barron’s, May 8, 2006, 17–18, 20, at 18. Transcript, Lou Dobbs Tonight, CNN, January 9, 2007. See also TollRoadsnews, “Lou Dobbs report on privatization of toll roads—with comment,” January 10, 2007.

notes / 155

3 Macquarie: The Early Years, Its Culture, and Its Growth 1. Macquarie Bank Ltd., Explanatory Memorandum, Proposal to Restructure the Macquarie Group Which Will Result in a New NonOperating Holding Company Macquarie Group Limited Becoming the Ultimate Listed Parent Entity of the Group, September 13, 2007. 2. A.G. Kenwood, Australian Economic Institutions Since Federation: An Introduction (Melbourne: Oxford University Press, 1995), 177–178. 3. I have drawn on Financial Times (London), “Go-ahead for Macquarie,” March 1, 1985, Section II, 18; Financial Times (London), “Hill Samuel receives £17m in restructure of Australian side,” February 8, 1985, Section II, 23; Economist (U.S. Edition), “Coming in from the outback” 291:7337(April 14, 1984): 98; Lachlan Drummond and David Lascelles, “Canberra gives Hill Samuel banking go-ahead,” Financial Times (London), April 6, 1984, Section I, 20. 4. Banks (Shareholdings) Act of 1972–1973, Section 10. 5. Australian Financial System, Final Report of the Committee of Inquiry (Campbell Report) (Canberra: Australian Government Publishing Service, 1981), xxvii. See also Tom J. Valentine, “What the Campbell Committee Expected,” in The Deregulation of Financial Intermediaries, ed. Ian MacFarlane (Sydney: Reserve Bank of Australia, 1991). For background on Australian financial deregulation in the 1980s, see Kenwood, Australian Economic Institutions Since Federation, 181–185 and Andrew S. Carron, “The Australian Financial System,” in The Australian Economy: A View from the North, ed. Richard E. Caves and Lawrence B. Krause (Washington, DC: Brookings Institution, 1984), 207–210. 6. Campbell Report, 1. 7. Ibid., 71–73, 144–145, 433, 439, 445–446. 8. Australian Financial System: Report of the Review Group (Canberra: Australian Government Publishing Service, 1984). 9. Commonwealth of Australia, Banking Act 1959 Authority to Carry on Banking Business in Australia, Macquarie Bank Limited, February 28, 1985. 10. John Ritchie, Lachlan Macquarie: A Biography (Melbourne: Melbourne University Press, 1986), 124–127, 158, 183, 192. 11. S.J. Butlin, Foundations of the Australian Monetary System 1788–1851, reprinted edition (Sydney: Sydney University Press, 1968), 79–84 and W.J.D. Mira, Coinage and Currency in New South Wales 1788–1829 and an Index of Currency References in the Sydney Gazette 1803–1811 (Sydney: Metropolitan Coin Club of Sydney, 1981) 23–26. 12. I have drawn on Kate Askew and Lisa Murray, “Klutz with the Midas Touch,” Sidney Morning Herald (Australia), December 18, 2004,

156 / notes

13.

14.

15. 16.

17. 18. 19. 20.

21. 22.

Business Section, 39; Jane Cadzow, “Harder faster richer,” The Age (Melbourne, Australia), October 7, 2006, Good Weekend Section, 28; Sunday Business (London), “All hail the sage of Sydney,” October 30, 2005, 1. Andrew Bary, “The World’s Best CEOs,” Barron’s 87:13 (March 26, 2007): 37–46, at 44 and Andrew Bary, “The World’s Best CEOs,” Barron’s 86:13 (March 27, 2006): 33–38, at 37. With his retirement in May 2008, Moss did not make the 2008 list. Andrew Bary, “World’s Best CEOs,” Barron’s 88:12 (March 24, 2008): 33–36, at 34. See, e.g., Jessica Silver-Greenberg and Mara Der Hovenesian, “More Muscle for Risk Managers,” Business Week 4072 (February 25, 2008): 62; Nomi Prins, “The Risk Fallacy,” Fortune 158:9 (November 10, 2008): 112–116; Steve Lohr, “Wall Street’s Extreme Sport,” New York Times, November 5, 2008, B1. Research by Uday Rajan, Amit Seru, and Vikrant Vig, “The Failure of Models That Predict Failure: Distance, Incentives and Defaults,” University of Chicago Booth School of Business, Working Paper No. 8–19, October 2008; (December 8, 2008), concluded that the quantitative risk methods used underestimated defaults by subprime mortgage borrowers. Quoted in Asiamoney, “Asia’s top executives of 2005” 16:11 (December 2005): 56–62, at 58. Quoted in Bethany McLean, “Would You Buy a Bridge from This Man?” Fortune 156:7 (October 1, 2007): 139–150, at 148. See also Chris Leahy, “Macquarie goes mainstream,” Euromoney 35:421 (May 2004): 46–48. Bethany McLean and Peter Elkind, The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron (New York: Portfolio, 2004), 240. Quoted in Sunday Business (London), “All hail the sage of Sydney.” Quoted in Giles Parkinson, “A toll tale,” Institutional Investor (International) 31:3 (March 2006): 52–58, at 58. Quoted in Sheridan Winn, “The Quiet Australian Who Is Making Big Noise in White City and the Isle of Wight,” Independent on Sunday (London), August 14, 2005, Business Section, 5. Four models, opportunist, enabler, producer, and advocate, companies can follow to grow internally are analyzed by Robert C. Wolcott and Michael J. Lippitz, “The Four Models of Corporate Entrepreneurship,” MIT Sloan Management Review 49:1 (Fall 2007): 75–82. Quoted in Lachlan Colquhon, “Architect who shaped the Macquarie Model,” South China Morning Post (Hong Kong), September 19, 2005, Business Section, 12. Quoted in Marc Moncrief, “Bully for Them,” The Age (Melbourne, Australia), February 17, 2007, Business Section, 1.

notes / 157

23. Quoted in Cadzow, “Harder faster richer.” 24. Quoted in Parkinson, “A toll tale,” 52. 25. Macquarie Specialist Funds Quarterly, September 2008, 27 (Macquarie Capital Funds Snapshot). 26. Quoted in Bruce Einhorn, “Way Up Down Under,” Business Week (International Edition) 3954 (October 10, 2005), at 40 . 27. Jenny Anderson, “Australian Bank Pursues Toll Roads and Other Public Works,” New York Times, January 20, 2006, C2. 28. Infrastructure Trust of Australia Group, Annual Report 1997, 7, 33–35. 29. Macquarie Infrastructure Group (MIG), Annual Report 2004, 54, 85; MIG, Annual Report 2005, 67 (Note 4(iii) to the Consolidated Financial Statements); MIG, Financial Report for the year ended June 30, 2005, 24 (Note 10(iii) to the Consolidated Financial Statements). 30. For details on Macquarie’s failed efforts to takeover Qantas see Kate Askew and Scott Rochfort, “If you knew Suzie . . . ,” Sydney Morning Herald (Australia), May 26, 2007, Business Section, 41; Danny John, Lisa Murray, Kate Askew, “Up, up, and away,” Sydney Morning Herald (Australia), May 19, 2007, Business Section, 41; Jennifer Hewett, “Crash,” Weekend Australian, May 5, 2007, Finance Section, 33. 31. Robert Clow, “Home and away,” Weekend Australian, January 21, 2006, Finance Section, 31. 32. Macquarie Group Ltd., 2008 Annual Report, 4. 33. Ibid., 2. 34. See, e.g., Rod Myer and Marc Moncrief “Macquarie Bank’s halo is slipping,” Sydney Morning Herald (Australia), October 24, 2005, Business Section, 19. 35. See, e.g., Kate Askew and Lisa Murray, “Macquarie: government by private enterprise,” Sydney Morning Herald (Australia), August 21, 2006, Business Section, 19. 36. Glenda Korporaal, “Chief’s $33.5m takes high finance to record level,” Australian, May 16, 2007, Local Section, 1; Danny John, “Top execs share in pool of $207m,” Sydney Morning Herald (Australia), May 16, 2007, Business Section, 19. 37. Institutional Shareholder Services (ISS), International Proxy Advisory Services, Macquarie Bank Ltd., July 5, 2007. See also Laura Santini, “New Macquarie Critic Derides Pay Plan,” Wall Street Journal, July 5, 2007, C3. Macquarie’s rebuttal is set forth in a letter from Dennis Leong, Macquarie’s Company Secretary, Macquarie Bank Group of Companies to Dean Paatsch, ISS, July 6, 2007, with attached Macquarie Bank Responses to ISS Comments. See also Macquarie

158 / notes

Bank Ltd., Directors’ Report—Remuneration Report for the financial year ended March 31, 2007. 38. Danny John, “MacBank brass stare down revolt,” Sydney Morning Herald (Australia), July 20, 2007, Business Section, 21 and Glenda Korporaal, “Macquarie celebrates another bumper year,” Australian, July 20, 2007, Finance Section, 21. 39. Macquarie Group, Press Release, “Macquarie Group proposes changes subject to shareholder approval,” March 31, 2009. 40. Macquarie Bank, Press Release, “First quarter profit substantially upinternational growth drives income,” July 19, 2007. See also Matthew Stevens, “Despite the setbacks, Moss still calls Oz home,” Australia, May 16, 2007, Finance Section, 33. 4

Macquarie: Its Current Operations and Its Growth Strategy

1. Quoted in Giles Parkinson, “Wizards of Oz,” Institutional Investor (International Edition) 40:11 (November 2006): 86–91, at 88. 2. Quoted in Giles Parkinson, “A toll tale,” Institutional Investor (International Edition) 31:3 (March 2006): 52–58, at 55. 3. See generally Macquarie Bank Ltd., Explanatory Memorandum, Proposal to Restructure the Macquarie Group Which Will Result in a New Non-Operating Holding Company Macquarie Group Limited Becoming the Ultimate Listed Parent Entity of the Group (Explanatory Memorandum), September 13, 2007, 25–35 and Macquarie Bank, 2007 Annual Review, 12–25. 4. Macquarie Bank, 2007 Annual Review, 12. 5. Ibid. 6. Macquarie Bank, Explanatory Memorandum, 35. 7. Dow Jones Business News, “Australia’s Macquarie winds up with Bankers Trust’s Investment Bank,” June 25, 1999. 8. Quoted in Gwen Robinson, “Macquarie takes step forward,” Financial Times (London), June 28, 1999, 30. 9. Macquarie Bank, Press Release, “Macquarie Group to acquire Giuliani Capital Advisors,” March 6, 2007. See also Russ Buettner and Randal C. Archibold, “Giuliani is selling investment firm,” New York Times, March 6, 2007, A18 and Christopher Cooper and Robert Block, “Giuliani sale may portend a Presidential Campaign,” Wall Street Journal, March 6, 2007, A8. 10. Macquarie Bank, Press Release, “Macquarie Bank to acquire ING’s Asian Equities businesses,” March 8, 2004. See also Andrew Hutchings, “Going for broker,” Asiamoney 16:4 (May 2005): 24–26; Anette Jonsson, “Macquarie finds niches for regional expansion,” South China Morning Post (Hong Kong), August 3, 2004, 2; Chris

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11. 12. 13. 14. 15. 16. 17. 18. 19.

20. 21. 22.

23. 24.

25. 26. 27. 28.

29.

30.

Leahy, “Macquarie goes mainstream,” Euromoney 35:421 (May 2004): 46–48. Macquarie Bank, 2007 Annual Review, 18. Ibid., 16. Macquarie Specialist Funds Quarterly, September 2008, 88 (A Global Real Estate Platform). Ibid., 101–114 (Real Estate Funds-Fund Snapshots). Macquarie Bank, 2007 Annual Review, 20. Ibid., 22. Ibid., 24. I have drawn on Macquarie Bank, 2007 Annual Review, 27 and Macquarie Bank 2007 Financial Report, 2–6. Quoted in Bruce Einhorn, “Way up down under,” Business Week (International Edition) 3954 (October 10, 2005), at 40; . Quoted in Francesco Guerrera and Sundeep Tucker, “London calling,” Financial Times (London), November 25, 2005, 15. Macquarie Bank, Explanatory Memorandum, vii. Macquarie Bank, Press Release, “Macquarie Bank Limited to seek shareholder approval for establishment [of a] Non-Operating Holding Company,” August 20, 2007. See also David S. Clarke, Chairman’s Letter, Macquarie Bank, Explanatory Memorandum, iii. Macquarie Bank, Press Release, “Macquarie Bank Limited to seek shareholder approval.” Financial System Inquiry, Final Report (Wallis Report) (Canberra: Australian Government Publishing Service, 1997). For an overview of financial regulation in Australia see V. Edwards and T. Valentine, “From Napier to Wallis,” Economic Record 226:74 (September 1998): 297–312. Wallis Report, 49, 346–348. Financial Sector Legislation Amendment (Restructures) Act 2007, No. 117, 2007. Financial Sector (Transfers of Business) Act 1999, No. 45, 1999. Australian Prudential Regulation Authority, Authority to be a nonoperating holding company of an authorized deposit-taking institution, September 5, 2007, published in Commonwealth of Australia Gazette, No. GN 36, September 12, 2007. Peter Costello, Treasurer, Notice of Approval under section 36C, Financial Sector (Business Transfer and Group Restructure) Act 1999, September 26, 2007, published in Commonwealth of Australia Gazette, No. GN 41, October 17, 2007. Letter, Macquarie Bank Ltd. to Australian Stock Exchange Ltd., October 25, 2007.

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31. Macquarie Bank Ltd. ACN 008 583 542 No. 2, in the matter of Macquarie Bank Ltd. ACN 008 583 542 [2007] FCA 1665, Federal Court of Australia, October 29, 2007 and Macquarie Bank, Press Release, “Macquarie Bank Limited (MBL) advises that it has today received final approval from the Australian Federal Court for Macquarie Group Limited (MGL) to become a non-operating holding company (NOHC) and the ultimate parent company of the Macquarie Group,” October 29, 2007. 32. Macquarie Group, Press Release, “Macquarie combines securities business to form Macquarie Securities,” June 2, 2008. 33. Macquarie Group, Press Release, “Establishment of Macquarie Funds Group,” June 4, 2008. 34. Asiamoney, “Macquarie subjected to stress test,” 18:8 (September 2007): 6. 35. Macquarie Group, 2008 Shareholder Review, 8 (Chairman’s and Managing Director’s Report). 36. Quoted in Lachlan Colquhoun, “Architect who shaped the Macquarie Model,” South China Morning Post (Hong Kong), September 19, 2005, Business Section, 12. See general William Duggan, Strategic Institution: The Creative Spark in Human Achievement (New York: Columbia Business School, 2007) who argued that instead of setting goals first it is better to watch for opportunities with large payoffs at low costs and then set goals. 37. Quoted in Brian Robins, “MacBank halo is slipping,” Sydney Morning Herald (Australia), August 3, 2002, Business Section, 43. 38. Quoted in Guerrera and Tucker, “London calling.” 39. Quoted in Sheridan Winn, “The Quiet Australian Who Is Making a Big Noise in White City and the Isle of Wight,” Independent on Sunday (London), August 14, 2005, Business Section, 5. 40. Quoted in Colquhoun, “Architect who shaped the Macquarie model.” 41. Quoted in Sunday Business (London) “All hail the sage of Sydney,” October 30, 2005, 1. 5 Macquarie: The Creation of Its Infrastructure Funds 1. The experience of France and Spain as modern pioneers in transport privatization is summarized in José A. Gómez-Ibáñez and John R. Meyer, Going Private: The International Experience with Transport Privatization (Washington, DC: Brookings Institution, 1993), 107–144.

