The $4.9 Billion Railroad Being Built by a Pension Fund
(Bloomberg Markets) -- Caisse de Depot et Placement du Quebec, Canada’s second-biggest pension fund, has developed a unique model for infrastructure investing in its home province of Quebec. The Caisse has struck a deal with the local transit authority in Montreal to develop a 67-kilometer (42-mile) rapid transit network, known as the Réseau express métropolitain (REM), in conjunction with funds from the provincial and federal governments. It’s a unique project for the pension fund, which usually invests in mature infrastructure assets. This time around, the Caisse is building the rail network from the ground up. The whole project is expected to cost C$6.32 billion ($4.88 billion), with the first trains scheduled to run in early 2021. Michael Sabia, chief executive officer of the Caisse, discusses the project, the bumps it’s already encountered, and how the pension fund plans to mimic REM in other jurisdictions, including in the U.S.
Scott Deveau: How does this investment differ from the other infrastructure investments the Caisse has made?
Michael Sabia: It’s the first time a pension fund has ever done this. There are two differentiating elements here. The first is that this is an entirely greenfield project. I’ll give you the history. The government did not have the financial wherewithal to pay for two projects it initially presented to us as something that needed to be done. The one was a link from the South Shore suburbs to downtown, and another one was a link from downtown toward the West Island. We looked at that and decided that wasn’t the best solution and that the best solution was to build a new integrated network that would run from the North Shore to the South Shore and from downtown to the West Island to the airport. It was an entire network that we proposed to build and connect to the existing Métro system—much bigger than the original plans. Our role was from conception, development and planning, financing, and overall overseer and project manager. We will build it. We own it. We will operate it. It’s from nothing to an operating transit system, and we’ve been responsible for the total span of that.
Differentiation No. 2 is in the financing of it. There we’ll have 53.5 percent of the equity in the business, and the two levels of government [provincial and federal] will have subordinated equity both in the amount of 23.3 percent each. The way that works is that we are able to earn a return of something of the order of 8 percent or 9 percent. The two levels of government earn a return of up to approximately 3.8 percent each, which is significantly higher than their cost of borrowing. Typically, governments finance these things as an expense where they get no return whatsoever and they borrow the money to do it.
Pension funds usually prefer to buy assets that are mature, or so-called brownfield assets, because it removes the risk associated with building the infrastructure. So why have you decided to go for greenfield assets?
Because it’s not the only thing we’re going to do. In other parts of our infrastructure business, we continue to do more traditional brownfield. But we think that the market is changing. Having conceived, planned, developed, owned, and operated infrastructure is an important differentiator for us in the years ahead. It’s in effect new product development. It’s what we’re doing to differentiate ourselves in a market that we think is increasingly commodified and where brownfield assets are becoming very expensive to prohibitively expensive.
The 8 percent to 9 percent return is typically a little smaller than what you would get on an infrastructure investment, isn’t it?
Well, no, I wouldn’t say so. There are brownfield deals being done at astonishingly low rates of return. There have been recent things in the market getting done at 5.5 percent or 6 percent. That sort of demonstrates the extent to which investor interest in infrastructure is bidding down brownfield returns. That’s why we want the capability of delivering greenfield because we do believe there is a significant dividend so long as you believe you can manage the risks. Those are the capabilities we are developing.
Those lower returns are a function of increased competition and billions of dollars chasing the same assets, I presume.
Have you had to do fairly dramatic changes internally to accommodate this shift in strategy?
Yes, we’ve had to build an entirely new team that [is capable of] project planning, project management, engineering, and tender process management. We’ve had to build all those skills in an entity that will become a subsidiary of the Caisse, an operating subsidiary.
Outside of Quebec, is there an opportunity to export this model?
We have had a great deal of interest in the United States from both mayors of major cities and governors of major states. I can’t go further than that, because those conversations remain confidential. All I can say is there has been a great deal of interest and we are actively engaged in at least two or three conversations with respect to doing this in the United States.
Will you have to prove out the model before those projects proceed?
I don’t know yet. But I’ll tell you how we think about this. Before we embark on another project of this kind, we will want to have made some meaningful progress in the actual construction of the network here. We want to stay focused on making sure we deliver here, because this project has always been proof of concept in our mind. We’re using a market that we know well—Montreal—that’s right in our backyard, to prove out the concept, and then we want to take that concept in effect on the road and export it. I’m convinced there’s a very interesting market out there for a pension fund like ours to do these projects elsewhere. There’s also interest, a little less advanced than in the U.S., but we’ve also had expressions of interest from other provinces.
