Infrastructure Finance

The changing landscape

in South Africa

March 2010
Synopsis

The political landscape has changed;

infrastructure is top of mind and there is
recognition of the large infrastructure
shortfalls locally and around the world.

Stimulus packages in many countries, including
South Africa, are being used to redress part of the
infrastructure gap, which in addition to achieving the
short-term goals of creating employment and fostering
spending, should create a good platform for increased
economic efficiencies going forward.
Governments need to look beyond short-term objectives
and articulate a much broader vision for enhancing
infrastructure as measured, not just by jobs created, but
by enhanced productive capacity for the future.
As a result, new and innovative Public-Private
Partnership (PPP) structures are needed to make projects
work. This article looks at how to structure a unique
and optimal partnership solution for each project.
The degree of risk sharing between the public and
private sectors needs to be flexible, and optimised on a
case by case basis to ensure that projects can become
a reality.

Funding is still a problem in the current constrained

credit environment, and although the stimulus
packages address some of the shortfalls, market
conditions are making it hard to fund the balance of
required projects in the private debt capital markets.
Budgetary constraints and reduced taxation collections
are impacting the State’s ability to fund large projects
beyond the stimulus packages, which have placed
further strain on national finances.
Introduction

After decades of neglect, and despite many other
distractions in the global economy, infrastructure has
finally made it to the top of the political agenda, not
only in South Africa, with its new focus on service
delivery and job creation, but in many other countries as
well. According to a recent survey, 77 percent of senior
global business executives believe that the current level
of public infrastructure is inadequate to support their
companies’ long-term growth. These executives believe
that over the next five years, infrastructure will become
a more important factor in determining where they
locate their operations.1
The public has awakened to the consequences of our
neglected roads, bridges, public transport, electricity
grid and other social infrastructure such as hospitals
and schools. The recent wave of service delivery unrest,
Eskom’s “load-shedding” and media exposés of the
country’s crumbling water and sewage treatment
infrastructure, have ensured that infrastructure delivery
remains top of mind. This is not purely a South African
phenomenon. According to a recent poll, 94 percent of
Americans are concerned about the condition of their
country’s infrastructure.2
Table 1 – Stimulus packages announced across the globe
Australia Around AUD 28 billion
Canada CAD 12 billion
China Around USD 438 billion
European Union Around EUR 173 billion
France Upward of EUR 10.5 billion
Germany Around EUR 19 billion
Japan Around JPY 2.6 trillion
India Around USD 33.5 billion
Sweden SEK 1 billion
United Kingdom GBP 3 billion (in capital spending brought forward)
United States Around USD 113 billion
Thanks to the stimulus packages unveiled in many
countries (see table 1), public infrastructure is receiving
long overdue attention and a significant infusion of
public funds. While these are welcomed developments,
the level of direct government funding proposed will
meet only a tiny fraction of infrastructure needs. In
the United States, according to the American Society
of Civil Engineers, there is a $2.2 trillion gap between
the supply and demand for roads, bridges, water and
sewage systems, public transit systems and other public
infrastructure.3 The infrastructure stimulus money from
the 2009 American Recovery and Reinvestment Act
(ARRA) addresses less than 5 percent of this need.
The current confluence of events presents government
leaders with a unique opportunity to make a timely
and economically productive down-payment towards
closing the global infrastructure gap. Funding
is however, not the only challenge. The current
inadequate state of certain infrastructure demands
innovative thinking in order to speed its improvement.
This means using the full complement of innovative
infrastructure financing and delivery solutions available,
while developing new approaches to address today’s
challenging market conditions.
The landscape for public and private infrastructure
financing has changed dramatically since the financial
crisis began (see table 2). Tightened credit markets
pose as an obstacle to raising debt finance for public
and private infrastructure delivery models. This depends
on high levels of up-front capital repaid over the long
term through user fees or general taxation. Just as
governments are strapped for cash, private firms face
difficulty raising capital in constricted financial markets.
However, this does not mean that private involvement
is off the table. Governments can make limited public
funds go further by leveraging the $180 billion in private
equity that has been raised by infrastructure funds over
the past few years.

