Pros and cons of electrical contractors entering into public-private partnerships in the U.S. construction market
Currently under construction, the Port of Miami Tunnel (POMT) is expected to alleviate traffic congestion on downtown Miami streets caused by the approximately 4,480 trucks that travel to and from the Port of Miami each weekday. Under the administration of the Florida Department of Transportation (FDOT), the project, estimated at $607 million, is financed as a public-private partnership (P3) between FDOT and Miami Access Tunnel (MAT), a company formed expressly by two finance investors to offer a proposal on the project, which was selected in a competitive bidding process. Meridiam Infrastructure Finance, made up of nine banks, holds 90% equity in the contract, and Bouygues Travaux Publics owns 10% equity.
A P3 is a contractual agreement between a public agency, such as FDOT, and a qualified private-sector entity or consortium — in this case, MAT. The P3 transfers the responsibility of designing, building, financing, operating, and maintaining (DBFOM) the project from the public administrator to the private entity. On Oct. 15, 2009, FDOT and MAT entered into a 35-year concession agreement, which includes 55 months for design and construction.
“A P3 agreement contains elements of design-build and finance,” says Colin Myer, managing director, project financing, at FMI Corp., the Raleigh, N.C.-based management consulting and investment banking firm for the engineering and construction industry. “It looks a lot like a lease agreement. It’s essentially a built-to-lease arrangement.”
Florida has agreed to pay for 50% of the capital costs — design, construction — and all of the operations and maintenance, estimated at $200 million over 30 years, while the remaining 50% of the capital costs will be provided by Miami-Dade County and the City of Miami. During the construction phase, MAT will be paid $100 million as it meets certain milestones and will finance the rest, partly through a Transportation Infrastructure Finance and Innovation Act (TIFIA) loan from the U.S. Department of Transportation. Upon final acceptance, it will receive an additional payment of $350 million. Once the tunnel is open, FDOT will make availability payments to the concessionaire, with an annual maximum amount of $32.5 million (in 2009 dollars plus an adjustment for inflation.) These payments will be contingent upon actual lane availability and service quality.
The tunnel is fully funded within the contract life and does not rely on tolls as a funding or revenue source. Additionally, under the contract, the company cannot impose tolls to recover its cost. The tunnel will be returned to FDOT in first-class condition at the end of the contract in October 2044.
The construction of several new U.S. transportation projects, such as the I-595 Corridor Improvements Project in Broward County, Fla., has been financed through P3 contracts. Additionally, P3s were also used to provide up-front payments to the public owners and finance significant reconstruction and maintenance of a number of existing facilities in the United States, such as the Chicago Skyway, the Indiana Toll Road, and the Pocahontas Parkway in Virginia. The increased interest in the P3 model, say infrastructure experts, is the lagging revenue collected during the recession by state, city, and municipal governments.
“There’s still a huge infrastructure need, but the public sector is showing an increasing reluctance to increase the debt load,” says Myer. “Property tax revenue is down, but we still need infrastructure to be built.”
In its recent report, “Public-Private Partnerships: What You Need to Know,” FMI reveals that although P3s have been previously used to finance projects in the United States — in fact, “thousands are operating today” — they are now just gaining more traction here. “Many industry analysts expect this trend to intensify, as P3s have proven a viable means to repair and upgrade infrastructure, particularly in a strained economy where public resources are limited and private capital is in need of strong, risk-adjusted investment opportunities,” reads the report.
Driven by owners seeking alternative delivery methods, the P3 model is expected to overcome some of the obstacles to its adoption, such as state-level legislation and the regulations/politics of state/municipal legislatures and councils, to become more widely accepted for both economic infrastructure, such as roads, bridges, and railways, as well as social infrastructure, such as hospitals, courthouses, and water treatment plants. “While it is unlikely that P3s will become the dominant delivery model in the future, we expect the model to thrive in certain pockets in certain states; it will certainly represent a sizable, robust niche market worth considering in the future,” according to the report.
According to Myer, the P3 model of structuring infrastructure deals is not as well known in the United States as it is in other countries. “However, as state and local governments in this country increasingly turn to the private sector for involvement in infrastructure development and financing, FMI has recognized that P3 is an evolving opportunity for companies in the construction and engineering industry,” he says.
In addition, faced with increasing competition over fewer available projects, many general contractor and subcontractor firms are looking to the P3 market to keep themselves afloat. “The impetus for firm leaders to move beyond the traditional business model has received a bump from the difficult market environment,” reveals the FMI report. “Scarce resources and hard-fought opportunities in the industry have seen contractors look for greater autonomy over procurement to enable their companies to stay working.”
