Category Archives: Blog

P3 May Prove Decisive In US State Elections As Cutbacks Get Ugly

By Henry Teitelbaum, Managing Editor, P3Planet.com

The difficult choices facing state governors and legislatures  across the US over how to maintain essential services amid worsening state budget deficits have been set into sharp relief by the July 1 start of the fiscal year.

Every state but one  (Vermont) is required to balance its  budget every year by law, and the strains are being felt across the country, with society’s most vulnerable, as usual, the most affected.

This is because declining stimulus funding from Washington and shortfalls in tax revenue collections due to continued high unemployment and the weak housing market are occurring simultaneously,  leaving governments no choice but to cut public jobs and services, sometimes drastically. The Center on Budget and Policy Priorities, a Washington, D.C. research institution, says 46 out of 50 states face shortfalls for the fiscal year that started July 1, with the bill totaling some $112 billion. Estimates vary somewhat according to which agency you ask, but most agree that the current fiscal year is going to be the worst of the cycle for cutbacks, as all of the easy cuts and accounting tricks have already been largely done.

A browse through local headlines gives you  an idea of how dire the situation has become. New Jersey, my home state, cut $1 billion from education to help close an $11 billion deficit, while Idaho cut aid to low-income elderly people and the disabled. Mississippi cut funds for the only juvenile delinquency training facility in the state, while California, still mired in recession with unemployment at 12.4%, is considering ending welfare for 1.3 million poor families to help close a $19 billion budget gap. Municipal governments there are taking even more drastic action, as shown recently by the city of Maybury, which fired its entire workforce, including the police.

All of this adds up to some very alarming polling figures for anyone unlucky enough to be an incumbent running for re-election in state or local elections this fall. It’s not as if anyone wanting to stay in office didn’t already have an uphill battle ahead of them after a year of  Tea Party anti-tax protests  across the nation. Now incumbents are becoming magnets for voter fury over real cuts in real services. Populist opponents are certain to claim that these cuts were unnecessary and that they could do better – at least until they’re in office and find out for themselves just how empty the coffers are.

What I find interesting about these elections is that incumbent Republicans and Democrats are just about equally vulnerable to the protest vote that we are about to see. There are 14 incumbent gubernatorial races to be contested this November, seven of which are Republican seats, and another 25 state elections for which incumbents are either not eligible to run, or else not seeking re-election, 13 of which are Republican.

With anti-incumbent sentiment running so high, and with so much at stake, it would seem natural for voters to give more than passing consideration to candidates who can demonstrate skill sets that will help them to manage this crisis without shutting everything down.  Of course, anyone running for office will be promising to find ways  to maintain services, create jobs and pave the way for a more productive and prosperous future for their local economy. That’s what politicians do. But most won’t really possess the background experience and the skills to deliver on those promises because few, if any, have ever had to operate within the constraints of the public sector that is so fiscally stressed that reliance on private financing is not so much an option as a requirement for the job.

Which brings me to my point. Public-Private Partnerships, or P3, should be at the forefront of any realistic debate over how state and municipal governments continue to deliver services and fulfill their campaign promises over coming years. P3 is a form of long-term contracting that allows public authorities to substitute private sector investment for increasingly precious public money in projects where its needed most – upfront. The model also creates a transparent and predictable schedule for long-term repayment of the private investment, typically over 20-30 years, that public sector authorities can live with.

Well-structured programs of P3 investments are being used around the world to counter some of the worst effects of recession by maintaining long-term investment spending and creating well-paid private sector jobs. This is being done especially to support investment at times like these, when government priorities have shifted from pump-priming the economy to cutting deficits.

Across the U.S., states have been adopting P3-enabling legislation at an accelerating pace, and states like California, New York, Virginia, Florida, Colorado,  Indiana and Michigan are starting to develop its potential for helping them through the crunch and then beyond. Projects such as the FasTracks municipal rail system in for Denver and the proposed Windsor/Detroit bridge project, both of which are going forward as P3 projects, or Washington State Department of Transportation’s exciting I-5 Alternative Fuels Corridor, which may become one,  are examples of how government can  engage the private sector for investment,  stimulate innovation and boost the economy while developing the transportation infrastructure of the future.

Comprehensive approaches such as the one adopted by Michigan Governor Jennifer Granholm (D), who has established a specialized office for developing expertise in the use of the P3 model in transportation, education, energy, water, corrections, public safety and information technology are clearly pointing the way forward.

But much of the work there builds on the achievements of California Governor Governor Arnold Schwarzenegger (R), who had the courage  to go to British Columbia and adopt the best aspects of Canada’s approach to procurement using the P3 model. At the end of the day, candidates for state or local office need to understand that P3 is not part of some political manifesto of the left or the right. It is simply a tool for advancing public policy objectives that makes use of the full range of resources that are available to the procuring authority.

Neither of these governors is running for re-election this year, but their legacy will be to challenge successive administrations to build on their efforts, whichever party wins.

The ability to call upon P3 for the badly needed infrastructure solutions to  the challenges facing our states and communities, and for political candidates to demonstrate the skills needed to effectively engage the private sector should be at the top of everyone’s agenda for this election.

Better Late Than Never: Dubai Gets Real About The Need for PPP

By Henry Teitelbaum, Editor, P3Planet.com

Being broke is not a necessary precondition for financially overstretched governments to discover the attractions of public-private partnerships for essential public infrastructure. But it sure helps.

