The Trouble with Transportation


High gas prices have dimmed private equity's hopes of rosy returns on infrastructure and transportation projects. Government could be the loser

For private equity investors, the sheen is wearing off purchases of public asphalt. A year ago, banks and private investment firms were racing to pour money into infrastructure projects such as highways and light-rail systems. Compared with an investment in stocks, buying or leasing a highway seemed like a low-risk bet with easily estimated, long-term returns. After all, competing highways or mass transit systems couldn't just spring up overnight to divert toll- and ticket-paying customers.

But $4-a-gallon gasoline slowed the enthusiasm for such projects. Many commuters are choosing to leave their cars in the garage and take mass transit, or don't have a job to drive to anymore. "If you look at the publicly reported forecasts for the Chicago Skyway or Wall Street estimates of global traffic, they are completely different now," said George Bilicic, a managing director at NYC private equity firm Kohlberg, Kravis, Roberts who spoke on a panel held Sept. 3 at the University of Minnesota. "It goes into the risk assessment associated with the investment decision."

The purpose of the panel was to bring politicians in town for the Republican National Convention together with business representatives in a discussion that fits into GOP efforts to find privatized solutions to large public problems such as crumbling infrastructure. "Transportation is both broke and broken," said panelist Bruce Katz, vice-president and director of metropolitan policy at independent research firm the Brookings Institution. "How do we have the collaboration with the private sector so we can really deal with the totality of this issue?"

Power to Private Equity

One answer may be to accept that private equity gets to dictate more terms, and use up-front revenues from long-term infrastructure leases to provide tax breaks offsetting higher commuting costs. That solution dovetails with the Republican convention theme of lower taxes.

But higher risk means investors are going to demand larger returns. And that's not welcome news for government officials. Some of those present at the panel discussion said they don't want to slam voters with higher commuting costs but do want private investment to fund improvements in roads and mass-transit systems (BusinessWeek, 5/7/07) not to mention provide immediate cash for other government projects. "We are acutely aware of transportation challenges in this community," said St. Paul Mayor Chris Coleman, referring to the difficulty of getting a light-rail system constructed between St. Paul and Minneapolis. "I think there is a lot of room for private investors to invest in our community."

Despite the economic downturn, private sources could still account for $240 billion of the capital needed for infrastructure worldwide each year, according to a September 2007 report by Ernst & Young. "The pools of private capital are gathering," says Bilicic. "And these pools are forming with a global point of view."

Renegotiating the Terms

But investors are adjusting by lowering their bids on long-term public infrastructure leases and demanding more assurances that the managing firms can raise tolls or adopt controversial measures such as peak toll pricing. (On one privately owned road in California, tolls jump from less than $2 to more than $20 during rush hour under the peak pricing model.) "Nobody will bid on [a toll road] at the fare of $1.50 per person," said panelist and former Washington Senator Slade Gorton.

Strapped commuters obviously are in no mood to pay for higher tolls. What investors are counting on is that taxpayers are even more averse to paying the higher taxes needed to repair century-old roads, bridges, and other public facilities. The American Society of Civil Engineers estimated in 2005 that it would cost $1.6 trillion to simply bring the nation's infrastructure up to "good" condition. That doesn't include the amount it would cost to add environmentally friendly mass-transit systems and other infrastructure upgrades needed to help people move closer to the cities where they work, thereby reducing vehicle-related pollution.

Many taxpayers are already skeptical about federal and state transportation expenditures, panelists said, because they often get allocated to politically powerful districts rather than where they are most needed. "It never made sense to me why we would tax ordinary people and use that money to subsidize this type of sprawl development," said panelist Tom Darden, CEO of Cherokee Investment Partners, a firm that works with government to invest in land development around new transportation hubs.

Congestion Plagues Cities

"It's hell trying to get around any city in America today, from sea to shining sea. We are just at a stall in congestion," said panelist John Mica, the ranking Republican on the U.S. House Transportation & Infrastructure Committee. "Some people think I have been smoking the funny weed and hanging out with college students when I say we need more than a trillion dollars… But we have got to do something."

Holahan is a writer for BusinessWeek.com in New York.

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