The changing landscape of infrastructure finance in South Africa 1

Table 2 - How the infrastructure landscape has changed in the wake of the credit crisis

Pre-crisis Demand Supply

• Limited public money for infrastructure
• High construction costs
• Fiscal dynamics encouraging governments to
explore alternative delivery models
• Well-functioning debt capital markets and
international project finance loan market
• Highly geared capital structures and attractive
equity returns
• Dominance of active equity investors and
emergence of infrastructure funds

Post-crisis Demand Supply

• Infusion of public money for infrastructure
• Falling construction costs
• Fiscal distress solidifying interest in alternative
delivery models
• Challenged debt capital markets, but aided by new
borrowing instruments
• Price and tenor constraints in international project
finance loan market
• Variability in equity returns
• Impairment of some active equity players, balanced
by continued growth in infrastructure funds

2
On the demand side
Infusion of public money for infrastructure
After a long period of underinvestment in public
infrastructure, the South African Government in 2008
announced a range of infrastructure investment projects
aimed at increasing the productivity of the South African
economy and creating much needed employment.
These projects are estimated to total some R785 billion
over three years (see breakdown in table 3).
Investing in public works to stimulate economic activity
is hardly a South African phenomenon. The 2009 ARRA
directs substantial public funding to transportation,
energy and IT infrastructure, schools and federal
building modernisation, among other areas. Around
the world, infrastructure investment has become a
significant component of a number of the economic
stimulus packages developed to respond to the global
recession. The European Union has committed upward
of $200 billion to infrastructure. Further east, India is
investing around $30 billion in upgrading the country’s
infrastructure, while China has announced that half of its
$585 billion stimulus package will go to infrastructure.
While the sizable influx of government stimulus dollars
will not come anywhere close to eliminating the
“infrastructure deficit,” stimulus funds should certainly
help improve the condition of infrastructure which has
been badly neglected over the past few decades.
Table 3 – Large South African infrastructure projects
Power Madupe
Kusile
Other Eskom projects
Transport Gautrain
Bus Rapid Transit System
Gauteng Freeway Improvement Project
Durban Harbour Widening
New locomotives
Multi-products pipeline (Dur-JHB)
New Durban Int airport
Extensions to JHB & CT Int airports
Fuel New Coega refinery
Water infrastructure Lesotho Highlands Phase 2
Berg River dam
Other Stadiums for 2010
Other
The changing landscape of infrastructure finance in South Africa
Falling construction costs
As of March 2009, investment spending (which includes
construction) was down 12 percent in the United States,
and over 20 percent in several Asian and Middle East
markets, with worldwide construction activity levels
not expected to return to their 2008 peak until at least
2011. Due to diminished global demand (for both
residential and non-residential construction), commodity
prices have fallen globally, and other construction prices
have fallen in some jurisdictions. With new stimulus
funds now available for infrastructure, government
leaders can take advantage of lower construction
costs while providing a needed boost to employment.
An estimated $50 million project at Baltimore’s BWI
Airport, for example, will be built for $8 million less
than originally estimated, partly because of increased
competition among contractors.
According to the BER 2009 Building and Construction
report, the BER South African Construction Cost index
fell by 4.3 percent in 2009, the first annual decline in
the index since its inception in 1962. Industry players
have suggested that Eskom should consider breaking
the earlier contracts for the construction of the planned
Kusile power station, and re-bidding for these at current
lower construction prices, since the original construction
contracts were contracted when global construction
prices were at a peak before the recession.
R102 billion
R142 billion
R96 billion
R25 billion
R25 billion
R11 billion
R3.2 billion
R12 billion
R10 billion
R7.4 billion
R14.6 billion
R102 billion
R7.3 billion
R1.5 billion
R8.4 billion
R217.6 billion
3
A possible risk is that contractors could adopt a
“low-bid” strategy and subsequently recoup the
discount through change orders. Governments
should be aware of these risks and develop strategies
to mitigate them through careful staging of capital
programmes and aggressive contract management.
The changing shape of the demand for PPPs
It is too early to tell for certain whether the infusion of
public money will dampen or stimulate governments’
demand for PPPs or other creative financing solutions.
More public subsidy does not necessarily mean less
private capital. In fact, it could actually foster the
reverse: better project economics, better credit and
more private capital put to work. If the hundreds
of billions in planned infrastructure spending in the
stimulus packages can be leveraged with private funds,
then stimulus dollars can generate an even more
profound impact on nations’ economies. There are
many viable options for integrating stimulus funds into
PPP project structures.
In many countries, PPPs have been successfully executed
for projects that required public subsidy to be viable. In
these cases, government funding was used to “write
down” particular project costs (capital and/or operating)
or risk elements either up front or over the entire project
life cycle. Such an approach could be used to leverage
stimulus funding.
4
The South African government appears to be making
increasing use of PPPs and other public-private
investment structures to achieve its infrastructure aims.
For example, the N4 highway from Johannesburg to
Maputo was concessioned, the Gautrain project was
structured as a PPP, Eskom is currently seeking a private
investor to take a stake in the Kusile plant, and there
are tenders out for PPPs across a range of other asset
classes. The PPP website maintained by the PPP unit in
National Treasury, lists 11 PPP projects active in South
Africa as at February 2010. William Dax, who heads the
PPP unit, has said that 25 PPPs with a private investment
value of R13.8 billion have been completed to date and
an additional R29 billion of private capital is committed
to new PPP projects.
In addition to “writing down” particular project costs,
jurisdictions are increasingly looking for innovative ways
to make projects viable by involving multiple public
sector entities, both within and across jurisdictions.
Public-public-private-partnerships (PPPPs) are starting
to emerge as a way to get projects off the ground
by combining multiple levels of public support. For
example, a new energy-from-waste project being
developed in Staffordshire in the United Kingdom is a
collaborative effort of a number of local governments
that are banding together to achieve economies of scale
that will make the project viable.
On the supply side

