Disenchanted with central government’s approach to the private finance initiative? There is a solution. Local authority PFI is getting airborne at Luton Airport and Bovis has just signed the first purely commercial contract.
Luton Airport has been branded “common” ever since Lorraine Chase wafted in from the Bedfordshire airfield, rather than paradise, in the 1970s Campari TV advert. From next month, all that is set to change, thanks to a new type of private finance initiative deal used at the airport that could provide an alternative to the increasingly infuriating central government PFI process.

This new form of PFI is financing a Foster and Partners-designed terminal that will double the number of passengers passing through Luton (or London Luton Airport as it is now known) to 5 million a year. The £150m, hi-tec building provides 60 extra check-in desks and is funded by Barclays Capital (which is providing 65% of the investment), service provider Airports Group International (25%) and US construction giant Bechtel (10%), which is design-and-build contractor.

The consortium, London Luton Airport Operations, has negotiated a deal with airport owner Luton Borough Council to run the airport for 30 years. The council will pay the consortium a regular fee to run the facility, and, at the end of the 30-year concession, direct ownership of the airport will revert back to the council. In a conventional PFI contract, central government would pay the consortium.

The Luton deal represents a new opportunity for contractors and consultants. One city banker says: “The deal has sparked huge interest in doing PFI deals with local authorities.” He adds: “We are particularly interested in funding regeneration projects where the PFI consortium provides libraries, healthcare and education buildings, and housing to a local authority, all in one package.” The opportunity to do PFI deals with local authorities was created by the introduction of the Local Government (Contracts) Act in 1997. Since this enabling legislation was passed, lawyers have been grappling with problems that arise when local government, rather than central government, pays the bills. The problem of ultra vires – or acting without authority – has been particularly troublesome. Philip Curry, managing director of Bechtel Enterprises, says this had to be studied in great detail for the Luton deal.

When putting together PFI deals with central government, the ultra vires risk is well understood. If the law changes and costs go up as a result, central government will have implemented that law and therefore has control over the issue. Local authorities, on the other hand, have no power over central government. So, if laws change and costs increase, who is responsible? Who takes the risk, and how can it be calculated? This uncertainty does not seem to have dampened enthusiasm for local authority PFI deals. Twenty contracts have just been signed, or are in the process of being signed. No one knows how big the market can become, but Curry estimates that at least one deal lands on his desk for scrutiny every month.

Social housing is the most recent market to take off. In April, eight local authorities were granted the right to borrow cash to refurbish and maintain social housing over 20-year periods.

European Capital Bank’s Paul Bryan estimates that 30 bidders are active in the local authority PFI market

European Capital Bank is another fan of local authority PFI deals, and has recruited the former head of the government’s public-private partnership programme, Paul Bryans, to look at opportunities. Bryans estimates that 30 bidders are active in the market. He says such is the wealth of possibilities, that no one is interested in bidding for anything worth less than £50m.

Potential bidders in the market face two hindrances. One is that the process involves an extra stage, an “invitation to submit outline proposal”, that bids for central government PFI projects do not entail. This increases the bid costs. The second is that local authority deals are linked to the Treasury’s gross domestic product deflator rather than being index-linked to inflation. But, says Bryans, local authorities will abandon the GDP deflator on 1 July. This could provide a catalyst for more deals.

Bechtel is steering clear of the local authority market for housing, education and libraries. It wants to win more airport work and other complex engineering jobs where the market is less competitive.

The US firm is also looking at another new area of PFI activity – the purely commercial deal. It is investigating projects to build silicon chip factories in Europe on a lease-back system similar to the deal recently signed by a Bovis-led consortium and drugs giant SmithKline Beecham, for a headquarters in west London.

The £135m deal involves Bovis, backed by investment bank Schroders, building a 79 000 m2 complex for SmithKline Beecham. SmithKline will pay the consortium an annual sum for the construction cost and operation of the building. No government funding is involved.

Now that the first purely commercial PFI deal has been signed, banks are queuing up to move to the private sector

Queuing up to sign private PFI deals

Now that this first purely commercial PFI deal has been signed, banks are queuing up to move from the public to the private sector. One leading banker says: “Major investment banks are likely to find dealing with big corporations very attractive, because it gets us away from the markets where all the diddy banks have jumped in and ruined the margins.” Bryans has reservations about private PFI. He says that although clients such as SmithKline have a triple-A credit rating, the government has an even better rating, so there is less risk to the revenue stream. But it is precisely this extra risk that is attracting the top banks. The leading banker says: “Because of the extra risk, we can increase our margins by a quarter of a point.” Another PFI market that is set to boom is higher education. Dr Barbara Young, director of Building Research Establishment Consultancy and Innovation, estimates that the higher education sector will provide more than a billion pounds worth of work. “Backlog maintenance needs £706m, £386m is needed for student residences and £589m for offices, teaching spaces and the like.

“Against this requirement, one-third of the institutions forecast that they will be operating in deficit by 2000-2001. This position, combined with a reduction in investment income and the need to service existing levels of external borrowings, limits the funds available for reinvestment across the building stock.” A rethink of funding is required, and 10 universities and colleges are looking to the PFI to spread the costs of capital investment. The projects are diverse. The University of East Anglia is looking at the PFI for a new nursing and midwifery school, Falmouth College of Arts wants 156 student accommodation units, and the University of Luton is considering the PFI for financial restructuring and outsourcing of student residences, says Young.

Young has tips for those targeting the higher education sector. Universities and colleges are moving away from small group teaching styles and investing in computer-dependent learning resource centres. She says universities are considering cutting-edge space planning for teaching staff. “More emphasis will be placed on staff adopting hotdesking principles and ‘hotelling’ – a slightly more structured version of the hot desk.” Just like PFI schools, which are designed to open after hours for conferences and adult education to maximise revenue, universities want facilities for weekend working and summer schools, she adds.

New opportunities for the PFI

1 Local authorities can provide safe revenue streams for PFI deals 2 Urban regeneration projects are set to take off, so firms will need to learn how to work with health, education and environment departments 3 Private PFI, where the revenue stream comes from commerce, will take off slowly because there are few clients with the right requirements and credit ratings 4 Higher education institutions are starting to look at the PFI for new buildings