A case in point is the tiny emirate of Dubai. The government’s efforts to turn a small Gulf port city into the pre-eminent global financial center of the Middle East and top tourist destination for the ultra-wealthy were at first financed by oil and gas reserves. More recently, spending has been sustained through the inflation of one of the world’s most over-valued property markets.

Over the course of the past five years that this was happening, Dubai’s more prudently run neighbours – notably Abu Dhabi – but also Jordan,  Bahrain, Egypt, Israel and even Saudi were busy preparing the regulatory groundwork for creating long-term value through PPP. Dubai for its part has made few efforts to sort out its own regulatory regime so that it too might  benefit from  the private investment, expertise and risk management that PPP can provide.

There’s really no excuse for this failure. Fellow emirate Abu Dhabi, which has a smaller population and far greater carbon-based energy resources upon which to rely for funding its social and economic infrastructure projects, has been using PPP since 2005 and now has one of the most active pipelines of PPP development work in the Middle East. Its Abu Dhabi Water & Electricity Authority has successfully procured 10 integrated water and power projects using the model, and has been applying it to ever greater effect in developing schools, hospitals, transportation, military projects and universities.

The $2 billion 400 km road stretching across Abu Dhabi to the Saudi border and a $1.7 billion Satellite facility are two recent examples of how sophisticated the emirate has become in applying the model. They also exemplify a key point about PPPs, which is that the model can deliver value for money to public authorities in both the short-term through on-time, efficient delivery, and over the long-term, through operations and maintenance contracts that oblige the private sector companies to stand behind their work.

While Abu Dhabi was busy lining up its ducks, Dubai made little productive use of PPP, signing a single $150 million waste recycling facility in 2007 and an operations and maintenance contract for its Metro system in 2008. Projects in the emirate have faltered with private developers due to the lack of a robust regulatory regime to support PPP.

This is a pity, as Dubai reels from a humiliating bailout and contemplates the realities of a shrinking economy and the end of its oil and gas-driven spending bonanza. It took a financial crisis to focus attention in Dubai on what its regional neighbours and competitors have been doing for years in PPP.

But it’s also good to see that people there are willing to listen and learn. A recent study from the Dubai Chamber is now calling for greater use of PPP in Dubai and throughout the UAE.  “Increasing PPPs will not only provide the government with a mechanism for financing, but also much needed public infrastructure at lower costs and high quality outcomes,” the report said.

That’s the kind of progressive thinking that Dubai needs to show more of at home – starting now.

Jarvis Collapse Offers Cautionary Lesson For All PFI Contractors

By Henry Teitelbaum

 

The recent collapse of rail and public infrastructure developer Jarvis PLC marked the end of the line for yet another company that relied too much on  ambition and good timing for its success.

 

The story-line is more suited to that of a dot-com casualty than a stodgy ‘old economy’ business built largely around the long-term services that come from 25-plus-year Private Finance Initiative contracts. But Jarvis, which grew from a shell of a company worth around £2 million in 1994 to Britain’s largest engineering and construction company in less than 10 years before its luck ran out, should be a case study for how not to manage a business that operates in the PFI space.

 

It should also help to reinforce the need for companies to share and uphold the public service values that should be at the core of their commitment to the communities they serve. 

 

Jarvis began its spectacular rise with the privatization of British Rail, when its then-CEO, Paris Moayedi, realized that key maintenance assets, including some of the most advanced track laying and upgrade vehicles in the world, were being put up for sale for a song. He bought the company that operated them, NIMCO, and instantly turned Jarvis into a leading rail maintenance force, responsible for upgrading key lines across the country.

 

Jarvis didn’t just become an overnight sensation and leading player in a lucrative market for maintenance services to the newly privatized Railtrack. It’s acquired  technology allowed it to earn margins of 8%, or about twice that of its peers at Amec, Balfour Beatty and other established competitors. Moayedi, who famously scoffed at the margins others were earning for their work, reportedly responded to questions about Jarvis’ margins by commenting “I don’t get out of bed for 3%”, a remark that would later come to haunt the business.

 

Moayedi’s ambitions led him to next focus Jarvis’ attentions on the developing PFI market in the UK, which began under Tory chancellor Norman Lamont in 1992, but was embraced with fervor by Tony Blair’s New Labour government as it strove to deliver improvements to roads, schools, and healthcare services. 

 

Jarvis quickly pushed to the front of the pack, winning preferred bidder status in tenders on everything from major motorway projects to new schools and hospital accommodation projects. Driven by Moayedi’s desire to build a huge forward order book, Jarvis drastically underbid competitors to get public authorities to award them PFI contracts, even when the company’s capacity to deliver was strained. When timetables began to slip, things got ugly. Jarvis would blame its legions of subcontractors for the problems and at times failed to pay them, leading to more costly delays and legal disputes. 

 

But it was the tragic accident at Potter’s Bar that really brought matters to a head. Although the company had admitted responsibility for several other derailments, the May 2002 crash in which seven people were killed raised questions about the  company’s commitment to passenger safety. While there was, and still is no evidence to show that Jarvis deliberately cut corners on safety in delivering maintenance on the tracks for which it was contractually responsible, the attention that the incident brought to the company’s industry high profit margins, along with its poor response to questions about its practices left lingering doubts.

 

It wasn’t long before the doubts reached Moayedi’s office. They combined with howls of anger at the overstretched state of Jarvis’ PFI business and its habit of recognizing profits not yet earned from long-term contracts, to force the CEO out in 2003. 

 

Several debt restructurings later,  Jarvis was up against the wall, forced out of the accommodation business, and beating a hasty retreat to a much reduced rail maintenance operation. It was even forced by the cash crunch into selling the  lucrative £150 million equity stake in the TubeLines consortium that would go on to deliver upgrades to the London Undergound. 

