For politicians and investors who often struggle to explain the concept of a long-term asset lease to the general public, there was rarely a better opportunity to do so than 13 February, 2009.
On that day, a Morgan Stanley-backed concession company, Chicago Parking Meters (CPM), dropped $1.15 billion into Chicago’s purse and in return were given 75 years to operate the city’s 36,000 parking meters. Chicago can fine or tow them out of the deal at any time if it finds good reason to do so and CPM has every incentive to go about its work efficiently before the meter runs out.
But minutes after the meter started running, a red flag popped up. CPM’s due diligence didn’t discover that Chicago had meters with different coin capacities and calibration technologies scattered throughout the city. So when rates went up, many coin-operated meters couldn’t hold all the extra change and malfunctioned, while others gave patrons less time than they’d paid for after recalibration. A flurry of parking tickets ensued, fueling public anger and vandalism of the meters.
Now, the Illinois Attorney General, the Chicago City Council and the Chicago Inspector General have stepped in, ticketing CPM itself in the form of subpoenas, hearings, legislation and scathing criticism.
CANISTER SIZE MATTERS
One of the value drivers of the parking meters lease was a city ordinance giving the concessionaire the power to increase rates. So, soon after CPM took over in February, it took 28 quarters, instead of 24, to buy two hours’ time in the city’s busy Loop district; 16 quarters, instead of 8, in the central business district around the Loop, and eight quarters, instead of four, for two hours’ time in many neighbourhood meters.
However, not all meters were equally prepared to take these additional quarters. There were two types of coin canisters scattered throughout the city’s parking meter system: large canisters and short canisters. Large canisters could hold up to $60 worth of quarters while the short canisters could hold only $30 worth of quarters. When the rates were raised, the smaller canisters filled up more quickly than the bigger canisters and CPM’s coin collection schedules became inadequate. Many meters became full and started to malfunction, stoking the ire of parking patrons to the point of vandalism, protests and boycotts.
Chicago aldermen took note. On 18 May, they called CPM to a hearing to address these and other issues. CPM pled ignorance, arguing that they did not know about the capacity issue until 13 February.
“The canister collection of the amount of coins that is handled by each different meter was not well known to us,” Alan Lazowski, chief executive officer of LAZ Parking, the company that did the due diligence for and operates CPM, told aldermen that day. “If we had the opportunity to physically open the meters within the system, it would have been a better take over process,” he concluded.
The aldermen didn’t buy this argument. They instead excoriated LAZ for poor due diligence and railed at the fact that CPM did not immediately inform the city of the capacity issue.
CPM countered that, as the system’s manager, they were responsible for the issue and thus didn’t believe they needed to get the city involved. Instead, they began to document coin capacity across the system and replace the $30 canisters with larger ones. But the process was complicated and time-consuming, so reports of malfunctioning meters dragged on for weeks.
To alleviate the situation, CPM hired additional meter mechanics and coin collection officers. Between mid-March and mid-June, the company went from employing 10 mechanics to 35 and from 15 collection officers to 38, says Avis LaVelle, a spokesperson for CPM.
LaVelle also points out that CPM accelerated its schedule for installing electronic pay boxes, which eliminate the coin capacity issues. But 250 of these also experienced malfunctions in May and some aldermen are worried about the privacy of credit card information recorded by them. Despite this, CPM is pressing ahead with their installation: 3,000 meters have already been replaced with payboxes and about 30,000 in total will have been replaced by the end of the year – 18 months earlier than required by the concession agreement.
Now, less than one percent of parking meters are down or inoperable in the city for any reason, LaVelle says. But that’s still chump change to many worried aldermen.
“We still have stories of breakdowns and I remain very concerned about this company’s ability to perform their obligations under the contract,” says Manuel Flores, alderman for Chicago’s first ward, who grilled CPM management at the hearing and says he found their answers “dodgy”.
NOT ENOUGH TIME
The capacity issue isn’t the only problem giving Flores pause. As CPM reprogrammed the meters to reflect the new rates, they didn’t realise that 5,800 meters in the city had two calibration technologies. Approximately half were “old generation” meters, which displayed seven minutes for the first quarter, and half were “new generation” meters, which displayed eight minutes for the first quarter. CPM was unaware of the difference, so it placed decals on all of them advertising eight minutes for the first quarter. As a result, some patrons got less time than they had paid for – or, in the words of alderman Leslie Hairston of Chicago’s fifth district, they got “gypped”.