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2. Urban Land Institute and Ernst & Young, Infrastructure 2007: A Global Perspective (Washington, DC: Urban Land Institute, 2007), 27, 51. 3. For a summary of privatization in Australia, see The Australian Council for Infrastructure Development, Delivering for Australia: A Review of BOOs [Build Own Operate], BOOTs [Build Own Operate Transfer] Privatisations and Public-Private Partnerships 1988 to 2004, March 2005. 4. EPAC Private Infrastructure Task Force, Final Report (Canberra: Australian Government Publishing Service, September 1995), x. 5. Ibid., 15. 6. Superannuation Guarantee (Administration) Act 1992, No. 111, 1992. Productivity Commission, Superannuation Industry (Supervision) Act 1993 and Certain Other Superannuation Legislation, December 2001, Chapter 2, “The superannuation industry,” summarizes the evolution of the superannuation industry. 7. Australian Prudential Regulation Authority, Annual Superannuation Bulletin, June 2007, 41 (Table 14) and Leslie P. Norton, “Aussie Upstart,” Barron’s, August 7, 2006, 19. 8. Development Allowance Authority Act 1992, No. 99, 1992. 9. Taxation Laws Amendment (Infrastructure Borrowings) Act 1997, No. 104, 1997. For a critical assessment, see Michael West, “Pay Per Trip and then A Whole Lot More,” Australian, October 15, 2005, Features Section, 21; Michael West, “After the Prelims, the Big Stoush,” Australian, October 8, 2005, Finance Section, 36; Michael West, “Tax Breaks ‘Key to Success to Toll Roads,’ ” Australian, September 29, 2005, Finance Section, 23. 10. Jane Cadzow, “Harder Faster Richer,” The Age (Melbourne), October 7, 2006, Good Weekend Section, 28. 11. Quoted in Lachlan Colquhoun, “Architect Who Shaped the Macquarie Model,” South China Morning Post (Hong Kong), September 19, 2005, Business Section, 12. 12. The background on the successful bid leading up to the August 1994 signing of contractual documents is summarized in Prospectus, M2 Motorway, Hills Motorway Trust, The Hills Motorway Ltd. (M2 Prospectus), 4. See also Linda Morris, “Full Speed Ahead for M2 Tollway,” Sydney Morning Herald (Australia), August 27, 1994, News and Features Section, 2; Stephen Bartholomeusz, “Motorway: A trailblazer in investment,” The Age (Melbourne), August 30, 1994, Business Section, 39; Glenn Burge, “M2 listing test for infrastructures,” Sydney Morning Herald (Australia), November 15, 1994, Business Section, 51. 13. The need for the M2 Motorway is set forth in M2 Prospectus, 9, 12.

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14. New South Wales Government, Department of Transport, Integrated Transport Strategy for the Greater Metropolitan Region, January 1995; and New South Wales Government, Department of Planning, Cities for the 21st Century: Integrated Urban Management for Sydney, Newcastle, the Central Coast and Wollongong, January 1995. 15. M2 Prospectus, 4. 16. SBC Warburg Dillon Road (Australia), Hills Motorway Group (HLY) M2 Motorway, 18 September 1997, 4. 17. M2 Prospectus, 23–24. 18. Ibid., 26, 61 (Project Deed—Material changes affecting the Project and Renegotiation of the Project—certain events). 19. Ibid., 4. 20. Ibid., 65–66 (Trust Lease and Trust Concurrent Lease). 21. SBC Warburg Dillon Read (Australia), Hills Motorway Group, 13. 22. M2 Prospectus, 18–19. 23. Ibid., 15. 24. Ibid., 16–17, 44. 25. Ibid., 5, 46–47 (Taxation Report, Blake Dawson Waldron, 7 November 1994). 26. SBC Warburg Dillon Read (Australia), Hills Motorway Group, 14. 27. M2 Prospectus, 6, 23–28. For a critique of the M2 traffic forecasts, see John L. Goldberg, “The Fatal Flaw in the Financing of Private Road Infrastructure in Australia,” Australasian Transport, 12–15, Research Forum (ATRF06) Brisbane, 2006. Macquarie asserted that Dr. Goldberg’s paper failed to note that toll revenue is a function of traffic forecasts and toll rate increases. Macquarie Infrastructure Group (MIG), Response to Dr. John L. Goldberg’s Paper, “Toll Road Operations In Australia: A Critical Examination Of The Financial And Economic Realities,” November 1, 2005. 28. M2 Prospectus, 31. 29. Hills Motorway Group, annual report 98, 83. 30. Infrastructure Trust of Australia Group, Prospectus (ITA Prospectus), October 22, 1996, 8, 18, 22–23, 37, 46. 31. Ibid., 39, 41–42, 45–46. 32. Ibid., 11, 54, 65. 33. Infrastructure Trust of Australia Group (ITA), Annual Report 1998, 52 (Notes to the Financial Statements, Note 19). 34. ITA Prospectus, 11, 88. 35. Ibid., 10, 14, 52, 88, 120–121. 36. Ibid., 22–23, 52, 88. 37. Ibid., 88. 38. ITA, Annual Report 1998, 53 (Notes to the Financial Statements, Note 20). 39. ITA Prospectus, 9. See also ibid., 53.

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40. Australian Accounting Standards Board, AASB 1030, Application of Accounting Standards to Financial Year Accounts and Consolidated Accounts of Disclosing Entities other than Companies, Standard 1030.11, 12/94. 41. ITA Prospectus, 53, 72, 86; ITA, Annual Report 1997, 43–44 (Notes to the Financial Statements, Note 1); ITA, Annual Report 1998, 43 (Notes to the Financial Statements, Note 1). 42. ITA, Annual Report 1997, 23, 40 (Operating Statement), 56 (Financial Structure and Valuation Principles) and ITA, Annual Report 1998, 40 (Operating Statement), 46 (Notes to the Financial Statements, Note 6), 61–62 (Valuation Principles). The revaluation process also generated losses for ITA Group, which wrote down the valuation of its holdings in the Horizon Energy Investment Group from A$170 million at the end of fiscal year 1997 to A$130 million at the end of fiscal year 1998. ITA, Annual Report, 58–59 (Financial Structure and Valuation Principles) and ITA, Annual Report, 40 (Operating Statement) and 46 (Notes to the Financial States, Note 6). 43. David Walker, “Mixed reaction to ITA’s chunk of revaluation,” The Age (Melbourne), February 10, 1998, Business Section, 3. 44. MIG, Annual Report 2001, 76 (Valuation Principles); MIG, Annual Report 2002, 68 (Valuation Principles); MIG, Annual Report 2003, 2, 35, 92 (Valuation Principles). 45. MIG, Annual Report 2001, 76 (Valuation Principles); MIG, Annual Report 2004, 2. 46. MIG, Half Yearly Report 2000, 5–6, 10, 22 (Notes to the Condensed Consolidated Financial Statements, Note 6), 32 (Valuation Methodology); MIG, Annual Report 2001, 17; MIG, Annual Report 2005, 29, 53 (Directors’ Report); MIG, Annual Report 2007, 56, 68–69 (Notes to the Consolidated Financial Statements, Note 6). 47. MIG, Half Yearly Report 2000, 11, 31; MIG, Annual Report 2001, 37, 77. 48. MIG, AAP Company News, “Acquisition of 40% Interest in Cintra,” September 4, 2001 and MIG, Annual Report 2002, 20, 30–31. See also Virginia Marsh, “MIG to acquire stake in Cintra,” Financial Times (London), September 5, 2001, Companies and Finance Section, 31. 49. MIG, Annual Report 2002, 20, 41 (Directors’ Report), 53 (Notes to the Consolidated Financial Statements, Note 4), 68 (Valuation Principles) and MIG, Annual Report 2005, 4 (Chairman’s Report), 67 (Notes to the Consolidated Financial Statements, Note 4 (iv)), 85 (Valuation Principles). 50. MIG, Annual Report 2003, 2–4, 75 (Notes to the Consolidated Financial Statements, Note 4), 92 (Valuation Principles); MIG, Annual Report 2006, 72 (Notes to the Consolidated Financial

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51.

52. 53. 54.

55.

56.

57. 58. 59. 60.

61.

Statements, Note 4(iv)), 97 (Valuation Principles); MIG, Financial Report, June 30, 2007, 2; MIG, Annual Report 2007, 22, 67 (Notes to the Consolidated Financial Statements, Note 5 (iii)); Macquarie Infrastructure Investment Management Ltd. (MIIML), ASX Release, “Macquarie Infrastructure Group: Exercise of Pre-emptive Rights to Acquire Additional 2.5 Percent Interest in the Westlink M7,” August 14, 2008. MIG, Annual Report 2006, 2–4, 28–29, 72 (Notes to the Consolidated Financial Statements, Note 4 (iv)), 97 (Valuation Principles) and MIG, Annual Report 2007, 67 (Notes to the Consolidated Financial Statements, Note (iv)). MIG, Annual Report 2003, 2–3, 67, 77 (Notes to the Consolidated Financial Statements, Note 5), 93 (Valuation Principles) and MIG, Results to December 31, 2007, 28. MIG, Financial Report for the year ending June 30, 2005, 2 and MIG, Annual Report 2006, 62–63. MIG, Annual Report 2002, 52 (Notes to the Consolidated Financial Statements, Note 4); MIG, Annual Report 2003, 74 (Notes to the Consolidated Financial Statements, Note 4); MIG, Annual Report 2004, 66 (Notes to the Consolidated Financial Statements Note 4); MIG, Annual Report 2005, 66 (Notes to the Consolidated Financial Statements, Note 4). MIG, Annual Report 2002, 52 (Notes to the Consolidated Financial Statements, Note 4); MIG, Annual Report 2003, 75 (Notes to the Consolidated Financial Statements, Note 4(i)); MIG, Annual Report 2004, 66 (Notes to the Consolidated Financial Statements, Note 4(i)). Australian Accounting Standards Board, AASB 139, Financial Instruments: Recognition and Measurement, Standards 139.9 and 139.55(a), July 2004. See also Craig Deegan, Australian Financial Accounting, Fifth edition (North Ryde, NSW: McGraw-Hill Australia, 2007), 516–520. Australian Accounting Standards Board, AASB 132, Financial Instruments: Presentation, Standard 132.11. Ibid. Australian Accounting Standards Board, AASB 139.9. MIG, Annual Report 2005, 66 (Notes to the Consolidated Financial Statements, Note 4); MIG, Annual Report 2006, 71 (Notes to the Consolidated Financial Statement, Note 4); MIG, Annual Report 2007, 66 (Notes to the Consolidated Financial Statements, Note 5); MIG, Financial Report June 30, 2008, 36 (Notes to Financial Statements, Note 10). MIG, Annual Report 2005, 66 (Notes to the Consolidated Financial Statements, Note 4); MIG, Annual Report 2006, 71 (Notes to the

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62.

63.

64. 65. 66. 67.

68. 69. 70. 71. 72. 73.

74.

Consolidated Financial Statements, Note 4); MIG, Annual Report 2007, 66 (Notes to the Consolidated Financial Statements, Note 5); MIG, Financial Report June 30, 2008, 36 (Notes to Financial Statements, Note 10). MIG, Annual Report 2006, 71 (Notes to the Consolidated Financial Statements, Note 4); MIG, Annual Report 2007, 66 (Notes to the Consolidated Financial Statement, Note 5); MIG, Financial Report June 30, 2008, 36 (Notes to Financial Statements, Note 10). Australian Accounting Standards Board, AASB 1041, Revaluation of Non-Current Assets, Standard 1041.5.1, July 2001. See also Australian Accounting Standards Board, AASB 1041, Revaluation of Non-Current Assets, December 1999. Australian Accounting Standards Board, AASB 1041.9.1. Australian Accounting Standards Board, AASB 1041.5.5. MIG, Annual Report 2001, 73 (Valuation Principles). See also Craig Deegan, Australian Financial Accounting, Third edition (Roseville, NSW: McGraw-Hill Australian, 2002), 168–172. Australian Accounting Standards Board, AASB 1024, Consolidated Accounts, May 1992 and ASRB 1024, Consolidated Financial Statements, December 1990. See also Deegan, Australian Financial Accounting, Third edition, 759–760. Australian Accounting Standards Board, AASB 1024.9. Australian Accounting Standards Board, AASB 1024.xv. Australian Accounting Standards Board, AASB 1024.xvi. Australian Accounting Standards Board, AASB 127, Consolidated and Separated Financial Statements, AASB 127, July 2004. See also Deegan, Australian Financial Accounting, Fifth edition, 941–945. ITA, Annual Report 1997, 17. MIG, Annual Report 1999, 47, 59 (Valuation Principles); MIG, Half Yearly Report 2000, 21 (Notes to the Condensed Consolidated Financial Statements, Note 6); MIG, Annual Report 2001, 60 (Notes to the Consolidated Financial Statements, Note 4); MIG, Annual Report 2002, 52 (Notes to the Consolidated Financial Statements, Note 4); MIG, Annual Report 2003, 74 (Notes to the Consolidated Financial Statements, Note 4); MIG, Annual Report 2004, 66 (Notes to the Consolidated Financial Statements, Note 4); MIG, Annual Report 2005, 66 (Notes to the Consolidated Financial Statements, Note 4). MIG, Annual Report 1999, 59 (Valuation Principles); MIG, Half Yearly Report 2000, 21 (Notes to the Condensed Consolidated Financial Statements, Note 6); MIG, Annual Report 2001, 60 (Notes to the Consolidated Financial Statements, Note 4); MIG, Annual Report 2002, 52 (Notes to the Consolidated Financial Statements, Note 4); MIG, Annual Report 2003, 71, 74–75 (Notes to the Consolidated

166 / notes

75. 76.

77. 78. 79. 80.

81. 82. 83. 84.

Financial Statements, Notes 2 and 4); MIG, Annual Report 2004, 64, 66, 68 (Notes to the Consolidated Financial Statements, Notes 2 and 4); MIG, Annual Report 2005, 66 (Notes to the Consolidated Financial Statements, Note 4); MIG, Annual Report 2006, 71 (Notes to the Consolidated Financial Statements, Note 4); MIG, Annual Report 2007, 66 (Notes to the Consolidated Financial Statements, Note 5); MIG, Financial Report June 30, 2008, 36 (Notes to Financial Statements, Note 10). Corporations Act (Australia) 2001, No. 50, 2001, 254T. See also ibid., 588G, requiring corporate directors to maintain solvency while making corporate distributions. MIG, 2007 Annual General Meeting presentation, 27, October 2007 and MIG, UK/US Conference presentation, 59, September 2007. MIG, Full Year Results to June 30, 2008, August 21, 2008, 30 (Distribution Policy). MIG, Full Year Results to June 30, 2008, August 21, 2008, 30 (Distribution Policy). MIG, Annual Report 2001, 10, 50, 61 (Notes to the Consolidated Financial Statements, Note 4). MIG, Annual Report 2004, 53, 60, 85 (Valuation Principles) and MIG, Financial Report for the year ended June 30, 2005, 23. MIG, Annual Report 2004, 54, 60, 67 (Notes to the Consolidated Financial Statements, Note 4); MIG, Annual Report 2005, 67 (Notes to the Consolidated Financial Statements, Note 4(iv)); MIG, Solid Track Record of Active Investment, May 2005; MIG, Full Year Results to June 30, 2008, August 21, 2008, 40 (MIG Track Record). See also TollRoadnews, “Cintra to be hispanicized, Macquarie stays in 407ETR,” June 6, 2004. MIG, Annual Report 2004, 84 (Valuation Principles) and MIG, Annual Report 2005, 53, 68 (Notes to the Consolidated Financial Statements, Note 4(vi)). MIG, Full Year Results to June 30, 2008, August 21, 2008, 40 (MIG Track Record). MIG, Annual Report 2005, 4, 53, 66; MIG, Results to June 30, 2005, 24; MIG, Financial Report June 30, 2006, 32. MIG, Investor Presentation, March 27, 2006, 7–9; MIG, Press Release, “MIG Mature Australian Roads Demerger Information and Updated 2007 Distribution Guidance,” June 20, 2006; MIG, Results to June 30, 2006, Portfolio and Capital Management Review, 39; MIG, Annual Report 2006, 4, 63; MIG, Financial Report June 30, 2007, 2; MIG, Annual Report 2007, 56; Sydney Roads Group, Prospectus and Product Disclosure Statement for Staple Securities, June 26, 2006.