However, there are a number of challenges firms may face when attempting to win work on P3 projects. Owners who keep changing the scope or nature of the project — or putting the risk exclusively onto the private sector — are detrimental to successful delivery of a P3 project. Contractors must have in-house staff able to fulfill the owner’s “fit for purpose” for the construction, as well as meeting schedule and budget demands. Also, it can take years for a P3 proposal to be finalized. As a result, trade contractors must be able to offer estimates, which may include materials with volatile pricing, long before construction begins.
In addition, lack of qualifications can also hamper a construction firm’s entry into the market. Firms with previous P3 experience are most likely to be considered for additional P3 projects, giving an advantage to international firms entering the new U.S. market. “Further exacerbating an increasingly diverse competitive environment is the relative inexperience of many new (domestic) market participants,” says the report. “Often they don’t have the necessary in-house capabilities, aren’t really committed to the process, or simply don’t understand the sophistication of the business.”
Still, contractors with previous experience in design-build and public operations and maintenance contractors could be a natural fit for the P3 model. “The best way to start into one of these is to team up,” says Myer (Getting Started on P3s). For example, for the POMT, MAT brought in subcontractors for the design, construction, and operations of the project, some of whom are affiliated with the equity investors.
Hoping to take advantage of this growing market, Hialeah, Fla.-based Horsepower Electric, Inc., a family owned and operated, full-service electrical contractor that specializes in traffic signal and lighting work; intelligent transportation systems, including variable message systems, vehicular video monitoring and identification cameras, and vehicular and speed radar devices; and maintenance services for traffic, lighting, and ITS, is currently seeking opportunities in P3 projects. “There are funding issues at all levels of government, but these jobs need to get done, so we’re seeing jobs being contracted using this type of method,” says Mike Martinez, general manager. “It’s a market that’s opening up, so we’re looking into it and pursuing P3 proposals with different agencies. We don’t want to be left behind.”
At Horsepower Electric, Martinez believes the firm can leverage its previous experience working on construction and maintenance in the public sector to acquire contracts under the P3 model. “We’re already offering those services,” he says. “Now, we’ve set up financing instruments for the financing package that’s part of the bid. That’s the main difference.”
According to the company, it has already forged the necessary relationships through its work on previous projects. “Our experience in crafting successful partnerships spans a wide variety of projects and industries,” claims the contractor on its website. “With a thorough understanding of legal, financial, and competitive influences, the team assists clients in developing innovative ways to accelerate project delivery, mitigate risk, and maximize return.”
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Currently, alternative project delivery methods, such as design-build, design-build-finance, build-finance, CM-at-risk, and various integrated project delivery (IPD) arrangements, comprise around 50% of non-residential contracts, according to the FMI report. P3s can be placed on the continuum between wholly owner-driven projects and purely collaborative, shared-risk models of project delivery.
Under a P3 agreement, the risk of the project shifts from the owner (the public entity) to the private-sector team contracted to build and operate it. Additionally, general contractors may try to shift a part of the risk to its trade contractors. If the general contractor is liable for financial penalties if the project is not delivered on time, it could download the responsibility to the subcontractors. This shift is called “liquidated damages” in a P3 contract.
According to the American Subcontractors Association, Inc. (ASA), Alexandria, Va., currently, there aren’t enough built-in protections for subcontractors on P3 projects. “As these types of projects become more popular, and governments at all levels seek private investments in projects to build projects that are traditionally known as public, one of the areas that is lacking in legislation is traditional protections for subcontractors in the form of payment bonds,” says David Mendes, senior director of communications and education, ASA.
As an example, Mendes says that on a traditional General Services Administration building financed entirely by the federal government, the payment assurance is guaranteed through the Miller Act Bond. However, payment assurance on that same project built under a P3, depending on how the deal for construction is structured, may not apply — and that bond may not be provided to protect the subcontractors. In addition, mechanic’s lien laws, used in private construction, generally do not apply to construction on public land, and federal, state, or local governments often own the real estate on which projects financed through P3s are built.
Nearly every state has a bond and/or lien protections for subcontractors. Bonds are required on public projects, and liens are available on private projects. “Each state has its own statute for providing those protections,” says Mendes, who also cites bond requirements on projects funded by the federal government. But under P3 contracts, this is not the case. “Nearly all states do not have enough protections for subcontractors on P3s. The federal government right now does not have enough protections for subcontractors on the federal projects funded by P3. Those protections that subcontractors typically count on are just missing. Subcontractors may not even know that they’re not required on some of those projects. So ASA is seeking at the federal and state levels to change the laws to assure those protections are in place.”
