MoPac and the Expensive Mess That Never Ends
Engineering company renovating the beleaguered stretch of highway gets bought out
As construction continues on MoPac's long overdue toll lanes, CH2M, the Colorado-based engineering company responsible for the project's design and construction – originally scheduled for completion in September 2015 – reported in its March 31 quarterly report that its disruption of Austin's westside commute was "approximately 75% complete." The delays have come with extreme cost overruns at CH2M; the company estimated them at $121.3 million in March, and blamed both the cost and delays on seemingly everything short of a plague of locusts: "survey engineering and design challenges, rework of previously installed work, client-caused delays including limited daytime access to portions of the site, greater than expected subcontractor costs, [and] subcontracting work previously planned to be self-performed."
March wasn't MoPac's first appearance in CH2M's quarterly reports. The project has been something of a bête noire for the contractor since September 2014, causing persistent problems as the company underwent two corporate restructurings in as many years. The project continued to hang around like a bad smell, even as CH2M restructured with the goal of becoming a fundamentally different engineering enterprise. Through the process, management made a habit of explaining that the project's cost issues were contained, and they were ultimately believed. On Wednesday (Aug. 2), the company announced that it would be acquired by Jacobs Engineering Group in a cash and stock deal that values the company at $3.27 billion – a 73% premium to their value in March. The deal is expected to close during the first quarter of Jacobs' 2018 fiscal year.
The MoPac job was commissioned by the Central Texas Regional Mobility Authority in 2013 to alleviate Austin commuters' own bête noire: traffic on the north-south highway. One toll lane northbound and another going southbound, the CTRMA suggested, would give motorists an opportunity to buy their way out of an ever-crowded moving parking lot between the Downtown exits and Parmer Lane.
CTRMA Executive Director Mike Heiligenstein told the Chronicle that its decision to solicit a design-and-build contract for the project – rather than designing the project itself or commissioning its design, then soliciting bids from contractors for the construction – was done in the interest of time and continuity. With a single contractor designing and building a project, the theory went, the planning and execution phases can be seamless. Aspiring D&B teams were narrowed to three serious bidders in September 2012; all three submitted detailed proposals in January 2013. With visions of an Austin newly bestowed with an affordable way to zip past traffic, the CTRMA selected CH2M's bid that February, and sent out its notice to proceed that April.
CH2M is a sizable government contractor with an impressive work portfolio. The company designs (and builds) power plants, airfields, and many other types of private and government infrastructure. Its proposal for the MoPac job was the work of an established outfit with too much institutional knowledge to get beat out of a bid for a highway toll lane. CH2M's bid featured a flex of the company's design chops, in the form of two "alternative technical concepts" – features that the CTRMA didn't envision in the original request for proposals, but that accomplished the same thing with a design innovation. The CH2M ATCs turned the planned overpass on-ramps to the north- and southbound express lanes (entering and exiting at Cesar Chavez and Fifth Street) into trim, elegant underpasses. The design cut down on sound pollution, preserved sight lines, and was just the type of thing a modern highway ought to have.
Just as notable was that CH2M's bid for the project came in at $137 million – a full $62 million cheaper than the closest competing bid. The CTRMA is bound by Texas statute to weigh the cost of the bid as 70% of its ultimate decision. Heiligenstein says they felt like CH2M "could come back on them legally" had the CTRMA rejected the highly cost-competitive and (supposedly) competent bid. Certain additional work, including the removal of old asbestos insulation in certain areas along the corridor and other potential improvements, was subsequently added to the project, bringing the budget to a cool $204 million.
"Significant Cost Growth"
Retrospectively, the first signs of trouble may have emerged almost immediately, as the real-time logistics of construction on an old railway-corridor-become-highway became obvious. Despite an apparent handle on the task at hand expressed in CH2M's bid, the effective reconstruction of 11 miles of highway – and the associated unearthing of sections of utility resources, both active and outdated – is prone to complication. Rerouting of various duct and utility lines, including the City of Austin's water line, added delays, as the various stakeholders coordinated the permitting and execution. Disagreements between the CTRMA and CH2M seem to have started in January 2014, when the approval of a rerouting of ducting by the Union Pacific Railway took longer than anticipated, and have continued since then at pace. Despite several early, unplanned delays, the CTRMA maintains that the contractor continued to assure them that the lost time could be made up.
In June 2014, CH2M subcontractors began work on the excavation necessary to install the subsurface drainage infrastructure for the southbound portion of the much-anticipated underpasses, and kicked off what appears to be the main source of delays – and, more importantly, the main source of conflict between the contractor and the CTRMA. Documents submitted as part of a dispute resolution process detail a litany of repeated equipment failures and repairs, and associated overtime that finally achieved the requisite goal of boring through rock to provide the necessary drainage for the underpasses in March 2015, six months later than was budgeted for. Boring work on the northbound drainage system began in November 2014, and finally finished the following July – allowing for the project to finally begin the actual excavation of the underpasses, right around the time the entire project was supposed to have been completed.
In September 2014, CH2M began telling its shareholders that its contribution to Austin's congestion was becoming rather costly. It would seem that geotechnical investigations didn't prepare them for the hardness of the Edwards limestone unit on the particular path of the drainage systems. The company took a $38.7 million charge because of "significant cost growth" associated with the project. In that same quarter in 2014, CH2M began the first of its corporate restructurings, calling for a total workforce reduction of 1,200 people and "a more disciplined approach to risk mitigation and project delivery."
