Private Sector Capital Strategies for Public Service ...

October 2011

IHS Consulting Strategic Advisory & Transaction Support

Private Sector Capital Strategies for Public Service Infrastructure

John Larson Vice President +1 202 481 9241

Justin Pettit Vice President +1 212 850 8552

Electronic copy available at: http://ssrn.com/abstract=1944317

PRIVATE SECTOR CAPITAL STRATEGIES FOR PUBLIC SERVICE INFRASTRUCTURE

Contents Private Sector Capital for Public Service Infrastructure ......................... 3 Why it’s Important ................................................................................. 3 Financial Strategy & Policy ................................................................... 4 Size the ―Problem‖ ................................................................................ 4 Types and Sources of Capital ............................................................... 5 Operations Funding........................................................................... 5 Financing Through Divestiture & Asset Sales.................................... 5 Debt Financing .................................................................................. 5 Equity Financing ............................................................................... 6 Hybrid Financing ............................................................................... 6 Hybrid Structures .............................................................................. 7 Surplus Notes & Trust Preferreds...................................................... 8 Capital Structure ................................................................................... 9 Ownership Structure ........................................................................... 10 Public-Private Partnerships ............................................................. 11 Joint Venture Success Factors ........................................................ 12 Operating Model ................................................................................. 13 Conclusion .......................................................................................... 14 Case Studies ...................................................................................... 15

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Electronic copy available at: http://ssrn.com/abstract=1944317


Private Sector Capital for Public Service Infrastructure Public service infrastructure faces the competing demands of age, capacity and economic headwinds

Global public service infrastructure faces the competing demands of age, capacity and economic headwinds. The aging infrastructure of Western economies needs upgrading – just as challenging economic conditions bring government spending and deficit measures to a head. And the inadequate infrastructure of emerging markets is in desperate need of expansion, putting a strain on available resources. This strain is not only in terms of capital resources, but also in many cases other resources too, such as talent. The U.S. air traffic system was built on a foundation of technologies developed as far back as the 1940s and 1950s, and many of these systems have far exceeded their original life expectancy. Demand exceeds capacity in several parts of the country, and modernization programs intended for ―technology refresh‖ have reached a point of diminishing returns. The Joint Planning and Development Office (JPDO) stated in 2007 that Department of Transportation (DOT) cost estimates for domestic air congestion were $9.4 1 billion per year due to passenger delays, growing to $20 billion by 2025.

Needs in developing economies

The needs in developing economies are also severe. China’s traffic congestion has become world-renowned, with light vehicle sales now dependent on expansion of the domestic road system, as authorities limit automotive sales to mitigate growing traffic congestion and resort to strict driving limitations based on vehicle tags (i.e. odd-even). Ghana needs greater electric generation capacity to keep pace with, and to accelerate, the country’s retreat from poverty. With the last significant power plant, Bui, nearing completion, Ghana will have exhausted its prospects for hydropower plants in the 100-plus MW capacity range, and require an efficient, reliable fuel supply for thermal power. Given the price advantage per MMBTU of gas over liquids, as well as inherent environmental and security of 2 supply advantages, Ghana needs gas terminal and pipeline capabilities.

Private sector capital for public service infrastructure is not new … nor is it a guarantee for success

Private sector capital for public service infrastructure is not new – the Tennessee Valley Authority was established by Congress in 1933, with powers to access independently the public debt markets. Nor is private sector capital a guarantee for success. Amtrak has been a target for criticism since incorporation in 1971, for dependency on federal subsidies. More recently, Fannie Mae and Freddie Mac have highlighted risks associated with agencies that lose their way after becoming infatuated with the public equity markets.

Why it’s Important For many strategic buyers and financial sponsors, the shortage of not only capital, but also capabilities and talent, makes public service infrastructure, and its entire supply chain, an interesting business opportunity that spans a wide spectrum of industry verticals. These represent significant growth Joint Planning and Development Office Business Case for the Next Generation Air Transportation System (version 1.0 August 2007). 2 Ghana Energy Commission estimates annual savings of nearly $1bn by 2015 via LNG Storage and Regassification (U.S. Trade and Development Agency grant, June 13, 2011). 1

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Significant growth markets with an attractive risk profile across a wide spectrum of industry verticals

markets with an attractive risk profile. Ultimately, participation in these plays might be as vendors, investors, business partners, or in the form of an M&A transaction. However, the fundamentals can be compelling for those who can bring to the table, the requisite capital, capabilities, or talent.

