Real Payoff

COPYRIGHT INDUSTREAMS LTD.
REAL PAYOFF
AN INDUSTREAMS INITIATIVE
TO EXPLORE BETTER WAYS OF WORKING WITH AND GAINING FROM VOLATILITY
(for strategy setting, decision-making and value creation
in port and infrastructure investment and portfolio management)

Why this initiative?
 The central challenge is variability in world markets and of
course world trade and by extension infrastructure and port
markets.
 Through many cases in the ports sector and subsequently in
the wider infrastructure field it is clear to us that the solution
cannot be in prediction alone.
 Precision forecasting is increasingly being debunked - the
limitations are too great and one of the key reasons why many
projects and acquisitions do not deliver the expected returns.
 So the starting point is that payoffs (say in the form of returns)
are distributed and cannot be reduced to very specific payoff
points (e.g. estimating an IRR to be a specific percentage point
such as 15% for a 40 year concession).
 That suggests that we must accept much wider variance in the
market variables we work with and greatly increases the
importance of the factors in our control and the function or
business model that turn market variables into payoff (such as
concession agreements, operating model, partnership model,
gearing etc. as well as optionality and flexibility).
 This presents both a great challenge and opportunity for
decision-making and value creation in investing and portfolio
management.
Ultimately this is about shareholder
value creation.
Shareholders are starting to intuit that
returns are distributed over a much
wider spectrum than previously
conceived and with that are going to
demand a better understanding of the
down side exposures and how you limit
them as well as your ability to expose
yourself to upsides.
Robustness and
upside will
increasingly
become the focus
of shareholders
The fragile will
sooner or later
leave the market
place
Note: Return on investment spread.

What this is about and the potential
 This is about embracing variability and about creating
value from variability.
 To do that we need new tools and ways of dealing with
variability in decision-making and value creation in
investing and portfolio management.
 With this initiative we will explore various solutions. In
this presentation we introduce a few of the many options
including simple heuristics and the payoff function to
address central issues in decision-making and what we for
now are calling the “value leap” as outlined to the right.
 Very simply put it is about creating robustness and upside
in asset and portfolio value as outlined below (for more
see the case).
For decision-making: Providing
the means to fully understanding
our up and downward exposure
also in the face of skewness and
with that how we make smart
tradeoffs as well as utilize or
create free options that
substantially shift our asset value.
Value leap: Many operators have
by now honed their skills at
creating value through
understanding and influencing the
market place. Most, however, are
not using their business model to
fully leverage and protect against
market uncertainty. This is where
we see some of the greatest un-
tapped value in todays market
place for operators.Note: From case outlined later in this presentation (changing NPV
range in USD from -1bn / +1.7bn to -0.3bn / +3.4bn).

Exploring a few of the components
1. Backdrop
Embracing variability and moving from single payoff point
paradigm to a payoff distribution and with that moving to real
investment strategies (payoff as expressed in e.g. IRR or NPV).
2. Framework
Exploring ways of moving from payoff distribution to payoff
function and utilizing that to working with and creating value
from market variability.
3. Case
A simulated case showing how we use levers at our disposal to
substantially shift our payoff distribution and thereby
investment returns (for inspiration purposes only).
In the following we will walk through the preliminary backdrop and framework and a specific case to
lay out frameworks and solutions for illustration purposes. It is not meant to be exhaustive in any way
– it is purely meant as an introduction and to spur ideas.

BACKDROP
(embracing variability)

Variability in port investing and assets
STATING THE OBVIOUS…
The Compounded Annual Growth Rate
(CAGR) for a sample country was 4.7%
over a 20 years historical period (here
simulated using partial US ports data).
But for the individual ports the range
was between 0.5% to 10.2% CAGR for
97.5% of the ports (weighted by
volume – see the y axis for one port
share of total). The obvious is that
even on a very aggregate level we
face substantial variability.
…AND IT GETS MUCH WORSE…
Our payoff (or lack of) is exposed to numerous factors
including the volume distribution in a port among terminals
(our terminal vs all the others), average revenue, operating
costs etc. And the more factors we add the fatter the tails
to either side and the greater the possible future outcome
for our payoff (say IRR or NPV). And this is before even
introducing any “skewness” which complicate matters
further.