 

Then, when Network Rail took over from the failed Railtrack as operator for the UK’s rail infrastructure in 2004, it was Jarvis that suffered the most from the greater discipline that was applied by the new operator to how money was spent. Much work was taken in-house and spending on other projects was postponed. Other major rail contractors were also winning a larger slice of the remaining work that was up for grabs. All this was happening to Jarvis at a time when its reliance on rail maintenance and upgrade work was nearly complete.

 

The final blow came when the recession led Network Rail to further cut new contracting work, leaving Jarvis no choice but to enter administration.

 

One has to feel for the 2,000 rail workers at Jarvis who now face an uncertain future. But Jarvis and the style of leadership that marked its heyday will not be missed.

 

There are many in the UK who now believe that PFI is nothing more than an invitation for private companies to raid the public purse, deliver enough of a school, healthcare facility or other public facility to meet the letter of the contract, and move on to the next one. Where this has been the case, it is often the likes of Jarvis that has been responsible for that perception. 

 

In the end, though, Jarvis’ shoddy, short-term profit driven approach to business availed the company and its shareholders very little. The lesson for anyone building a business around PFI contracting is that you either plan for the long-term and build your business around delivering quality long-term services to your customers, or expect to fail. 

 

In the end, good businesses get rewarded. And bad businesses go to the wall. 

London Underground PPP Still Holds Best Hope For Tube Improvements

LONDON – Despite all the shouting, the public private partnership (PPP) tasked with fixing much of the London Underground is clearly delivering the goods. It’s been a messy, rancorous and politically-charged experience, but seven years into the project, the record points to improved services and value for money.

The project was never going to be easy. London Underground is a Victorian sprawl of multi-gauge rail track, dilapidated stations and ancient power & communications networks. It was littered with nearly two centuries of accumulated kit that was frequently incompatible from line to line. For decades, neglect of maintenance left a system that was dangerously overcrowded and easily brought down by the slightest problem. This shambles was and remains the world’s most expensive for customers by far and it’s still losing money.

As if the engineering challenge wasn’t enough, the political backdrop was decidedly unsympathetic. The 30-year PPP contract was imposed in 2003 by the UK’s Department for Transport over the objections of London’s transportation authority, Transport for London (TfL), and public sector unions. London’s newly installed mayor, Ken “Red” Livingstone, did everything short of throwing himself on the tracks to block the PPP.

Fast forward to 2010, and the whole PPP experiment looks to be unravelling. Metronet Rail, the larger of the two consortia engaged to deliver the upgrade work, went spectacularly bust in 2007 after failing to control costs. Not only did the consortium’s five member companies take huge investment write-offs, but taxpayers were on the hook for up to £410 million of the losses. That wasn’t supposed to happen, according to the way risk transfer is designed on such deals.

The other consortium, Tube Lines Ltd., is some 10 months behind schedule on its upgrade of the Jubilee Line at a monthly cost to the company of about £4 million in penalties, plus additional costs for keeping subcontractors on the job. It would take a small miracle for Tube Lines, which is owned by Bechtel and a unit of Spain’s Ferrovial, to break even.

Meanwhile, negotiations on a second seven-and-a-half-year funding period from July 1are looking unpromising. The independent PPP Arbiter, Chris Bolt, priced upgrade work on the Jubilee and Northern Lines for this next period at £4.4 billion, or some £1.35 billion below Tube Lines’ estimate, a significant funding gap for the company. Tube Lines has also lost a £327 million compensation claim against London Underground relating to cost overruns on the Jubilee and Northern Line upgrades, creating concerns over its solvency. In a further setback, Mayor Boris Johnson last month called on the UK’s Transport Secretary to block the payment of £1.1 billion of secondment fees to shareholders of Tube Lines to help fill a funding shortfall at TfL.

Politics is complicating matters in other ways. The opposition Conservative Party originally gave tacit support to the Labour government’s embrace of Private Finance Initiatives (PFI), a moniker that was first introduced by the last Conservative government in 1992 for its own PPP program. With a general election imminent, though, the Tories have turned against the program, with shadow chancellor George Osborne pledging to end PFI as we know it in the UK if the Conservatives come to power.

Ancient infrastructure, years of neglect and high-octane politics all seem to have conspired to produce a truly British debacle that is so typical of this country’s infrastructure spending.

But there’s another side to the story: Tube Lines is actually doing what it was intended to do. The key performance indicators by which the PPP’s delivery of maintenance and upgrade work are measured are being achieved, and this publicly available information deserves more attention.

On track maintenance, for example, the costs per kilometer since Tube Lines took control of the Jubilee, Piccadilly and Northern Lines have fallen steadily. They are down some 20% since the 2003-04 measurement period and currently stand around £72,000 per kilometer. This compares with around £170,000 per kilometer for the other consortium, now consisting of the collapsed Metronet and London Underground itself. What’s more interesting is that Metronet/LU’s maintenance costs have risen during the comparable period and have shown no improvement in the latest 2008-09 period, which post-dates London Underground’s takeover of maintenance on the former Metronet lines.

Rolling stock costs are more difficult to compare from line to line because of wide variations in the fleets that need to be maintained. Nevertheless, Tube Lines’ costs are now on average some 30% below Metronet/LU per car. And while Tube Lines can claim to have scored significant cost efficiencies on the basis of its accounting procedures, it is difficult to determine whether any efficiency gains have been delivered by its public sector-run counterpart at all.