Financial Strategy & Policy There are several degrees of freedom in the development of a financial strategy for public service infrastructure. A financial strategy and its blueprint – the financial policy – are interdependent with the needs of the business and its stakeholders, and require alignment with overall public mission, enterprise capabilities and strategy, and practical priorities and constraints. We organize our approach to the financial strategy development as follows: Financial Strategy Framework Navigating a Financing Solution

The blueprint for financial strategy – financial policy – involves sizing the need, types & sources of capital, capital structure, ownership structure, and operating model Source: IHS Consulting

Size the “Problem” The first step is to size the ―problem‖ (aka need). This is not a decision, so much as a distinction, in discerning between operations funding and capital financing to evaluate the overall size and profile of the financing need. Funding pays for operating costs and generally needs to be funded from operations (or public subsidy). From an accounting perspective, funding is an income statement item, not a balance sheet item. Cash from operations, liquid assets, public subsidies, and short-term borrowings are the most common public service funding sources. For example, it can be necessary to disentangle and fund future uneconomic activities (e.g. DOE’s Nuclear Waste Fund). And there may be need for preserving more government control or influence over some areas than other areas. For U.S. public services, the Office of Management and Budget (OMB) guidelines define these ―inherently governmental‖ services. Financing pays for capital assets such as plant, property and equipment and may involve raising the money through private or public capital markets. From an accounting perspective, financing is a balance sheet item, and may be categorized as either debt or equity.

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Types and Sources of Capital Private sector financing may be Private sector debt or equity, capital marketsand from have either been aprivate source or public of capital capital for public markets service infrastructure through many different markets Joint ventures and vehicles have become Private sector increasingly financing may be popular for large debt or equity, and capital projects Private sector from either private financing may be or public markets debt or equity, and from either private or public capital markets E&P projects are growing in scale, complexity and risk profile, making it increasingly difficult to go it Financial strategy alone requires alignment with public mission, enterprise capabilities and strategy, NOCs areand another practical priorities unique aspect There may alsoofbe andenergy constraints the industry opportunities tobe There mayto also that helps drive raise capital, opportunities toof the prevalence reduce the need for raise capital, or JVs and(or other capital both), reduce the need for It can be necessary collaborative deals through asset capital, through to disentangle and sales, divestitures, asset sales, private fund future and outsourcing or public market uneconomic agreements divestitures, or activities … there outsourcing may be need for agreements preserving more government control over some areas than others

Private sector capital markets have been a source of capital for public service infrastructure for years, by many different organizations, and through many different markets and vehicles. We illustrate this idea below, with examples of attracting private sector capital to public infrastructure services. Private Sector Capital in Public Service Infrastructure Representative Examples

Source: Booz Allen Hamilton, IHS Consulting estimates

Operations Funding Operating costs are generally funded with cash from operations, fees, public subsidy, or potentially, short-term debt (e.g. seasonal debt), whereas financing is generally a permanent balance sheet item that pays for assets such as plant, property and equipment – this may involve raising money through private or public capital markets, and may be in the form of either debt or equity. Financing Through Divestiture & Asset Sales Notwithstanding the need for preserving government control or influence, there may be elements of a public service that can become an effective source of funding or financing for the broader project. Before traditional financing, there can be opportunities to raise capital, and reduce the need for capital, through asset sales, private or public market divestitures, and outsourcing agreements 3 (of elements that do not meet ―inherently governmental‖ requirements). Debt Financing The first decision regards the nature of the capital financing, in terms of debt or equity, or something in between. This decision is driven by the specific needs of the situation, and the characteristics of the alternatives (see below). For example, debt instruments might include lines of credit, revolving facilities, leases or other asset-backed facilities such as securitizations, term loans and 3For

more on public market divestitures, see for example, Pettit, Justin, Positioning for Growth: Carve-Outs & Spin-Offs (April 2004). Available at SSRN: http://ssrn.com/abstract=546622.

