Episode Transcript:

Johan– Let's go ahead and just do a little bit of an intro on the genesis of public private partnerships, how long they've been around and what they are and maybe you can just give a little intro to the listeners here.

Aleks– Sure.  Thank you.  Actually public private partnerships or P3s have been around and they've been very popular outside of the US for a number of years.  But they've only become popular in the US probably over the last five years with any regularity.  And I'll explain the reasons for that in a minute.  But generally a public private partnership or a P3 is an agreement between the public sector, whether it's a state, municipality, or other governmental body and the private sector, either an equity fund, a lender, construction company, or certainly a combination of all of those, to renovate or construct, operate, maintain and or manage a particular facility or a system such as a road, a bridge, parking structures, lighting systems, etc.  Anything that's infrastructure in nature, typically, and at the municipality or state happens to have an interest in.  The reason why we are sort of lagging behind, in fact I just served as a Moderator and a Chair in a couple of conferences over the last couple weeks in New York and they're all the fifth annual, the fourth annual, which shows how young this class is, P3s and infrastructure investing in general is in the US.  But the reason P3s have particularly been slow to take hold here is that historically we've had a very affective and full blown federal transportation program, which is not the case in many countries outside of the US.  Also, the bond market, the municipal bond market was something that the municipalities and states could really use to improve their infrastructure or grow whatever needs they had, they were effectively able to finance all of those infrastructure needs through the bond market.  Now, unfortunately given the economic situation that we have currently, the reduction in the gas tax revenues that has certainly affected our federal transportation program as well as all of the local ones.  And the difficulty that the municipal and state bodies now are having to be able to raise funds through the municipal market because of the combination of factors; one is their ratings have declined because their budget deficits are so significant.  Those two factors have really led people to focus on P3s as another solution, and a solution that I think will be very valuable because the infrastructure needs are vast and growing. 

Johan – A couple of points here, I'd like to interject.  One is that first of all the premise here is that the private entity is able to manage these projects more efficiently both in the construction phase and then in the operation phase, more efficiently than the public entity.  Has that fact been born out?

Aleks – Yes, I think the US Government Accountability Office has with respect to, for instance, the Indiana Toll Road; there was a GAO report in 2006 that did indicate greater efficiencies.  I think that some public sector officials may argue and certainly that's an argument that's used in many cases against P3s and people perhaps don't like the implication that the government is not capable or efficient enough in its functioning.  And there haven't been, I don't think, statistical studies on all of the transactions to give you an answer, but I think for the most part the view is that they are more efficient.  What's happening though these days is that there is a much more stringent review of these P3s by both the local municipality as well as you probably heard the federal government has been focusing on them as well and so people are being very careful and trying to make sure that predications on efficiency are born out.  I think we have a much more realistic view of what the efficiencies might be.

Johan – Let's focus in on some recent trends here because of the credit crisis of the last couple years here.  One is that many of these P3 partnerships were financed through private capital markets transactions and I must only assume that those have been more difficult to accomplish.  And then secondly we have the effects of all the stimulus from the federal government into infrastructure.  How have each of those two factors affected the number of P3s that are being proposed and accomplished right now?

Aleks – Well actually those two questions were topics of great discussion in these conferences that we've had in New York over the last couple of weeks.  To answer the first one, certainly the bigger deals are not getting done and that's why you saw what's happened with the Midway Airport P3, they just couldn't get the financing together.  But there is a lot of interest in infrastructure assets generally.  And what most equity funds that have been speaking about this issue and are still in the market, they're very much focused on private-to-private deals.  They're waiting for the P3 market to really sort of become very robust and right now in the interim what we're seeing is a lot of private-to-private transactions.  Probably more in the energy space than anywhere else.  And because the financing is easier to get in that space for two reasons.  One if it's a private transaction then you do take away the governmental uncertainty.  Number two from a regulatory perspective, we have a very sophisticated and regulated utility and energy industry in the US and it's very predictable.  And as long as it's predictable financing can be found.  One of the things that everyone stressed is while it's been difficult, everybody suffered, if you looked at the performance of the infrastructure funds themselves, infrastructure is still a very good play right now, because it's a long term asset, typically with continuing cash flow models so it's a good investment and I think it's easier to get that financing.  But not for the big deals.  Everyone's focusing now on trying to accomplish something that's more manageable.  And I think on the stimulus end, frankly, and we asked this of various public officials, that has not really affected P3s at all because, first of all you needed to have shovel-ready projects within 120 days and it's very difficult to get those P3s done in that kind of a framework.  And so the projects transactions that are taking place with the stimulus funds are really those that cities and states have had on their books that are easy to put into effect.  It's really a neutral with respect to P3s.  It certainly has helped that the Obama administration is focusing on infrastructure investing and certainly on projects related to that and I think that sort of helped P3s in the infrastructure world because everybody's now looking at ways in which to finance infrastructure developments, but the stimulus funds themselves have not really had any impact on getting those projects completed. 

