In analyzing prospective transportation PPP projects, it is important for both public and private sector partners to determine the financial criteria for evaluating the project and the assumptions that underlay the financial analysis to determine project feasibility from financial perspective. Potential bases for financial evaluation depend on the perspectives of each partner. Public partners look primarily at the ability of the project cash flow to cover the full costs of the project over time, including the costs of operations and maintenance, debt service, various reserve or coverage funds, long-term preservation costs, and capital expansion costs (if needed).
Private partners want to ensure that the project can provide a reasonable return on invested capital, whether debt or equity, net of design and construction, operation and maintenance, reserve or coverage funds, tax costs, and any sharing of revenue proceeds from the project. Therefore the results of private financial analyses for PPP projects focus on the Internal Rate of Return (IRR) on invested capital and/or the Net Present Value (NPV) of the net proceeds from the project over the term of the contract. Projects which provide an IRR greater than that which the financial community can obtain by investing its capital funds elsewhere are considered viable, as are projects with a positive NPV.
Public sector sponsors of PPPs are becoming increasingly interested in the financial returns from PPPs given the potential for some deals to generate windfall profits far above the purported rates of return required by the private sector to consider a project financially feasible. The challenge is how to balance the financial risk-taking by private partners financing or helping to finance a project through a PPP, which may not achieve minimum rates of return. More recent PPPs involving private financing are introducing revenue-sharing based on levels of rates of return on invested capital achieved from the project, with increased proportions of project revenues going to the public sponsor as the project IRR reaches greater levels, such as the Pocahontas Parkway PPP refinancing deal. The most recent deals have including revenue-sharing between the public and private partners starting when the project opens, such as the Texas State Highway 130 PPP concession. With revenue-sharing the public partners retain a financial interest in the success of the PPP project, which limits the potential for the private partners to earn windfall profits. Revenue sharing generally reduces the total value of the deal to the private sector and consequently the up-front payment a concessionaire may be willing to provide the sponsoring agency for a long-term concession lease.
Typical issues associated with the financial analysis of transportation PPP projects include:
• Assumed inflation rates on costs and interest rates on debt
• Length of contract term - affects value of PPP deal and ownership status of lease12
• Required debt coverage ratios and level of reserve funds
• Treatment of risks - range of outcomes
• Taxable versus non-taxable debt and equity - timing issue
• Transparency - public availability of private sector project financial information
Other financial issues relate to the use of IRR and NPV calculations to determine the value of a long-term concession lease or the profits from a PPP involving financing by the private partner. Both calculations depend on assumptions regarding the future level of background inflation, which may not transpire as projected. In the case of NPV calculations, the results become unusable beyond a twenty-year contract term due to the declining value of project costs and revenues that far into the future due to the effects of inflation. Long-term contracts of fifty or more years are even more difficult to project financial results, which makes revenue-sharing a risk sharing strategy for both public and private partners to a long-term PPP involving financing - possibly with both the public and private sector participating in the financing arrangements.
Other financial concerns relate to the basis for determining project IRR or NPV values and the source of the financial data upon which these calculations are based. If the private partners to a PPP collect and retain control over project revenue proceeds, including toll revenues and financial transaction fees collected during the term of the contract, it is uncertainty whether the information is a complete or accurate representation of the financial status of the project. Where the private sector retains control of project revenues and this information is used to determine IRR thresholds for revenue sharing, the asymmetrical nature of this financial information can raise questions about the veracity of the results. Revenue-sharing arrangements require that the public sector have access to a project's full financial records for audit purposes to ascertain their authenticity.
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12 IRS rules require lease contracts of 50 years or more for the lessee to be considered the effective operating owner, thereby granting the lessee the ability to take depreciation tax credit against the value of the asset. This suggests PPP legislation grant PPP contract term at least up to 50 years to maximize value to the public sponsors of long-term concession leases.