Efficiency gains are also coming through in station upgrades. At Tube Lines, work on all 96 stations that were scheduled will have been delivered on-time and on-budget by the end of the first review period. But station renewals on a scaled down program for the former Metronet lines were running 62% behind schedule in 2008/09. These differences reflect specific changes Tube Lines brought in to better manage staff and supply chains and to improve organization and logistics. One result is that the upgrade of Waterloo Station, a major interchange, cost Tube Lines only £18 million to complete, as little as one-fifth what it will likely cost the LU to deliver comparable improvements at Oxford Circus Station.

There have also been service improvements. Notwithstanding weekend outages, the number of lost customer hours on Tube Lines is down by 50% since 2003 because the private contractors target maintenance and upgrade work around problem hotspots rather than using a simple calendar based schedule. This is no accident: financial penalties on Tube Lines come straight off its bottom line when customer hours are lost during high passenger traffic hours. At London Underground, there are no meaningful financial penalties since it is all taxpayer money.

The improvements delivered by the private consortium to date suggest an even more compelling reason to continue with this and other PPP projects. Without the PPP, there would be no way to assess public sector performance on delivery, value for money or to even determine, let alone share best practice across the London Underground. There would simply be no performance standard against which  London Underground maintenance and renewal work could be judged, no basis for demanding more efficient delivery of public sector services and no way to control costs. Indeed, that lack of scrutiny over the decades is what got the Tube into such a mess in the first place.

At the end of the day, PPP is simply a model for improving delivery of public projects by using the best skills, financial resources and risk management capabilities of the private sector. The mixed experience of the London Underground PPP to date should be seen more as the front end of a steep learning curve than a failure. Anyone riding the Tube before PPP came along knows what a failure that was.

Infrastructure UK: Nice Idea, But Can It Deliver What’s Needed?

It’s easy to be cynical about New Labour’s late season roll out of an advisory body to develop long-term infrastructure planning for the UK.  Was it, for example, only the prospect of a close election that finally pushed Gordon Brown to order up a long-term strategy for meeting Britain’s infrastructure needs? If so, that would put the PM only about 15 years late with the idea. Or was it shadow chancellor George Osborne’s recent promise to end PFI as we know it that caused Labour to realise how profoundly vulnerable it was on the issue?

I’m not privy to the motives, but I do know that New Labour has been its own worst advocate for PFI. Throughout the six-year course of  government efforts to improve healthcare and education infrastructure, not once did I hear either Gordon Brown or his predecessor, Tony Blair, confront the hostile and often ill-informed press attacks on the use of PFI to deliver those improvements. Nor, for that matter, have government’s  industry partners ever presented a  case for PFI.  That’s a terrible record, particularly for a government that in other aspects of policy seemed obsessed with its public image. But the greatest crime, as many of those involved in putting together proposals will attest, is Labour’s failure to improve the PFI model itself, to make it simpler to use or more cost-effective.

The fact remains that while Labour dithered with mostly ineffectual efforts to improve the process for engaging private financing, expertise and risk management, public sector authorities across Europe, North America, Asia and Australia were busy demonstrating that it could be done. Countries around the world have now long since surpassed the UK by adopting the best practices of the UK model and making them far better. They have demonstrated, for example, that by establishing clear decision-making criteria and putting the right people in charge, they can lower costs, accelerate the tendering process and improve outcomes. It’s not by accident that as states across the US struggle with their fiscal demons, it is to Canada and Australia, and not the UK, where they look for ways to engage private money for public assets and services.

Much of the problem in the UK relates to the way procurement in the public sector operates. The UK is a crazy quilt of local, departmental and central government planning authorities, some with closely linked responsibilities and each with its own ideas and own special interests to protect. Everyone has got their finger in the pie, management responsibility is always diffused and no-one ever takes charge. A typical example might be the way schools procurement works. You start with the local authority, the Department of Education and the Treasury all seeking the same outcomes, but all with their own staffs, priorities  and timetables.

What Mr. Brown has done has been to add new layers of bureaucracy instead of improving the process. Partnerships UK, which was designed to accelerate project delivery and will now be largely subsumed by Infrastructure UK, is just one example of a well-meaning government effort that has failed in its mission to reduce the time it takes to deliver projects.

So while other jurisdictions around the world have streamlined decision-making by establishing clear lines of responsibility, empowering small teams of trained civil servants and getting out of their way so that they can do their jobs, the UK has been busy adding people to oversee an already bloated and sclerotic procurement system. This has  added to costs, demoralized the best public administrators, and still not achieved the desired goals. No wonder staff turnover is high, with the system requiring regular short-term transfusions of expertise from the private sector.

It is in this context that Infrastructure UK is being introduced. Hardly the “proactive approach” to addressing infrastructure challenges that its comes billed as, Infrastructure UK is an overdue attempt to consolidate the excessive number of policy, financing and delivery bodies that have grown up over time. To its credit, however, Labour appears to be quietly acknowledging the inadequacies of its existing models, the seriousness of the infrastructure challenges, and the critical role that the private sector will need to play in whatever models are adopted.

The challenges are huge, with some GBP200 billion of infrastructure investment needed over the next decade, including new investments in waste recycling projects, low carbon energy production, high-speed rail and telecommunications. Moreover, the UK banking system’s capacity to support this investment has been severely constrained by the financial crisis, with two of the largest UK bank investors in PPP/PFI now owned by HM Treasury itself. The need to tap into alternative long-term institutional and retail investment has never been stronger, and will persist long after the banking system recovers.

