Good Partners?

The Role of Joint Ventures and PPPs in Modern Business

Remember Lane Cove? What about Cross City Tunnel? Public Private Partnerships (PPP) in the modern business environment appear to be a necessity due to the sheer magnitude of the projects they finance; but to many people they may not be worth the candle. In the realm of infrastructure development, the PPP has a particularly chequered recent career.

Lane Cove Tunnel in Sydney was placed in receivership after the failure to repay its $1.14 billion debt early in 2010, three years after it opened at a cost of $1.1 billion. The project proved an embarrassment for Connector Motorways (a joint venture between Leighton Holdings, Mirvac and Hong Kong billionaire Li Ka-shing).

As for the Cross City Tunnel in the same city, Transurban bought $75 million of debt last November from Royal Bank of Scotland, EISER Infrastructure Partners and Leighton Contractors, who in turn bought the 2.1km east-west link road in 2007 after it was placed in receivership by its original owners.

But these may be blips in a trend toward the PPP, a policy devoutly espoused by government. According to federal department Infrastructure Australia, PPPs “are vital to the development of social and economic infrastructure in Australia. In line with the National Public Private Partnership Policy, the Australian, state and territory governments will consider a Public Private Partnership for any project with a capital cost in excess of $A50 million.”

In particular – and perhaps paradoxically – this is good news for smaller and medium-sized companies who may get more of a ‘fair go’ if they can bid for work as part of a much larger joint venture. Even the major construction companies often balk at taking on the risk of a $50 or $100 million project solo; a consortium of companies spreads the exposure much more acceptably, providing the tier twos and threes with a point of entry.

The National Infrastructure Construction Schedule established an Australia-wide infrastructure project pipeline. “Its implementation is a collaborative effort between the Commonwealth, state, territory and local governments.” The schedule contains information on all infrastructure projects over $50 million procured by the general government sector. “In line with the National Public Private Partnership Policy, a number of these projects are likely to use a Public Private Partnership delivery model.”

Two points quickly became evident once government set out to analyse the situation. First, transport projects are notoriously expensive and difficult to finance; secondly, neither state governments nor Canberra is actually very good at doing them or making money out of them, compared to the private sector (though to be fair, the private sector is reluctant to own projects that are not going to be profitable – a key factor in whether rail networks should be run for profit or for public benefit).

In December 2013, Infrastructure Australia compared the performance of a cluster of private infrastructure assets to that of another set run by the public sector. The aim was to identify whether a number of the most commercial, publicly owned infrastructure assets generate dividends of a similar scale to infrastructure assets in the private sector. Where dividends of public sector assets are lower, there is likely to be a benefit to public sector balance sheets by transferring assets to the private sector, even after the consideration of public sector dividends.

Infrastructure assets usually require high levels of capital expenditure to construct, but once built they usually generate strong returns, according to the report. Prices are often regulated and revenues relatively certain, with the high capital expenditure often creating barriers to new entrants. Operating expenses are relatively low and margins can be significant. This means privately owned infrastructure assets usually generate high dividend yields once constructed.

Dividends for infrastructure companies are also often relatively stable, the report concluded. “Revenues are relatively certain, operating risks are low and markets are relatively stable. Such companies can usually manage any demands for capital expenditure over the medium term through their capital structure to ensure a stable dividend stream. The dividend yield, which measures the ratio of annual dividend returns to the market value of equity invested in the company, is relatively high for the Australian listed infrastructure. The average for the Australian infrastructure companies is 5.3 per cent, compared with an average of 4.5 per cent for the largest 200 Australian listed stocks and 4.4 per cent for the All Ordinaries index which comprises the largest 500 stocks. This is in line with the view that once constructed, infrastructure assets have relatively low operating costs and strong margins. They often have limited growth prospects and therefore need to offer a healthy dividend return. In addition, dividends tend to be stable, capex is high and gearing is relatively high.”

Doing the same analysis on public-sector assets, the report found dividend yields are on average less than half the level for the Australian private sector comparators, averaging only 2.3 per cent of the equity values, which have been conservatively estimated. Higher asset values would lower these dividend yield estimates further. Dividend yields were highest for regulated electricity transmission and distribution and lowest for port assets and for the freight rail sector. Five assets which were valued on transfer to the private sector at over $5 billion were found to have produced no material dividends over the five years analysed.

This suggests returns to the public sector from ownership of infrastructure assets are on average significantly lower than those in the private sector. Dividend payments are also significantly more volatile in the public sector than the private sector, and gearing is relatively low. Public sector companies in the study’s sample on average spend approximately 160 per cent of their operating cash flow on capital expenditure; this is double the average for private sector comparators. This could be due to these companies generating lower operating cash flows and/or spending more on average on capital expenditure.

The report explains that the capex spend was lowest in port and some energy generation assets, and highest in the energy and water distribution businesses. Dividend returns from publicly owned infrastructure are unlikely to generate sufficient value to public sector balance sheets to compensate for likely proceeds from a transfer to the private sector. Governments are likely to have more capacity on their balance sheets to fund new infrastructure if such transfers occur, even after accounting for public sector dividends.

Australia has a growing infrastructure deficit, the report acknowledged. “Much of the deficit is the responsibility of State Governments, who have only limited capacity to fund new infrastructure, given existing and likely future budgetary constraints. The main benefits to the Government balance sheet from asset transfers include the financial gain to government where the proceeds from asset transfers exceed the net present value of future dividends that the assets would have otherwise produced; and removing government financial obligations and risks associated with the future capital expenditure requirements which in many cases, given the nature of the assets, can be quite significant. For example, at the time of the sale of Queensland Rail’s freight operations, the Queensland Government stated that the transfer would free the government from having to contribute an estimated $7 billion in future capital expenditure on QR National infrastructure.”

Across the Tasman in Auckland, the city’s mayor is claiming, as of 30 January, that public-private partnerships (PPPs) can relieve the burden on ratepayers. A leader in the NZ Herald thundered: “I wonder if he has done his homework. It’s not a vision, it’s a mirage. PPPs are joint ventures between government, or local government, and companies to build major projects such as bridges, tunnels and underground rail – and, in Britain, also hospitals. Too often, PPPs overseas end in the failure of the commercial organisation, with the public picking up greatly increased costs to clear up the mess.”

That is hardly in doubt – look at the UK’s catastrophic failures with healthcare PFI initiatives that have cost billions of pounds while bankrupting the NHS. Of course it is easy to suppose (a) that corruption is rife up there; and that (b) it couldn’t happen here. However, given that the future, as Infrastructure Australia says, is distinctly PPP-coloured, it would be good to know for sure that these partnerships are not just going to provide short-term budget solutions for state or federal bean-counters – and longer-term pain for the taxpayer.

Making Sense of Management

Management is the art, or science, of getting things done through people. Sounds fairly straightforward – except for the fact that people are not robots waiting to do our bidding. People have their own minds, motivations, and goals. So how do managers keep operations – and the people behind them – running as planned?

December 19, 2018, 5:11 AM AEDT