Real payoff (or return) distributions
In real life the payoff distributions
are, well, distributed over a larger
spectrum (of e.g. potential returns
or net present values). Examples are
given to the right which are some of
the potential real distributions and
of course any mix thereof.
Symmetrical
payoffs with
more or less
variance.
Skewed
payoffs either
right or left
tail.

Real and false investment objectives
It may well be that
there are only two
real non-narrative
investment
objectives. One is
decreasing the
overall variance
through market
structure selection,
deal frames etc.
(and willingness to
tradeoff upside for
less downside). The
other is creating
investments with
high payoff upsides
and little downside.
The diagrams to the left illustrate narrative positions in investments where the expected
singly point payoff is very different from the real possible payoffs. One in which payoff is
symmetrical and where the upside is welcome but the downside might prove detrimental
to the company in question and thus not what they really wanted. The other a pure
loosing position where the potential downside is big and the upside capped (sometimes
seen in acquisitions).

FRAMEWORK
(exploration of concepts for working
with and gaining from volatility)

From distribution to function
 Consider the payoff distribution as a
result of market variables and the
function (or business model) that
translates these variables into
payoff. Left some of the most
obvious examples.
 We cannot compute probabilities to
any single point of payoff (or
return).
 But we know much about how our
function works at different market
variables and thus how these
translate into payoff.
 Using the payoff function is a means
to working with variability.
 Another way to think of the
difference is as market variables
being “x” and the function being
“f(x)”.
Market variables or x
Payoff (or return)
MARKET VARIABLES
 Volume
 Rates
 Unit costs
 Currency exposure
 Interest rates
 Etc.
FUNCTION
 Operating model
 Concession terms
 Expansion, phasing and
other options
 Funding and ownership
model
 Insurance
 Etc.
Payoff function or f(x)

The function we wish to achieve and avoid
Very simplified when we translate real payoff distributions into payoff functions they
roughly match up as laid out below. This gives us a broad idea of what we wish to
achieve and avoid for our payoff function (or business model).

What we know and what we control…
What we know…
…is that market variables can vary much
and have a lot of inherent volatility in
particular over long time horizons.
What we control…
…is how our function (or business
model) translates that volatility into
payoff.
We have all seen outcomes that we thought were
extreme at time of conception of both ends of the
market spectrum in numerous investment cases
across the sector. What has never been observed is an
investment case turning into the exact expected
return values.
We chose and
design our
own payoff
function. We
chose
whether to
hardcode it to
be robust
with
substantial
upside or
fragile.
Conceivable return
scenarios
This never happens

…using it for decision-making
Exposure
Where are we? We need to understand our upward and
downward exposure – a single payoff point won’t give
us any information about that. This get’s even worse
and much more critical when there is any form of
skewness involved which occurs in all investment cases
one way or the other.
Value creation
Some of the levers at our disposure including very much
optionality (such as investment phasing or expansions)
have the potential to simply improve our payoff function
by limiting down side and increasing upside (but hidden
if only considering single payoff points).
Tradeoffs
Others situations may be more complex with tradeoffs.
Good examples include concession terms or operating
models. In such circumstances the payoff function help
us understand what we are trading off and would often
lead to very different conclusions than a single payoff
point paradigm would. In the example to the right we
think we have made a decision that provides a small
gain seemingly for free, but in reality has provided much
more downside and less upside.

…and value leap through f(x)
Value creation through x
Value creation through x and f(x)
Best of both worlds
The leading operators in general have
great insight to the market place and
how to impact it. But the biggest area
of untapped value creation and most
overlooked may well lie in the
function itself (including optionality).
So one way to look at x versus f(x) and
value creation would be to consider
value creation through x as mainly
market selection focused. That is to
say select an opportunity that has
reasonable likelihood of delivering a
positive return from an average point
of view.
f(x) value creation then takes place
within a given market setting in terms
of how best to transform the payoff
distribution by limiting the down side
(or left tail) and expanding the upside
as much as possible (right tail).
Pre- and post-investment
This analogy works both for
investing as well as asset and
portfolio management.
Whereas x value creation pre-
investment is centered around
market selection a good
example post-investment would
be capturing higher market
share or securing higher rates.
For f(x) value creation post-
investment would include all the
factors pre-investment
(although a number more from
a tradeoff perspective) and also
include the development of new
options as well as more
operational levers (including
contracting aspects of
commercial, operations and
procurement).

