Private investors elbowed out of Oz mega projects

Private investors have been excluded from building Sydney’s second international airport, raising questions about who should build large-scale infrastructure projects.

Infrastructure investors in Australia are disappointed by the federal government’s decision to bypass a competitive tender process in favour of building a A$6 billion second international airport in Sydney on the public purse.

The project has been on the country’s agenda for four decades and has remained in the too-hard basket due to rail access issues and concerns about whether it could attract enough airline traffic to make it viable.

Such large-scale national transport projects tend to take years to come to fruition in Australia. Still, many investors had expected that once the conditions were right, the second airport would be open to private tender. Instead, Prime Minister Malcolm Turnbull has decided that the government will build the airport with a completion date of 2026.

It is a bold move and represents a switch in focus for infrastructure funding from traditional grants to equity injections.

Australia’s federal government doesn’t have a stellar track record running design and construction processes on mega projects. Most of the work now under way on new road and rail networks is being executed by state governments.

There are two other large-scale projects on the national agenda that have languished for years – a high-speed bullet train connecting Melbourne and Sydney, and an inland rail project between Melbourne and Brisbane, mainly to carry freight.

Turnbull has now set aside A$8.4 billion to finish the inland rail project but market commentators are concerned about the government’s ability to deliver project on time and on budget.

The only current project on the federal ticket is the national broadband network (NBN), a A$40 billion upgrade to the country’s fibre, wireless and satellite system. Work on the NBN began six years ago and has been mired in mismanagement and delays. It is carrying a cost overrun of A$15 billion according to numbers crunched by The Australian Financial Review newspaper. The NBN does not publish a full set of financials claiming commercial confidence. 

Some say Turnbull’s decision on the second Sydney airport is a throwback to his former career as an investment banker. He ran his own advisory firm in the 1990s and was then chairman and managing director of Goldman Sachs Australia between 1997 and 2001. He likes to do deals.

“Infrastructure news always makes the front page and can become highly politicised,” said Michael Hanna, head of infrastructure Australia at IFM Investors, which has investments in nine airports in Australia and overseas.

Hanna is one of the voices who wishes Turnbull had put the project out to private tender.

“As owner of the existing Sydney Airport, Macquarie had first option on the build and as soon as they declined in May we had hoped the government would spend three to six months canvassing interest from other investors, but that didn’t happen,” Hanna said.

Macquarie’s first right of refusal was negotiated when it purchased the city’s main airport in 2002 and was intended to protect the asset from early competition. However, the provision had expired and negotiations to build the new airport began in 2014. Eventually Macquarie turned down the option citing risks associated with the development and the lack of guaranteed returns for investors.

Hanna believes Macquarie couldn’t make the numbers work because the entity that owns the facility – Sydney Airport Corporation – is a listed company with dividend commitments. “People buy the stock for its dividend income and taking on a project with a five-to-seven year capital investment programme would put a dent in that distribution yield,” he said.

“Of course, that’s not the case for infrastructure funds like IFM which have a long-term view and whose investors aren’t necessarily demanding a cash distribution from day one,” Hanna said. “The aggregate remaining duration of key asset leases in our portfolio is over 80 years.”

Aside from IFM, there are plenty of other infrastructure funds with interests in airports and an appetite for new investments. The A$130 billion Future Fund which holds stakes in airports in Melbourne, Perth, Launceston, Edinburgh and London Gatwick, and the $40 billion New York-based Global Infrastructure Partners fund, which has interests in Gatwick and Edinburgh. Spanish infrastructure company Ferrovial owns four airports in Britain – London Heathrow, Glasgow, Aberdeen, and Southampton.

Risky ventures

Turnbull’s reasons for shutting out the private sector may never be known and the government did not reply to a request for comment on the issue.

It is true that funding large-scale national projects in Australia remains tricky. The market has been talking about a high-speed bullet train connecting Melbourne and Sydney since 1984 and yet it lingers on the drawing board.

Mega transport projects like these are usually justified by their broader economic benefits rather than the benefits to fare-paying users, and that makes it hard to guarantee returns to the private sector.

