A recent Alan Pyke article at Think Progress brought attention to a labor dispute between the union representing toll booth operators for the Chicago Skyway (“Skyway”) and Cintra-Macquarie, the entity that acquired the right to operate the Skyway approximately ten years ago in a $1.8 billion transaction. While the dispute was resolved before the workers went on strike, Pyke’s article goes beyond the labor dispute and makes broader criticisms of public-private partnerships (“P3s”) like the one that operates the Skyway. While I have no intention of winning the hearts and minds of those opposed to such arrangements, as a conditional defender of them, my purpose here is to point out the shortcomings in Pyke’s article by providing readers the proper way to analyze certain aspects of these arrangements, especially the financial ones.
Pyke quotes Shar Habibi, a research and policy director with In the Public Interest, and I think this is a good starting point for me:
“The private entity has a lot of control over what rates are gonna be to actually use this asset,” Habibi said in an interview. “If the solution was raising fares or raising toll rates, could the government have done that and pocketed that money themselves? If a private corporation can do it why can’t the government do it?”
The quote plays into two criticisms of P3’s: 1) private entities do/have the potential to screw people over through rate increases and 2) the benefits of such increases accrue solely to private entities. Yes, toll rates on the Skyway went up immediately after the private entity assumed control, and in a more notorious example, the parking meter rates in the City of Chicago increased by as much as four times after the city sold the rights to operate the parking meters to a private entity. I suppose that the impression that private entities screw over people when they assume control of municipal assets is made because the private entities are the ones that make the increases. However, the reality is that the rate increases are negotiated as part of the transaction and are a function of the value private entities pay (more on this later). Both parking meter rate increases (Schedule 9 – Page 257) and toll rate increases (Page 627) were heavily negotiated, agreed upon by both the City of Chicago and the respective private entities, and put into the transaction documents. Does that constitute a lot of control? No. The level of control private entities have in these transactions is a function of what municipalities are willing to accept given their goals and objectives.
As far as governments being able to achieve the rate increases and “pocket the money themselves”, the approach is overly simplistic. As the situation with the parking meters showed, perhaps after the fact, the parking rates charged by the private entity would not have happened if they had been put up to a vote. Politics is one hurdle. Another problem with this approach is that implication that governments can in effect profit from increases in revenues although the same governments have never shown (nor should) the ability to operate municipal assets at a profit. That said, the biggest issue I have with this belief is that it’s flat out wrong to assume that government isn’t benefiting from future rate increase.
The City of Chicago received $1.8 billion from a private entity to operate the Chicago Skyway for 99 years. On what basis did it make that determination of value? Seeing as it was operated by a government and not at a profit, its operating history wasn’t going to justify the price. Rather, the current owners believed that it could assume control of the Skyway, operate the road at a profit and generate free cash flows over time. The owners made assumptions for the rates it could charge, assumed various traffic volumes, expenses, capital requirements, etc and generated a number of cash flow projections. Those cash flow projections are then discounted on a risk-adjusted basis to a single present value amount that an investor is willing to pay. More importantly, whatever assumptions are made are vetted and scrutinized internally before private investors elect to move forward with a transaction. Yes, they can end up being terribly wrong, but any proposed valuation gets heavily scrutinized. I understand that I’m taking a basic Underwriting 101 approach to what is a very complex valuation/ investment committee process, but the reason I do so is because the value the private investor paid for the Skyway took into consideration those rate increases. Even though government foregoes the benefit of receiving revenues from those increases in the future, it benefits to some degree today because the pricing will reflect them.
After discussing the risks associated with the loss of control of municipal assets, Pyke moves on to valuations and bringing up Chicago’s sale of the rights to operate the parking meters:
If the public underestimates what it should be charging a company for an operating contract, the consequences can be even more dire. Chicago itself recently leased its 36,000 parking meters to Morgan Stanley and other partners for 75 years, in exchange for a billion dollars. But it quickly turned out that a fair price should have been more like $2 billion.
Chicago didn’t just leave a billion dollars on the table and allow private companies to raise parking rates and bank the returns, Habibi said. It also made its fiscal future dimmer.
Personally, I’m not a fan of this specific transaction, if only because the service was too essential and required complete control by the City. That said, I think the valuation criticism against the sale is without merit. Let’s refer to Page 3 of City of Chicago Inspector General’s Analysis of the Lease of the City’s Parking Meters (here):
The report finds that if the City were to keep control of the parking-meter system and operate it under the same terms as the private company, the system would be worth approximately $2.13 billion to the City over 75 years…This means that the City received about $974 million less for the parking-meter system than it was worth to the City – or alternatively, that the City leased the system for a price that was 46% lower than its value to the City.
This is a simple “hold vs. sell” analysis. The report claims that the value to the City was $2.13 billion if it retained control of the parking meters. Given that the fair market value of the parking meters was determined through a competitive process at $1.18 billion, according to the report, the City should have elected not to sell. The City received the fairest price it was going to get from the market at that time, and the competitive process used to solicit bids saw to that. Again, if the value to the City was greater than the value it could get from the market, the claim according to the report, then the City didn’t get the best deal.
While I think the report makes good points about the way the deal was done, I think the $2 billion value is fiction. The reports assumes that the City could have operated the meters under the same terms as a private company. That’s a lofty assumption given that the unpopularity of the parking meter increases when they did happen and the fact that the City never operated is parking meters at a profit. There are more than enough reasons to oppose this specific transaction, but the “fact” that the City left $1 billion on the table isn’t one of them. Not even close.
I’ll note that valuations can go the other way. Given that the owners of the Indiana Toll Road were forced to declare bankruptcy in 2014 and based it’s $3.8 billion on traffic volume that never materialized, I think Indiana has done pretty well with this so far. The same can be said for the Chicago Skyway. The $1.8 billion price it paid was approximately $1 billion higher than any other bidder, and that value was based on traffic projections that never materialized. Add the Great Recession to the mix and it’s clear that this has not been a winner for the current owners, so much so that they announced that they are selling their interests. With an an operating income of an approximately $60 million USD, finding a buyer willing to pay $1.8 billion, an amount equal to 30 times the operating income, is likely impossible.
Again, I didn’t write this to try to change hearts and minds. At least with the financial aspects of these transactions, I think the criticisms of P3s are pretty underwhelming when they’re looked at from my perspective. That said, quantitative considerations should not be the decisive variables. Qualitative considerations, especially with respect to control rights, risk to taxpayers, political considerations,etc. are equally if not more important to consider. That I don’t consider them at all in this post does not mean I don’t think they’re important (they are). It only suggests that I chose to limit the scope of this post. Nothing more.
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