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notes, or bonds, each with their own respective costs and benefits. Each of these vehicles will have its own characteristics in terms of pricing, availability, terms, etc. and these characteristics tend to be quite issuer-specific, even dealspecific, and need to be weighed against issuer objectives and constraints. Equity Financing

Joint ventures have become increasingly popular for large capital Private projects sector financing may be debt or equity, and from either private or public capital markets E&P projects are growing in scale, complexity and risk profile, Private making sector it increasingly financing may be difficult to go itand debt or equity, alone from either private or public capital markets Private sector financing may be NOCsorare debt equity, another and unique from either aspect private of thepublic energy industry or markets that helps to drive the prevalence of JVs and other collaborative deals

Equity instruments might include common stock, preferred stock, options, or longer dated warrants, again, each with their own respective costs and benefits. And while the benefits of debt have been well documented in the academic literature, much of this discussion pertains to the tax shield of debt, for taxable entities. The over-riding business needs and the intangible nature of many of the benefits of leverage, lead practitioners to make their decisions on target credit ratings and the associated capacity for debt, due to control issues, and a reluctance to dilute ownership. Hybrid Financing Now, there can also be a host of alternatives in between plain vanilla debt and equity, tailored to suit the circumstances. For example, surplus notes originated in the early `90s as a credit-friendly way to raise ―equity‖ despite not being publicly traded (see inset on Surplus Notes); however, investor demand for structured solutions and hybrids tends to vary widely with market conditions. In general, these securities are better suited to larger, higher quality, and more seasoned names, with ―on-the-run‖ (aka regular) tenors, and for times when the markets are less turbulent and wide open. Private Sector Capital in Public Service Infrastructure Spectrum of Alternatives

Source: Booz Allen Hamilton, IHS Consulting estimates.

The second decision point is between the sources of financing, in terms of public capital markets or private capital markets, based on factors such as cost and terms, availability, and covenant requirements. This decision may be driven by other considerations such as liquidity, regulatory requirements,

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Hybrid Structures There is a host of alternatives between plain vanilla debt and equity that can be tailored to suit the circumstances. In general, these securities are structured to accord greater ―equity content‖ and are thus credit rating-friendly to lower the all-in cost of funds. Design features that enhance the credit rating include: long-dated tenors, e.g. long or perpetual, non-call (NC), or NC5+ (non-callable 5+ years), Contractually enforceable replacement capital covenants that require substitution by equal or greater equity content Deferral triggers that defer/suspend dividend servicing at predetermined ratios Hybrid content capped by S&P at 15% of tangible book capital including the hybrid. Moody's caps equity credit at 25% of: hybrid equity credit/(equity + hybrid equity And while much of the structuring relates to enhancing the credit ratings profile without diluting shareholders or losing tax efficiency, there may be other objectives too. For example, a business with a natural inflation hedge (e.g. postal rates) might issue inflation-linked notes to lower its total cost of funds. A selection of hybrid structure examples follow:

Hybrid Security Structures & Features Illustrative Equity Content Spectrum

Source: UBS, Booz Allen Hamilton, IHS Consulting estimates.

For regulatory capital purposes, there is a stated cap on equity credit at 20% of the statutory surplus, and this can depend on factors such as profitability, cash flow, liquidity, leverage, and overall capitalization. Hybrid content is also capped by the ratings agencies, as noted above. But the credit ratings agencies are more holistic than the regulators and will also evaluate the ability of the organization to meet its financial obligations, the cost of the capital relative to other current and historic costs, earnings performance, intended use of funds, and the tail of the insurer’s book of business.

