Privatizing the Indiana Toll Road

Following Mark Thoma’s comments on the sale of the Indiana Toll Road, I thought I’d add some comments here. It looks like Indiana has reached an agreement to lease the Indiana Toll Road to a consortium of Cintra and the Macquarie, two firms with a history of such investments (they were the winners, as I recall, in the lease of the Chicago Skyway toll road). Their winning bid was $3.85 billion for a 75-year lease. According to Toll Road News, the lease payment will be a lump-sum, not an annual payment.

Apparently, the Indiana Toll Road’s revenue has been slightly less than $100 million a year recently (with plans to add about $77 million a year in revenue from toll increases), with operations costs (toll collecting and routine maintenance) of around $65 million a year; this is a nice spread for Indiana, in the absence of long-term infrastructure investments and in the absence of meaningful accounting for depreciation. Indiana has developed plans to spend about $770 million on improvements (not routine maintenance) on the Toll Road over the next decade; it is not clear whether those improvements will be paid for by Cintra-Macquarie under the terms of the lease, or whether the State of Indiana will make them, and pay for them.

What seems clear, unless I’m missing something, is that Cintra-Macquarie will be hard pressed to turn a profit unless tolls increase substantially. Assume they have to pay 7% per year to fund the $3.85 billion lease payment (or, alternatively, that they could have earned 7% per year on cash on hand that they use to make the payment). That’s an annual cost of funds of $269.5 million. Assume that they manage to hold the operating costs 20% below what Indiana has been paying, from a combination of smarter management, cost-saving technological change, and lower wages. That’s $52 million a year in operating costs (which seems damned low to me, in any event). We’re up to $320 million or so in annual costs, in the absence of depreciation or improvements.

Indiana’s plan called for revenues of about $175 million per year over the next 10 years. Cintra-Macquarie will need about $600 million to earn an after-cost-of-funds return of 7% on its investment. That’s more than three times what Indiana planned to collect in tolls (and other revenue). That suggests that tolls will need to triple—or more—on the Toll Road.

But it’s worse than that. For much of its length, and especially for the heavily-traveled western end of its length, the Toll Road has direct competition from a freeway. Now the freeway (I80/94, known locally as the Borman Expressway) is highly congested, and already a fair amount of the Toll Road traffic is a diversion because of that congestion. But if the tolls triple, then some, perhaps significant, portion of the traffic will divert back to the freeway.

Perhaps I’m missing something. Perhaps there’s some obvious way in which this can be a profitable venture. I can’t believe Cintra-Macquarie would offer up $3.85 billion if they didn’t have a plan to make a reasonable profit. But, right now, I just can’t see it.