The Commonwealth of Pennsylvania has received 14 responses to its request for qualifications (RFQ) for a lease of its turnpike. Edward Rendell, Pennsylvania's Governor, says that the state could select a concessionaire before the end of the year. The proposed concession has been valued at between $10 billion, by the more conservative bankers, and as much as $20 billion by the optimistic Governor, and anywhere between the two by other players in the industry.

However, the concession is a political hot cake. Bankers and advisers alike are sceptical as to whether the deal will happen at all, and suggest that if it does, it will not adhere to Rendell's vision.

How to monetise?

The discussions regarding the future of the turnpike followed a report, published in May 2007 byMorgan Stanley. It identified a shortfall of $1.725 billion in funding annually for the maintenance and upgrade of the state's transport system, of which $965 million is required for highways and $760 million for transit.

The report proposed three options for the road, each with its own assumptions. The analysis of long-term lease of the turnpike estimated that a concession, based on either a 75 or 99-year lease, could raise between $12 billion and $18 billion in upfront fees, which if invested at a rate of 7%-9% would provide $1.3 billion to $1.6 billion of the current annual shortfall. The single concession would cover approximately 750km of highway.

The second option was for a non-profit model, involving the formation of a new agency with the authority to enter into short-term operations and maintenance contracts of up to 10 years. It would issue tax-exempt debt and increase tolls after 2010 at the greater of the increase in nominal or per capita GDP or inflation, subject to a 2% per year floor. This model has not been discussed again since its inception.

The third option is for the Pennsylvania Turnpike Commission (PTC), the current operator of the Turnpike, to continue to run the highways, and implement a 25% increase in tolling by 2010, and a congestion tax of $1 in Harrisburg, Pittsburg, Scranton and Philadelphia. This option is the main competitor to a concession, but involves, however, the introduction of a toll on the currently free Interstate 80 at the same rate as the turnpike.

The possibility of a lease of the turnpike was overruled by the Pennsylvania legislature in June 2007. The outcome of the vote, which resulted in Act 44, was close, and resulted in the Pennsylvania Turnpike Commission (PTC) taking control of the turnpike across 67 municipal areas in what it referred to as a public-public partnership. The legislation, which explicitly rejected a concession, allowed PennDOT to seek permission from the federal authorities to toll I-80.

Can we bid it?

There remains no enabling legislation for the lease of the turnpike, even though the state has issued an RFQ and received responses. Speaking at Project Finance's North American PPP & Infrastructure Finance conference on 25 September 2007, Rendell explained, "once the proposals are in place, and a preferred bidder is identified, I will re-introduce the idea of a concession to the legislature". Governor made it clear that the state is seeking as much revenue towards its transportation deficits as it can raise.

Though the RFQ has stirred a great deal of interest, many in the market are remaining circumspect; "If the concession happens, it will be a big step forward for project financing in the US, because it's a monumental deal" says one banker who is currently working on a proposal to act as a financial adviser to one of the 14 teams. But, he continues, "it's not the right time to introduce a deal of this size into a very tight market, there is a big squeeze on leveraged deals, and banks want to wait, we don't want to have more debt on our books right now".

Another banker, who also wishes to remain anonymous, is in talks with another of the teams; "If I were selling the turnpike," he says, "I'd wait until at least next year. It could prove to be a very successful deal, but not with the market as it is."

But Rendell, saying that political conditions are unlikely to stay as favourable as they are now, wants to move fast. He has identified two major factors that work in favour of the concession plan. The tolling of I-80 has proven a major point of contention in Pennsylvania. The proposed toll was set at the same rate as the turnpike, but Rendell says that public opinion is more against paying for something that was previously free, than against paying its turnpike tolls to a different entity.

Nevertheless, despite Rendell's push, the PTC has signed a 50-year lease agreement with Pennsylvania Department of Transportation (PennDOT). The proposal to toll the I-80 has not yet been approved by the US Department of Transportation. The application was submitted on 13 October 2007.

