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SEIFFE:  The Mayor's Good Idea

Sunday , February 12, 2006

By Ralf Seiffe

Mayor Daley’s recent decision to effectively sell the Skyway provides an example of how the state might fill the financial hole that several governors and the General Assembly have dug.  Illinois needs to sell the Tollway.  

News that the mayor had cooked up a deal to lease the Skyway for 99 years generated two reactions.  The first is an “at-a-boy” because at one time “Skyway Bonds” was interchangeable with the term “municipal default”.  The fact that he was able to find a buyer and sell it with a guarantee that tolls would rise only moderately and then be frozen for several years is a real accomplishment.  

Usually, transactions of this sort would generate all sorts of questions about which of the mayor’s buddies made out.  The size of the deal -- $1.8 billion -- means there was enough for everybody. But, the sale’s very magnitude also brings up a second, more fundamental question: why was the mayor able to find a buyer at all?  

Governments should take on projects only when there is no private sector entity willing or able to undertake them.  Governments are able to tackle large projects because they enjoy extraordinary privileges, like taxing power and eminent domain, to build roads, dams or even stadia.  In return, the public expects that government will do the least possible damage to the lives and economy of its citizens.  This means condemning the fewest number of homes and to set prices at revenue producing projects that just recovers costs but that does not make a “profit”.  

Theoretically, the tolls the Skyway collects should equal the cost of employing the toll-takers, the cost of maintaining the property and paying the interest and principle on whatever bonds may still be outstanding.  Simplistically, there should be no Skyway “profits” nor should there be an expectation that there will be.  Accordingly, there should be no market value for the property.  

Despite this, an investment group was willing to plunk down serious money -- even in Euros -- for the right to operate the Skyway.  The investors would only risk their capital if their risk-adjusted forecast showed a positive return.  

At first, I was skeptical about the motivation to sell the Skyway but upon querying members of the financial press, it appears to be a brilliant transaction.  That’s because the price was 40 times revenues. To put this into perspective, the same valuation applied to an exquisitely profitable software company earning a juicy 25% after-tax profit margin on sales would result in a stratospheric P/E Ration of 160.  That’s 2.2 times better than the market’s valuation of Google.  

What’s fascinating is that this is not a risk-free deal for the investors.  The Skyway has alternatives -- economists would call them substitutes -- that will get you to Indiana .  Since these substitutes are toll-free expressways, the Skyway investors cannot raise their prices without diminishing their traffic count.  Given the operating and financial leverage this transaction reportedly has, the new operators must figure a price that maximizes their revenues and, thereby, their bottom line.  

The investors must believe there’s a big enough profit to be made even without a big toll increase.  If they can’t meaningfully raise prices in the short-term, they must believe they can reduce costs to make a profit.  So, here’s an example where private sector efficiencies applied to a public sector projects results in the elusive win-win result.  

Springfield should pay attention to the mayor’s coup and take steps to realize the same valuation for its revenue producing assets.  The closest analog to the Skyway is the Tollway System and a quick check of the Department of Transportation’s web site reveals that the Tollway generated more than $360 million in 2003.  Since then, the system has doubled prices for those that do not use the I-Pass system, so, combined with natural growth, the system’s 2006 revenues might approach $450 million.  

Applying the Skyway’s valuation to the Tollway means Illinois politicians are sitting on a marketable asset worth some $18 billion.  

If the proceeds could be kept safe from the irresponsible spenders in Springfield , a sale to investors could eliminate 30-40% of the state’s unfunded liabilities. Republicans should lead the charge; by positioning the sale as a way to make public employee’s pensions safe, Republicans could gain their support and use the event to introduce a fiscally-responsible defined contribution plan.  

© 2006 Ralf Seiffe

Ralf Seiffe advises business start-ups and product launches from Chicago, Illinois and is a political analyst and columnist for the Illinois Leader and Illinois Review.