November 25, 2008

Midway Airport Financing Confirms Public-Private Partnerships Politically Viable Countrywide

The city of Chicago recently announced a landmark plan to privatize the Midway Airport, which is a medium-size hub airport on the South Side, anchored by Southwest Airlines. The first privatization of its kind, a consortium of investors and the city set up a deal enabled by federal legislation that features the mutual benefits of public-private partnership. To detail this landmark deal, TPR/MIR was pleased to speak with David Narefsky, partner at Mayer Brown, who also helped close the Chicago Skyway deal, which has been given credit for paving the way for large-scale public-private partnership's around the country.

David Narefsky

This article was featured in the November 2008 issue of TPR/MIR.

When TPR/MIR last interviewed you, we talked about the prospects for more public-private infrastructure partnerships in the United States. This fall, Chicago announced it had just negotiated the privatization of the Midway Airport on the south side of Chicago, priced at $2.5 billion, with $1 billion going to the city. What was the rationale for this public-private transaction? Is it perceived as a good deal?

First, I'd like to give some context and sense of timing of the transaction. The $2.5 billion winning bid to which you referred was submitted at the end of September by a consortium called MIDCo. It is a consortium comprised of three members: Vancouver Airport Services (whose parent owns and operates the Vancouver International Airport and about sixteen other airports around the world); Citi Infrastructure Partners, which is a major international infrastructure fund; and the John Hancock Life Insurance Company. The Chicago City Council approved the transaction in early October, by a 49-0 vote. The city then submitted a required final application to the Federal Aviation Administration. The approval of that application is expected in the early part of 2009; with the city and MIDCo proceeding to closing shortly thereafter.

After the city's successful closing of the Chicago Skyway transaction, the city looked at what other assets might be appropriate for a public-private partnership under a concession lease structure like the Skyway transaction. Midway was attractive for a couple of reasons. One, it is regarded as a very well run airport. It had recently completed a new terminal-the project was a combination of a reconfiguration of an existing terminal and an expansion, so it's fair to think of it as a new terminal. Southwest Airlines is the major tenant at Midway. When we started the transaction, Southwest controlled about 65 percent to 70 percent of traffic. Now it's well over 75 percent-it may even be over 80 percent. Southwest is an attractive anchor tenant because it's the only American airline that has been consistently profitable.

A series of regulatory aspects also made it attractive. U.S. airports can be privatized under a public-private partnership structure established by a federal pilot privatization statute passed by Congress in 1996. The statute had received fairly limited attention until the Midway project. The only airport that had been privatized was Stewart Airport, about 60 miles from midtown Manhattan in Newburgh, New York. It's a small airport with less than a half-million passengers a year.

Under the federal airport privatization statute, only five airports can be privatized. Only one opportunity is reserved for an airport the size of Midway, a large or medium "hub" airport. The city saw all of this as an interesting opportunity to pursue, with Midway qualifying for the one spot for an airport the size of Midway.

Another fact that makes Midway a privatization candidate is that under the federal pilot program, an exception can be granted by the FAA from the general requirement that airport revenues are required to remain "on airport." Under the federal pilot program, and with FAA approval, the revenues derived from the privatization can be used for non-airport purposes. That was attractive to the city in that it could capture and benefit from the asset value of Midway.

Where major public-private projects been concluded in recent years in the United States? Has the focus of these projects changed at all?

That's a good point to focus on. Since the Skyway transaction, which closed in early 2005, the other major privatizations through concession leases have been the Indiana Toll Road, which closed in the first half of 2006; Chicago completed another asset privatization for its 9,100-space underground parking system under Grant Park and Millennium Park at the end of 2006; privatization of the Northwest Parkway, which is a relatively small toll road in the Denver metropolitan beltway, which closed in 2007 (this tollroad was struggling to achieve traffic projection and so a public-private partnership turned out to be a very effective solution); and the privatization of the Pocahontas Parkway, a toll road in the Richmond, Virginia area, which also completed a PPP in the 2006-2007 period.

In this recent period of time, there has also been increased focus on using the public-private partnerships structure for the development of new transportation assets, so-called "greenfield" projects, where you have several transactions that have closed and a number that are in various stages of procurement.

What enticed the Vancouver Airport Authority, Citi Infrastructure Partners, John Hancock, and professionals like your law firm, to join together with the city to form this new Midway public private entity?

Vancouver Airport Services (YVRAS) is owned by the Vancouver Airport Authority, which manages the Vancouver International Airport. Vancouver Airport Services currently operates and manages eighteen airports around the world. The Hamilton Airport outside of Toronto is the second largest of the Canadian airports that they operate. They also operate a number of airports in the Caribbean-in the Bahamas most notably. They also operate airports in other parts of the world. For example, they are the operator of the international airport in Cyprus. They have teamed up in this transaction, and potentially for other airport privatizations around the world, with Citi Infrastructure Partners.

