Privatizing Government: Will It Really Solve State Funding Woes?

Polling Question 1:Which of the following options is the most realistic for overcoming revenue shortfalls in the state’s budget?

1. Privatization

2. Tax hikes

3. Bonds

4. Reducing government spending

Polling Question 2:Which area will be best suited in the long term for privatization ?

1. State lottery

2. Toll roads and highways

3. Water/wastewater management

4. Airports and ports

5. Correctional facilities

Polling Question 3:Will privatization help solve the state’s budget woes?

1. Yes, privatization will be a long-term solution.

2. No, privatization will be only a short-term fix.

Source: California Department of Finance

California Revenues and Expenditures FY 1976-77 to 2007-08

07-0802-0397-9892-9387-8882-8377-78

40

30

20

10

0

-10

Percent Change, Year Ago

Total Revenues and TransfersTotal Expenditures

Source: Legislative Analyst’s Office

California Budget for Capital OutlayPercent, FY 1985-86 to 2007-08

07-0804-05

01-0298-99

95-9692-93

89-9086-87

100

80

60

40

20

0

PercentTransportationEducationOthers

Sources: U.S. Department of Transportation, U.S. Census Bureau, Milken Institute

California Growth Index: VMT, Lane Length and Population

1994 Value = 100

200520042003200220012000199919981997199619951994

125

120

115

110

105

100

95

1994 Index = 100

Vehicle Miles Traveled (VMT)Lane LengthPopulation

Sources: Global Insight, Milken Institute

Tax Burden2006

Least ExpensiveThird TierSecond TierMost Expensive

Source: U.S. Department of Transportation

Road ConditionsCalifornia vs. U.S., 2005

United StatesCalifornia

120

100

80

60

40

20

0

PercentVery Good GoodFair MediocrePoor

Source: U.S. Department of Transportation

Bridge ConditionsCalifornia vs. U.S., 2006

United StatesCalifornia

100

80

60

40

20

0

Percent

GoodDeficient

Costs to Relieve CongestionU.S. Urban Areas

Source: Reason Foundation

Urban Interstates and Freeway

Other Principal Arterials

Minor Arterials, Collectors, Local Streets

50000

25002.5

5

Costs to Relieve Congestion (US$ Mills.)

Highway Congestion in Urban Areas 2007

Source: Texas Transportation Institute

Rank Urban Area

Annual Delay per Traveler

(Hours) Travel Time Index

(Value)Congestion Cost

(US$ Millions)1 Los Angeles-Long Beach-Santa Ana, CA 72 1.50 9,3252 San Francisco-Oakland, CA 60 1.41 7,3833 Washington, DC-VA-MD 60 1.37 3,9684 Atlanta, GA 60 1.34 2,7475 Dallas-Fort Worth-Arlington, TX 58 1.35 2,730

11 New York-Newark, NY-NJ-CT 46 1.39 2,07612 Boston, MA-NH-RI 46 1.27 1,82013 San Diego, CA 57 1.40 1,70814 Seattle, WA 45 1.30 1,68715 Philadelphia, PA-NJ-DE-MD 38 1.28 1,41316 San Jose, CA 54 1.34 1,17617 Denver-Aurora, CO 50 1.33 1,12618 Orlando, FL 54 1.30 1,09919 Riverside-San Bernardino, CA 49 1.35 1,00520 Baltimore, MD 44 1.30 95524 Sacramento, CA 41 1.32 71130 St. Louis, MO-IL 33 1.16 459

All 437 Urban Areas 38 1.26 179

2030 State Congestion RankingsUrban Area Total

Source: Reason Foundation

Rank StateLane Miles Congested State

Lane Miles Needed State

Total Costs of Lane Miles Needed (US$ Billions)

1 California 8,730 California 13,132 California 121.92 Texas 7,986 Texas 12,929 Illinois 55.03 New York 4,735 Florida 8,536 Texas 49.14 Arizona 4,082 Colorado 4,668 New York 45.05 Florida 3,990 New York 4,512 Florida 38.76 Illinois 3,037 Pennsylvania 4,465 Michigan 27.17 Pennsylvania 2,456 Illinois 4,459 Pennsylvania 25.58 Michigan 1,785 North 4,361 Massachusetts 21.99 North Carolina 1,537 Arizona 3,813 D.C. 16.2

