Unyoking the Cash Cow: Who Should Own the New Jersey Turnpike?

1. Derrick Leung, Class of 2008 Advisor: Professor Alain Kornhauser 7 December 2009 Unyoking the Cash Cow: Who Should Own the New Jersey Turnpike? ORFE Senior Thesis Presentation

2. 1: Introduction

3. The New Jersey Turnpike • Interstate 95; 148 miles • Opened in 1951-1952 • FY06 toll revenues: $533.4 million • FY06 ridership: 250 million trips • 5th most traveled highway (IBTTA) • Current valuation • $6 billion (Lesniak, Mar. 2006) • $30 billion (Villaluz, July 2005) • $40 billion (Edwards, Feb. 2008) 1

4. Privatization Debate • Improved operational efficiency • Innovative tolling • Public sector needs for fresh capital • Incentives to use private equity (leverage) • Uncertain private sector advantage • Conflicting public/private goals • Transaction costs ($30 milion to $200 million) Public Benefit Company (PBC) For Privatization Against Privatization 2

5. Motivation • Private sector management • Public sector control • Proposed structure of toll increases • Chicago Skyway, Jan. 2005 • $1.83 billion, 99-year lease • Indiana Toll Road, June 2006 • $3.85 billion, 75-year lease • $29.7 billion as of June 30, 2007 • $2.6 billion annual charge Public Benefit Company (PBC) Previous Asset Monetizations New Jersey State Debt 3

6. 2: New Jersey Turnpike Valuation Model

7. Formulation • Modified DCF formulation • Free Cash Flow (FCF) formulation 4

8. p x Traffic Model Parameters • Valuation timeframe: 75 years (2007-2081) • Inflation measure: 3% increase in CPI • Revenues: • Projected using regression of growth rates over past 9 years • Five (5) different tolling scenarios • Price elasticity of traffic: • 0 (inelasticity), -0.19 (average), -0.15 (low bound), -0.31 (high bound) • Expenses: • Projected using regression of growth rates over past 9 years • Interest and principal payments; capital expenditures 5

9. Tolling Strategies • Case 1: Status Quo • Current real toll maintained • Case 2: Leung-Kornhauser Plan • Initial real toll doubling • Case 3: Break-even Toll Plan • Calculation of real toll such that net present valuation yields 0 • Case 4: Governor Corzine’s Plan (PBC) • “50% maximum real toll increases in 2010, 2014, 2018, and 2022 plus annual increases, based on CPI, levied to capture the prior 4 years, starting in 2010 and every 4th year thereafter.” • Case 5: Private Entity Plan • Initial real toll increase that yields optimal (maximum) valuation 6

10. Data and Projections 7

11. 3: Results

12. Case 4: Governor Corzine’s Plan (PBC) Functional form of solution Valuation sensitive to more inelastic traffic 8

13. PBC Equivalent • PBC Equivalent Cash Flow structure • Tolling structure of current plan inefficient • Inspired by Leung-Kornhauser plan • Gains to setting initial three-time (quadrupling) real toll increase • Greater cash flow in earlier time periods 9

14. Case 5: Private Entity Valuation Functional form of solution Private Entity Valuation unbounded for elasticity of 0 10

15. Valuation Sensitivity to Line-Item Costs Valuation insensitive to individual line-item costs (5%) 11

16. Valuation Sensitivity to Cost Basket Material benefit due to cost reductions seen from reduction in cost basket (20%) 12

17. 4: Conclusion

18. High Valuation Drivers Valuation driven by increased tolls when traffic is price inelastic Valuation driven by cost reductions when traffic is price elastic 13

19. The Motorist’s Perspective 14

20. High Arbitrage Gain • Case 1: Status Quo • Arbitrage Gain = $0 • Case 2: Leung-Kornhauser Plan • Arbitrage Gain = $9.1 billion • Case 3: Break-even Toll Plan • Arbitrage Gain = N/A Arbitrage Gain = High Valuation – Current Valuation • Case 4: Governor Corzine’s Plan (PBC) • Arbitrage Gain = $31.5 billion • Case 5: Private Entity Plan • Arbitrage Gain = ∞ 15

21. Recommendation: The Buyer’s Perspective Implement PBC Equivalent: 3x initial increase of real toll 16

22. 5: Thesis Application in the Real World

23. Goldman Sachs • Investment Banking • Mergers and Acquisitions • Industry coverage groups (Technology, Media and Telecom (TMT), Natural Resources, Financial Institutions, Industrials, Consumer/Retail, Real Estate) • Product group (Leveraged Finance, Equity Capital Markets) • Asset Management • Asset Management (GSAM) and Private Wealth Management (PWM) • Trading and Principal Investments • Equities • Fixed Income, Currency, Commodities (includes Special Situations Group) • Merchant Banking/Private Equity Division • Principal Investment Area (Corporate Equity, Corporate Debt, Mezzanine, Real Estate, Infrastructure) 17

24. What is Private Equity? • Acquisition through leveraged buyout (LBO) of mature, stable cash flow businesses with free cash flow generation used to support debt service • Reasonable growth, defensive business model, strong management team, low capital expenditures, over-equitized capital structure • Leverage used to increase purchase price in auctions • 2004-2007: 75% debt / 25% equity, low cost of debt (low credit spreads) • 2008 and after: at most 50% debt / 50% equity Private Equity Firm (General Partner) Investors (Limited Partners) Private Equity Fund (Limited Partnership) Investment B Investment C Investment A 18

25. Characteristics of Infrastructure Investments • Stability • Provision of essential services to communities • Insulated from business cycles, high barriers to entry • Duration • Nature of services supports asset longevity • Long-term cash flows support long-term investment horizon • Inflation • Regulation or concession determines pricing (inflation-linked cash flows) • Yield • Current yield through free cash flow • Diversification • Low correlation with other asset classes • Alternative to other investments (including traditional private equity) 19

26. Competitive Landscape • Competitors • Private equity firms • KKR, TPG, Carlyle, Blackstone, Bain Capital, Apollo • Boutique infrastructure investment firms • Global Infrastructure Partners, Alinda, Macquarie, Babcock & Brown • Investment Banks • Morgan Stanley • Insurance companies / pension funds • Sovereign wealth funds 20

27. Selected Transactions • Sea Ports • Restructuring of $5 billion North American terminal operator • Distressed LBO of $5 billion international port and rail company • Opportunistic acquisitions of distressed competitors and emerging markets ports through current investments • Toll Roads • LBO of Florida toll road through P3 auction; approx. $1 billion transaction • Proprietary recapitalization strategy for select North American toll roads • Other • Infrastructure: Airport services, gas network, district energy, airport parking • Energy: Debt investment in transcontinental pipeline company • Healthcare: Home therapy services provider in Florida • Fundraising • Maintaining investor relations for current $6.5 billion fund (GSIP I) • Raising equity capital for new infrastructure fund (GSIP II) 21

28. Then and Now • Mega funds • Diversification of investor base • Auctions accepted • Use of leverage • Cheap cost of debt (low spreads) • Long tenor (7-10 years) • Steep growth profile underwritten • Stable, solvent companies Pre-Credit Crisis Post-Credit Crisis • Smaller funds • Limited Partners want to exit • Negotiated transactions • More equity required • High cost of debt (debtor risk) • Short tenor (3-5 years) • Low base, moderate growth • Restructuring strategies through debt or equity investments 20

29. 6: Q&A