Autopista Central, S.A. the Valuation of a Toll Road Project in Chile
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The Fuqua School of Business at Duke University FUQ-04-2010 Rev. April 30, 2010 Autopista Central, S.A. The Valuation of a Toll Road Project in Chile Manuel Flores arrived to his office in Madrid on Monday after a relaxing weekend spent with his family. It was mid-November 2007 and Flores, senior vice-president of Business Development for the Spanish construction and services company ACS, had spent the last three weeks visiting ACS project sites in Latin America. Upon his return to Spain, he had had gone to a three-day infrastructure and project finance conference in Majorca where many of the most important players in the industry had been in attendance. At the conference Flores was approached by Juan Albán from the toll-road and airport operator Abertis and Sergio Sandoval from the private equity arm of Santander Bank who had an interesting proposition for him. Specifically, Albán and Sandoval expressed considerable interest in jointly buying ACS’ stake in a 61 kilometer toll-road that the firm had constructed and was now co- operating in the Chilean capital of Santiago. ACS had a 48% equity stake in this venture known in Chile as Autopista Central or “Central Highway” which had received investment of more than USD 800 million by 2007. Although some had recently begun to speculate that world asset prices had reached a peak, companies like Abertis and Santander still had appetite for infrastructure projects that they viewed as being relatively safe investments. Flores, Albán, and Sandoval had had a series of informal meetings regarding Autopista Central at the conference in which the group decided that Flores would discuss the idea of a sale of ACS’ stake with the firm’s CEO, Florentino Pérez, as soon as possible. Regardless of Pérez’s and the Board’s decision regarding a potential sale of the asset, Flores knew he and his team would have to spend the next few weeks valuing the toll-road. As Flores sat down at his desk in Madrid, he pondered a major question regarding the valuation ahead of him. Specifically, how should he determine the project’s cost of capital in a market where limited access to reliable information and the presence of market inefficiencies violate many of the assumptions of the Capital Asset Pricing Model? Given the size of the potential deal, he would have to travel to Chile to better assess the risks that he should include in his discount rate. He knew he could not falter with two big players like Abertis and Santander and he sighed as he picked up the phone to call his wife to tell her that their family vacation would have to be postponed for another two weeks. This case was prepared by David Keller, Belisario Galarcep, Massimo Paone, and Javier Vilardell for the course Advanced Topics in Corporate Finance under the supervision of Professor Campbell R. Harvey and was written as a basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. Copyright © 2010 - all rights reserved. The Fuqua School of Business, Duke University, 1 Towerview Drive, Durham, NC 27705, USA. http://faculty.fuqua.duke.edu/~charvey/Cases/index.htm . Autopista Central, SA: The Valuation of a Toll Road Project in Chile FUQ-04-2010 Chile: A Brief History Prior to the arrival of the Spanish in 1536, present day Chile was inhabited by around 500,000 indigenous people who lived in a series of interconnected villages throughout the country. The Spanish effectively annexed the territory in 1540 and in this year established the present day capital of Santiago. From Santiago the Spanish managed their economic and political interests in Chile. The colony never was as profitable as some other Spanish colonies in Latin America such as Peru or Mexico and the Spanish crown remained largely disinterested in Chile until the late 18 th century. As was the case in many Latin American colonies, the people of Chile grew tired of Spanish- imposed rules and regulations and formally declared independence on September 18, 1810. Actual independence was not achieved until 1818 upon which the country descended into a brief period of relative anarchy. In 1879 a conflict with Chile’s neighbors to the north, Bolivia and Peru, over the ownership and development of nitrate reserves led to a war between Chile and the two nations (see Exhibit 1 for a map of the region). Chile was victorious in the conflict and took control of a large swath of Bolivian and Peruvian territory that resulted in an increase of Chile’s territory by one-third. In the exchange, Bolivia lost all of its coastal territory and Peru lost the maritime rights over rich fishing waters, events that continue to be a source of considerable Bolivian and Peruvian resentment with Chile even today. After the War of 1879, Chile entered into a