10 Georgia 1,516 Michigan 3,668 Georgia 14.3

Source: Reason Foundation

2030 Expected Travel Time Delay U.S. Urban Areas

Rank City Population in 2030

(Thousands) Congestion Index

in 20301 Los Angeles-Long Beach, CA 15,652 1.942 Chicago, IL 9,522 1.883 Washington, WA 5,973 1.874 San Francisco-Oakland, CA 4,968 1.865 Atlanta, GA 5,009 1.856 Miami, FL 7,551 1.847 Denver-Aurora, CO 3,210 1.808 Seattle-Tacoma, WA 3,963 1.799 Las Vegas, NV 1,029 1.79

10 Minneapolis-St. Paul, MN 3,370 1.7611 Baltimore, MD 2,437 1.7512 Portland, OR 2,513 1.75

Source: American Society of Civil Engineers

California Infrastructure Report Card2006

Category GradeAviation C-

Levees/Flood Control FPark/Open Space D+

Ports C+

Solid Waste BTransportation D+

Urban Runoff D+

Wastewater C+

Water C+

California's Infrastructure GPA C-

Annual Investment Needs $37 Billion

Sources: Public Policy Institute of California, California Infrastructure Coalition

Infrastructure Bond MeasuresOn the November 2006 State Ballot, All Approved

Funds (US$ Billions) Proposition

Transportation, Air Quality and Port Security 19.9 1BHousing and Emergency Shelter 2.9 1CEducation 10.4 1D K-12 7.3 Higher Education 3.1Disaster Preparedness and Flood Prevention 4.1 1EWater Quality, Safety and Supply, Flood Control, Natural Resource Protection, and Park 5.4 84Total 42.7

Source: RREEF

Case for Privatization

Problems with Old/Public Model

• Underinvestment

• Fees that are not cost-reflective

• High costs

• Low productivity

• Accountability; providing appropriate service level

• Shortages

Benefits of Privatized Model

• Increased investment

• Cost-reflective fees

• Improved incentives for efficiency

• Access to superior management

• Improved service quality

Forms of PrivatizationUsed by U.S. States

Contract 80.0%

Grant 5.7%

Franchise/Concession 5.0%

Public-Private Partnership 4.3%

Voluntary Action 1.8%

Voucher 0.7%

Other 2.5%

Source: RREEF

Privatization of Existing Toll Facilities2006

State Location RoadCost

(US$ Billions) TypeMI Detroit Detroit-Windsor Tunnel $0.07IL Chicago Skyway $1.83 99-Year LeaseIN Indiana Indiana Toll Road $3.85 75-Year LeaseVA Loudoun County Dulles Greenway $0.62

Total $6.37

Source: RREEF

Source: RREEF

New Public-Private PartnershipToll Roads in Operation

2006

State Location RoadCost

(US$ Billions)AL Tuscaloosa Black Warrior Pkwy. $0.025AL Montgomery Emerald Mt. Expwy Br. $0.004Al Foley Foley Beach Express $0.004AL Montgomery River Pkwy. Br. $0.012MO Lakeof the Ozarks Lakeof the Azarks Br. $0.040ND Fargo Fargo Br. $0.002CA Orange County 91 Express Lanes $0.130SC Greenville Southern Connector $0.191TX Laredo Camino Colombia $0.090VA Loudoun County Dulles Greenway $0.430VA Richmond Pocohontas Pkwy. $0.325

Total $1.293

Source: California Lottery

California Lottery Allocation of Revenues

Percent, 2006

Prizes Awarded 53.9%

Public Education 34.6%

Retailer Bonuses and Commissions

7.0%

Operating Expenses 2.8% Game Costs

1.6%

Source: La Fleur's World Lottery Almanac

California Lottery Expenditures Percent, 2006

Direct Cost 14.0%

Operating Expenses

25.0%

Retailer Compensation

61.0%

California Lottery As Percent of Sales, 2006

Source: California Lottery

Daily 34.0% Daily Derby

0.3%

Fantasy 5 4.1%

Hot Spot 4.6%

Mega Millions 12.7%

Super Lotto Plus

20.5%

Scratchers 53.8%

Source: La Fleur's World Lottery Almanac

2006 Lottery Sales Per Capita Sales, Selected States

States RankSales (US$) States Rank

Sales (US$)

