Moving out of the comfort zone

If you ask most infrastructure developers when they made their largest deals, or which year they chose to expand out of their core markets, 2009 will probably not feature in the conversation very often. While last year was not quite the period of paralysis many thought it would be when it started, for most it was not a year for hubristic investments or expansion. On the contrary, it was a time of modest activity, of keeping the house tidy and casting watchful glances at the balance sheet.

Roland Jurecka

But ask someone at Strabag for the date when the company completed its biggest deal and the answer will be: June 29, 2009. On that day, Strabag reached financial close on the largest single order in the company’s history – a €1.6 billion stretch of Poland’s A2 highway, a public-private partnership contract.

In the ensuing months between then and now, Strabag has continued to win deals in places like Kenya and Denmark – and is now in pole position for a road deal in Cyprus. Not a bad track record considering how cautious many of its peers have been in light of the financial crisis.

Did the downturn not make Strabag think twice before chasing some of these projects, especially as they were outside of its traditional core markets? Roland Jurecka, the head of Strabag’s concessions unit and a member of the company’s board of directors, answers disarmingly:

“To be honest, it didn’t. We look at all PPP projects – regardless of the crisis – with the same approach: are they good, or not? Concessions and PPPs are long-term projects that usually last over 30 years. It is almost certain that there will be crises during this time period and the projects have to be good enough to survive them. Even if the economic environment is good when we win a project, that project has to be good enough to survive the inevitable downturns.”

Long-term perspective

Having served at Strabag for the last 41 years, Jurecka has experienced the ups and downs of economic cycles several times over. A civil engineer and lawyer by training, Jurecka joined Strabag in 1969, starting his professional career in the firm’s design department before steadily rising through the ranks.

His CV, indicating impressive loyalty to the Strabag cause, highlights that here is a man who believes success lies in the long term – a good match for a unit managing projects with life cycles of 30 years. So it comes as little surprise to hear Jurecka say that “you cannot do PPPs if you are not prepared to take a long-term approach to the market”. Short-termism and the pursuit of quick returns do not fit the asset class and can lead to costly failures – something Strabag cannot afford:

“We simply cannot fail,” he stresses. “Even having one project fail can have disastrous consequences since it would affect the confidence our financial sponsors place in us. We need a spotless track record because without financial investors backing us, we cannot do PPP projects.” Which is why Strabag established a concessions unit to look at projects independently, he explains.

Vienna-based Strabag is now one of Europe’s largest construction companies. Its core markets, from which it derives the majority of its output, are Germany and Austria, but it is present in all of the countries of Eastern and South-eastern Europe, parts of Western Europe, the Arabian Peninsula, Canada, Chile, China, Kenya and India.

The concessions unit accounted for 15 percent of the company’s total output when Strabag released its half-yearly results for 2009, a not-insignificant number. The majority of its projects are located in Austria and Germany. But its recent PPP deals indicate a company growing beyond its home turf.

“Our expansion is mainly a result of the European Union’s open market. As soon as the EU created the conditions for a unique market for services and construction we started tapping into it. We are just one of the first major players in the market to have a true European vision,” Jurecka says.

Deal drought

The EU’s common market certainly creates that opportunity, but another reason why Strabag may increasingly notch up concessions outside of its comfort zone has to do with simple necessity. While Central and Eastern European (CEE) countries were regarded as some of the most promising PPP markets of the future, it’s a promise that has arguably failed to materialise.

Even having one project fail can have disastrous consequences since it would affect the confidence our financial sponsors place in us

Roland Jurecka

“It’s true,” Jurecka agrees. “The CEE market has not developed as fast as we would like. One of the major reasons for this is that they don’t have the administrative resources in place to deal with PPP projects. Look at Romania: they have been trying for years to launch their first road PPP [the A3], which was only recently awarded to a VINCI/Aktor consortium.”

“But the first time the project was tried must have been some ten years ago. However, it kept not happening for several reasons. Sometimes there were political reasons; other times the quality of the documents was just not up to the highest standards, preventing the project from moving forward,” he says.

Russia, another promising PPP market and one in which Strabag has already been present for 19 years as a construction company, has also disappointed.

“I don’t believe in Russia as a PPP market – at least for the moment. The problem is that there simply aren’t many financial institutions that are willing to accompany developers to the Russian market. If you look at the flow of Western money into Russia you will find that it comes mostly from the oligarchs. That is to say, the oligarchs’ money leaves Russia, is invested in the West, and then returns to Russia,” Jurecka explains.

The reason for this is that few – if any – international banks are willing to take on the currency exchange risk, a reality Strabag experienced first-hand when it failed to convince banks to reach financial close for the €5 billion WHSD project, a ring road around St. Petersburg.

“No international bank wanted to take the ruble risk on WHSD. For deals to be done in Russia, the government, or some other entity, has to hedge the currency risk. But so far, institutions like the World Bank and the European Bank for Reconstruction and Development haven’t been willing to take on ruble risk,” he argues.

Police probe 

The company also has experience of some of the other pitfalls that come with doing business in emerging markets, such as political risk. Last October, several of its Moscow offices were raided by the police searching for evidence of tax evasion. Then the Moscow Building Authority placed a petition with the Russian Anti-Monopoly Commission to revoke Strabag’s building licence in the country. That petition was rejected in November 2009, prompting the group’s chief executive, Hans Peter Haselsteiner, to comment:

“We have been active in Russia for 19 years. We have survived the ruble crisis, the political turmoil of the nineties and various attacks by mafia-like organisations. We will survive this media campaign as well. We know from where it was launched.”