period of considerable economic expansion led by growth in its mining and manufacturing industries. Much of this development was made possible by foreign loans and a state-run economy that permitted the rise of an urban middle class. The centrally controlled economy was unable to transition to the trend towards market-based reforms that began in the early 1900’s and consequently the country experienced flat economic growth and periods of high inflation during this time. In 1964, Eduardo Frei of the center-left Christian Democratic Party (PDC) won the presidency and initiated a series of radical reforms including agrarian reform and the nationalization of many of the country’s copper mines. Following a particularly acute recession that began in 1967, Chile elected the socialist Salvador Allende of the Popular Unity Party (UP) in 1970 in a hotly contested election against the U.S.-favored Conservative Party candidate, Jorge Alessandri. Upon taking control, Allende nationalized many of the country’s businesses and banks and instituted a series of reforms aimed at redistributing wealth to the lower classes. As a result, foreign and national investment in Chile dried up and the nation became very polarized between the left and the right. Some on the right called for open military intervention to remove Allende and received support from the U.S. who, under the back drop of the Cold War, was interested in thwarting any resemblance of communism in the Western Hemisphere. 2 Autopista Central, SA: The Valuation of a Toll Road Project in Chile FUQ-04-2010 On September 11, 1973, a military coup led by the commander-in-chief of the Chilean military, General Augsto Pinochet, and the covert support of the U.S., removed Allende from power in an attack on the presidential palace in which Allende took his own life. Under Pinochet all political activities were suspended and a brutal campaign to eliminate all left-wing opposition was undertaken. Pinochet declared a permanent state of emergency in which congress was dissolved and all left-wing parties were banned. Over the following 15 years, more than 2,000 people were killed by the Pinochet regime while thousands more were arrested or tortured. During this period the government’s role in the management of the economy was drastically reduced as the regime privatized most industries even though it maintained strict control over any political activities. The beginning of the 1980’s saw the Pinochet regime gradually permitting more free speech, freedom of assembly, and political associations which eventually set the stage for a 1988 national referendum on the future of Pinochet’s rule. Pinochet lost the referendum and respected the results. Chileans then elected Patricio Alywin of the PDC party in 1989 who would go on to govern Chile in a transition government from 1990 to 1994. All post-Pinochet presidents of Chile, Eduardo Frei (1994-2000), Ricardo Lagos (2000-06), and the current president, Michelle Bachelet have been affiliated with a center-left association of parties known as the Concertación or “The Agreement” 1. Chile: The Economy Chile averaged 4.4% real GDP growth between 2002 and 2006. Such steady and robust growth was partially facilitated by the introduction of a broad reaching fiscal reform in 2000. This reform reduced the volatility of GDP growth. Real GDP rose from a 2.2% rate in 2002 to 3.9% in 2003, averaged 5.9% in 2004-05, and then fell to 4% in 2006. Starting in about 2003, soaring global demand and the resulting increase in commodities prices boosted the Chilean economy. In addition, relatively cheap and available worldwide credit contributed to significant increments in investment in Chile. Notwithstanding a robust growth in exports, between 2003 and 2007 the contribution to growth from the external sector resulted in a negative balance of trade as private consumption grew steadily as a consequence of higher levels of employment and a stronger local currency. The country’s GDP decreased in 2006 mainly due to a one month strike at the world’s largest copper mine (Chile is the world’s largest producer of copper having around 1/3 of total world reserves). At the same time, growth was hampered by rising energy costs due to a unilateral cut in Chile’s gas supplies by its neighbor, Argentina. On the supply side, the most dynamic economic sectors until 2006 were communications, financial services, and agriculture and forestry. In 2007 GDP was on track to grow around 5% even in light of tighter monetary policy implemented by the government that was aimed at dampening private consumption. 3 Autopista Central, SA: The Valuation of a Toll Road Project in Chile FUQ-04-2010 Chile: Monetary Policy The independent Banco Central de Chile (The Central Bank - BCC) manages the monetary policy of Chile and has reached an international degree of credibility.