dialoguepartnerships

DA L E A N N E R E I S S

Infra-Investment
Public infrastructure attracts private investment worldwide.
Infrastructure is the backbone of the global economyand what supports its growth. Countries depend on it to move people and goods expeditiously, efficiently, and safely. But many countries have not been able to build and maintain The infrastructure problemlike so many other problemsessentially comes down to money. Resistance to higher taxes, government budget deficits, and increasing competition for government resources have meant that insufficient public dollars are available for infrastructure funding in many countries. Though governments generally have access to relatively low-cost debt capital (such as the municipal bond market in the United States), their infrastructure needs are so great that they are struggling to plan for future infrastructure needs, raise sufficient capital to build and maintain essential infrastructure, and prevent catastrophic failures of aging and brittle infrastructure, all without overwhelming their budgets. In the United States, a congressional committee has identified infrastructure investment needs that could reach $100 billion annually, including $53.6 billion a year to maintain existing highways, bridges, and transit systems in their current condition. Despite the costs, underinvestment in our nations transportation and infrastructure needs is penny wise and pound foolish, the committee said in a report. Governments have used a number of traditional as well as innovative public financing tools to pay for infrastructure construction and maintenance, including various types of bond financing, lease structures, special tax districts, revolving loans, tax incentives and credits, and user and other fees. Governments increasingly are entering into public/private partnerships (PPPs) not only to bridge the gap between capital available and capital required for infrastructure investment, but also to transfer risk to the private sector and limit governments exposure. There are many types of PPPs, but governments typically solicit bids from private companies to upgrade, operate, and maintain existing infrastructure or to design, build, operate, and maintain new infrastructure. In entering into PPPs in the roads sector, for example, governments and private investors typically sign concession agreements that address questions such as road maintenance standards, limits on toll hikes, fare increases, and capital improvement dollars. As governments are quick to note, the PPP model is not a privatization in which a private entity acquires the infrastructure. Rather, the government retains ownership of the asset and leases or licenses it to the private entity under a longterm lease arrangement, after which the infrastructure reverts to the government. The private entity operates and maintains the infrastructure during the lease period and generates revenue from tolls, fees, and other revenue streams. In return, the private company usually pays the government a substantial upfront fee. The state of Indiana, for instance, recently approved a $3.8 billion offer of Macquarie Infrastructure Group and Cintra SA for the joint venture to lease and operate the 157-mile (253-km) Indiana Toll Road for 75 years in exchange for all toll and concession revenue. The

DALE ANNE REISS is Ernst &

Youngs global and Americas director of real estate. Tim Philpotts, a partner with Ernst & Young Canada, and Charles Shorter, an executive director with Ernst & Youngs Transaction Real Estate Group, contributed to this article. (The views expressed herein are those of the authors and do not represent the views of Ernst & Young LLP.)

roads, highways, freeways, tunnels, bridges, levees, airports, ports, and other infrastructure to keep pace with population and economic growth. The problem is especially acute in developing countries, which a September 2005 World Bank report said now face the challenge of correcting for huge infrastructure gaps that threaten growth and the achievement of social and other broader development goals.