Meanwhile, back on MoPac, crews were still trying to figure out how to effectively get through the hard rock of the Edwards limestone unit. After they eventually did so, in July 2015 CH2M tried unsuccessfully to recover the cost overruns through the fixed price contract's dispute resolution process, arguing that the density and unworkability of the rock was an unforeseen circumstance – a "differing site condition" for which the contract provided extensions and cost entitlements if encountered. CH2M's bid for the MoPac project proclaims that initial investigations found that the rock was "soft and rippable," and its arguments to the dispute resolution board leaned on the fact that neither its own drilling nor the holes provided by the CTRMA found rock as hard as what was encountered. The CTRMA countered, successfully, that the Edwards limestone unit is well-known to be composed of varying densities, and that CH2M ought to have known that – and certainly ought to have made the necessary adjustments sooner. By September 2015, the 2014 restructuring had cost the company $96.2 million, and it was taking another $53.6 million operations charge for "additional cost growth" on MoPac.
MoPac certainly hasn't been the only costly project afoot at CH2M, and it isn't even the only fixed-price contract that has given the company any headache. But its central place in the ongoing financial firefighting at the company is undeniable, and it became a perennial source of cost overruns that's frequently cited in company disclosures as an example of the type of business that CH2M was restructuring to avoid. The company executed an unprecedented sale of preferred stock to New York-based private equity firm Apollo Global Management in June 2015, a $300 million deal that included an agreement to require the explicit approval of the preferred equity holders before the company enters into "certain firm, fixed-price or lump-sum design-build or EPC contracts."
The Apollo deal also contained clauses that effectively gave the fund the ability to force a sale or IPO of CH2M should such an event not take a natural course in the first five years following the financing. The distinctly fund-friendly deal pays Apollo a 5% annual in-kind dividend, and lets Apollo maintain a 20% interest in the contractor through any future offerings.
Government contractors are cash intensive businesses and, as such, operate with revolving credit loans. The terms under which CH2M borrows money from a consortium of banks (including Wells Fargo and JPMorgan) was reworked in May 2016, and reported in their September 2016 quarterly report. Company press releases detailing the change in credit terms noted: "Factors in 2016 that negatively affected the company's borrowing capacity included the charges the company incurred for increased estimates in costs to complete two design-build, fixed-priced contracts."
The amended agreement appears to betray lenders' concern over the never-ending project, specifically prohibiting CH2M from incurring any more than $50 million in costs attributed to MoPac after June 24, 2016, for the purpose of calculating their adjusted EBITDA (earnings before interest, tax, depreciation, and amortization) in the context of the agreement. Despite the amount being capped in its loan agreement, the company warned shareholders in its March 2017 quarterly report that the $121.3 million it's already charged against the project may not be the end of it, and spread the blame around in the process.
"While management believes that it has recorded an appropriate provision to complete this project, we may incur additional costs and losses … not previously included in our total estimated loss," read the report. "These possible cost increases include extensions of the schedule to complete the job, lower than expected productivity levels, and performance issues with our subcontractors." The agreement also caps the paper cost of a second restructuring plan at the $70 million that's estimated.
This second restructuring began two years after the first restructuring, and three years after CH2M submitted its bid to design and build MoPac's toll lanes. It promised to more fully align global operations with a "client-centric" strategy through workforce reductions and facilities consolidations. Accordingly, the company saw "involuntary turnover" of 3,247 employees in 2016. Joe Schroeder, the lead project manager listed on the MoPac bid, is no longer with CH2M. The circumstances under which he left the company are unknown. CH2M declined to answer questions for this story. In announcing the sale on Wednesday, CH2M chairman and CEO Jacqueline Hinman said the company was "delighted" about the merger. "Since late 2014, we've been transparent about our plans to pursue an ownership transition, providing sustained access to capital for growth," she said.
The Work Continues
Work on the project continues to alter traffic patterns on the crowded highway. Meanwhile, reports from the Maintenance of Traffic (MOT) indicate that measures taken to provide working crews with access to the areas they need to work with appear to have been as contentious among the people working on the highway as with those driving on it.
The CTRMA told the Chronicle that CH2M felt that lost time could be made up through an aggressive MOT plan that moved traffic off the main highway and onto side streets as crews undertook bridge widening at Enfield Road; the CTRMA would not approve such a plan. The shifting of lanes as crews moved their work from lane to lane led to serious complaints about previous road markings remaining visible and the active lanes being unclear. Re-masking and re-striping was undertaken to make the active lanes more obvious.
Despite a clear disdain for the project, and cost overruns approaching the original bid price, CH2M crews continue to soldier along with paving and widening the toll lanes.
CH2M continued to express its intention to recover the cost overruns, or at least a portion of them, from the CTRMA. The CTRMA has not moved off of its position that the delays were caused by the contractor, and that budget overruns on the fixed price toll lane that never ends will remain on the contractor's balance sheet. The CTRMA has largely backed off on issuing hard completion dates for the project, and has yet to comment on whether or not it plans to attempt any sort of legal action for non-performance on the albatross of an ongoing project that was originally scheduled for completion two Septembers ago. (Jacobs declined to comment Wednesday as to whether the merger could impact progress on the project.)
The latest progress update, given at a public meeting on May 31, announced that the CTRMA would be hiring a new contractor to complete some finishing work, including additional sound walls – a natural extension of an apparent breakdown in relations between the contractor and the CTRMA. The progress report announced that the final paving of the underpass exchanges on the Downtown access "should" be done in June. In a break with tradition, the June 28 progress update did in fact show substantial paving having been completed on those underpasses. Gingerly, CTRMA Deputy Executive Director Jeff Dailey projected that the MoPac toll lanes would be open to drivers by September.