Departments — May/June 2005

Concessions: A New Paradigm in Project Delivery?

Public-private partnerships aren't new, but international investment firms could push aside local contractors in developing transportation projects.

Karen J. Hedlund ATTORNEY AT LAW Karen Hedlund is a partner of Nossaman, Guthner, Knox & Elliott, LLP in Arlington, Va. She advises state and regional transportation agencies throughout the United States on the structuring of public-private partnerships.

Over the last year, there have been a number of startling developments in the U.S. transportation market that suggest a paradigm shift may be occurring in the way state and local governments deliver and fund major projects.

In December 2004, a Spanish consortium led by CINTRA offered to pay $1.2 billion to the state of Texas for a 50-year operating concession on 316 miles of new tollroads that will cost them an additional $6 billion to build.

In January 2004, the city of Chicago closed on a remarkable $1.8-billion concessioning of its Skyway, a 50-year-old toll bridge on the city's South Side.

Both transactions have drawn the attention of public officials in other states. The governors of Indiana, New York, New Jersey and Delaware have recently announced that they are exploring similar tollroad privatizations. Texas, Oregon and other states are looking to the concession model to fund new roads.

Public-private partnerships are hardly new in the United States. Over the last 15 years, more than $20 billion of highway, bridge and transit projects have been built using alternative procurement methodologies, including design-build, design-build-operate-maintain and comprehensive development agreements.

These projects have involved significant upfront investment by design-build teams in project development, including preliminary engineering, environmental clearance and structuring revenue-based financings. However, few projects have involved actual long-term equity investment by the contractors themselves.

The recent private equity deals have attracted a new group of market participants that have the financial resources to make billion-dollar investments on their own. International firms such as CINTRA of Spain, and Macquarie Investment Group and Transurban of Australia, which have experience in owning and operating private tollroad concessions around the world, are leading the concession bids.

In this new arena, the international firms may threaten to eclipse the role of the large U.S. design-build firms such as Kiewit, Fluor, Washington Group and Bechtel and their regional subcontractors, which have helped to structure most of the public-private partnership projects in the U.S. to date.

The Next Wave

Are concessions going to be the wave of the future? And will these international investment firms really supplant local and national design and construction firms in leading the development of the nation's future transportation infrastructure?

We should not overlook the fact that 95% of our infrastructure projects will still be delivered using traditional public funding and procurement methodologies. The pending Transportation Reauthorization Act, while fiscally constrained, is still expected to provide more financial resources to the states than its predecessor, The Transportation Equity Act of 2001. Concessions, on the other hand, will be suitable for a limited number of large, complex projects that yield revenue streams sufficient to pay operating costs and produce a return on the private investment.

The principal source of such revenue on highway projects is tolls, which the public will generally tolerate only for urgently needed projects in highly congested corridors for which public funding is unavailable or inadequate.

But even the private investment models should not deprive local contractors of work. The international investors, for their part, can be expected to subcontract most of the design and construction of the large new projects to local companies. On the mega-projects, federal and state partners may be expected to limit "self-performance" by the lead constructor and insist on competitive procurement of subcontracts.

Where existing facilities are "sold" to investors under long-term concessions, the proceeds will provide a new source of funds for unfunded projects, which may well be procured conventionally.

Looked at from this perspective, concessions should be seen not as limiting the market for local contractors, but as providing additional opportunities that would otherwise not have been available until years in the future.

Will the concession model result in pressure on participating design and construction firms to put their own equity into these deals and exclude firms without significant independent financial resources? I think not. The most likely source of equity in these transactions will be from "passive investors" looking for utility-type low-risk, long-term returns that grow with inflation, for which toll roads are a good match. The pension funds and insurance companies have a trillion dollars of capital they are eager to invest in this new market.

Contractors will continue to make money on these projects the old-fashioned way, by getting the facility designed and constructed on time and under budget and letting others worry about the funding.