Aug 22, 2008
Executives
Tracy Wise - Vice President of Investor Relations Sam Pollock - Co-Chief Executive Officer John Stinebaugh - Chief Financial Officer Aaron Regent - Co-Chief Executive Officer
Analysts
Robert Kwan - RBC Capital Markets Brendan Maiorana – Wachovia Capital Markets, Llc Andrew Kuske - Credit Suisse Peter Sklar - BMO Capital Markets Scott Mackay - Bryn Mawr Bank Corporation Michael Smith - National Bank Financial Chris Haley - Wachovia Cherilyn Radbourne - Scotia Capital
Operator
(Operator Instructions) At this time, I would like to turn the conference over to Tracy Wise, Vice President of Investor Relations.
Tracy Wise
Thank you all for joining us for Brookfield Infrastructure Partners’ second quarter 2008 earnings conference call. On the call today, we have Co-Chief Executive Officer, Aaron Regent and Sam Pollock who will discuss our discuss our second quarter operating performance and provide comments on our strategy going forward.
We also have John Stinebaugh, our Chief Financial Officer who will review our financial results. Following their remarks, we look forward to taking your questions and comments.
At this time I would like to remind you that in responding to questions and in talking about our growth initiatives and our financial and operating performance, we may make forward-looking statements. These statements are subject to known and unknown risks and future results may differ materially.
For further information on known risks factors I would encourage you to view our annual report on form 20-F which is available on our website. With that I would like to turn the call over to Sam Pollock.
Sam Pollock
Second quarter results were in line with our expectations as strong transmission results were offset by weak results from our timber operations. Second quarter 2008 adjusted net operating income or what we refer generally as ANOI was $16.4 million compared with second quarter 2007 pro forma ANOI of $17.9 million.
Similar to the first quarter, transmission result benefited from the receipt of nonrecurring revenues associated with the retroactive application of Transelec's recently approved transmission rates for its transmission system for the 2004-2006 periods. However, unlike the first quarter when we received dividend income from TBE that was considerably higher than our expectations, in the second quarter, our dividend income from TBE was minimal.
Results from our timber operations reflect the poor housing market in the United States, which continues to adversely impact demand and pricing for wood products in general. However, prices that we are realizing on our second growth Douglas-fir saw logs have stabilized as harvest levels are more closely balanced with current levels of demand from converting operations in regions where we operate.
Now, I would like to discuss our transmission operations in more detail. The transmission segment performed well during the quarter.
Results were primarily driven by the strong performance at Transelec, where revenues increased due to inflation indexation and the commissioning of upgrades and expansions to its system. These improvements, however, were offset to a degree by the impact of a stronger Chilean Peso relative to the U.S.
dollar. As mentioned earlier, Transelec's results also reflect non-recurring revenues of approximately $4.7 million related to the retroactive implementation of its recently finalized rate proceeding.
Our Ontario transmission operations' results were consistent with the prior period and in-line with plan. Finally, our dividend payment from TBE was only $100,000 in the second quarter in comparison with $5.6 million in the first quarter.
You should know that TBE's dividends are paid periodically and not necessarily on a quarterly basis. Overall, the prospects for our transmission business are positive.
In our Chilean operations, based on progress to date, Transelec continues to be on track to invest a billion dollars in growth capital expenditures over the next five years, of which Brookfield Infrastructure's share is approximately $180 million. With our existing book of business, we forecast that 2008 growth capital expenditures will be substantially greater than 2007.
In addition, our capital expenditure backlog is robust, and we see opportunities to continue increasing the level of investment in our system over the next few years. We are also in the early stages of development of a number of sizeable transmission projects in Ontario that leverage our competitive position within that province.
With respect to TBE, we have the ability to exercise our put option to sell our interest to our partners between September 16, 2008 and November 15, 2008. During the quarter, we have executed a foreign currency hedge to lock in the value of the proceeds in the event that we decide to exercise this option.
Now, let us turn to timber operations. The quarterly earnings and cash flows from our timber business continue to be negatively affected by the weak U.S.
housing market. For the quarter, harvest levels and pricing were consistent with the first quarter but down significantly from the prior year.
Pricing in general has stabilized somewhat, however pricing for certain grades, such as pulping logs, have actually improved due to the reduced chip supply stemming from low levels of activity among regional sawmills. To optimize the value of our timber inventory, we are harvesting and merchandizing timber in stands that have a higher concentration of logs that are in demand, such as pulp logs, cedar and cypress logs.
We are also increasing export volumes to capitalize on higher realized prices, net of transportation costs, where we can. In the case of our Island Timberlands’ operations, our exports increased to 34% of sales in the quarter.
Furthermore, we will continue to delay the ramp up in harvest of our second growth Douglas-fir stands until market conditions improve in order to preserve the value of this stands in particular. We believe that the real strength of our assets is their operational flexibility.
This enables us to actively manage our resources and enhance net asset values by balancing production quantities and product mix to meet market demand. While this approach may reduce cash flows in the short run, our most valuable trees will continue to grow and increase in value during periods of weak demand.
On a net present value basis, we believe that this strategy will be far more valuable to our unit holders as prices recover in the medium to longer term. Now, I would like to turn it over to John Stinebaugh to discuss our financial results.
John Stinebaugh
I am going to spend a few minutes walking through our financial results in more detail and then I will update you on some recent financing initiatives. In our supplemental information which is available on our website, we have provided our second quarter 2008 results and have also provided pro forma results for the three and six-month periods ending June 30, '08 and '07.
For the prior periods, our pro forma results assume that our operations where all held by Brookfield Infrastructure on the same basis as in the current period. I will focus on our proportionate results which are calculated base upon Brookfield Infrastructure's ownership percentage for all of our businesses other that TBE which is accounted for on a cost basis.
Furthermore, I will focus on ANOI which is net income plus depreciation and amortization, deferred taxes and certain other items. We highlight this metric because we believe it is a good proxy for cash flow from our operations, which is the key driver of our business.
