Hochtief Project Development has emerged as one of the major global players in toll road development, with involvement in bridges, roads and tunnels in countries as far apart as Argentina, Canada, Israel and South Africa.

And the firm has also recently started construction of its first concession project in its home market of Germany, where the government is now encouraging private investment in transport infrastructure. Add to that pre-qualifying work on four projects in Greece, a toll road bid being made in Chile, and plans to bid on two projects in Australia, and it is clear that the level of activity is on the increase.

Hochtief is part of the German energy and utility group RWE, and is organised into six divisions: Airport, Construction, North America, International, Services, and Development. The Development division doubles as a home for all the infrastructure development activities, encompassing toll roads, bridges and tunnels, and receives support from the in-house structured finance department, which is also active in other sectors such as airports.

In addition to doing projects under its own name, Hochtief also sometimes works internationally via affiliate companies. There are three main development competence centres around the world, including Hochtief group headquarters in Essen. The company also operates via 48.75% owned Armbro/ BFC in Canada, and 49.6% owned Leighton Holdings Limited in Australia, through which Hochtief took part in the Eastern Distributor airport motorway project in Sydney.

So far European governments have tended to lag behind on toll projects, but that is changing fast, and Hochtief is busy working on a number of projects nearer to home.

?In Europe 2001 was mainly a year of pre-qualification work, and for example we did pre-qualification work on four projects in Greece, again working together with Dragados and Skanska,? says Bernward Kulle, who heads up the infrastructure department at Hochtief Projektentwicklung in Essen.

?We feel that the main potential in the coming years is in Europe, looking at both the volume and stability of projects,? Kulle says, and this will include projects in central & eastern Europe as well as western Europe. ?We are interested in Poland and the other European Union accession countries, though the level of equity needed in these projects will probably be between 30% and 40%, versus 25% in Germany.?

?We also see plenty of opportunities the Asia Pacific region, including Australia. In Latin America we find Chile an attractive market, though the bidding processes are extremely competitive,? Kulle continues. ?Canada and the United States will also play a role in the coming years.?

?In Germany the coming concessions for a system of electronic tolls for trucks using the autobahn presents a huge potential,? Kulle adds. ?Starting 2003 there will be concessions operating to collect these tolls on trucks weighing over 12 tonnes, and part of the money collected will be pledged by the government to finance privately built sections of the autobahn system.?

Given its background in the construction sector, Hochtief usually has part of its bid to construct the project, but as a developer it also views itself as very strong on the financial structuring side, and on a BOT project the construction and developer functions are kept separate for internal purposes.

?We have a divisional structure at Hochtief, and there is a separation between construction and project development, so we have internal contracts between the divisions,? explains Ansgar Bendiek, a project finance expert in the Structured Finance unit within Hochtief Projektentwicklung. ?When we make a bid a project has to be feasible purely from the investor point of view. We don't figure construction profits into the decision, and most of the construction risk is taken by the Hochtief Construction division.?

?There is a construction element in most of the road projects right now, but this might change, as it has changed in the Airport division,? Bendiek continues. ?The Airports division now invests in projects that have no construction related business, and acts as a pure investor and manager of airports.?

Developing a global asset portfolio

The latest project on which Hochtief is preparing a bid is in Chile, for the Americo Vespucio Norte segment of the ringroad in Santiago de Chile. It has joined forces with Dragados y Construcciones SA and Skanska AB, with Citibank as financial advisor to the consortium. Hochtief has previously bid unsuccessfully on two other parts of the Santiago toll road system, Autopista Norte-Sur and subsequently Americo Vespucio Sur, but remains interested in the Chilean market.

?In Chile there is a quite well established legal framework for toll roads, you can increase the toll level by inflation, and you can also make real toll increases over time, and you also have certain instruments for exchange rate hedging,? says Bendiek. ?In the financial model you can run certain sensitivities within an exchange rate band, and you should have a project which is robust against any adverse movements,? he adds, though he acknowledges that currency movements in countries such as Chile and Brazil have been very wide over the past three years.

One advantage for projects in Chile is that the government offers some exchange rate protection. ?For the first set of financing agreements, the developer takes the exchange rate risk on the first 10%, and thereafter the risk is taken by the government,? says Bendiek. ?However when the project is refinanced you have to take the whole exchange rate risk. Thus your exchange rate risk depends on the tenor of the initial financing.?

Fortunately in Chile this initial financing can be done long term in the local bond markets, which are highly developed, thanks mainly to the pension funds system, which needs high quality long term assets to invest in. Twenty-year domestic bonds are not unusual in the Chilean market.

?In Chile you have a possibility to mitigate the currency risk via local currency bonds, which are bought mainly by the pension funds,? says Bendiek. ?Project bonds are in general becoming a more important source of financing for toll roads,? he adds, and the upcoming toll road projects in Greece may possibly being suited to bond market financing.

In Argentina the Rosario Victoria Crossing, a series of bridges and viaducts that will connect the cities of Rosario in Santa Fe province and Victoria in Entre Rios province, will soon be completed. Clearly given the serious economic situation in Argentina there is little else happening in terms of new projects being signed, and the toll bridge could be impacted in the event of a major devaluation. But it will open on time in 2002.

