A bridge too far

By Chris Cook

I was interested to read the other day that a plan to raise the bridge tolls on the Humber Bridge – already the most expensive in the UK – has been postponed due to the moribund economy.

Anyone interested in the crazy effects of compound interest should look no further than the case of the Humber Bridge, which was completed for £90m in 1981, but in respect of which the debt is now £332 million. Indeed, it would have been spiralling towards £1bn by now had it not been restructured twice, and the interest rate reduced to its current rate of 4.25%. Even at the current rates of tolls and traffic, the debt is not expected to be cleared for 25 to 30 years.

I believe that there’s another way of financing public assets – through the use of a UK Limited Liability Partnership (LLP) as a framework for sharing revenues between managers and investors.

I think of this new investment possibility as Public Equity.

Risk Disclosure: anyone uninterested in financial matters should tune out at this point.

The Alchemy
The simple, but revolutionary financial concept that underpins the proposed Humber Bridge Partnership is to divide the bridge’s gross revenues into proportional shares – “nth’s” – and to sell these to investors, using the proceeds to repay the debt. The result is shares – but not shares as we know them, with a “par” value of (say) £1.00.

The current gross toll revenues are about £22m. Imagine that tolls are cut by a third to £15m, but the index-linking which has been suspended this year, is then reapplied.

The revenues are divided into “billionths”, each of which has the right to one billionth of the gross toll revenues and these are allocated between the stakeholders.

Operating expenses are currently about £3.5m, so the Operating Partner is allocated 25% . The original design life was 120 years, so we very conservatively allocate another £3.5m – ie a further 25% of revenues – to a maintenance / sinking fund. This leaves 50% or 500 million of the “billionths” – carrying £7.5m in revenue – available for sale to investors.

The Investment Proposition
Investors are receiving billionths of the gross Humber Bridge revenues, and unlike the position if these were conventional shares, the management does not get the first crack at the Bridge revenues. So this income is more certain than conventional equity in a Humber Bridge Plc, and the managers’ interests are aligned with those of the investors.

Toll revenues will rise and fall with traffic levels, but since tolls are index-linked then if the traffic levels remain the same, income will at least rise with inflation.

However, if tolls are cut by a third to more affordable levels, investors can be pretty confident that use of the bridge will increase, and probably stabilise at a higher level, so that the return will in fact be greater than the initial rate. So, while on the face of it the rate of return is uncertain, it is likely to be greater than a conventional fixed or index-linked rate.

Since “billionths” are not debt, an investor will have to find buyers for them if he wants to cash them in, but it could be expected that a market will soon develop in what is an extremely simple new financial product.

Crunching the Numbers
We aim to raise £320m from investors to pay off the outstanding debt, and £7.5m has been initially allocated to them. A buyer of 1000 of these “billionths” (ie a millionth) would therefore invest £320.00 and receive £7.50 in income initially.

This represents an initial return of 2.34%.

But we are also throwing in what is known in the investment world as a “kicker” or initial bonus – albeit of unknown size. If the toll income rises by 10% to £16.5m due to the toll reduction, then the investor receives £8.25, which will increase with inflation thereafter, at constant levels of traffic.

Also, the conservative allocation to the sinking fund will both lower the financing costs – through buying back “billionths” on the market – and probably leave room for toll rebates or reductions.

Who would invest?
These “billionths” represent a form of investment which is perfect for long term investors, particularly for pension investment, although UK pension investors lose tax benefits. However, overseas pension investors, sovereign wealth funds,and in particular Islamic investors (since no debt is involved) would undoubtedly be interested in such an “asset-based” UK public sector investment in these uncertain times. Possibly local motorists who buy “billionths” could redeem them against season tickets at a discounted rate.

By way of comparison, Wessex Water – a not dissimilar investment proposition – were able not long ago to sell 50 year index-linked bonds at a return of 1.49%.

Public Equity
What I find most interesting is that the conventional wisdom – that the Public sector must necessarily borrow to invest – is blown clear out of the water. The example of a Humber Bridge Partnership demonstrates that it is quite straightforwardly possible to raise finance for investment without using the Victorian vintage legal form – the Joint Stock Limited Company – which is what makes the private sector “Private”.

I believe that new forms of Public Equity such as that in a Humber Bridge Partnership are capable of revolutionising the financing of public assets.