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85. Stephen Bartholomeusz, “MIG Spin-off Should Satisfy Disaffected,” Sydney Morning Herald (Australia), March 30, 2006, Business Section, 24. 86. MIG, Annual Report 2007, 56 and MIG, Financial Report June 30, 2007, 2. 87. MIG, Full Year Results to June 30, 2008, August 21, 2008, 40 (MIG Track Record). 88. MIG, Press Release, “Sale of interest in Lusoponte,” September 30, 2008. 89. MIIML, ASX Release, “MIG Announces Sale of Interest in Westlink M7,” December 1, 2008. 90. MIG, Annual Report 2001, 41 and MIG, Annual Report 2002, 32. 91. MIG, Annual Report 2005, 4, 37, 59; MIG, Financial Report for the year ended June 30, 2005, 2; MIG, Annual Report 2006, 36; MIG, Circular to Stapled Security Holders, October 28, 2004, 12–15. Bermuda law allows companies to pay distributions without reporting a profit, provided solvency is preserved. Companies Act 1981 (Bermuda), Section 54. 92. MIG, Annual Report 2005, 53, 59, 60, 79; MIG, Financial Report for the year ending June 30, 2005, 39; MIG, Financial Report, June 30, 2006, 32. 93. I have drawn on MIIML, ASX Release, “M6 Toll £1.03 billion/ A$2.55 Billion Debt Refinancing Complete,” August 24, 2006; MIG, Annual Report 2006, 3, 55; MIG, Annual Report 2007, 68–69; MIG, Financial Report, June 30, 2007, 2–3, 38. See also Peter Smith, “Owner of M6 Toll Operator Pays Itself Pounds 392m,” Financial Times (London), August 26, 2006, National News Section, 2; and Sean Keating, “Emperor’s New Shoes?,” Project Finance 273 (September 2006): 33–34. 94. Quoted in Robert Clow and Michael West, “Road sage,” Australian, October 22, 2005, Finance Section, 33. For a critical assessment, see Merrill Lynch, “Beware ‘Accretive’ Transaction Structures,” December 11, 2006. 95. MIG, Analyst Package 2006, 78 and MIIML, ASX Release, “Macquarie Infrastructure Group: APRR-3Q2007 Revenue and Traffic Results,” October 24, 2007. 96. MIG, Interim Report for the Period Ending December 31, 2007, 8, and MIG, Results to December 31, 2007, February 21, 2008, 32. 97. MIG, Annual Report 2003, 61, 67, 76 and MIG, Annual Report 2006, 77. 98. MIG, Annual Report 2006, 55; MIG, Financial Report June 30, 2006, 2–3; MIG, Press Release, “Securitisation of Future Airport Motorway Cash Flows,” July 8, 2005; MIG, Press Release, “Securitisation of

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Future Interlink Roads and Statewide Roads Cash Flows,” December 20, 2005. 99. MIG, Annual Report 2001, 58. 100. Ibid.; MIG, ASX Release, “MIG Payment of Performance Fee,” July 9, 2001; MIG, Financial Report, June 30, 2002, 3, 39 (Notes to the Consolidated Financial Statements, Note 29). 101. MIG, Annual Report 2002, 50; MIG Prospectus 2002, 48; MIG, Financial Report, June 30, 2002, 3, 39 (Notes to the Consolidated Financial Statements, Note 29). 102. MIG, Annual Report 2002, 34. 103. MIG, Annual Report 2003, 72 and MIG, Financial Report, June 30, 2003, 3, 43 (Notes to the Consolidated Financial Statements, Note 29). 104. MIG, Annual Report 2004, 61, 65; MIG, Financial Report, June 30, 2004, 3, 47 (Notes to the Consolidated Financial Statements, Note 30); MIG, Financial Report for the year ending June 30, 2005, 42. 105. MIG, Financial Report for the year ending June 30, 2005, 1, 42–43 (Notes to the Consolidated Financial Statements, Note 30). 106. MIG, Financial Report for the year ending June 30, 2006, 53–55 (Notes to the Consolidated Financial Statements, Note 28). 107. MIG, Financial Report, June 30, 2007, 47–48 (Notes to the Consolidated Financial Statements, Note 27). 108. MIG, Notice of Annual General Meeting 2006 and Explanatory Notes, 10–11 and MIG, ASX Release, “MIG 2006 AGM Results,” November 27, 2006. 109. MIG, Financial Report June 30, 2008, 59 (Notes to Financial Statements, Note 26). 110. Ibid., 61 (Notes to Financial Statements, Note 26). 111. MIG, Annual Report 2002, 33, 35–36. 112. ASX Corporate Governance Council, Principles of Good Corporate Governance and Best Practice Recommendations, March 2003. 113. MIG, Annual Report 2003, 43. The latest Macquarie statement on Corporate Governance in Macquarie Managed Funds is set forth in Macquarie Group, 2008 Annual Report, 37. 114. MIG, Annual Report 2003, 43–48, 54; MIG, Annual Report 2005, 37–41, 47; MIG, Annual Report 2006, 36–41, 48. 115. MIIML, ASX Release, “Macquarie Infrastructure Group (MIG) Announces Changes to its Corporate Governance Framework and Publication of Management Arrangements,” October 22, 2008. See also Ross Kelly, “Macquarie Shifts Structure of Funds,” Wall Street Journal, October 23, 2008, Money and Investing Section, C6; and Peter Smith, “Macquarie Agrees Shake-up at Fund Boards,” Financial Times (London), Companies International Section, October 23, 2008, 18.

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116. Macquarie Specialist Funds Quarterly, September 2008, 67 (Macquarie Infrastructure Group). 6 Macquarie and the Privatization of Highways in the United States 1. I have drawn on Daniel Klein and John Majewski, “America’s Toll Road Heritage: The Achievements of Private Initiative in the Nineteenth Century,” in Street Smart, ed. Gabriel Roth (New Brunswick, NJ: Transaction Publishers, 2006). See also Daniel B. Klein, “The Voluntary Provision of Public Goods? The Turnpike Companies of Early America,” Economic Inquiry 28:4 (October 1990): 788–812; Daniel B. Klein and Gordon J. Fielding, “Private Toll Roads Learning from the 19th Century,” Transportation Quarterly 46:3 (July 1992): 321–341; Daniel B. Klein and Chi Yin, “Use, Esteem, and Profit in Voluntary Provision: Toll Roads in California, 1850–1902,” Economic Inquiry 34:4 (October 1996): 678–692; Peter Samuel, “The Role of Tolls in Financing 21st Century Highways,” Reason Foundation Policy Study 359, May 2007, 27–28; José A. Gómez-Ibáñez and John R. Meyer, Going Private: The International Experience with Transport Privatization (Washington, DC: Brookings Institution, 1993), 164–168. 2. Klein and Majewski, “America’s Toll Road Heritage,” 296 (Table 12.7, A Rough Tally of the Private Toll Roads). 3. Federal-Aid Highway Act of 1956, Public Law 84–627. For background on the enactment of the Federal-Aid Highway Act of 1956, see Tom Lewis, Divided Highways: Building the Interstate Highways, Transforming American Life (New York: Viking, 1997), 98–123. For background on the Interstate Highway System, see Lewis, Divided Highways; Dan McNicol, The Roads that Built America: The Incredible Story of the U.S. Interstate System (New York: Sterling, 2006); Wendell Cox and Jean Love, “40 Years of the US Interstate Highway System: An Analysis,” American Highway Users Alliance, June 1996. 4. Federal-Aid Highway Act of 1956, Public Law 84–627, Section 209. 5. Federal-Aid Highway Act of 1956, Public Law 84–627, Section 113, adding 23 USC Sections 9a and 9b, subsequently renumbered, Sections 129(a) and 129(b). 6. An Act To permit the granting of Federal aid in respect of certain roads and bridges, Public Law 69–773. See generally, Gary L. Gittings, “Some Financial, Economic, and Social Policy Issues Associated with Toll Finance,” in Transportation Research Record 1107, Private-Sector Involvement and Toll Road Financing in the Provision of Highways (Washington, DC: Transportation Research Board, National Research Council, 1987), 21.

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7. Surface Transportation Assistance Act of 1978, Public Law 95–599, Section 105. 8. The 2005 Safe, Accountable, Flexible, Efficient Transportation Equity Act: A Legacy for Users (SAFETEA-LU), Public Law 109–59. See also CRS Report for Congress, John W. Fischer, Coordinator, “Safe, Accountable, Flexible, Efficient Transportation Equity Act—A Legacy for Users (SAFETEA-LU or SAFETEA): Selected Major Provisions,” October 18, 2005, CRS-11-CRS-12. 9. Ibid., Section 1604(b). 10. Ibid., Section 1604(c). 11. Ibid., Section 1604(a), amending Section 1012(b)(8) of Intermodal Surface Transportation Efficiency Act of 1991, Public Law 102–240. The Congestion Pricing Pilot Program, established by the Intermodal Surface Transportation Efficiency Act of 1991, Section 1012(b), was renamed the Value Pricing Pilot Program by the Transportation Equity Act for the 21st Century, Public Law 105–178, Section 1216(a). For an analysis of the Value Pricing Program, see K.T. Analytics, Inc. and Cambridge Systematics, Inc., Value Pricing Pilot Program: Lessons Learned, Final Report, August 2008. 12. U.S. Department of Transportation, “High Occupancy Vehicle (HOV) Facilities, SAFETEA-LU Section 1121 (23 USC 166)” (December 5, 2008); U.S. Department of Transportation, “Interstate System Reconstruction & Rehabilitation Pilot Program” (December 5, 2008); U.S. Department of Transportation, “Title 23 United States Code (23 U.S.C.) Section 129 Toll Agreements (December 5, 2008). 13. SAFTEA-LU, Section 11143. 14. Department of Transportation, Office of the Secretary of Transportation, Applications for Authority for Tax-Exempt Financing of Highway Projects and Rail-Truck Transfers Facilities, Federal Register 71:3 (January 5, 2006): 642–644. See also FHWA, Innovative Finance Quarterly, “$3.37 Billion in Conditional Private Activity Bond Allocations Made” 13:2 (Spring 2007): 1–2. 15. I have drawn on Macquarie Infrastructure Group (MIG) Analyst Package 2008, 63–66; MIG, Annual Report 2003, 19; MIG, Press Release, “SR125 South Financial Close,” May 23, 2003; MIG, “SR-125 Acquisition Agreement,” September 2, 2002. See also Steve Schmidt, “New Era Tolls for County’s Commuters,” San Diego Union-Tribune, November 16, 2007, News Section, A1; Jeff Ristine, “Company Seeks More Time to be Owner of SR-125 Toll Road,” San Diego UnionTribune, May 31, 2005, Local Section, B2; United States Department of Transportation, Report to Congress on Public-Private Partnerships, December 2004, 155.

notes / 171

16. Pursuant to California Codes §143.1, as amended in 2006, tolls can be collected on the project for forty-five years, up from the original thirty-five years, under specified terms and conditions. 17. Public Law 105–178, 23 U.S.C. §§601–609, as amended by SAFETEA-LU. See also Humberto Sanchez, “Slow Out of the Blocks But TIFIA Still Gets High Marks From Experts, Bond Buyer 336:31128 (April 30, 2001): 1, 5, 8; and U.S. Department of Transportation, Report To Congress, 95–97. 18. Fitch Investors Service, Inc., “Chicago Skyway Toll Bridge Topical Report,” May 19, 1994. 19. 35 ILCS 200/15–60 and 200/9–195. See also Yvette Shields, “Windy City Windfall,” Bond Buyer 305:3201 (November 17, 2004): 1. 20. Elaine Schmidt, “Chicago Skyway Rebuild Ensues in Traffic,” Midwest Construction 5:9 (August 2002): 73; and Jim Sulski, “Riding High,” Chicago Tribune, November 10, 2002, Transportation Section, 1. 21. Chicago Skyway Concession and Lease Agreement, dates as of October 27, 2004, by and between the City of Chicago and Skyway Concession Company LLC (Skyway Concession and Lease Agreement); MIG, Press Release, “MIG with Cintra Announced as Preferred Bidder for Chicago Skyway,” October 17, 2004; MIG, Press Release, “Chicago Skyway Concession and Lease Agreement Signed,” October 28, 2004. 22. Skyway Concession and Lease Agreement, Section 7.1 and Schedule 6. 23. Concession and Lease Agreement for the Chicago Skyway Toll Bridge System, Volume I of II, Maintenance Manual, n.d., Chapter B. Roadway Maintenance, B-8 (Table B.3.3.1: Performance Time Frames.) 24. Skyway Concession and Lease Agreement, Section 6.1. 25. Ibid., Section 4.2 and Schedule 2. 26. Ibid., Section 16.1. 27. Quoted in Gary Washburn, “Skyway toll may go to $2.50,” Chicago Tribunes, October 28, 2004, Metro Section, C1. See also Giles Parkinson, “A toll tale,” Institutional Investor (International Edition) 31:3 (March 2006): 52–58, at 56. 28. TollRoadsnews, “Chicago Skyway Handed Over to Cintra-Macquarie after Wiring $1830M,” January 24, 2005. 29. Moodys.com, “New Issue: Moody’s Upgrades the Rating to As3 From A1 and Revises the Outlook to Stable on the City of Chicago’s $5 Billion of GO Debt Outstanding Credit,” February 9, 2006 (March 11, 2008). 30. John Schmidt (attorney, Mayer, Brown, Rowe and Maw LLP), Transcript, Nightly Business Report, November 24, 2006. 31. Andrew Bary, “Toll-Road Sales,” Barron’s, May 8, 2006, 17–18, 20, at 18.