Meanwhile in Australia, group affiliate Leighton is bidding on two more projects, which are the Cross City Tunnel and the Western Orbital, both in Sydney. Hochtief recently sold its stake in its one existing project in Sydney, illustrating the fact that in today's market infrastructure projects are more and more becoming viewed as tradeable assets.

Up to now disposals have tended to be done on an opportunistic basis, though Bendiek is currently responsible for developing a more formal group strategy on asset disposals.

?Our affiliate Leighton has recently sold our 11% stake in the Eastern Distributor Tollroad in Sydney, which Leighton developed together with Macquarie,? says Kulle. ?The concession company, Airport Motorway Ltd, was already listed on the stockmarket, and we sold our stake via a share placement, which was done by Macquarie.?

?We are currently working on putting in place a more systematic exit strategy,? Kulle explains. ?After projects have been in operation for two or three years, have proven that the traffic forecasts are being met, and are generating stable cashflows, there are a lot of investors who are interested in those stable cashflows, and there may be an opportunity for us to sell, though we may often still keep a small stake to stay involved with a project.?

Unlocking the home market

So far all the completed projects, which also include a participation via Hochtief affiliate Concor Limited in the $300 million Bakwena toll road in South Africa, have been outside of Hochtief's home market, but that is soon to change. Earlier this year financial close was reached on a tunnel project in Luebeck in northern Germany, which Hochtief is developing in a 50:50 partnership with Bilfinger & Berger. Together with the Warnow Crossing in Rostock, being developed by Bouygues, this is a landmark project for the German infrastructure sector.

Both the Herrentunnel, also known as the Travequerung, and Warnow Crossing have involved many years of preparation. As early as 1997 LB Kiel and Natwest were working on the Herrentunnel project, with Natwest later dropping out, leaving LB Kiel as sole arranger. At this point it was decided that development bank Kreditanstalt fur Wiederaufbau be brought in as co-arranger.

The city of Luebeck had already secured Eu88 million worth of federal infrastructure funding, and asked for permission to take this cash, and bring in private capital for a more expensive but more efficient bridge or tunnel facility. The design eventually agreed upon was a tunnel, which will replace the existing bridge across the River Trave, which is a traffic bottleneck since it lifts up to allow ships to pass underneath.

Hochtief became the preferred bidder for the BOT project in 1998, and in March 1999 it closed the concession contract. At that point the planning procedure started. The consortium started working on the financial issues in the middle of last year, co-operating closely with the Infrastructure Ministry, and clarifying various questions that had to do with the structure of the tariffs, how they would be calculated, what costs we could put into this calculation, the amortisation period, ROE expectations, and so on.

Hochtief finalised its term sheet at the end of last year, and was eventually awarded the license for the toll tunnel in February of this year. Financial close took place in June, with a Eu116 million loan underwritten by LB Kiel and KfW. Equity totalled Eu23 million. Construction began in October, and it will open in 2005, with vehicles paying a physical toll.

Clearly future projects in Germany will have to move quicker, but the first two projects succeeded in ironing out many of the difficulties, and planned new legislation should also help matters.

?The Herrentunnel in Luebeck and the Warnow Tunnel in Rostock are the two pilot projects to be found in Germany, and the tendering procedure was done via the town of Luebeck and the town of Rostock, even though the two projects are subsidised by the Federal government,? Kulle explains. ?Upcoming projects include parts of the Federal road system, including the first privately financed stretch of autobahn.?

?For the Herrentunnel project Landesbank Kiel was responsible for developing the financial model, but this process was done together with Hochtief since it was necessary to discuss the assumptions and the structure of the model, and run certain sensitivities,? adds Bendiek. ?But it was difficult to implement the current toll legislation regime into this financial model.?

Like the other developers, Hochtief is awaiting planned changes to the laws governing toll roads, which are expected to be passed during the next year. There is already a draft, and one important change is that there will be a right for developers to sue the government if they fail to issue the toll decree for a project. Another crucial change is that it will also now be possible to calculate an approximate target toll at the project financing stage, taking into account the calculations on construction costs, financing costs, return on capital forecasts which were part of the offer, etc. Under the present system the developer has to build the project, and then apply to the government for permission to levy a toll.

In practice there is an assumption that it will happen, and there is close co-operation between the various ministries and the developers and arranging banks. But large amounts of private capital are going to be needed in the toll road sector in Germany in the coming years, and a clear legal framework will be better for all parties. Certainly many foreign banks would be unlikely to get involved as lenders under the current system.

The next project in Germany on which Hochtief intends to bid is the Strelasund bridge which will link the mainland to the island of Rugen on the northern coast. There is already a bypass in operation here, which means that although traffic is likely to be heavy in the summer holiday months, there could be a dropoff in winter, so the Strelasundquerung is viewed in the market as a challenging project. It is the first toll project to be attempted at the federal level.

Next year bidding is also expected to take place on the Hochmoselquerung, a federal road and bridge network in the state of Rheinland Pfalz. And by the end of 2002 there may be some progress on the first privately built stretch of autobahn, the A8 near Stuttgart.