PFI in limbo

PFI may not be high on the agenda at this week’s Labour Party Conference in Brighton, but outside the claustrophobic world of party politics concern is mounting that it is not delivering the goods. A report published on Monday by the Construction Products Association has warned that the government has missed – or is set to miss – crucial targets for building hospitals, schools and roads. In the report, called Achievable Targets 2004, the CPA reveals that the government’s delays in PFI schemes is a key contributing factor (see ‘What’s the hold-up?’, page 28).

In the 10 years or so since the government first got into bed with PFI there has been debate over whether lack of capacity and bid costs would prevent the industry from delivering government targets. Now, with project delays an ever-present reality, the challenge is to stop the contractors that helped make the UK the PFI world leader from deserting the domestic market. Tempted by the promise of quicker, more manageable projects in the relatively uncharted waters of continental Europe, contractors are starting to take their project expertise, financing experience and staff overseas.

Tim Stone, international chairman for PPP advisory services at KPMG, says it is increasingly an issue for the UK government. “As activity builds in Europe, there is an increasing pressure to say, ‘where should I best deploy my troops?’ All the good groups will go to where the process is simpler. There are no geographic borders.”

Bovis Lend Lease is one stalwart of PFI bid lists becoming bullish about exploring opportunities across the Channel. “Historically, they are delivering a lot more quickly in Italy and Spain,” says John Spanswick, chief executive.

Spanswick believes that PFI project delays, especially regarding the government’s ambitious hospital building programme, are lengthening. “In the past 18 months it has probably got worse rather than better,” he says. “It certainly has an impact on the number of projects you can bid for – we only have a certain number of bid teams.”

Bovis spent about £11m bidding for the £1bn Ministry of Defence Allenby and Connaught scheme at Aldershot and Salisbury, only to lose out to the Aspire consortium, led by Mowlem. Although Bovis has won a fair share of projects, a financial hit of this order is never easy to swallow.

Bovis has already turned at least part of its attention to the Continent, where a PFI market in the health and education sectors is developing fast, and road projects are well established. In Italy, the firm has already started work on the £16.3m first phase of the Brescia hospital project, near Milan, where it is construction manager.

The work involves widening of two six-storey buildings and is expected to complete in May 2005. Bovis is also negotiating a contract for the £105m second phase, with financial close expected in June next year, involving the construction of two blocks comprising operating theatres and wards, radiology units and other support facilities. It is anticipated that a further phase will be released for the refurbishment of the remaining hospital complex.

Laing is another PFI specialist that is looking further afield, and is hoping to be involved in a Portuguese PFI project to build 10 hospitals. Adrian Ewer, Laing’s finance director, acknowledges that Laing’s quickest ever PFI project was outside the UK. It won the contract to create Norway’s first concession road, the £130m E39, in partnership with Swedish group Skanska. ”It was 15 months between first expression of interest to financial close. That was down to the local government’s will,” says Ewer.

As activity builds in Europe, there is increasing pressure to say 'where should I deploy my troops?'

Tim Stone, KPMG

But surely the will to achieve these turnaround times also exists within our own government? Improving national infrastructure without burdening the public purse was the raison d’etre of the PFI a decade ago, and the need for new schools, roads and hospitals is as pressing today.

“There have been many efforts to make it quicker here, but it is just [a question of] the structure of our central government. The corridors of power are quite long,” says Ewer. He adds: “The project team [in hospital schemes] has the NHS executive sitting above them; they need Treasury approval and are surrounded by advisers that are paid by the hour. Everybody gets involved.”

In other European countries, the corridors of power are shorter and the layers of bureaucracy fewer. For instance, KPMG’s Stone refers to the Irish roads programme, where many UK personnel with valuable PFI experience decamped after delays on UK road-building programmes, including the widening of the M25. Stone says that Ireland’s PFI teams carefully prepare their projects before going to the market, cutting time and costs for everyone.

A spokesperson for the Treasury says that the UK government has demonstrated commitment to reducing the time involved with PFI projects, with the introduction of a standardised set of terms and conditions in July. He says that PFI projects are still attracting sufficient numbers of bidders in the UK and cites the roll-out of the primary healthcare LIFT projects as good examples: “On LIFT, there has not been any occasion where there has been fewer than three bidders.”

Irrespective of the long-term gains, Christopher Hill, partner at law firm Norton Rose, does not agree that in terms of the procurement process, Europe is a haven for PFI contractors seeking greater efficiency: “The bureaucratic and legal barriers are no lower than in the UK,” he says. “There are more complicated tax and budget law hurdles to get over.” Hill says Norway, which is not a member of the EU, is an exception in that PPP is much simpler and cheaper to procure because of common consent.

Contractors eyeing up opportunities abroad have not yet lost faith in PFI in the UK. The government has committed to channelling 15% of its capital investment through PFI schemes.

Many hopes are resting on the government’s ambitious Building Schools for the Future programme, which aims to create a standardised process to speed project delivery. Projects in the £2.2bn first wave of the programme were announced in February, and more are due later this year. Each local education authority selects one contractor to deliver all the refurbishment works and new schools for that region, in what is to be called a Local Education Partnership.

The idea is to develop a blueprint agreement that should, in theory, simplify the process of improving and building the government’s target. “You don’t have to reinvent the wheel,” says Ewer.

The important thing is to select projects where there is a commitment for them to be delivered

Adrian Ewer, finance director, Laing

PFI bidders have reacted positively to the proposals, and are excited by the government’s long-term commitment. “The important thing is to select projects where there is a commitment for them to be delivered,” Ewer says.

However, industry hopes for PFI in the education sector may be premature – the government’s school building programme has already been delayed. Despite an initial target of spring 2004, the first schemes are still to be released to the market.

Still PFI in the UK could be turning a corner, with the development of a secondary market.

The sale of PFI equity stakes holds great financial potential for contractors, able to sell on the investment once a project is complete. Over the past 18 months the secondary market for PFI equity stakes has become very active. For instance, Carillion sold its share in the Derent Valley Hospital scheme to Barclay’s UK Infrastructure Fund for £16.4m, four times the value of its original equity investment. While Laing has yet to sell any of its PFI stakes, it has always maintained that it will at some point.

Undoubtedly the secondary market will play an increasingly vital role in PFI, not only because it will free up cash for contractors with little capital to reinvest in PFI projects, but also because PFI stakes make an ideal investment for pension funds. It is a reliable, long-term asset class, but provides enough risk to produce significant returns. Although City institutions are actively looking for deals, the tax structure has hindered an explosion in the secondary market to date. However, that looks set to change thanks to standardised schemes and more accessible financing.

The UK has already established a track record in PFI that many other countries would envy.

“The genie is out of the bottle,” says Stone.

“We have shown it can be a better way to deliver many public schemes.” The UK government now has to provide the conditions for PFI expertise to stay in the UK, and not let the genie take up residence overseas.