Slowly but surely

The US remains an ‘emerging’ PPP market, but the fundamentals are now in place in many states, argues John Sellers, Principal at regional infrastructure merchant bank, Yavapai Regional Capital

In the four years since President Obama was elected, the US’s reputation as the largest emerging PPP market is still, well, emerging. 

Although few transactions have closed, the need for private capital appears to be fundamentally and broadly accepted. Whatever one’s stance regarding the government’s spending versus private investment, one thing is clear: infrastructure is on people’s lips. But the question is how do you build the pipeline in a market with a highly devolved system of government? People often ask ‘what is the US model?’ In reality the answer is ‘there isn’t one’. 

The signs are good however. Banks are healthier, with a competitive parallel private debt market and some are slowly working their way back into the business of project finance lending. Wall Street has the equity to fund deals, TIFIA is back in support of transport infrastructure and the promise of a National Infrastructure Bank may be back in play. 

Two issues remain: 

- Who’s going to put up the first dollar for project development capital and kickstart the pipeline?
- And how will trust be maintained between public and private sector partners, without hindering the wellbeing of taxpayers? 

Issues like this have a serious impact on the viability of PPPs moving forward and whether they will retain the bureaucratic procurement process coupled with long-term private financing – an expensive combination. The most efficient is the reverse. Get the private sector in at early stages with development capital, enabling them to take control of the design, build, and construction process as well as reap the benefits of savings. Follow this by utilising public debt sources over a 30-40-year period, such as the commonly used build and transfer method. 

Potentially this leads to more unsolicited proposals and more importantly, the private sector essentially kickstarts the process in a more entrepreneurial fashion, with fewer consultants involved. 

But the question is, how does one raise the development capital and what is the risk allocation? Put another way, what does an ‘infrastructure venture capital’ model look like? 

Ideally the private sector should finance the first million in order to prepare a large-scale project, and risks should be calculated based on what you can control. The risk allocation model is based on project finance principles, so risk what you can control – but only those risks – without general risk sharing. The key document then becomes an Interim Development Agreement, wherein the private sector takes the commercial risk that a project proposal can be turned into a cooked, finance-able deal a year or two later. However, the developer’s capital is repaid at a modest premium if certain political risks manifest themselves, such as a change of mind by the public sector. This results in a classic split of commercial/political risk well known to project financiers.

In this model, financial investors should take the dominant role in initial capital provision, albeit not necessarily exclusively. It’s the reason we are assembling a fund to do this and have just seeded our first project.    

Because a modest amount of development capital early on can provide great value, the returns are very attractive closer to triple digits than two, if properly structured. The capital, from an investor’s standpoint vis-à-vis political risk, has a floor price of par. As far as commercial risk, and compared to the risks high-tech venture capital faces, infrastructure is a market where investors have some assurance of the demand for their product whether it be sewage, water or roads. Compare this to high-tech venture capital where the market for a widget or software coming out of the proverbial garage, and whether anyone will buy it, is close to a black box.  

With infrastructure, the period of risk is also probably closer to two to three years, not seven. The common thread between both types of start-up capital is a low overhead approach with quality on-the-ground people, well-motivated by project equity. Because projects tend to continue the way they start, focusing on efficiency early on ensures a much more competitive approach to costs throughout the whole project cycle. It’s entrepreneurship at the PPP interface, otherwise known as small business. It’s the American spirit of free enterprise resulting in more competitive user charges, a highly marketable concept for the public.

As for managing the “trust zone” between the public and private sectors, independent non-conflicted development capital, laid before public officials, can insist that the project is assembled transparently, balancing the conflicting interests of private investors and public officials.  

In other words, no cosy deals that end up costing the citizen user more than they should pay. This requires a willingness to be in the hot seat in the middle, with a clear, unambiguous statement of ethics and transparency. As we say, if we are not being shot at by both sides, we are doing something wrong.