iir mezzanine conference 18.10.2006 final is a member of the advisory panel for the iir mezzanine...

Mezzanine in Infrastructure finance?

IIRMezzanine Conference

© [email protected] [1]

Agenda

Mezzanine under pressure New opportunities? The Chicago Skyway halo effect How will mezzanine fit in?


Mezzanine pricing trends down

Effect

Mezz issuance has witnessedexponential growth since 2003

But the influx of investors has seendemand outstrip supply

Vicious pricing compression againsta backdrop of rising leverage andweaker security as mezz moves to3rd ranking after 2nd Lien

Is there any relief in sight forinvestors?

Cause

Source: Fitch Ratings


Demand continues to outstrip supply … when / how can this change?

Mezzanine pricing will improve only when supply / demand regainsequilibrium …but how?

Are we going to wait for the cycle to turn and affect demand? Is there another solution on the supply side?

Source: S&P LCD


PE firms target new areas as competition intensifies ... will mezzanine follow suit?

Source: S&P LCD, Alcentra

New targets emerge Cyclicals (NSX, Freescale) Segments - jumbo deals (HCA) Regions (India, China, Asia) Other asset classes - Infrastructure

(pipelines, power stations, roads)

Entry multiples for traditional targetshave risen fast

Buying at sensible multiples isincreasingly difficult for PEs

PEs respond by expanding focus onnew targets

The going gets tough


• Macquarie (LSE, BAA, M6)• Bridges & Roads• KKR, MD (Power & Pipelines)• Terra Firma (Tank & Rast)• 3i, Innisfree, Carlyle

• Perry, Och Ziff (Peacock) • Cerberus (Alamo, Warner)• Boxclever (Perry, Cerberus)

• Drax - Power (Perry)• Kaltima Coal

The new ”convergence” model

InfrastructureProject Finance

Hedge Funds PE Funds


Private Equity & PF, PFI have many similarities

25 - 50 yrs10 - 12 yrsFull amortisation

Limited recourse

Both are limited recourse financing structures but with subtle differences Lack of residual equity & long-term investment horizon generally limits scope

for traditional junior debt in PF & PFI

Residual (embedded) equity

Laminated financing

Investment horizon

Debt to Ebitda multiples

High Leverage

20 - 30 yrs3 - 10 yrs

10 - 30x 5 - 8x

90%75%

Infrastructure / PFIPrivate Equity


A new target for mezzanine?

Historically mezzanine has slipstreamed PE firms This appears to be happening with the new targets Infrastructure is a broad church and covers a wide range

» Regulated assets (water, gas, electricity, airports, ports)» Roads, tunnels, ridges, rail, pipelines» Government procurement - PPP / PFI

PPP / PFI has remained largely untouched by mainstream PE(Innisfree apart)


PPP

Covers a range of structures and concepts which involvesharing of risks and responsibilities between public and privatesectors

In the UK, there are three basic variations / structures» Sale of majority or minority stake» Concessions (e.g. PFI)» Joint ventures with the Private Sector

“PPP” or “3P” = Public Private Partnership“PFI” = Private Finance initiative


PFI

The public sector contracts to purchase services, with definedoutputs, on a long-term basis from the private sector, includingmaintaining or constructing the necessary infrastructure

Typically structured as DBFO (Design Build Finance Operate) Sponsor designs and builds project funded with debt and

equity» Debt is repaid by contractual payments from public body over life

of concession covering operating / running costs, debt serviceand an equity return (c 12% - 16%)

Revenues are contractually guaranteed for life of project… subject to performance


Conventional PFI project (with mezzanine)

Concession & loan terms

32 year concessionTerm

HBoS (and mezz)MLA

HBG Projects (Sponsor)Equity

£37.5 million @ L+100bps; with29.5 year term

Senior

£39m at close June 2002Closed

Cheshire Police Training ForceCentre (DBFO)

Project

£1.5 million @ L+ c. 500 bpswith 29.5 year term (4 yearpayment holiday thenamortisation)

Mezz.

Comment


Mezzanine does not fit easily into conventional PFI

Concession periods are very long …. 20 years plus Senior debt is amortised over similar period with very small

“tail” … one to two years Traditional subordination of principal not practical …

mezzanine providers won’t wait 20 years No “embedded equity” on termination of concession … difficult

to provide any equity kicker


Chicago Skyway tolled-bridge facility (Macquarie Nov 2004)

Macquarie acquired right to collect tolls &maintain route for 99 years

Paid $1.8bn vs $800m next highest bid Chicago got $234.6 million a mile, $13.3

million a yard, $4.4 million a foot or $367thousand per inch!

The Laughing Cavalier (Frans Hals)

Wallace Collection

“This bold and dramatic venture is probablythe best deal ever in Chicago’s history …Not since the sale of Manhattan to theDutch, for 60 Gilders, the price of a goodbottle of wine, has there been anythingclose to this windfall”.

Edward Burke,Chair of Finance Committee (Chicago)


Chicago Skyway “halo” effect

Concession & loan terms

Sponsor benefits Embedded equity provides greater

financing flexibility Laminated LBO-style debt structures

possible with junior debt, bullets &equity kickers

Contractual revenues facilitatehigher leverage and lower cost ofcapital

State realises dormant “equity” Risk moved to efficient private sector Regulatory controls and residual

ownership limits political fall-out

State benefits


How will mezzanine fit in?

For sectors with volatile revenues, roads, bridges,tunnels and (in the future schools and hospitals)

Structured as share of higher revenues / excess profit

Equitykickers

Repaid from early refinancing or Rolled till exit and repaid from embedded equity

PIK?

