In its Budget on 6 May 2014, the State Government of Victoria confirmed that it would privatise the Port of Melbourne in Australia. We expect significant investor interest.
This briefing note sets out our understanding of the proposed privatisation. We will update this briefing note as more information becomes available.
This briefing note has been prepared by Dr Martyn Taylor in our Sydney office and is current to May 2014.
Overview of the Port
The Port of Melbourne is one of the top four container ports in the Southern Hemisphere. The Port is Australia’s largest and most important maritime trade hub for container, automotive and general cargo. The Port supports the State of Victoria and south-eastern Australia.
The Port of Melbourne handles around 37% of Australia’s container trade, amounting to some 2.51 million containers (TEU) per year in the year to June 2013. During the 2012/13 financial year, the Port experienced some 3,200 commercial ship visits, throughput of 85.6 million revenue tonnes (35 million mass tonnes) and handling of over 370,000 automotive units.
As well as containers, motor vehicles and general cargo, the Port handles liquid bulk products (such as crude oil imports and petroleum product exports), and dry bulk products (including cement, gypsum and sugar as imports, and wheat, canola and barley as exports).
The Port comprises 34 commercial berths over 7 kilometres of quayline.
Timetable for privatisation
A scoping study for the privatisation of the Port of Melbourne was completed by KPMG in early 2014. As at May 2014, the Government has not yet appointed financial advisors but will now look to do so.
An expression of interest process is expected to commence in early 2015.
Political context to the privatisation
Since the late 1990s, Australia has sought to privatise port infrastructure in order to reduce government debt and improve port performance and productivity. In 1996, the State of Victoria privatised two of its major ports, but abandoned plans to privatise the Port of Melbourne following opposition by port users.
In recent years, Australia has experienced a series of port privatisations. The Port of Brisbane was privatised in 2010, followed by Port Botany and Port Kembla in 2013, and Port Newcastle in 2014. The privatisations of a number of other ports are also proposed. The Port of Melbourne remains one of the few major ports on the east coast of Australia still owned by a State government.
The State of Victoria is scheduled to have an election on 29 November 2014. The Labor Party (currently in opposition) has stated that it will also privatise the Port of Melbourne if it is elected. Privatisation should therefore occur irrespective of the outcome of the State election. However, the two major political parties, the incumbent Liberal/National Coalition (in government) and the Australian Labor Party (in opposition) currently have different views on the optimal privatisation structure.
Privatisation proposed by the Coalition
The Port of Melbourne is approaching full capacity. While a current expansion is addressing immediate capacity constraints, both political parties recognise that a second port is required. The key point of difference between the political parties involves the location of that second port and the long-term role of the Port of Melbourne.
Under the Coalition, the Port of Hastings (a natural deep water port) is the favoured second port. The successful bidder would have an option to participate in the development of the Port of Hastings. The revenue from the sale of the Port of Melbourne would be used in part to assist that development.
The Coalition would intend to shift the long-term focus of port activities away from the Port of Melbourne to the Port of Hastings, thereby releasing valuable land currently held by the Port of Melbourne to facilitate the expansion of the Melbourne central business district. A lease of 40 years, rather than 99 years, would be granted over the Port of Melbourne with an intention to decommission operations at the Port at the end of this period.
The Victorian Treasurer has commented that tying the sale of the Port of Melbourne to expansion of the Port of Hastings should create a more attractive proposition for bidders.
Privatisation proposed by the Labor Party
The Labor Party favours development of a second container port at Bay West, between Geelong’s Little River and Point Wilson. The Labor Party argues that a port located at Bay West would be a more economic option than the expansion of the Port of Hastings and would avoid potential constraints on berth capacity and logistics.
The privatisation contemplated by the Labor Party would involve the grant of a 99 year lease over the Port of Melbourne. The grant of a 99 year lease implies that the Port of Melbourne would continue to operate over that period and hence land would not be released from the Port for the expansion of the Melbourne central business district. It has not yet been determined whether a bidder would also be given any rights in relation to Bay West.
In practice, the key difference between the two political parties is therefore the duration of the lease and the nature of any optionality in relation to the development of the second port.