As Sam mentioned, in the second quarter of 2008, ANOI was $16.4 million. Now, I will provide more detail for each one of our segments.
On a pro forma basis, ANOI from our transmission segment was $15.6 million in the second quarter of 2008, compared with ANOI of $11.8 million in the second quarter of 2007. The main drivers were improved results in our Chilean operations due to the non-recurring revenue of $4.7 million that Sam mentioned, as well as increased revenues due to inflationary indexation and $1.7 million of incremental revenue from the commissioning of the growth capital expenditures.
Adjusting for the non-recurring revenue, operating margins at our Chilean transmission operation decreased to 84.4% for the second quarter of 2008, in comparison with 86.8% for the second quarter of 2007, primarily as a result of negative impact of foreign exchange rates on our predominantly Chilean peso based cost structure. As Sam mentioned, dividends from TBE declined to $100,000 during the current period.
Depending on whether or not we exercise our TBE put option, we expect a higher run-rate of dividends from TBE in the second half of the year than the first half. Offsetting these benefits were certain non-cash expenses in our Chilean transmission operations, primarily depreciation and amortization, as well as non-cash inflation indexations on our Chilean peso denominated debt.
Our timber segment generated $4.4 million of ANOI for the quarter. In our Canadian operations, our sales volumes for the quarter were 35% below the second quarter of 2007, which benefited from a strong price environment and exceptional harvest conditions.
The second quarter of 2008 reflected a reduction of sales of second growth Douglas-fir and a shift of our product mix to species such as cedar and appearance grade logs which are less dependent on U.S. home construction.
Due to higher prices net of transportation costs, we also continued our efforts to increase our exports to the Asian market with approximately 39% of sales in the quarter shipped to this market versus 29.9% in the comparable period last year. However, due to the lower margins on our cedar and appearance grade log products compared with our second growth Douglas-fir product, as well as higher fuel costs, our net operating margin fell to 28.4% for the quarter versus 34.8% in the prior year.
Additionally, harvest levels in our Canadian operations, particularly for primary growth stands which are at higher elevations, were well below plan as a result of abnormal snow packs which were slow to melt due to a relatively cold spring. In the second quarter of 2008, sales volumes in our U.S.
timber operations were down approximately 5% compared to the prior year. Consistent with the first quarter, our product mix reflects a lower amount of Douglas-fir and a higher than normal proportion of pulp logs and low grade saw logs.
Margins for these products are lower than our higher value Douglas-fir stands resulting in lower overall profitability. In order to take advantage of the greater relative strength of the Asian markets, our US operations were also continuing to develop new channels to access the export market.
However, volume shipped to Asia declined in the quarter to 17.8% compared with 19.1% in the prior year and 27.5% in the first quarter of 2008 due in part to the timing of export shipments, a number of which fell into the first and third quarters of 2008.For the quarter, margins decreased to 38.9% versus 42.8% in the prior year due to the change in product mix, lower overall pricing, as well as higher fuel costs. Let me take a minute and update you on a few financing initiatives.
As we have previously disclosed, on June 18, we closed a $450 million revolving credit facility with a syndicate of global financial institutions. The facility includes two tranches, a tranche A with a maximum principal amount of $135 million for general working capital including acquisitions and a tranche B with a maximum principal amount of $315 million for acquisitions.
We believe that closing this facility during the extreme dislocations in the credit markets highlights the quality of our assets and strength of our relationships with the financial community. This credit facility will provide significant liquidity for us to execute our business plan.
Another financing initiative involves Transelec which is finalizing a credit facility of approximately $200 million to partially finance its growth plan. The facility will be drawn to fund capital expenditures and will be refinanced through the issuance of long-term debt.
Before I conclude the financial review, I would like to provide an update on the foreign exchange front. In order to hedge our exposure to the Chilean peso, Transelec increased its short-term portfolio of currency hedges during the quarter.
Furthermore, with our partners, we agreed to a long-term hedge program that we are in the process of implementing. Our hedge program calls for converting our remaining U.S.
dollar debt into Chilean peso debt on a match maturity basis that is indexed to inflation. This will effectively match the liabilities with the Chilean inflation indexed component of Transelec’s asset base.
We are also swapping additional Chilean peso exposure to U.S. dollars, on a nominal basis.
That concludes my remarks. Now I will turn it over to Aaron to walk through our growth initiatives and outlook.
Aaron Regent
As we look to grow our business, we are seeking opportunities to broaden the scope of our investments within the infrastructure industry. A sector that we have been looking at is social infrastructure, which includes assets such as hospitals, convention centers, court houses and police stations.
We are well positioned to participate in the social infrastructure industry as a result of Brookfield Multiplex’s track record of developing, constructing, managing and most recently investing in these types of facilities in both Australia and the United Kingdom. Brookfield Multiplex has constructed, or is constructing, 25 social infrastructure facilities with a capital cost in excess of $2.0 billion.
The Public Private Partnership (PPP) model has been developed to facilitate private sector participation in the financing of these types of assets. Under the PPP model, governments grant long-term concessions through which the private sector constructs, owns and operates assets for use by the government for the duration of the concession contract.
The PPP market has grown rapidly as governments continue to realize the benefits of delivering social infrastructure services in conjunction with the private sector. Industry sources indicate that in 2007, $70 billion was invested word-wide through the PPP model, an increase of 40% versus the prior year.
We believe that this model will grow substantially as governments worldwide continue to adopt this model as a means of funding critical social infrastructure projects in an era of substantial governmental budgetary constraints. Brookfield Multiplex's strategic focus was to provide construction and management service to investment consortiums.
Historically, it took minimal equity positions, if any, due to capital constraints. As a result a large number of attractive investment opportunities were foregone.