The idea of an Infrastructure Bank to support long-term investment in infrastructure clearly has momentum behind it. It shouldn’t be seen as a substitute for PPP/PFI, but rather as part of a “mixed economy” for enabling private investment in infrastructure. If the structure of such a utility allows it to avoid the same pitfalls that have befallen PPP/PFI, all the better.

But the key measure of success for Infrastructure UK will be whether it can roll back the layers of institutional red tape that have bogged down the various bodies it is set to absorb, so that Britain can start to build the 21st century infrastructure that the country needs and the people deserve. The record of achievement isn’t promising, but one lives in hope.

Texas Cedes Leadership After Moratorium Puts Toll Road PPPs On Ice

The great state of Texas takes pride in the grandness of its visions, the ambitiousness of its undertakings and the scale of its achievements. From the wild-catting days of the late 1800s to Mission Control, Houston, the pioneering spirit of Texans has been an inspiration to the nation and the world.

So when the idea of building a new 4,000-mile network of giant multi-modal super-corridors took shape to supply modern transportation infrastructure, move people and goods from the Gulf Coast and Mexican border through to the major population centers and on to the Oklahoma border, it was bound to be big.

And so it was. The Trans Texas Corridor project, I-35, would have been 370 meters wide, four American football fields,  and run for 6,400 Km. It was going to supply multiple lane toll highways for passenger traffic, separate lanes for freight travel, rail lines, water pipeline, natural gas and oil pipelines, fiber optic cable lines and even power transmission infrastructure for wind energy. In so doing, it would have resolved increasingly dire traffic problems for Texas’ most congested highways, and prepared the state not only for the alternative energy revolution, but for the flood of goods from Asia that are due to start arriving there after the Panama canal widening project completes in 2025.

The plan for TTC-35 wasn’t just big, it did real justice to Texas’ visionary traditions. The private partner companies that undertook the design and construction of the route, Cintra-Zachry, were committed to providing long-term infrastructure maintenance – resolving an increasingly important issue as gas tax revenue continues to dwindle.

Financing was to be provided through similarly innovative structures, with Cintra-Zachry funding 22% of the initial construction costs through equity investment and the remainder coming through tax-exempt bank bonds. In return for shouldering the initial $8 billion of costs and risks associated with construction of  infrastructure, Cintra-Zachary would have gained the right to charge tolls, and to collect anywhere from $104 billion to $142 billion in toll revenue over the 25 years of the concession. It would have not only been by far the largest Public Private Partnership ever undertaken in the U.S., but one of the largest in the world and set an example for the rest of the nation.

But so big were TTC-35’s ambitions in delivering comprehensive 21st century solutions that it wasn’t long before the concept ran into trouble. Some of the opposition was valid, some of it ideological, some of it opportunistic, and some of it just plain bizarre.

There were property owners who were rankled at the indiscriminate use of eminent domain to seize land for the project. Property rights are taken seriously by Texans, notwithstanding the physical size of the state, and it didn’t help that the lack of clarity on the exact path of the corridor necessitated seizure of more acreage than would actually be used in the project. It also stirred the hackles of environmentalists, for whom the scale of the project seemed unjustified. Much of this opposition was legitimate, and should have been better anticipated.

More attention should also have been given to the anti-tax lobby, which is perhaps uniquely influential on both sides of the aisle in Texas. Here the libertarian notion that the government has no right to tax anyone for anything other than to support national defense, (or to defend the Mexican border) is widely entertained. The idea of paying for access to motorways, however necessary to maintain them, was always going to be a tough sell to this crowd, notwithstanding the best efforts of then-governor Rick Perry to convince them otherwise.

Opposition to TTC-35 also began to probe the paranoid reaches of the Texas psyche, tapping into anti-foreign sentiment with help from a book written by a far right conspiracy theorist, who postulated that TTC-35, or the “NAFTA Superhighway” was nothing less than a plot to surrender America’s sovereignty to some mythical North American Union with Mexico and Canada. It didn’t help that some of his ideas were picked up by future presidential candidate Ron Paul. But the icing on the cake for xenophobic crackpots was that Cintra is part of Spain’s Ferrovial SA,  leading to some amusing, but ultimately damaging tales about the Spanish crown having an interest in the project.

While all of this was happening, local public sector highway authorities such as the North Texas Toll Authority, and the Harris County Toll Road Authority went to work on legislators to get them to wind back the clock on PPP, which had only been adopted in Texas in 2003. They worried about losing the most lucrative toll road projects to the private sector, and NTTA in particular was determined to get back in the game, by any means necessary. So in early 2007, soon after Cintra and its financial backer JPMorgan  won a competitive tender for building and running the state’s first PPP toll road, SH 121, with a $2.8 billion 50-year concession bid, the Texas Department of Transportation was told to reopen bidding on the road. This ultimately led to NTTA trumping Cintra with a $3.3 billion offer that relied on dubiously assembled public funding that would leave the taxpayer far more exposed to toll revenue shortfalls in the event of recession than a fully private financing package.

The combined forces of opposition to PPP that began with TTC 35 culminated with a vote by the Texas Legislature in mid-2009 not to reauthorise long-term highway PPPs in Texas, at least until 2011. That puts PPP on hold for the next two years just when the rest of the U.S. is waking up to its potential.

I mention all of this because there are broad consequences to think about. While the legislature ponders whether to reauthorise PPP in 2011, Texas will be doing things the old-fashioned way, straining public coffers and risking its credit rating while trying to build transportation infrastructure to meet the needs of a population that’s growing at the rate of 1,000 people a day. Other states have already learned from Texas’ experience in crafting their own PPP legislation, and are avoiding the pitfalls that undermined efforts there. States like California and Arizona,  which have set up PPP units within the past year, are actively soliciting private investment and expertise from companies that might otherwise have been looking to fund projects in Texas.