Johan – So there's some really large state deals that have derailed but there's still activity going on in more manageable projects, more downstream projects, smaller infrastructure projects, I mean how far downstream are we getting?  Are we getting to a city of 10,000 with parking meters and privatizing those?  Where are deals getting done? 

Aleks – That's a very good question.  It's amazing, but there are a number of new players out there right now focusing new funds that aren't the Carlyle, the Blackstone, etc., but smaller funds that are focusing specifically on fairly minor in size municipalities.  The size could be as little as 4 million, 5 million in population.  The question is do they have assets?  Can you bundle those assets?  You can combine a parking structure and a lighting system, etc., and do they have the will to get it done?  And so to answer your question in terms of the types of deals we're seeing now, everybody's focusing on parking structures and parking meters.  You saw the Chicago deal get done.  There was a lot of criticism in terms of the pricing because the meter prices went up fairly substantially and there were some other mistakes made, but certainly LA, Harrisburg and other cities are very carefully focused on that and the private sector is looking, and they see that the parking structure and parking meter deals are easier to get done.  It's not like tolling a road although there is some political backlash.  If managed properly those deals can get done.  But it's a matter of education.  I think that everybody's going out to these municipalities and saying, “Let's look at your asset list, this is what we can do for you.”  And I was just talking to one of the funds today, they're actively looking at roads and parking structures, and there are RFPs out there coming out on a daily basis from these municipalities because they need money and this is one way certainly to help restore that budget deficit or otherwise be able to finance an infrastructure project.

Johan – You've been participating in these conferences for about five years and it's a relatively new concept here versus Europe perhaps, but the people who populate these conferences, maybe you can contrast who was there two, three years ago versus who was there now.  What's the mood?  Who are the people trying to accomplish this and how's it changed?

Aleks – It's interesting.  The mood has shifted.  It's sort of a running joke because most of the attendees at these conferences are the big players, are the Cintras, the Macquaries, the representatives of some of the major municipalities.  This year we had representatives of Florida, typically Virginia's very much on the forefront, we had Michigan representatives because Michigan is starting to get very active.  The mood is certainly not as dour as it was perhaps last year but there is this sort of growing impatience because we're all waiting to see when will this really take off and the setbacks that P3s have experienced in Texas for instance, have been significant.  And certainly other states, Nevada and Georgia, it's a very difficult thing to get through unless you're extremely politically astute.  New York recently had, actually June 1, produced a very extensive report called SAM, State Asset Maximization Report, and they've taken a very methodical approach to identifying assets that they have and they basically included people from all sorts of industries and views, political views and otherwise and constituents, to get a buy-in upfront.  Michigan, for instance, is being very careful. They have an Office of Public Private Partnership and they had a task force that they put into place, studied this issue and made sure that there was a consensus among, whether it's the unions, the municipal employees, the legislators, etc.  So the mood is optimistic—but cautiously optimistic.  At the end of the day we need an answer and P3s are certainly one answer.  But we still have political issues and of course we also have had a lot of developments and certainly the Oberstar Bill that came up with the white paper and then the draft legislation that is now being considered, was another very important and controversial subject at these conferences because now we've got the Federal Government with this Office of Public Benefit and people are very skeptical about the benefit of that legislation.  And there's a lot of discussion about is this really going to help or hurt P3s? 

Johan – This Office of Public Benefit, that's inside the Department of Transportation though so that would cover predominately just roads and bridges.  Or does it also cover parking structures and things of that nature?