Brookfield Infrastructure is not positioned to fill this role which will create a portfolio of attractive investment opportunities for the benefit of regular shareholders as well as strengthen Brookfield Multiplex's competitive position in the market by being able to provide a complete solution to government within one family of companies. To establish a platform to participate in PPPs within the social infrastructure sector, we reached an agreement to acquire Brookfield Multiplex’s interests in three social infrastructure PPPs; the Royal Melbourne Show grounds and Long Bay Forensic and Prison Hospitals in Australia and the Peterborough Hospital in the United Kingdom for a purchase price of approximately $25 million.
The concession terms for these projects range between 25 years and 34 years. The concession contracts provide for availability payments backed by government credits, ensuring a high quality long-term cash flow stream.
While the initial investment is relatively small, we believe that we can build this into meaningful business unit overtime. Now since it is a related party transaction, the acquisition is subject to obtaining a satisfactory fairness opinion from an independent financial advisor, in addition to customary closing conditions, including regulatory approvals.
We anticipate that the transaction will be completed in the third quarter. I would now like to make some comment about the outlook for the balance of the year.
From our existing asset base, we anticipate similar performance for the balance of the year. Due to embedded revenue indexation, our transmission business should generate consistent growth.
Furthermore, as we do not expect the price environment for logs to improve for the balance of the year, our timber results should be comparable to the first half of the year. An increase in harvest levels to planned levels will largely be dependent on a recovery in the U.S.
housing market, which we do not anticipate until the end of 2009. In the interim, the value of our timberlands remains intact as our inventory of trees continues to grow and increase in volume.
Our strategy is to continue optimizing and growing our existing timber and transmission operations in conjunction with diversifying our asset base into other infrastructure asset classes. The acquisition of Brookfield Multiplex’s social infrastructure assets will establish a new business platform that we intend to grow.
In addition we continue to review a broad range of investment opportunities. The current business climate is challenging; however, we believe this environment is ideally suited for those that finance their assets conservatively and are able to extract additional value through their operational capability.
With the closing of our credit facility and our access to the capital markets combined with our business development pipeline and execution capabilities, we believe that we are well positioned to build our business and create unit holder value. That concludes or our formal remarks.
Operator, I would now like to turn it over to you and we are open to take questions from those on the line. Thank you.
Operator
(Operator's instruction) Your first question comes from Robert Kwan - RBC Capital Markets.
Robert Kwan - RBC Capital Markets
Aaron, you mentioned on the Multiplex acquisition, or just Multiplex going forward, that it would provide, or fill the roll, for investment in the PPP project. Are there any formal agreements to collaborate or acquire new investments or acquire future projects from Multiplex?
Aaron Regent
I would say that there are no formal agreements, if you will, we do not have any thick documentation to support that thrust. But from a strategic perspective, we are working closely with the Brookfield Multiplex organization, particularly on the construction of the facilities management side.
And as a group, we are now looking at the potential pipeline of projects in the future and working together on those opportunities.
John Stinebaugh
Also Robert, the business development group for the ‘PPP’ business is within the infrastructure group.
Robert Kwan - RBC Capital Markets
And if you look forward, what would you envision or feel comfortable with social infrastructure, with respect to percentage of the overall portfolio in BIP?
Aaron Regent
I would say we do not have a specific target. But we should perhaps manage expectations a little bit, in the sense that, when you look at these projects, because they are backed by governments, you have very high credit ratings supporting the cash flow streams.
And because of that, you could finance them fairly aggressively, typically in the 90% type level. So, the consequence level equity per project is relatively small.
So, as we look to build the business, we do not anticipate this to be a huge business within BIP, particularly as we look to expand into other areas as well. So on a percentage basis I am not sure what the number might be, but, I would say though that we think we can build it into a meaningful business.
But, I do not think it is going to be a huge business within BIP.
Robert Kwan - RBC Capital Markets
And then just the last question on the social infrastructure side, how does your view of appropriate discount rates for these types of assets differ from your views on timber or electric transmission and whether that has levered or unlevered?
Aaron Regent
I think it depends at what point you are getting involved in the three ‘P’ side. For example, with the projects that we are acquiring right now, there has been a lot of de-risking that has taken place, and so that is going to be reflected in a lower discount rate.
But if you are looking at three Ps on the development side, we are targeting returns in the 12% plus type range. So when you look at those returns, it is consistent with the types of returns we're looking for in some of the other assets that we're looking to acquire.
Robert Kwan - RBC Capital Markets
And that 12%, that is levered? Did I get that right?
Aaron Regent
That would be levered.
Robert Kwan - RBC Capital Markets
And then on a, if you were to step into a de-risked asset, an operating asset..?
Aaron Regent
There might be some…
Robert Kwan - RBC Capital Markets
High single digits?
Aaron Regent
No. It might be probably around lower double digits or high single digits.
Robert Kwan - RBC Capital Markets
Just the last question I had on TBE, John, you referenced that you would expect a higher run rate if depending on what you would do with the put. If you decide to put it, are you trying to signal that you probably will not receive any dividends from TBE?
John Stinebaugh
It really offsets, given the way the put price works, the exercise price, because to the extent that we exercise earlier then any dividends that we forego would basically be made up in the put price that we receive. So, they offset each other.
Robert Kwan - RBC Capital Markets
Right, actually I am just trying to back into, John, your estimate of $480 million right now, whether that assumes that there is no dividend for the third quarter?
John Stinebaugh
That assumes that there was not any material dividends paid.
Robert Kwan - RBC Capital Markets
And are you disclosing the hedge rate on the FX hedge?
John Stinebaugh
We have not.
Operator
Your next question comes from Brendan Maiorana - Wachovia.
Brendan Maiorana – Wachovia Capital Markets, Llc
Regarding the participation that you guys will be doing, you are going to be for; I understand on the 3, I think you will just be on the stable asset side. Going forward, you will be participating both in terms of the development side and on the underlying ownership of the asset upon completion.