Act 44, which allowed tolling on I-80, stipulates that the lease must generate a minimum of $83.3 billion for the state's transportation needs over its life, after investment in the I-80 and its maintenance costs. The PTC estimates it will invest $33 billion in the I-80 and other projects additionally.

The crude average is $1.67 billion per year, though according to Rendell $1 billion is closer to the accurate sum. The payments are incremental, starting at $750 million in 2008, and the PTC paid $62.5 million to PennDOT in August 2007, before the lease was even signed.

Can the PTC take it on?

However, revenues from the I-80 lease legally cannot be used to fund transit projects, and therefore the state's transit funding deficit remains unaddressed.

Rendell attributes the public opposition to tolling a free road as fundamental to the reconsideration of a lease on the turnpike. Protests across the state, along the route of I-80, and particularly a protest staged by truck drivers in Harrisburg, have given representatives cause to rethink their opposition to the concession. Should the turnpike concession go ahead, Act 44 would be repealed and replaced with an enabling bill, and I-80 will remain untolled.

Many of the senators who were initially opposed to the turnpike lease have constituencies along I-80. Congressmen Phil English and John Peterson are vocal among these: The former has publicly criticised the PTC chief executive Joe Brimmeier, who had suggested that the authority's I-80 tolling application was a fait accompli, despite it not yet having been approved. Indeed, as Project Finance went to press, there is speculation that the Federal Highway Administration (FHWA) is unlikely to authorise the application at all.

The second main factor that Rendell identifies was the Minnesota bridge collapse on 1 August 2007, which brought the need for investment in infrastructure back into the political forum. Pennsylvania's Governor has, in the Morgan Stanley report, a number ready to hand for what the state needs to spend on improvements to its bridges, roads and mass transit – $11.8 billion, or another $1.7 billion per year. Pennsylvania currently has in excess of 7,000 structurally deficient bridges.

The PTC has agreed to pay the state $1 billion per year under the terms of the lease. Rendell says that he would not take a bid to the legislature unless the spread was significantly high enough to contest the Turnpike Authority's contribution; specifically not less than $1.5 billion in annuity payments, though he suggests this is a minimum figure. "The spread needs to be significant enough to reform the I-80 plan. There are no guarantees, since even if the proposals are high enough, the legislature could still say no," explained the Governor, who did not temper his enthusiasm for the concession option.

Quality dimes?

The 14 responses to the RFQ involved 34 companies, including several parents and subsidiaries counted twice. In addition to these construction companies, infrastructure funds and equity providers, many of the international banks' project finance teams have confirmed that they are assessing the deal, both in the capacity of financial adviser or arranger.

The list comprises: Abertis, ACS, AIG, Babcock & Brown, Borealis, Canada Pension Plan Investment Board, Cintra, Citi, Global Via, Goldman Sachs, Industry Funds Management (IFM), Isolux Corsan, JE Jacobs, John Hancock Financial Services, JP Morgan, Macquarie, Merrill Lynch, North American Strategic Infrastructure Partners, OHL, Ontario Teachers' Pension Plan Board, PA Turnpike Employees and Partners, POPT, RREEF, Santander, The Herrick Company, Transfield, Transurban, and UBS.

Rob Collins, executive director of Morgan Stanley responsible for its infrastructure M&A business in the US, says "we are extremely pleased with the quality and the quantity of the responses". He believes that the state could have a bidder selected by the end of 2007, dependent on "capital market considerations". The next step in the process, he explains, "is to provide time for additional due diligence on the bids".

The proponents at this stage are effectively bidding on a concession which may not materialise, and this will affect the quality and size of their bids. Though Rendell has stated there are some provisions in place for the state to contribute financially to the bid, the risks are evident. The cost of putting together a competitive bid is always a gamble for proponents, but bidders usually do this with the prize in view. In this case, though the theoretical award may be the largest seen in US PPP history, it is in the gift of a fractious and hesitant legislature; one that has already voted against a concession.

However, despite the political wrangling and the evident financial risks for investors, if the concession should happen, it will be the largest project finance deal in the hemisphere to date. It may also set a precedent in other states, where transport and infrastructure deficits and shortcomings are an increasing safety concern.

Historical Turnpike Revenue