“This was an issue that resulted from the calibration technology of old generation meters, a situation unknown to us when we took over the system,” Dennis Pedrelli, chief executive officer of CPM, explained to Hairston during the 18 May hearing. In practice, patrons were actually only losing 30 seconds per quarter and, regardless of which generation they were using, 50 cents resulted in 15 minutes’ time Pedrelli added.
“Okay. Humor me right here because as somebody plugging a quarter into a meter, I don’t care whether they are new generation, old generation, grandmother generation. I don’t care,” Hairston shot back. She suggested a fine of $10,000 for each of the 5,800 parking meters, or $5.8 million, as restitution for what she termed a deceptive business practice of knowingly giving customers less time than was advertised on the meters.
Pedrelli said that CPM didn’t know of the problem until 10 April, so it could not have knowingly deceived patrons for seven weeks. After discovering the issue, he said CPM changed all the decals on the meters to advertise 15 minutes for every 50 cents and began to reprogram them to give customers one extra minute for each 15 they bought.
“That way, no one should ever feel that they’re being shortchanged, and that will continue until the meters are replaced by pay-boxes,” says LaVelle.
But Hairson, one of five aldermen to vote against the deal in December 2008, remains as skeptical as fellow alderman Flores, if not more so.
“I’m angry and I’m frustrated at the lack of cooperation by LAZ and I’m angry that myself and thousands of Chicagoans have been taken advantage of,” she says.
Amid this anger, of course, state and local politicians can’t keep silent. Over the past two months, they have each contributed their two cents on what went wrong and how to fix it.
Allegations by Hairston and others of deceptive business practices prompted Illinois Attorney General Lisa Madigan to open a consumer fraud investigation into the parking meter deal. In May, subpoenas were sent to Morgan Stanley, LAZ and Chicago Parking Meters. The outcome may well determine whether the city council will seek to throw CPM out of the deal.
“If the investigation comes back that these folks are guilty of deceptive business practices, we should terminate the contract,” Flores says.
Flores and other several other aldermen have also proposed legislation that would give similar deals greater scrutiny in the future. In early June, they enacted a measure requiring all the asset lease agreements to be made public as electronic, searchable files on Chicago’s finance department website. Another measure under consideration would also establish a minimum 60-day review period to allow the council to assess asset lease or sales agreements and adjust them prior to the solicitation of bids. And after the conclusion of the bidding, the council would have a minimum 15-day cooling off period to decide whether to accept the winning bid.
Chicago Inspector General David Hoffman has also joined the fray. In early June, Hoffman published a scathing report which argued that the city leased the parking meters for nearly $1 billion less than they’re worth. William Blair and Company, the city’s advisor on the deal, indicated a preliminary valuation range between $650 million and $1.2 billion. But using a discount rate of 7 percent that he claimed to be “appropriate” and “conservative”, the inspector general placed the range at more between $1.7 billion and $2.6 billion. Both will be called to testify how their methodologies reached such disparate conclusions, advises Flores.
“We want to know. I think people deserve to know and I want to know – my interest has been piqued,” he says.
For all the mayhem, though, industry participants remain positive that the difficulties surrounding the deal will serve as a minor speed bump on the road to a bigger, more mature market for PPPs – in Chicago and elsewhere.
“The Chicago market is one of the leading PPP markets and will likely remain so, because the governing body has experience with PPP transactions,” says Tim Carden, managing director at Chicago-based financial advisory firm Scott Balice Strategies.
Carden, who advises on PPP-type transactions, sees other cities and states moving ahead with potential deals for non-revenue generating assets “with limited concern about the public debate over the future potential value of Chicago’s meters”. For those looking at revenue-generating assets, though, he sees important lessons that should not be missed.
“The most important lesson from the Chicago meters transaction may be the importance of having an objective valuation of assets undertaken before and during any bid for private investment,” he says.
In nearby Milwaukee, Chicago’s neighbor to the north, politicians may already be taking note of this. After authorising the city comptroller to initiate a search for a sell-side advisor for the city’s water utility, Milwaukee aldermen have put the process on hold until they evaluate how much the water works are worth to the city over the term of a potential lease – a process that could conclude sometime this autumn.
In the meanwhile, Milwaukee officials look to Chicago with curiosity, not fear, in their eyes.
“Hopefully the examples of Chicago and anyone else can be something we can learn from and put in appropriate safeguards and avoid the same pitfalls,” says Milwaukee Comptroller Wally Morics. “For someone who is still crafting the [PPP] process, it is something to be very careful and very mindful of.”
At present all live PPP projects in the US are helping shape the strategy for the next, which means no one should ignore the lessons from Chicago’s meters. Planning, execution and delivery all need to be successful, otherwise others can – and will – start dismantling your investment for you.