Is that how that operation is going to work?
Aaron Regent
But I think the way you characterize it, it is right, in that we will be looking at participating both on the development side and then in providing the equity component of the investment.
Brendan Maiorana – Wachovia Capital Markets, Llc
So, you guys will be participating I guess in effect probably with Brookfield Multiplex on that and earning a return, or a cost-plus return, on the development and then earning a return just on the stabilized. That seems a little bit different than maybe my original expectations for possibly this platform.
Sam Pollock
There are several aspects to a consortium when you pull it together. There is the construction, design, development group, and obviously BIP would not be participating in that aspect of the transaction.
BIP would be participating when it comes to forming a group, coming up with developing a consortium, putting together the financing and bringing all the parts together, and what typically happens in that case, you take on additional bid risk in a sense that you may not be successful, so you incur some costs, but you are not taking any sort of operational risk. So, it is a different type of risk, but for taking on bid risk, you can earn returns of upwards of 15%.
And then once you get to selection and financial close, then from that point on, because you subcontracted many parts of the delivery of the project to a facilities management provider or a builder, then really there is very low risk at that point. And that is the stage that we have acquired these projects, and so the return we would expect and the risk we are taking on is very minimal.
And so, we would expect lower returns for the projects we have now acquired. But to the extent that we do take on the risk prior to financial close, then we would expect higher returns.
Brendan Maiorana – Wachovia Capital Markets, Llc
Turning over to the timber and specifically as it relates to the HBU side of the opportunity there, what is the status of the HBU lands in terms of the entitlement process?
Sam Pollock
Your question was what is the status of our entitlements on the HBU front? And maybe just to clarify, when we monetize HBU properties, sometimes they are entitled properties, and sometimes we sell off untitled properties.
I think what you are referring to is situations where we are looking to develop master-planned communities, MPC is how we refer to them, which are sort of like the really high-impact, value-created situations, and those take some time. And we are probably still a good one to two years away from our first project coming on stream, and so we do not have entitlements for it yet.
But, we continue to monetize HBU properties, smaller ones here and there, over the next couple of years.
Brendan Maiorana – Wachovia Capital Markets, Llc
You are monetizing some non-entitled lands, or your non-residential entitled lands, and some you are taking through that process. In terms of the ones where you take those through the process for these MPC communities, you will be spending horizontal development dollars on those in the prior to monetization to earn higher return expectation on those potential sales?
Is that correct?
Sam Pollock
That is our expectation. Obviously, what we do at that time is make a decision whether or not we can create more value beyond the entitlement stage by putting money into the ground, or we may decide if it makes more sense that there is a large number of builders who would like to take on that risk and pay us an attractive price.
And we may just sell our property, once we have it fully entitled. But, the big value creation though is the stage from now to entitlement, and that really for our first project will take place over the next two years.
Brendan Maiorana – Wachovia Capital Markets, Llc
And then just last on the timber, I would be interested in your perspective on what you think the supply and the near-term supply impact has been from Canadian supply from the impact from the pine beetle infestation. Just in terms of the near term, is that increasing current supply?
And if so, how long do you think that is likely to persist until that supply goes away?
Sam Pollock
Maybe I can deal with some of the market conditions on the timber front. First off, on the supply side, I do not have great visibility for you as to whether the supply has increased or decreased.
Obviously, there are days that are very challenging markets and so the producers in the interior of B.C. are having a difficult time putting more products into the market and making money at it.
So I do not believe volumes are increasing, and at the same time, we all realize that the resource in that particular part of the country is dying and will probably be non-existent or much reduced, probably four to five years from now. So, we still see some volume that will come out of there over the next couple of years and obviously, they will do their best to recover and salvage as much as they can.
On your Russian log export side, we have seen some dramatic impact on the world markets, probably less so here in North America, but if you look over in Finland and northern Europe and the Baltic States and probably over in China, we have seen the effects that this export tax has had on log supplies. And the amount of Russian logs that are in the market have decreased, and we have seen in particular places like Finland, prices for softwood and hardwood pulpwood have increased dramatically and are at record highs, I think over the last eighteen years.
As far as the demand side, there are some bright spots. We still see fairly good prices on the specialty saw-log front, which is really the appearance grade market, consisting of cedar and cypress.
The peelers have done well in Japan in the Japanese market and also with respect to plywood, and of course the place that has been hardest hit is the lower grades of saw logs and the chip-n-saw logs, which are aimed at the commodity market.
Operator
Your next question comes from Andrew Kuske - Credit Suisse.
Andrew Kuske - Credit Suisse
First question is for John, and it just relates to TBE and what looks to be the increase in value that you stated within your outlook statements. And I am just curious if you could drill into that a little bit on what are the parts of that?
Is that just the U.S. dollar relationship to the Brazilian real?
What portion of it is the underlying value actually appreciating? And then finally, and I think this goes to a previous question, just the dividend value being withheld because the payment was pretty nominal this quarter.
John Stinebaugh
Yes. I will start with maybe an overview of how the production works to provide a little context.
The exercise price is basically equal to a price that will enable us to realize a 14.8% return in Reais when the transaction would close. So, it is a real return.
It is indexed by IGP-M, the Brazilian Wholesale Inflation, so a couple of factors. IGP-M has been quite high.
Recently, it was set for the twelve-month period at 11.5%, so that is considerably higher than where our previous expectations for IGP-M were. The second component has been, as you know, the Reais has strengthened very considerably against the dollar.
So because the payment is in Reais, we have realized gains on the FX side of things. So in the middle of June, we put in place foreign exchange hedge in order to lock in the value in dollars.
And the final piece of your question is dividends have not been withheld. That really just goes to the infrequent, or a bit lumpy, payment of dividends from TBE.
But as I said earlier to one of the questions, when we calculated the anticipated proceeds, we did not forecast future dividend payments because they are a little bit uncertain in terms of timing.
