The Private Infrastructure Opportunity
July 22nd, 2015
Across America, cities and states remain cash strapped. At the same time, they have tremendous needs to modernize infrastructure projects and build new ones in order to grow out of crisis. Private equity funds and other global investors are positioning themselves to step in and supply money to pay for safe drinking water, structurally sound bridges, and well built primary schools. Fund managers have raised large sums since the start of the Iraq War when global interest in United States opportunities began to attract real money. Nonetheless, as fund managers raised sizable sums, the deals only trickled in. All this has changed. The market is starting to take off.
For instance, recently a consortium led by Plenary Group, a Canadian investor, advanced $899 million to the State of Pennsylvania. It will cure 588 of the states most structurally deficient bridges. One of the advantages of partnerships is that they create incentives to be less costly at the construction stage, expedite work, and better solve complex engineering challenges than traditional approaches. In Pennsylvania this means not only that the bridges will be fixed at all, but they will be done in under three years. Rather than let the fresh bridges then fend for themselves against other government fiscal priorities, the Plenary consortium will maintain the bridges for the next twenty-five years. The investors will receive money for sunk costs and an agreed upon profit from the state. Most bridges cannot sustain tolls, especially given the large number covered by the project, so money will be paid out of general revenues over time.
The public-private partnership project which sparked the broadened opening of the market is the Port of Miami Tunnel. It opened for business this Fall. The Miami project’s agreement was finalized at the height of the financial crisis. At the time, as a nation, we were in intense reflection over the economic prospects of our country.
Many private investors were nonetheless bullish on the United States. Meridiam, a European global investor, put money, a little over $843 million, on the table toward building the Miami project, the cost of the overall tunnel was about $1 billion. The Panama Canal is in the midst of a dramatic expansion, making it possible for much larger ships to pass through. The Miami Tunnel project allows the port to accommodate these ships. In reality, this expansion solidifies Miami not only as the gateway to the southeast, but also as an accelerator of exports.
The tunnel adds capacity to bring a greater volume of goods back and forth from the port to the regional expressway. Previously, trucks carried goods through a congested downtown already with limits on the capacity of its roads to accommodate them. In a companion project, Florida has also deepened its port to facilitate the next generation of container ships.
Like the Pennsylvania project, the Miami Port repayment relies upon incremental payments from the government over, here, a thirty-five year period. Payments are contingent upon the private investor meeting specific performance benchmarks.
In an era dominated by partisan bickering and intransigence, the Miami Tunnel was a partnership between Florida and Meridiam. It also was made possible through a financial collaboration among federal, state and local governments. Republican Governor Rick Scott worked closely with the Obama Administration to finance the project.
In the past year alone, we have seen many significant deals close. In December, the private equity firm, KKR, together with United Water, entered into a partnership agreement with the borough of Middletown, Pennsylvania. It gave the borough $43 million to meet public debt service such as pension obligations and agreed to $83 million in improvements to the water and waste water system in exchange for user payments over a 50 year period. This deal follows on water partnerships spearheaded by Table Rock Partners, Union Labor Life Insurance Company (ULLICO), and Carlyle Group in California, Montana, and New Jersey. This past Congressional term, a bipartisan bill easily sailed through both chambers to establish a federal financing authority to scale the water opportunity by providing long term low interest federal loans to municipalities for large job creating projects. The loans will be repaid through charges on the water bill. The program is explicitly modeled on a longstanding successful federal transportation program.
Since the onset of public-private partnerships, mega transportation projects have dominated. Traditionally, they have mainly happened in California, Florida, Texas, and Virginia. Again, these partnerships have been bipartisan with similar federal support made available to this club under both the administrations of Bill Clinton and George W. Bush. Other active places have been Chicago and Indiana. We now have projects in the planning or construction stage in all of these states in addition to ones in Alabama, Colorado, Kentucky, Maryland, Massachusetts, New Jersey, New York, Ohio, and Pennsylvania. Again, this expansion has also happened with strong bipartisan support.
Projects are now occurring on the frontier of partnerships, in the area of social infrastructure. This area includes public buildings and other facilities mainly in the sectors of K-12 and university education, courthouses and justice complexes, prisons, sports stadiums, defense, and more broadly property under management at all levels of government. Our public buildings are deteriorating and, like other infrastructure, past their natural life but asked to deliver vital services. This market started to take off with the private financing of a state-of-the-art courthouse in Long Beach replacing one which had been left to degrade over decades. We now have projects on the table such as the large scale expansion of the University of California at Merced and justice complexes.
In the social infrastructure space, we have not seen the labor strife experienced by an early stage of transportation projects. When the Carlyle Group pursued a social infrastructure project in Connecticut to modernize Route 95’s rest stops, it publicly showcased the fact that it was maintaining unionized workers in the new stops. When New Jersey passed a social infrastructure law permitting partnerships in the education sector, it required project labor agreements at a prevailing wage. That said, prevailing wage laws within social infrastructure vary from state to state, and partnership sponsors will undoubtedly reach varying accords in different parts of the country. It may be more important to look at the changing landscape of investors such as the $10 billion commitment at the Clinton Global Initiative made by the AFL-CIO and American Federation of Teachers to United States infrastructure, as an Expert to the Clinton Initiative I have worked on its implementation.
As with other public-private partnerships two questions are front and center. How does private equity get paid? And, from the government’s point of view, why is it financially advantageous? As with other partnership projects, investors get repaid either through user charges or else regular government payments. For instance, justice complexes and courthouses do not have paying users so rely upon government payments, while rest stops, airport terminals with retail and food outlets and also university dorms can rely upon user charges.
So, when it comes to social partnerships, what is in it for governments and the broader public? Many areas go to the core of government functions including the schools in which our children learn, the housing of our military families, and the buildings where justice is done. Of course, property partnerships are not always essential or noble – when they are not, it is especially important to see a demand for their services matched with a viable profit motive.
Regardless, property partnerships are costly because our infrastructure needs are so great. We have long term needs brought about by a preoccupation among some public officials with the short-term. Our traditional approaches to government financing are no longer able to sustain even our core government functions. For instance, no workable plans exist to fix our grade schools or defense bases.
The main financial benefits of private investors to governments is that they have a long term investment horizon, sometimes willing to be paid over a fifty year period. Also, the multinational construction firms have the engineering capacity to take on large-scale, often complex, building challenges in a way that is cost-effective – much cheaper than traditional projects. It bears reminding that we have used private investment to grow out of financial crisis at key points in our country’s history, after the War of Independence, the Civil War, and the Great Depression.
Private investment in public infrastructure is now widely accepted and growing. The number of leading private equity firms in the space increases regularly. Pension funds, insurers, sovereign wealth funds and family offices are aggressively increasing allocations. Private investors agree on the prospects of the United States and are coming off the sidelines. It is perhaps the greatest bipartisan success since the financial crisis and an area which we will see a Republican Congress and the Obama Administration build on.
Our next goal must be scaling this success. Doing so means equipping governments with a sophisticated understanding of capital markets. For their part, investors must realize that increased deal flow and higher returns on investment mean understanding how to serve a country with exceptional aspirations. We are one nation with needs in a myriad of infrastructure sectors, across fifty states, and thousands of cities. The deals are there for the taking, it is a matter of identifying, cultivating, and securing them. Both of these challenges can be solved with the right guidance. America not only welcomes private participation in our economy, but we have the best investor protections in the world.