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32. Parkinson, “A Toll Tale,” 56. 33. See, for example, TollRoadsnews, “Cintra-Macquarie Paid Too Much for the Chicago Skyway—an opinion,” April 14, 2005. 34. Quoted in Parkinson, “A Toll Tale,” 56. 35. Steven Malanga, “How to Keep Our Bridges Safe,” Wall Street Journal, August 4, 2007, A7. 36. I have drawn on MIG, Presentation, Skyway Refinancing, August 17, 2005; MIG, Press Release, “MIG—Refinancing of Skyway Concession Company LLC,” August 17, 2005; Financial Security Assurance Inc., Press Release, “Chicago Skyway Refinancings Completed,” August 17, 2005; MIG, Annual Report 2005, 59 (Overview of Major Transactions). See also TollRoadsnews, “Skyway Refinances with more Debt, Gets 5.9 Percent,” August 17, 2005; Project Finance, “Skyway refinancing” 263 (September 2005): 17; Project Finance, “North American Project Bond Deal of the Year 2005” 267 (February 2006): 48; Maria Matesanz and Joshua Schaff, “Deep Impacts,” Project Finance 276 (December 2006): 40–43; Euromoney, “How Banks are Muscling in on the Monolines’ Infrastructure Business,” Online extra, March 2007 . 37. Deutsche Bank, “Macquarie Infrastructure Group: Pulls Cash Out of Chicago Skyway,” August 17, 2005. 38. Ibid. 39. Mitch Daniels, “For Whom the Road Tolls,” New York Times, May 27, 2006, A23. 40. TollRoadsnews, “Enabling Legislation for Indiana Toll Road Concession Passed,” March 15, 2006. 41. Martine DeAgostino, “Daniels Ready to ‘Start Digging,’ ” South Bend Tribune (Indiana), January 24, 2006, A1. See also James Wensits, “Bauer Vowing to Fight Plan to Lease out the Toll Road,” South Bend Tribune (Indiana), November 14, 2005, A1. 42. Martin DeAgostino, “Toll Road Changes to Private Ownership,” South Bend Tribune (Indiana), June 30, 2006, Local Section, B1. 43. Theodore Kim, “Toll-Road’s ‘Foreign’ Tag Stirs Unease,” Indianapolis Star (Indiana), February 20, 2006, A1. 44. Bary, “Toll-Road Sales,” 18. See also Daniels, “For Whom the Road Tolls.” 45. Indiana Toll Road Concession And Lease Agreement, dated as of April 12, 2006, by and between The Indiana Finance Authority and ITR Concession Company LLC (Indiana Toll Road Concession and Lease Agreement), Section 2.1. See also Project Finance, “North American Transport Deal of the Year 2006,” 277 (February 2007): 34. 46. Project Finance, “Indiana Toll Road,” 272 (July 2006): 18. See also TollRoadsnews, “Cintra-Macquarie Bid of $3.85b for Indiana TR Accepted,” January 23, 2006.

notes / 173

47. Indiana Public Law 47–2006, Section 5, adding Indiana Code 8–14-14, Section 6, adding Indiana Code 8–14-15, and Section 39, adding Indiana Code 8–15.5, Chapter 11. See also Martin DeAgostino, “Lease of Toll Road to Take Effect Wednesday,” South Bend Tribune (Indiana), June 25, 2006, Local Section, B1. 48. Moody’s Investors Service, Inc., “Moody’s Assigns Aa2 Rating to Indiana Finance Authority’s $65 Million Facilities Revenue Bonds, Series 2006A,” August 14, 2006. 49. Indiana Finance Authority, Proposed Rule, Section 13, adding 135 IAC 2–5-2.1 Payment of tolls, Indiana Register 29:2 (November 1, 2005): 603–607. See also Martin DeAgostino, “Road plan unveiled,” South Bend Tribune (Indiana), September 27, 2005, A1; and TollRoadsnews, “Indiana Gov Daniels Says Differences over Toll Road Concession will be Negotiated,” February 28, 2006. 50. First Amendment To The Indiana Toll Road Concession And Lease Agreement, dated as of April 12, 2006, by and between the Indiana Finance Authority and ITR Concession Co. LLC (First Amendment), Sections 1 and 5. 51. Indiana Finance Authority, Emergency Rule, Sections 1 and 2, adding 135 IAC 2.5–1-1 and 2.5–2.1, Article 2.5. Public-Private Agreements, Indiana Register 29:10 (July 1, 2006): 3389–3396. 52. First Amendment, Sections 1 and 5. See also DeAgostino, “Lease of Toll Road to Take Effect Wednesday.” 53. Indiana Toll Road Concession And Lease Agreement, Section 7.1 and Schedule 7.1; First Amendment, Section 6. 54. Concession and Lease Agreement for the Indiana Toll Road, Operating Standards Manual, Volume I of III, Maintenance Manual, E.3.3 and K.3.3. 55. Indiana Toll Road Concession and Lease Agreement, Section 6.1. 56. Ibid., Section 1.1 and 14.1(e). 57. Ibid., Section 14.1. 58. Ibid., Section 14.1(e). 59. Ibid., Section 16.1. 60. Ibid., Sections 4.2 and 5.5 and Schedule 5.5. See also MIG, Presentation, Macquarie Securities Conference, May 2006, 27. 61. I have drawn on MIG, Press Release, “MIG-Cintra Consortium Reaches Financial Close on Indiana Toll Road,” June 30, 2006. See also Project Finance, “North American Transport Deal of the Year 2006”; Project Finance, “Indiana Toll Road”; Euromoney, “How Banks are Muscling in on the Monolines’ Infrastructure Business.” 62. Matesanz and Schaff, “Deep Impacts.” 63. Bary, “Toll-Road Sales,” 18, 20. 64. Keith Benman, “ ‘I-Zoom’ Tolling Hits Northwest Indiana Toll Road in May,” Times (Munster, Indiana), March 21, 2007, A1.

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65. NW Financial Group, LLC, “The Chicago Skyway Sale: An Analytical Review,” May 1, 2006, 7; and NW Financial Group, LLC, “Then There Were Two. Indiana Toll Road vs. Chicago Skyway,” November 1, 2006, 8. See also Dennis Enright, Testimony, PublicPrivate Partnerships: Innovative Financing and Protecting the Public Interest, Hearing Before the Subcommittee on Highways and Transit of The Committee on Transportation and Infrastructure, House of Representatives, 110th Congress, 1st Session, February 13, 2007, 34–36; and Dennis J. Enright, NW Financial Group, LLC, Statement, “Innovative Public Private Partnership Financings and Protection of the Public Interest, Ibid., 86–88. 66. NW Financial Group, LLC, “Then There Were Two,” 8. See also NW Financial Group, LLC, “The Chicago Skyway Sale,” 6. 67. IRC §197(a), (d)(1)(D), (d)(1)(F) and Reg. §1.197–2(b)(8), -2(b)(10) (i). See Victor Hollender, “Privatizing Our Infrastructure: Taxing the Toll or Tolling the Tax,” Tax Notes 122:12 (March 23, 2009): 1479– 1492. 68. IRC §§197(d)(1)(D), (d)(1)(F), (e)(2), and (e)(5)(A) and Reg. §1.197– 2(c)(3). 69. Virginia Highway Corporation Act of 1988, Code of Virginia, Sections 56–535 to 56–552. 70. For background on the Dulles Greenway, see Auditor of Public Accounts, “Dulles Greenway,” n.d. and TollRoadsnews, “Macquarie Buying VA Dulles Greenway for $615m,” 2005–08-30. See also U.S. Department of Transportation, Report to Congress, 153–154; Peter Samuel, “Bringing Back the Turnpikes,” Forbes 155:2 (January 16, 1995): 57–59; Michael Janofsky, “New Toll Road Offers Glimpse at Future,” New York Times, September 29, 1995, A16; David Segal, “Investors’ Hope Ride on Privately Run Toll Road,” Washington Post, July 24, 1995, Financial Section, F5. 71. Fitch IBCA Inc., Press Release, “Fitch IBCA Assigns Dulles Greenway Refunding Conditional Rating,” April 19, 1999; Commonwealth of Virginia, State Corporation Commission, Application of Toll Road Investors Partnership II, L.P., Order Approving Refinancing, Case No. PUF980025, November 24, 1998; MIG, Annual Report 2006, 76–77 (Notes to the Consolidated Financial Statements, Note 6). See also Richard Taliaferro Jr., “Greenway Runs Into Financial Troubles,” Richmond Times Dispatch (Virginia), September 28, 1997, A17; Peter Pae, “Higher Tolls in the Works for Drivers on Struggling Dulles Greenway,” Washington Post, March 29, 1997, Metro Section, B3; Peter Pae, “Struggling Dulles Greenway to Raise Toll,” Washington Post, November 2, 1996, Metro Section, B5; Peter Pae, “Missed Payment Put Dulles Greenway at Risk of Foreclosure,” Washington Post, August 4, 1996, Metro Section, B1.

notes / 175

72. Commonwealth of Virginia, State Corporation Commission, Application of Toll Road Investors Partnership II, L.P., Final Order Approving Refinancing and Amending Certificate of Authority, Case No. PUF010017, November 7, 2001. 73. I have drawn on MIG, Press Release, “MIG to Invest in Dulles Greenway Toll Road, Virginia and Take Operational Responsibility,” August 30, 2005; MIG, Press Release, “Dulles Greenway-Financial Close,” September 9, 2005; MIG, Financial Report, June 30, 2006, 2, 45, 57. See also Giles Parkinson, “Macquarie Gets Stake in Va. Turnpike,” Daily Deal/The Deal, August 31, 2005, Middle Market Section; Humberto Sanchez, “Infrastructure,” Bond Buyer 353:32220 (September 2, 2005): 5; Citigroup, “Macquarie Infrastructure Group: Expanding in the USA,” August, 30, 2005. 74. Commonwealth of Virginia, State Corporation Commission Application of Toll Road Investors Partnership II, L.P., Final Order, Case No. PUE-2006–00081, September 11, 2007; and State Corporation Commission, Division of Information Resources, News Release, “SCC adopts revised tolls for Dulles Greenway,” September 12, 2007. See also Sandhya Somashekhar, “Drivers seeing red over Greenway tolls,” Washington Post, September 17, 2006, Metro Section, C1. 75. Wall Street Journal, “Macquarie Fund’s net falls 59 percent,” August 25, 2006, Money and Investing Section, C4. 76. MIG, Financial Report, June 30, 2007, 2, 28 (Notes to the Consolidated Financial Statements, Note 11). 77. See, for example, Scott Rochfort, “MIG dons Uncle Sam mask for America,” Sydney Morning Herald (Australia), August 25, 2006, Business Section, 21; and Robert Clow, “MIG driven to road sell-off,” Australian, August 25, 2006, Business Section, 19. 78. Macquarie Infrastructure Investment Management Ltd. (MIIML), ASX Release, “Macquarie Infrastructure Group: Expanded On-Market Buy-Back of MIG Securities,” November 24, 2006; MIIML, ASX Release, “Macquarie Infrastructure Group: Completion of Divestment of 50 percent of Macquarie Infrastructure Group’s Interests in Its Four US Tollroads to Macquarie Infrastructure Partners and Expansion of On-market Buy-back up to A$1 billion,” December 18, 2006. See also Florence Chong, “MIG Get the Nod for $1.3bn Buyback,” The Australian, November 28, 2006, Finance Section, 23. 79. MIG, Annual Report 2007, 66–67 (Notes to the Consolidated Financial Statements, Note 5) and MIG, Financial Report, June 30, 2007, 27–29 (Notes to the Consolidated Financial Statements, Note 11). 80. Tyler Duvall, Assistant Secretary for Transportation Policy, U.S. Department of Transportation, Testimony, Public-Private

176 / notes

81.

82.

83. 84.

85.

Partnerships: Innovative Financing and Protecting the Public Interest, 4–6; Tyler D. Duvall, Assistant Secretary for Transportation Policy, U.S. Department of Transportation, Statement, Ibid., 66. Report of the National Surface Transportation Policy and Revenue Study Commission, Transportation for Tomorrow, December 2007, Volume II, 3–12. See also U.S. Department of Transportation, 2006 Status of the Nation’s Highways, Bridges, and Transit: Conditions Performance, Executive Summary, ES–4 and Report To Congress, 3–3. American Society Civil Engineers, “Report card for America’s infrastructure,” 2005, estimated that 27.1 percent of the nation’s bridges were “structurally deficient or functionally obsolete.” Structurally deficient connotes the need for significant maintenance, rehabilitation, or replacement; functionally obsolete means a lack of lane widths, shoulder widths, or vertical clearance adequate to serve traffic demand. See also Malanga, “How to Keep Our Bridges Safe.” U.S. Department of Transportation, 2006 Status of the Nation’s Highways, Bridges, and Transit, Executive Summary, ES-10 and Report To Congress, 6–10, 6–12, 6–18, 6–20. See also Report of the National Surface Transportation Policy and Revenue Study Commission, Transportation for Tomorrow, Volume II, 4–6 to 4–10, 4–24 to 4–26. U.S. Department of Transportation, 2006 Status of the Nation’s Highways, Bridges, and Transit, Executive Summary, x, ES-14 and Report To Congress, 8–4 to 8–5. American Association of State Highways and Transportation Officials (AASHTO), Standing Committee on Finance and Administration, “Report on Long-Term Financing Needs for Surface Transportation,” September 2007, 11–12. See also National Cooperative Highway Research Program, “Future Financing Options to Meet Highway and Transit Needs,” NCHRP Project 20–24(49), December 2006, 2–5 and A4; Colleen Marie O’Connor, “A New Breed of Toll Collector,” Investment Dealers Digest, May 15, 2006, 20–26 (citing John Hasting, head of infrastructure, RBC Capital Markets); Colleen Marie O’Connor, “Wanna Buy a Bridge?,” Investment Dealers Digest, April 3, 2006, 25–27. Report of the National Surface Transportation Policy and Revenue Study Commission, Transportation for Tomorrow, Volume I, 39–42, 44, and Volume II, 5–22. Alternative federal, state, and local transportation revenue sources are analyzed in Ibid., 5–17 to 5–18, 5–24 to 5–30, 5–32 to 5–51. The National Surface Transportation Policy and Revenue Study Commission was established under SAFETEA-LU, Section 1909. National Chamber Foundation of the U.S. Chamber of Commerce, Future Highway and Public Transportation Financing: Phase II, 2005, 30–75, also summarized the short-term and long-term

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86.

87.

88. 89.

funding options. See also AASHTO, “Revenue Sources to Fund Transportation Needs,” September 2007; AASHTO, “Report on Long-Term Financing Needs for Surface Transportation,” 12–16, 18–24; National Cooperative Highway Research Program, “Future Financing Options to Meet Highway and Transit Needs,” Chapter 3.0–7.0. See, for example, Mary E. Peters, “Gas Taxes Are High Enough,” Wall Street Journal, January 18, 2008, A13; and John Hood, “Higher Fuels Taxes Won’t Help Anything,” Investor’s Business Daily, March 25, 2008, A11. Mary Peters, Secretary of Transportation, Remarks, “Anaheim Transportation Intermodal Center News Conference,” Anaheim, CA, February 20, 2008 (December 17, 2008). David Nason, “Beware Road Rage Toll in US, says MIG,” The Australian, September 22, 2006, Finance Section, 21. Felix Rohatyn and Everett Ehrlich, “A New Bank to Save Infrastructure,” New York Review of Books, October 9, 2008, 27–29; Felix G. Rohatyn and Warren Rudman, “It’s Time to Rebuild America,” Washington Post, December 13, 2005, A27; Commission on Public Infrastructure of the Center for Strategic and International Studies, “Guiding Principles for Strengthening America’s Infrastructure,” March 27, 2006. Senators Christopher J. Dodd (D–Connecticut) and Chuck Hagel (R–Nebraska) introduced the proposed National Infrastructure Bank of 2007, S. 1926, 110th Congress, 1st Session, August 1, 2007. See 153:125 Congressional Record, August 1, 2007, S10614–S10615 (Statement of Senator Dodd). 7 Macquarie and the Privatization of Airports Globally

1. The privatization of the British Airports Authority is analyzed in José A. Gómez-Ibáñez and John R. Meyer, Going Private: The International Experience with Transport Privatization (Washington, DC: Brookings Institution, 1993), 212–216 and Anne Graham, “Airport Planning and Regulation in the Untied Kingdom,” in Aviation Infrastructure Performance: A Study in Comparative Political Economy (Washington, DC: Brookings Institution, 2008), 105–106. See also New York Times, “British price airport stock,” July 9, 1987, D4. The common ownership of BAA airports come under attack. In August 2008, the U.K. Competition Commission reported that common ownership of London’s three largest airports by BAA plc had significant anticompetitive effects. In March 2009, it required BAA to sell two of its London airports, Stansted and Gatwick, and one of its main Scottish

178 / notes

2.

3.

4.

