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Public Works Management & Policy
DOI: 10.1177/1087724X07303680
2007; 12; 320Public Works Management PolicyKathleen Brown
Are PublicPrivate Transactions the Future of Infrastructure Finance?
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ARE PUBLICPRIVATETRANSACTIONS THE FUTURE OF
INFRASTRUCTURE FINANCE?
KATHLEEN BROWN
Goldman, Sachs & Co., Los Angeles, California
Demand for infrastructure in the United States continues to grow dramatically
while governments at all levels struggle to balance their budgets. As a result,
state and local governments are looking more to nontraditional sources of financ-
ing for their capital and operating needs. Public Private Partnerships (PPP) are
financing strategies that are widely used around the world but are still relatively
new in the United States. Under these agreements, state and local governments
maintain ownership and control of the assets but receive financial compensation
to contract with a private operator who provides operating, maintenance, and/orconstruction expertise for large-scale infrastructure projects.
Keywords: public private partnerships; PPP; P-3; infrastructure finance; inno-
vative financing concession
Demand for infrastructure in the United States continues to grow dramatically while gov-
ernments at all levels struggle to balance their budgets. As a result, state and local govern-
ments are looking more and more to nontraditional sources of financing for their capital and
operating needs. Publicprivate partnerships (PPPs) are financing strategies that are widely
used around the world but are still relatively new in the United States. Under these agree-ments, state and local governments maintain ownership and control of the assets but receive
financial compensation to contract with a private operator who provides operating, mainte-
nance and/or construction expertise for large-scale infrastructure projects.
This market for PPPs is being fueled by the enormous amounts of cash that pension funds
and insurance companies need to invest in steady, predictable long-term cash flows. For
example, when PPPs are used to finance toll roads, the future traffic volume and toll revenues
can be monetized to provide dependable returns to the private investor while future operating
and capital expenditure risk is minimized for the public sector. As a result, in many overseas
markets, the PPP has become the primary source of infrastructure funding for government
transportation agencies. There are various ways to structure a PPP concession, and the result-
ing benefits may vary from a substantial upfront payment, an ongoing annuity, or both. Initial
construction and/or expansion programs can be accommodated under any of these models.
With the successful completion of major PPP transactions in Chicago and in Indiana, with aninvestor class with a strong interest in infrastructure assets, and with a growing understand-
ing and acceptance of the PPP concept in states and local governments, PPPs are emerging as
a key part of the new frontier of infrastructure finance.
320
PUBLIC WORKS MANAGEMENT & POLICY, Vol. 12 No. 1, July 2007 320-324
DOI: 10.1177/1087724X07303680
2007 Sage Publications
Kathleen Brown is head of
public finance for the West
Region at Goldman, Sachs
& Co. and was treasurer of
the State of California from
1991 to 1995, during which
time she was responsible for
managing the states $24
billion investment portfolio
and overseeing all debt
issues for the state.
This market for PPPs is
being fueled by the
enormous amounts of
cash that pension
funds and insurance
companies need to
invest in steady,
predictable long-term
cash flows.
COMMENTARY
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Brown / PUBLICPRIVATE TRANSACTIONS 321
Market Overview
The United States is at a crossroads in its transportation infrastructure lifecycle. Large cap-
ital investments, critical to sustaining our economic growth and quality of life, have been
identified across the nation. Traditional funding sources such as gas tax revenues have not
kept pace with these needs, thereby requiring local governments to search for alternative and
increasingly innovative financing approaches to deliver capital projects. Given the magnitudeof the major capital needs looming on the horizon, state and local governments have been
forced to consider alternative means of financing them, including the significant resources
that can be provided by the emerging global infrastructure market for PPPs.
Although it has been customary for local municipalities to provide the funding for
improvement and maintenance of their infrastructure, they face constraints on traditional rev-
enue sources and are limited in the alternative approaches they can take to finance these
assets. Many states, cities, and public authorities have already amassed millions, if not bil-
lions, of dollars of debt associated with past construction and improvements which limits their
ability to return to the tax-exempt bond market. In addition, the tax-exempt market imposes
strict limitations on the amounts of financial leverage that can be layered onto each asset as
well as other restrictive requirements and fiscal tests.