Andrew Kuske - Credit Suisse
If I could just change directions just on the timber side of it, there is a number of packages of timberlands that are in the market right now. I am just curious to your thoughts on valuation.
We are still seeing a pretty big disconnect between publicly-traded timberlands and their underlying valuations and what we are seeing in the private deals that are done, whether pension funds or other players. Sam, I guess if you care to give us any thoughts that you have on that and some of the assets that are being shopped right now?
Sam Pollock
There are, as you mentioned, a number of packages in the market. We are seeing offerings from both industrial companies who are looking to sell timberlands to generate cash to reinvest back in their business, and we are also seeing some sales from TIMOs, who either are trying to liquidate properties because they have funds that are running to the end of their period, or they are trying to help establish values for the rest of their portfolio.
I would say that values are still very robust. It is probably the best word I could use.
I think that we have, in our case, found opportunities and we are looking at opportunities in particular with some of the operators where they do not necessarily value price as the only criteria for a sales process. They are also looking at arrangements that they can make with a timber operator where they can get comfort that they will have an adequate log supply agreement.
And so, there are opportunities where we think we can acquire timberlands on a good value basis. Having said all of that, prices are still very strong, and there is still a strong interest from the institutional community for this asset class.
Andrew Kuske - Credit Suisse
So, given some of your operational capabilities through the Brookfield group, does that mean we should expect opportunities, or packages that you are more interested in would be in the Pacific Northwest and, to a lesser degree, in the New England market?
Sam Pollock
I would say two things to that. First off, we probably have a competitive advantage in looking at packages that are in our operating areas so that we can obviously have an informational advantage but also some synergies to bear.
And so, we are looking at those. We are also looking at situations, which may not be on the market today but which, I think, may come on the market where there are industrial assets surrounding timberlands where again we can use some of the Brookfield operating capabilities to extract further value from those combined situations.
Andrew Kuske - Credit Suisse
And then one final question just as it relates to the three ‘P’, there is a whole spectrum of social infrastructure and the way these deals are structured, and I think if we look at it on a continuum, on one end of it is really just a real estate development play and real estate management play for a prolonged period of time. And then, the other end of the spectrum is full operation of, whether be a hospital or a prison.
Where do you want to be in that spectrum? I think I know what the answer is going to be, but I am concerned to a certain degree that we see this drift towards more private ownership and operation of businesses, which you do not have a lot of experience in.
Aaron Regent
Well just to touch on maybe our experience, I think that the one thing that we will be able to benefit from is the experience that Multiplex has developed in this sector over the past number of years. And I think in our remarks, we commented that they have been involved with over 25 different projects.
Probably, actually it is higher than that. They do have a fair amount of experience in the sector, and when you look at the operations, it is really on the facilities management side.
And so, the core operation of these assets is not taken on by the private-sector sponsor. It is really just the maintaining of facilities, whether it be the mechanical systems, landscaping, the painting, things along those lines.
So, I think you should maybe just put it in that context as well to really better understand what it is. I think in terms of the range of opportunities we are looking at, from our perspective, I think Sam sort of described how we see approaching the business.
There will be potentially opportunities where there is more of a real estate component. And in that area, that is not where we will likely be looking to spend a lot of our resources, but we do, I think, benefit from the fact that Brookfield overall has a very strong real estate capability.
And so, there may be partnership opportunities where we can work with different parts of our organization, which will really enhance our competitive position in terms of pursing some of these opportunities. So, I think that is a great strength.
With that being said, the real estate development component, outside of the three ‘P’ concessions, is not something that we would be focused on.
Andrew Kuske - Credit Suisse
Yes. But, there is no intention, once you have a concession from a government and say, for the example a hospital, to actually fully run a hospital as in some business models in the U.S.
and elsewhere around the world?
Aaron Regent
No. Like HMOs?
No we are not doing that. It is really just the bricks and mortar.
Operator
Your next question comes from Peter Sklar - BMO Capital Markets.
Peter Sklar
Again on this triple ‘P’, I am finding understanding this, it is still a little bit cloudy. Could you explain exactly on the acquisitions what you will be doing and what you are paying for and maybe address some of the issues?
Like, I do not understand why you are acquiring three projects. The equity cost is only $25 million, which seems such an inconsequential amount of value.
Maybe it is because of the amount of leverage that is in the projects. And also address, I do not understand what your role is and what Multiplex's role is.
And also, there was a comment made by Sam that I do not understand where he talked about taking on the bid risk and getting a return on that aspect of the process. So, if you could address those issues?
- BMO Capital Markets
Again on this triple ‘P’, I am finding understanding this, it is still a little bit cloudy. Could you explain exactly on the acquisitions what you will be doing and what you are paying for and maybe address some of the issues?
Like, I do not understand why you are acquiring three projects. The equity cost is only $25 million, which seems such an inconsequential amount of value.
Maybe it is because of the amount of leverage that is in the projects. And also address, I do not understand what your role is and what Multiplex's role is.
And also, there was a comment made by Sam that I do not understand where he talked about taking on the bid risk and getting a return on that aspect of the process. So, if you could address those issues?
Aaron Regent
So I think to start, the initial investment of $25 million will grow, probably to around the $40 million level, because if you look at the Peterborough Hospital, for example, there is still dollars that have to be spent to complete that project. So, I think we highlighted, this is not a huge investment for us, but it does get us into the business and gives us increased activity and visibility in this space, which we think has a lot of promise.
I think that with respect to the current projects, if you look at the segmentation of the activities, I think as Sam kind of highlighted, you have the construction component, you have the facilities management component, and then you have the basically the oversight of the entity that actually holds the concession and is responsible for the financing. And it is in that area that we will be more involved.
But with respect to the construction, that is a Multiplex’s responsibility. And in terms of facilities management, that is also Multiplex's responsibility.
And so with respect to any cost overruns or any things of that nature, that is their risk, not our risk. So, we are really insulated from that.
