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A Primer on Public Private Partnerships for Municipalities 

by Ann D. Fillingham and Aleksandra A. Miziolek

Published: June, 2009

Submission: August, 2009

 



This is the second of a three-part report on “public private partnerships.” Also known as “PPP” or “P3” projects, there is an increasing amount of press regarding these projects, some of which is contradictory and some of which is just plain confusing. The purpose of this three-part report is to provide you with some useful information in identifying and analyzing P3 opportunities. The first part of the primer provided an introduction to the P3 concept. This second installment provides some basic tools in analyzing P3 proposals.


Initial Questions


While reviewing any infrastructure proposal (or crafting parameters for an RFP) can be a complicated undertaking, there are a few initial issues that can be helpful in setting the parameters for review:


1. Identify the character of the proposal.


2. Identify the level of “partnership” involved.


3. Identify your ideological parameters.


4. Identify your economic goals.


5. Identify the limits of governmental power and authority.



Project Character


As outlined in Part I of this primer, proposals for monetization of existing infrastructure (often referred to as “brownfield” projects) raise significantly different issues than proposals for the construction and financing of new infrastructure (often referred to as “greenfield” projects). Brownfield projects are often driven by a desire to generate funds to deal with current or future budgetary issues which may or may not relate directly to the project being monetized. For example, the State of Indiana monetized future Indiana Tollroad monies, allowing it to simultaneously create funds for future transportation projects and limit future exposure to operating & maintenance (O&M) increases.


In contrast, the drivers of greenfield projects may include a mix of (i) optimizing allocation of limited financial resources, (ii) limiting exposure to project cost overruns and O&M cost increases, (iii) the political realities of limitations on governmental ability to increase toll and/or fee structures, and (iv) the need to spur economic growth through infrastructure development when resources available for 100% public financing of such projects are limited.


Differing Levels of “Partnership”


All P3s are not the same, and the level of private “partnership” ranges from traditional provision of select services on one end of the continuum to complete privatization on the other end of the continuum. In addition, public-private relationships are significantly different in the securitization of an existing asset than in the structuring of a new project. Since the third part of our primer will focus on monetization projects, here we will explore only new or rehabilitation greenfield projects.


Two models in between full public and full private projects include “design-build” (“DB”) and “design-build-finance-operate-maintain” (“DBFOM”) projects (which can include numerous variations on the level of private control and operation). In a DB model, the governmental unit engages private parties to design and build a proposed project, committing to a project cost and schedule, but the governmental unit retains full ownership of the asset, once constructed, and is obligated to finance and maintain the asset once financed.


Under a DB project (considered by many not to constitute a “real P3”, since the public sector retains full ownership and control of the project), the primary criteria in assessing a DB proposal are cost and time. Can the private sector deliver the project more efficiently and in a more cost-effective manner?


Under a DBFOM model (few P3 projects are undertaken under a full privatization/divestiture model, even most “real P3” projects use some variation of a concession agreement model), the governmental unit not only engages private parties to design and build the project, but also to procure some or all of the financing for the project and assume some or all of the O&M responsibilities of the project for the term of the agreement. This is done in exchange for some or all of the revenues to be generated from the project.


Under a DBFOM model, since the public sector is considering transferring some level of ownership and/or operating rights, the real question is not one just of cost, but of return on investment. With the assistance of financial professionals, a State or local governmental unit needs to compare the full economic matrix of a traditional publicly financed and owned project against a DBFOM model. The return on investment of varying proposals then needs to be considered together with a risk matrix, weighing the potential for loss of services, revenues, employment and control. While the components of the economic matrix will vary by type of project, typical considerations will include project cash flow projections (generally analyzed under both an “upfront proceeds” option and a “revenue sharing” option, as P3 partners are generally willing to consider differing cash flow structuring options), present value calculations, and financial feasibility tests.


In order to help analyze the differing financial models and decide the “appropriate” level of partnership on any potential project, a governmental unit also needs to identify its ideological parameters.



Ideological Parameters


The P3 dialogue necessitates an almost ideological discussion of the appropriate role of the governmental unit’s involvement, including the following questions:


1. Ownership. Are you comfortable with something less than full fee ownership? Can the public’s access to the public asset be adequately protected?


2. Regulation and Control. If a concession arrangement might be palatable, what is the correct role for regulating use, operation and maintenance of the project? Do you want full control or just the ability to regulate rates like a utility commission? What is an acceptable length of the concession arrangement, knowing that the private investor will want a long term commitment?


3. Profit Regulation. What protections do you feel are necessary to build into a project to protect against potential windfall private profits while at the same time ensuring adequate return for the private sector’s assumption of risk? Do you want to regulate profits or monitor revenues through some type of revenue sharing arrangement?


Establishing your goals with respect to these matters requires a thorough understanding of the costs and benefits of a P3 project.


Identifying Economic Goals


The government sector generally has access to cheaper capital than the private sector: it can issue tax exempt debt, it doesn’t pay property, sales, fuel or other similar taxes, and it has statutory limits on insurance and other liability.


Furthermore, the equity markets have historically demanded a greater return on investment than the debt markets. Consequently, it is reasonable to assume that in the absence of other economic realities, it is usually not cheaper to finance a governmental project privately rather than publicly. So should a governmental unit ever proceed with a full public-private partnership? The question can most often be answered affirmatively in situations that involve the competing realities of finite resources and underfunded priorities.


1. Finite Resources. If the credit crisis has reminded us all of anything, it is that no one, not even a “AAA” rated governmental unit, has unlimited access to the credit market, and that there can be serious consequences of over-leveraging. Therefore, governmental units need to establish their project priorities and their capital budgets. A matrix that involves exploring P3 innovations as a means to fulfilling financial responsibilities may be part of the equation.


2. Underfunded Priorities. Many governmental units are currently faced with the need to undertake infrastructure and economic development to spur economic growth at a time when resources are limited and structural deficits are a reality. Greenfield projects funded with private dollars may free up governmental resources that can then be used for other worthy infrastructure projects. Exploring P3 options provides the ability to “leverage” limited resources.


In order to adequately analyze this possibility, however, it is important to have hard data available not just about the particular project, but sound pro-forma general fund projections (including solid revenue and tax projections), local economic projections (and their impact on revenues), debt capacity knowledge and an understanding of the impact of P3 projects on general credit agency models.


It is also critical to understand what you can and cannot do and your various statutory charter and constitutional limitations.


Limits of Governmental Power and Authority


Governmental units do not operate like private entities. Unless they are “home rule” entities, they have only that power and authority that is granted to them by statute. In evaluating any public-private partnership proposal, it is critical to consult knowledgeable counsel about the limits of existing authority and the need for legislative authorization for certain aspects of many P3 proposals.


Conclusion


P3s can be an effective “tool” in the “toolbox” municipalities have available to them to accomplish their goals. They can be extremely complicated, however, and require time and effort to appropriately review, and generally require consulting with both financial and legal experts. The purpose of this newsletter is not to tell you all you need to know, but to equip you with intelligent questions to ask as you consider or evaluate these possibilities. Part III will focus on considerations specific to a monetization proposal.

Visit Dykema's Infrastructure and Project Finance Practice Area at: http://dykema.com/infrastructure


 


 

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