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For years, states and cities around the country have been using duct tape and baling wire to patch over a gargantuan problem: They don't have nearly enough money to maintain their transportation systems, electrical grids, ports, and other crucial facilities. The gap between what governments are likely to spend on infrastructure and what is needed over the next five years, according to the American Society of Civil Engineers, is a mind-numbing $1.1 trillion.
That's why it seemed like good news a few years ago when Wall Street came calling. Kohlberg Kravis Roberts (KKR) and other big private equity firms talked about privatizing highways and parking facilities, and snapping up utilities, airports, and other infrastructure. They would funnel billions into the nuts and bolts of everyday life, getting access to stable operations that would throw off steady income streams.
KKR launched its infrastructure fund in 2008, citing a "multi-trillion dollar" market opportunity. Blackstone Group (BX), Citigroup (C), Deutsche Bank (DB), and others piled in. So far, though, KKR has yet to announce any major investors for its fund, much less do a deal. Other firms haven't fared a whole lot better.
As private equity firms waded into public projects, overly optimistic projections and high leverage led to a string of failures. "Aggressive operating and financial assumptions, in times when debt was cheap, resulted in acquisitions that had little or no pricing discipline and didn't work for investors," says Dunia Wright, head of U.S. and Europe for Industry Funds Management, an Australian firm that oversees $19 billion.
At the same time, there has been public backlash against Wall Street buying up Main Street. In Chicago, for example, Mayor Richard Daley faced sharp criticism last year after leasing 36,000 parking meters for 75 years to an investor group led by Morgan Stanley (MS). The profit-minded new operators quadrupled some meter rates and eliminated free parking on Sundays—moves that provoked outrage from drivers and local officials. "Putting us against the investment banks in a deal like that is like having little leaguers play the New York Yankees," says Alderman Thomas Allen of Chicago's 38th Ward, who proposed an ordinance requiring a mandatory 15-day review period for similar agreements.
The marriage of private equity and infrastructure has worked better outside the U.S., since Sydney-based Macquarie Group pioneered the concept of raising money from private investors to buy roads and utilities. To cite just one example, Global Infrastructure Partners, created by Credit Suisse and General Electric, has been running London City Airport successfully since 2006; last year it took over Gatwick Airport.
In the U.S., private equity firms began to focus on infrastructure in 2005, after Chicago turned over a 7.8-mile elevated road known as the Chicago Skyway to a group that included a Macquarie-managed fund. The 99-year, $1.8 billion agreement, the first major privatization of an existing U.S. highway, led to a surge of infrastructure fund raising that peaked at $34.3 billion in 2007, according to consulting firm Probitas Partners.
The flood of capital produced a series of missteps on land, sea, and in the air. In 2007, Deutsche Bank acquired Maher Terminals, which operates shipping facilities in Port Elizabeth, N.J., for its North America Infrastructure fund, paying $2.1 billion. Deutsche Bank planned to sell its interest to outside investors. But as shipping activity plunged amid the worldwide recession, the bank had trouble finding takers.
Deutsche took a charge of $205 million after shifting Maher Terminals in 2008 to its corporate division from its group that manages alternative assets. Executives can now check on their unwanted acquisition by gazing across the water to New Jersey from the windows of Deutsche Bank's U.S. headquarters in downtown Manhattan.
"Investing in infrastructure can't be just a financial play," says Stephen Mentzines, head of Maquarie Capital Funds in North America. "It takes sector expertise and the ability to operate assets."
In early 2009, Chicago cancelled plans to lease Midway Airport for 99 years when a group of investors including Citigroup failed to raise financing. A Fortress private equity fund ran off the tracks when it paid $3.5 billion for Florida East Coast Railway in 2007. It was counting on the Florida state legislature to fund the development of a rail corridor running between Jacksonville and West Palm Beach—but the funding hasn't come through. Fortress has done better with its $450 million investment in Florida's RailAmerica, however.
KKR and Blackstone say they remain committed to making infrastructure investments. And federal stimulus efforts may give Wall Street a chance to find its footing. The Transportation Dept. is set to receive $4 billion to help create a so-called infrastructure bank that would "effectively leverage non-federal resources, including private capital," according to the budget President Obama submitted to Congress in February.
Rude experience may have taught private equity firms better ways of doing these deals. In November, Carlyle Group's infrastructure fund inked a $178 million public-private partnership to manage 23 service areas along Connecticut's highways for 35 years. Carlyle didn't use any leverage, and it worked to win the support of state departments of transportation and environmental protection, as well as community groups and labor unions.
Carlyle managers say it may serve as a model for future transactions. "A lot of people have come to talk to us about it," says Robert Dove, co-head of Washington-based Carlyle's infrastructure group. "There continues to be a real interest in bringing the private sector in."