Peter Sklar
So, explain exactly what your role would be then. Go back to the third area.
You talked about the oversight.
- BMO Capital Markets
So, explain exactly what your role would be then. Go back to the third area.
You talked about the oversight.
Sam Pollock
Maybe with the respect to the projects that we have currently taken on, they are all beyond financial close. So all the bid risk, all the raising of capital and structuring of the transaction is complete, so and because the facilities management has been subcontracted out and because there is essentially a turnkey contract with Multiplex for the two projects that continued to be built, there actually is really no role for us going forward, other than collecting the checks.
Peter Sklar
So maybe, Sam, explain to us what your role would be in a Greenfield.
- BMO Capital Markets
So maybe, Sam, explain to us what your role would be in a Greenfield.
Sam Pollock
So just, if I can just back up one second is you also asked about why our check sizes were relatively small, and Aaron answered that. But just to add to it, our ownership percentage in these two assets ranges between 30% and 50%.
In the case of Peterborough Hospital, there are still amounts of money to be spent. So that will grow, and that is the largest one of the bunch and it is the one where we have the smallest interest, 30%.
And in the case of leverage, the leverage in each of these situations ranges between 90% and 92%, so they are obviously highly levered transactions, and that goes back to the fact that these are availability-style payments and highly secured and backed by very strong credits. So, that is the reason why the check sizes are small.
And as an equity consortium member, one of the risks you take if you participate at what I call the development stage and this is where you are working with the contractor, the designer and the financial parties to come up with the cash and to come up with a proposal that will be accepted. You are usually, at that stage, short-listed to a group of two or three people, and you obviously split the bid risk amongst the various parties with the construction part of it taking the lion's share of the bid risk.
But, the equity parties do take on some bid risk, and to the extent that you have a ratio of wins of one every two, or one every three, you have to factor that into your economics of the business.
Peter Sklar
So, what risk are you taking on? You are investing in the proposal?
- BMO Capital Markets
So, what risk are you taking on? You are investing in the proposal?
Sam Pollock
That is exactly right.
John Stinebaugh
It is a development role where what we would be doing as developer is we need to negotiate the final concession contract with the government. That contract is going to have various provisions that address the pricing, so we also are going to have to work with the construction contractor to appropriately manage the construction cost risk.
And then on a going-forward basis, the contract with the government will have various key performance indicators that we must meet. To the extent we do not meet those, there may be some penalty provisions and things of that nature, so we have to negotiate an appropriate facilities contract in order to manage that risk.
And then the final thing would be, once the contract structure has been put together that appropriately hedges risk, then we would have to arrange the financing in order to project finance this basically prior to construction.
Aaron Regent
Yes. I think we have probably each added a lot.
I will add my additional two cents. I think the bottom line is, basically it is our group that is going to have the responsibility for choosing which bids we are going to pursue.
And then, it is our job to basically pull together all the components to lead to a successful outcome, and that is all the components that John just talked about and Sam already talked about.
Operator
Your next question comes from Scott MacKay - Bryn Mawr.
Scott Mackay - Bryn Mawr Bank Corporation
But from a high-level kind of business model and economic standpoint, you seem to be very much in growth mode, it is the recent spin-off. But, it is a little bit frustrating to shareholders to see such a massive discount between the current equity value and your NAV as well as your book, for that matter.
How do you view this kind of disparity in the marketplace today, and why not pull a couple of triggers available to you to narrow that discount, such as perhaps considering sales of non-core timberland, like your peers have, who are trading at 52-week highs, because they are playing that arbitrage between private and public market values as well as any excess capital you have, maybe buying some stock back? Thanks.
Aaron Regent
I think that we share your frustration in that we are not thrilled with where our unit price is trading relative to the net asset value and the book value of the business. We do think though that we are a relatively new entity.
We have just been spun out, and so there is a certain recycling of units that are taking place, and there is an education process that is also taking place. And so, I assure you that we are spending a lot of time in the market trying to meet with investors to broaden our unit holder base, to make sure that people understand the intrinsic value of the company.
So, we are optimistic that as we continue to do that, hopefully our unit price will obviously perform well. The only other thing I would say is I hear what you are saying about selling off assets to prove our values.
That is a fair way and a fair strategy. What I would say though is that it is probably more of a short-term strategy as opposed to a longer-term strategy.
And in some respects, we should be beneficiaries of the activity that others, that our peers, the activities that they are following in that, as they prove out the values, it should also spill over to the values of our assets as well. So, we should beneficiaries of that.
But, I would say that our focus is to build a business, which is going to increase value for unit holders over the long term, and so there are going to be points in time where we may obviously, the unit price may not reflect the intrinsic value of the business. But over the long term, we believe that it will.
And I think the other thing is that we understand we have to continue to execute our business plan, whether it be demonstrating and enhancing the value of our existing assets as well as both diversifying our asset base and growing the business. So I think if all those things come together, we think that that should translate into better unit price performance.
John Stinebaugh
And one of the other things that we need to do, Scott, is increase the liquidity of the stock. So, that is one of the reasons why, in addition to what Aaron was talking about, our growth strategy etc.
that buying back stock and producing the public float right now, we think would not be in the best interest over the longer term.
Scott Mackay - Bryn Mawr Bank Corporation
Well, how would you increase the liquidity of the stock then?
John Stinebaugh
We ultimately want to build the business and to the extent we can continue driving our earnings and with that hopefully driving the performance of our stock. Then, we need to be able to, with incremental investments we do, as well as we need to get more equity out there and build up the public float and increase the scale of the company, which is the longer-term plan to use this as the vehicle to fund our infrastructure business.
Scott Mackay - Bryn Mawr Bank Corporation
I know you mentioned earlier that you are looking at several timberland opportunities. I would just, from a shareholder standpoint, obviously it is not a terrific business right now given your transmission business is much better, but the reason for my question was really from a kind of deployment of capital standpoint, putting money in low-return businesses when you have opportunities to put money in high-return businesses, just doing the basic math, I would be a proponent if you do have any non-core timber.