Citi Infrastructure Partners is one of a number of very large infrastructure funds that have been established within the last five years as global capital has focused its attention on U.S. infrastructure assets as an attractive opportunity. It has focused not only on Midway, but is also reported to be considering a bid for the Gatwick Airport in London in partnership with Vancouver Airport Services. Gatwick is the second largest airport in the London area and is the subject of potential asset sale transaction by BAA, its current owner. John Hancock, which is U.S-based but owned by Manulife, a Canadian-based insurance holding company, is looking, as are many insurance companies and institutional investors, at U.S. infrastructure as an attractive, long-term investment that matches up well with long-term financial obligations. We have seen institutional investors like John Hancock investing through infrastructure funds. In this case, they are investing directly in the MIDCo airport consortium.

What has been the role of Mayer Brown, and the other law firms and lawyers like you, in this transaction?

The city team in the Midway transaction was led by a core group of city officials, all working under the direction and leadership of Mayor Daley. The team was led by Paul Volpe, who is the city Chief Financial Officer. He had two key staff people working with him, Lisa Schrader and John Laera. Also on the team from the Department of Aviation team was Commissioner Rich Rodriguez and his managing deputy, Erin O'Donnell. This group comprised the core transaction team, advised by a group of outside advisors. Mayer Brown acted as the lead outside counsel. We worked with three other law firms: Costilas Law Firm; Pugh, Jones, Johnson and Quandt; and the Sanchez, Daniels, and Hoffman firm. The city also had a team of financial advisors. The lead advisor was Credit Suisse, with expertise both in its Chicago and London offices. This team of advisors was comprised of Bank of America, Popular Securities, and M.R. Beal.

The Los Angeles-based law firm of O'Melveny and Myers represents the MIDCo consortium, with lawyers in both its L.A. office and Washington D.C. office.

Is this array of professional talent typical of other public-private partnership transactions in the United States?

That is fair to say. There are other advisers as well-accounting advisors and economic advisors-representing and providing advice to both of the teams. I should also note that the city had a number of bidders during the course of the procurement process. This was conducted, as many of the prior transactions that we've talked about, in a competitive auction process. MIDCo submitted the highest bid and therefore won the auction.

Let's turn again to the Midway transaction. It offers $1 billion to the city of Chicago. Does that explain why the City Council voted unanimously in support of the transaction? What helped aligned all of the city's interests to approve this public-private transaction?


The City Council vote is reflective of the fact that the city already had success with prior public-private partnerships, both the Skyway transaction and the underground parking garage transaction. The City Council had an understanding of the transaction and understood how public-private partnerships could be beneficial to the city. Second, there is the net-billion-dollar asset value from the transaction. Certainly that is a significant amount of money under any circumstances, but in particular during these troubled economic times. The Alderman recognized that it was a valuable economic transaction for the city.

The other important thing is that the city will in no way be walking away from Midway Airport. It will enter a long-term lease with MIDCo, which will be responsible for Midway. Written into the transaction documents is that the city's obligation to maintain a strong and ongoing level of oversight and management of MIDCo's performance. There are very detailed operating standards built into the transaction lease, which the city will enforce. There are a series of remedies, should MIDCo either violate the operating standards or any of the other provisions in the lease. Those remedies include terminating the lease, removing MIDCo without compensation, and the city's reacquiring the airport.

This is not just a financial arrangement, although the financial terms are very attractive. Midway is a very important asset of the city, and the city will make sure the asset is maintained with necessary capital improvements and provides customer service at the highest levels. The transaction documents are designed to make sure that can happen.

When TPR/MIR last interviewed you on this topic, you commented that public-private partnerships of this kind are not partisan, even if in theory it seems more Republican than Democrat. Could you elaborate?

I was at a conference workshop yesterday at which a speaker referred to the "de-polarization" of public-private partnerships in the last several years. Among the leaders around the country are: Mayor Daley in Chicago; Governor Rendell, who is very active in pursuing a public-private partnership in Pennsylvania; and Mitch Daniels, the Republican governor of Indiana. We're seeing that this is really not a partisan issue. Elected officials from different parts of the political spectrum, Democratic and Republican, believe that these can be attractive transactions to implement.

At the national level, we're seeing elected officials indicating that public-private partnerships may be an attractive and important tool in the kit for financing infrastructure. House Speaker Nancy Pelosi not too long ago indicated that public-private partnerships and accessing private capital seemed to be a logical part of the overall infrastructure financing mix. You also have both Democratic and Republican members of Congress-the Senate and the House-expressing similar views. Elected officials from both political parties recognize that under the right circumstances, the right transaction structure, and with the right public policy decisions, public-private partnerships can be an attractive part of our infrastructure financing equation.

You and your firm worked on a concession lease for the Pennsylvania Turnpike, which did not close. What happened with that transaction opportunity?