Massachusetts 1 707 Delaware 1 903Georgia 2 342 South Dakota 2 890New York 2 342 West Virginia 3 865Connecticut 4 274 Massachusetts 4 707Maryland 4 274 Rhode Island 5 621New Jersey 6 267 New York 6 364Rhode Island 9 241 Georgia 7 342Delaware 22 145 Connecticut 9 274West Virginia 24 118 Maryland 9 274Colorado 27 96 New Jersey 11 267California 28 94 Colorado 27 96Arizona 36 75 California 28 94South Dakota 39 52 Arizona 36 75* Video Lottery Terminal

Without VLT* With VLT*

2006 Lottery Prize Payout Percent, Selected States

Source: La Fleur's World Lottery Almanac

StatesPrize Payout

(%)

Per Capita Sales*(US$)

Massachusetts 71.9 707Georgia 61.4 342Texas 61.2 159Florida 59.6 230New York 59.4 342Ohio 59.0 198New Jersey 57.4 267Michigan 57.3 219California 53.9 94* Sales from Video Lottery Terminals are not included.

Charter School Market Share 2006

Source: Reason Foundation

Rank Community Charter School

Market Share (%)1 New Orleans, LA 692 Dayton, OH 283 Washington, DC 254 Pontiac, MI 20

Kansas City, MO 20 Youngstown, OH 20

5 Chula Vista, CA 18 Detroit, MI 18 Southfield, MI 18 Toledo, OH 18

6 Cincinnati, OH 177 Brighton, CO 16

Cleveland, OH 16 Milwaukee, WI 16

8 Buffalo, NY 15 Mohave County, AZ 15

9 Dearborn, MI 14 Oakland, CA 14

10 Minneapolis, MN 13

California Charter School Facts

Sources: The Center for Education Reform, California Department of Education

Opening in 2007-2008 80Total Closed Since 1992 91Total Operating 710Total Enrollment 238,593Startups vs. Conversion Schools 84% vs. 16%Site-Based Schools vs. Others* 76% vs. 24%* Non-classroom-based or combination of site-based and non-site-based

Outcomes of Water and Wastewater Privatization Contract Renewals

Source: Reason Foundation

Renewed by Negotiation

75.0%

Renewed by Competition

10.0%

Won by Other Company

6.0%

Deprivatized 8.0%

Other 1.0%

Potential P3 Opportunities in California

Prisons/Jails

Courthouses and Other Facilities

Toll Roads and Goods Movement Transit and High Speed Rail

Lottery Others

Student Loan$100,000

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Student Loan$100,000

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Water

California History with Transportation P3s is “Mixed”

• AB 680 Toll Roads (1989) – Authorized Caltrans to undertake four “demonstration projects” for private construction and operation of toll roads. Only two projects were undertaken. Subsequent legislation, AB 1010 (2002), prohibited Caltrans from entering into new agreements after January 1, 2003.– SR 91 in Orange County and Riverside County

• California Private Transportation Company was initial franchise operator (constructed and opened in 1995)

• Litigation over “safety improvements” vs. “non-compete clause” was settled by Caltrans in late 1999• Multiple restructuring proposals were considered; ultimately purchased by OCTA after enactment of AB

1010• SR 91 presently generates net surplus (after operations and debt service) of $23 million per year• RCTC has adopted plans to extend public SR 91 toll lanes into Riverside County in cooperation with

OCTA– SR 125 in San Diego County

• Lease agreement completed and initial project studies and design commenced in 1991; environmental clearance not granted until 2001

• Received financing from Macquarie Infrastructure Group/California Transportation Ventures (CTV) and commenced construction in 2003; cost overruns necessitated enactment of SB 463 to extend lease agreement and tolling period

• Opening expected by end of 2007

• An early example of successful P3 project in California is the Alameda Corridor project– Benefit to the private sector was compelling, enabling container charges to secure revenue-backed financing– Innovative leveraging of federal dollars also was key to success

