By Fortune Magazine [October 2 2007]
Macquarie Bank has made infrastructure funds a smoking-hot investment class. But the way it finances its deals has short-sellers circling, writes Fortune’s Bethany McLean.
(Fortune Magazine) — "This is the greatest single financial coup in the history of Chicago." That’s how alderman Edward Burke, chairman of the city council’s finance committee, described the 99-year lease of the Chicago Skyway, a 7.8-mile toll road, to a private operator for the stunning sum of $1.8 billion – almost $1 billion more than the next-highest bid. The deal, struck in late 2004, was the first privatization of a toll road in the U.S.
The Skyway runs from the skyscrapers downtown to the old steel mills of northwestern Indiana, where it meets the Indiana Toll Road, a 157-mile highway. Before long, Indiana Governor Mitch Daniels announced that he’d leased that road to the same private operator for $3.8 billion.
Unusual as the deals may sound, the real surprise is that it took so long for them to happen. All around the world governments have been selling off infrastructure like toll roads, not necessarily because they want to but because they don’t have a choice: They need the money.
The same is true here – the U.S. needs $1.6 trillion in infrastructure investment over the next five years, according to a report by the Urban Land Institute and Ernst & Young – but perhaps because we’ve been reluctant to face up to that fact, the bankers and consultants who do deals like the lease of the Skyway refer to the U.S. as an "emerging market."
If anyone thought that the investment wasn’t a matter of urgency, the collapse of Minnesota’s Interstate 35W bridge this summer, which took 13 lives, showed otherwise.
4 infrastructure stocks ready to boom
Another surprise about these deals is that they weren’t done by the usual suspects, like big Wall Street banks. Both the Skyway and the Indiana Toll Road were leased by two foreign companies working in partnership – a Spanish company called Cintra and a rapidly growing, highly controversial Australian firm called Macquarie Bank.
Macquarie, via funds that it controls, now owns chunks of 108 infrastructure assets around the globe, from parking lots in Manhattan to airports in Sydney, Brussels, and Tanzania to the Thames Water Co. in London to the Changshu Xinghua port in China.
Each day some 1.7 million cars drive on Macquarie’s toll roads, some 115 million people pass through its airports, and some 60,000 people report to work at its assets. That, of course, makes Macquarie into something very different from just another financial services firm.
"These are major assets that affect people’s lives," says Adam Nicolopoulos, a former UBS banker turned consultant.
Macquarie has its roots in Australia, where a serendipitous convergence took place in the mid-1990s. That’s when a law was passed requiring Australians to put a percentage of their salaries into investments for retirement. At the same time, the cash-strapped government had begun turning over things like toll roads to private companies.
It was Macquarie that had the brilliant idea to put the two together by buying the right to run a toll road from the government and then selling that road to the public in an IPO. The theory was that a toll road – unlike, say, a technology stock – is a handy way to save for retirement because it produces a steady stream of cash that is relatively unaffected by economic downturns (are you going to stop using the roads?) or by competition (what other road are you going to use?).
Today "infrastructure funds" specializing in everything from toll roads to broadcast towers are as common in Australia as mutual funds are in the U.S.
The "Macquarie model," as both believers and skeptics call it, is now spreading around the world. Macquarie has funds listed everywhere from the New York Stock Exchange to the Singapore exchange. In total, the firm now manages A$225 billion, roughly half of which is devoted specifically to infrastructure; in the past 17 months, a fresh A$34 billion poured into its coffers, almost 80% of which came from outside Australia.
"It’s just a huge market," says Macquarie CEO Allan Moss. "I think we’ve just scratched the surface of what we can do." Analyst Brian Johnson at J.P. Morgan is even less reserved. "How big is the opportunity?" he asks. He pauses, and then screams, "Massive!"
Risk returns with a vengeance
If the general public doesn’t know the name "Macquarie" yet, Wall Street certainly does. Some 20% of its stock is owned by North American investors, including mutual fund giant Fidelity. U.S. pension funds such as the Illinois State Board of Investments are handing Macquarie money to manage.
And powerful firms from AIG (Charts, Fortune 500) to Goldman Sachs (Charts, Fortune 500) are following in its footsteps by raising multibillion-dollar infrastructure funds of their own. "MacWho?" was the question during the Skyway deal, says Dana Levenson, the former CFO of the city of Chicago, who is now leading an infrastructure group at the Royal Bank of Scotland. "Now these guys are everywhere, and everyone is taking notice."
Macquarie says it offers a straightforward service ("It’s bloody simple," says Murray Bleach, head of the firm’s North American investment-banking business).
In leasing the Skyway, Chicago got $1.8 billion in cash right away instead of by collecting tolls for 99 years. That enabled the city to pay down debt and put another $500 million into a rainy-day fund on which it collects interest – more interest than it was getting in annual tolls, says Levenson. It is now Macquarie and Cintra’s responsibility to run the road, which encompasses everything from removing dead animals within eight hours to funding capital expenditures. (Within three months of taking over, it had installed electronic tolling.)
If, in 50 years, we all have individual flying machines and no one is using the road, it’s a problem for Macquarie and Cintra, not for Chicago. And if the new operators fail to meet the city’s roughly 300 pages of operating standards, the city can take the road back.
Of course, there’s a price for all this. The toll went to $2.50 from $2 on the day that Macquarie and Cintra took over, and it will continue to increase.
Then again, it really isn’t all that simple. There is widespread resentment and cynicism about the notion of private companies making money off what has long been perceived as public property.
Look no further than Indiana, where Governor Daniels’s popularity ratings plunged in the wake of the sale of the toll road amid a hue and cry about foreign firms’ owning our roads. And as the self-styled populist Lou Dobbs asked, "What right do they have to sell something that belongs to the taxpayer?"
But that’s not the only reason Macquarie is controversial. No less a critic than Jim Chanos, the president of Kynikos Associates, who earned worldwide fame for being an early critic of Enron, is selling Macquarie’s stock short. He argues that instead of inventing a new way to finance infrastructure, the firm is engaging in an old-fashioned Ponzi scheme.
So what does it mean if the financial structures underpinning Macquarie’s assets are actually as unstable as the steel that supported the Interstate 35W bridge?