P3s An Infrastructure Development Tool

Transcription

1 P3s An Infrastructure Development Tool to Evaluate with Caution By J. Ben Watkins and Nora Wittstruck

2 Public-private partnerships (P3s) are transactions that involve a wide variety of activities or enterprises. P3s generally involve an agreement between a publicsector entity and a private company, and the partnership is reflected in complex legal documents detailing the rights, responsibilities, and obligations of the public and private participants. A complete and thorough understanding of the details contained in the partnership agreement is critical in protecting the public participants interests and ensuring the benefits of a P3 arrangement. P3 agreements can take various forms, from contracts to operate a concession (e.g., a service contract for a vendor to operate food services on a university campus), to bundling design and construction with a single private firm (e.g., a design-build contract), to procuring a private concessionaire to design, build, finance, operate, and maintain public infrastructure under a long-term agreement (e.g., a concessionaire agreement to design, build, finance and operate a toll bridge). Public-sector entities have traditionally used P3s for outsourcing services where the private sector could operate more cost effectively. Recently, however, P3s have evolved as an alternative to using traditional tax-exempt bonds to finance infrastructure and as a way to address a public entity s budgetary pressures by receiving an upfront payment in exchange for the sale or lease of a public sector asset (e.g., parking garages, toll roads, or utility systems). When used as an alternative delivery mechanism for financing infrastructure, the P3 method usually involves selecting a private party, or the concessionaire, to design, build, finance, operate, and maintain a project for the public sector s constituents. A complete and thorough understanding of the details contained in the partnership agreement is critical to protecting the public participants interests and ensuring the benefits of a P3 arrangement. The evolution of P3s as an alternative delivery mechanism for developing and financing infrastructure has generated significant interest in the public sector under the premise that the private sector can deliver capital assets more efficiently and cost effectively. However, this generally only works in the public sector s interests when it provides adequate August 2015 Government Finance Review 33

3 safeguards, ongoing oversight, and maintains control over important elements of the transaction and subsequent operations. Therefore, publicsector participants must carefully and thoroughly evaluate any project with a proposed P3 delivery method. P3 proposals should be approached cautiously and only executed after carefully evaluating alternatives and thoroughly understanding all costs, risks, and obligations involved in the transaction. POINTS TO CONSIDER Statutory Authority. When the governmental entity starts evaluating this potential delivery mechanism, it should first determine whether it has clear statutory authority, which provides a framework for procurement, evaluation, and oversight. Governments also need to make sure they include all relevant parties (e.g., outside professionals such When the governmental entity starts evaluating this potential delivery mechanism, it should first determine whether it has clear statutory authority, which provides a framework for procurement, evaluation, and oversight. as bond counsel and a financial advisor) in the process of evaluating the alternatives. The government s finance officer and/or debt manager should be included throughout the process to help define the goals and objectives of the P3, evaluate the impact of the P3 obligations on the government s long-term liability profile, determine the differences in financing costs between taxexempt debt and the private-sector concessionaire, and validate estimated project costs, revenue projections, and operating performance (if the project is expected to generate revenues). The financing costs associated with a P3 are typically higher than those of a project financed with traditional tax-exempt debt because of the higher returns required by private-equity investors. These higher financing costs may be offset by operational efficiencies or risk transfer that warrant using a P3 instead of traditional public-sector procurement, project development, and financing. For example, when developing a start-up toll road, the higher financing costs may be appropriate because the P3 concessionaire takes on the ridership risk if the traffic and revenue do not perform as projected, rather than exposing the governmental entity. However, under availability payment P3 agreements (where the governmental entity appropriates a payment to the concessionaire for operating, maintenance, and capital costs of the project) construction risk may be transferred, but the government retains other operating risks in which case the tradeoff must be carefully evaluated in relationship to the higher financing costs. In any case, a P3 is justified only when the expected benefits of using a P3 outweigh the higher financing costs. Cost-Benefit Analysis. The financing costs associated with each delivery method are only one area to consider when evaluating the costs versus the benefit of a P3. Another consideration is the cost savings associated with having the private-sector entity operate the facility, allowing the public sector to forego new staffing requirements. This is also 34 Government Finance Review August 2015