The Port of Melbourne is currently operated by the Port of Melbourne Corporation (PMC), a State-owned statutory corporation. The privatisation is most likely to follow the privatisation structures used for the recent privatisations of the Port of Brisbane, Port Botany, Port Kembla and Port Newcastle in Australia:
- First, the Victorian Government would enact implementing legislation. This legislation would amend relevant State legislation to facilitate and authorise the privatisation as well as effecting any changes necessary to implement the desired post-privatisation regulatory framework.
- Second, the relevant State assets to be privatised would be transferred by the Victorian Government into a State-owned port assets Ministerial holding corporation (HoldCo), a State entity established by the implementing legislation to hold Victorian port assets to be leased to the private sector.
- Third, a Project Company would be created to enter into a 40 year lease with HoldCo. The lease would provide for the lease of the rights to use the Port and charge users. The lease would also provide for the lease of port land and associated strategic infrastructure, including wharves, buildings, terminals and roads (Port Assets). The Government would retain the underlying freehold ownership. The Government would retain step-in rights and the ability to terminate the lease if the Project Company were in breach of key obligations.
- Fourth, the lease would be supplemented by a concession agreement giving the Project Company the right to operate/use, maintain and receive the economic benefit of the relevant Port Assets, but imposing a range of performance obligations. Existing key contracts would be assigned the Project Company. The Project Company may also be conferred with an option over the development at the Port of Hastings.
- Fifth, some employees of PMC would transfer to the Project Company, supported by various Government commitments intended to preserve employee entitlements.
The privatisation would subsequently occur by the sale of 100 per cent of the shares in the Project Company by the Victorian Government to an investor consortium. In this manner, investors would be offered a pre-packaged deal without any involvement in the negotiation of the 40 year lease.
This transaction structure is illustrated in the following simplified diagram:
Click here to view diagram.
Process for the transaction
We anticipate that the Victorian Government will adopt a process for the transaction that is similar to that followed in New South Wales and Queensland for the recent privatisations of some ports in their respective States.
Under this approach, the Victorian Government would prepare a detailed and confidential information memorandum (IM) containing all the information that bidders will require to evaluate the asset. Once the Port of Melbourne was ready for sale, the IM would be supplemented by a vendor due diligence report that addressed key issues.
Following a shortlisting process, the shortlisted bidders would be given access to management presentations and an extensive data room, thereby enabling a full due diligence to occur. The shortlisted bidders would each be issued with pro forma contract documents at the same time they were granted access to the data room. The contracts would be negotiated independently with each bidder, hence providing scope for bidders to include various provisions (such as indemnities and undertakings) to address any concerns.
The shortlisted bidders would be invited to submit their bids in conjunction with the negotiated contracts. The winning bid would normally be the highest bid, bearing in mind any contractual concessions.
Likely sale price
As at May 2014, the Victorian Government has not publicly identified a budgeted sales price for the 40 year lease, although the State budget recognises its effect. The media have speculated on a figure of AUD 5 billion.
Different port leases have different cost, revenue, risk and growth characteristics that impact upon their valuations. Accordingly, it is difficult to make meaningful comparisons between the sales prices achieved for different ports.
However, some guidance as to the likely sales price for the Port of Melbourne is provided by the sale prices achieved for leases in the context of other recent port privatisations:
- In 2013, Port Botany was privatised for AUD 4.31 billion and Port Kembla for AUD 0.76 billion under respective 99 year leases. The NSW Government indicated that the aggregate figure of AUD 5.07 billion was some 25 times the annual earnings (EBITDA) from those ports. The budgeted sales price was AUD 3 billion.
- In 2013, the Canadian pension fund CDPQ acquired a 26.67% stake in the Port of Brisbane for about AUD 1.4 billion, implying an enterprise value (including debt) of AUD 6.2 billion and a multiple of roughly 27 times annual earnings (EBITDA).
- In 2014, the Port of Newcastle in New South Wales was sold for AUD 1.75 billion under a 98 year lease. The NSW Government indicated this figure was some 27 times the annual earnings from that port. The budgeted sales price was AUD 700 million.