Pennsylvania, for the last year and a half, has been looking for solutions to its long-term transportation funding needs. There have been two main competing alternatives: Governor Rendell's alternative is a long-term lease of the Pennsylvania Turnpike under a structure similar to the Chicago Skyway and the Indiana Toll Road. The Turnpike Commission, which has responsibility for operating the turnpike, proposed a different alternative-to place tolls on Interstate 80, which currently runs through the northern tier of Pennsylvania, paralleling the Pennsylvania Turnpike, which runs across the southern portion of the state. Neither of those alternatives have been implemented to date. The plan for Interstate 80 could only be accomplished under a federal pilot program. Pursuant to 2004 federal highway legislation, or SAFETEA-LU, tolls can be placed on three interstate highways. Pennsylvania applied to the U.S. Department of Transportation and the Federal Highway Administration for permission to toll Interstate 80, with the plan that the tolls would serve as the incremental funding source for the transportation needs of the commonwealth. The federal government rejected the application for the tolling of Interstate 80 during the third quarter of this year.

At the same time, the Governor and the Department of Transportation were pursuing the public-private partnership concession lease alternative for the Pennsylvania Turnpike. In May of 2008, Pennsylvania received a $12.8 billion bid from a venture comprised of Abertis and the Citigroup Infrastructure Fund. Abertis is a Spanish toll-road operator. That bid was taken to the Legislature but was never called for a vote. The bid was held open for a number of months but, as of September 30, the Pennsylvania Legislature did not approve that transaction, and the bid was no longer going to remain open. In fact, September 30 came and went and there was no legislative action on the proposed privatization of the Pennsylvania Turnpike, so that transaction did not go forward. In 2009 Pennsylvania will need to revisit which of these alternatives, or perhaps others, make the most sense for the Commonwealth.

Last December, California's Governor Schwarzenegger proposed a statewide plan to encourage and prioritize public-private partnerships for state infrastructure projects. Little has happened since then. Are their opportunities in California for new public-private partnerships to meet the financial needs of state and local infrastructure?

The climate is evolving. As we speak, L.A. County Metro has a request for qualifications outstanding to hire teams of consultants to advise on the right strategy for seeking out and implementing public-private partnerships to finance expansions of the existing mass transit system.

I know from my visits to the LAEDC that there does seem to be additional focus on what kind of public-private partnership opportunities might exist in the L.A. airport sector. I don't think people are considering a complete privatization of LAX or any of the other airports under the Los Angeles World Airport system. Rather, they are looking at how public-private partnership models might be appropriate for particular projects, for example, a public-private partnership structure to develop, implement, and operate a new energy system for the airport.

The thinking would be that new airport energy infrastructure is the kind of project which the private sector would be able to both finance and operate. This kind of paradigm is something you're going to see increasingly, not just in the privatization of existing infrastructure assets, but also bringing the public-private partnership model as an attractive alternative for public financing and public sector operations and management. It's early, but we'll have to wait and see whether that opportunity moves forward in Los Angeles.

How has this public-private notion evolved over the last two or three years, and where you think it's going to go in light of both politics and the financial markets today?

The first thing to note is that we are still at a fairly embryonic stage of the public-private partnership market. The Skyway transaction in Chicago, which in many ways catalyzed attention on the public-private model, closed only at the beginning of 2005. That's only three-and-a-half years ago, and there were only a few transactions completed before then. For example, there were projects in California, like SR 125 and SR 91. Even counting those transactions, we still have a relatively small number of completed transactions. Again, it is important to remember that we're still at an embryonic point in the PPP market.

Second, as we move forward, the challenges of financing the development of America's infrastructure are very large and people are now paying more attention to this issue. The 2008 election really did bring attention to the importance of infrastructure investment and to the recognition that there are a number of alternative ways that infrastructure can be financed. Moving forward, it's likely that there will there be an increase in direct investment by the federal government, including as a part of an economic stimulus package. We're hearing lots of talk about $18 billion to $20 billion of the economic stimulus being targeted towards investment in infrastructure. We've also seen attention to the possibility of the creation of a national infrastructure bank, which was one part of President-Elect Obama's platform for enhancing America's investment in infrastructure. That would be a $60 billion investment over a multi-year period. We're seeing an enhanced focus on the need for infrastructure investment by the federal government, but there is a recognition at the federal level and the state and local level that public-private partnerships can provide a very valuable additional source of capital.

The experience in other parts of the world, in Europe, Asia, and Australia, where there has been a much greater history of this approach, is that it has been well developed and proven it can be successful for the private sector and also for the public sector to achieve its public policy objectives. When you look at the needs that America has to finance its infrastructure and what are inevitably going to be constraints and limitations on the amount of available public capital, public-private partnerships seem like a very logical part of the solution. People are beginning to recognize that its not just a financial decision-PPP's can also provide attractive ways to bring private sector expertise to the financing, operation, and development of infrastructure. We're going to see an increased attention on the use of public-private partnerships as a tool.



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