“For large scale projects the risks are just too difficult to assess, which is why they can stay on the drawing board for decades,” said Paul Kenny, a partner and government sector lead at law firm Allens. “Usually the only way the risks can be alleviated is with significant government support,” said Kenny.

His sentiments are echoed by Steve Lambert who runs the global capital markets business at National Australia Bank. Lambert said while there is no shortage of private debt or equity for carefully structured projects, it doesn’t mean the private sector is always the best builder of mega projects.

“Private sponsors will always want the government to assume as much construction risk as possible and there is a tipping point where it becomes more economical for the government to build it themselves,” he said, adding that he expects the second airport to be leased to private interests once the facility is operational.

Whether such an offer will also be extended to foreign investors remains to be seen. The last time a Chinese company, for example, tried to buy a strategic asset in Australia it was knocked back by the country’s finance minister Scott Morrison. He said at the time that a bid by China’s State Grid and Cheung Kong Infrastructure to purchase a stake in electricity distributor Ausgrid was “not in the national interest”.

Foreign investors have also been targeted in a recent move by the Australian Taxation Office (ATO) to crackdown on the use of stapled structures for infrastructure investments. The ATO wants to limit the possibility that offshore investors are avoiding tax by investing via stapled vehicles. Almost all of the recent privatisations in the country have been executed using stapled vehicles, so any change to the status quo would have serious implications for the industry.

The ATO has said it will make an announcement on the issue in July.

Value capture

Kenny at Allens said the bullet train between Sydney and Melbourne is another project where the business case is marginal for private investors. “It seems to get mentioned during election campaigns and then forgotten again.”

The last time the government costed the 1,750-kilometre project it estimated a construction cost of around A$115 billion, and that was in 2012.

That said, recent developments suggest there may be some movement on the idea. In May the department for infrastructure and regional development said it had set aside A$20 million to review business proposals for the rail line. Interested parties have until September this year to submit proposals.

One party likely to submit is a private consortium called the Consolidated Land and Rail Australia (Clara), which put forward a plan to build the line in July last year based on an innovative value capture structure. Clara’s board includes representatives from the public and private sectors in the US, as well as former Australian state premiers Steve Bracks and Barry O’Farrell, and former trade minister Andrew Robb.

The audacious plan involves bypassing existing towns along the route and building eight new regional cities on land it will acquire from private and state owners. While Clara didn’t respond to FinanceAsia’s requests for an interview, the consortium has previously said that deals to secure almost half the private land needed for the project have been struck on multi-year option agreements.

The proposition sounds compelling as it has no call on the public purse but it rests on the notion that the new cities will flourish and people will want to live there. It may also require that Clara is given government powers to compulsory acquire land under non-market conditions.

Kenny at Allens said the government is a long way from giving private investors approval to do this. “Not so much because it is reluctant to consider such an option but because it is unlikely the idea has been put to the government in any real form,” he said.

He believes there are holes in Clara’s plan. “For a project of this size to be funded entirely on value capture would be very challenging,” he said. “The question is whether the increase in land values along the route would be sufficient to warrant the investment.”

Pundits say a more traditional form of value capture – involving taxing the windfall gains enjoyed by private landowners surrounding a project – may be used by the federal government as it moves ahead with building of Sydney’s second airport. It might also consider issuing public airport bonds.

A day after Turnbull’s airport announcement in May the financial press in Sydney reported that Chinese investors were already responding to the possibility of a quick spike in property prices by moving in to purchase land within a 30-kilometre radius of the site in Sydney’s outer Western suburbs.

The reports are hard to verify, however, and FinanceAsia’s own intelligence says Chinese investors have been pulling back from Australia’s property market since Beijing began its clampdown on foreign exchange. New lending and tax rules in Australia have also made it more expensive for the Chinese to purchase property in the country. And there is a weight of evidence to indicate that property prices in Australia may have finally peaked.

The proposed airport in western Sydney is currently due for completion by 2026.

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