CASE
(what this could look like
for a sample investment case)

Introduction
 The following case has been made purely for the purpose of illustrating how a real
view of payoff can enable us to vastly alter our payoff function and thereby
distribution.
 It showcases a greenfield investment and how we can use levers to change our
payoff distribution from a range of -968mn / +1,707mn to -293mn / +3,438mn
changing the potential max gain from 1.76 times to 11.75 times that of our potential
loss (the case was simulated for NPV in USD, but could of course be applied to any
metrics used to measure payoff or returns).
 The base case scenario has by intention been kept the same throughout the
simulation to show how knowledge of one payoff point provides very little
information of our real payoff distribution.
 Whereas this shows an investment case the same methodology is applicable to
investment and portfolio management and decision-making in general.
 In the case we use a few of the obvious levers that can be used to transform our
payoff distribution but they are just a few of what is conceivably a vast array of
levers.

Base case (greenfield sample)
Base case assumptions
 20 year concession
 1,500 meters of quay and 100ha at cost of 500mn USD
 Capacity 1.5mn TEU (ramp-up period of 6 years)
 Average rate at 200 USD per TEU, average variable cost
at 50 USD per TEU
 Fixed cost at 5mn USD per year
 Concession cost at 50mn USD per year (fixed)
 25% corporate tax rate
 10% discount rate
Simulation methodology
 Base case at index 100 for volume and
average rate (scenario 11)
 Payoff function tested for index 0 (scenario
1) through to 200 (scenario 21)
 Average price and volume thus tested for
data sets 0/0, 10/10, 20/20 etc. up to index
200/200 of base case (21 scenarios in
total)
 All other items kept constant
Note: NPV values in million USD
Comments
 As capacity is capped at
1,5mn TEU volume only
has an impact up to the
base scenario thereafter
only avg. rate increase
make a difference
 Lowest payoff point
mainly consisting of
investment and
concession liabilities
Return spread (NPV in USD)
Base case 241mn
Minimum -968mn
Maximum 1,707mn
Max./Min. 1.76 times
Base case

Changing the function (just a few of the levers)
Base case 241mn
Minimum -543mn
Maximum 1,703mn
Concession structure
 Previous fee $50mn per
year
 New fee $44.25 per TEU
 PV value of concession
fee remains $426mn (at
10% discount rate) as per
base case
Investment phasing
 Previous commitment at
500mn USD
 Option introduced to
phase in 2 parts of
$250mn per phase
Expansion option
 Capacity capped at
1.5mn TEU in base case
 Option introduced to
double capacity by
investing additional
$500mn USD
Base case 241mn
Minimum -718mn
Maximum 1,707mn
Base case 241mn
Minimum -968mn
Maximum 3,766mn

Transformed payoff (function and distribution)
Combined
 Changed concession
structure
 Investment phasing in
two parts
 Expansion option to
increase capacity
Base case 241mn
Minimum -293mn
Maximum 3,438mn

Disclaimer
This presentation is issued for information purposes only and does not constitute an
agreement, offer, obligation or invitation to enter into transactions or investment
business.
With this presentation, INDUSTREAMS LIMITED does not act in any way as your advisor.
This presentation is not intended as, nor should it be, a substitute for consulting with
INDUSTREAMS LIMITED.
Whilst this presentation has been produced from sources believed to be reliable, the
information, views and opinions expressed in this presentation are provided as of the
date of this presentation and remain subject to verification, completion and change
without notice. No representation or warranty whatsoever (whether express or implied)
is or will be made as to, or in relation to, the accuracy, reliability or completeness of the
information contained herein or in the appendices to this presentation.
INDUSTREAMS LIMITED will not be liable towards you or any third party for any eventual
damage you may incur, caused by the information contained in this presentation and its
appendices.

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