Budget wrap - significant infrastructure investment and divestment

In brief

Following last week's release of the New South Wales and South Australian budgets, it is clear that most state and territory budgets handed down since the Federal Budget have shown an alignment with the Federal Government's national agreement on infrastructure investment and asset recycling. Partner Paul Kenny and Senior Associates Emin Altiparmak and Penny Alexander look at the implications of the policy. 

Infrastructure initiatives announced in 2014-15 budgets

As Allens Partner John Greig outlined in his recent Focus article, the National Partnership Agreement on Asset Recycling was signed by the Federal, state and territory governments on 2 May 2014.

If we fast forward to the present, eight out of nine government budgets for 2014-15 have now been handed down, with the Tasmanian Budget due in August. Substantial infrastructure investment was a key theme in all budgets announced to date. Leading the way was the Federal Government, which announced two separate programs as part of its 2014-15 budget that were designed to boost investment in infrastructure across Australia:

• the $39 billion Infrastructure Investment Program; and
• the $11.6 billion Infrastructure Growth Package, including the $5 billion Asset Recycling Initiative.

No doubt influenced in part by the initiatives announced in the Federal Budget, the Australian states and territories have committed to a substantial number of new infrastructure projects in their respective 2014-15 budgets in key areas including roads, rail and social infrastructure. In addition to the significant investment in new infrastructure, the state and territory budgets also signalled the likely divestment of a range of existing state-owned infrastructure assets.

While the formal nomination and agreement processes under the Federal Government's Asset Recycling Initiative are yet to be completed, it is clear that many new infrastructure projects will benefit from the additional Federal funding provided under the Initiative, and an asset divestment and investment pipeline, which will offer substantial opportunities for the private sector over coming years, already appears to be taking shape.

Asset Recycling Initiative

The centrepiece of the Federal Government's commitment to boosting infrastructure investment across Australia was the Asset Recycling Initiative announced as part of the Infrastructure Growth Package in the 2014-15 Federal Budget.

The Asset Recycling Initiative involves the Government agreeing to pay the states and territories an incentive payment equal to 15 per cent of the proceeds from asset divestments to the extent that such proceeds are reinvested by the relevant state or territory in new infrastructure. Incentive payments will be made in two instalments:

• 50 per cent of the estimated total payment (based on the book value of the asset being divested) is payable when both the divestment process and the planning and approvals process for the new infrastructure project have commenced; and
• the remainder of the payment (trued-up to take account of the actual divestment proceeds to be reinvested) is payable on completion of the divestment and commencement of construction of the new project.

Certain sunset dates apply, so that all divestments and new projects must be agreed by 30 June 2016, and all divestments must be completed, and the construction of the new projects must commence, on or before 30 June 2019. There are a number of other limitations and rules that apply to the Initiative, as detailed in John Greig's recent Focus article. In the draft legislation to establish the Initiative, the Federal Government has initially allocated $5.9 billion that it hopes will lead to almost $40 billion of new infrastructure investment from the states and territories. 

Asset divestment pipeline

At this early stage, we are waiting to see which divestments and new projects will be formally nominated by the states and territories and agreed with the Federal Government as part of the Asset Recycling Initiative. However, a sense of what the asset divestment pipeline looks like can be ascertained from the recent budgets and related announcements. As shown on the map below, the focus is clearly on ports and power assets. The large scale and proximity in timing of some of these proposed divestments suggest that some investors may face bandwidth issues, both from a funding and resourcing perspective. It is therefore in the state and territory governments' interests to adopt a coordinated approach when implementing the divestment pipeline, so that competition for their respective assets is not diminished. This is especially so in a context where there are a number of Commonwealth assets (such as ASIC's corporate registry business) potentially up for sale over the same timeframe. Although not infrastructure assets, the Commonwealth divestments are likely to attract similar investors, such as pension funds.

Ports

The Victorian Government responded quickly by announcing as part of its Budget a proposed 40-year lease of the Port of Melbourne, with the proceeds (estimated to be in excess of $5 billion) being earmarked for the funding of significant new infrastructure. The sale process is scheduled to commence in the first quarter of 2015 (after the State election, scheduled for 29 November 2014), and the Government is currently tendering for the appointment of legal and financial advisers to help it get the process underway, having already completed a scoping study on the asset. The lease of the Port of Melbourne will represent a different proposition for investors, compared with the lease of the NSW ports (Botany, Kembla and Newcastle), not only because of the shorter lease term but also because of the capacity constraints at the port, the Government's objectives for the development of the Port of Hastings and, more broadly, its longer term vision for Melbourne's CBD to potentially expand into the port precinct.