And while Cintra still has plenty of business coming its way in Texas, including two huge projects in and around Dallas, other companies with the expertise to deliver and maintain long-term PPP concessions might think twice about setting up shop in a state where contracts can be withdrawn after they are awarded. There’s also some real fence-mending that will need to be done to reassure foreign-based  companies, particularly the several other Spanish construction firms with strong technical qualifications, that Texas is still open to their business and their capital.

Yes, TTC-35 as originally envisioned was too big to push through as a first-time project in a state that’s just getting started with PPP.  Future undertakings, should they be allowed to resume in 2011, will need to be more targeted, and better planned before going through a tender process. Until then, the Lone Star state will just have to watch the use of PPP in highway redevelopment gain momentum across America from the side of the road.

Balfour Beatty Fires First Salvo In U.S. Infrastructure Consolidation

Balfour Beatty PLC’s acquisition of U.S.-based privately owned Parsons Brinckerhoff Inc. could well mark the beginning of a signifiant consolidation of the evolving U.S. infrastructure delivery landscape. Indeed, with the U.S. market for infrastructure experiencing fundamental shifts on the buy-side as state and municipal governments look to change the way they procure everything from highways to schools, it seems a good time to consider last month’s merger in the context of what will be needed in the U.S. in an age of increasingly scarce public sector resources.

Balfour Beatty, already the largest construction and engineering concern operating in infrastructure in the U.K. and one of the top three in PPP investments, knows what it is doing in both areas. An early and significant participant in major U.K PFI projects, BB has built up one of the most successful track records in the delivery of PFI projects and one of the largest portfolios of investments in the sector in the U.K.

The company has also been steadily building up its U.S. infrastructure activities in rail transport and military accommodation, most recently with the acquisition in April 2008 of GMH Military Housing for $350 million. But the acquisition of Parsons Brinckerhoff for $626 million puts BB into a whole new league, positioning it to challenge the biggest players in the U.S. just as budget pressures are forcing states and municipalities to turn to the private sector to fund, deliver, operate and maintain infrastructure.

It’s increasingly obvious that governments at all levels in the U.S. will need to ramp up their use of alternative long-term financing to get big infrastructure projects off the ground, particularly in transportation. There are some 27 states that have enabled the use of PPP as a means for delivering infrastructure assets, with Arizona and Massachusetts becoming the latest two to enact state legislation – and that was just over the summer. The speed with which PPP is moving to the forefront of state and municipal thinking now is an important, if little noticed trend in the U.S. market for infrastructure, especially considering that a framework for the use of PPP in the U.S. was first put in place as far back as 1995.

PPP is a model for infrastructure procurement that involves public authorities selecting through a competitive tendering process a consortium of private sector developers and their financial backers for the design, delivery, operation and maintenance of a public asset. In return for the providing the financing necessary to build or restore the asset, the private consortium earns the right to recoup its investment and earn a share of long-term revenue through the charging of tolls or from tax revenue for its operation. It has been in use in the UK since 1992, and has seen increasing acceptance in countries in Europe, Canada, Africa, Asia and Australia.

One clear area where businesses operating in public sector contracting in the U.S. need to adjust their models is to accommodate a market where PPP plays a significant, if not dominant role in the delivery and long-term management of public infrastructure. Among the new skills that these companies will need to develop will be to manage the life-cycle demands of contracts that will typically run 30 years or longer. It is a challenge to do without greatly expanding the size of a business, though developing or acquiring those services can be very rewarding because the work produces steady and reliable revenue flows that help to reduce the notorious boom-and-bust cycle of traditional contracting work.

What BB has successfully achieved in its home market, and what the Parsons Brinckerhoff acquisition moves it towards achieving in the U.S. (and to a significant extent in other nascent markets for PPP around the world) is to give the combined company both critical mass and a leading position among the relative handful of active project management service providers in the U.S. that can offer the full range of skills that are needed to build, operate and maintain these big projects throughout their life-cycle. In particular, Parsons Brinckerhoff brings its own extensive experience with alternative financing learned from international activities, which should make for a healthy cultural fit with BB as they work to grow the business in the U.S. But it also brings excellent, well-established long-term relationships with public authorities and people in policy-making positions. This strength is not to be ignored in a country where foreign company motives are continually viewed with suspicion, and where their participation in large projects can lead to unpredictable and unfortunate outcomes. (Consider the furore over the Trans-Texas Corridor and failed effort to lease the Pennsylvania Turnpike)

Besides helping to quell suspicions of foreigner intentions, Parsons Brinckerhoff brings to Balfour Beatty a particular strength in U.S. domestic transportation infrastructure development that could prove decisive to winning much of the coming wave of projects that go to tender. It brings not only experience, and an operating margin that is roughly twice that of its acquirer, but size to a business where size really matters. Unlike the U.K., distances in the U.S. tend to be much larger, so that questions about the capabilities of bidding consortia are never far from the minds of decision-makers. The combined business takes BB’s U.S. revenue base to 32% from 29% immediately and significantly towards its goal of a 40% U.S., 40% U.K. balance, and towards taking the perception of dependency on U.K. sources off the table once and for all.

