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Is p3 the cause of private investment decline in public infrastructure

Daniel Melo
Daniel Melo

Ideas about how to improve the financing, transparency, and efficiency in infrastructure projects implementation and management are needed. It is essential to attract investors to help to leverage the much-needed growth in this sector at good rates of returns and well-managed risks.

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DANIEL VICTOR MELO Infrastructure Finance & P3 Specialist Out 2018 Daniel Melo Is P3 the cause of the Private Investment decline in Public Infrastructure? Last week The Wharton School of the University of Pennsylvania edited a transcript of Knowledge@Wharton radio show on SiriusXM, called Why Private Investment in Public Infrastructure Is Declining. (link:http://knowledge.wharton.upenn.edu/article/private-investment-in-public- infrastructure/) This transcript criticizes the role of P3s with tenuous arguments and little foundation and tries to show a decline in infrastructure investment without a deeper analysis of causes. Below are my considerations and counterarguments. Saying that The basic reason you do a public-private partnership is that the government doesnt have the resources to build whatever it is you want to build it is an extremely simplistic and derogatory statement. The basic reason why a project is procured as P3 is due to its ability to deliver greater Value for Money (VfM) than other procurement methods. The P3 involves a) risks transfer to the party that best knows how to manage them (mostly the private partner), b) private equity participation and c) private companies responsibles for the operation and maintenance with performance requieres. If a project is bad, that is, it does not deliver value for money, it will be bad in any form of procurement. P3 is a procurement method, and cannot be condemned for its misuse. It is like saying that a tool does not work, when in fact it is the user who does not know what this tool is for.
DANIEL VICTOR MELO Infrastructure Finance & P3 Specialist People who believe in public infrastructure should really take a close look at Southern Europe and why they got into trouble. As in all orders of life, there are cases of success and failure. What happened in Southern Europe (not in all the projects how is suggested here) is the opposed to what happens in Australia, New Zealand, Canada, and Great Britain, where there are P3 projects that work very well. In South America, Chile's road concessions are another example that works well. In the US, HOT lines in Virginia (http://www.p3virginia.org/categories/completed-p3-projects/) are also a solution that today work fine for both the public and the private sector. Private companies are increasingly less interested in investing in these types of ventures. I would say that private companies that invest in Infrastructure are extremely limited in their capacity to invest. Those who do not understand why private companies invest less in infrastructure despite the available capital, citing the lack of attractiveness, do not understand the industry and who invests in Infrastructure. Private participation in infrastructure projects is materialized through the figure of P3. For greenfield and brownfield projects with a certain degree of investment in updating / increasing infrastructure facilities, the only players that accept to invest in these projects are those who understand the risks in the construction phase, that is, the Sponsors, mostly (almost exclusively) construction companies. If we consider the security package total amount represented by guarantees and equities that the Sponsors must place to materialize the universe of potential good infrastructure projects during the construction phase, and we take only construction companies Corporate Balances to back this total amount, we will see that there is no capacity for backing the whole amount needed in working capital loans, bridge loans, insurances and equity for this universe of projects. There are not non-recourse Project Finance for the construction phase, on the contrary, we see heavy security packages for infrastructure projects backed mostly by Construction Companies. The investors money is managed by Investment Funds. Very few investment funds understand the construction risks, and worse, most of them put in very little effort to understand them. The majority of Investment Funds are interested in cash flow after completion, leaving to the Sponsors the heavy burden of