And I do not think you do. You have mentioned that to me in the past, but I would much rather see more capital put into the transmission businesses as Ontario and Chile projects come up versus more timberland.
That is just, I will just say that. But, thanks for that good quarter.
Thanks.
John Stinebaugh
Thanks.
Sam Pollock
And Scott thanks for your question. I think just one last comment on that, obviously we think we have a fantastic transmission business, and we appreciate that our timber business is not providing, the cash flow results that we would hope for.
However, we do think that on a long-term basis, on a total return basis, we will see fantastic results from our timberlands and that as the number of macroeconomic factors that we have talked about over the last number of calls take place that you will see over the next couple of years some fantastic results from timberlands. And we will be very pleased with those assets.
Operator
Your next question comes from Michael Smith - National Bank Financial.
Michael Smith - National Bank Financial
Just on the triple ‘P’ I think you mentioned earlier in the call that you are looking for levered internal rates of return of around 12% for development deals. What would it be for acquisitions?
And what would the typical first year unlevered return be?
Aaron Regent
I think clearly we hope we can do better than 12%, but that is kind of a data point. In terms of acquisitions, in the three ‘P’ market, it is a very liquid market for equity investments in these three ‘P’ projects, and I would say that the rates of return or the market rates for example, would be lower, probably less than 8%, or something along those lines.
So from our perspective, that is not a strategy that we are looking to pursue. We will look at some of those investments as they come to the market, in the secondary market, but our focus is really in the primary side, not on the secondary side.
Michael Smith - National Bank Financial
And on the primary side, what would be typical, like first-year unlevered return be, not on acquisition but on actual development?
Aaron Regent
First-year unlevered?
John Stinebaugh
I can give you a sense as to the first-year levered return because these are concessions and typically have 25 to 30-year life. The profile tends to be that they have got very strong current yield initially.
So, you will see current yields that are in the 10%-type ball park, right out of the box for these types of projects.
Aaron Regent
On a levered basis.
Michael Smith - National Bank Financial
And what kind of spread would you expect over your cost of debt? And how long would that debt typically be?
Would it match the concession? Or, would it be just, do you have a 30-year concession; maybe go for 15-year debt?
Or, what is your thinking along those lines?
Aaron Regent
Well just on the debt, the debt is typically amortized over the life of the concession, and there might be a twelve-month or eighteen-month tail or something like that, reserve tail at the end of it. But typically, they amortize over the life, and the spreads would be priced off of something probably a bit higher than the sovereign credit.
Operator
We have a follow-up question from Brendan Maiorana - Wachovia.
Brendan Maiorana – Wachovia Capital Markets, Llc
In terms of when you guys are looking at acquisitions, you have kind of laid out what your return expectations are for different areas of infrastructure investment, and the range is I think is on an equity basis is 11% to 15% roughly. When you are evaluating potential investment opportunities, how much does your cost of capital, your thoughts on your long-term cost of capital, how much does your current unit price weigh into that calculation?
Or, are you more just looking at the long-term equity-return expectation for a given asset class and factoring that into your cost of capital?
Aaron Regent
I think there is a number of different ways we look at it. We do look at each investment on a discreet basis to a certain extent, so whatever sector it is and we have different return expectations on those sectors.
And as you highlighted, our return expectation is kind of 11% to 15% type range. So, that is one part of the analysis.
Then the second part of the analysis is on the funding side, and there is funding on a short-term basis and there is funding on a long-term basis. And on a short-term basis, we have credit facilities in place, which we will access to bridge an acquisition.
But in time, we would want to put more permanent financing in place, which means we would likely look to issue more equity units. And in terms of how and when we do that, it follows on the discussion we had already.
As we do an acquisition, as we keep telling our story, we are hoping that it will translate into better unit price performance, which will drive down our cost of capital.
Brendan Maiorana – Wachovia Capital Markets, Llc
Aaron, I think on the last call you had sort of given us an update in terms of your outlook on acquisitions and pricing for infrastructure, and you have talked about timber and social a little bit. In terms of the other major areas, the regulated and then transportation, I think last go around you were saying that sellers' expectations had come down a little bit.
My sense is that you guys felt that you could still be a little bit patient and that prices may come down a little bit further. I am just wondering what your outlook is today.
Aaron Regent
I think our outlook is probably very consistent with where we were last call in that the market continues to be very turbulent. I think everyone on the call has experienced that, and if you look at particularly the debt markets and capital availability, it has not grown.
In fact, it is probably even contracted a bit more, particularly as the banking sector has had to absorb a number of significant write-downs and then reduction in their capital base. So I think out of that, it is a plus and minus.
The minus is, I think for a lot of potential acquirers, it is more difficult to raise financing to fund acquisitions, and the type of financing you are getting is more expensive. And the leverage ratios are lower, but we do not see that as a big negative.
I think for us we are fortunate in that we have excellent relationships with the banking community, and so we still have access to that capital. And I think that the closing of our debt facility in this environment is kind of reflective of not only our assets but those types of relationships.
So, we do not see that as hindering our ability to pursue opportunities. But I think on the valuation side, sellers' expectations are changing and also there is a period of time when acquisitions were highly, highly levered, and going back say 12 months or 24 months ago, and I think the issue is now for a lot of those acquisitions, the ability to maintain that type of leverage is no longer possible.
And so, there is a significant amount of de-leveraging taking place, both with specific opportunities and with corporations. And so, I think there are corporations who are looking to surface liquidity and because of that, I think there is a number of assets that will likely come on the market, and they may come on the market at very attractive valuations.
So we have a number of things we are looking at, and hopefully over the next little while we will be able to transact on them. I would say that we continue to be patient.