4 important if the government lacks the necessary business expertise to operate the enterprise. Additionally, integrating the design and construction of a project with a design-build contract can add value by making one firm responsible for both aspects of project development; this can be more cost effective than a low-bid contract. In all cases, the public-sector participant should expect recurring costs associated with the time and effort necessary to monitor the concessionaire s performance and ensure accountability. Lastly, the government should consider whether the P3 will affect similar operations or governmental enterprises. Numerous assumptions drive the cost-benefit analysis, and the public entity should be prepared to consider each of those assumptions and conduct due diligence to determine whether the assumptions are realistic. In many P3s, the cost-benefit analysis and value of the project is justified by a value for money analysis, which is usually prepared by the professionals involved in the transaction (e.g., the financial advisor in consultation with the private-sector concessionaire). The public entity should independently validate the assumptions and conclusions in the value for money analysis, which may be biased toward demonstrating value, especially if the financial advisor s fee is contingent on successful execution of the transaction or the financial advisor s business specializes in P3 advisory work. The value for money analysis should demonstrate that the P3 delivery method provides benefits to the public entity over a traditional project delivery method and justifies the higher financing costs of a P3. Security Provisions. Following a comprehensive costbenefit analysis and evaluation of the risks that are retained by the government and the risks that are transferred, the public entity needs to review the amount of equity (if any) the concessionaire must contribute to the transaction to ensure that it is protected throughout the term of the agreement. Other security provisions include payment and performance The financing costs associated with a P3 are typically higher than those of a project financed with traditional tax-exempt debt because of the higher returns required by private equity investors. bonds, work warranty agreements, and required renewal and replacement, maintenance, or handback reserves the concessionaire funds by the end of the term. Security provisions and specified remedies ensure that the governmental entity is protected if the transaction fails to perform as envisioned (i.e., termination by the concessionaire or the public entity before the end of the agreement). These provisions also attempt to insulate the governmental entity from the substantial cost of renovating or repairing the project after the end of the term and the handback by the concessionaire. Return on Investment. Finally, the public participant must consider the private party s return on investment (ROI) for developing and operating a public asset through a P3 agreement. The concessionaire has a vested interest in maximizing profits, and the governmental entity should limit August 2015 Government Finance Review 35

5 the user fees or rates charged and/or share in the profit or ROI. By entering into a P3 agreement, the governmental entity is granting a franchise to develop public infrastructure, and the concessionaire s profit should be appropriately capped or shared with the government accordingly. CONCLUSIONS When considering critical infrastructure needs and investment, P3s provide an alternative tool that governmental entities may choose to consider. The benefits of using a P3 to develop public infrastructure should be considered in the context of the risks and costs associated with the use of a private concessionaire. The costs and benefits should be carefully analyzed, with all appropriate members of the public entity involved in the discussions and analysis especially the finance officer or debt Also consider the cost savings associated with having the private-sector entity operate the facility, allowing the public sector to forego new staffing requirements. manager. To best serve the public s interests, governmental entities should exercise caution and critically evaluate all aspects of the P3 agreement and transaction to ensure that the P3 generates the proposed benefits and more than offsets the higher financing costs. For more information on evaluating P3, see the GFOA best practice, Public-Private Partnerships, available at y J. BEN WATKINS is director of the Florida Division of Bond Finance, a member of the GFOA Executive Board, and a former chairman of the GFOA Committee on Governmental Debt. NORA WITTSTRUCK is a bond development specialist with the Florida Division of Bond Finance and was an assistant vice president and analyst with Moody s Investors Service. Create change. Create hope. Citi recognizes the work of Government Finance Officers Association and those who work together to build a better tomorrow Citigroup Inc. All rights reserved. Citi and Arc Design is a registered service mark of Citigroup Inc. 36 Government Finance Review August 2015