Aleks – I don't think it covers parking.  It doesn't go as far as that, you're right, I mean it is clearly simply a highway, whatever the extent of the Department of Transportation authority, that's where it goes.  But it's a very controversial one, especially at these conferences.  It was amazing how critical most every speaker was to the tee, to the last one, about this Office of Public Benefit because we're having a difficult time enough to get people to really understand how a public private partnership works and to get a level of comfort with it.  Although frankly the Lazard Poll that just came out not too long ago, where they basically polled the variety of voters on their views of P3s generally, and tolling in particular, the poll seemed to imply that there is greater acceptance of these types of transactions among the general population.  But there is still a lot of controversy because the federal government, Oberstar in particular, as well as certain state legislators feel that there is still this negativity that the private sector is somehow taking advantage of the public sector and therefore P3s should not be viewed favorably. 

Johan – Yeah, the fundamental suspicion there is one that the public's going to get charged more than it otherwise would in the future because it's a private entity managing it or two the sale of the assets or the lease of the assets occurred at too low of a price.  I mean that's ultimately the two fundamental suspicions, right?

Aleks – Right.  Certainly one thing we all would agree that those first couple of deals, the [Chicago] Skyway and the [Indiana] Toll Road deals and probably some others, given where the economy was those were really good deals for the public entity.  I think another suspicion and another big issue with getting people comfortable with P3s is the concept of displacement.  There's a lot of vested interest at the municipal and at the state level. 

Johan – Of employees?

Aleks – Employees and actual departments and authorities, that feel that their authority is going to be displaced and they will no longer have the ability to basically rule the roost when it comes to particular assets.  And that's where a lot of effort is being placed and now the P3 deals are very careful, the private sector is very careful to make sure that it's inclusive of these employees.  Actually P3 projects are very much a method by which you help the economy of the state or the city because, especially if it’s a greenfield project, which means it's a brand new construction, you are bringing work in and usually in these P3 transactions you have a certain agreement as to what percentage of your workers is going to come from the locality in which the project is being built.  And so I think that the private sector probably went a little overboard early on but is now very, very careful in working with all the various constituents to make sure that everybody has interests that are aligned because we all have to work together to get the project going.  And unfortunately no one is interested in putting a lot of effort in, and the private sector does have to put a lot of upfront effort in, that may be unreimbursed, and you don't want to do all of that and then get basically nixed either by the legislature or by the governor or by some other political upset that might come along.

Johan – Well doesn't it all come down to price at the end of the day and the price is driven off these hundred year projections on where the economy's going to go?  I'm curious to hear your commentary on, generally speaking how projections have born out vis-à-vis actuals of the projects that you are aware of, and if the modeling of projections is a harder task now, or subject to controversy given that nobody expected the crisis to occur and how to project the future now?  It might be a little bit harder.

Alexs – That's absolutely true.  Clearly we have seen reports of difficult economic times that have hit especially hard some of the projects that are based on vehicles and transportation movement back and forth.  Not all of them have been hit equally, but clearly because of the decline in ridership, whether it's due to the gas prices, whether it's due to just lack of commercial activity, was certainly unexpected and has certainly made these projects not as profitable as certainly the investors would have wanted them to be. 

Johan – Okay, so let's just wrap up here again with what's in your opinion, the near-term and long-term outlooks for P3s. 

Alexs – The near-term outlook I think is still slow to market.  We are seeing more states adopting P3 legislation.  Arizona's governor is about to sign its legislation, Michigan is pushing through, we just had Puerto Rico adopt some very extensive legislation, and certainly we have now probably close to 26, 27 states that have comprehensive P3 legislation in place and so the question is what kinds of deals can get done in this kind of market?  And so for the short term we're going to see smaller deals and it's still going to be tough to get them done.  In the long term, however, especially if some of these states that are just starting off really continue in their methodology of approaching this in a way that takes the political concerns and makes them the utmost and really maneuvers and navigates those political concerns in a way that helps get these deals done without much contention and disruption, and more education.  We have to have more education of the various municipalities so that there is an understanding that this is not a way to basically take assets away and sort of fill the pockets of the private sector, but rather this is a mutual goal.  And there are policy issues here that I think people are really starting to understand better.  Basically it's in the interest of all of us, all Americans generally, to look at this as a means of upgrading our infrastructure because as a practical matter we're running out of choices.  And we're not just talking about transportation.  That's the topic here, but there's social infrastructure, there's water systems, there's energy, etc.  P3s are really something that should be considered in all of these arenas.

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