5.

airports. Kevin Done, “BAA is ordered to sell three airports,” Financial Times (U.S. edition), March 20, 2009, Companies Section 18; Julia Werdigier and Matthew Saltmarsh, “British regulators’ report suggests the breakup of a major airport operator,” New York Times, August 21, 2008, Business Section, C9; Kevin Done and Michael Peel, “BAA report threatens to muddy the waters,” Financial Times (Asian edition), August 21, 2008, Companies Section, 17; Jonathan Buck, “Regulator urges sale of British airports,” Wall Street Journal, December 18, 2008, Marketplace Section, B2. Graham, “Airport Planning and Regulation in the United Kingdom,” 128–131, analyzed the common ownership issue and concluded that the “competition benefits that could be gained from splitting up the group” outweigh the claim that “a more fragmented ownership would undermine vitally needed investment.” Ibid., 131. David Gillen and Hans-Martin Niemeier, “Comparative Political Economy of Airport Infrastructure in the European Union: Evolution of Privatization, Regulation and Slot Reform,” Centre for Transportation Studies, Working Paper 2007–6, 5; David Gillen and Hans-Martin Niemeier, “Airport Economics, Policy and Management: The European Union,” Comparative Political Economy and Infrastructure Performance: The Case of Airports, Madrid, September 2006, 15 and 48–491 (Table 12 Airport Privatization in Continental Europe); David Gillen and Hans-Martin Niemeier, “The European Union: Evolution of Privatization, Regulation, and Slot Reform,” in Aviation Infrastructure Performance, 41–44. The various types of privatizations, namely, share floatation, trade sale, concession, project finance privatization, and management contract, are summarized in Anne Graham, Managing Airports: An International Perspective (Oxford: ButterworthHeinemann, 2001), 19–27. AAP Newsfeed, “Macquarie Bank purchase of The Portland Group nudges share price,” October 31, 2000 and Macquarie Airports (MAp), Prospectus, July 18, 2002, 30. See also Australian, “Bank stretches wings,” November 1, 2000, 25 and Chris Wright, “Macquarie Takes to the Markets and the Skies,” Asiamoney 13:3 (April 2002): 10–11. Macquarie Bank, ASX Company Announcement, “Underwrites $100m acq of 50% stake in Bristol Intl Airport,” December 20, 2000 and MAp, Prospectus, 35–36. See also Andrea Felsted, “Joint venture to buy Bristol Airport,” Financial Times (London), December 20, 2000, Companies & Finance UK Section, 28; Anthony Hughes, “Macquarie kicks off airport fund with Bristol purchase,” Sydney Morning Herald (Australia), December 21, 2000, Business Section, 22. AAP Company News, “Announces 365m Euro first close of Macquarie Airport Grp,” August 15, 2001. See also Brian Robins, “MAG on runway

notes / 179

6.

7. 8.

9.

10.

11.

with $632m aboard,” Sydney Morning Herald (Australia), August 16, 2001, Business Section, 24; Virginia Marsh, “Airport investment takes off in Australia,” Financial Times (London), August 16, 2001, Companies & Finance Asia-Pacific Section, 27; MAp, Prospectus, 31. Macquarie Bank, ASX Announcement, “Looks to final fund close,” December 13, 2001; AAP Newsfeed, “Macquarie Airports set to buy 24pct of UK airport,” December 13, 2001; MAp, Prospectus, 35–36. See also Brian Robins, “Macquarie Airport Group and $233m of UK asset,” Sydney Morning Herald (Australia), December 14, 2001, Business Section, 24. MAp, Prospectus, 29, 82 and MAp, Annual Report 2002, 20. MAp, Prospectus, 28; and MAp, Press Release, “Macquarie Airports investment opportunities,” April 12, 2002; MAp, Annual Report 2002, 16–19, 42 (Notes to the Consolidated Financial Statements, Note 4(ii)), 44 (Notes to the Consolidated Financial Statements, Note 5), 52; MAp, Annual Report 2003, 46, 52 (Notes to the Consolidated Financial Statements, Note 4(ii)). Macquarie Airports Management Ltd., ASX Release, “Macquarie Airports financial close of disposal of interest in Birmingham Airport,” September 20, 2007 and MAp, Annual Report 2007, 10, 49. See also Financial Times (London), “Macquarie to look at sale of Birmingham stake,” January 15, 2007, Companies UK Section, 19 and Florence Chong, “MAp to quit Birmingham hub,” Australian, January 16, 2007, Finance Section, 17. MAp, Press Release, “Macquarie Airports secures largest shareholding in Sydney’s Kingsford Smith Airport,” June 25, 2002; and Southern Cross Airports Corp., Press Release, “Southern Cross Airport Corporation Consortium wins Sydney’s Kingsford Smith Airport,” June 25, 2002; MAp, Letter to Shareholders, July 12, 2002. See also Reuters News, “Macquarie led group buys Sydney Airport,” June 25, 2002. MAp, Prospectus, 46–47, describes the acquisition of its interest in the Sydney Airport. See, e.g., Stephen Bartholomeusz, “Macquarie must test its own sales pitch and the reward may be huge,” The Age (Melbourne), August 14, 2002, Business Section, 3; Brian Robins, “MacBank halo is slipping,” Sydney Morning Herald (Australia), August 3, 2002, Business Section, 43; Brian Robins, “Infrastructure growth engine mangles the smooth Macquarie message,” Sydney Morning Herald (Australia), July 27, 2002, Business Section, 48; Stephen Bartholomeusz, “Macquarie needs to pass next test to prove it is indeed a fast learner,” The Age (Melbourne), July 17, 2002, Business Section, 3; Brian Robins, “Giant bid beats off foes but fuels failure predictions,” Sydney Morning Herald (Australia), June 26, 2002, News and Features Section, 7; Fiona

180 / notes

12. 13.

14.

15. 16. 17.

18. 19.

20.

21.

Haddock, “Why Is It Open Season on Macquarie?,” Asiamoney 13:8 (September 2002): 25–29. Quoted in Robins, “MacBank halo is slipping.” Macquarie Bank Ltd., Presentation to Macquarie Bank Annual General Meeting, Allan Moss, Managing Director, July 25, 2002, 24–26. See also Florence Chong, “Macquarie executives feel pay chill,” The Australian, July 26, 2002, Finance Section, 19; Stephen Downie, “Investors with altitude put MacBank in fryer,” Daily Telegraph (Sydney), July 26, 2002, Finance Section, 90. Brian Robins, “Macquarie back with a vengeance,” The Age (Melbourne), June 16, 2004, Business Section, 6; Brian Robins, “Fat and hungrier than ever,” Sydney Morning Herald (Australia), June 12, 2004, Business Section, 43. Quoted in Haddock, “Why Is It Open Season on Macquarie?,” 28. Macquarie Bank, Press Release, “Macquarie Bank selldown of Macquarie Airports (MAp) Securities,” January 22, 2003. Quoted in Brian Robins, “Bid a flight of fancy—or sleight of hand?,” Sydney Morning Herald (Australia), June 29, 2002, Business Section, 47. See also MAp, Prospectus, 8, 59, 76–77; MAp, Annual Report 2002, 6, 12; MAp, Sydney Airport Institutional and Analyst briefing, Presentations by Kerrie Mather, Chief Executive Officer of MAp, and Max Moore-Wilton, Executive Chairman and Chief Executive Officer of Sydney Airport, July 30, 2003; MAp, Letter to Shareholders, July 12, 2002. See further Andrew White and Richard Gluyas, “How a $5.6bn deal got airborne,” Weekend Australian, June 29, 2002, Local Section, 1 and Stephen Bartholomeusz, “Macquarie will open up revenue streams from Sydney Airport’s deal,” The Age (Melbourne), June 26, 2002, Business Section, 3. Scott Rochfort, “Banking on A,” Sydney Morning Herald (Australia), February 4, 2006, News and Features Section, 32. MAp, Press Release, “MAp welcomes appointment of Max MooreWilton AC as CEO/Executive Chairman of Sydney Airport,” December 18, 2002 and MAp, Press Release, “Sydney Airport appoints new CEO & MAp appoints new chairman,” January 20, 2006. See also Brian Robins, “MAp get Max-imum thrust,” Sydney Morning Herald (Australia), December 21, 2002, Business Section, 35. MAp, Press Release, “MAp welcomes Sydney Airport and Virgin Blue T2 agreement,” November 6, 2002; Sydney Airport Corp. Ltd., Press Release, “Sydney Airport and Virgin Blue Reach Agreement on T2,” November 6, 2002; Southern Cross Airports Corp. Holdings Ltd. (Southern Cross Holdings), Annual Report, 3, 6, 14. Re: Virgin Blue Airlines Pty. Ltd., 195 F.L.R. 242 (Australian Competition Tribunal 2005), appeal dismissed, Sydney Airport Corp. Ltd. v. Australian Competition Tribunal, 155 F.C.R. 124

notes / 181

22.

23.

24. 25. 26.

27.

28. 29.

(Federal Court of Australia, 2006). See also Richard Gluyas and Steve Creedy, “Airport ‘misused its power’,” The Australian, December 10, 2005, Local Section, 1; “Airport’s wings clipped,” Lawyers Weekly (Australian edition), February 3, 2006 ; Steve Creedy, “Sydney Airport loses grip on fees,” The Australian, October 19, 2006, Finance Section, 26. Australian Government Productivity Commission, Review of Price Regulation of Airport Services, Productivity Commission Inquiry Overview, No. 40, 14 December 2006. The monitoring regime is analyzed in Peter Forsyth, “Airport Policy in Australia and New Zealand: Privatization, Light-Handed Regulation, and Performance” in Aviation Infrastructure Performance, 85–93. Southern Cross Holdings, Annual Report, 3, 5–6, 9, and Southern Cross Holdings, Annual Report 2007, 13, 17. For a critique of Southern Cross’s operation of the Sydney Airport, see Jenny Stewart, “Runways and checkouts,” Canberra Times (Australia), January 15, 2007, A9. See also Cameron Gordon, Mark Hughes, and Andrew Read, “Is there ‘value for money’ in transportation PPP’s?: The case of Macquarie and Sydney International Airport,” Paper Presented at Transportation Research Board, 86th Annual Meeting, January 21–25, 2007. Quoted in Giles Parkinson, “A Toll Tale,” Institutional Investor (International Edition) 31:3 (March 2006): 52–58, at 57. MAp, Prospectus, 46–47, 107–108 and MAp, Annual Report 2002, 26–27, 41–42 (Notes to the Consolidated Financial Statements, Note 4(i)–(ii)). MAp, Press Release, “MAp acquires 3.43% stake in MAG from Abbey National for €$17.15m,” August 4, 2003; MAp, Press Release, “Macquarie Airports completes acquisition of additional stake in Sydney Airport,” July 22, 2003; MAp, Annual Report 2003, 41, 46, 51, 52 (Notes to the Consolidated Financial Statements, Note 4(ii)). MAp, Press Release, “Macquarie Airports completes acquisition of additional stake in Sydney Airport,” November 18, 2003; MAp, Press Release, “MAp to acquire additional 4.96% stake in Sydney Airport to be funded via $119 million placement,” November 12, 2003; MAp, Annual Report 2003, 41, 46, 51 (Notes to the Consolidated Financial Statements, Note 4(i)). MAp, Press Release, “MAp offer to acquire shares in Macquarie Airports Group (MAG),” February 24, 2004. MAp, Prospectus, 35, 107; MAp, Press Release, “Macquarie Airports offer to Macquarie Airports Group (MAG) shareholders,” March 19, 2004; MAp, Annual Report 2004, 48; MAp, Annual Report 2005, 65; Macquarie Airports Management Ltd., ASX Release, “Restructure of Macquarie Airports Group and increased investment in Bristol Airport,” May 16, 2008.

182 / notes

30. MAp, Press Release, “Sydney and Bristol Airport options,” June 27, 2006; TICkETS, Entitlement Offer, Macquarie Airports Reset Exchange Securities Trust, July 20, 2006; MAp Annual Report 2007, 49. 31. See generally, Paul Smith, “BIG MAC Gets Bigger,” Airfinance Journal 292 (July 2006): 34–35. 32. MAp, Prospectus, 108. 33. MAp, Press Release, “Southern Cross Airport Corporation Holdings produces strong 1st quarter result,” October 21, 2002. 34. MAp, Annual Report 2004, 8 and Sydney Airport, Media Release, “Sydney Airport announces successful completion of $3.155 billion refinancing,” September 13, 2004. 35. MAp, 2005 Interim Results Presentation, August 24, 2005, 16 and MAp, Annual Report 2005, 31. 36. Sydney Airport, Media Release, “Successful completion of senior debt refinancing,” 18 December 2006; Macquarie Airports Management Ltd. (MAML), ASX Release, “Macquarie Airports notes announcement of Sydney Airport hybrid issue and progress of senior debt refinancing,” November 8, 2006; MAp, Annual Report 2006, 11; Southern Cross Holdings, Annual Report 2007, 63. 37. MAML, ASX Release, “Macquarie Airports notes announcement of Sydney Airport hybrid issue and progress of senior debt refinancing,” November 8, 2006. 38. MAML, ASX Release, “Macquarie Airports—First quarter 2009 results for Sydney Airport,” April 24, 2009; Sydney Airport, Media Release, “Three months to March 2009 Financial Results for Sydney Airport,” April 24, 2009; MAML, ASX Release, “Macquarie Airports—Sydney Airport capital management,” February 23, 2009; Sydney Airport, “Funding finalised for 2009 financing requirements,” February 23, 2009; MAML, ASX Release, “Macquarie Airports—Sydney Airport successful arrangement of capital expenditure funding,” November 26, 2008; Sydney Airport, Media Release, “Successful arrangement of capital expenditure funding,” November 26, 2008. 39. MAp, Press Release, Letter to Shareholders re Rome Acquisition, July 19, 2002; MAp, Press Release, “Acquisition of Aeroporti di Roma announcement,” July 16, 2002; MAp, Press Release, “MAp confirms acquisition of Rome Airport and AdR 2002 results,” March 25, 2003. 40. MAp, Prospectus, 18. See also Aeroporti di Roma S.p.A. Sale and Purchase Agreement, ibid., 177–179 and Macquarie Airports Luxembourg S.A. Shareholders’ Agreement, ibid., 184–186. 41. MAp, Annual Report 2003, 47. A summary of the convertible loan agreement is set forth in MAp, Prospectus, 188–191.

notes / 183

42. MAp, Annual Report 2005, 33. 43. MAp, Annual Report 2006, 29. 44. MAp, Annual Report 2007, 49; MAML, ASX Release, “Macquarie Airports financial close of disposal of interest in Aeroporti Di Roma,” July 19, 2007; AAP Newsfeed, “Macquarie Airports sells out of Rome for $1.96 bln,” June 18, 2007; Paul Betts, “Italy’s pyrrhic victory,” Financial Times (London), June 19, 2007, Companies International Section, 24; Andrew Trounson, “MAp to weigh Rome airports,” Australian, June 11, 2007, Finance Section, 27; Reuters News, “Rome airport investors head to mediation after row,” May 8, 2007. 45. MAp, Annual Report 2004, 18, 48–49; MAp, Press Release, “Consortium successful in bid for Brussels Airport,” November 9, 2004; MAp, Acquisition of Brussels Airport, November 2004. See also Kevin Done, “Macquarie wins race to control Brussels airport,” Financial Times (London), November 9, 2004, Companies Europe Section, 28; Peter Trute, “Strong response to MAp capital raising,” AAP Newsfeed, November 10, 2004. 46. MAp, Annual Report 2004, 62 (Notes to the Consolidated Financial Statements, Note 4(vii)). 47. MAp, Financial Report for the Year Ended 31 December 2007, 54 (Notes to the Financial Statements, Note 16(3)). See also Project Finance, “BIAC: Just the TICKETS” 258 (March 2005): 18 and Project Finance, “EMEA Acquisition Financing Deal of the Year 2005” 268 (March 2006): 43. 48. MAp, Annual Report 2007, 49; MAML, ASX Release, “Macquarie Airports increased shareholding in Brussels Airport,” October 23, 2007; AAP Newsfeed, “MAp picks up 3.2 pct stake in Brussels Airport, outlook positive,” August 29, 2007; MAp, Press Release, “MAp purchases additional interest in Brussels Airport,” September 1, 2006. 49. MAp, Annual Report 2007, 24; MAML, ASX Release, “Macquarie Airports successful refinancing of Brussels Airport,” June 21, 2007; MAp, Financial Report for the Year Ended 31 December 2007, 55 (Notes to the Financial Statements, Note 16(10)). 50. MAML, ASX Release, “Macquarie Airports financial close of disposal of partial interests in Brussels and Copenhagen airports,” November 6, 2008. 51. MAp, Annual Report 2005, 22–23, 64; MAp, Press Release, “MAp acquires 11.3% of Copenhagen Airports A/S,” February 16, 2005; MAp, Investment in Københavns Lufthavne A/S, February 2005. 52. MAp, Press Release, “Macquarie airports launches recommended tender offer for Copenhagen airports,” October 24, 2005; MAp, Recommended Tender Offer, Københavns Lufthavne (Copenhagen Airports), October 24, 2005; Macquarie Airports Copenhagen

184 / notes

53. 54.