I am not sure what your views are, but we do not see this situation cleaning up in the next three to six months. In fact, it will probably be a lot longer than that.
And so, we do not see the need and we do not feel like we are under pressure to do something imminently, because we think that the environment will continue to improve in our favor.
Chris Haley - Wachovia Capital Markets, Llc
Actually just a broader question on the timber business, I listened to the tone of your comments about asset pricing in the timber markets, North American, nominally. And then, I listened to the other professionals in this space.
And we hear of obviously the companies are making, their actions are telling us that now is a good time to sell because there is a fair amount of buyer demand for that asset class, or that product. I would be interested what you guys are hearing from your own contacts and in the Brookfield umbrella about, at the TIMO level, or the institutional level, what are the allocations that institutions are targeting, or timber investment?
And where are they versus that target? And obviously underpinning that question is just how long can these asset-pricing levels hold when the operating cash flow levels are arguably so far below what we would think?
Sam Pollock
Chris, and I guess there is a couple of questions I think in your comments there, one asking what we think the allocation levels are among institutional timber investors, and then I think, I am not sure if it was a question. But, I think you were asking do we think that the asset levels today are supportable by the underlying economics of timber right now.
So on your first question with respect to timber allocations, we have some reasonable visibility into that space, and what I would tell you is that there are a number of TIMOs out there looking to raise capital from the institutional market, both in Canada, the U.S. and in Europe, in particular.
We do not see a lot of timber buyers out in the Far East, but there are a fair amount in Europe, the U.S. and Canada.
There are still a fair amount of allocations that are being made to the space. I think some of the institutional buyers are waiting to see how the next year pans out and whether or not there will be better times to acquire, much along the tone that you are implying with your question.
But nonetheless, there are more allocations going into this sector than being pulled from the sector. In fact, I would say it continues to be a focus for people, and we are seeing some U.S.
institutions that had made noises that they were getting out of the sector are actually coming back into the sector. So I think on that front, the institutional market is very, very healthy.
And so, that goes well for long-term investors into the space. As far as the underlying economics of timber today, clearly the weakness in the sell-out market in the U.S.
has dampened results from not only our business but most other businesses in the U.S. Having said all that, our view and I believe it is the view of many others, although I think we are probably more optimistic than obviously some people you have been speaking to, that prices in the not-to-distant future will significantly spike.
And we saw it on the many commodities over the last number of years where there was a real change in the supply/demand fundamentals. You saw it in food.
You saw it in oil. We strongly believe that you're going to see that on the timber market in the next four to five years as all those structural elements take place on the supply side and as the demand normalizes in the U.S.
on the housing front. And so, people like ourselves are building that into our models, and we think that the returns you are going to see longer term will be very attractive.
Chris Haley - Wachovia Capital Markets, Llc
Two follow-ups; on the institutional investor side TIMOs, what are the targeted, promised, communicated, unlevered rates of returns that are being targeted in North American timber as from what you are seeing? And obviously the transactions you are losing, I would be interested in maybe how far off you might be.
And then regarding this potential price spike down the road, that is obviously several years out, but this is a longer-term type of investment. Do you believe that that is a potential spike is something that is kind of a plateau that gets raised?
Or, is it just a short-term spike?
Sam Pollock
First off, returns generally promised from timber funds are in the 10% to 12% range, levered, after tax. And then towards, I guess the second question was whether or not the prices would be sustained at a higher plateau down the road.
And the answer is, yes and no. We believe there will be a higher level, although we believe there will be a spike that goes above the norm for a period of time.
Chris Haley - Wachovia Capital Markets, Llc
Sam, and is that on a leveraged basis, one-to-one leverage?
Sam Pollock
Yes, approximately.
Operator
Our last question comes from Cherilyn Radbourne of Scotia Capital.
Cherilyn Radbourne - Scotia Capital
I just have a couple of questions with respect to Transelec. There was a comment made that you do expect a material step-up in the growth CapEx in 2008, which naturally has positive implications for the cash flows going forward.
I think you spent about $4 million on gross CapEx in Q2. Should we think about multiplying that by four?
And is that a good run rate to use for the year as a whole?
John Stinebaugh
Maybe the best way to think about that is the five-year plan that we have articulated calls for the billion dollars of CapEx for the 100%, which our share of which is about $180 million. And as I see that playing out in the 2008 timeframe, we think we are not going to be at that average run rate level.
We will be a bit lower than that. However, if I look at the book of business that we are winning, we think that we are in the 2008 timeframe going to be able to win more business, call it, than that average level, which would mean that in the 2009 timeframe thereafter, we are very positive about the backlog of growth CapEx that we are going to be able to invest in the business.
Cherilyn Radbourne - Scotia Capital
Could you just sort of clarify the currency risk that you have got with respect to Transelec, both as it relates to sort of your operating expenses and the debt and to what extent you have mitigated both with the transactions that you undertook this quarter?
John Stinebaugh
The currency risk is a function of the indexation formula, and the best way to think about it is that we have got predominantly Chilean-peso-denominated asset base in the two-thirds ball park, call it. And then, one-third of our asset base from an economic standpoint is in U.S.
dollars. So, on the revenue side as the indexation formula works, revenues increase to the extent the peso increases against the dollar for the Chilean peso piece of the rate base.
In addition, with the indexation formula inflation, both on the Chilean side and the U.S. side increase revenues.
The cost side is pretty much exclusively Chilean peso. So, that is where the peso impacts the cost side of the equation.
What we are doing with the long-term hedging plan that we are in the process of executing right now is we are converting our remaining U.S. dollar debt to peso debt.
And what that will do is it will then offset against the peso revenue, net of the peso expense. And with the remaining hedges we are looking to put in place, we are looking to basically hedge out pretty much the remaining peso exposure.
Operator
That concludes today's question-and-answer period.
Sam Pollock
And so as we are done, I would like to thank everyone for joining our call today, and we look forward to speaking to you again next quarter.