From a business diversification perspective as well, the acquisition makes great sense for BB, which faces not so much the risk, as the certainty of seeing its U.K. public sector project pipeline shrink. This is due in part to public spending cuts, but also to the reality that government spending on big PFI projects in healthcare and transportation are now moving towards completion. Indeed, with 50% of BB’s current group earnings coming from the public sector, and 25% linked to U.K. public sector work, a move to diversify geographically would appear to be well-timed.

The overwhelming enthusiasm that has greeted the Balfour-Parsons deal should logically lead one to ask who might be next to go. The question has special relevance now, while the weak dollar would seem to favor companies making a play out of Europe or Australia. Parsons Brinckerhoff occupies a fairly special place in the firmament of leading U.S. project management service providers, but there are others. There are publicly traded companies in the sector with international expertise, but these are generally of a size that would make them too big to swallow. However, the shifting landscape of procurement in America could shake up thinking at Fluor Corp., KBR Inc, and Jacobs Engineering Group Inc. And it certainly will cause companies with similar profiles to Parsons Brinckerhoff to consider their future as part of something larger. With eight times 2008 earnings the new standard by which they might expect their businesses to be valued, it seems likely there will be more tie-ups of the Parsons Brinckerhoff variety in the very near future.

Arizona Wrestles With its Fiscal Gremlins

By Henry Teitelbaum

State budget problems are a fact of life across America these days. In this regard, Arizona is no different than California, Michigan or Florida, to name just  a few. It’s all just a matter of degree. But what tests the mettle of a state government most in times of fiscal stress is how creatively they go about addressing the  budget shortfalls that accompany these downturns.

For Arizona, the government response has been decidedly mixed. In one month, the state governor signed well-considered  legislation that could set the standard for the nation in planning for the development and long-term care of essential assets.  But little more than a month later,  the governor hastily approved a ruinous short-term response to the fiscal crisis that runs totally against any concept of good governance, while virtually guaranteeing that the budget crisis weighs on state finances for years to come.

In July Governor Jan Brewer in July signed into law HB 2396, a bill granting the state contractual authority to enter into virtually any project delivery arrangement with private developers and their financial backers  As a result, the state will have the flexibility to choose the best model for procuring all future infrastructure assets from among a wide range of options. These include public-private partnership models that vary from granting concessions on existing assets to innovative DBFO, DBFOM, and other arrangements that ensure the selection of the most efficient long-term financing solutions while also addressing the need to repair and maintain public assets over their life-cycle. Critically at a time of economic stress and budgetary shortfalls, the government has gained the right to do procurement deals that engage private financing resources now, when they are needed most, and on terms that will ensure that repayment can be managed to coincide with a recovery in the the state’s finances as the economy recovers.

What’s more, the bill allows Arizona to introduce innovative solutions that clear away many of the issues that have hobbled PPP in other states, such as the past relinquishment of eminent domain rights over property needed for new development, concerns over “double-taxation” on existing roads, and non-compete agreements with existing privately developed roads.

But no sooner has the ink dried on this piece of innovative legislation than the state sets forth plans to sell and then lease back up to 32 properties, including state capitol buildings, on highly disadvantageous terms, to try to close a $3 billion budget deficit. Governor Brewer, who signed the bill allowing the sale of state buildings on Sept. 3, still has to decide what to sell and lease back, but it already looks like he has sent up the white flag, and is willing to surrender the  keys to the state capitol to anyone with $735 million in cash to spare and a desire to double that sum over 20 years, (with no risk to principal and no responsibility for anything, not even  repairs and maintenance for the buildings in question).

It wouldn’t be so galling that the government is being short-sighted with future taxpayer revenue if the sale/leaseback deal wasn’t being done for assets already purchased with taxpayer money. The fact that maintenance of the increasingly dilapidated assets will still have to come from public coffers, while the state pays $60,000 a month in rent  only  adds insult to the taxpayers who will have to foot the bill.

It’s a study in contrasts when one takes the time to craft intelligent PPP legislation to safeguard and respect taxpayer interests over the long-term, only to blow it on silly short-term giveaways that waste their money, invite abuse, and undermine the state’s long-term interests. Just don’t blame the private sector for what happens next.

P3 Investment Model Ensures Market Stability Where Regulation Can’t

It is by now broadly acknowledged, even by market regulators, that signals were ignored or misunderstood about the nature of the systemic risks that were mounting due to the unfettered sale of toxic investment instruments. But the remedies that are so far attracting the most attention in trying to restore stability; tightening up risk procedures at banks, shifting OTC derivatives onto multilateral clearing facilities, and improving accounting for off-balance sheet investment vehicles, suggest they still don’t appreciate the full nature of the problem.

In particular, they need to examine the buy-side conditions that led to such explosive growth in markets for these inherently dangerous engineered financial tools. If they did so, they would quickly find that among the fundamental pre-conditions for the crisis was a chronic structural shortage of liquid, high-yielding, and widely available assets for long-term investors.

For more than 10 years, while interest rates and government bond yields remained at historically low levels, easy credit terms allowed mortgage borrowing to expand to unprecedented levels. In the near absence of  safe, high-yielding alternative investments, mortgage-backed securities and then the newly engineered CDOs became almost the default investment for banks, insurers, hedge funds and others in search of yield. It is to a large extent because investors could find no safer, higher quality long-term assets to buy that the market for these instruments became so large, so quickly.

Going forward, regulating markets will certainly have a role to play, but what financial markets and society need even more to restore stability is a wider choice of liquid long-term investments, particularly ones that encourage and reward value creation, rather than just those that cater to opportunist instincts. Indeed, if alternative investments had been identified and made available to investors during the early stages of the credit boom, the same low interest rates that lured investors into the real estate bubble might have drawn some of that money into financing alternative energy projects, rebuilding highways and bridges or other more stable, long-term assets.