55. 56. 57. 58. 59. 60.

61. 62. 63. 64. 65. 66. 67. 68.

ApS, Recommended tender offer to the shareholders of Københavns Lufthavne A/S (Copenhagen Airports A/S), October 24, 2005; MAML, ASX Release, “Macquarie Airports: Completion of the recommended tender offer for Københavns Lufthavne A/S,” December 14 , 2005. See also Patricia Koza, “Macquarie lands Copenhagen Airports,” Daily Deal, October 25, 2005, M and A Section and Airfinance Journal, “Happy Landings” 288 (March 2006): 16–19. MAp, Annual Report 2007, 10–11, 49. MAML, ASX Release “Macquarie Airports interest in ASUR,” August 20, 2008; MAML, ASX Release, “Macquarie Airports interest in ASUR,” September 9, 2008; MAML, ASX Release, “Macquarie Airports interest in ASUR,” September 16, 2008. MAML, ASX Release, “Macquarie Airports financial close of disposal of partial interests in Brussels and Copenhagen airports,” November 6, 2008. MAp, Annual Report 2005, 63 and MAp, Financial Report for the Year Ended 31 December 2005, 4. MAp, Annual Report 2003, 48 (Notes to Consolidated Financial Statements, Note 1 (c)). MAp, Annual Report 2003, 39; MAp, Annual Report 2004, 47; MAp, Annual Report 2005, 62; MAp, Annual Report 2006, 57. MAp, Annual Report 2007, 47. MAp, Financial Report for the Year Ended 31 December 2004, 23 (Notes to Consolidated Financial Statements, Note 10). The Southern Cross Holdings Shareholders’ Agreement is set forth in MAp, Prospectus 166–174. MAp, Financial Report for the Year Ended 31 December 2005, 40 (Notes to the Financial Statements, Note 15(b)). MAp, Financial Report for the Year Ended 31 December 2007, 40 (Notes to the Financial Statements, Note 9(i)). MAp, Annual Report, 2003, 39; MAp, Annual Report 2004, 47; MAp, Annual Report 2005, 62. MAp, Annual Report 2004, 47; MAp, Annual Report 2005, 62; MAp, Annual Report 2006, 57. MAp, 2007 Final Results, February 20, 2008, 8. Macquarie Specialist Funds Quarterly, September 2008, 65 (Distribution Coverage). MAp, Prospectus, 31–32, 212–213. MAp, Financial Report for the Year Ended 31 December 2003, 33 (Notes to the Consolidated Financial Statements, Note 21); MAp, Financial Report for the Year Ended 31 December 2004, 33 (Notes to the Consolidated Financial Statements, Note 23); MAp, Financial Report for the Year Ended 31 December 2005, 51 (Notes to the

notes / 185

69. 70.

71. 72.

73. 74.

Financial Statements, Note 26); MAp, Financial Report for the Year Ended 31 December 2006, 74 (Notes to the Financial Statements, Note 27); MAp, Financial Report for the Year Ended 31 December 2007, 69 (Notes to the Financial Statements, Note 24). MAp, Annual Report 2002, 21; MAp, Annual Report 2003, 34; MAp, Annual Report 2004, 43, 49. MAp, Annual Report 2004, 54, 61 (Notes to the Consolidated Financial Statements, Notes 4(ii)); MAp, Financial Report for the Year Ended 31 December 2004, 33 (Notes to the Consolidated Financial Statements, Note 23); MAp, Financial Report for the Year Ended 31 December 2005, 51 (Notes to the Financial Statements, Note 26); MAp, Financial Report for the Year Ended 31 December 2006, 74 (Notes to the Financial Statements, Note 27); MAp, Financial Report for the Year Ended 31 December 2007, 69 (Notes to the Financial Statements, Note 24). MAp, Prospectus, 32–33, 214–215. MAp, Annual Report 2002, 21; MAp, Annual Report 2003, 4; MAp, Financial Report for the Year Ended 31 December 2003, 33 (Notes to the Consolidated Financial Statements, Note 21); MAp, Annual Report 2004, 54; MAp, Annual Report 2005, 66; MAp, Financial Report for the Year Ended 31 December 2005, 51 (Notes to the Financial Statements, Note 26); MAp, Financial Report for the Year Ended 31 December 2006, 74 (Notes to the Financial Statements, Note 27); MAp, Financial Report for the Year Ended 31 December 2007, 69 (Notes to the Financial Statements, Note 24). MAp, Financial Report for the Year Ended 31 December 2007, 69 (Notes to the Financial Statements, Note 24). Ibid., 70 (Notes 24 to the Financial Statements, Note 24). In determining the independence of a director sitting on MAp boards, its responsible entity looks to Macquarie’s fund policy previously discussed in chapter 5. See, e.g., MAp, Annual Report 2006, 42–45. In 2009, MAp implemented further changes in its governance framework, giving the Macquarie Group a less direct role in MAp’s management. Under the new arrangements, MAp security holders can nominate and vote on all directors to MAp boards. Previously, the Macquarie Group nominated and appointed most directors of the MAp boards. Macquarie also intends to abstain from voting the securities it holds in MAp in relation to the appointment of MAp directors and financing decisions requiring security holder approval. MAML, ASX Release, “Macquarie Airports changes to corporate governance framework and publication of management arrangements,” October 22, 2008. See also Ross Kelly, “Macquarie shifts structure of funds,” Wall Street Journal, October 23, 2008, Money and Investing Section, C6.

186 / notes

75. MAp, Prospectus, 90, 156; MAp, Financial Report for the Year Ended 31 December 2002, 33, 34 (Notes to the Consolidated Financial Statements, Note 22). 76. MAp, Annual Report 2003, 41; MAp, Financial Report for the Year Ended 31 December 2003, 34 (Notes to the Consolidated Financial Statements, Note 21). 77. MAp, Financial Report for the Year Ended 31 December 2004, 34 (Notes to the Consolidated Financial Statements, Note 23). 78. MAp, Financial Report for the Year Ended 31 December 2005, 53 (Notes to the Financial Statements, Note 26). 79. MAp, Financial Report for the Year Ended 31 December 2006, 76 (Notes to the Financial Statements, Note 27). 80. MAp, Financial Report for the Year Ended 31 December 2007, 71 (Notes to the Financial Statements, Note 24). 81. Federal Aviation Reauthorization Act of 1996, Public Law 104–264, Section 149. 82. Department of Transportation, Federal Aviation Administration, Airport Privatization Pilot Program: Application Procedures, Federal Register 62:179 (September 16, 1997): 48693–48708 and Federal Register 62:228 (November 26, 1997): 63211–63213. 83. 49 USC §§47107 and 47152. 84. Public Law 104–264, Section 149, adding 49 USC §47134(b)(2). 85. 49 USC §§47107(b) and 47133. 86. Public Law 104–264, Section 149, adding 49 USC §47134(b)(1) and (3). 87. Public Law 104–264, Section 149, adding 49 USC §47134(g). 88. Public Law 104–264, Section 149, adding 49 USC §47134(c). 89. NYSDOT in the News, “Governor Pataki: Stewart Airport Privatization Takes Off (Orange County),” March 21, 2000 and NYSDOT in the News, “Governor Pataki Hands Stewart Airport Keys to National Express (Orange County),” March 31, 2000. 90. Stewart International Airport, Final Application Under the Airport Privatization Pilot Program, January 8, 1999; National Express Group PLC (National Express), Press Release, “Lease-Signing of 99 year for Stewart, New York, airport in USA,” September 24, 1999; National Express, Press Release, “Stewart Airport—Update on disposal,” January 26, 2007; National Express, Press Release, “Stewart Airport—sale of operating lease completed,” November 2, 2007. 91. Bob Sechler and Amy Merrick, “Chicago cancels $2.52 billion deal to privatize Midway Airport” Wall Street Journal, April 21, 2009, Marketplace Section, B4; Susan Saulny, “Private Firm Set to Run Chicago Midway Airport,” New York Times, October 1, 2008, A16; Susan Carey, “Citigroup, Investors to Assume Lease

notes / 187

92. 93. 94.

95. 96. 97. 98. 99. 100. 101.

of Chicago Airport,” Wall Street Journal, October 1, 2008, Marketplace Section, B4; Susan Chandler, “What Happens When the City Leases Public Assets to Private Investors?,” Chicago Tribune, September 7, 2008, 1. 35 ILCS 200/15–185. 50 ILCS 615/20 and 615–40. Robert Poole, “Will Midway Lease Re-Start U.S. Airport Privatization?,” Public Works Financing 212 (January 2007):22 (October 21, 2007) and U.S. General Accounting Office, Airport Privatization: Issues Related to the Sale or Lease of U.S. Commercial Airports, November 1996, GAO/RCED-97–3, 17. Federal Aviation Administration, Report to Congress, National Plan of Integrated Airport Systems (NPIAS) 2007–2011, September 2006, 51. Airports Council International, Airport Capital Development Costs 2007–2011, May 2007, 3 (Table 1: Airport Capital Development Cost Estimates by Year and Airport Category). American Society of Civil Engineers, 2005 Report Card for America’s Infrastructure, n.p. Steven A. Morrison and Clifford Winston, “Delayed! U.S. Aviation Infrastructure Policy at a Crossroads,” in Aviation Infrastructure Performance, 31. See, e.g., MAp, Annual Report 2005, 12–13. Macquarie Specialist Funds Quarterly, September 2008, 68. MAML, ASX Release, “Macquarie Airports interim results for the period ended 30 June 2008,” August 20, 2008; MAp, 2008 Interim Results Presentation, August 20, 2008; MAML, ASX Release, “Macquarie Airports intention to commence buyback of MAp Securities,” September 22, 2008; MAp, Special General Meeting, October 17, 2008; MAp, Notices of Meeting, October 17 , 2008; MAML, ASX Release, “Macquarie Airports special general meeting results,” October 17, 2008. See also Iain McDonald, “Macquarie Sells Stakes to Support Buyback,” Wall Street Journal, August 21, 2008, Marketplace Section, B2 and Rebecca Sharp, “Macquarie Airports to Sell Stakes as Watchdog Signals Baa Break-Up,” Financial Times (U.S. edition), August 21, 2008, Companies and Markets Section, 13. In May 2009, Map reduced its forecast payments to investors by 22 percent. MAp, Press Release, “Macquarie Airports Agreement to participate in Japan Airport Terminal Buyback Offer and amended distribution guidance for 2009,” May 19, 2009. See also Bill Lindsay, “Macquarie Airports plans to cut its payout,” Wall Street Journal, May 21, 2009, Money and Investing Section, C2.

188 / notes

8 The Macquarie Model: Looking to the Future 1. Dow Jones Business News, “Chanos Highlights Macquarie as Short Trade,” May 25, 2007. For background on Chanos and Enron, see Bethany McLean and Peter Elkind, The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron (New York: Portfolio, 2004), 319–321. 2. Quoted in Tim Johnston, “As Credit Tightens, Investors Grow Wary of Bank’s Reliance on Debt,” New York Times, August 10, 2007, C5. 3. Quoted in Asiamoney, “Macquarie Subjected to Stress Test” 18:8 (September 2007): 14–16 and Glenda Korporaal, “MacBank Execs Can Afford to Ignore the Critics,” Weekend Australian, July 21, 2007, Finance Section, 37. See also Bethany McLean, “Would You Buy a Bridge from This Man?,” Fortune 156:7 (October 1, 2007): 138–150, at 144, 146. 4. John L. Goldberg, “The Fatal Flaw in the Financing of Private Road Infrastructure in Australia,” Australian Transport Research Forum (ATR06), 2006, 18. 5. Elizabeth Fry and Peter Smith, “Macquarie Feels Subprime Effect,” Financial Times (London), August 2, 2007, Companies International Section, 21; Lyndal McFarland and Iain McDonald, “Another Australian Fund Faces Big Losses from Market Turmoil,” Wall Street Journal, August 1, 2007, Money and Investing Section, C3; Kate Kelly, Liam Pleven, and James R. Hagerty, “Wall Street, Bear Stearns Hit Again by Investors Fleeing Mortgage Sector,” Wall Street Journal, August 1, 2007, A1; Richard Pullin, “Macquarie Flags Losses at Two Funds on Subprime Woes,” Reuter News, July 31, 2007. 6. Ross Kelly, “Macquarie Fortress Fund Winds Its Way Down to Zero,” Wall Street Journal, October 22, 2008, Money and Investing Section, C3; Macquarie Fortress Fund, Interim Investment Update, October 31, 2008; Macquarie Fortress Fund, Interim Investment Update, April 8, 2008. 7. Macquarie Group, Press Release, “Macquarie Group announces $A604m half year profit,” November 18, 2008. 8. Macquarie Group, 2008 Annual Report, 132 (Notes to the financial statements, Note 2x). See also UBS Investment Research, Macquarie Group Ltd., November 12, 2008, 4–8. 9. Cynthia Koons, “Macquarie raises capital after all,” Wall Street Journal, May 2–3, 2009, Marketplace Section, B3 and Macquarie Group, Press Release, “Macquarie Group announces $A604m half year profit.” 10. Macquarie Bank, Press Release, “Macquarie Bank expects record half year result,” September 14, 2007; Macquarie Bank, Press

notes / 189

11. 12. 13. 14.

15.

16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27.

Release, “Macquarie Announces 45% increase in interim profit, transition to new structure,” November 13, 2007; Macquarie Group Ltd., Operational briefings (Allan Moss), February 5, 2008. See also Rebecca Thurlow, “Macquarie Model Dodges Subprime-Crisis Pitfalls,” Wall Street Journal, December 12, 2007, Marketplace Section, B3B and Credit Suisse Equities (Australia) Ltd., Macquarie Group, Equity Research, Half-Yearly Results, November 14, 2007. Laura Santini, “Macquarie’s Flat Earnings May Signal Slower Growth,” Wall Street Journal, May 21, 2008, Money and Investing Section, C3. Thurlow, “Macquarie Model Dodges Subprime-Crisis Pitfalls.” UBS Investment Research, Macquarie Group Ltd., August 26, 2008. Macquarie Group, 2008 Annual Report, 19; Macquarie Group, Management Discussion and Analysis Year Ended March 31, 2008, 6 (Table 1.2 Segment Analysis), 11. See also Florence Chong, “MacGroup Puts Its US Sub-Prime Losses at $300m,” The Australian, May 21, 2008, Finance Section, 31. Macquarie Group Ltd., Result Announcement for Year Ended 31 March 2008, Presentation to Investors and Analysts, May 20, 2008, 19 (Fee and commission income). See also Andrew Peaple, “Macquarie Must Resell Backers on Its ‘Model’,” Wall Street Journal, May 21, 2008, Money and Investing Section, C16. Macquarie Specialist Funds Quarterly, September 2008, 59 (Macquarie and Macquarie Capital Funds). Macquarie Group, Management Discussion and Analysis, Half Year Ended, September 30, 2008, 7–8. Ibid., 8. Letter, John Roberts, Executive Director, Macquarie Capital Funds to Marc Siegel, Risk Metrics, May 14, 2008. Deutsche Bank, “Macquarie Bank: Pay for performance,” July 14, 2007, 3–4. Macquarie Specialist Funds Quarterly, September 2008, 51 (Appropriate and Aligned Fee Structure). See, e.g., RiskMetrics Group, Infrastructure Funds: Managing, Financing and Accounting, April 2008, 22. McLean, “Would You Buy?” 150. Macquarie Specialist Funds Quarterly, September 2008, 39 (Evidence of Investment Discipline). See, e.g., RiskMetrics Group, Infrastructure Funds, 22. Quoted in Peter Smith, “Macquarie Chief Hits Back at Critics over Leverage,” Financial Times (London), October 16, 2007, Companies and Markets Section, 15. Macquarie Infrastructure Group (MIG), 2008 Annual General Meeting, October 22, 2008, 20 (Appropriate gearing).

