Do your homework

26 Mar 2016
Returns: Infratil made a marked profit with this timely sale of its share in Tauranga. Credit: Abaconda Management

Returns: Infratil made a marked profit with this timely sale of its share in Tauranga. Credit: Abaconda Management

Dave MacIntyre finds out how investors can take the rough with the smooth in port commitments

Investing in ports can be anything but the conservative investment that normally characterises infrastructure or utilities, as some have found to their cost. Terminal operators, shipping companies, pension funds, private equity companies, infrastructure funds and insurance companies are all now active in the ports market, but a key question is what degree of due diligence they undertake to underpin their investment?

There have been successes and failures. When Hutchison bought the IIHC portfolio of terminals from ICTSI it conducted detailed due diligence on each terminal property and got the “mother” port authority to sign over each concession. There were no problems after acquisition.

On the flip side, Hutchison’s expansion in Australia involved excessive costs in trying to take on an established duopoly. The implication is that they did not drill down enough to ensure they would put in place a highly-competitive operating entity.

When DP World bought P&O Ports it is well known they only undertook corporate-level due diligence, rather than detailed due diligence of each individual business unit. Subsequently, a problem arose in India when its Mundra International Container Terminal, previously owned by P&O, lost its sub-concession with the Mundra Port and Special Economy Zone.

DP World had not sought permission from the state port regulator, the Gujarat Maritime Board, which was mandatory under the concession agreement. While DP World managed to negotiate a continuation of its operations at MICT, it was overlooked when the second container terminal was developed.

Further failings

An earlier example of failure was the-then Dubai Ports Authority signing a management contract for the Beirut Container Terminal in 1998, but a few years later pulling out after miscalculating throughput and revenues.

A more recent dud was the Chinese consortium’s acquisition of a majority shareholding in Kumport, Turkey. Immediately afterwards the terminal lost the business of Maersk and MSC - MSC had opened its Asayaport facility and also has shares in Kumport’s neighbour MARPORT. It is understood that about 40% of the terminal’s throughput disappeared - no joke when you have paid top dollar for a majority stake in the business.

Other investors have had marked successes in port investments.

New Zealand and Australian-based listed company Infratil acquired a 25% shareholding in the Port of Tauranga when local understanding of the port sector was still developing and sold at a marked profit as the company matured. Another investment was in the Port of Portland in Australia.

James Waldie of H.R.L. Morrison & Co - Infratil’s investment manager - tells Port Strategy that it seeks long-term returns when considering a port investment. These are primarily but not solely analysed based on a detailed 30-plus year discounted cashflow valuation, translating underlying demand drivers (e.g. trade volumes/ship visits) into earnings forecasts.

The growth outlook and international competitiveness of the export products sourced from the port’s hinterland are analysed, as well as likely growth of imports.

“It is important to overlay any physical constraints (including both within port precinct, and external limitations such as road/rail congestion) of the port’s capacity into the forecasts, and make allowance for major expansionary capital expenditure which will improve the port’s long-term ability to handle trade flows - as well as assess and provide for adequate maintenance capital expense given the harsh marine environment.”

All-time high

Recent Australian port transactions have occurred at all-time-high earnings multiples, as institutional capital seeks low-risk yielding assets in a low-interest rate environment plus leverage from businesses with GDP-plus growth prospects and relatively fixed-cost bases.

Mr Waldie says a key determinate is the relative riskiness of the port’s business.

“A major container port typically has material barriers to entry, strong pricing power and a diverse range of customer and commodity volumes. An investor will be able to obtain a level of comfort in the port’s earnings potential and long-term viability and will ascribe a lower return hurdle/higher valuation.

“In contrast, smaller regional ports can be reliant on a more concentrated set of commodity flows which tend to be more volume volatile and, in some cases, more competition from neighbouring ports.

“In these circumstances, an investor will require a higher return, implying a lower valuation.

“Sometimes what’s on offer is not the port itself but specific port operations, such as container stevedoring or bulk liquid storage. These are also considered as investment prospects.”

Importantly, Morrison & Co believes that infrastructure assets such as ports benefit from an active management approach.

“For us this means making sure that we have board representation at a minimum and an active role in recruiting and incentivising senior executives. We also deploy our executives to support key strategic initiatives in the business where the business does not have sufficient in-house resource.”

What about ports seeking to entice an investor? Mick Payze, director of Australian-based Shipping and Freight Enterprises P/L, recently spoke on the effectiveness of public private partnerships (PPPs) to an industry conference in Papua New Guinea. He said many countries have moved to involve the private sector in port management to achieve operational improvements, to answer challenges such as the ever-increasing size of vessels.

Get together

A possible way forward is a joint venture between a private investor and a landlord port authority in a PPP (although terminal operators may have reservations as it gives the port management strings to interfere).

A PPP may be where the parties join as equals to operate the port functions or may be more a master-servant relationship where the state or public authority retains control but financial accountability is shared.

From a government perspective, the advantages of a PPP include easing the burden on the national budget, attracting foreign investment, transferring all or part of the risk to the private sector, and freeing up capital. A government may also look to regulatory oversight to ensure that the public interest is protected, including the ability to retain control over tariffs and the KPIs for the port or terminal.

Mr Payze says the governance can adopt one of several structures: management contracts can assure public ownership of assets is retained with operational management outsourced to the private sector, whereas lease and rent contracts also retain public ownership of the main terminal infrastructure with the private sector using those assets under licence.

Alternatively the government may act as both regulator and landlord, or the private sector may assume operational responsibility and operational and financial risk. Lease payments can be set either on a fixed basis or with some combination of a cargo-throughput levy.

How can a port initiate the search for a concession holder? Two key steps may involve requesting Expressions of Interest - which involves technical and financial qualification - and (from qualified parties) a Request for Proposals.

Usually two envelopes are involved: technical and financial. In mature economies usually the winner emerges not just based on the financial offer but also for technical competence/innovation, business plan, operational plan, environmental management and safety systems and so on.

Mr Payze says there should be a set pattern of information collation and disclosure to meet with due diligence standards set by finance institutions. The data required will cover existing and projected cargo demands, institutional and management arrangements, options for a port management structure and ownership model, preliminary costs of building and developing the required port facilities and the cargo-handling costs, and the projections of FIRR (financial internal rate of return) and EIRR (economic internal rate of return) to ensure a viable result.

Generally, it is preferable for the terminal operator to be a lead partner in the successful consortium.



FINDING A CONCESSION MODEL THAT FITS

Concession agreements come in many shapes and sizes, but they generally fit with one of the following models:

  • the landlord port authority;
  • the fully craned or 'tool port', where the port authority owns the quay cranes or cargo handling infrastructure and the stevedore provides the mobile equipment and waterside workers;
  • LOT, or lease, operate, transfer, contracts in which the port authority constructs the wharf and levels the land and the concession holder finishes off the civil construction and provides the mobile handling equipment;
  • BTO, or build, transfer, operate, contracts where the operator transfers the ownership of assets it constructs to the port authority immediately upon completion and then enters a management contract for a term;
  • BOT, or build, operate, transfer, where investors fund the provision of infrastructure and also the provision of the handling equipment;
  • BOOT, or build, own, operate, transfer, contracts where the operator owns the site on which the improvements are to be constructed until the end of the concession period—the predominant model for PPPs;
  • Full privatisation

Links to related companies and recent articles ...

DP World

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International Container Terminal Services Inc.(ICTSI)

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Hutchison Port Holdings:

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