PPP - Pressure Release

Thu, 15 Oct 2009 13:55

Can private finance provide the solution to efficiency and cost control within the public infrastructure milieu? ISIZA speaks with Robert Gecelter from Investec's Capital Markets division.

In 1994, the ANC's raison d'être changed almost overnight, from revolution to democracy. The transition was always going to take time as the two make awkward bedfellows.

Accordingly, Government is fighting to keep up. Service delivery is a serious concern, especially at provincial and local levels. Since 1994, due to infrastructure's sluggish development, certain business models were possibly unable to realise their full potential. Even up to two years ago, public private partnerships (PPP) were a rarity. However, in his Budget speech of February 2006, Trevor Manuel announced that infrastructure investment and skills development were "the main frontiers ahead" and that these fresh journeys held promise of "unprecedented opportunities for initiative and partnership".

The following month, the South African Revenue Service (SARS) announced a tax collection of R418.1 billion, R45.3 billion more than its original printed estimate. This revenue, more than 90% of which comes from taxes on income, profits, goods and services, is a critical enabler of government spending. From spark to flame, the budget surplus, coupled with healthy levels of optimism, led to a dominant push in the infrastructure arena.

Current expenditure eclipses anything the former apartheid government did previously. Indeed, Government committed to spend- ing R372 billion between 2006 and 2009, at which point the three-year spending forecast soared to R787 billion. Between roads, hospitals, rail, water, ports, prisons, electricity and more, the complexity and scale of the projects necessitated the use of highly skilled labour, most of which resided in private enterprise. Traditional methods of procurement within the public sector led to projects all too often plagued by delays, inefficiency, quality concerns and, ultimately excessive costs. On the other hand, case studies were showing that PPPs were characterised by thorough planning, good communication, high efficiency and strong commitment. The end result being a public asset delivered on time, to spec and in budget.

The rationale behind the rise of PPPs over the last few years has been that of expertise, the need for experienced and highly skilled minds. The unforeseen credit crisis, which burst onto the scene late last year, forced the rationale behind the decision making to change.

It became extremely difficult for everyone, including Government, to access money. Nonetheless, a decade of prudent spending and the recreation of a budget surplus proved invaluable at this point, enabling Government to continue spending during its first recession in 17 years. Even though the deficit has returned, and Government borrowing is rising sharply, the cost of servicing the debt (while currently high) may remain relatively low.

The matrix of money flow is very complex, but the bottom line is that Government is spending wisely. Where governments around the world are lending a hand to the fallen, South Africa's is spending its money on a serious upgrade. This brings into question the most efficient means of allocating funds. In other words, how can Government make the most of what it has?

Robert Gecelter of the Project and Infrastructure Finance team at Investec Capital Markets, suggests, ""There is no doubt in my mind that for South Africa, PPPs are more critical now than they ever have been, and for a number of reasons. Value for money is the primary concern, so with that in mind, Government needs to harness the financing capability of private enterprise."

THE PPP MARKET

As far as the PPP market is concerned, there has been an increasing level of activity over the last two years. PPPs lend themselves very well to development within the construction industry. First and foremost, construction joint ventures (JV) within the consortia are often formed by a partnership of small and large companies. The smaller companies are generally more empowered, while the larger ones have the bargaining power and the ability to transfer skills.

Through the lure of lucrative Government contracts, there has been a great deal of interest from smaller companies trying to gain access to the sector, but they often fall short in their capacity to deliver projects of such scale. Inevitably, they join hands with the bigger companies, who often benefit from the empowerment credentials.

The PPP model has vast BEE potential, especially through the sub-contracting and procurement mechanisms. They can involve a full spectrum of large, medium and small enterprises, the local economic benefits of which can be spread to targeted groups of people. However, one of the challenges smaller companies face is that their resources can often get tied up in lengthy negotiations and tender processes, some of which may never be won. However, smaller companies are often eligible for assistance from the likes of the Development Bank of South Africa (DBSA) and the Industrial Development Corporation (IDC), for working capital, legal due diligence or empowerment funding.

Robert says, "Banks like to see project sponsors – builders and operators – taking more equity in their projects. The long-term nature of PPPs provides a perfect opportunity to grow black equity and management. Risk is clearly identified, costed and allocated, allowing black partners the security of understanding their commitment well in advance. Furthermore, with Government as the client, a steady revenue stream to the private party decreases risk to the new black partner even more."

Conventional methods often result in projects that are over budget and over time, which in turn adds significant cost to the client. PPPs can be shown to be more expensive than conventional procurement methods, but the PPP assumes a much higher level of risk., and international studies have shown that despite the perceived increased cost, the PPP delivers on budget, and on time.

When one considers the cost explosions among most of South Africa's current megaprojects, what would peace of mind be worth in knowing your project will be delivered on time, and on budget?

CREDIT WHERE DUE

Government's financial resources are being tugged and pulled from every direction, making it very difficult to allocate funds effectively. It must choose carefully; certain projects can access private funding, and others cannot. Logic suggests that Government should spend its own money on those that cannot, leaving private finance to those that can. The PPP model is founded on the principal of private finance. Robert says, "Since 2007, three main elements have changed within the PPP market.

Firstly, rates have picked up, and not because the banks are being greedy, simply that it costs much more to access cash. Furthermore, there is heightened risk. Perhaps the global banking system hadn't adequately perceived the risk associated with long term lending. "Secondly, there is a tendency for banks to lend shorter instead of long-term tenures, which reflects the lower levels of liquidity in the markets. This is problematic for infrastructure deals because they cannot be funded on a short-term basis. They are long-term assets, so the tenures need to be comparatively long-term.

"Fortunately, Government and the National Treasury's PPP Unit have been very alive to the credit crisis, and how they can alleviate certain pressures on banks and the funding mechanisms. The Unit has been attempting to introduce shorter funding structures as alternatives to traditional long-term debt.

"It has brought a certain amount of complexity into the market, but so far, under the new paradigm, no deals have closed. Given the current reality the facts are simple; short-term debt is cheapest and Government, as the client, is looking after its own best interests. "Thirdly, banks are looking at everything with far more care than they did before. Credit committees are trying very hard to make sure they avoid the mistakes that caused the credit crisis."

One example is that banks have increased their minimum debt service cover ratio (DSCR) requirements. The greater the operating cash flow, the higher the number, and the more secure the lending. The closer the DSCR gets to one, or below it, the higher the risk. For example, a DSCR of .95 would mean that the cash flow would only cover 95% of the debt repayments. As a result of the crisis, banks have increased the minimum ratio requirements.

"I think the one thing that this crisis has shown us is that we cannot take anything for granted anymore. Companies assumed to have been safe and secure credit risks in the past, went under."

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