The US market for private investment in transportation infrastructure through public-private partnerships (PPPs) can still be considered an emerging market, especially when compared with other, more mature alternative investment markets such as private equity and venture capital. In the US, simply put, the public sector has traditionally dominated the marketplace.
The results haven’t been good, however. In the transportation sector for instance, traditional public sector funding sources have in recent years proven inadequate to address the country’s infrastructure needs. This has resulted in the declining quality of infrastructure, much of which is now outdated and in poor condition.
Current macro-economic conditions have further exacerbated this problem. Decreasing GDP and rising unemployment have resulted in a reduction of government income, including gas tax receipts, precipitating growing fiscal deficits. With government budgets coming under greater stress and tax revenues continuing to decrease, investment in transportation infrastructure has steadily declined, even as user demand has risen.
Though the public sector alone lacks sufficient revenue to support needed investments, it can leverage private capital through PPPs. By leveraging private capital, state and local governments will prove their commitment to fiscal sustainability by creating a larger pool of funds to finance infrastructure needs, without relying on additional debt and taxes. Well-structured PPPs combine all available sources of capital to be invested in infrastructure, providing a sustainable source of employment that will boost local economies, while providing a stable return on investment to both public and private partners.
Backlash after poor alignment
To date, few PPP deals have occurred in the US. The most notable ones are principally recognised by the public controversy that surrounded the procurement processes and their business model. Until now, a “private equity” approach to infrastructure investment has dominated the US PPP landscape. This model has primarily attracted investors who take a short-term investment approach whereby returns are generated via fees at multiple points in the deal process. Private equity investors have also acquired infrastructure assets looking for capital appreciation and expecting to divest early in the concession’s life. Consequently, the model has had difficulty aligning public and private interest in the long-term, which has resulted in a political backlash against PPPs.
In response to this backlash, states and municipalities are reevaluating the “private equity” PPP model as they look for a more sustainable PPP approach to addressing transportation needs. The public sector is now more focused on aligning long-term public and private interests by sharing responsibilities and risks throughout the life of the concession and achieving common goals instead of short-term budget fixes.
The evolution towards a sustainable long-term partnership PPP model in the US will likely lead to fundamental changes in the perspectives of both the public and private sector. To assure the public’s interest is being served well, public officials are now paying more attention to define their strategic transportation plans and project objectives before deciding on their procurement strategy. Analytical tools such as “Value for Money Analysis”, which takes into consideration the total estimated life-cycle costs of traditional procurement versus PPPs, are more frequently being used by state and local authorities to quantitatively assess whether or not a PPP produces better results for the taxpayer than traditional procurements.
Beyond demonstrating that a project is procured through the most cost-effective method, when a PPP proves to be the best approach, both the public and private parties will likely structure PPP contracts to focus on the long-term value of the asset. Unlike the “private equity” model focused on a short-term investment approach, a long-term perspective creates totally different incentives. The long-term approach ensures that value is extracted through transparent cash flows and predictable yields, which are supported by the implementation of sustainable user fees, the creation of operational efficiencies, and a commitment to a life-cycle approach to capital investment. It also enables improvements to costumer service, which is key for achieving organic growth.
As the PPP market transitions away from the “private equity” model and moves towards an approach that addresses long-term policy priorities and focuses on the partnership between the public and private sectors, the public sector will take a “supervisory” role, thus concentrating on monitoring compliance of performance standards, ensuring coordination with other public entities and supporting the operations. At the same time, the private sector will focus on delivering better services at the most efficient cost for the users.
It is also important to note that the value added by PPPs will not come at the expense of labour. Some PPP contracts are likely to include pre-established policies for labour protection, which will require private operators to offer competitive compensation and fringe benefits, similar to those offered by public authorities. However, this should not preclude “labour mobility”. The new operating company should be able to asses its workers’ skills, as well as new technologies, on an ongoing basis, and adjust its workforce and business processes to seek productivity improvements.
Benefits to all parties
This sustainable approach to PPPs will not only provide a better alignment of interests among all stakeholders (private investors, labor, public authorities, users, communities, etc), but also will broaden the investor base by attracting direct investment from Pension Funds and other institutional investors. According to data recently compiled by the research firm Preqin, over 80 US State and local pension funds, with combined assets of over $1.3 trillion have either committed to investing in infrastructure or are considering it. Total investment allocated by these institutions is approximately $38 billion; however, this number is likely to significantly grow as the institutions already investing in infrastructure increase their percentage allocation, whilst other investors begin to target infrastructure investments for the first time.
Participating institutional investors will benefit from stable cash-flows that match their long-tailed portfolio liabilities and by incorporating inflation-hedged assets into their portfolios. The low correlation of infrastructure investments with other asset classes will also improve portfolio diversification. Even more important, by investing in local infrastructure projects, public pension funds can significantly contribute to job creation and economic growth while at the same time safely investing pension contributions in US transportation assets that offer attractive risk-adjusted returns.
As the PPP market matures in the United States, it will likely move away from short-term procurement processes towards sustainable long-term public-private partnerships. It is clear that states and municipalities face drastic budget and infrastructure shortfalls and will seek ways to find new funding sources, including private capital dedicated to infrastructure. However, through private investment states and municipalities will not only gain additional investment capacity, but also benefit from innovation, management efficiencies and costumer focus that world-class infrastructure managers could bring to the table. In addition, a sustainable investment approach will broaden the investor base as public pension funds and other institutional investors look at infrastructure as a market that not only offers stable risk-adjusted cash flows but also helps such investors achieve important public policy goals.
It will be this combination of public and private sector skills, as well as effective risk allocation, that will result in the long-term success of PPPs in the US. In the end, a successful PPP market will benefit all players: end users, urban and rural communities, industry, construction and finance communities, policy makers, and ultimately the economy as a whole.
Jordi Graells is the managing director of Toll Roads, North America & International at Abertis Infraestructuras SA, and president of Abertis USA. Luis Palazzi is a director of Toll Roads, North America and vice president of Abertis USA.