And it’s by no means clear that markets are yet structuring the kinds of assets that will attract that investment in the future. There are funds that make equity investments in infrastructure projects, and these are increasingly widespread. But the amount of equity available to date in these projects is far too little to meet the demands of large pension funds, life insurers, university endowments and other institutions with long-term Liability-Driven Investment (LDI) needs. Nor has infrastructure equity, particularly through the recent equity market decline, demonstrated any of the presumed non-correlated performance that many were expecting.

Elsewhere, prospects for creating investable assets for these institutions are no better.  In the U.S., for example, neither federal, nor state, nor municipal authorities can any longer be relied upon to develop public assets on a scale that they did in previous decades. The federal deficit is over 12% of GDP and rising after the bailouts and stimulus program, while the municipal bond market, traditionally a key source of infrastructure financing, is under scrutiny as never before as states absorb the impact of job losses and a collapsed housing market. It’s not by accident that Moody’s Investor Service has warned that municipal credits face their first-ever across-the-board downgrade following the credit crisis.

From a long-term investor perspective, this has deep meaning. In a world already short of investable opportunities for pension fund investment, it’s hard to see how muni bonds, the new Build America Bond program or any other government-sponsored investment vehicle can be relied upon to supply the size of issuance that is needed to keep them invested. Considering the already diminished capacity for borrowing that states face for years to come, can municipal bond issuance even begin to cover a nationwide infrastructure deficit that the American Society of Civil Engineers recently revised upward to $2.2 trillion?

It is here where I see a singular opportunity for investors in a market for the delivery of public infrastructure through public-private partnerships. PPP, or P3, involves the public tendering of the design, delivery, operation and maintenance of public infrastructure over the long- to very long-term through the use of private sector investment, expertise and risk management. By its very structure, it involves long-term commitments from all sides; on the part of the private sector partner for the initial financing, operation and maintenance of the assets, and on the part of the public sector partner for the repayment of the initial investment, plus interest. The model, which has been used successfully for more than 15 years in the U.K. and is being rolled out in nations around the world, has a proven track record of delivering projects on-time and on- budget. Moreover, the experiences of governments with the P3 model at all levels are extensively and publicly documented.

P3 creates investable assets of a size and credit quality that can be sufficient to meet the long-term structural investment needs of many institutions. The debt of such assets is not only secured by highly reliable cash flows linked either to the asset’s use or directly to the government’s tax revenue, it tends to be indexed to the rate of inflation, which allows pension funds to more easily match their long-term  commitments to providing for people’s retirement needs.  That’s true as well for life insurers and other institutions with LDI requirements.

But a program of P3 investment does more than just incentivize long-term investment from pension funds. Construction companies and their sub-contractors, who build or maintain P3 assets, themselves become invested in the long-term success of projects, whether through the flow of maintenance work that they are eligible to win, or through a share of equity in the project. Increasingly, contractors are looking to mandate renewals and equity investments to produce the long-term revenue streams that help smooth the notoriously cyclical construction business. Whether its cleaner healthcare facilities, well-functioning schools facilities, or safer, well-maintained roads, they too are incentivized to think long term and to work towards delivering the best outcomes for the people they serve. Other private sector participants in P3 projects are drawn towards a long-term view of the service they deliver, whether its in facility maintenance or risk management.

Not to be overlooked in this virtuous circle of long-term investment are the many benefits of P3  to the public sector, which has often been forced by what might be called the “tyranny of the ballot box” into taking too short-term an approach to its long-term investments. We have all seen or read about projects that came in way over budget or were never delivered; where the investment was too much or too little, or the asset that was built was unusable. Too often, this is the result of inadequate planning. In today’s political reality, if public money isn’t spent soon after it’s been budgeted, there are other administrative bodies that will be all too happy to have it reallocated to their own departments.

Through P3, public servants can instead of hastily using public money just to have control over it or procure assets mainly with a view to the next election cycle, choose the best solution from among a variety of design proposals and project delivery partners. P3 takes  the risks of under-delivery, late delivery or spiraling costs off the public sector’s hands and places them with private sector partners, who are better able and better incentivized to manage and mitigate them.

In the wake of the worst financial disaster since the Great Depression, public sector authorities can no longer afford business as usual. Public sector unions need to understand this. After stimulus spending programs run their course, there will be little in the way of major public sector contracting work available for years to come as governments at all levels rebuild their balance sheets. Unions need to adapt to the changes that are underway in the market for their skills, or risk becoming irrelevant. The jobs created through P3 programs will require the trade skills of every unionized public employee that transfers to the private sector and a whole lot more. Public sector authorities and private sector contractors must do everything in their power to encourage broad acceptance of the P3 model, whether it is by guaranteeing public sector pensions, providing work guarantees or offering membership in private sector trade unions. Public sector pension funds can also play a role in encouraging participation in delivering P3 projects by investing directly in the equity and debt generated through the financing of P3. This would link a portion of their union members’ retirement benefits to the performance of the assets they help to build – yet another way to incentivize long-term oriented behavior.

One way or another, innovative solutions need to be found for all aspects of the way our markets operate, and government has a responsibility to set an example by incentivizing long-term investment and the creation of long-term asset management solutions.

P3 is  a model that mobilizes the private sector to play a larger and increasingly indispensable role in financing, delivering and maintaining  the public infrastructure that will be needed for all of society to function and thrive.

(This article appeared in American Banker and Global Pensions magazine, October 2009)