190 / notes

28. 29. 30. 31. 32. 33.

34. 35. 36. 37. 38. 39. 40. 41. 42. 43.

Ibid., 21 (Prudent hedging of interest expense). Ibid., 12 (Solid performance, strong position). McLean, “Would You Buy?,” 148–150. MIG, Response to Goldman Sachs JB Were Equity Portfolio Strategy Article, February 15, 2006. Macquarie Specialist Funds Quarterly, September 2008, 43 (Businesses Demonstrate Resilient Operating Performance and Sustainable Cash Flows). MIG, Interim Report for the Period Ended 31 December 2008, 4 (Major Asset Performance) and MIG, 2008 Annual General Meeting, 14 (Continued revenue growth in FY2009). For the month of April 2009, Macquarie Airports reported the following passenger traffic declines in comparison to April 2008: Copenhagen, 9.6 percent; Brussels, 5.4 percent; Bristol, 14.4 percent. In contrast, Sydney passenger traffic increased by 1.0 percent during the same period. Macquarie Airports Management Ltd. (MAML), ASX Release, “MAp Reports on Traffic Performance at Its Airports to April 2009,” May 19, 2008. For the three months to March 31, 2009, MAp reported earnings before interest, taxes, depreciation, and amortization from its four key holdings in comparison to the same period in 2008 as follows: Sydney, plus 2.2 percent; Copenhagen, minus 22.1 percent; Brussels, minus 24.2 percent; Bristol, minus 29.8 percent. MAML, ASX Release, “MAp First Quarter Results for Core Portfolio,” April 28, 2009. See, e.g., Merrill Lynch, Macquarie Infrastructure Group: Beware “accretive” transaction structures, December 11, 2006. MIG, Response to Bethany McLean’s Article: “Would You Buy a Bridge from This Man” in Fortune Magazine, October 8, 2007. Quoted in McLean, “Would You Buy?” 144. See also RiskMetrics Group, Infrastructure Funds, 8, 15–16. Macquarie Specialist Funds Quarterly, September 2008, 65 (Distribution Coverage). MIG, 2008 Annual General Meeting, 23 (Distributions). Merrill Lynch, Macquarie Bank, More “Holey Dollars,” January 18, 2007, 13–14. See, e.g., RiskMetrics Group, Infrastructure Funds: Managing, Financing and Accounting, April 2008, 26–27. MIG, Financial Report for the Year Ended 30 June 2007, 20–21 (Notes to the Consolidated Financial Statements, Note 2). TollRoadsnews, “Macquarie Tollroad Writedowns Evoke Extreme Excitement Downunder,” August 21, 2008 (December 8, 2008). See, e.g., Michael Wilkins, “The Amazing Growth of Global Infrastructure Funds: Too Good to Be True?,” in Standard and Poor’s,

notes / 191

44. 45. 46. 47. 48.

Corporate Securitization Ratings, Reaching New Frontiers, Global Credit Survey 2007, February 2007, 56. Probitas Partners, Infrastructure Market Review and Institutional Investor Survey, October 2008, 2. In 2007, infrastructure funds raised $34.3 billion. Ibid. I have drawn on Ryan J. Orr, “The Rise of Infra Funds,” Project Finance International-Global Infrastructure Report 2007, Supplement, June 2007: 2–12. Mary Beth Corrigan et al., Ten Principles for Successful Public/Private Partnerships (Washington, DC: ULI—the Urban Land Institute, 2005). Nelson D. Schwartz and Ron Nixon, “Privatizing the Prize,” New York Times, October 14, 2007, Business Section, 1. Quoted in Giles Parkinson, “A Toll Tale,” Institutional Investor (International Edition) 31:3 (March 2006): 52–58, at 58.


I n de x

Abbey National Bank, 118 Abigroup Ltd., 61 accounting standards, Australian Accounting Standards Board Standards 127, 71; 139, 69–70; 1024, 70–71; 1030, 64–65, 69; 1041, 70 adjacency, 51, 58 Aeroporti di Roma, S.p.A., 122, 123 AIE Holdings LLC, 103 Airport Council International, 134 airport governance, United States, 133 Airport Improvement Program grants, 131, 134 Airport Motorway Group, 63, 64, 75, 77 Airport Privatization Pilot Program, 130–133 airports Macquarie and, 8, 110–111, 113, 118, 123 Macquarie Airports, 8, 111–113, 114, 117–120, 122–136 operational model, 110, 133–134 privatization of, 8, 109–110 airports, operational model United States, 133–134 worldwide, 110 airports, privatization United States, 130–134 worldwide, 109–110 Alinta Ltd., 32–33 Ambac Assurance Corp., 121 American Association of State Highway and Transportation Officials, 105 American Recovery and Reinvestment Act, 9

assets refinancings Brussels Airport, 124 Chicago Skyway, 93–95 critique, 147–148 Macquarie and, 7, 75–77, 93–95 Macquarie Infrastructure Group, 75–77 Sydney Airport, 120–121 asset revaluations critique, 148–149 Infrastructure Trust of Australia Group, 64–66 Macquarie and, 7, 64–66, 69–72, 104, 148–149 Macquarie Airports, 125–128 Macquarie Infrastructure Group, 64–66, 69–72, 104 asset sales critique, 147 Macquarie Airports, 123, 124, 125 Macquarie Infrastructure Group, 72–74, 103–174 Australia asset privatization, 6, 54–55 banking, deregulation of, 26–27 commercial banks, restrictions on, 26 concession model, 7 financial systems, deregulation of, 27 foreign exchange controls, deregulation of, 27 retirement system, 7, 55–56 tax changes, 7, 56–57 Australian Competition and Consumer Commission, 116

194 / index Australian Competition Tribunal, 116 Australian Corporations Act of 2001, 47 Australian Financial System Inquiry, 47 Australian Government Productivity Commission, 117 Australian Prudential Regulatory Authority banking regulations, restrictive, 27, 46–47 Macquarie, and, 46–47, 49 Australian Stock Exchange Corporate Governance Council, 80 Autoroutes Paris-Rhin-Rhône, 68, 76, 146 Autostrade International, SpA, 102 BAA plc., 110 Babcock and Brown Ltd., 33 Bankers Trust Australia Ltd., 38–39 bankruptcy, 22 Barron’s, 2, 29 Bauer, B. Patrick, 95 Birmingham Airports Holdings Ltd., 130 Birmingham International Airport asset revalued, 126 Macquarie Airports and, 112 Macquarie Airports Group and, 111, 112 Bristol Airports Bermuda Ltd., 142 Bristol International Airport asset revalued, 126 Macquarie Airports and, 112, 119, 122 Macquarie Airports Group and, 111 Macquarie Bank and, 111 British Airports Authority, 109 Brown and Root, 102 Brussels Airport asset revalued, 126–127 Macquarie Airports and, 2, 109, 123–124, 135, 136, 144 The Brussels Airport Co., 123 Brussels International Airport Corp. NV/SA, 123

Burke, Edward, 91 Caldon, John, 66 California Department of Transportation, 88 Campbell Committee, 27 capital sources privatization and, 14–15, 107–108, 134–135, 150 Chanos, James, 137–138, 147 Chicago Midway International Airport legislative restrictions, 132 privatization announced, 132–133 Chicago Skyway background, 89–90 concession agreement, 90–91 debt refinancing, 75, 78, 93–95, 144 Macquarie and, 7, 89–90, 92, 93, 94 Macquarie Infrastructure Group and, 7, 74, 75, 89, 90, 94, 102, 103–104, 149 Macquarie Securities (USA), Inc., 78 post-privatization changes, 92–93 privatization, 7, 83, 90–92 privatization proceeds, use of, 91 stepped-up interest rates, 146 synergies, 99 Cintra Concesiones de Infraestructuras de Transporte Bristol International Airport, 111 Chicago Skyway, 89, 90, 93, 94 Indiana Toll Road, 96, 98, 99 Macquarie Infrastructure Group and, 67–68, 69, 72 public offering, 72, 75, 78 Citi Infrastructure Investors, 133 Cities for the 21st Century, 58 City Link, 63 Clarke, David Hill Samuel Australia, 25 holding company structure, 46–47 Macquarie Bank, 25 Macquarie Group, 25 competency, 51 competency, impact on Macquarie funds, 149–151 concession model

index / 195 Australia, 6 capital, source of, 14–15 competition, future, 19–20 competitive bidding, 13–14 contact, provisions in, 12–14, 151 efficiency, 15–17 in general, 5, 12 lease payments, 14, 151 length of, 15, 20–21 negotiation, 22–23, 151 operating standards, 13 overview of, 12–14 performance standards, 13 public sector and, 12, 22–23, 151–152 terms of, 12–14 user fees, 17–19 Connect M1-A1 Holdings Ltd., 73 Copenhagen Airport Macquarie Airports and, 109, 124–125, 135, 136, 144 Copenhagen Airports A/S acquired, 124 investments, international, 125 Daniels, Mitchell E. Indiana Toll Road, privatization of, 95, 96 toll collection, cost of, 16 Daley, Richard M., 90 debt refinancing Brussels Airport, 7 Chicago Skyway, 75, 78, 93–95 contract provisions, negotiation of, 19 critique, 147–148 Macquarie and, 7 Macquarie Infrastructure Group, 7, 75–83, 94 Sydney Airport, 120–121 windfalls from, 19, 151 default, 22 Deutsche Bank AG, 38 deleveraging, 121, 136, 143, 145 Develop Australia Bond Program, 56 dividends coverage, 72, 127, 136, 147 legal benchmark, 72, 127 Dobbs, Lou, 20 Dulles Greenway background, 102 Macquarie Infrastructure Group, 7, 68, 74, 84, 102–103, 149

Macquarie Securities (USA), Inc., 77–78 Dulles Greenway Partnership, 102 Economic Planning Advisory Commission, 55 efficiency, privatization and, 15–17 Eisenhower, Dwight, 85 Enright, Dennis J., 100 Express Lanes Demonstration Program, 86 Federal Aviation Administration, 130–131, 133, 134 Federal Highway Administration, 105 Federal Highway Trust Fund in general, 85–86 reauthorization, 86 Ferrovial Aeropuertos, 111 Ferrovial Infrastructuras SA, 119 financial engineering Brussels Airport, 124, 126–127 critique, 147–148 Chicago Skyway, 93–95 Macquarie Infrastructure Group, 69–79 Macquarie and, 7, 63–66, 69–79, 93–95 Rome Airport System, 123, 126 Sydney Airport, 119–122, 126–127 Financial Sector Legislation Amendment (Restructures) Act of 2007, 47 Financial Security Assurance, Inc., 94, 121 Financial Times, 2 Financière Eiffarie SA, 68, 70, 78 FLIERS (Floating IPO Exchangeable Reset Securities), 120, 121 407 ETR, 67, 76, 145, 146, 149 407 International Ind., 67, 70, 72 Four Corners Capital Management LLC, 139 freedom within boundaries, 29 Funds Management Activity Policy, 80 Gemina S.p.A., 122, 123 Global Infrastructure (Sydney Holdings) Pty Ltd., 119

196 / index Giuliani Capital Advisors LLC, 39 Goldberg, John L., 138 governance Macquarie Airports, 185, n. 74 Macquarie Infrastructure Group, 79–80 greenfield projects capital needed, 150 City Link, 63 M2 Motorway, 58–60, 63 M6 Toll Road, 67, 75 South Bay Expressway, 68, 74, 87–88 Grupo Aeroportuario del Sureste de Mexico S.A. de C.V., 125 Grupo Ferrovial S.A. Bristol Airport, 111 Cintra Concesiones de Infraestructuras de Transporte, 68, 73 GS Infrastructure Partners Fund, 149 Hainan Meilan Airports Co. Ltd., 125 high occupancy vehicle lane conversions, 87 Hill Samuel Australia Ltd. founding, 25 operations, 26 Hill Samuel and Co. Macquarie, founding of, 26–27 Macquarie, sale of interest in, 26, 31 merchant bank in Australia, establishment of, 26 Hills Motorway Group Australian Stock Exchange, listing on, 61 concession, term of, 59–60 Hills Motorway Ltd., 60 Hills Motorway Management Ltd., 60 Hills Motorway Trust, 60 Infrastructure Trust of Australia Group, 63 M2 Motorway, 58–60 Macquarie and, 73 Moss, Allan, 58 risk factors, 61 Hills Motorway Ltd., 60 Hills Motorway Management Ltd., 60 Hills Motorway Trust, 60 Hochtief Airport GmbM, 118

holding company structure, 46 Horizon Energy Investment Group Infrastructure Trust of Australia Group, 32 Loy Yang Power Partnership, 32 Macquarie Infrastructure Group, 32 Indiana Finance Authority, 96 Indiana Toll Road concession agreement, 97–98 Macquarie and, 7, 83 Macquarie Infrastructure Group, 7, 68, 74, 103–104 privatization, 7, 95–99 privatization, benefits of, 96–97; financing of, 98–99, 146; politics of, 95–96; proceeds, use of, 96–97 stepped-up interest rates, 146 synergies, 99 ITR Concession Company LLC, 96, 97–98 infrastructure asset class, 3–5, 145–146, 150 asset, selection, 51 investments, comparison with, 4–5 political risk, 5, 152 privatization, policy aspects, 5–6, 14–23, 151–152 sovereign risk, 152 Infrastructure Borrowings Scheme, 56–57 Infrastructure Borrowing Tax Offset Scheme, 56–57 infrastructure fund model critique of, 8, 137–138, 144–151 fees, 3, 142–143 future of, 8–9, 151–152 Infrastructure Trust of Australia Group, 62–66 Macquarie and, 1, 3–5, 8, 31, 38, 62, 63–66, 137–138, 144–151 new sectors and, 51, 152 origins of, 31, 53, 54–57, 62 overview, 3–5, 8–9 Integrated Transport Strategy, 58 Infrastructure Trust of Australia Group assets, initial, 62–63 Australian Stock Exchange, listing on, 62 fees paid, 64

index / 197 fee structure, 63–64 Horizon Energy Investment Group, 32 origins, 7, 31, 62 public offering, 62 stapled security, 62 ING Group, Asian equities business, acquisition, 39 Institutional Shareholder Services, 34 Japan Airport Terminal Co. Ltd., 122 Interlink Roads Pty Ltd., 62–63, 65, 71, 75, 77, 78 Interstate Highway System, 85–86, 104 Interstate System Construction Toll Pilot Program, 86 Interstate System Reconstruction and Rehabilitation Pilot Program, 81 John Hancock Life Insurance Co., 133 Johnson, Mark R. G. Hill Samuel and Co., 25–26 Hill Samuel Australia, 25 Macquarie Bank, 26 Kellogg, Brown and Root, 103 Københavns Lufthavne A/S, 124 Kvaerner Corporate Development Ltd., 66 Kvaerner Investments Ltd., 66 Kynikos Associates, 137 lease payments, privatization and, 14–15, 151 Leonardo Holding S.A., 122, 123 leveraging, critique of, 145–147 London Stock Exchange Group Plc., 32 Loy Yang Power Partnership, 32 Lusoponte Concessionária para a Travessia do Tejo S.A., 67, 69, 70, 74 M2 Motorway concession, terms of, 59–60 construction, 58–59 financing, 60–61 Macquarie, fees, 61–62 risk factors, 61 M6 Toll Road interest rate hedging, 145

