n Altemat;ve INFRASTRUCTURE VALUATION INFRASTRUCTURE INVESTOR ~ lns1ght A guide to the valuation of privately held infrastructure equity and debt

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1 n Altemat;ve ~ lns1ght INFRASTRUCTURE INVESTOR INFRASTRUCTURE VALUATION A guide to the valuation of privately held infrastructure equity and debt By Frederic Blanc-Brude and Majid Hasan EDHEC.:Risk Institute

2 Figures and tables About the authors 1 lntroduction 1.1 Why infrastructure? 1.2 The demand for benchmarks 1.3 A roadmap 1.4 This book vii xi PART 1: UNDERSTANDING PRIVATELY HELD INFRASTRUCTURE INVESTMENTS 2 The nature of investable infrastructure Existence of investable infrastructure The role of long-term contracts The role of commitment The contractual nature of underlying infrastructure investments Creating and regulating investable infrastructure Monopoly privatisation and regulation Project finance and corporate governance Conclusion: lnfrastructure assets are not real assets 19 3 lnfrastructure project financing Investment delegation and project financing Definition Agency and monitoring in project finance A response to the long-term investment problem Project financing as risk optimisation Conclusion: lnfrastructure project finance as a reference asset 35 4 Risk and the cost of capital in infrastructure projects Construction risk Leverage Revenue risk Contract renegotiation Political risk Conclusion: Systematic sources of risk in project finance 47 iii

3 PART II: ISSUES WITH LONG-TERM INVESTMENT PERFORMANCE MEASURES 5 6 Benchmarking infrastructure investments: Objectives and challenges 5.1 Why benchmark infrastructure investments? 5.2 Two challenges Addressing the challenges of long-term investment benchmarking 6.1 Bayesian inference for long-term investment benchmarking 6.2 Towards intersubjective pricing measures 6.3 Families of generic infrastructure projects PART III: MEASURING THE PERFORMANCE OF INFRASTRUCTURE PROJECT DEBT 7 Objectives and characteristics of infrastructure project debt Objectives Defining infrastructure debt Observable asset values Covenants and embedded options ldentifying default triggers Reorganisations llliquidity and lumpiness Documented performance Conclusion Approaching the valuation of infrastructure debt 8.1 Asset-pricing models 8.2 Corporate debt valuation models 8.3 Proposed approach 8.4 Conclusion Valuation framework 9.1 Intuition 9.2 Cash flow dynamics 9.3 Structural framework Debt restructuring model 10.1 Restructuring upon a technical default 10.2 Restructuring upon a hard default Model implementation 11.1 Cash flow model 11.2 Risk-neutral measure 11.3 Debt rescheduling upon default iv

4 11.4 Algorithm 11.5 Results PART IV: VALUING EQUITY INVESTMENTS IN INFRASTRUCTURE PROJECTS Objectives and approaches 12.1 Objectives 12.2 Existing approaches to private equity valuation 12.3 Proposed approach Expected dividend model 13.1 A Bayesian framework 13.2 Cash flow metrics and risk measures 13.3 Dividend state transitions 13.4 (Conditional) dividend payment distribution 13.5 Prior elicitation Valuation framework 14.1 Modern asset-pricing theory 14.2 A state-space framework Observation (pricing) equation 15.1 Pricing equation 15.2 Matrix formulation 15.3 Observation equation State (discounting) equation 16.1 Term structure model 16.2 Matrix formulation 16.3 State equation Filtering of the term structure 17.1 State-space model 17.2 Filtering and updating 17.3 Parameter estimation 17.4 Model outputs 17.5 Conclusion Model implementation 18.1 Prior elicitation 18.2 Equity cash flow projections 18.3 Results 18.4 Return measures 18.5 Risk measures 18.6 Market dynamics Sensitivity to conditional dividend volatility estimates V

5 PART V: CONCLUSIONS 19 Conclusions 19.1 Key points 19.2 Data collection and standardisation 19.3 Next steps PART VI: TECHNICAL APPENDICES A B Debt valuation A.1 Risk-neutral measure A.2 Risk measures A.3 Return measures Equity valuation B.1 Cash-flow metrics B.2 Bayesian estimates B.3 Pricing equation Bibliography About PEI vi