Highway projects are most typically (and conservatively) financed through motor fuel
taxes, either on a pay-as-you-go basis or to securitize debt. Over the past decade, this revenuestream has been flat or decreasing and is not nearly enough to cover the outstanding mainte-
nance and rehabilitation costs associated with existing infrastructure let alone construct new
facilities. Although these funds can be supplemented by federal programs such as GARVEE1
bonds and TIFIA2 loans, these financing mechanisms, though extremely effective on a project-
by-project basis, are not adequate to address the national infrastructure deficit, nor do they rep-
resent new revenue. They are simply borrowing against future revenue streams. Increasingly, the
public sector is looking to the private sector to finance and operate what has heretofore been
considered public infrastructure projects. Publicprivate partnerships can provide municipalities
with the capital necessary to sustain a healthy transportation system. In addition, PPPs offer
the municipalities a means to monetize the value of selected assets and use this revenue to
accelerate other desperately needed projects.
PPP Overview
PPP TRENDS IN THE UNITED STATES
As this is written, many governments have already used PPPs to meet their capital fund-
ing goals. The State of Indiana found itself faced with a $2.8 billion deficit in its 10-year
transportation plan. After determining that the maximum amount available from tax-exempt
debt financing would be insufficient to fund its plan, Indiana began a PPP concession process,
which concluded with the acceptance of a $3.85 billion bid in exchange for a 75-year lease to
operate and maintain the Indiana Toll Road. The proceeds from the lease will be used to fully
fund the transportation plan and accelerate several other projects to upgrade and enhance
infrastructure in the state. Indirect benefits of this strategy will be a significant increase in new
construction and manufacturing jobs and a reduction in future costs for debt issuance and
interest. In addition to this upfront payment, the private operator expects to spend $4.4 billion
(2006 dollars) to maintain and expand the Indiana Toll Road over the life of the leasefunds
that were not available under the roads previous management structure. Similarly, the City of
Chicago awarded a $1.83 billion concession lease of the Chicago Skyway in 2005. The pro-
ceeds were used to pay down existing debt, establish a $500 million Rainy Day fund, allo-
cate $375 million to the annual operating budget, and fund several social service programs.
In addition, the Citys debt was upgraded fromA toA+.
Given the magnitude of
the major capital needs
looming on the horizon,
states and local govern-
ments have been forced
to consider alternative
means of financing
them, including the
significant resources
that can be provided
by the emerging global
infrastructure market
for PPPs.
Increasingly, the public
sector is looking to the
private sector to finance
and operate what has
heretofore been consid-
ered public infrastruc-
ture projects.
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322 PUBLIC WORKS MANAGEMENT & POLICY / July 2007
Texas recently announced a concession agreement that will provide a $2.1 billion upfront
payment plus $560 million for design and construction of State Highway (SH) 121 in Denton
and Collins Counties. In addition, the successful bidder will pay $700 million in lease pay-
ments over the next 49 years as well as $1.7 billion for operation and maintenance of the toll
road. The SH 121 project will now be completed by 201125 years faster than would have
been possible with traditional gasoline tax revenue. This project is significant for several rea-
sons. It is one of the first greenfield PPPs in the United States, and the Regional Transpor-tation Council of the DallasFort Worth area will largely decide how the upfront funds will
be spent on projects in their region. Furthermore, above certain revenue targets, the Texas
Department of Transportation will share an increasing percentage of the gross revenues in
addition to the upfront payment and guaranteed annual payments.
In light of these transactions, many governments have realized that the combination of steady
annual cash flow that tolls produce, coupled with the ability to depreciate the asset for tax pur-
poses, is of immense value to private operators. One of the key drivers of value in the Indiana
Toll Road, Chicago Skyway, and Texas SH 121 leases was the ability of the concessionaire to
make an upfront payment in return for the future cash flows that the projects would produce.