The Port of Melbourne made an AUD 65.9 million operating profit in the 2012/13 financial year and AUD 123.4 million in earnings before interest and tax (EBIT). Adding back AUD 75 million in depreciation and amortisation, the Port’s earnings before interest, tax, depreciation and amortisation (EBITDA) were around AUD 200 million. Applying a 25 times multiple suggests a valuation of at least AUD 5 billion for a 99 year lease.
However, the Port is experiencing significant growth and is strategically significant. A figure of AUD 5 billion for a 99 year lease may therefore be at the more conservative end of any valuation range. If the 99 year lease proposed by the Labor Party were adopted, the Labor Party has stated that it would expect to receive at least AUD 6 billion.
On the other hand, the price for a 40 year lease of the Port would be expected to be lower than the price for a 99 year lease. The incremental value to be ascribed to any lease beyond the 40 year mark is open to debate. Any optionality in relation to the second port may also have a value that influences the sale price.
A number of issues are raised by the proposed privatisation of the Port of Melbourne. Some preliminary issues worthy of consideration for potential bidders include:
- the current expansion of the Port and development of a second port;
- the extent to which regulatory clearances may be required by bidders;
- the extent to which Victorian regulation of port charges will be maintained; and
- the extent of any Commonwealth regulation of port charges.
There are also a number of unique features of the Port to be considered in undertaking any due diligence.
Expansion of the Port and development of a second port
In 2011, the Australian Competition and Consumer Commission (ACCC) suggested that if further capacity were not developed by the Port of Melbourne, capacity constraints could be encountered as early as 2015.
The Port of Melbourne currently has two international container terminals located on the east and west sides of Swanson Dock with a capacity of some 2.7 million TEU. However, container trade at the Port is forecast to double over the next decade, from the current level of 2.51 million TEU. Annual compound growth rates are forecast to be around 6% per annum.
Automotive units are similarly expected to double over that period from the current 370,000 automotive units handled and are forecast to exceed 1 million units by 2040.
To address these issues, the Victorian Government announced in April 2012 that it would undertake an AUD 1.6 billion redevelopment of the Port, including the construction of a new container terminal at Webb Dock East, a new world class automotive terminal, and infrastructure upgrades at the existing container facility at Swanson Dock.
In March 2013, the Port commenced construction of the new container handling terminal. The new terminal will add further capacity of around 1 million TEU to the Port from late 2016. The Government has also suggested that the upgrading of Swanson Dock could increase capacity to some 4 million TEU. We understand an expanded Port of Melbourne could be able to manage around 5.1 million TEU by the early 2020s.
In the longer term, the expansion of the Port of Hastings has been estimated to cost up to AUD 12 billion in order to provide a further capacity of some 9 million TEU. The precise details of any such expansion are still being considered, but the ultimate objective of the expansion would be to make the Port of Hastings the primary freight facility in Victoria.
Bidders will need to consider how the extent and nature of any rights in relation to the development of a second port may influence the sale price. We are unclear at this stage whether the Victorian Government would intend to confer any rights on bidders in relation to the Port of Hastings, but the privatisation of the Port of Melbourne could include an option to participate in any expansion and development of the Port of Hastings.
In considering the nature of any such optionality, the Government will also likely consider the views of port users. Some port users have stated that they would prefer the Port of Melbourne and Port of Hastings to be independently privatised, thereby ensuring competition between the two ports.
The same issues arise in relation to the Labor Party’s proposal for a second port at Bay West.
Regulatory clearances for bidders
Key regulatory clearances required by bidders may include foreign investment approvals and competition clearances. Foreign investment approvals are straightforward and rarely withheld, but are a necessary formality.
In the context of the current privatisation of the Port of Newcastle, the Government of New South Wales imposed specific bidding restrictions on parties who had a controlling interest in certain operations downstream from that port from bidding for the long-term lease of that port. This restriction was imposed to preserve the independence of the private sector lessee from producers exporting through the port and the integrity of access arrangements. While it is possible that similar restrictions could be applied to the Port of Melbourne, the heavily integrated nature of operations at the Port of Newcastle made such restrictions more critical for that port.