Instruments with margins circa 500bps Amortising deferred for interim period (circa 5 years) or

repayment on PIYC basis / leverage grid Returns will be boosted by higher leverage owing to

contractual/ guaranteed nature of revenues (offtake)

Second lienCharacteristicsStyle


How big is this market? … will it run out of steam ?

CEE, Asia, Africa, South America Too big to calculate

Otherregions

One project - the Trans-Texan Highway alone is worth$187 billion

US road system maintenance bill is $91 billion p.a. Schools (illiteracy at 35% but declining manufacturing)

USA - thesleepinggiant

Italy completed €22 billion projects in 2004/5 Most of Europe and RoW is playing catch-up

Europe

700 projects worth £49 billion have been signed since1992

200 projects worth £26 billion will close by 2010

The UK


Supply is inevitable

Governments don’t have the financial resources to meetincreasing demands for (expensive) public services or meetliabilities (unfunded pensions)

Traditional public procurement is inefficient - over budget andlate (e.g. Scottish Parliament - 10x over budget)

73% of traditional government projects are over budget vs20% for PPP #

70% of traditional government projects are late vs 24% forPPP #

# Source: NAO


Demand is driven by the “pensions effect”

Pension funds need secure government grade assets at tomatch their long term book

But demand for safer government government securities hasforced up prices & driven yields down further

Annuity yields have dropped over the last 15 - 20 years from10% to circa 4-5 % today #

Accounting changes have driven more conservative treatmentby pension trustees (e.g. FRS17, IAS19) #

There is a virtuous circle between pension investment needs and public servicesfunding which has yet to be fully recognised by many governments and politicalparties; there is a major economic prize to be gained by those who do.# Source: KPMG Report “PFI - over the next 10 years”


The main constraints

There are two major constraints one private one public Private - lack of sufficiently qualified professionals and

expertise to complete deals Public - government inertia and public opinion

PFI and PPP is changing the focus on transparency, contestability andfundamental accountability in the way public services as a whole aredefined and delivered ….The demand is vast …. the issue will be how to provide thehuman/intellectual and financial capital to feed the demand.”# Source: KPMG Report “PFI - over the next 10 years”


Michael Dance

Michael Dance is the Managing Director of MBO Training International, a company providing trainingand consultancy services on acquisition finance, leveraged and management buyouts and projectfinance to clients in the Europe, The Middle East, North America and Africa.

His clients embrace a wide selection of professionals involved in those industries. Over the past fewyears he has presented in-house programmes to KPMG Corporate Finance, KPMG TransactionServices (Canada, Germany and Finland), PWC (Europe and Africa), E&Y (UK and Moscow), CloseBrothers, AIB, Morgan Stanley, Barclays Capital, CIBC, Cinven, Deutsche Bank, SJ Berwin,Macfarlanes, Bingham McCutchen, Berwin Leighton Paisner, Ogier, White & Case, NationalAustralia Group (Europe), Lloyds TSB, Rand Merchant Bank, Bank of China, Siemens AG andOmani Oil. He is also a visiting lecturer at the CASS Business School for the M Sc. programme inBusiness Administration and Finance.

He has a number of clients whom he has advised on mezzanine and other forms acquisition finance.He is a member of the advisory panel for the IIR Mezzanine Conference (2006). He was involved inthe EU Phare programme during which advised the Estonian Government on its privatisationprogramme. Prior to founding MBO Training International, Michael was head of cross border M&A atMiesPierson in London, an Assistant Director at Hoare Govett and an executive at Lazard Brothers.He qualified as a lawyer in South Africa and as a Chartered Accountant with Deloitte. He holdsvarious degrees including BA, LLB, B Compt (Hons), Diploma in Taxation and is a CA (SA).


Appendices

Supplementary materials


Infrastructure - the new rage?

Infrastructure assets are the new rage for private equity firmsas many firms raise new funds for that market» Madison Dearborn & KKR, Carlyle, 3i, CSFB/GE Infrastructure

($1 billion fund) Goldman Sachs with a $3 billion fund» Morgan Stanley, Merrill Lynch and JP Morgan

Pension funds also targeting the asset class» UK Universities Superannuation Scheme announced in June that

it intends to invest up to 25% of its assets in alternatives,including infrastructure

» France's €29 billion state fund, the Fonds de Rerve pour lesRetraites

What is infrastructure and is there room for mezzanine


Investors

ContractingAuthority

PROJECT COMPANY

Equity

GovernmentRoad users

OperatorContractor

Lenders

FinanceDebt

EPCContract

TollPayments

ConcessionAgreement

SupportAgreement

OperatingContract

Maintenance Contract

Toll Road Concession (Real)


Chicago Skyway tolled-bridge facility

Chicago Skyway is a 7.8 mile, 6 lane toll road & bridgeconnecting I-94 and the Indiana toll road

Sold to Macquarie / Cintra in Nov 2004 for $1.8 billion for rightto collect tolls & maintain route for 99 years

Next bidder (Goldman Sachs/ Fluor) bid $800 million Chicago got $234.6 million a mile, $13.3 million a yard, $4.4

million a foot or $367 thousand per inch! Funding

» $439m Series “A” Senior Secured FRNs due 2017» $961m Series “B” Senior Secured FRNs due 2026

Estimated IRR for Macquarie - circa 12%

iir mezzanine conference 18.10.2006 final is a member of the advisory panel for the iir mezzanine...

Documents