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Surplus Notes & Trust Preferreds Surplus Notes were often smaller denominations and shorter durations, especially for smaller, less seasoned issuers. Securitized pools of Surplus Notes (see below) were employed to allow greater access and duration (investors were wary of lending money in a regulated industry, with uncertain earnings, under ―private‖ ownership, especially for longer tenors). Larger, seasoned names generally do not need pools and could go directly to the market. Surplus Note & Trust Preferred Structures Illustration of Pools Trust-Preferred Securities

Holding Company 1

Surplus Notes

Junior Subordinated Debentures

1 Mutual Insurance Company

Statutory Business Trust

Proceeds

1. Holding company issues junior Long-Term subordinated Subordinated Proceeds debentures/operating Debt company issues surplus notes 2. SPV pools collateral and issues CDO in different tranches for investors 3. CDOssold to Investors

Surplus Notes

Proceeds

Special Purpose Vehicle (SPV)

33

Collateralized Debt Obligations (CDO)

Proceeds

2

4

4. Proceeds channelled back to company Investors

Source: A.M. Best, UBS, Booz & Company, IHS Consulting estimates.

Surplus Note pools (CDOs) were issued in three to four tranches of $300-$500MM each, with no single issuer accounting for more than a 5% share, and were marketed to private, institutional investors. These were generally long-dated (30-yr) junior subordinated notes, non-amortizing, non-callable for 5 years (in practice tenor may be effectively truncated with a pairing of 5-year put/calls). These were often priced at LIBOR + 300-400bps, and were often swapped to a fixed rate for the first 5-years (the non-call period). Trust-Preferreds are also created by issuing junior sub-debt to a trust, while the trust issues the trust-preferred securities, of 30+ year term, callable, with interest deferral up to 5 years. Regulators give full equity credit to Surplus notes and Trust Preferred Notes, pending regulatory approval of issuance and regulatory oversight of any payment of interest or principal. There is a stated cap on equity credit at 20% of statutory surplus, but this depends on factors such as profitability, cash flow, liquidity, leverage, and overall capitalization. In both cases, the process flows as follows: Operating Company issues surplus notes, or Holding Company issues junior subordinated Debentures, Special Purpose Vehicle (SPV) pools this collateral and issues collateralized debt obligation in tranches, Debt tranches are sold to investors, and Proceeds are routed back to the issuer (Operating Company/Holding Company) The rating agencies tend to give C- or D-bucket treatment (60–80% equity) as long as there is strong replacement and dividend deferral language. Ratings agencies are more holistic than the regulators and will evaluate the ability of the organization to meet its financial obligations, the cost of the capital relative to other current and historic costs, earnings performance, intended use of funds, and tail of the insurers book.

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transparency, governance and control issues. Investor control through monitoring or restrictive covenants – characteristic of private capital – can be weighed against public disclosure. And the more complex a company and its plans, the more difficult and expensive it is to issue equity … public investors can be at an informational disadvantage to insiders or financial sponsors. Project cash flows dictate the debt capacity for a given credit rating, while equity fills the remaining need …

… the optimal proportion of debt in the capital structure has steadily declined since most executives were in business school

Thus, private sector financing options can span the range of public and private market options for debt and equity, as well as hybrid securities.

Capital Structure Financial policy (financial leverage, cash and liquidity, and shareholder distributions) is not only about finding the correct settings, but also about alignment between each of the elements and with the management agenda. Capital structure in public service infrastructure projects tends to be governed by issues of ownership control and dilution, which put virtually all forms of debt at the top of the ―pecking order‖ for sources of capital. Project cash flows dictate the debt capacity for a given credit rating, which is a reasonable proxy for requisite financial strength. Equity generally fills the remaining needs. Debt is the perhaps the simplest form of financing, and it avoids diluting the ownership interest of equity holders. Debt service can be a tax efficient use of operating cash flows (for taxable entities) and so financial leverage can reduce the weighted average cost of capital (WACC) of an enterprise by substituting lower cost debt for more expensive equity. Leverage can also reduce ―agency costs‖ through increased fiscal discipline. However, the optimal proportion of debt in the composition of a corporation’s capital structure has steadily 4 declined since most executives were in business school. Financial Leverage within Credit Ratings Interquartile Ranges for Industrials, Debt/EBITDA 6

Utilities

5

Telecom

Utilities Utilities

4

Materials Energy

Telecom Materials

3

Energy

Telecom Energy

2 1 0 As

BBBs

BBs

Source: Standard & Poor’s, Factset, UBS, IHS Consulting estimates.