Tightened credit markets Variability in equity returns

Financing markets are improving, but they may remain
less attractive than usual for the near term. In this
context, financing markets include both government
bond markets and the international project finance loan
markets that provide capital for many PPPs. While many
market participants view infrastructure as an attractive
defensive asset class during this recessionary period, the
dynamics of the credit markets, particularly with respect
to the tenor of debt, have moved in the opposite
direction. As a result, deal volume is down. Transactions
that are being executed are taking more time, incurring
higher costs and relying more heavily on official funding
from institutions like the European Investment Bank.
A number of governments are proactively trying to
ensure that the credit crisis does not stall needed
infrastructure projects. The UK government has decided
it is better to provide additional government-backed
debt finance than to delay projects or restructure scores
of scheduled PPP transactions. Toward this end, the UK
Treasury announced in February 2009 that it will lend
directly to those Private Finance Initiative (PFI) projects
that cannot on their own raise sufficient debt finance
on acceptable terms. Across the EU, the European
Investment Bank has increased lending to ensure that
significant deals are executed.
In principle, the great variety of PPP structures makes
it difficult to generalise about equity returns in the
infrastructure market. For example, in some PPP
structures, reduced gearing can lead to lower equity
returns. In others, it can have the opposite effect. The
difference lies in the nature of the revenue supporting
the structure. For example, in availability payment style
structures where debt costs are passed through to a
government payor, equity returns are stable or rising; in
availability payment style structures where revenues are
fixed, equity returns are stable or declining.
Potential flight to quality
On the positive side of the equity equation, there is
likely to be an eventual “flight to quality,” with investors
seeking sound prospects in the infrastructure sector,
particularly if other asset classes remain severely
impaired (see table 4). This is particularly relevant for
pension funds, since long-term infrastructure projects
are a good fit for pension fund liabilities. Over the
past several years, billions of dollars have migrated to
infrastructure funds - the total value of which now far
exceeds the likely equity component of PPP projects in
the pipeline. There are over 10 infrastructure funds and
provincial growth funds active in Southern Africa.