Even successful examples have been source of public controversy or challenges

Evolution of Infrastructure Project Public-Private Partnerships

• Increase in global liquidity• Patient international equity investors• Tax-exempt/taxable spread

compression• Private sponsor appetite for

infrastructure investments• Established long-term international

concession financing models• Established international credit and

rating criteria

Financial Markets Perspective

• Increased willingness to shift cost to users

• New focus on optimizing revenue streams

• Longer-term perspective on revenue generation capability of infrastructure assets

Government Perspective

Catalysts

New Paradigm for US Infrastructure Investment

through Public-Private Partnerships

• Fiscal challenges• Increasing capital needs• Lack of funding sources• Resistance to tax increases• Infrastructure maintenance/

development needs• Management of non-core assets• Operational cost savings• Accelerated project requirements

Evolution of Infrastructure Financings

• Shift to life-cycle financial analysis for construction and O&M• Shift in pricing regimes from cost-recovery to market-based with indexed

caps• Private investment replaces or supplements public debt• Long-term asset management transfers to private sector with public

oversight through contractual agreements• Long-term debt financing horizons considered investment grade (50 years

plus)• Deferred principal amortization (can be negative amortization)• Multiple rollovers/refinancings are modeled in base finance plan similar to

corporate finance model

As a result of recent concession financings, the following characteristics are becoming accepted for domestic infrastructure financings

Infrastructure Financing Dynamics: Ownership

• Public:– Control of operations and residual interest– Traditionally very conservative leverage with minimum A-category

rating targets• Public/Private:

– Public control of operations and residual interest in most cases– Opportunity to increase leverage at BBB rating category and/or with

private investment while keeping majority interest• Private:

– Public contractual control of operations and maintenance throughconcession agreements with residual value shifting to private investors

– Maximizes leverage and upfront capitalization of value

Partial or full private ownership may attract additional capital

Paradigm Shift Driven by Recent Market Developments

• Increased private sector interest in infrastructure investments presents new financing opportunities for public-private partnerships

• Market acceptance of long-term financing structures beyond traditional fully amortizing 30-40 year final maturity practice– Rating agencies: realize long-term debt repayment capability– Credit enhancers: assume embedded refinancing risk– Private investors: desire stable, long-term investment return

• Financing proceeds can be increased through extended final maturities, managed pricing regimes, and/or partial or full ownership sales

• Pricing regime and residual value policy is critical to the evaluation of options

Ability to unlock value in infrastructure assets not realized under traditional municipal financing can be applied to public, joint and private ownership models

Recent evolution of long-term financings of infrastructure projects

• P3 is a standard practice around the world and highly developed in Europe and Canada– A range of P3 approaches provide varying degrees of public sector control, risk transfer, and economic

benefit– Rationale increasingly compelling:

• Accelerating the implementation of high priority projects• Accessing new technology from the private sector• Accessing global private sector expertise• Private sector management of projects to control lifecycle cost and shift risk• Accessing financial resources of the private sector • Leveraging scarce public resources (personnel, monetary)

• National demand for infrastructure projects substantially outstrips resources from traditional financing tools

• P3 market is evolving in the United States with a broad spectrum of execution models– Brownfield Projects: Chicago Skyway and Indiana Toll Road– Greeenfield Projects: Port of Miami Tunnel, SH121 (Texas)

• Private sector participants view the world as their market and are ready to compete. They look for:– Senior leadership and commitment– An empowered team with professional advisors– Certainty of execution, with a transparent process– A level playing field (all bidders, public and private)– Projects that demand innovative solutions

P3 alternatives: used world wide, complex, and evolving

Summary and Conclusion

Public-Private Partnership: Case StudyGround Water Recovery San Juan Basin Desalter Project

• In December 2002, Lehman Brothers underwrote $32 million San Juan Basin Authority Lease Revenue Bonds. The Bonds funded a 5.14 MGD brackish water treatment facility using the reserve osmosis treatment process that will improve potable water to the City of San Juan Capistrano. The Bonds are limited obligations of the Authority, payable from lease payments to be made by the Water District. Neither the full faith and credit nor the taxing power of the Water District is pledged. The Project will receive a subsidy from the Metropolitan Water District as an incentive to develop alternative water sources.