See chapter 7 of Strategic Corporate Finance: Applications in Valuation & Capital Structure (Wiley 2007) by the same author. 4

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Beyond the overall proportion of debt within the capital structure, financial policy should address optimal cash and liquidity, and construct of the debt portfolio

More highly leveraged companies (see above) tend to have lower credit ratings – a key target toward which to manage. An optimal capital structure provides sufficient financial flexibility to support a value maximizing strategic plan, while providing an efficient weighted average cost of capital. Many companies sense that the ratings requirements, especially the important thresholds for investment grade (BBB−) and A1/P1 commercial paper access (long term A rating), have been tightened in response to the financial crisis and that markets are smaller and less accessible for lower quality credits. Debt/EBITDA is one of the more universal leverage ratios that works well across most industrial sectors. But its limitations include the effects of cyclicality, anomalous tax or depreciation cases, asset-light service industries, or sectors characterized by short asset lives. EBITDA-based metrics also overlook growth in working capital, quality of earnings, and liquidity. And liquidity became a very important issue in the recent financial crisis. Beyond establishing the overall proportion of debt within the capital structure, financial policy should address optimal cash and liquidity, and an optimization of the 5 construct of the debt portfolio—liability management.

Ownership Structure Ownership structure can be more of a constraint than an optimizing function in the financial blueprint design for an infrastructure project. Once the amount of equity is determined, as a function of project size and debt capacity, the key is to determine its optimal composition. There are many available variants in the ownership structure including the partial public offering of a stake, minority interests and passive private placements, variations in public-private partnerships, and use of joint venture vehicles (see below). Deal Design Landscape Illustration of Ownership Structure Alternatives

Source: Booz & Company, IHS Consulting estimates 5

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Ibid for discussion of ladder, gaps and towers, fixed-floating, swaps, liquidity and distributions.

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Public-Private Partnerships

Private sector participation can go well beyond financing models

Public-Private Partnerships (PPPs) are a unique joint venture construct that involves a public institution alongside private enterprise, with equity contributed by both the private and public sectors. One important element in the case for PPP for public service infrastructure is the transfer of expertise from private partner to public entity. To be attractive and viable, the shareholding structure of the JV must secure the interest of both the public and private partner, namely providing enough public capital and sufficient private sector expertise. The literature on private capital in public sector investments compares higher outlays on construction for the public sector with higher capital costs for the 6 private sector. For public infrastructure, empirical research in the U.K. and the U.S. shows that the private sector is indeed able to build infrastructure cheaper 7 than the public sector. These savings amount to 15-30 percent and can be attributed greater capabilities, more efficient project management and shorter 8 construction time, as well as lower administrative expenses. On the other hand, in developed markets the cost of capital for the private sector is on 9 average 100-300 basis points higher than for the public sector.

PPP viability varies across industries depending on the nature of public infrastructure, capital intensity, and technology required

An optimal capital structure is achieved with both the public and the private parties as shareholders – different knowledge transfer schemes determine the optimal shareholding structure. For example, the higher financing cost of the private sector is offset by the savings of development outlays, in the continuum 10 between sole public or sole private shareholding, in an optimal solution. Private sector capital participation in public sector infrastructure can go well beyond financing models (see below). For example, PPPs have helped to connect specialized capabilities with the growing needs of public infrastructure. Private Sector Participation in Public Service Infrastructure Spectrum of Business Model Alternatives

Source: Booz Allen Hamilton, IHS Consulting estimates.