Table 4 - Infrastructure investors

Strategic buyers/ • Traditionally, operators, developers or contractors in the infrastructure sector

concessionaires • Often benefit from sector operational expertise, which enhances value add
• Long-term investment strategy
Infrastructure • Private or listed equity funds focused on infrastructure investments
funds • Strong liquidity awaiting investment opportunities
• Lower equity returns than for financial sponsors
• Typically look to take part in a consortium
• Medium- to long-term investment strategy
• Fund sizes are smaller than for financial sponsors
Financial sponsors • Private equity funds with shorter exit strategy
• High equity returns (+20 percent) may limit ability to bid competitively, but have been achievable in certain
opportunities
• Normally look for short-term investments with a clear exit strategy
• Typically look to take part in a consortium
• Fund sizes range from $6 billion to $16 billion

The changing landscape of infrastructure finance in South Africa 5

Structuring effective PPPs
for infrastructure
With a greater number of priorities (and industries)
competing for public funds in the wake of the credit
crisis, governments are under more pressure than ever
to be creative about how infrastructure needs are met.
If infrastructure gaps are to be narrowed, the traditional
models of financing and delivering infrastructure must
give way to new, innovative models and a portfolio
of hybrid approaches. The structure and financing
of infrastructure projects involving both the public
and private sectors will need to evolve in response
to changing conditions in the financial markets. In
countries around the world, we are starting to see the
outlines of what such innovations may entail.
• In early 2009, the Florida Department of Transportation
entered into a $1.8 billion 35-year concession with a
private consortium, headed by the Spanish firm ACS
Infrastructure Development, to build and operate
high occupancy toll lanes near Fort Lauderdale.
The financing includes more than $200 million in
equity, $750 million in commercial bank debt and
a $603 million loan from the federal Transportation
Infrastructure Finance and Innovation Act (TIFIA)
programme.4 In this PPP, the Florida Department of
Transportation will set toll rates, retain all revenues
and make “availability payments” to the private
concessionaire annually out of all of its revenues
(including state appropriations, tax revenues and tolls).
The project is the first US toll road PPP structured with
performance based availability payments.
• The United Kingdom is in the midst of the nation’s
largest-ever school buildings investment programme,
with a goal of rebuilding or renewing nearly every
secondary school in England. To realise this ambitious
goal, the central government has created a PPP model
called Local Education Partnership (LEP), a private
sector consortium working in formal partnership with
local authorities and the central government. Certain
LEP projects are being delivered through conventional
capital funding and design-build contracts, while
others employ PPP models. The programme is
designed to capture economies of scale in delivery by
bundling multiple facilities into a single procurement.
6
• Other innovative structures emerging around the
world include combining multiple public authorities
(such as neighbouring local government entities) to
procure a single project or service. The improved
project economics can attract a broader array
of bidders to the procurement, resulting in cost
efficiencies for the local authorities.
These projects, each with its own distinct mix of public
and private participation, demonstrate the diversity of
delivery models available today. There is no longer a
binary decision between public and private. In reality,
nearly every public infrastructure project involves a
large degree of private sector participation through the
normal channels of a market economy. Most PPP models
simply represent a way of deepening and/or broadening
the private sector’s engagement in delivery in exchange
for sharing in the associated risks and rewards. The
question policymakers need to answer is: What is the
optimal mixture of public and private sector participation
in the project to maximise public value?
This is the central question facing infrastructure
policymakers today. And there’s no one-size-fits-all
answer for every situation. Most infrastructure
projects are composed of five elements for which
responsibility must be assigned: design, construction,
service operation, ongoing maintenance and finance.
Theoretically, any of these elements and their related
risks can be allocated to either the public sector or the
private sector. The shape of that allocation determines
the structure of the partnership.
Determining the right mix of public and
private involvement in infrastructure financing
and delivery
The following three steps should be considered
when determining the right mix of public and private
involvement in infrastructure financing and delivery.
Step 1: Determine public authority - What am I
allowed to do?
What laws and policies exist regarding the delivery of
infrastructure and the potential involvement of private
finance? Are there political, legal or policy constraints
that would make it difficult to use certain partnership
structures? These questions are among the first that
need to be answered before a public sector entity gets
too far ahead of itself. The legal and policy framework
in place, in addition to the temperament of the
electorate, will automatically narrow the pool of possible
partnership options. Most public sector entities face
restricted choice in partnership arrangements.
Recently, several governments have improved upon
their existing PPP legislation. The State of California
has adopted a new legal framework for transportation
PPPs that authorises regional transportation agencies
and Caltrans to enter into an unlimited number of
PPPs through 2017, removing earlier restrictions on
the number and type of projects they may undertake.
The South African PPP guidelines, as issued by the PPP
unit in national treasury, have been similarly relaxed
post the credit crisis, permitting government to retain
higher levels of risk in order to make proposed projects
fundable by private sector bidders.
In addition to legislative constraints, political factors
often determine the extent or nature of private sector
involvement. For example, in Canada and elsewhere,
“core” services (such as teaching, health care and prison
guards) are distinguished from “non-core” services (such
