Numbers are being crunched on the NSW government's upcoming sale of a 51 per cent stake in Sydney's WestConnex motorway, but alarm bells are starting to ring over assumptions that toll road operator Transurban will be the most likely buyer.
To date, Transurban has been considered to be in the hot seat to buy the Sydney Motorway Corporation, the government entity that is building the $17 billion WestConnex project in three stages.
Transurban chief executive Scott Charlton is an excellent deal-maker, and has been keen to add WestConnex to the company's six existing Sydney toll roads, expanding its NSW network by as much as 40 per cent.
Transurban, which will team up with investment partners to make a bid, has an advantage over other bidders because it is familiar with Sydney's toll road traffic patterns and can spread costs across its portfolio.
Other than WestConnex M4, which has been tolled since mid-August, there are only three toll roads in Australia not operated by Transurban: the Sydney Harbour Bridge, the Sydney Harbour Tunnel and Melbourne's EastLink.
Mr Charlton has already seen the NSW's government's traffic forecasts for the first and second stages of WestConnex and believes them to be reasonable.
But Citigroup has urged caution over a potential WestConnex acquisition, warning that traffic on the motorway in 2031 could be about 10 per cent below the government's projections.
The bank warns that people with low discretionary income are likely to switch to free alternative routes after WestConnex tolls are introduced, particularly when toll fares increase faster than the rate of inflation.
Fares on WestConnex will rise at least 4 per cent annually, while tolls on the adjoining M5 south-west motorway could extend past 2026 as part of a deal with the successful WestConnex bidder, although the government has said it "will not remove" an existing cash-back scheme for private vehicles.
"We don't regard WestConnex as being a must-have for Transurban's portfolio," said Citigroup analyst Anthony Moulder in a report. "If the WestConnex sale terms cannot be agreed to a desired outcome, we believe Transurban are better to await a better entry price, as management did successfully with Lane Cove Tunnel, Cross City, Airport Link etc."
Citigroup argues it is difficult for companies to achieve targeted returns on tunnel investments compared with surface roads due to high construction and operating costs, and fewer entry and exit points. Traffic through tolled Australian tunnels has historically been lower than expected, forcing all previous tunnels into bankruptcy. Most of the 33-kilometre WestConnex motorway will be underground.
"While this does not necessarily mean WestConnex would follow the similar path, we see pressure in delivering the appropriate return unless a better term on the sale process is agreed with government," Mr Moulder said, adding an acquisition could end up being "value destructive" to Transurban shareholders.
Better terms could include the government taking on the risk of traffic being lower than expected and compensating the eventual buyer for any shortfalls, or awarding the successful bidder the right to toll motorists using the Sydney Gateway – another road connecting WestConnex with Sydney Airport.
Transurban's knowledge of the Sydney network could also turn out to be an Achilles heel if the company bids only what it thinks WestConnex is worth – as would be expected by its investors – rather than making a knock-out bid to trump competitors anxious to break into the Australian market.
Transurban lost a US public private partnership tender to build new express lanes on Virginia's Interstate-66 highway to Spain's Ferrovial in late 2016 after bidding about $1 billion less than its rival, despite having the advantage of owning two toll roads nearby.
Mr Charlton stressed Transurban expects "significant competition" on WestConnex but plans to remain financially disciplined.
As a publicly-listed company, Transurban needs to reassure investors that it is not overpaying for assets and maintain its track record of delivering steady increases in dividends to shareholders. It already dominates Australia's toll roads, with full ownership or controlling stakes in 11 toll roads and stakes of 50 per cent in Sydney's M7 and M5 motorways.