The Queensland Government announced in its Budget an estimated $33 billion asset sales program, principally intended to help reduce the State's significant debt burden but with around 25 per cent of the expected proceeds allocated to new infrastructure spending. Within that program, the Government announced proposed long-term leases of the Port of Gladstone and the Port of Townsville, the latter combined with the Mt Isa Rail Line. The Government plans to take its asset sales program to the next State election, which is expected in 2015 and due no later than 20 June 2015, and so any sale process will not commence until after the election.

In delivering its Budget, the Western Australian Government identified a list of assets that may be divested, including the Utah Point Bulk Export Facility at Port Hedland in the Pilbara and the Kwinana Bulk Terminal which forms part of the Port of Fremantle. The Government lost its AAA credit rating late last year and this has served as a catalyst for considering further asset divestments. However, the Government is yet to firm up a timetable for any sales process.

While not announced as part of its Budget, and at the smaller end of the scale, the Northern Territory Government is expected to commence, in the near term, a sale process to lease or facilitate private investment in Darwin Port. The Government appointed Flagstaff Partners earlier this year to undertake a scoping study to assess its options with Darwin Port as well as the development of a planned second port at Glyde Point.

Power

Following its highly successful divestments of the Ports of Botany, Kembla and Newcastle, the New South Wales Government has turned its attention to its poles and wires assets.

State Coalition MPs recently voted in favour of taking the privatisation by way of long-term lease of an overall 49 per cent equity interest in its electricity transmission and distribution assets to the next election, scheduled for March 2015. Essential Energy, which serves rural areas, was ruled out as a divestment opportunity, following strong opposition from State Nationals MPs, leaving transmission company TransGrid and distributors Ausgrid and Endeavour Energy to form part of the package. There is speculation that despite being framed as a divestment of a minority interest, the Government may structure the transactions in such a way as to provide private investors with the opportunity to assume management control.

Gross proceeds of the privatisations are estimated to be in the order of $20 billion, while net proceeds after repayment of debt are estimated to be about $13 billion. All of the net proceeds have been earmarked for reinvestment in new infrastructure projects, including a proposed second Sydney Harbour rail crossing and extensions to WestConnex at the northern and southern ends. The Government has confirmed that a scoping study will be undertaken to consider, among other things, the form of transaction and how to manage retained holdings. The scoping study is expected to complete in November 2014, while the sales process is expected to commence shortly after the election.

Also as part of the asset sales program in its budget, the Queensland Government announced plans to sell electricity generation companies Stanwell Corporation and CS Energy, and offer a hybrid investment in electricity transmission company Powerlink and electricity distribution companies Energex and Ergon. Under the hybrid investment model, the State would retain full equity ownership, private investors would be issued hybrid securities (which would be debt for legal purposes, but equity for tax and accounting purposes), the existing debt in the companies would be replaced by the private sector debt (and therefore removed from the State's balance sheet) and the private investors would fund future capital expansions. Again, the Government plans to take these proposals to the next election, and so any sales process will not commence until after the 2015 election.

Further down the road, there is speculation that the Western Australian Government may seek to make the case at the next election, scheduled for March 2017, to sell its poles and wires assets through a full or partial sell-down of interests in electricity transmission and distribution companies Western Power (responsible for the South West WA network) and Horizon Power (which covers the more remote areas of WA).  WA generation assets could also be up for sale, including the Muja power station, connected to the south west interconnected system, and a number of regional generators. Given that assets to be divested under the Asset Recycling Initiative need to be agreed with the Federal Government by 30 June 2016, if an election mandate is required to divest any of these assets, it may be prove problematic to include such assets in the Initiative.

Major infrastructure commitments

Although it remains to be seen which will be nominated as part of the Federal Government’s Asset Recycling Initiative, key spending commitments in relation to $1 billion plus infrastructure projects announced as part of 2014-15 state and territory budgets included the following road, rail and social infrastructure projects.

Project values and timing in the table are indicative only.

Implications

The focus on infrastructure investment and divestment in the budgets tabled for 2014-15 will undoubtedly lead to significant opportunities for Australian and offshore companies to become involved in a large number of major projects over the next five plus years, whether as a developer, equity investor, financier, consultant or service provider. We expect to learn more as the state and territory governments start to nominate projects as part of the Asset Recycling Initiative, and as details of the infrastructure projects announced as part of the various 2014-15 budgets begin to crystallise.

If involved, or seeking to become involved, in these projects, it will be important for interested parties to be familiar with the wide range of transaction structuring, risk allocation, regulatory and financing issues associated with these types of projects.