Emerging secondary market for PPP equity: Does value for money assessment still hold?

By The Standard and Newsday | Sep. 1, 2021 | 7 Min read

By Justice Mundonde

THE PPP terminology emerged in 1997 in the United Kingdom. Arrangements of similar private public partnerships (PPPs) existed though in the UK prior to 1997 and these were categorised under the private finance initiative of 1992. The acceptance of PPPs for infrastructure financing stems from the fact that satisfying the demand for sustainable infrastructure remains a challenge in many jurisdictions including Zimbabwe. The capacity of the traditional forms of public procurement through State budgetary allocations has proven to be insufficient largely due to numerous consumptive competing claims to the State purse. PPPs have, thus become an alternative to infrastructure financing. The concept of value for money is amongst the key theoretical underpinnings of PPP implementation.

Value for money in PPP infrastructure finance posits that participation of private players in the provision of public infrastructure is instrumental in creating incremental value in project development. In value for money analysis, a cost comparison has to be made between the PPP-based mode of infrastructure delivery and the traditional sole provision of infrastructure through government funding. The objective is to make a business case for the most appropriate method for infrastructure provision. A comprehensive value for money analysis must include an objective full-life-cycle (FLC) cost and revenue analysis before a decision is arrived at with regard to choosing a particular project delivery method over another.

However, important value for money assessment is in project finance, un-anticipated innovations on the PPP financial landscape is demanding a revisit to the decision tool altogether. An emerging phenomenon in PPP finance is that of the secondary market for PPP equity. Largely a feature of developed economies, the phenomenon is of equal significance to developing countries pursuing PPP infrastructure policy. Fundamental to the emergence of this market in the early 2000 is the fact that during this period, a sufficient number of PPP projects in North America and Europe had reached the operational phase, making it feasible for equity holders with the special purpose vehicle to secure buyers of their stake. Once a PPP project has reached the operational phase, investors can be convinced that project risks relating to construction and operational subjects can be efficiently managed and as such they become comfortable in holding PPP-backed securities. The average time period between financial close and the execution of the first secondary market trade ranges from five to 10 years depending on the term of the concession contract.

The demand for PPP equity securities is anticipated to remain strong for a number of reasons. Institutional investors in particular view such assets as affording comparatively high risk adjusted returns and stable cash inflows long into the future. Besides, empirical studies have confirmed infrastructure-backed assets to be performing comparatively well relative to other asset classes such as bonds and stocks. Investors’ search for higher yields further explains the heavy attention that listed and unlisted infrastructure funds are paying on PPP infrastructure securities. Consultants advising governments on the need to shift from State-led infrastructure finance in favour of opening up more space for private sector compounds the momentum of the secondary market for PPP equity.

In addition, the resilient nature of the market to economic shocks is a vital pulling factor to holding PPP infrastructure-backed equity. Infrastructure market analysts noted that even though the global financial crisis had a marked effect on the secondary market for PPP equity, it did not take long for the same to rebound, thus confirming the resilient nature of infrastructure assets. From a supply side, corporate interest in PPP equity holders to a greater extent drives the upsurge in transactions. For instance, companies in financial distress and those confronting falling share prices can be compelled to dispose of their stake while some other companies may opt to transfer PPP equity to pension funds which they are member to in lieu of annual cash payments into the fund.

A number of positive outcomes can be associated with the emergency of secondary PPP equity market. For primary equity investors who many not want to hold equity position in PPP infrastructure assets, a developed PPP secondary market provides an exit route for such investors. Essentially, this provides an opportunity for primary investors to recycle both initial capital outlay and any realisable capital gains and dividend income into available bankable project opportunities. Furthermore, the benefits of an active secondary PPP market spills back into the financial decisions of the special purpose vehicle in a positive sense as the cost of equity can be reduced. Whether capital recycling in fact takes place is a question of empirical interest.

Inasmuch as there are positives to be derived from secondary PPP markets, using the United Kingdom as a case study, which identified some negative externalities that come with this phenomenon on the PPP finance architecture. Conceivably, trading equities whose value is backed by the performance of public assets can bring about a clash between the public interest of long-term delivery and the opportunistic interest of market participants. On average, the projected internal rate of return (IRR) for bidders of PPP infrastructure deals is 15% at financial closure. Of course, the rate may vary from country to country and from sector to sector depending on the project risk profile. Researchers have documented evidence with regard to windfall gains of up to 50% annualised-return being generated on secondary trading of PPP equity. These staggering returns flow to the original private partner involved with the project, secondary market investors reselling equity in the project company together with any other shareholder with a stake in the project. None of the revenues generated flows back to the project company managing the affairs of the PPP project or to the government departments in their capacity as the principal in the deal. Clearing return on investment of this magnitude is well above what a normal business case can anticipate and present. It is this level of profiteering that is the cause for concern given that the ultimate funding of PPP infrastructure projects lies with the public authority whether in the form of unitary charges or State-financed grants. The magnitude of profiteering on PPP secondary markets to a large extent invalidates the original value for money assessment that justifies the PPP deals in the first place. If the potential for profiteering is factored in, not many projects can provide a sound business case on the basis of value for money analysis.

Keep Reading

Analysing the type of institutions active in the secondary market for PPP equity helps to bring some other important issues to light which public actors in a PPP deal ought to take due cognisance of. Even though there is evidence of intra-primary equity investor trading of shares, a great constituent of the transactions is going the direction of infrastructure investment funds whose primary objective is return on investment to meet the expectations of their clientele. The Beitbridge modernisation project earlier this year reached financial closure and recent reports confirm the likely construction of a second pipeline under PPP arrangement. If comprehensive safeguard mechanisms are not instituted by the State partners prior to ratifying the PPP deals, a significant tranche of these assets can end up under the control of private investment infrastructure funds which are not a part of the original PPP deal. These funds may not be sensitive to the socio-economic, environmental, and political responsibilities that come with ownership of some infrastructure assets since the overriding goal will be to maximise return.

Accountability in PPPs can be weakened if not lost as ownership transfers from the original contractors and financiers to unlisted secondary market investors domiciled in foreign markets for instance. This is in view of the fact that it is often the case that PPP equity transactions like most financial deals are considered private and governed by strict confidentiality clauses limiting the oversight role of public bodies. Understandably, this concern can be managed better if the private investment fund is domiciled in the market on which the physical infrastructure is situated with the fund being registered on the domestic bourse. At least with effective listing requirements, there will be a legally-backed mandate on the part of the fund to comply with any such laws, thus providing reasonably degrees of transparency.

The Victoria Falls Stock Exchange can become handy in this regard subject to infrastructure funds getting registration on the bourse. Nonetheless, research provides evidence of private infrastructure investment funds delisting from domestic exchanges moving to offshore tax havens. Scenarios such as this not only pose concerns about tax avoidance but rather make it extremely difficult on the part of authorities to evaluate the impact of decisions as they are made by the funds, thus complicating assessments about performance of PPP projects.

It is this researcher’s view that legally-backed preferential treatment be extended to domestic financial institutions to hold stake in PPP infrastructure deals in Zimbabwe. That way we can at least guard against exporting value to foreign capital markets at a time when the Victoria Falls Stock Exchange, for instance, is struggling to take off. Presuming that the equity holders in the Beitbridge Border Post modernisation PPP decides to dispose their equity stake, the South African capital markets stand to benefit more given the active participation of South African banks relative to Zimbabwean banks in the deal. In the interest of capital market development and strengthening domestic demand, we are better off as a country if secondary market PPP equity sales are to be executed through domestic capital markets.