Early last week, NCDOT released an analysis of the cancellation penalties. Unfortunately, the headlines have dutifully blared the cancellation penalty could be as high as $300M. Like so many other “independent analyses”, a look past the headline yields a different result.
Consultant’s Independence Questionable
The analysis was performed by Clary Consulting, headed by a Mr. Lowell Clary. Clary has long championed the Public-Private Partnership (P3) model employed in the current I-77 HOT lanes contract. He used to be an Assistant Director with the Florida Department of Transportation (FDOT) where he was described as the “architect of the P3 model” in Florida. He resigned from FDOT in 2007. The first public record of Clary being in the same room as Cintra was in 2007 when they were panelists at a conference in Washington DC. Clary and Cintra will cross paths at least one more time when they are panelists/sponsors of another DC conference this summer.
An estimation of cancellation penalties is purely a financial analysis. It does not require transportation or P3 expertise. Hence, we question the “independent” nature of this audit.
In the case of a termination for convenience, the contract requires compensation for the greater of the Senior Debt Termination Amount or the Fair Market Value of the project. We’ll discuss each in turn.
Senior Debt Termination Amount
The only debt issued thus far was $100M in Private Activity Bonds (PABs), issued on May 13, 2015. (Interesting… this was a week before Financial Close of May 20,2015!) Redeeming the bonds before they are due incurs a penalty of 5 years of interest. Clary calculates this at $22M. (As an aside, if the contract were cancelled today you the taxpayer shell out five years of interest a mere seven months after it was issued. Who negotiates a deal like that?) So Clary calculates the SDTA as $122M ($100M + $22M).
However, the penalty is reduced by the unspent portion of the loan. Clary reports as of Oct 31, 2015 Cintra had spent $51.5M, leaving a cash balance of $48.5M. Adding in demobilization and other miscellaneous costs, Clary comes up with a penalty under this scenario of $82M.
But let’s go back to that cash balance for a minute. Back in October, before they started “construction”, Cintra apparently managed to rack up over $50M without paving single square inch of asphalt. By comparison the new stretch of I-485, including the interchange, cost $138.5M…
We have no issue with Clary’s analysis for this scenario, but the amount Cintra supposedly spent on the project strikes us as hugely inflated.
Fair Market Value
Because there is no operational history yet, to calculate the Fair Market Value (FMV) Clary used Cintra’s revenue & cash flow estimates to come up with a penalty of $295M. Here’s where we run into problems with the analysis.
First, Cintra’s revenue estimates are unreasonably optimistic. Below is a chart showing annual revenues vs metro population for every toll lane operation in the US. As you can see, toll revenues roughly correlate to population; the larger the metro area, the higher the toll revenues.
There is, of course, one glaring exception: I-77. Using Cintra’s projections, I-77 would be the second highest grossing toll lane in the country while serving the second smallest metro area. Clearly their estimates are not supported by historical data. Based on population, I-77 toll lanes revenues are more likely in the $5-6M range.
So this is the first problem with the analysis: Clary did not review any existing operations as proxies. This is a grievous omission, reducing their analysis to a Cintra dream scenario.
Second, the model they used for the cash flow includes the public contribution. So the taxpayer is apparently expected to pay a penalty on their own contribution. This is not a trivial sum: $94M in upfront taxpayer contribution, and up to $75M in tolling subsidies. Discounted to today’s dollars, this amount would be less, of course, and it is unclear as to how much the taxpayer contribution increases the penalty. Regardless, the taxpayer contribution should be removed from the cash flow analysis.
The third issue has to do with financial analyses. Clary states they used the Internal Rate of Return (IRR) of 12.5% as the annual discount rate. Using this rate, they calculated the net resent value- ie the project value in today’s dollars- as $295M. Here’s the problem: by definition, IRR is the discount rate at which the net present value is zero. In plain English:
Let’s say you have a long term project. In the early years you expect to lose money, but in later years you expect to make money. How do you value the project? Of course, a dollar today is worth more than a dollar next year, and every year further out becomes more uncertain. So you discount those future dollars back to present dollars using the discount rate. You add up all those discounted cash flows and that gives you the present value of the project.
However, another way to look at this is what kind of return you’re getting on your money. In this case, you set the present value to zero and then calculate the discount rate needed to achieve that. This discount rate is the IRR.
By definition, then, using the IRR means the present value is zero. But Clary uses an IRR and comes up with a value of $295M. Perhaps they misused the term but there’s another issue. The Comprehensive Agreement says the overall IRR is 14.3%. Again, using the proper definition of IRR, the present value is therefore zero. Clary used 12.5%, a mere 1.8% difference, and it created a whopping $295M in value.
Something doesn’t add up.
Regardless, officials would be well to study the number and ask the tough questions. Because right now this “independent” audit reads more like a Cintra Dream Scenario: they get paid half the cost of the project before they’ve barely started.