DANIEL VICTOR MELO Infrastructure Finance & P3 Specialist covering all the security packages with their Corporate Balances, decreasing their leverage capacity for new projects. Let's see this example: Bridging North America (BNA), a consortium comprised of Fluor, Aecon, and ACS Group, through its affiliates ACS Infrastructure (Iridium) and Dragados, has closed financing for the Gordie Howe International Bridge project, valued at over CAD3.8 billion (US$2.94 billion). The consortium has secured short-term financing to cover the construction period including a bank loan syndicated by five institutions: RBC, Desjardins du Quebec, TD Bank, Mizuho, and HSBC. The financial close also entails the injection of CAD93 million (US$72 million) of private equity by the consortium members at the end of the construction period. Until then, this finance is guaranteed through letters of credit. Fluor, Aecon, and ACS each hold 40%-20%-40% equity interests in the consortium. (http://www.infrapppworld.com/news/megaproject-1341-us-3- billion-canada-usa-bridge-ppp-reaches-financial-close ) As we can see, the burden of Sponsors Corporate Guarantees (all construction companies) is extremely high, and no Investment Funds are participating in this phase of the project. But Investments Funds are not the only ones that do not understand construction phase risks, Banks are in the same position. Everything has to be backed with Sponsors Corporate Guarantees (Corporate Balance Sheet) decreasing leverage capacity for new projects. FIRST PROPOSAL: I perfectly know that risks have to be managed by the part that knows them better, but what would happen if the Investment Funds and the Banks incorporated professional construction risk specialists? Engineering areas acting in the Funds and the Banks, analyzing and quantifying risks during the construction phase in order to revisit the amount to be backed with Corporate Guarantees. I personally worked on some projects where the Bank agreed to reduce its Corporate Guarantees demands after understanding that certain risks were limited and easily manageable due to the very nature of the project. In addition to trying to find a solution increasing the Investment Funds participation and reducing the Project Sponsors Corporate Guarantees burden required by Banks, through a better understanding of construction risks (incorporating work teams staff who understand and know how to quantify
DANIEL VICTOR MELO Infrastructure Finance & P3 Specialist construction risks), we can look for a solution trying to introduce new funding providers. SECOND PROPOSAL: The concept of crowdfunding could be incorporated, making it an additional Equity provider for Infrastructure Projects (Crowdfunding is the practice of funding a project or venture by raising amounts of money from a large number of people). There are numerous articles on the internet that deal with this topic in greater depth (https://research.arup.com/projects/crowdfunding-platforms-as-alternative- source-of-finance-for-urban-infrastructure/). As well as small investors can access to finance infrastructure projects through the Municipal Bonds, they could also participate as Equity providers (obtaining better returns) through a platform specifically created for this purpose. They would be able to buy SPV shares (with no voting rights) using the same MuniBonds fundamentals. It does not seem positive to attack Infrastructure and trying to discredit its role by citing cases of failure and debunking one of the best procurement mechanisms that introduce private participation in the development, implementation, and management of infrastructure projects, without seeking alternative solutions to improve the sector attractiveness. A good P3 project starts with a viable cost-benefit analysis (CBA), which after a deeper Value For Money (VfM) analysis, goes ahead only if it is corroborated that it will deliver good value. Next, after defining the financial structure and the payment mechanism, risks are allocated and mostly transferred to the private partner (contract structure), procurement strategy is defined (Request for Qualifications and Request for Proposal), Tender process is launched, Proposals are evaluated, the contract is awarded, and after previous commercial and financial conditions (financial close) are fulfilled, the contract begins to be managed by the private partner under defined performance requirements. There is an orderly procedure that helps to take control of deviations and allows making adjustments much more effectively than the traditional procurement method. The fact of renegotiating 30 or 50 years tenor great magnitude projects due to not contemplated changes that occur after 10 or 20 years of project implementation does not seem to me to be an outrageous thing. Besides, in P3 cases there is a business model (the one presented in the offer) that is validated by the Grantor when the contract is
DANIEL VICTOR MELO Infrastructure Finance & P3 Specialist awarded. This business model, not used in projects implemented under the traditional method, allows us to monitor and detect the cause (s) of the difference (s) in a quick and accurate way. In this manner, we know what needs to be adjusted, and we can develop an action plan that allows us to know the origin, impact on the budget and adjustments to be implemented. Additionally, we can discover if changes obey current conjectural causes or if it is a private partner failure. (See the following article: https://irei.com/news/p3s-high-cost-transparency/). The debate is open, ideas about how to improve the financing, transparency, and efficiency in infrastructure projects implementation and management are needed. It is essential to attract investors to help to leverage the much-needed growth in this sector at good rates of returns and well-managed risks.

