Key among the financial activities that we must drive to conclusion is the traffic and revenue model. Simplistically, this model is the "top line" in the subsequent financial analysis. Traffic and revenue modeling is an area requiring further development in the U.S. market to reflect the sophistication of Contractor/Developer's business models when contrasted with traditional 100 percent debt financing models used in municipal bond financing activities.
Capital costs must be developed on a full-risk basis as there is no other source of funds than the top line of the project. Operations & Maintenance (O&M) costs over extended periods of time must be estimated, as must tax rates, inflation and a myriad of uncertain costs.
Fundamentally different financing approaches must be competitively evaluated including a range of taxable and tax exempt models. Legislative changes must be weighed and tax effects considered, including both rate and depreciation opportunities. A range of financing tools is also considered, including equity, debt, subordinated debt, subsidies and alternative revenue sources. Specialized tools such as Private Activity Bonds and limitations on tolling regimes of different delivery options based on the financing model must be considered.
The financial modeling of a PPP is, if nothing else, a comprehensive modeling of uncertainty over an extended period of time. Historically, in the United States, this uncertainty was handled by sufficiently high coverage ratios to make the bondholders comfortable that they would eventually receive their money. It was also handled by traditionally low sovereign risk premiums, providing an advantage that many other markets did not similarly enjoy. This historical approach is not extendable to the PPP marketplace where the degree of sophistication in the modeling and evaluation of competing concepts is fundamentally no different than that of any large, long-time scale capital investment with a measurable degree of revenue or marketplace uncertainty.
Whether it is using Monte Carlo techniques to model risk and returns in an uncertain future or Real Options or other pricing methods traditionally applied by the financial sector in other capital endeavors, our industry must move beyond the municipal finance mentality more aggressively than it has to date.
A simple case can be used to make a point-a PPP competition with two different offers for the same project. One offer proposes the use of 50-year concession with taxable financing and a series of payments over time to the government that totals several billion dollars. Any excess revenue beyond the assumptions made in this first offer would de-risk the project and provide additional returns to the Contractor/Developer. The second proposes a 30-year offering employing a tax-exempt financing structure which would use any excess revenue to retire debt early and return the facility to the government even faster than the 30-year timeframe. In the second case, the revenue stream from the time the tax exempt debt is retired to year 50 would belong to the government.
Which of these scenarios provides the greater benefit to the government? Simply put, it depends. The public sector framework for evaluation of these two competing offers must consider total economic impact, carefully evaluating the differing time frames, the period where benefits accrue directly to the government and how and who captures the value of progressive project de-risking.