as janitorial services, food services and transportation),
and the public sector generally retains the former. In
the South African context, the resistance of trade union
bodies to perceived “privatisation” of essential services is
well documented. In addition, concerns have been raised
around the possibility of privatising Eskom’s generating
capacity, which is seen as a strategic national asset.
The changing landscape of infrastructure finance in South Africa
Step 2: Define project needs and objectives - What
do you want to do?
Once a public sector entity has determined what it is
permitted to do, the next step is to define the project
goals. First, define the need. For example, it could be
decongesting a certain corridor by 15 percent over the
next three years. The next step is to define the service
solution and associated assets to meet that need. In this
case, the solution might be to deliver a new toll road
with specific capacity within a specified time period.
Lastly, policy makers must determine how the solution
will be delivered and funded. Can tolls or congestion
charges be introduced, or must public funds from
general (or special) taxation be made available?
Four of the most common variables that governments
should consider when defining the need that must be
fulfilled are speed, efficiency, degree of certainty about
needs and innovation.
Step 3: Determine the best “owner” for each project
component - Who can and should do what?
Determining what you have authority to do and then
what you want to do will begin to narrow the options
for structuring the relationship with the private sector.
The next step is sorting out who can and should
do what. The sorting process has three principal
components: capabilities, finance and risk.
• Capabilities - What capabilities do we have in-house
to deliver and/or manage the project?
In what areas of project delivery does the public
sector project sponsor excel: design, operations,
maintenance or financing? What capabilities are
present in the market? For example, if a government
excels at road maintenance but is weak in
construction (cost or timing), it might decide to bear
responsibility for long-term asset condition, but allow
a private partner to add value at the front end of
the project. The same goes for management. Large
capital projects are complex and require a great deal
of experience to manage successfully. Partnerships
add another layer of complexity, and institutional
capacity building must be a core element of any PPP
programme. Effective project management is essential
to limit risk and cost overruns and streamline delivery,
so the presence of competent staff is of particular
importance when funding is tight.
7
 • Financial - How are we going to pay for the
infrastructure?
An important, but often confused distinction to
draw when considering the financial elements of an
infrastructure project, is that between funding and
financing. The funding for a project is its long-term
source of support. In the case of public infrastructure,
this may be revenues generated by the project,
dedicated tax revenues or general resources of the
sponsoring public sector entity. The financing of a
project is the means by which the funding is leveraged
to provide enough upfront cash to purchase, construct
or adapt the project. While there may be many
creative financing vehicles available, once the funding
structure is established, all of these financing vehicles
will be “securitising” the same project economics.
In the current tight monetary environment,
partnership structures may prove appealing for many
public sector entities. They may consider partnership
structures that reduce the public sector’s capital
payments over the lifetime of the asset (or contract),
monetising existing assets to pay for new ones (for
example, Eskom could sell one of its existing operating
power stations, for example, Majuba, to raise cash to
fund the construction of Kusile) or allow for financing
by the private sector that does not eat into public debt
capacity. Using PPPs to raise private capital for public
projects can help to spur job creation when projects
would otherwise be put on hold.
• Risk transfer - How much risk should be transferred?
Answering this question correctly and allocating
risks accordingly maximises public value. There are
several risk allocation conventions, for example, a
private contractor is naturally positioned to efficiently
manage construction risks, and a government is
better positioned to control and absorb regulatory
risk. However, every partnership is unique and
carefully negotiated.
8
As partnership models proliferate around the world,
risk allocation principals are becoming increasingly
sophisticated and the parties are becoming more
adept at crafting structural solutions to risk capacity
constraints. For example, many PPPs have been
structured to isolate discrete and identifiable chunks
of risk (such as tunnelling) to avoid contaminating the
overall risk-sharing approach with inefficient pricing.
The public sector has discovered efficient ways to
“write down” those elements and still achieve value.
The key is to optimise, rather than maximise, the level
of risk transfer.
One of the core tools being used in international
PPPs is the Public Sector Comparator or Value for
Money analysis. The term Public Sector Comparator
(PSC) refers to the risk-adjusted whole-of-life cost
of procuring an asset or service through whatever
is considered the conventional public procurement
method. The term Value for Money (VFM) refers to
the result of a comparison between the PSC and
the risk-adjusted whole-of-life cost of procuring
the same asset or service from a private party. The
PSC/VFM analysis is used to describe the difference
in risk-adjusted cost to the public sector between
conventional procurement and PPP procurement. In a
direct comparison, whichever model produces a lower
cost is said to provide value for money.
The practice in many countries is to perform
this analysis as part of the approval process for
undertaking a project as a PPP. In those cases, unless
VFM can be proven, the project is either aborted
or pursued by conventional procurement means.
The South African Municipal Services Act provides
for a similar comparison to be performed by any
municipality wishing to outsource any aspect of
service delivery. The act requires the municipality to
first calculate the cost and capacity of providing the
service in-house, to provide a benchmark against
which to compare the proposed costing for any
outside service provider to provide the same service.
Conclusion