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Is p3 the cause of private investment decline in public infrastructure

  • 1. DANIEL VICTOR MELO Infrastructure Finance & P3 Specialist Out 2018 Daniel Melo Is P3 the cause of the Private Investment decline in Public Infrastructure? Last week The Wharton School of the University of Pennsylvania edited a transcript of Knowledge@Wharton radio show on SiriusXM, called Why Private Investment in Public Infrastructure Is Declining. (link:http://knowledge.wharton.upenn.edu/article/private-investment-in-public- infrastructure/) This transcript criticizes the role of P3s with tenuous arguments and little foundation and tries to show a decline in infrastructure investment without a deeper analysis of causes. Below are my considerations and counterarguments. Saying that The basic reason you do a public-private partnership is that the government doesnt have the resources to build whatever it is you want to build it is an extremely simplistic and derogatory statement. The basic reason why a project is procured as P3 is due to its ability to deliver greater Value for Money (VfM) than other procurement methods. The P3 involves a) risks transfer to the party that best knows how to manage them (mostly the private partner), b) private equity participation and c) private companies responsibles for the operation and maintenance with performance requieres. If a project is bad, that is, it does not deliver value for money, it will be bad in any form of procurement. P3 is a procurement method, and cannot be condemned for its misuse. It is like saying that a tool does not work, when in fact it is the user who does not know what this tool is for.
  • 2. DANIEL VICTOR MELO Infrastructure Finance & P3 Specialist People who believe in public infrastructure should really take a close look at Southern Europe and why they got into trouble. As in all orders of life, there are cases of success and failure. What happened in Southern Europe (not in all the projects how is suggested here) is the opposed to what happens in Australia, New Zealand, Canada, and Great Britain, where there are P3 projects that work very well. In South America, Chile's road concessions are another example that works well. In the US, HOT lines in Virginia (http://www.p3virginia.org/categories/completed-p3-projects/) are also a solution that today work fine for both the public and the private sector. Private companies are increasingly less interested in investing in these types of ventures. I would say that private companies that invest in Infrastructure are extremely limited in their capacity to invest. Those who do not understand why private companies invest less in infrastructure despite the available capital, citing the lack of attractiveness, do not understand the industry and who invests in Infrastructure. Private participation in infrastructure projects is materialized through the figure of P3. For greenfield and brownfield projects with a certain degree of investment in updating / increasing infrastructure facilities, the only players that accept to invest in these projects are those who understand the risks in the construction phase, that is, the Sponsors, mostly (almost exclusively) construction companies. If we consider the security package total amount represented by guarantees and equities that the Sponsors must place to materialize the universe of potential good infrastructure projects during the construction phase, and we take only construction companies Corporate Balances to back this total amount, we will see that there is no capacity for backing the whole amount needed in working capital loans, bridge loans, insurances and equity for this universe of projects. There are not non-recourse Project Finance for the construction phase, on the contrary, we see heavy security packages for infrastructure projects backed mostly by Construction Companies. The investors money is managed by Investment Funds. Very few investment funds understand the construction risks, and worse, most of them put in very little effort to understand them. The majority of Investment Funds are interested in cash flow after completion, leaving to the Sponsors the heavy burden of
  • 3. DANIEL VICTOR MELO Infrastructure Finance & P3 Specialist covering all the security packages with their Corporate Balances, decreasing their leverage capacity for new projects. Let's see this example: Bridging North America (BNA), a consortium comprised of Fluor, Aecon, and ACS Group, through its affiliates ACS Infrastructure (Iridium) and Dragados, has closed financing for the Gordie Howe International Bridge project, valued at over CAD3.8 billion (US$2.94 billion). The consortium has secured short-term financing to cover the construction period including a bank loan syndicated by five institutions: RBC, Desjardins du Quebec, TD Bank, Mizuho, and HSBC. The financial close also entails the injection of CAD93 million (US$72 million) of private equity by the consortium members at the end of the construction