I-395/95 HOT Lanes Proposal at a Glance

How does Fluor-Transurban's plan to expand the existing HOV lanes?  Through an innovation called paint!  They will repaint the current 2 - 12 ft lanes into 3 -11 ft lanes.  The difference between 24 feet and 33 feet is made up by reducing the shoulder.  Inside the belt, this will mean a 2 ft. left shoulder and a 9 ft right shoulder from King St. until you get to South Joyce; then the shoulder will be 3 feet and 2 feet respectively until the 14th St. Bridge.  South of King St, the left shoulder is reduced to 5 feet or less until you get to the portion of the HOV lanes that have an open shoulder.  Are you shocked?  See this plan from the proposal
What you may miss about this proposal is the Bus Rapid Transit component.  Fluor identifies areas which are under-served by mass transit.  The solution: existing bus services.  Not to totally discount this, Fluor will add new park & ride facilities with 500 car spaces a pop along with a few stations that will have no parking available (all of those start as you get close or inside the belt).  More info is in section 2a of the proposal.  What happens when development in Prince William and Stafford counties (due to this project) exceeds capacity at the park & rides or capacity of the lanes?  Who knows?  The impact on development is not covered as far as I can tell.  And in this sense, I mean an estimation of the impact on existing transportation facilities, and whether their BRT improvements cover the entire 60 year lease term they propose.

How do they plan to enforce the tolls and ensure compliance with HOV-3 free?  Through yet another innovative solution: state troopers.  And who will be paying for state troopers to enforce the tolls so that Transurban gets its revenue?  I take the following statement to mean the taxpayers of Virginia:

Notwithstanding, the passage of State Legislation (see discussion is Section 3.d) the specific operations of enforcement for the I-95/395 BRT/HOT Lanes System Project is a major area of cooperative activity that will need to be addressed in partnership with VDOT.

Numerous options are available for developing an enforcement strategy aimed at achieving the proper behavior from HOV travelers on the I-95/395 BRT/HOT Lanes System Project. These options include conventional manual systems where Highway Patrol Officers (HPOs) are positioned at key points along the route and use conventional police methods to enforce the law. At the commencement of BRT/HOT operations, it is likely that this type of enforcement will be part of the strategy used.

For the enforcement piece see section 2.h.2.2 Approach to Customer Service.

Now the juiciest piece of the entire proposal (for me anyway): Financing!  Fluor-Transurban offers two approaches to financing the project. 

Option one is to create a tax exempt entity that would issue debt to finance the construction.  I'll let them lay it out:

Fluor will be responsible for a turnkey design/build construction of the project, and Transurban will be responsible for toll systems, start-up, toll operations, customer service, and for arranging ongoing O&M contracts. A transit subsidy payable after O&M expenses and debt service on publicly traded and TIFIA debt (but ahead of return on the Fluor- Transurban Investment) would be transferred to VDOT. This is projected to generate up to $510 million for that purpose. In addition to the priority $510 million, residual cash flow after funding a major maintenance reserve and repayment of the Developer Investment will be transferred to VDOT for transit or other purposes in the Capital Beltway/I-95/395 corridor.

Option Two (and this is the more troublesome of the two).  Under this option, Fluor and Transurban would create a concession company that would then lease the HOV/BRT/HOT lane facilities for 60 years.  The concession company agrees to a Return on Equity (ROE) threshold.  Above the ROE threshold, they would share the revenue with VDOT.  The clincher here is that in their projections, they don't provide proforma financials for the 60 years, so you don't know what revenue would actually be shared with the state.  And what does the state receive for leasing the facility for 60 years?  $250 million. 

Now is $250 million a fair number for this asset?  Let's take a look at a couple of things.  First let's look at the tax benefit the concession company (a partnership of Transurban and Fluor) receives.  Under the structure of the lease, the concession company would get to treat this as a depreciable asset under the largest corporate tax giveaway section of the tax code called Modified Accelerated Cost Recovery System (MACRS).  The concession company would get to recover the cost of the asset over a 15 year life.  Under the 15 year asset classification, they use a declining balance method depreciation at a rate of 150%.  This just boils down to most of the asset is depreciated early in its life.  In order to determine the value of this tax treatment to the concession company, we first need to assume an effective tax rate of 35% (average for a corporation) and then we need a discount factor.  In this case, I have used their weighted average cost of capital (WACC), as laid out in the proposal.  Based on this financing structure and using a current LIBOR rate of 5.23%, I calculate a WACC for the concession company of 5.9% (based on debt-to-equity ratio of 3.76).  Using that as a discount factor, the present value of the tax depreciation benefit to the concession company is $299.66 million. 

Next let's look at their projected residual revenues.  For some reason, they project less revenue under Option One than under the concession option, but no matter.  Using the same WACC for the concession company, discounting revenues after operations & maintenance (O&M) expense and debt service to the present gives you a present value of $370.5 million.  Now that is using the concession company's WACC as a discount factor.  If the project were completely financed by the state, we can use a lower discount factor.  In this case, I used the financing information for option one and assumed the equity component would be replaced at a cost of capital rate equivalent to the TIFIA loan (4.5%).  This gives you a discount factor of 4.55%; and it results in a net present value of those cash flows of $1.265 billion.  That's billion with a "B." Now is $250 million a fair price?  You see how ridiculous this is? 

My calculations may be wrong based on the discount factor used and the fact that Fluor-Transurban's proposal does not break out the revenue sharing component in their projected cash flows.  Regardless, I think we can all agree that $250 million is not even close to the value of those lanes of traffic.

The bottom line is that private industry is not doing this out of some sense of civic duty and good will.  They will make boatloads of money in the long term.  Can someone tell me why the Commonwealth would sell our valuable infrastructure like this?

And please provide comments!  If you have other points about the proposal, I'd love to hear them.  If you think my calculations are off, let me know that as well.

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