Public, Private Partnership, better known as PPP or P3, financing has gotten a lot of play as the panacea for infrastructure investment. Will it work? The jury is still out on whether PPP is a cure or snake oil to financing infrastructure projects in the US.

PPP: Three letters that stand for “public, private partnership.” They are being bandied about these days as some kind of magic incantation for creating infrastructure. They form the foundation of what the Trump administration says will be a trillion dollar effort to rebuild America’s crumbling roads, bridges, tunnels and waterways without a massive tax increase.

PPP is the source of hope. It’s also the source of wide-scale misconceptions and unrealistic expectations. What can be built and what’s likely to fly with both governments and investors can be very different.

“The devil’s in the details,” said Michael LaFaive, who analyzes PPP at the Michigan-based Mackinac Center for Public Policy, where he is director of the Morey Fiscal Policy Initiative. “There are a massive number of projects that can be structured with P3. But if they’re not done methodically, the whole initiative could be stymied by the first bad deal that comes along.”

A definition: PPP usually means a long-term contract between a government entity and a private party for providing an asset or service to the public. The private party has management responsibility and should bear significant risk, with payment linked to performance. Within this sphere, there is a wide range of private sector involvement and risk. They vary from merely management and operating contracts to full design construction, ownership and operation.

Financing can come in a variety of ways as well. Banks can provide loans. The government can offer funding. The company can raise money privately from investors, or it can obtain money through revenue bonds, which are secured by the income the project generates. Something called a private activity bond can be issued on behalf of a local or state government, but for the purpose of providing financing to certain PPP projects such as highways and transit.

Often US politicians point to major infrastructure projects abroad in countries in the Middle East or Asia but these mega-projects are often financed through sovereign wealth funds – governmental funds – whose socio-economic objectives are long-term.

PPP & Jurisdictions

These partnerships are gaining ground in many countries. The US has in some areas lagged because rules and regulations governing PPP and financing options vary widely from state to state. Fourteen states have no laws authorizing PPPs whatsoever, although that doesn’t necessarily mean they can’t be done.

“We live in a country with fifty different jurisdictions,” said a New York-based project finance lawyer.

So saying, PPP has been around for more than a quarter-century. In the US, it’s been used for a wide range of projects and purposes. A list of current projects includes everything from streetlights in Washington DC to light rail in Miami, a courthouse in Baltimore to student housing in Massachusetts.

Some projects have been extremely successful. Denver’s light rail system, for example, has been widely credited with helping to transform and energize the city and decrease traffic congestion. Some $5.3 billion has been invested or committed into the system that stretches more than 100 miles, with new lines to open this year and next.

There are, on the other hand, plenty of examples of abject failures in the US and elsewhere, ones in which the taxpayers get stuck with the bill. One of the most notorious was in London, when two private consortia took control of the subway system in 30-year contracts. After only four years, in 2007, one of the two went bankrupt and the government bought out the other before it could collapse as well.

The $3.5 billion Indiana Toll Road lease was the largest PPP project pre-financial crisis in America. It ended in bankruptcy as well in 2014.

After the global financial crisis, PPP in the US has largely moved from private takeover of existing infrastructure to building new infrastructure. The benefits to the public shifted as well. With privatization, the primary intent for a government was to make money off an existing asset. Now, goals include completing a greenfield project more efficiently and quickly, transferring risk and enhancing accountability, according to an analysis by Stephen Goldsmith, a Harvard Kennedy School professor, and Andrew Deye, a longtime advisor on public-private partnerships.

PPP - Risk versus Reward

That kind of motivation works best for “capital intensive, highly complex infrastructure projects,” the two wrote.

Private companies are likely to be more attracted to those kinds of projects as well. Simply put, their payout depends on an ability to not only figure out cost, but construction duration and long-term revenue as well. The more complicated the project, the higher the potential for both risk and reward.

“If it’s difficult to do, difficult to price, the kind of project with lots of thorny issues and the return is predicated on getting it done as efficiently as possible, then it makes sense,” said the project finance lawyer. “If it’s just paving a road, well, just about anyone can do that, so why bother?”

The lawyer cited as a prime example of complex projects the $4 billion New York-LaGuardia terminal, one of the biggest PPP initiatives ever in the US. It’s also one of the trickiest. A new central terminal, roadway system and parking garage must all be constructed while busy airport operations continue unabated and uninterrupted, a truly daunting task.

The consortium, which includes the Swedish construction and engineering giant Skanska and the French infrastructure-investing powerhouse Meridiam, took over operations June 1, 2016, when ground was broken on the five-year project. Two-thirds of the financing is private. The lease runs to 2050.

LaGuardia is immensely challenging. But no one would argue about the short and long-term need by the airlines for gates at the airport, demand that will translate into healthy cash flow.

That formula isn’t universal. Take another obvious infrastructure project: the Flint, Michigan water supply. It will cost well over $100 million to replace the damaged lead pipes that have contaminated the city’s water supply. While there may be many private companies willing to operate the waterworks, it’s hard to conceive any that would front the money for the massive overhaul and be willing to wait decades to recoup its cost. Charging an exorbitant sum to residences isn’t a viable option, either.

Tax Credit

Like most of his pronouncements, Trump hasn’t explained in detail how he can further jumpstart PPP-related infrastructure without pumping in mammoth amounts of federal dollars. One big hint came in the form of an October position paper from two Trump advisors, economist Peter Navarro and Wilbur Ross, a highly successful private equity head who is Trump’s nomination as commerce secretary. The two proposed a federal tax credit equal to 82% of the equity pumped into any infrastructure project by private investors. They claimed it wouldn’t drain federal coffers at all. While that claim is debatable, there are big problems with the plan and even bigger assumptions.

In a low-interest rate environment, that kind of tax credit in itself isn’t big enough to convince investors to act on marginal projects. And, non-US infrastructure funds such as Meridiam wouldn’t qualify.