NSW Government effects major asset privatisation: WestConnex sale tips Asset Recycling Model into overdrive

The underlying assets

WestConnex is a complicated series of transactions, involving the separate procurement of three major motorway tunnel projects, the operational integration of these three motorways and the sale of 51 per cent of the equity in the entities holding the concessions to operate and toll the roads. On the sale, the NSW Treasurer was pleased to declare: "The transaction not only funds the completion of the congestion-busting WestConnex, but will allow the Government to inject billions more towards infrastructure projects like new schools and hospitals".

The WestConnex assets form part of a 33 km combination of motorways in the heart of Sydney, Australia's largest city. Western Sydney is one of the key regions of population growth in Sydney and has one of the largest growing urban populations in Australia. Once completed, WestConnex will link this growing population and the industrial areas of Western Sydney with Sydney's key economic and employment regions (the central business district and airport corridor). The completed motorway will also provide vital links to the major international gateways at Sydney Airport and Port Botany.

The WestConnex programme of works comprises the following three construction Stages, shown in the diagram below:

• Stage 1 (green) The New M4 being the M4 East (a new 6.5 km tunnel) and a 7.5 km widening of the M4 West;
• Stage 2 (light blue) – The New M5 being a new 11 km tunnel which, when completed, will form part of the M5 Motorway concession along with the existing 10 km M5 East and, from 2026, the existing 21.5 km M5 West Motorway; and
• Stage 3 (dark blue) – The M4-M5 Link being a new 7.5 km twin tube tunnel connecting Stages 1 and 2, to be separately followed by a major interchange at Rozelle and a link to the Iron Cove bridge.

The total cost of delivering WestConnex is expected to be A$16.8 billion. The widening of the M4 West is already complete and the other elements of the new works are expected to be delivered in various stages between now and 2023.

The need for the project in terms of reducing congestion and providing transport links across the city was demonstrated in a strong "Benefit Cost Ratio" of 1.88 assessed at the commencement of the project.

A procurement programme structured for sale

At the heart of the NSW Government's business case for WestConnex was a strategic decision to effect a sale of the toll road concessions. However, the size and complexity of the project and investor appetite at the time the project commenced in 2012 dictated that the State would not achieve a value-for-money outcome by undertaking a traditional PPP-type procurement approach.

As a result, the NSW Government adopted a number of innovative approaches to the procurement and delivery of WestConnex, all designed to optimise the outcome for the State upon sale. The first of these innovations was to separate the procurement of the design and construction of the project from the sale of the concession. To achieve this separation, the NSW Government created a state-owned company, Sydney Motorway Corporation (SMC), which undertook the procurement of the D&C packages. SMC took on roles traditionally performed by the NSW Roads and Maritime Services (RMS), such as project scoping and setting the overall project requirements.

SMC was established as a non-guaranteed private limited company 100 per cent owned by the NSW Government. SMC in turn established subsidiaries for each project stage which were special purpose vehicles that would enter into the project deeds with RMS. These project deeds set out the terms of the concession and the right to toll the roads until 2060. In anticipation of the expected sale, the project deeds were arm's length to RMS, the SMC entities were restructured in a tax-efficient dual trust arrangement and appropriate tax rulings for a post-sale operation were obtained.

Also, non-recourse project financing was secured for each of Stage 2 (with financial close in 2015) and Stage 1 (with financial close in 2016). This standard form project financing was not guaranteed by the State and involved banks taking both construction and patronage (demand) risk on each of the individual stages. The technical and traffic due diligence undertaken by the banks for the debt funding combined with the arm's length investment decision-making by the SMC board in relation to the equity element provided a rigorous and independent review of the structuring of each Stage.

Stage 3 was then procured in parallel with the sale process and reached financial close at the same time as the sale process.

The sale process and outcome

The NSW Government ran a sale process for the equity in each of the project vehicles. The sale process was "quarantined" from the underlying concessions for each of the Stages: in other words, the potential bidders had no opportunity to re-negotiate the underlying project documentation or financing. In effect, each of the concessions for the three stages of WestConnex was sold on an "as is" basis. This approach enabled the management of the ongoing construction activities for Stages 1 and 2 and the procurement of the D&C Contractor for Stage 3 to proceed in parallel with the sale process.

The consortium Sydney Transport Partners (STP), led by Transurban, was the successful bidder in the sale process. The STP consortium comprises Transurban (50 per cent), AustralianSuper (20.5 per cent), CPPIB (20.5 per cent) and Tawreed Investments Limited, a wholly owned subsidiary of Abu Dhabi Investment Authority (9 per cent). STP entered into a Sale and Purchase Agreement to purchase the 51 per cent equity stake in WestConnex from the NSW Government for A$9.3 billion. The STP Consortium and the NSW Government also entered into a unitholders' agreement.¹

Indicative diagram of WestConnex programme of works

As the diagram below sets out, based on the STP purchase price, the enterprise value of the equity in WestConnex is A$25.2 billion, taking into account the existing debt funding and cost-to-complete of the various stages.

WestConnex construction funding composition (A$ billion)

Source: Transurban Retail Entitlement Offer - 5 September 2018

With a A$16.8 billion expected cost for the WestConnex project, the NSW Government was very satisfied with the outcome of the equity sale. The State's full intentions with respect to its remaining 49 per cent interest in WestConnex is yet to be announced but, based on the STP purchase price, it currently has a value of around A$9.0 billion.

