PPPs — True Financial Costs and Hidden Returns

Abstract

The cost of using private finance is at the centre of the public private partnerships (PPPs) debate, but until now most works considered only the direct financial costs such as the loan interest rate and the shareholders return on equity and were based on various secondary sources. This paper focuses on seven shadow toll deals closed in Portugal between 1999 and 2002 and reports the financial costs of the PPP model considering also the associated transaction costs and is based on detailed information included in each concession's financial base case. The transaction costs include financial costs such as banking fees, due diligence costs and the impact of all cash distribution traps, such as reserve accounts or minimum-level of debt ratios. The PPP financial costs were then compared with the costs arising from raising public debt through a government or a public agency bond. Our analysis shows that the PPP ‘true' financing costs are, on average, 370 basis points above the cost of raising public debt and that the ‘transaction costs' account for around 40% of that financial premium.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. There is no universally accepted definition for PPPs in either general discourse or the scholarly literature. For the purpose of this article, a PPP consists in a long-term relation between the public and private sector, involving the design, construction, financing, maintenance and operation of a public infrastructure or a public facility by a private agent, with revenues (either from user or government) based on services supplied, transforming the role of government from a provider to a purchaser of public services. For a summary of definitions used by different scholars, governments and international organisations see, for example (Kwak, Chih, & Ibbs, 2009, p. 52).

2. See Grimsey for a review of PPP's construction performance vis-à-vis traditional procurement (Grimsey & Lewis, 2007, p. 175).

3. Edward, Shaoul, Stafford, and Arblaster (2004, p. 9) calculated that the Highways Agency UK paid a premium of some 25% of construction cost on the first four Design, Build, Finance and Operate roads to ensure the projects were built on time and to budget.

4. Competition for the market is essential as the PPP model creates a monopolistic situation managed by a private partner; however, the complexity of the contracts web, the extensive life cycle (Marty & Voisin, 2008), the type of procurement process, the level of transaction costs (Soliño & Gago de Santos, 2010) and the demand for equity (Demirag, Khadaroo, Stapleton, & Stevenson, 2011, p. 296) restrain the competition: “one in three PFI projects has attracted only two bidders” (Shaoul, 2009, p. 6). On the other hand to much competition could be counterproductive as might take bidders to submit excessive low bids (Marty & Voisin, 2008, p. 9) or to assume too much risk.

5. UK's Public Accounts Committee (2003, para. 6) concluded that:

the desire to show that the PFI deal is ‘cheaper’ than the public sector comparator has led to manipulation of the underlying calculations and erroneous interpretation of the results’ and ‘the accuracy of public sector comparators is limited (..) decisions can be made on the basis of small and spurious differences between the public sector comparator and the PFI option.

6. According to Broadbent, Gill, and Laughlin (2008, p. 42) “where there is no possibility of placing a numerical probability on something occurring or not, the unclear future state is referred to as an ‘uncertainty’ rather than a ‘risk’”.

7. Froud (2003, p. 586) states that “dealing with uncertainty, however, requires a responsible state which has the rights to initiate changes in the use of assets, and whose autonomy is not limited to the robustness of contracts enforced within private markets”.

8. Not surprisingly, the three best “perceived benefits” were “help government spread payment over life of Asset”, “increased investments in infrastructure” and “on-time delivery of assets” (Umar, et al., 2013, Table 1).

9. In this paper, financing refers to the money, raised by borrowing, required upfront for construction of the infrastructure. Funding means raising income to repay the associated debt (Shaoul, et al., 2006, p. 272).

10. Riess (2008) estimates that it costs society more than one euro to transfer one euro from the private sector to the government.

11. The investors are also exposed to inflation risk and, in some cases, to liquidity risk.

12. The total cost of financing includes, beside the rate of return, the administration costs associated and the contingent liabilities of the project (Chan, et al., 2009, p. xxv)

13. Project finance allows the private sector to finance the project off-balance sheet. For a detailed examination of the project finance technique see (Finnerty, 2013), for an analysis of the capital structure optimisation see (Sharma, Cui, Chen, & Lindly, 2010; Zhang, 2005) .

14. Also Grimsey and Lewis (2005, p. 374) claim that the private sector, having money at risk, promotes an improved management. However, the role of the financial parties are sometimes overvalued. In a Portuguese PPP, a motorway designed with 2 × 2 lanes was built with 2 × 3, by decision of the sponsors, and the financial entities have only realised the situation when they were invited to increase the financial envelope to finish the works.

15. It is assumed that a PFI project yields a 22% return for the Treasury (Shaoul, Stafford, & Stapleton, 2008, p. 108).

16. Strong protests occurred in Portugal after the toll increase of the bridge over the Tagus river, in Lisbon (1994), and the introduction of tolls in the Western Concession (1998). These incidents were still fresh in the memory and were taken into consideration in deciding on the funding model to be used in those sections.

17. Beside the shadow toll payments, bonuses (or fines) are also foreseen in the contracts, based on performance indicators. The performance is evaluated based on accident rates and number of hours of lane closure for maintenance.

18. There were legal constraints in Portugal that required the issuer of a bond to have a two-year trading record. A SPV, set up for the purpose of financing a concession, by definition had no such record.

19. The IGCP, Agência de Gestão da Tesouraria e da Dívida Pública — IGCP, E.P.E., is the public entity responsible for the integrated management of cash, funding and the direct debt management, including the issuance of all the debt instruments of the Portuguese Republic. www.IGCP.pt.