GRM 2010 GRM 2011

Abstract Details

 
AUTHOR NAME
 
Family Name:
Fremlin
 
First Name:
Per
 
ABSTRACT OF PAPER
 
Title of Paper:
PLP: Public-Like-Private for Greater Public Value
 
Paper Proposal Text :
The GCC (and indeed many other country’s public sectors) has the opportunity to adopt and convert the best practices of private capital into publicly managed project financing and management. The proposition is to supplement Private Public Partnership (PPP) with a hybrid, potentially novel, approach: Public-Like-Private (PLP). In PLP, the public plays the role of private finance and governance. A PLP structure would not eliminate the need for private capital, but the public would own the “lead equity arranger” process and take the primary risk-taker equity role. Thus, the public would thereby also enjoy the majority of the financial upside (apart from the upside of the delivered project).

PPP has historically been structured to inject private capital when the public has lacked financial and/or expertise resources. Private capital (normally) has a higher cost of equity (than public), has higher risk tolerance, and seeks higher risk return hurdles than if the project was entirely publicly financed. The extent of this private capital premia is often a deciding factor to whether a project can and should be undertaken. For example, a toll bridge may only be economical to build with private (and public) funds, but the tolls may only be affordable to users if debt-to-equity is very high (minimizing private capital costs and upside while maximizing long term debt and credit risk). This public-private tug-of-war to find the right balance and aligned incentives is often a reason why PPP has proved to be a challenge, and a limitation to widespread success.

PLP combines this public-private model. In PLP, the public owns and runs a “private capital” entity whose roll is essentially the same as any Private in PPP. That is, securing funds (public and private, equity and debt), organizing the optimum project structure, financial modeling, setting exit strategies, and so on. Moreover, the PLP takes the equity risk (as majority equity holder) and therefore the eventual upside (or downside) at exit. The fundamental philosophy behind PLP is that the public benefits from the delivery of a public-service asset, while also controlling and enjoying most of the financial value creation, i.e., skin in the game. This investment value creation is then available to the public, to reinvest, to reduce project (and user) costs, reduce the equity hurdle rate, or to have other flexibility.

The economics of PLP are, at first glance, compelling. A simplified example is a $3 billion, 10 year, 20% equity IRR, 80/20 (debt/equity) project. After 10 years, the equity holders yield about $175m of cash flow, and proceeds from the sale of the $3.3 billion asset (assuming asset value creation). If the PLP is responsible for 80% of the equity funded, this is a substantial value-add to both the project economics and public treasuries. One could argue that PLP is merely a significant reduction in private capital, substituted with public funds. Mathematically true. In practice, however, project private capital return (and indeed most investments) is a function of professionally risk managed assets, motivated by expected returns above cost of equity, with a goal to increase the value of the asset by exit.

For PLP to be successful, there are a number of expectations. One is that public equity is available and cost-effective. This requires a holistic view of total public funds and trade-offs, including sovereign wealth and other commitments as well as future sources (e.g., natural resource and privatization, or user revenues). This also includes measuring true cost of public equity (risk/returns), with sovereign debt pricing as one of many proxies. Another major PLP success factor is the ability to operate as a private capital entity. Risk
PLP: Public-Like-Private for Greater Public Value


governance, investment principles, and independence (within the public sphere) are noteworthy attributes. This includes the appetite to exit an investment (or accept lower equity IRR). Thirdly, PLP requires deep and varied access and relationships into private capital. That is, although most of the equity raised is presumed to be public funds, PLP would benefit from a diversified source of capital, debt, and investment markets. This access is an advantage from project creation (funding), to a successful exit (placement). Lastly, there exists a political acceptance of public funds deployed as “private” investors, without “crowding out” risk appetite from private sources.

It appears the GCC has the ingredients for a successful PLP structure. Even though public funds are strained by a secular reduction in energy prices, other source of funds remain, including sovereign wealth and liquidating/privatizing other assets. Private capital structure and governance should be obtainable, from a mature domestic finance industry, or outside the GCC, as a joint venture or other constructs. The GCC has also very deep connectivity with the capital and investment markets, which can be tapped (or re-aligned) to enable PLP. The GCC public investment industry is already considered world-class in placements. The ability for GCC countries to “act like private capital” appears to be publicly acceptable. If executed correctly, A GCC PLP model could reduce long-term public financing needs while at the same time creating attractive assets for foreign direct investment.

Other countries (e.g., Germany and Sweden) have initiated “PLP”-type programs for early-stage technology start-ups, incubators and other public capital assistance and governance for entrepreneurs. These programs tend to exit after proof of concept and private capital is sought by Series A timeframes or later. There is no reason a GCC PLP program can continue public equity involvement in early-stage innovations and act as primary risk taker all through late-state and mature technologies life cycle. This “end to end” view creates additional value, both in financial and intellectual capital.

Starting up a PLP program is very attainable via concurrent work streams. First, identify one or a handful of suitable projects to use as reference. Second, organize a PLP unit with the mandate for the project as well as to structure PLP going forward (e.g., the right projects, source and amount of funding, partnerships, people). The third activity is communication with the private sector, especially finance. Private capital still has a role to play as minority investor, and obviously at exit. Public-Like-Private is not a panacea for all large infrastructure (or public) programs, but can be a valuable alternative to create societal value.

 
 
 

WITH THE GENEROUS SUPPORT OF