Competition clearances may be important if one of the consortium parties has existing port operations in Australia, is a potential or actual user of the Port of Melbourne, or has a relevant ownership association with any such person. As far as we are aware, none of the parties that bid for the Port Botany and Port Kembla assets considered it necessary to seek informal clearance from the ACCC for their respective proposed acquisitions.
If competition issues were identified, the strategy and timing for any approach to the Australian Competition and Consumer Commission (ACCC) would need to be carefully considered. Generally, the ACCC is not willing to provide clearance without undertaking public market inquiries. If confidentiality issues precluded inquiries prior to bid submission, the bid may need to be made conditional on any ACCC clearance.
The ACCC may be concerned if the acquisition of shares in the Project Company could result in a substantial lessening of competition in any market in Australia. Concerns could arise, for example, if one of the consortium parties was a potential or actual acquirer of services at the port (to the extent that this was not already prohibited by any bidding restrictions). In such circumstances, the ACCC may be concerned at the potential for a vertically integrated port controller to discriminate in favour of its own downstream port operations.
However, the inclusion of a Port of Melbourne user or associate in a bidding consortium is not necessarily fatal to any ACCC clearance. The ACCC’s reaction would turn on the circumstances of the case. The Port user or associate could have an immaterial shareholding or role that gave it no practical influence. It may also be possible to provide a voluntary undertaking to the ACCC to seek to address any competition concerns. For example, an undertaking could be provided that competitors to the relevant Port user or associate would be given access to the Port on a non-discriminatory basis.
State-based regulation of Port charges
Consistent with principles adopted by the Council of Australian Governments (COAG), the Victorian Government will normally seek to promote commercial outcomes where markets are competitive, but implement price monitoring where regulatory oversight is required. Based on the experience in New South Wales with the Port Botany and Port Kembla privatisations, the Victorian Government will wish to retain price oversight powers and monitor prices charged at the Port of Melbourne by the private sector lessee.
Under the Port Management Act 1995 (Vic) (PMA), the Essential Services Commission (ESC) is responsible for the economic regulation of the Victorian ports sector. The ESC is the State of Victoria’s independent economic regulator of essential services.
The PMA establishes an economic regulatory framework that applies to Victoria’s four commercial seaports, including the Port of Melbourne. This framework has two main elements:
- First, certain port infrastructure services are subject to the ESC’s price regulation powers under theEssential Services Commission Act 2001 (Vic) (ESC Act). These services are known as the “prescribed services”. At present, the Port of Melbourne is subject to price monitoring in relation to these prescribed services. The level of regulation is subject to five yearly reviews with the potential for heavier or lighter regulation to be applied.
- Second, an access regime exists for shipping channels, known as the “Victorian Channels Access Regime”. This regime provides potential users with the right to gain access to declared shipping channels and provides the ESC with powers to make determinations with respect to access disputes (including with respect to prices). However, as no shipping channels have been declared to date, the regime has not yet been activated.
Under the first of these two regimes, the prescribed services are currently:
- the provision of channels for use by shipping in Port of Melbourne waters, including shared channels used by ships bound either for the Port of Melbourne or for the Port of Geelong;
- the provision of berths, buoys or dolphins in connection with the berthing of vessels carrying container or motor vehicle cargoes in the Port of Melbourne; and
- the provision of short term storage or cargo marshalling facilities in connection with the loading or unloading of vessels carrying container or motor vehicle cargoes at berths, buoys or dolphins in the Port of Melbourne.
ESC must conduct a review of the prescribed services every five years to determine the level of regulation (if any) to be applied in respect of the prices charged for the provision of, or in connection with, these prescribed services. The 2014 review is currently underway and a draft report is expected to be released towards the end of May 2014.
In the previous 2009 review, the ESC exercised its price regulation powers by implementing a light-handed price monitoring framework. The ECS did not impose more formal price regulation and removed its own powers to intervene during the five year price monitoring period from 2009 to 2014. However, the ESC retained powers to undertake inquiries for the purposes of bringing any concerns to the attention of Government.