• The Water District engaged ECO Resources under a 20-year fixed price design/build/operate Service Contract (with corporate guaran-tee) subject to performance-related liquidated damages at a capped amount. The District has the right to terminate the lease if ECO defaults on the Service Contract and the cure/replacement period expires. If the District terminates the lease under these situations, it would relieve them of their obligation to make lease payments and bondholders would have no other recourse for payment.

• Before Lehman Brothers was engaged, attempts by ECO, the City, and the Authority to finance the Project in financial markets proved uneconomical. Lehman Brothers worked with ECO, the City, and the Authority to restructure the transaction, including advising on revamping the Service Contract and the leasing structures during construction and operation. The transaction resulted in a structure in which ECO’s liabilities are capped, and the City is provided a reliable water source without construction or technology risk.

• Financial close reached with Lehman BrothersJanuary 2003

• City’s 1st attempted financing was uneconomicalLate 2002

• Lehman Brothers prices restructured transactionDecember 2002

• Water District engaged ECO ResourcesSeptember 2002

Timeline

Details of San Juan

Tunnel Concession Port of Miami Tunnel

• The Port of Miami Tunnel Project had been considered for over 25 years with numerous studies completed

• The State of Florida and the Florida DOT could not find the funding necessary for the Project• By 2006, the cost of the Port was estimated at over a billion dollars• By utilizing a design-build-finance-operate P3 structure, the total cost of the POMT came in

considerably less than a traditional procurement • The POMT is an extremely technically challenging project with many geotechnical risks• The transfer of much of the risk inherent in the Project to the private sector, coupled with cost

savings, has made the POMT a true example of the benefits of P3s

Public-Private Partnership: Case Study

• Financial close expectedNovember 2007

• Request for proposals released to the marketNovember 2006

• Request for qualifications submittedMarch 2006

• Request for proposals submittedMarch 2007

• Request for qualifications released to the market

February 2006

Timeline

Details of POMT

Public-Private Partnership: Case Study

The 100 Cambridge Street Project redeveloped existing unoccupied 565,000 sq. ft. 22 story Commonwealth of Massachusetts office building in Boston, MA

In May 2002, Lehman Brothers served as senior managing underwriter for the $195.8 million tax-exempt and taxable revenue bond offering through the Massachusetts Development Finance Agency, pursuant to a long-term ground lease from the Commonwealth of Massachusetts

- The bond structure consists of senior lien bonds and subordinate lien bonds with a 32 year final maturity. The Project includes a fully redeveloped Class A office tower as well as new construction of 75 condominium units and 35,000 sq. ft. of retail space on an existing street level plaza and the remodeling of the existing 415 space multi-level underground parking facility

The lower half of the office tower (12 floors of approximately 286,000 total sq. ft.) will be sub-leased back to the Commonwealth of Massachusetts at a below market rate of $22 per square foot on a ‘triple net’ (NNN) basis for an initial 50-year term with extensions

The Agency’s equity contribution to the project was $20 million or about 9% of the total capital structure

Public Facility 100 Cambridge Street Redevelopment Project

Details of 100 Cambridge Street Redevelopment Project

• 100 Cambridge Street Office building closed

June 2000

• Revitalized 100 Cambridge Street openedJanuary 2004

• Financial close reachedMay 2002

Timeline

Concept As Completed

International Experience

• Canada as an example:

– Infrastructure Ontario

– Partnerships British Columbia

Centre of Expertise/Best Practices is Critical

Centre of Expertise

• Project Management of Complex Projects• Best Practices Utilized• Examples:

– Pre-Feasibility– Business Case– Competitive Selection Process– Contract Negotiations– On-Going Project Monitoring

Centre of Expertise

• Beyond Project Management…

– Market Development

– Transparency and Fairness Requirements

– Communication

Key Principles

• Five key principles:

– The public interest is paramount.

– Value for money must be demonstrable.

– Appropriate public control/ownership must be preserved.

– Accountability must be maintained.

– All processes must be fair, transparent and efficient.

Canadian Experience

• Highways

• Bridges

• Rapid Transit

• Healthcare

New Hospital Facility

• Justice

• Energy

• Water Treatment

Borealis

• Started in 1999.

• $8 billion of invested and committed capital in infrastructure projects.

• Alternative asset investment manager for Ontario pension fund.

• 20% of pension fund assets committed to infrastructure investing.