Debt markets, which have historically funded public toll roads, rely primarily on historical
growth to determine acceptable borrowing levels. However, because they are not as risk-averse
as the tax-exempt debt market, equity investors in PPP projects are willing to take a more entre-
preneurial view of the future performance and value of established revenue-producing assets.Currently, several other states are investigating similar models to develop alternative fund-
ing streams for infrastructure expansion. Specifically, the state of Texas is assessing the
financing alternatives for new toll roads, including a private concession model and the applic-
ability of Private Activity Bonds and TIFIA loans to be used in combination with a PPP. The
state of Utah also is engaged in determining the appropriate funding technique for a new toll
road project and, in conjunction with this process, recently passed legislation to allow PPPs
to be considered as a viable financing alternative for the project. New Jersey and Pennsylvania
are evaluating the benefits of long-term concessions for their existing toll roads.
BENEFITS OF PPPS FOR THE PUBLIC SECTOR
The growing list of executed concessions serves to demonstrate the multiple benefits to thepublic sector arising from PPPs. These include the following.
Flexibility with use of proceeds. Municipalities can utilize the upfront proceeds to accel-
erate needed transportation or other projects. A significant benefit of the PPP is the flexibil-
ity it provides the public partner to utilize the proceeds for any public purpose. The value of
this flexibility is particularly enhanced when compared to the strict limitations on the use of
proceeds from tax-exempt bonds. For example, the proceeds can be used to address public
needs ranging from accelerating the schedule of planned transportation projects to funding
social service programs for which other revenues are not available. The City of Chicago
placed a portion of the proceeds from the lease of the Skyway into a rainy-day fund that
aided in upgrading the citys debt and will lower future borrowing costs.
Greater upfront proceeds. A PPP allows the municipality to capture greater upfront valueat less cost than a municipal bond transaction because the value is based on the projected
growth of future cash flows as compared to historical data.
Strict operating and maintenance standards. The public partner can carefully craft the terms
of the concession agreement to achieve strict operating and maintenance standards that meet
public policy goals. If the concessionaire does not comply with these standards, the concession
can be terminated and control of the project will revert to the public sector. Both the Indiana Toll
Road and the Chicago Skyway transactions have 300 pages of operating standards that address,
in great detail, the manner in which the roads will be operated and maintained.
. . . many governments
have realized that the
combination of steady
annual cash flow that
tolls produce, coupled
with the ability to
depreciate the asset for
tax purposes, is ofimmense value to
private operators.
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CONSIDERATIONS OF PPPS
Important questions for the public sector to consider when determining whether to pursue
a PPP versus another financing strategy include the following.
What are the public policy implications of retaining ownership but transferring operations
to another entity for a predefined period of time in accordance with a concession agreement?Clearly, public policy issues are a major factor in a PPP and must be addressed very carefully.
Such factors as the rate and magnitude of toll increases, safety and environmental concerns,
and the status of public employees in the new management structure will be major concerns.
Recent positive experience supports the premise that PPP financing can work to satisfy both
public policy needs and the interests of investors.
What authority does the municipality relinquish under the PPP model? The public partner
retains ownership of the asset, which inherently enables it to retain a great degree of control
over ongoing operations and maintenance. Typically, the concession agreement contains a
detailed list of operating standards that the concessionaire is required to follow. The munici-
pality has the right to terminate the lease and take back operation of the facility if the con-
cessionaire fails to meet these standards. This is the publics ultimate control under a PPP.
What is the appropriate term of the concession agreement to maximize benefits to both
parties? The term of the concession must be sufficient to provide the concessionaire with the
tax benefits from depreciation, and this is possibly the least understood aspect of PPP. The
ability to depreciate an asset worth hundreds of millions or billions of dollars, although of
enormous value to the private partner, holds little or no value for the public sector. A longer-
term agreement provides flexibility to depreciate the asset in the most attractive manner
which will be reflected in the amount the private partner is willing to pay for the concession.