We anticipate that the Victorian Government may wish to await the outcome of the 2014 review by the ESC before determining what changes (if any) should be made to the current regime in the context of privatisation. Consistent with the COAG principles, we expect a light-handed monitoring regime to continue, subject to periodic ESC review.
Commonwealth-based regulation of Port charges
It remains open for any third party to seek a declaration by the Commonwealth Treasurer of aspects of the operations of the Port of Melbourne under the national infrastructure access regime in Part IIIA of theCompetition and Consumer Act 2010 (Cth)(National Access Regime). This means that the Port of Melbourne is potentially subject to Commonwealth price regulation as well as the existing State-based price regulation.
To avoid the application of the National Access Regime, it is possible for the Victorian Government to have its State-based regime formally certified as “effective” so that only State-based regulation would apply. Two examples of such an approach in relation to ports in Australia include the Dalrymple Bay Coal Terminal in Queensland, and the South Australian Ports Access regime. However, certification would take significant time and this approach was not adopted by the Government of New South Wales in the privatisation of Port Botany and Port Kembla. Accordingly, the Port of Melbourne will most likely continue to remain subject to Commonwealth regulation.
Under the National Access Regime, regulation can be applied to services provided via infrastructure following the ‘declaration’ of that infrastructure by the Commonwealth Treasurer. In order to be declared, the infrastructure must meet certain statutory criteria. We would expect many services provided at the Port could meet these criteria.
If a declaration occurred, the relevant terms and conditions of access to those services (including pricing) could become subject to arbitration before the ACCC in the event that commercial negotiations for access failed. Any determination by the ACCC would be legally binding. Port charges could therefore be subject to price regulation by the ACCC on a dispute-by-dispute basis.
To date, the National Access Regime has been rarely applied and has been accompanied by significant delays and extensive litigation where it has been applied. Moreover, the National Access Regime has not yet been applied to port infrastructure in Australia. Following the reviews in 2013 and 2014, we expect some future legislative reform to the National Access Regime that will increase the ease with which regulation can be applied, but this seems unlikely to trigger a rush of applications for declaration.
In summary, while there is a theoretical risk that regulated access to port services could occur under the National Access Regime, the practical risk may be low. As such, the more critical regulation for the Port of Melbourne is State-based regulation rather than Commonwealth-based regulation.
Other issues to be considered in due diligence
As part of due diligence, any bidder will need to understand the upside and downside risks associated with the various cash flows generated by the Port of Melbourne under the privatisation structure. The bidder will need to identify the most significant revenue cash flows and the degree of risk associated with those cash flows.
The revenue cash flows are affected by port volumes and are constrained by the capacity of the Port. As identified above, they are also subject to regulation. Capacity expansions at the Port will increase cash flows. A number of current and proposed developments at the Port therefore provide potential revenue upside, as identified above. Conversely, events that reduce the efficiency of Port operations will reduce cash flows, including shipping accidents or industrial action, creating inherent operational risk.
The Port of Melbourne covers a substantial area of land, so any bidder will need to investigate the title structure. A thorough investigation of the existing leasing arrangements will need to be undertaken. Major leases will need to be assessed to clearly identify major terms, such as length of term, options to renew and the rental levels. Land at the Port may also need to be subject to an environmental audit as part of any due diligence.
The precise nature of the separation of the on-going operations at the Port of Melbourne will also be a key issue and will have a direct impact on the nature of the obligations and risks to which the Project Company is subject. In the context of the privatisation of Port Newcastle, the Government of New South Wales indicated that certain functions would remain with the Newcastle Port Corporation (and hence would not to be transferred) including:
- harbour master, vessel traffic centre and related port safety operating licence functions;
- pilots, including the cutter crew and pilot transfer vessels; and
- statutory functions, such as dangerous goods approvals, marine pollution, and emergency response.
If a similar approach is adopted with the Port of Melbourne Corporation (PMC), we would expect the Project Company to be subject to a range of contractual obligations to enable the PMC to discharge these functions.