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transaction is scheduled to close June 30, 2006. To finance their investments in infrastructure projects, private investors usually invest their own equity, supplementing it with loans from specialist infrastructure banks or other lenders. In smaller greenfield or new development projects, these investors usually are construction companies or specialist operators or suppliers involved in building projects under PPP agreements. However, these companies do not have the capital to finance the multibillion-dollar investments that typically are required for large projects. To meet that need, commercial banks, investment banks, and other sponsors are creating funds to raise capital from pension funds, private equity funds, and other investors for investment in infrastructure. Private equity funds alone are estimated to have more than $100 billion available for investment globally, and in their search for investment opportunities, some funds are diversifying into infrastructure from real estate and other private market investments. New funds also are being formed. For example, the Carlyle Group, a global private equity firm, recently said that it had established a team to conduct investments in infrastructure, with an emphasis on U.S. transactions of $100 million to more than $1 billion. More and more, PPPs and infrastructure funds are used globally to finance infrastructure projects. According to an August 2005 Federal Highway Administration study titled Synthesis of Public/Private Partnership Projects for Roads, Bridges, and Tunnels from Around the World: 19852004, nearly 2,100 such projects with a total estimated cost of $887 billion were planned and funded worldwide between 1985 and 2004 (the latest year for which figures are available). About a third of these projects were for roads, the others were for railroads, airports, bridges, seaports, and other infrastructure. PPPs (or private finance initiatives, as they are also known) and infrastructure funds are common in Europe and Australia. In the past ten years, Innisfree, a U.K.-based fund manager, has invested in 60 projects with a total capital value of more than $20 billion. Australiabased Macquarie Group manages a number of funds that invest in infrastructure acquisitions and development projects worldwide. Its funds. Without a private partner, state officials say the project would not be feasible. A public/private partnership is not the way its been done in the United States, but it will probably be the way major projects are done in the future, says a project spokesman. The Texas Transportation Commission recently invited the private sector to submit proposals to finance, design, construct, operate, and maintain I-69/TTC, a 600-mile (960km), multiuse transportation corridor extending from northeast Texas to Mexico. This is a change in the way major transportation assets are built and paid for in Texas, notes a commission official. Private investment, not taxpayer dollars, will be where we look first for funding. In California, the San Francisco Bay Area Rapid Transit (BART) District recently announced plans to solicit new bid proposals by this fall on a project to build a connector line between the Oakland Coliseum BART station and the Oakland International Airport. The bid request will include a private sector funding component. In early April, Californias legislature enacted the largest public works package in the states history: a $37.3 billion plan to repair roads and schools, prevent flooding, and encourage construction of housing in urban areas. Last year, President George W. Bush signed the long-delayed federal highway bill, with guaranteed funding for highways, highway safety, and public transportation totaling $244.1 billion. It was designed to encourage the formation of transportation PPPs and provides for issuance of up to $15 billion of tax-exempt private activity bonds to finance highways and other infrastructure. Another federal program, the Transportation Infrastructure Finance and Innovation Act, empowers the U.S. Department of Transportation to provide secured loans, loan guarantees, and standby lines of credit to public or private entities in connection with qualifying transportation infrastructure projects, with a view to leveraging federal funds by attracting private investment. Infrastructure funds are attractive to investors because they are professionally managed and provide stable, long-term cash flows with competitive yields and quantifiable risks. They can be structured as corporations, tax partnerships, or hybrids to meet the tax requirements and other goals of investors. With more funds entering the infrastructure market, investors are beginning to have more investment choicesnot as many as in the private investment market, but more than when infrastructure funds were first started. As with other fund investments, investors also have more liquidity compared with investing directly in the underlying assets. PPPs involving the sale of an existing asset to the private sector interest governments because, as noted, they may receive billions of dollars in upfront fees, which can be used for purposes such as paying down debta particularly attractive proposition for local or state governments that are heavily leveraged and pay relatively high interest costs. Among other benefits, governments may realize more value from leasing the asset than from the costs of building, operating, and maintaining it. The risk inherent in operating and maintaining the asset passes from the government to the private investor. Governments may realize significant time and cost savings from entering into PPPs. On new U.S. infrastructure projects, these savings range from 6 percent to as much as 40 percent of construction costs, the U.S. Department of Transportation (DOT) reported. PPPs also are attracting investments from businesses and real estate investors who do not have a direct equity interest in an infrastructure project but will benefit from it. An example is San Franciscos $2 billion Trans Bay Terminal project. Local experts say the rebuilding and conversion of this outdated bus terminal into an intermodal public transit complex

Private equity funds alone are estimated to have more than $100 billion available for investment globally, and in their search for investment opportunities, some funds are diversifying into infrastructure from real estate and other private market investments.
Macquarie Infrastructure Group is one of the worlds largest developers or operators of toll roads. PPPs are coming into wider use in Asia, too. India, for instance, is using PPPs and private capital to help finance a $38 billion project to rehabilitate its roads. Its government has awarded contracts to remodel and upgrade the Mumbai and New Delhi airports to consortiums of domestic and international investors. PPPs and infrastructure funds are starting to attract more government interest in the United States. A number of states have granted legal authority for private sector participation in transportation projects. Texas, Virginia, and Florida are among the states in the forefront of PPP initiatives. Floridas transportation department recently announced plans to solicit competitive bids for a PPP to finance a $1 billionplus Port of Miami tunnel using mostly private

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could spur $10 billion to $20 billion in commercial and mixed-use development in the immediate neighborhood over the next ten years. Going forward, governments and private entities must address a number of issues in structuring PPPs. Among them are that some public officials may believe they are better qualified than private operators to manage public infrastructure, and the public may resist empowering a private operator to determine tolls and other fees for use of infrastructure. Governments want assurances that private operators will repair and maintain the infrastructure properly, and that if the operator should default on its contract, the government can take back control of the asset. Governments also want PPP agreements to provide the flexibility to adapt to changing economic and demographic needs, such as a future need to expand a tollway to accommodate increased traffic. For their part, private investors and operators need to have a clear understanding of the risks inherent in a PPP. They need to understand the political and regulatory environment in which contracts are negotiated and projects are operated, and they want assurances that governments will be consistent in their relationships with operators over the life of the contract, and that contracts will not be subject to sudden and arbitrary government changes. All of these are issues that government and investors can address in negotiating contracts. As existing PPPs have demonstrated, government and private investors/operators can successfully work together in building and operating projects. In the emerging PPP market in the United States, best practices eventually may be established for future PPP contracts, perhaps with governments and contractors adapting best practices from the more mature European market. In any event, the challenges are being overcome, and PPPs are the wave of the future. U L

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