This difference in perspective also has political implications. For this reason, Indiana ulti-
mately decided to scale back the Toll Road lease from 99 years to 75 years after it was deter-
mined that investor value would not be severely affected.
PROCESS OVERVIEW
Developing a successful PPP is a complex process and dependent on many factors. The
process usually can be completed within 9 to 12 months, and a strong foundation of prelimi-
nary groundwork will contribute heavily to a successful effort. The key steps in the process
are as follows:
Legislative approval
Prepare feasibility study/projections
Obtain any Federal Highway Administration or other federal approvals
Draft concession agreement and operating standards
Solicit bidders and select top quality firms/consortia
Due diligence/negotiation of key agreements
Why the Sudden Emergence of the PPP Market?
Seemingly overnight, a variety of private funds have emerged to pool large amounts of
money solely to invest in infrastructure. For example, Goldman Sachs has created an infra-
structure investment fund of more than $6 billion. Other firms, such as Morgan Stanley, the
Carlyle Group, GE-Credit Suisse First Boston, and JP Morgan have established funds of sim-
ilar magnitude. These funds are driven by the convergence of two mutually supportive trends.
First, as described earlier, the public sector is strapped for revenue just at a time when its need
Brown / PUBLICPRIVATE TRANSACTIONS 323
The ability to
depreciate an asset
worth hundreds of
millions or billions of
dollars, although of
enormous value to the
private partner, holds
little or no value for the
public sector.
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to invest in infrastructure is cresting. Second, investors with large cash holdings and long-
term payout responsibilities such as pension funds and insurance companies are looking for
moderate returns that are stable and predictable and carry a minimum of risk. Other investors
are looking to the infrastructure asset class as an additional means of diversifying their invest-
ment portfolios. The revenue potential of U.S. infrastructure as an asset class is essentially
untapped. The difference in value that can be captured by a private investor in a PPP over and
above what can be realized in the tax-exempt market by the public sector is the main driverof the PPP market. Private investors can realize more value from these assets than the public
sector and are willing to pay for the opportunity to do so. Ultimately, a private investment
group, in conjunction with an experienced facility operator, is highly incentivized to hold
down expenses and manage the asset efficiently and can do so because of economies of scale
and broad experience with similar holdings.
Are PPPs the Future of Infrastructure Finance?
The need for alternative funding to repair and replenish the nations infrastructure has
given rise to the increased interest and application of PPPs in the United States today. There
are enormous pools of private capital that are available for this very purpose. Publicprivate
partnerships can be truly mutually beneficialmunicipalities are able to monetize assets forupfront cash payments to fund future projects or inject additional capital in others while pri-
vate owners, operators, and investors are able to access the steady stream of cash flows pro-
duced by infrastructure assets. The marriage of private operating efficiencies and incentives
with essential public assets can only enhance our nations transportation infrastructure.
As budgets become increasingly constrained and funding sources harder and harder to
come by, it is likely that PPPs will become a prominent fixture in the infrastructure finance
landscape. The recent growth in the PPP market has been exceptionally strong, and there is
every reason to believe that it will continue in the future. Publicprivate partnerships are a
very real and practical solution to many of our local municipalities transportation funding
crises. Although a PPP may not be appropriate for every project or municipality, it provides
a valuable alternative to the current financing options that are available.
Notes
1. Grant Anticipation Revenue Vehicles (GARVEE) can offer states and local governments additional sources of
funds for their infrastructure projects but can be subject to conservative assumptions and a haircut of value because
of the inherent risk of reimbursement.
2. Transportation Infrastructure Finance and Innovation Act (TIFIA) loans are specifically designed to aid pro-
gressive transportation projects by providing low cost funds that offer immense flexibility for new and complex pro-
jects. They can, however, also be quite restrictive.
324 PUBLIC WORKS MANAGEMENT & POLICY / July 2007
Private investors can
realize more value from
these assets than the
public sector and are
willing to pay for the
opportunity to do so.
The marriage of private
operating efficiencies
and incentives with
essential public assets
can only enhance our
nations transportation
infrastructure.
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