The big frontier

Overall, $2 trillion (£1.4 trillion; e1.5 trillion) is expected to be lavished on infrastructure projects every year to 2015, with $1 trillion being spent annually for the next 25 years, according to the OECD. But for private financiers, the market remains largely in heavy infrastructure: most countries restrict private investment to roads and bridges, fearing a political backlash if they’re seen to ‘privatise’ social infrastructure such as schools. That might be starting to change.

Governments are keen to create jobs through big building projects, and the credit crunch makes eye-wateringly expensive heavy infrastructure schemes hard to launch: there simply isn’t enough credit available at the moment for $1 billion projects. Throwing up a few schools and fire stations might be a more realistic option, short term. They’re relatively cheap to build, and can scramble some finance even in this market. If governments want to create construction jobs they need to think small – and shiny new schools and the like are always a good vote winner.

They also need to find a new source of money, with state budgets already stretched beyond screaming. “There’s a big assumption from governments that the private sector will help,” says Stephen Harris, Tribal’s international development director. How much of it will be social infrastructure and how much will be things like roads and rail is far from clear, though. “Every country will be different,” says Harris.

At the moment, the global infrastructure market is split in two. A handful of countries are using private money to revamp social infrastructure. The rest restrict private investment to heavy infrastructure. The UK, Canada and Australia lead the first group, although continental Europe is catching up fast. These countries use public private partnerships to fund everything from new railways to schools and hospitals. The UK is the most mature, with the present government using PPPs heavily since 1997, especially in health and education. The crunch forced the number of deals to halve to 30 last year, but they were still worth £6 billion.

Other countries are eyeing the UK’s experience with interest, with France among those intending to use PPPs as heavily as the Brits as it accepts that social infra will suffer without off budget finance. “France has €10 billion of projects coming up,” says Chris Ecob of technical advisors Mott Macdonald. The EU has committed itself to spending heavily on construction to beat the recession, and with France and Germany’s budget deficits well above the 3 percent of GDP eurozone limit, private cash is likely to be the only option. France, along with Spain, Italy and others, has ramped up its schools and health PPP programmes. It will be a few years for such programmes to be fully up to speed, but continental Europe could eventually host a series of national markets to equal the UK’s.
That could be the case for the other two mature markets, Canada and Australia, too. Canada has a strong pipeline of schools and hospital deals, with a C$634 million ($513 million; €398 million) deal for 18 new schools in Calgary and Edmonton agreed last September. Australia’s infrastructure gap has been estimated at A$25 billion (€14 billion; $18 billion), and prime minister Kevin Rudd has promised to make plugging it a priority. New South Wales, Queensland and Victoria have all been busy launching social infrastructure projects including health and school schemes.

So progress is good in countries that accept the idea of using private money to revamp the social side. But there still aren’t very many of them. The question now is whether financial meltdown will force other countries to use PPPs more broadly as well.

Countries like the US, India and the old communist states of Eastern Europe still largely restrict private investment to heavy infrastructure, supported by simple, concessionary-style investment structures. In the US, new president Barack Obama has talked a lot about the need to invest in infrastructure. So far, the focus has been on revamping roads and bridges, but there’s hope the agenda will soon turn to the condition of the country’s schools. “I think the US will move into social infrastructure,” says Ecob.
Harris adds that there has been a major shift in attitude in America in recent months, with roads and bridges dropping down the political agenda as schools, government buildings and health services start to hog the rhetoric. As popular discontent with crumbling buildings increases, so the pressure will mount to use private cash more widely. But at the moment, America remains way behind Europe: it’s starting to talk about using PPPs more widely but doing little.

That makes it fairly typical of PPP development. Generally, PPPs begin with big, expensive heavy infrastructure projects that are politically uncontroversial – few will complain about an airport being privately funded, whereas the stink over private schools can be intense. These relatively simple, concession based projects make some sense for an early market, judging by Egypt. It tried to launch a major schools PPP as its first project. But the scheme had to be scaled down and has been described by one expert as a “complete basket case”. Social PPPs can be too complicated to launch in a new market.