In these challenging times, governments are coping with

the normal course of fiscal stress overlaid with a new Contact
set of extraordinary demands on their resources. At the André Pottas
same time, it is clear that reverting to a default setting of Partner
earlier times - putting infrastructure investment on hold Tel: 031 560 7033
until the economy has recovered - will put economies E-mail: apottas@deloitte.co.za
in an ever more precarious position going forward.
If infrastructure gaps are to be narrowed, the public
sector must respond with creative and flexible solutions
that evolve with the changing environment. Too often,
public sector entities are unaware of the alternatives
available to them or of the considerations involved in
selecting the most appropriate delivery models for their
capital projects. By applying a bottom-up approach to
the development of a partnership structure, the public
sector can deliver projects in a way that most closely
approximates the optimal solution within the confines of
what is possible.

References
1 Top Executives Say Current Infrastructure Investment Won’t Support Business Growth, Says KPMG
Study,” PRNewswire, January 14, 2009
<http:// news.prnewswire.com/DisplayReleaseContent.aspx?ACCT=ind_focus.story&STORY=/www/
story/01-14-2009/0004954443&EDATE>.

2 Building America’s Future, “Building America’s Future Releases New Poll: Majority of Americans Ready
to Pay for Better Infrastructure but Demand Accountability,” press release issued on January 8, 2009
<http://investininfrastructure.org/newsroom/pr_010809.pdf>.

3 American Society of Civil Engineers, “2009 Report Card for America’s Infrastructure,” January 2009
<http://www.asce.org/reportcard/2009/index.cfm>.

4 Federal Highway Administration, US Department of Transportation, “USDOT Approves $603 Million

Loan to Build New Express Lanes In Florida: Sunshine State Lands Nation’s First TIFIA Loan of 2009,”
March 4, 2009
<http://tifi a.fhwa.dot.gov/news/fhwa0709.cfm>.
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