For PPP contracts, with their long life cycles, this sort of risk is a crucial issue. This is why Strabag sold a 25 percent stake in the company to Russian billionaire Oleg Deripaska in 2007. “Our partnership with Deripaska is to be viewed precisely in this context – we thought that having a Russian shareholder would protect our interests against political risk,” Jurecka says, straightforwardly.

Despite the setbacks, he is pragmatic about the risks of emerging markets. “As a construction company, you need to go to these markets if you want to grow because in Europe the market is already mature and there simply aren’t that many opportunities anymore. Russia, being next door to our core markets, became the largest target for expansion.”

I don’t believe in Russia as a PPP market – at least for the moment…If you look at the flow of Western money into Russia you will find that it comes mostly from the oligarchs.” 

Roland Jurecka

All of which arguably leaves the concessions unit with little choice but to expand out of more familiar territories if it wants to grow. But despite the unit’s increasing importance, it is still Strabag the construction company that drives other parts of the group and determines how they will expand.

“For the moment, we make decisions solely on the basis of seeking employment for our construction unit. We believe our portfolio is still small for more select decisions,” Jurecka explains. “For example, Denmark is part of our expansion strategy and we decided to establish a presence there two or three years ago. This road PPP is a result of that. We are very keen on the Nordic market and expect to become one of the major players in the region over the next couple of years.”

Beware bank charges

Fundamental to its expansion in the PPP market is the company’s ability to attract capital – the main reason why Jurecka insists on keeping his unit’s track record spotless. But while he can understand banks’ wariness towards emerging market risks in the post-Lehman Brothers world, he believes banks are still overpricing PPPs in general.

“Bank margins have improved but they are still higher than they should be. I recognise that in the middle of 2007, when banks had liquidity to spare, margins were too low – and that’s precisely one of the reasons why things went wrong. But margins today are too high in relation to the risk profile of the projects they are financing,” Jurecka argues.

Part of the solution could be for banking institutions to better educate themselves on how to mitigate risks for these kinds of projects, Jurecka suggests. But he is also hopeful that some of the new solutions currently being discussed in the market – such as senior debt funds – will contribute to lower margins.

“Any additional sources of capital are a good thing because they have the potential to stimulate competition and lower prices in the face of increased bank margins,” he says.

Jurecka also believes pension funds will have a larger part to play in infrastructure, though not necessarily as direct investors.

“We would be quite keen to have pension funds co-invest directly in a project with us and we are ready to start a dialogue with any pension that approaches us. But I am not sure direct investment is something pensions will start doing massively. This is because institutional investors need bundles of PPP projects for their investments to make sense. It makes little sense for them to invest in singular projects. Besides, most of them are not interested in taking on project risk and that’s why I believe they will continue to use vehicles like [infrastructure fund manager] Meridiam, who handle those risks for them.”

Initiatives such as the EU’s €1.5 billion Marguerite fund are steps in the right direction, Jurecka argues, but should be viewed in context. “If you think about the €6 billion being mentioned in connection to the Marguerite fund [€1.5 billion in equity plus a debt co-financing facility of €5 billion] what does that buy you? Not more than a couple of roads in Slovakia,” he laughs.

Good times roll

Jurecka is expecting 2010 to be a good year for the Austrian company. “We grew in 2008 and 2009 and we are very positive about this year,” he says. “Actually, as a construction company, these last two years have not been so difficult. They have been hard for financial institutions but if you look at our competitors, like VINCI, you will find that they also grew.”

The real question for us is what will happen in 2012, when many of the measures put in place in our core markets to combat the crisis will end

Roland Jurecka

One might be tempted to conclude from this that construction companies, at least Austrian and French ones, are inexplicably immune to the global downturn but Jurecka is quick to dispel any possible misinterpretation:

“Construction companies are always behind the whole economy because they have significant order backlogs. The real question for us is what will happen in 2012, when many of the measures put in place in our core markets to combat the crisis will end. Then we might see growth slow because we are dependent on governments’ commitments to infrastructure for our business.”

It’s a valid point, even though cash-strapped governments are likely to continue to rely on infrastructure for economic growth and job creation in two years’ time. If anything, their dependence on the private sector to finance projects could even increase.

Still, this will certainly force Strabag to accelerate its expansion and start laying claim to new territories in order to keep growing. If its recent concession contracts are anything to go by, the company is not prepared to wait for 2012 to get started.  

Strabag: a potted history

Strabag was founded in 1835 by Anton Lerchbaumer. It is now one of Europe’s largest construction companies, employing some 73,000 people. The company recorded an output volume of €13 billion in 2009, a slight decrease compared with 2008, although Jurecka’s concessions unit increased output by 47 percent over the period. The unit accounted for 15 percent of the group’s output at half-year 2009.

Strabag closed two high-profile PPPs in 2009: Poland’s €1.6 billion A2 and Germany’s €660 million A5 roads. It also won a €740 million road project in Kenya in addition to smaller social infrastructure PPPs. Earlier this year, it won and closed Denmark’s first road PPP taking its PPP portfolio to 30 projects in total.