As such, ASA is seeking to extend the federal Miller Act protections to P3s. “As opportunity arises to influence legislation that would require the payment bonds, ASA is sending out action alerts and calls for action to contact their federal legislators and get those protections into federal law,” says Miller.
In the meantime, subcontractors involved in P3 projects should carefully read the contracts. “As always, the question is, ‘What does the contract say?’” says Mendes. “It really depends on the contract.”
For example, if P3 requires a sufficient payment bond and it covers the subcontractors, then the subcontractor has a payment assurance. “The subcontractor still may want to obtain a copy of the bond to ensure that it’s a sum that will cover the subcontractor’s work,” continues Mendes. “Reviewing the bond is always a good practice.”
He advises that if the contract for that P3 work doesn’t contain a requirement for a payment bond for the subcontractor, then that should raise a red flag for the sub. “They should be asking that question before they sign the contract,” he says. “What is going to be provided in the way of payment assurance on this project since I can’t lien this project, and there’s no bond?”
However, at Horsepower Electric, this additional risk isn’t a deterrent from seeking P3 contracts. “Most of this work is bonded, so subcontractors are still protected,” says Martinez. “The same protections that are on a regular project are on a P3 format. We have the same rights and laws there for protection for the subs. I don’t see an issue with that.”
SIDEBAR: Getting Started on P3s
The best way to get started on public-private partnerships (P3) is to team up, according to Colin Myer, managing director, project financing at FMI Corp., the Raleigh, N.C.-based management consulting and investment banking firm for the engineering and construction industry and co-author of “Public-Private Partnerships: What You Need to Know.” FMI interviewed industry leaders and surveyed FMI experts to reveal helpful strategies contractors can use to acquire projects under P3 contracts.
- Build your expertise through strategic joint ventures. What you learned in previous construction jobs does not necessarily apply to P3s. Therefore, it is important to start cautiously, educate yourself as you move along, and work with experienced project partners. This is the time to consider new types of partnerships and joint ventures.
- Plan comprehensively for project complexities. P3s are typically very complex, large-scale projects. Therefore, it is important to know what to expect of the partnership beforehand and to outline expectations and responsibilities at the outset in an extensive, detailed contract. On top of that, a conflict-resolution contingency should be on hand to deal with inevitable disputes, whether large or small.
- Understand the cost and risk barriers to entry. Due to the magnitude of P3 projects, contractors are often required to provide proof of strong balance sheets and solid bonding capacity. More often than not, the concessionaire will require a large (i.e., financial) parent company to back the performance of the design-build and request very large Letters of Credit (LOC) as additional performance guarantees of the design-build in order to meet the lender’s requirements for backing the deal with debt. While the amount of equity a firm looks at fronting is one obvious consideration, the issue with greater potential impact on a firm’s balance sheet is the financing risk it is taking on. P3s bring with them greater risk in terms of a longer life cycle, larger scale of liability, and heightened vulnerability to changes in external dynamics as the project progresses.
- Be strategic about the projects (and owners) you go after. Preparing bids for P3 projects can take years and millions of dollars of investment. Therefore, it is paramount to have a deep understanding of the owner’s “ecosystem” (What are his budgeting process, timetable, and constraints? What does his decision-making process look like? How is the public agency run?) and the viability of the project, which is often dependent on the public and political context.
- Get in the door early. Start building relationships with public officials and finance representatives now. P3s require commitment and support from senior public officials, who must be actively involved in supporting the concept of P3s and taking a leadership role in the development of each given partnership if they are to succeed. Start conversations with public officials and finance representatives long before projects have been announced. Understanding both their project needs, as well as the P3 process, is key to building trust with a given stakeholder — crucial if they are to personally invest themselves in a P3. Long-term relationships with key influencers will help you shape and develop P3 projects from the onset.
- Collaborate and innovate. P3 projects are highly complex and collaborative in nature and therefore cannot be run in a silo-type manner. New emerging technologies, as well as owner demands, are pushing design professionals and contractors to work as a cohesive team from the outset, communicating and approaching projects more holistically. As part of this effort, it is key to build strategic alliances with reliable partners and to develop a deep network of companies that are team players, open-minded and innovative. Experience in design-build delivery methods as well as a background in finance, operations, and maintenance are a huge plus and can help your company differentiate itself even further.