period. Until then, this finance is guaranteed through letters of credit. Fluor, Aecon, and ACS each hold 40%-20%-40% equity interests in the consortium. (http://www.infrapppworld.com/news/megaproject-1341-us-3- billion-canada-usa-bridge-ppp-reaches-financial-close ) As we can see, the burden of Sponsors Corporate Guarantees (all construction companies) is extremely high, and no Investment Funds are participating in this phase of the project. But Investments Funds are not the only ones that do not understand construction phase risks, Banks are in the same position. Everything has to be backed with Sponsors Corporate Guarantees (Corporate Balance Sheet) decreasing leverage capacity for new projects. FIRST PROPOSAL: I perfectly know that risks have to be managed by the part that knows them better, but what would happen if the Investment Funds and the Banks incorporated professional construction risk specialists? Engineering areas acting in the Funds and the Banks, analyzing and quantifying risks during the construction phase in order to revisit the amount to be backed with Corporate Guarantees. I personally worked on some projects where the Bank agreed to reduce its Corporate Guarantees demands after understanding that certain risks were limited and easily manageable due to the very nature of the project. In addition to trying to find a solution increasing the Investment Funds participation and reducing the Project Sponsors Corporate Guarantees burden required by Banks, through a better understanding of construction risks (incorporating work teams staff who understand and know how to quantify
  • 4. DANIEL VICTOR MELO Infrastructure Finance & P3 Specialist construction risks), we can look for a solution trying to introduce new funding providers. SECOND PROPOSAL: The concept of crowdfunding could be incorporated, making it an additional Equity provider for Infrastructure Projects (Crowdfunding is the practice of funding a project or venture by raising amounts of money from a large number of people). There are numerous articles on the internet that deal with this topic in greater depth (https://research.arup.com/projects/crowdfunding-platforms-as-alternative- source-of-finance-for-urban-infrastructure/). As well as small investors can access to finance infrastructure projects through the Municipal Bonds, they could also participate as Equity providers (obtaining better returns) through a platform specifically created for this purpose. They would be able to buy SPV shares (with no voting rights) using the same MuniBonds fundamentals. It does not seem positive to attack Infrastructure and trying to discredit its role by citing cases of failure and debunking one of the best procurement mechanisms that introduce private participation in the development, implementation, and management of infrastructure projects, without seeking alternative solutions to improve the sector attractiveness. A good P3 project starts with a viable cost-benefit analysis (CBA), which after a deeper Value For Money (VfM) analysis, goes ahead only if it is corroborated that it will deliver good value. Next, after defining the financial structure and the payment mechanism, risks are allocated and mostly transferred to the private partner (contract structure), procurement strategy is defined (Request for Qualifications and Request for Proposal), Tender process is launched, Proposals are evaluated, the contract is awarded, and after previous commercial and financial conditions (financial close) are fulfilled, the contract begins to be managed by the private partner under defined performance requirements. There is an orderly procedure that helps to take control of deviations and allows making adjustments much more effectively than the traditional procurement method. The fact of renegotiating 30 or 50 years tenor great magnitude projects due to not contemplated changes that occur after 10 or 20 years of project implementation does not seem to me to be an outrageous thing. Besides, in P3 cases there is a business model (the one presented in the offer) that is validated by the Grantor when the contract is
  • 5. DANIEL VICTOR MELO Infrastructure Finance & P3 Specialist awarded. This business model, not used in projects implemented under the traditional method, allows us to monitor and detect the cause (s) of the difference (s) in a quick and accurate way. In this manner, we know what needs to be adjusted, and we can develop an action plan that allows us to know the origin, impact on the budget and adjustments to be implemented. Additionally, we can discover if changes obey current conjectural causes or if it is a private partner failure. (See the following article: https://irei.com/news/p3s-high-cost-transparency/). The debate is open, ideas about how to improve the financing, transparency, and efficiency in infrastructure projects implementation and management are needed. It is essential to attract investors to help to leverage the much-needed growth in this sector at good rates of returns and well-managed risks.