There’s a storm coming

Optimal conditions have arrived for greenfield PPPs in the US, but who will benefit? Andrew Fraiser of Allen & Overy examines the evidence.

Despite the exponential rise in the number of states that have enacted public-private partnership (PPP) legislation over the last five to seven years, it is interesting to note that more brownfield PPP deals closed in the US prior to the start of the Great Recession than have closed since.

Some argue that consequential increases in the cost of capital and/or lack of liquidity in the debt and capital markets are to blame, but the more sophisticated answer is that public authorities are keener than ever (in some cases too keen) to demonstrate “best value” to their taxpayers before entering into such transactions. 

In short, it is becoming increasingly common for brownfield projects to hit road blocks while the relevant public authority tries to find ways of objectively demonstrating to its critics the socio-economic value (as opposed to the economic benefit) of disposing of an asset -and that is where the problem lies, because broadening the definition of “value” beyond “highest tendered price” requires the application of subjective judgement and invariably results in a reduction to the market value of the asset.

Ironically, the greenfield PPP market may, in the medium term, be able to help unblock some of the bottlenecks that are plaguing the brownfield market, for the following reasons:

– Through the successful implementation of less politically contentious greenfield projects, empirical data can be collected to demonstrate that many of the concerns associated with brownfield projects are unfounded (e.g. risks of foreign ownership, short-term “fat-catism” and operator performance);

– Provided the relevant infrastructure is considered essential and the environment is respected, new infrastructure projects are generally well received by both politicians and taxpayers, allowing good news stories to be generated in relation to the successes of PPPs;

– Although greenfield projects do not typically involve the transfer of labour from public to private sector, an increasing presence in the US market of privately operated infrastructure can only serve to assist in demonstrating to labour union activists that there are benefits to doing the same job in the private sector; and

– One of the frequently cited benefits of greenfield PPPs is that they require the public authority to properly articulate what it wants and demonstrate that a PPP solution represents better value for money. It is not simply a question of several bidders competing on price.

Notwithstanding the theory behind why greenfield PPPs may be able to assist in unblocking some of the bottlenecks affecting the brownfield space, the US greenfield PPP market is pretty thin when it comes to the number of deals currently in procurement. The good news is that 2011 should mark a step-change in deal flow – the greenfield PPP equivalent of the “Perfect Storm” is making its way to the shores of the US and it not a question of whether it comes to pass, but where it comes to land. 

Those states that manage to join the dots between the factors that have accidentally come together to form this perfect storm will deliver to their taxpayers billions of dollars of new infrastructure at bargain basement prices and at the same time stimulate their local labour markets. The message has to be – act now!

Furthermore, they will be able to do this without spending a single cent for several years, within which time state tax revenues may recover to levels much closer to those achieved before the onset of the Great Recession. The perfect storm has arisen as a result of the following factors simultaneously coming to bear on the market:

Historically low construction costs – construction costs are running at historically low levels. To the extent that public authorities can accelerate their spending programmes, comparatively high levels of construction per $ can be achieved.

Decreasing tax revenue – “Buy now, pay later” – although studies show signs that state tax revenues are increasing, they are still at historically low levels and the impact of the collapse of the property market has not yet impacted tax revenues. Greenfield PPPs allow public authorities to purchase infrastructure now, but commence payment for it in several years time, when it is hoped that tax revenue levels will have re-stabilised.

Unemployment – all states currently have a desire to kick-start their labour markets and provide opportunities for their unemployed to return to work. Accelerating infrastructure spending will assist in achieving this objective.

Low political risk – in comparison with brownfield projects, experience in both the US and elsewhere shows that greenfield projects are less politically sensitive. Ask any American if they would like to see the toll road that they most regularly use privatised and the answer is invariably an emphatic “no!” Ask the same American if they would like to see new infrastructure built in their community that will be operated by a private company and the answer is invariably “yes, in fact I don't care who operates it. I just want it.”

Limited collective bargaining – several brownfield PPP projects in the US are currently being prejudiced by the scope of collective bargaining powers held by the labour unions. One of the key benefits of greenfield PPP projects is that they rarely involve any labour movement between the public and private sector.

Increasing muni bond yields – for most of 2010, yields on municipal bonds were at historically low levels, but towards the end of Q4, there was a sharp spike. Analysts are predicting a difficult year for the municipal debt markets and that is likely to result in most public authorities’ weighted average cost of capital increasing. One benefit of this is that it reduced the gap between the cost of public and private debt, an issue that is frequently cited by critics of PPP.

TIFIA programme / mezzanine debt – the TIFIA product works and the market has now found ways to structure around some of the novel features of it (e.g. the springing lien) but as many states have learnt to their detriment, it is in short supply. Although more expensive than TIFIA money, the arrival of mezzanine debt funds in the market is timely – in due course, it will be interesting to see the extent to which the new mezzanine providers will have any appetite for greenfield PPP projects.

The Perfect Storm will soon hit the shores of the US, but which states will it pass over and which will it rain down on? There are two key factors that will determine this – the creditworthiness of a state and its friendliness towards PPP. The creditworthiness of a state is fundamental for the following reasons:

– Appropriations risk: with regard to availability payment projects, the US PPP market has already encountered the difficulty of banking projects in the states that have high levels of debt (e.g. Long Beach Courthouse); and

Demand risk deals: precedent has demonstrated that in order to achieve the minimum credit rating required for greenfield PPP projects, there needs to be either very low gearing on the project or some form of mezzanine tranche of debt to attract interest from the senior debt market (be it commercial bank debt or the capital markets). TIFIA has performed this role on many projects to date, but as the number of greenfield projects in the market increases, who will provide the mezzanine tranche if TIFIA funding is not available for the project? Mezzanine debt funds that are currently being raised may be the answer, but another option is the provision of mezzanine debt by the public authority procuring a project, perhaps even replicating the TIFIA product. This should not cause concern for highly rated state governments that have relatively low costs of capital.

Andrew Fraiser is a partner and member of the projects practice at law firm Allen & Overy in New York