Raising infrastructure financing internationally for Russian projects has never been an easy task. However, there is resilient interest from high-profile international investors to well-structured transportation projects at the early post-development stages. Such projects offer a high degree of inflation protection to the shareholders, which, coupled with the limited traffic risk, enable potential investors to take a longer-term view on their exposure to the Russian economy. We expect that, as more projects (both federal and regional) complete construction phases, we will see more appetite from international players, both financial and strategic.
This investment in Russian infrastructure continues to focus on the transportation sector, which offers the most attractive economics to both investors and granting authorities. The most noteworthy deals have been taking place in the airport and road sub-sectors. At the heart of the Russian government’s efforts to encourage international infrastructure investment lies its commitment to public-private partnerships. The PPP concept has proved to be a successful framework for attracting private funds to the country’s infrastructure sector.
To date, the clear majority of the PPP and concession projects in Russia have been essentially rouble-linked, thereby limiting appetite from international investors, contractors and operators. Therefore, the main focus has been on the mobilisation of the available rouble liquidity from the Russian banks and pension funds. A particular emphasis is on utilising significant balances of Russian pension funds which have not been active in the concession sector due to the existing regulatory constraints.
However, there are notable exceptions that show evidence of a growing trend for international investors who see the potential long-term rewards from Russian infrastructure projects.
A LANDMARK DEAL
Pulkovo Airport in St Petersburg, the fourth-largest in Russia with passenger traffic of 13.3 million in 2016 and anticipated traffic of more than 16 million in 2017, was transferred to the private sector under a PPP scheme. There was unprecedented interest in the asset from international investors – largely because the business provides a natural hedge against local currency exposure due to a high proportion of international traffic (more than 35 percent) and euro-driven revenues. This has enabled the international shareholders to take a long-term view on their investment with moderate (infrastructure-type) return expectations.
There are at least two remarkable features about the Pulkovo transaction. First, the deal was implemented on an economically self-sustained basis – there was no state guarantee or subsidy required. Moreover, the winning consortium has an obligation to pay 11.5 percent of its annual revenue as a ‘concession fee’ to the City. Second, the VTB-Fraport consortium managed to raise the financing in the middle of an economic downturn in Russia, due to a high-quality project structure, including optimal risk allocation, a fixed-price turn-key construction contract, and a robust lenders’ security package. The Pulkovo PPP project has been a great success story, with the airport expansion phase completed on time and on budget in 2014, transforming Pulkovo into a world-class air transportation hub.
But there is more to the story. In October 2016, the Qatari Investment Authority bought a 24.99 percent stake in Pulkovo Airport for €240 million, valuing the airport at a level commensurate with high-quality international assets. In September 2017, VTB sold a 25 percent stake to a consortium of the Russian Direct Investment Fund, Mubadala and Baring Vostok, an international private equity firm operating in Russia, at a price reflecting the airport’s strong fundamentals and growth prospects.
As well as the Middle East, there is still activity coming from within the EU countries and there have been significant moves made in Russian roads. Recent years have seen a lot of PPP and concession activity in the Russian road sector and both federal and regional projects have been brought to the market. At the federal level, the most high-profile projects are the new M11 toll road between Moscow and St Petersburg (Sections 7-8) and the Central Ring Road in the Moscow Region (Sections 3-4). The other sections of those roads are being procured either outside the concession framework or with the support of direct state guarantees (such as Sections 1-2 of the M11).
The M11 and CRR projects are similar in many aspects: both are new toll roads in central regions of Russia, procured by the same grantor (state company Avtodor), underpinned by an availability payment structure, co-financed by government grants. In addition, both are purely rouble-based and procured under the Federal concession law. The key differences between the two are the timing, risk allocation and market volatility. The M11 tender was run in 2013, which allowed the bidders to prepare competitive proposals within the constraints of the allocated state grant. The M11 tender was won by an international consortium comprising VTB Bank and VINCI Concessions. The M11 project reached financial close in 2015. Apart from the state grant, it was financed by non-recourse debt facilities of more than 22 billion roubles from Russian banks and pension funds, and 4 billion roubles of the shareholders’ funds.
At the regional level, activity in the road sector has been moderate, as the PPP and concession framework is still a rather new procurement mechanism for local governments. All the major road projects assume introducing tolling for customers. This is in line with the strategy of the Russian government aimed at ensuring new major road assets operate on a self-sustaining economical basis. As a trade-off, the grantors need to structure the projects under an availability scheme to attract serious interest from private investors. Until now, direct traffic risk has not been generally accepted by domestic and international investors in the Russian road sector. This is not unusual for developing markets, and the traffic risk appetite is expected to grow as a track record of successful traffic stories builds up.
How do the federal and regional road projects compare? For major projects, they tend to be rather similar, because the regional authorities have learnt to rely on market precedents and communicate with key market participants in advance of launching their tenders. Still, there are some differences between the two. Regional concessions tend to be less sophisticated from a structuring perspective. This is not necessarily a bad thing because, in our experience, ‘over-structuring’ may become an impediment to the timely completion of the deal and to the efficiency of operations. Securing state grants may prove more difficult at the regional level, largely due to competition among the regions for budgetary allocations.
Raising debt financing is also more challenging for regional projects because of the lower credit rating of the grantors and strict constraints on the ability of pension funds to invest in local issues. However, given the limited number of major regional transportation projects currently in the market, we see no issue with the availability of financing from domestic banks and investors. The current trend of lowering the base rate by the Central Bank of Russia already has a positive impact on the ability of raising affordable long-term debt financing for new regional and federal projects.
There are several challenges facing Russian infrastructure projects that affect the ability to raise financing from outside the country. However, with a tried-and-tested PPP model operating strongly inside the country, and several very successful projects either under way or completed, prospects appear solid. The appetite is there for external investors to be involved in Russian infrastructure and new quality opportunities will be welcomed by market participants.