India, for one, seems to have taken the message on board and it is concentrating on heavy infrastructure for the moment. It’s urgently needed. The country has barely any motorways linking its major economic centres, for example. And it’s focussing on plugging these basic gaps as it launches a massive investment programme, with plans to spend $500 billion on infrastructure in 2007-12. Other emerging markets, such as Eastern Europe, are also focussed on upgrading roads in particular.
But things are starting to change. India wants to do some school projects, while countries like Bulgaria and Poland publicly acknowledge the need to improve social infrastructure to maintain the standards set for them under the terms of their entry into the EU.

But why on earth would these countries look at an expanded role for private finance when it’s all but impossible to find? In some ways, it’s far from a recent shift, because the OECD among others has been saying for years that social infrastructure can only be maintained with private cash. Slowly, governments are listening. But there’s also little doubt that things are being accelerated by the desperate search for jobs in the recession. And with governments keen to create construction work at any cost, the present lack of credit means they must look at ?smaller, and safer, projects, with glamour puss motorways and the like unaffordable in the short term.

“For the investor, the social infrastructure deals will usually be lower risk,” says Richard Tierney of accountants BDO Stoy Hayward. There will always be demand for social housing, schools and hospitals, and that makes them look increasingly good in a recession. Rising unemployment “can have a real detrimental effect on, for example, shadow toll income on roads, or the need for rail infrastructure”. Fewer people commute during a recession.

So social infrastructure’s guaranteed, government backed cash flows look increasingly attractive. Better still, these deals are small enough to be doable. In the US, investors aren’t willing to stump up much more than $30 million in debt for a project. That means even mid-sized deals must juggle several different funders, causing sometimes fatal delays to projects.

“It is very difficult to speedily reach financial close with more than two or three lenders,” says Martin McCann, a lawyer at Norton Rose in London. “With the exception of true pathfinder deals such as the UK’s M25, in most cases lenders will only consider ticket sizes of about $20 million- 35 million. Therefore the deals most likely to be financed are around $100 million.”Deals this size are likely to be for social infrastructure. School deals are done at local authority level, for example, and councils are unlikely to require much more than £200 million. And Jim Crossman, of technical consultants Currie and Brown, points to the social housing projects that are “bubbling up” at the moment. “They’re smaller deals so they’re easier to get away and quicker of foot.”

Political factors could also be playing a part. “With the credit crunch really biting, the electorate isn’t interested in new roads or trophy infrastructure if they don’t have decent housing or care for the elderly,” says Tierney. “This has to be one reason for the change of focus in many parts of the world.” Paul Davies, an accountant at PricewaterhouseCoopers, adds: “Given the levels of debt governments have got, I would expect to see schemes focussing on where the political priorities are.”
Robert Osborne of consultants Navigant suggests things might go even further. With budgets squeezed, he says there will be a focus on the ‘same for less’ agenda, and that can only be delivered by spending more on services than on shiny new buildings – very much the preserve of PPPs, rather than project finance type structures.

“I think there will be a move towards investment in change, focussing on how services are delivered,” he says. “This breaks the link with the old assumption that if you build new infrastructure you get improved services. Unless you think about how, for example, healthcare is to be delivered, you’ve wasted money on a shiny new hospital.” The credit crunch could help push the ‘same for less’ agenda forward, because governments might begin to realise they can get more electoral support by delivering good services than new buildings alone.

Maybe, but there’s still no clear evidence of where the money will come from for these more complex projects, or any others at the moment. “Who’s providing the funding?” asks Stephen Peters, an analyst at Charles Stanley. “There is still some interest from the large players in Canada, but beyond that, who’s going to invest? I don’t know.” Many of the traditional sources of investment cash are short of money at the moment, with Babcock & Brown in trouble and the likes of Macquarie now a lot more conservative over funding.

But the big problem, of course, is over debt for these traditionally highly leveraged deals. “While debt and equity have gone out for lunch, deals are just not happening,” says Crossman. “Colleagues are spending a lot of time on projects that are going nowhere. The will is still there but the last bits of the jigsaw puzzle are not.” Politically, the battle for social infrastructure investment looks increasingly close to being won. But that might not translate into many deals for a good few years yet, at least outside of the established markets.