The Ohio State University Deal
Privatization is not a new concept but seems to be getting more attention in the parking industry especially on the heels of the recent deal between OSU and LAZ Parking. By now, I’m sure you have all heard that Ohio State made the decision to let LAZ Parking manage their parking operations for 50 years in exchange for $483 million (a pretty hefty Enterprise Value/2012 EBITDA of 24x). That seems like a lot of money… until we think about the recent Instagram purchase of $1 billion!
We have seen articles and opinions flying around and we decided to give the analysis on this deal a shot as well. We also understand privatization remains controversial but instead of getting into something rhetorical, let’s dissect this specific deal as a basis to form a view. Did LAZ increase its return on invested capital? Did OSU leave money on the table? Let’s find out!
Given our expertise and background in finance we decided to roll up the sleeves and do some quick back of the envelope number crunching. CAUTION – if you don’t like dealing with numbers stop reading now.
We have to say that we’re impressed with Ohio State’s approach and transparency of the bidding process. They have a dedicated site with all the latest information and resources located at http://www.osu.edu/parkingproposal/.
It didn’t take long to find the Request for Qualification completed by Morgan Stanley. Flashbacks to the investment banking days quickly surfaced as this RFQ looks identical to a CIM (Confidential Information Memorandum) used in every sell side process. MS did an outstanding job at laying out OSU’s parking situation. Hours of work and likely all-nighters were put into completing this document and it’s nice to be on the other side for a change!
Although we don’t have details for all the fine print in the contract, the document provides us with enough numbers (with the baseline being 2011) to formulate projections and perform a valuation using a discounted cash flows methodology. Here are the assumptions we used for the model.
- 50-year term
- $483 million dollar lease
- 5.5% annual rate increases for the first 10 years (the rate the winning bid proposed); 4% or the rate of inflation for the remaining years (whichever is higher) (section 2.1 of the RFQ)
- 68% EBITDA margin (the current, and highly admirable EBITDA margin stated in the RFQ) that increases slightly to reflect operational efficiencies gained by LAZ
- $2 million of yearly capital expenditures
- 25% tax rate
- Discounted using a mid-year convention (assumes cash flows come mid year vs. end of the year)
Below is a snapshot of the framework we used to project out the cash flows for 50 years using the aforementioned assumptions above.
Articles mention that LAZ will “walk away with $3 billion”. Here is the basis for that number. If you cumulatively sum the net cash flow for all 50 years it totals about $3 billion at the end of year 50 as shown below.
The reason why LAZ’s offer is in the millions and not billions is because you have to determine what that stream of cash flow is worth to you today. You do this by discounting the projected cash flow by LAZ’s cost of capital. Since we already knew LAZ’s bid, we backed into what the range of discount rates needed to equate the stream of cash flows to the $483 million bid.
Wave the magic wand and voila! Out comes one of the key takeaways. Using high-level assumptions we see the discount rate is about 6.5-7%. So what does this mean? At a high-level it represents the opportunity cost that LAZ must compare this investment versus others with similar risk profiles. Estimating the cost of capital is a topic on its own but tells us what LAZ expects to earn from the deal.
As you can see the implied deal value using the various discount rates ranges from approximately $400 – 500 million. The chart below compares the pure free cash flow from parking to what those cash flows are worth today.
OSU plans to take the $483 million cash injection and invest it in their endowment where they state that they expect a growth rate of 9%. This is a very lofty goal considering the average S&P 500 return is around 9% (Robert Schiller Online Data, which includes dividend reinvestment) without any management fees or taxes layered on top. Layering on 1% management fees, which would be relatively low, and a 10% tax (not all of the investments would turn over year to year) you would come to a total growth rate of roughly 7%.
OSU will also continue to receive all revenues from ticketing less LAZ’s cost to enforce. This is for another topic but what incentive does LAZ have to ticket when they don’t benefit from the additional overhead?
So is this a good deal? Taking our endowment breakdown above you will find that using 7% growth rate will give you an net present value on the cash flows of $406 million. If OSU does an average job of investing these funds, they should come out on the better end of the trade.
But, as always, the devil is in the details. It’s not totally clear how LAZ is limited or how creative they can be with price increases. For instance, can they change a variable rate structure to charge more up front while keeping the daily max within the 5.5% maximum raise? This would represent a significant increase in revenues from day one and would change the picture painted here dramatically.
There are other questions involved that we won’t have answers to, or won’t have the time to find, but given the information available, the deal doesn’t look as bad from OSU’s side as so many people are stating.
Also, let’s not forget one of the biggest risks LAZ takes on with this bid: betting that both the financial climate and academic appetite will remain strong for the next 50 years. With education costs continuing to rise at astronomical rates and the emergence of alternative education methods through the Khan Academy, iTunes University and others that we expect to pop up, LAZ is going all chips in that student enrollment will continue to rise, the economy will thrive and they will be able to leverage operational efficiencies. That’s a pretty big wager.
OSU has obviously taken a risk here themselves. A diversified portfolio is a good thing to have, and one could argue that OSU’s parking revenues are a great diversification tool. They represent a steady revenue stream even in an economic downturn. There are also questions about goal alignment. Is the goal of parking at OSU to maximize revenues? If so, then selling off parking is not a problem. But, if the goals are elsewhere, then selling off parking is a dubious decision.
In the end, after balancing all of the issues presented and money trading hands, we think the deal came out right about where it should. If the market treats OSU kindly, they will come out on top. If we face rough head winds in the next few years, OSU will be wishing they held onto those steady revenues. LAZ created a high hurdle for themselves, but we think they are privy to some knowledge that we are not. Starting revenue 10% higher by adjusting rate structures and lowering costs and capex by 10% can significantly improve their situation. If they can accomplish these tasks, the deal would end up great for LAZ as well.
Check back with us in 50 years for the final analysis.