Macquarie Infrastructure Group and, 67, 149 refinancing, 75–76 Macquarie, Lachlan, 28 Macquarie Airports, 8, 110–111, 113 background, 1–3, 6, 26–27 Bristol International Airport, 111 cash management trust, 6, 43 compensation system, 33–34 fees, 3, 63–64, 77–79, 128–130, 142–143 highways, U.S., 83, 104, 108 infrastructure assets, 3–5, 56, 83, 145–146 infrastructure fund model, 1, 3–5, 8–9, 38, 62–66, 137–138, 144–151 intellectual capital, 33–35 Moss, Allan, 25, 26, 28–31, 32–34, 35, 37, 45, 47, 50 operations, current, 6, 37–45, 140–143 origins, 26–27 personnel, 33 profits, 33, 140 restructuring, 6, 45–50 risk management, 6, 30, 35, 37, 43–45 Rome Airport System, 123 strategy, current, 50–51, 152 toll roads, privatization, 7, 9, 57, 83, 107–108 transformation, 1–2, 6, 31–32 Macquarie Airports asset revaluations, 125–128 asset sales, 123, 124, 125 Australian Stock Exchange, listing on, 113 Brussels International Airport, acquisition, 109, 123–124; divestiture, partial, 124, 135, 136, 144; funding, 123–124; ownership increased, 124 Copenhagen Airport, acquisition, 109, 124–125; divestiture, partial, 125, 135, 136, 144 corporate structure, 111–112 debt refinancing, 120–121 dividends, coverage, 127, 136, 147 fee structure, 128–129 fees paid, 128–130, 142

198 / index Macquarie Airports—Continued financial engineering, 120–121 investors, returns to, 135 Macquarie Airports Group and, 112, 118–119 Macquarie Bank and, 111, 114, 122 Rome Airport System, acquisition, 109, 122; sale, 122, 123, 144 securities, buy back, 135, 136, 148; prices, 113, 114, 144 Sydney Airport, acquisition, 109, 112–113; debt refinanced, 120–121; operation, 115–117;ownership increased, 117–119 TICkETS, 124, 130, 135, 145 Macquarie Airports Group Ltd. Birmingham International Airport, 111, 112 Bristol International Airport, 111 Macquarie Airports and, 112, 118–119 origins, 111 restructured, 118–119 Rome Airport System, 122 Sydney Airport, 118 Macquarie Airports Holdings (Bermuda) Ltd., 111–112, 122 Macquarie Airports (Brussels) S.A., 123, 124 Macquarie Airports Copenhagen ApS, 125 Macquarie Airports Feeder Trust, 119 Macquarie Airports Ltd., 112 Macquarie Airports Luxembourg S.A., 122, 123 Macquarie Airports Management Ltd., 112, 128, 129 Macquarie Airports Reset Exchange Securities Trust, 124, 130 Macquarie Airports (Sydney Holdings) Pty Ltd., 117–118 Macquarie Airports Trusts No. 1 and 2, 111 Macquarie Autoroutes de France SA, 68 Macquarie Bank Ltd.

acquisitions, 38–39 Airport Motorway Group, 63 airports, privatization, 110–111 Australian Stock Exchange, listing on, 31 banking license, 26, 28 Bristol International Airport, 111 Brussels Airport, 123 culture, 28–31 failures, 32–33 Funds Management Activity Policy, 80 growth, 31–32 Hills Motorway Management Ltd., 60, 62 infrastructure funds, 31–32, 38, 62–66 Infrastructure Trust of Australia Group, 62 logo, 28 Macquarie Airports, 111, 114, 122, 129–130 Macquarie Airports Group Ltd., 111 Macquarie Communications Infrastructure Group, 114 Macquarie Fortress Investments, 139 Macquarie Infrastructure Group, 74–75, 77, 78, 79 mistakes, 32–33 Moss, Allan, 25, 26, 28–31, 32, 34, 35, 37, 45, 47, 50–51 operations, initial, 27; subsequent, 37–43 restructuring, 48 risk management, 30, 35, 43–45 Sydney Airport, 113, 118 Macquarie Capital Advisors Ltd., 79 Macquarie Capital Funds (Europe) Ltd., 75, 112, 128 Macquarie Cash Management Trust, 43 Macquarie Central Office Corporate Restructuring REIT, 41 Macquarie Communications Infrastructure Group, 114 Macquarie Corporate Finance Ltd. Airport Motorway Group, 63 Hills Motorway Trust, 62 Macquarie CountryWide Trust, 41

index / 199 Macquarie DDR Trust, 41 Macquarie Direct Property Fund, 41 Macquarie Equity Capital Markets Ltd., 78, 79, 129 Macquarie European Infrastructure plc, 74 Macquarie European Infrastructure Fund, 119, 123, 125, 127 Macquarie European Infrastructure Fund II, 119 Macquarie European Infrastructure Fund, 3, 124 Macquarie Financial Products Management Ltd., 139 Macquarie Fortress Investment Ltd., 138–139 Macquarie Global Infrastructure Fund, 118, 122 Macquarie Global Infrastructure Fund II, 123 Macquarie Goodman Hong Kong Logistics Fund, 42 Macquarie Group Ltd. Australian Stock Exchange, listing on, 48 Capital Group, 48 credit crisis, impact on, 8, 140–142 growth strategy, 50–51 holding company structure, 48 infrastructure assets, 31–32 infrastructure funds, valuation of, 142 Macquarie Airports, 130 Macquarie Fortress Investments, 139 Macquarie Infrastructure Group, 74–75 management fees, 142–143 Moss, Allan, 47, 50–51 operations, 48 performance, 140 performance fees, 142–143 prospects, 140–143 restructuring, funding of, 49–50 risk management, 43–45, 48 Sydney Airport, 118 unlisted funds, impact of, 143, 150 write-offs, 140, 141–142 Macquarie Infrastructure Bermuda Ltd., 74 Macquarie Infrastructure Canada, Inc., 68

Macquarie Infrastructure Company Trust, 73 Macquarie Infrastructure Group acquisition discipline, 144 assets, 66–69 asset refinancings, 75–77, 94 asset revaluations, 69–72, 104, 148–149 asset sales, 72–74, 103–104 Australia, 7, 67, 68, 73–4 background, 7, 66 Canada, 7, 67 Cintra, 67–68, 69, 72 corporate restructuring, 74–75 Chicago Skyway, 7, 68, 74, 83, 90, 94, 103 dividends, coverage, 72, 147 debt refinancings, 7, 75–77, 94, 147–148 Dulles Greenway, 7, 68, 74, 83, 102–104 fees paid, 72, 77–79, 142 fee structure, 77 financial innovation, 76 Horizon Energy Investment Group, 32 Indiana Toll Road, 7, 68, 74, 83, 98, 103 Interest rate hedging, 145 investors, returns to, 81 leverage, 145 origins, 7, 66 securities, buyback, 75, 148; prices, 144 South Bay Expressway, 83, 87–89, 103–104 stepped-up interest rates, 146 traffic, 146–147 United Kingdom, 7, 67 United States, 7, 83, 87–89, 90, 94, 98, 102–104 Macquarie Infrastructure Group International Ltd., 67, 74 Macquarie Infrastructure Investment Management Ltd., 63, 74 Macquarie Infrastructure Investment Management (UK) Ltd., 74 Macquarie Infrastructure (Luxembourg) S.A., 68 Macquarie Infrastructure Partners, 74, 103–104

200 / index Macquarie Infrastructure (Toll Route) S.A., 68 Macquarie Infrastructure Trusts (I) and (II), 74 Macquarie Infrastructure (U.K.) Ltd., 66 Macquarie Investment Management (UK) Ltd., 112, 128 Macquarie Leisure Trust Group, 42 Macquarie Midland Holdings Ltd., 67 Macquarie Model, 1, 3–5, 8, 62, 63–66, 137–138, 144–151 Macquarie Motorways Group Ltd., 67 Macquarie NPS REIT, 42 Macquarie Office Trust, 42 Macquarie 125 Holdings Inc., 68 Macquarie Property Income Fund, 42 Macquarie real estate, 40–42 Macquarie Real Estate Equity Funds, 42 Macquarie Securities (Australia) Ltd., 79 Macquarie Securities (USA), Inc., 78 Macquarie Underwriting Ltd. Airport Motorway Group, 63 Hills Motorway Group, 61–62 Infrastructure Trust of Australia Group, 64 Macquarie Yorkshire Ltd., 73 Martin Committee, 27 MBIA Insurance Corp., 120, 121 McKinsey, 30 Midland Expressway Ltd., 67 Midway Investment and Development Co., 133 MIG Chicago Holdings LLC, 78 MIG Investments 2 (US) LLC, 102 MIG Westlink Funding Trust, 79 mini groups, 127 Missouri Safe and Sound Bridge Improvement project, 87 Moody’s Investors Service, Inc., 91, 94, 96 Moore, Nicholas W. background, 50, 57 Capital Group, 50 compensation, 34

Macquarie, infrastructure funds, 57; strategic model, 51 Sydney Airport, 115 Moore-Wilton, Max, 115–116 Morgan Stanley Infrastructure Fund, 149 Moss, Allan E. adjacency, concept of, 51, 58 background, 28 Bankers Trust’s Australian investment banking business, acquisition, 38–39 Chicago Skyway, 8, 92 compensation, 34 competency, concept of, 51 Hill Samuel Australia, 28 holding company structure, 47 leverage, 145 Macquarie, culture, 6, 29–31, 32, 35; future of 152; positions held, 28–29; responsibilities, 2; strategic model, 31–32, 38 Macquarie Airports, 114 Macquarie Bank, founding of, 26; share price decline, 114 managing director, role as, 45 risk management, 6, 25, 29–30, 35, 37, 45 Sydney Airport, 113, 117 Moss, William J., 30 National Cooperative Highway Research Program, 105 National Express Group PLC, 132 National Investment Bank, 107–108 New South Wales Department of Planning, 58 New South Wales Department of Transportation, 58 New South Wales Roads and Traffic Authority, 58, 60 Newcastle International Airport, 125 Obayashi Corp., 61, 63 Ontario Teachers Pension Plan, 76 political risk, 5, 152 Port Authority of New York and New Jersey, 132 Port of Miami Tunnel project, 87 The Portland Group, 110–111 Principal Finance Group, 38

index / 201 Principles of Good Corporate Governance and Best Practice Recommendations, 80 private activity bonds, 87 privatization airports, 8, 109–110, 112–113, 123, 130–135 privatization Australia, 6, 54–55 bankruptcy, 22 benefits, 9, 14–19, 104–108, 134–135 capital source, 14–15, 107–108, 134–135, 150 Chicago Skyway, 7, 83, 90–93 default, 22 disadvantages, 19–22 efficiency, 15–17 foreign operators, 21–22 highways, 7, 8, 9, 54, 55, 83, 90–93, 95–98, 104–108 Indiana Toll Road, 7, 83, 95–98 lease payments, 14, 151 policy aspects, 14–23, 151–152 public interest and, 12, 22–23, 151 toll roads, 7–8, 9, 54, 55, 83, 90–93, 95–98, 107–108, 130–133 United States, 55, 83, 90–93, 95–98, 107–108 user fees, 17–19 windfalls, sharing, 19, 151 worldwide, 54–55 xenophobia, 21–22, 95 public-private partnership, definition of, 9 Qantas Airways Ltd., 32, 116–17 Reset Convertible Notes, 76 risk management Macquarie, 25, 29–30, 35, 43–45, 48 Moss, Allan, 25, 29–30, 35, 37, 45 Rome Airport System assets revalued, 126 Macquarie Airports and, 122–123, 144 refinancing, 123 San Diego Expressway Limited Partnership, 68 Section 129 Toll Agreements, 87

Shenandoah Greenway Corp. of Virginia, 102, 103 Shenandoah Holdings LLC, 103 SKIES (Sydney Kingsford Smith Interest Earning Securities), 121 Skilling, Jeffrey, 29 Skyway Concession Company LLC concession and lease agreement, 90 refinancing, 93 Skyway Concession Company Holdings LLC Chicago Skyway, 93 Macquarie Securities (USA), Inc., fees, 78 refinancing, 75, 93 South Bay Expressway financing, 88–89 Macquarie Infrastructure Group and, 7, 74, 87–89, 149 rate of return on invested capital, limitation on, 89 South Bay Expressway L.P., 88 Southern Cross Airports Corp. Pty Ltd., 113, 117, 119–120 Southern Cross Airports Corp. Holdings Ltd., 118, 119–120, 121 Southern Cross Australian Airports Trust, 117–118 sovereign risk, 152 SPAL Ltd., 64 Standard and Poor’s, 94 State Route 125, 68, 87 Statewide Mobility Partners LLC, 96 Statewide Roads Ltd., 67, 77, 78 Stewart International Airport, 132 SWF Airport Acquisitions, Inc., 132 Sydney Roads Group, 73, 79 Sydney Airport asset revalued, 126, 127 Australian Competition and Consumer Commission, 116 Australian Competition Tribunal, 116 debt refinancings, 119–121, 145 financial engineering, 119–121 Macquarie Airports and, 2, 8, 113–114, 117–120 management, 115–116 ownership, 117–118 privatization, 112–113

202 / index Sydney Airport—Continued retail development, 115 Virgin Blue and, 116–117 Sydney Airports Corp. Ltd., 112, 113, 117, 120 tax aspects, concessions, long-term, 100–101 Telstra Corp., 33 Thames Water Co., 2 TICkETS (Tradeable Interest-Bearing Convertible to Equity Trust Securities), 124, 130, 135, 145 toll roads privatization, 7–8, 67, 68, 83, 89–99 United States, 84–85, 86–87, 107–108 Tollaust Pty Ltd., 61 Toll Road Investors Partnership II, L.P., 102 Transportation Infrastructure Finance and Innovation Act of 1998, 88–89 Transroute International S.A., 61 Transurban Group Ltd., 63, 73, 78, 79 UBS, 79 Urban Land Institute, 1 user fees control of, 17–19 privatization and, 17–19 United States Airport Privatization Pilot Program, 130–132 airports, 8, 9, 130–135 bridges, 7–8, 9, 104–105, 151–152 capital investment, shortfall, 105–106 Express Lanes Demonstration Program, 86 Federal Aviation Administration, 130–131, 133, 134

Federal Highway Administration, 105 Federal Highway Trust Fund, 85–86 highways, 7–8, 9, 84–87, 104–108, 151–152 infrastructure, financing, 9, 85–87, 104–108, 151–152; funding needs, 105–106, 134 Interstate Highway System, 6, 85–86, 104 Interstate System Construction Toll Pilot Program, 86 privatization, benefits, 9, 14–19, 83, 107–108; highways, future of, 104–108; resistance to, 95, 107 toll roads, 7–8, 9, 84–86 turnpikes, private, 84 Value Pricing Program, 86–87 United States Department of Transportation, 9, 86–87 Value Pricing Program, 86–87 Virginia Department of Transportation, 102 Virginia State Corporation Commission, 102, 103 Wallis Report, 47 Warnowguerung GmbH and Co. KG, 67 Western Sydney Orbital Funding Trust, 76 Westlink Consortium, 68 Westlink M7, 74, 76, 79 Westlink Motorway Group, 68 Yorkshire Link Holding Ltd., 67, 73 YVR Airport Services Ltd., 133

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