How Port of Melbourne became a gobsmacking deal

The final $9.7bn lease price was an inconceivable outcome when the auction process started.

Whether it is serendipity, good luck or good management, the timing of the Victorian Government’s sale of a 50-year lease over the Port of Melbourne has produced an extraordinary deluge of cash for the state.

Actually, it is probably a mix of the three.

The serendipitous element is that the protracted wrangling with the Opposition over the period of exclusivity that would be granted to the successful bidder delayed the actual bidding until what appears to be the perfect moment.

The good luck came with that timing, at a point where global interest rates and yields are at historically unprecedented levels and the hunger for positive returns, particularly from pension funds with their long-dated liabilities, is at extreme levels.

For the bidders for the long-term lease of the port, debt is ultra-cheap and their expectations of returns have been vastly reduced in the post-crisis environment.

The good management came from the foresight of successive government to create a port – the largest in the country – with sufficient capacity to cope with increased container volumes that could be expected to be generated by the underlying longer-term growth in Victoria’s population and economy.

The controversial channel-deepening project, the $1.6 billion expansion of Webb Dock and the introduction of a third stevedore to the port have, with the fortuitous timing, helped create a growth opportunity that ultimately has produced a price that was inconceivable when the process started.

At the outset $6 billion was regarded as a good price for the port, with expectations pushing up towards $7 billion as the bidding process neared its conclusion.

The headline price of $9.7 billion, which includes $800 million for the pre-payment of 15 years of licence fees, is a gob-smacking outcome for a state which is in the midst of a massive transport infrastructure spending spree.

If Daniel Andrew and Tim Pallas can hold the Federal Government to its promise to contribute 15 per cent of the proceeds of state government asset sales provided they are recycled into infrastructure spending, there could be an extra $1.45 billion to add to the pot.

The winning consortium – it has named itself the Lonsdale Consortium – includes the Future Fund, Queensland QIC, Global Infrastructure Partners and OMERS (Ontario Municipal Employees Retirement System).

Within the consortium there is considerable expertise in port management and ownership, both local and international, while the nature of the overseas consortium members – well-regarded and credentialed asset managers that invest ultimately on behalf of pension fund members – means there should be no national interest sensitivities, despite a reported investment by China’s sovereign wealth fund within one of the consortium’s funds.

The winners fought off, reportedly by quite a narrow margin, a rival offer led by IFM Investors, Macquarie Infrastructure and Dutch asset management business, APG.

The intensity of the contest has produced an outcome that, in terms of multiples of historical earnings, would be off the charts and would normally generate considerable alarm among port users, concerned that the NSW experience of successful bidders justifying the high prices paid for ports by jacking up charges might be repeated.

Historical performance isn’t particularly relevant for Port of Melbourne, given that increases in its revenue from recent changes to the charges – a new long-term rental deal with DP World that will probably flow through to a similar deal with Patricks as well as the introduction of the Philippines-based International Container Services to the port – will see its revenue base expand very significantly over the next couple of years. ICT is investing more than $500 million building a high-tech new terminal within the port.

With an overall cap on its charges of CPI and returns-based regulation by the Victorian Essential Services Commission, the new lessors won’t be relying on gouging users to rationalise the price they’ve agreed to pay. A material slice of any efficiency gains may also be regulated away by the VESC.

The consortium is betting that the volume of containers flowing through the country’s biggest port will, thanks to the growth in the population and economy, increase materially over the next 50 years, generating CPI+ growth in income for their funds.

For pension funds, assets that generate CPI+ returns over decades are peculiarly valuable because they enable them to match the growth in their long-tail liabilities.

That’s why there is such competition for infrastructure assets, competition that has intensified as the returns from other low-volatility assets, like government bonds, have evaporated as a result of the unconventional monetary policies being pursued by the major central banks.

Globally, major infrastructure assets with the Port of Melbourne’s scale, dominance (it handles about a third of Australia’s container volumes) and inherent growth characteristics are increasingly scarce.

The Port of Melbourne has another potentially valuable option, albeit one that probably won’t be exercised for another 15 years or so.

The party-political wrangling over the period of exclusivity to be granted to the winning bidder – the government originally proposed 50 years and the Opposition eventually wore them down to 15 years – was pointless.

The mooted new competitor port at Hastings is unlikely to be built (if it’s ever built) much before 2050.

That’s because, should the existing port look like reaching its capacity (at present it handles about 2.5 million TEUs -- standard container units -- but the expansion of Webb Dock would nearly double the capacity), there is a relatively low-cost expansion option.

Webb Dock North could add another 2.5 million to 3 million TEUs if needed, although it is unlikely that moment would rise until after about 2030.

If there were any prospect of Hastings being developed as a competitor port (at a cost estimated at more than $10 billion) the Lonsdale Consortium would inevitably commit to Webb Dock North, at a cost (in today’s dollars) of about $2 billion.

The unexpected windfall the bidding process, overseen by Morgan Stanley and Flagstaff Partners, has produced for the Government will help fund projects like the level crossing removal program, Melbourne Metro and the Western Distributor project, with the government also saying that it would invest $970 million in regional and rural infrastructure.

With total proceeds that, with the licence fee pre-payment add up to nearly $3 billion more than the Government anticipated, and another $1.45 billion potentially to come from the federal government, Andrews and Pallas were understandably delighted with the outcome and the positive message it sends about the winning consortium’s view of Victoria’s long-term prospects.