Multiple construction works packages

The A$16.8 billion expected cost of the new works was far too large for the Australian contractor market to manage under a single contract. Therefore, the NSW Government divided the scope of work into five major construction packages: two for Stage 1, one for Stage 2 and two for Stage 3. For three of the construction packages (which were each valued around or above A$3 billion), local and international construction contractors formed joint ventures of three or more entities. The composition of the joint ventures differed between the various procurements and no one D&C contractor was successful on all four of the packages which have been tendered to date. The final package (for Rozelle Interchange) is expected to be awarded later this year.

The staging of the procurement for the D&C works provided the market with a constant stream of bidding opportunities for more than five years. Competitive tension was achieved on all packages and the market became familiar with the risk profile, which mirrored that in the Project Deed.

A major challenge in the procurement of the M4-M5 Link Main Tunnel works was now to achieve integration of the M4-M5 Link tunnel with the New M5 tunnel and M4 East tunnel which were at that time under construction. Further challenges included the use of a single motorway control centre and significant retro-fitting works to the existing motorway control centre, which is to be undertaken by the Stage 3 D&C contractor.

Maintaining a fair and competitive bidding basis was a key consideration and was balanced against the risk allocation under the D&C contract. The M4-M5 Link Main Tunnel provided an additional challenge given that completion of this element of the works required the entire WestConnex programme to operate on an integrated basis. Some of this integration risk was mitigated through SMC mandating key technology providers (initially selected for earlier stages on a competitive basis) as nominated sub-contractors for Stage 3.

Patronage-based project financings

The project is being funded through a combination of NSW Government contributions, a Commonwealth of Australia concessional loan, private financing and a distance-based toll.

The sale transaction leveraged the existing project financings for Stages 1 and 2 which SMC had put in place earlier in the project. These were traditional patronage-based, non-recourse financing arrangements, supported by technical and commercial due diligence. Both financing transactions had been well supported by the project finance bank market and marked the first successful patronage risk road financings in Australia following a number of high-profile challenges in the sector.

The concessional loan structure provided by the Commonwealth of Australia was used to partially finance Stage 2 of WestConnex, the initial purpose of the loan being to allow the State to accelerate capital recycling by proceeding with Stage 2 before the State sold down its equity interest in Stage 1. The concessional loan was structured as subordinate debt and a heavily structured intercreditor arrangement was put in place to regulate the Commonwealth's relationship with the initial senior syndicated lenders and to facilitate future financing and re-gearing arrangements.

A key feature of the structuring of WestConnex was the combination of greenfield and brownfield traffic risk. This was achieved for both Stage 1 and Stage 2. By the time of the sale, the financing arrangements for Stage 1 and Stage 2 had been developed so as to work in conjunction with the development of Stage 3 and the integrated operation of the WestConnex motorway.

Planning approvals 

Given the scale and impact of the WestConnex motorways across Sydney, the planning approval process was highly complex. The planning approval process was divided into separate State significant infrastructure (SSI) approvals. These separate SSI approvals allowed for local impact issues to be dealt with in sufficient detail to address community and stakeholder concerns. The use of separate planning approvals matched the three-stage procurement of WestConnex and allowed for the conditions to be aligned to the D&C packages and for an appropriate risk allocation to be achieved in the D&C contracts.

Given the accelerated nature of the entire project, one challenging feature was that the D&C contracts for the early stages of WestConnex were signed prior to the granting of the planning approval for the respective stages. This necessitated a solution to enable the procurement process to be completed within the time frames required for the overall project delivery.

Operations and Operational Integration

A key challenge in structuring the operations of the three separate toll road concessions was to ensure the safe operation of the separate motorway tunnels which join up underground. Key concerns included the need for a co-ordinated response to major incidents and efficiencies in the operation of the roads. The ability to achieve savings on key cost items such as electricity was an important but secondary consideration. The WestConnex approach to these issues involved a unique "OpCo" structure which devolved a defined scope of integrated operations works to a new entity jointly owned by the three concession-holding entities. Cross-default risk between the concession holders was mitigated through the design of the motorways and, at a contractual level, through a fault attribution mechanism under which limited relief was provided to RMS for non-defaulting concession holders. In return, RMS obtained the right to integrate future motorways into the structure.

Conclusions

WestConnex has proven to be a highly successful infrastructure development for the State of NSW. Despite its complexity, the innovative structure enabled SMC to break down the various elements of the project and to deliver both a value-for-money outcome on the individual procurements, as well as a strong sale price on privatisation. The accelerated timing for the entire process was a challenge but nevertheless validated the use of the asset recycling model to fund this ambitious project.

Our roles

Ashurst has been a key legal adviser to the NSW State Government and its agencies on the WestConnex deal. Our roles have included: lead legal adviser on structuring and drafting the toll road concessions for Stages 1, 2 and 3; sole legal adviser on the D&C procurements for Stages 2 and 3; sole legal adviser to RMS on the planning approvals; sole legal adviser on the debt raising for Stages 1 and 2 and joint legal adviser to Sydney Motorway Corporation on the sale of a 51 per cent equity interest in the WestConnex concession-holding entities.

Co-Author: Achal Gupta, Associate 

1. A unitholders' agreement is the equivalent of a shareholders' agreement where the operating vehicle is a trust.