See for example, Broadbent and Laughlin (2003), pp. 332-341; UK National Audit Office: www.nao.org.uk/guidance/focus/000154_pp5-6.pdf. 7 See Wright (1987), pp. 143–216, and Viscusi et al. (2000), pp. 448-449. 8 Wallance and Junk (1970, quotation from Viscusi et al., 2000, p. 448) even claim that public enterprises have investment outlays 40 percent higher than private ones. 9 See American Chamber of Commerce in Poland (2002), p. 20. 10 As discussed by Moszoro, Marian and Gasiorowski, Pawel, Optimal Capital Structure of PublicPrivate Partnerships (December 2007). IMF Working Papers, Vol. , pp. 1-13, 2007. Available at SSRN: http://ssrn.com/abstract=1087179. 6

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There have been many case studies of participation by private sector capital in select public services (see Appendix). Empirically, at the industry level, PPP determinants vary across industries depending on the nature of public infrastructure, capital intensity, and technology required. Private participation in PPP projects depends on the expected marketability, the technology required, and the degree of 'impurity' of the goods or services. At the country level, PPPs tend to be more common in countries where governments suffer from heavy debt burdens, where aggregate demand and market size are large, and where there is previous case experience. Macroeconomic stability is also essential for PPPs, as is institutional quality – less corruption and effective rule 11 of law is associated with more PPP projects. Joint Venture Success Factors Joint ventures have become increasingly popular for large capital projects

Joint ventures (JVs) have become increasingly popular for large capital projects – for example, Saudi Aramco manages a large number of JVs with international oil companies, both domestically and overseas. And to facilitate shale-specific capability development, Eni established a Barnett Shale joint venture with Quicksilver. The KazakhstanCaspiShelf (KCS) was established to oversee Caspian Sea resource development in the Kazakhstan sector. The Shell - ExxonMobil venture, Infineum, has been successful. And while TNK-BP has gone through turmoil in recent years, it has been a financial success. Joint Venture Strategic Intent Rationale for JVs in Public Service Infrastructure Energy projects are growing in scale, complexity and risk, making them increasingly difficult to go alone. There has been a surge in collaborative deals to gain access, build capabilities, and share both capital and risk.

Projects are growing in scale, complexity, and risk, making it increasingly difficult to go alone

National Oil Companies (NOCs) are another aspect of the energy industry that drives the prevalence of collaboration for knowledge transfer and capabilities building.

Source: Booz & Company, IHS Consulting estimates.

The BP-Rosneft alliance is one example in the upstream Arctic. This equity swap is the first major example of NOC and Independent Oil Company (IOC) establishing cross shareholdings. For BP, the deal offers further potential to grow its reserves and production base. BP has the right to book reserves and future production equivalent to its share in the venture. And with Rosneft being Hammami, Mona, Ruhashyankiko, Jean-François and Yehoue, Etienne B. Baba, Determinants of Public-Private Partnerships in Infrastructure (April 2006). IMF Working Paper, Vol, pp. 1-39, 2006. Available at SSRN: http://ssrn.com/abstract=902765. 11

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75% state owned, closer ties with the Russian government via Rosneft’s 5% stake may provide additional support for BP in Russia. For Rosneft, the deal provides access to BP’s technical expertise, and potential for international collaboration opportunities elsewhere. And downstream, the refining JV gives Rosneft potential to tap a significant European customer base. As with M&A, or organic initiatives, JVs can provide access to advantaged positional assets & organizational capabilities

As with M&A, or organic initiatives, JVs can provide access to advantaged positional assets & organizational capabilities. In fact, partnerships have become a more popular approach to unconventional entry than acquisitions. Properly structured joint ventures can confer many of the same benefits as an acquisition, plus more flexibility. Empirical research over two decades of data demonstrates that joint ventures (JVs) create value. Event studies have documented significant wealth gains with JV announcements: Highest gains to horizontal combinations in concentrated industries Gains relate to characteristics such as firm size, the degree of relatedness of the JV with the parent, and the effect of a parent’s JV capabilities JVs typically add value when two companies have complementary assets, creating an opportunity for operational synergies as well as sharing of risk, technology and capital. On average, both parties gain – the more so with ―marriages of equals‖ (unlike M&A). JVs often have more ―option value‖ than M&A deals, by providing a firm with the flexibility to increase or decrease investment depending upon on how conditions develop:

Despite their prevalence, the experience with JV’s has been poor – their structure can lead to operational difficulties that impair both value creation and value capture

Commitment may increase, as partners learn more about the environment, Commitment may be reversed at lower cost, by selling to the partner, and Commitment may be deferred, through step-up provisions. Despite their prevalence, the experience with JV’s has been poor – some executives even refuse to consider them. While JVs are common, their structure leads to operational difficulties that impair both value creation and capture. The complexity of JV’s – evidenced by the number of key issues – makes them more difficult to execute successfully. And lately in the upstream, the incumbents are capturing the lion’s share of value creation. Many problems stem from an M&A-oriented negotiation approach instead of a design process. JVs require a more balanced, less competitive design style (than M&A) that can help set the tone for a good relationship. Successful JVs are crafted with the aim of building trust and achieving a shared vision and understanding (versus a contract with explicit provisions for all possible contingencies), and strong incentives to seek business solutions instead of legal remedies. JVs also tend to have finite lives, and successful structures are often designed with a clear operating model and exit.

Operating Model Due to these challenges, best practice dictates a broader emphasis on operating model design, versus simply ownership structure. The operating model (see below) includes deal structure, governance (information & oversight), organizational design, management processes, decision rights, and culture & incentives.

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Operating Model Design JV Design Elements Go Beyond Deal Structure A JV operating model creates the key elements of the new enterprise. Design of the ownership structure has implications for the governance and organizational design. A focus on the requisite capabilities and roles helps to drive an appropriate organizational structure with natural boundaries.

Best practice dictates a broader emphasis on operating model design, versus simply ownership structure

A mapping of the key management processes is required to allocate roles and decision rights, and to reduce the emphasis on the ―boxes and lines.‖ Roles and responsibilities are typically built around RACIs (i.e. Responsible, Accountable, Consulted, and Informed) and begin by clearly defining a purpose or charter. Decision rights can be set by combining role and process step to identify responsibilities & accountabilities. Source: IHS Consulting estimates.

An operating model defines the key elements of the enterprise

Deal Structure: What is the ownership structure for the new entity? What are the mechanisms for dissolving the entity or changing its capitalization? How will financial policy (e.g. financing, dividends, and buybacks) be set? Governance: How will it be governed? What information will be shared with the owners, at what frequency, and what will be the cadence and involvement of oversight? What are the authority levels for the new entity? Organization Design: What are the key roles (e.g. organization structure, functional statements) within the new entity? Management Processes: What are the key management processes for the new entity (e.g. capital expropriations, budgeting & planning, performance management, cash management, talent management and succession)? Decision Rights: What are the decision right allocations (i.e. Responsibility, Accountability, Consulted, and Informed) for processes? Culture: What are the key principles for company culture & social norms in the new entity? What are the design principles for formal and informal processes, including incentives and rewards in the new entity?

Conclusion We have outlined the many degrees of freedom to finance public service infrastructure, including the design elements of a successful operating model. All too often, approval processes undermine decision efficiency and effectiveness because it involves one individual or entity (operator) presenting a recommendation to the decision makers (owner’s committee). An advocacy approach forces decision makers into an accept/reject decision, rather than collaborative dialogue to build choices from elements in a slate of alternatives, through an iterative dialogue that builds alignment and enables action.

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Case Studies

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IHS Inc. (NYSE: IHS) is a leading information company, that helps the world’s top businesses, governments, and organizations to make their most important decisions every day. IHS Consulting provides advisory services on these issues. Today, with more than 1,000 professionals in 150 countries around the world, we bring information, insight, and expertise to major business decisions. Visit www.ihs.com to learn more about IHS.

Contact Information

About the Author

New York

Justin Pettit brings nearly twenty years experience in corporate strategy, financial strategy, and mergers and acquisitions, as a management consultant, bulge-bracket investment banker, and corporate executive. He is the coauthor of Merge Ahead (McGraw Hill 2009), and sole author of Strategic Corporate Finance: Applications in Valuation & Capital Structure (Wiley 2007).

Justin Pettit Vice President +1 212.850.8552 [email protected]

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