Some of the risks associated with building this project have already manifested themselves: It’s gone over budget and been delayed by about a year. Does that concern you?
We said pretty much from the beginning it would be about C$6 billion to C$6.1 billion, and we’re at C$6.32 billion now. That’s with firm turnkey proposals from the two consortia [led by SNC-Lavalin and Alstom SA] that are going to build this thing. We had some negotiating to do as of November, and to get that done at the prices we wanted, which we have now done, imposed a three- or four-month delay. We had said our hope was to have the first trains running on one of the lines we’re going to build by 2020. Now it will probably be in the winter or very early spring of 2021.
Wasn’t the original budget meant to be about C$5.5 billion?
No, that was before the final configuration of the network. We added three stations from the initial proposal to better connect to the existing network. That and some other adjustments in the network itself [were made] to make it go a little farther west.
Do you have any concerns about the pace of progress?
No, to be honest, this whole thing has gone better than we had expected in terms of the process of getting all this stuff approved and the financing we needed from two levels of government and the tender process, which was a very complicated process. We did have to do some negotiating to get the prices in a zone that we thought was appropriate and would protect our returns. But at every turn this thing has gone reasonably well.
There seemed to be a lot of enthusiasm around the project, but lately it appears to have become a political punching bag. The Montreal mayor has called for greater transparency on the terms of the deal, including its fees and noncompete clauses, and the provincial separatist party, the Parti Québécois, has even called for it to be scrapped. What do you make of these complaints?
There’s a lot of misunderstanding around this. I’m not going to comment on the political situation in Quebec. You can draw your own conclusions. We’re just in the business of building an infrastructure project, and the political class will do and say as they wish in the election season that is under way here. We will be releasing the texts of these agreements, and I think people will see there has been a lot of miscommunication, so we’re going to put them out publicly. This concern about incremental costs hitting the municipalities, there’s no issue there. We have said for the last year or year and a half that this project will cost the totality of the municipalities—all of them—something like a potential increase of C$40 million to C$60 million annually. But that’s it. They will have an entirely new transit system for that incremental expense over what they’re paying today. The more recent concern is that it will be higher than that. No, it will not be higher than that. Period. Full stop.
In terms of this sort of noncompetitive thing, this is how the transit authority here works. It’s not just for us. It’s for other transit systems as well. The objective is really no more complicated than if we’re going to build a rail system over the Champlain Bridge and into downtown—it’s to protect us from somebody starting a competing bus service. If that were to be the case, then we can’t fulfill our fiduciary duties to our depositors because, all of a sudden, there’s a competitive system running parallel to ours. It throws off our revenue and traffic projections. There’s been people here saying that it means they’re not going to be able to build any more transit systems in Montreal. That is wrong. There’s nothing in the agreements we’ve signed with the province or the transit authorities here that would preclude the development of any transit system across the Isle of Montreal.
You’ve had to make some tough decisions already. The decision to award train manufacturer Alstom the train car and related equipment came as a surprise to many in Quebec because it’s a competitor to Quebec’s Bombardier Inc., whose rail division the Caisse has a significant investment in. How did you come to that decision?
Because we ran a competitive process, and Alstom won. We’re an investor in a lot of companies, and many of those companies were involved in the bidding on this project. So we thought from the very beginning it was important to create a tender process that was beyond reproach. We set up very specific criteria for which the bidders would be judged. We set up a process whereby two external auditors audited everything that was done and attended virtually every meeting we had with the bidders. Then we set up a committee chaired by a former justice of the Supreme Court to oversee the whole thing so there could be no concern around conflict of interest or anything else. We went through that whole process, and our experts went through all the bids. The people who won on the rolling stock won on the merits of their bid.
It’s sort of interesting this project was being developed outside of the federal government’s Canada Infrastructure Bank, which has been set up to help finance projects like this across the country.
Well, yes and no. We wanted to secure the federal funding in a manner that allowed us to keep to our schedule. The federal government made a commitment to this in the amount of essentially C$1.3 billion with the option—and we’re working on this right now—in effect transferring that investment from the federal government to the Infrastructure Bank itself. So it may be that that funding comes as one of the investments or potentially one of the first investments from the Infrastructure Bank.
Deveau is a deals reporter at Bloomberg News in Toronto.
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