PUBLIC PRIVATE PARTNERSHIPS

Dr. Wei Xiong

Associate professor,
School of Management & Economics,
Tongji University
Self-Introduction
 EDUCATION
 Ph.D, Department of Civil & Environmental Engineering, The
Hong Kong University of Science & Technology;
 Visiting Scholar at Department of Economics, Harvard
University and Hass School of Business, UC Berkeley.
 RESEARCH INTERESTS
 My research primarily concerns financial, contractual,
organizational, institutional, and political issues in the
provision of infrastructure and public services, such as Public
Private Partnerships (PPP), public procurement, and platform
economics.
 I served as a PPP expert in China’s National Development
and Reform Commission.
 Outline
3

 PPPs

 PPPs in China
 PPP Cycle

 Financial Analysis

 Value for Money

 Performance Management

 Successes and Failures

 Public–private partnerships
4

 Public–private partnerships (PPPs) describes a government

service or private business venture which is funded and
operated through a partnership of government and one or
more private sector companies.

 One of the most obvious trends in the project finance market at

a global level is the gradual shift from entirely private
initiatives to projects involving the public administration.
 Contractual Relationships (Road)
5

Source World bank

 Financial Modeling
6

+VE

Transfer

Non-debt Breakeven point Project life (Years)

financing
Maximum
Debt cost
financing

Construction
period Operation and maintenance period
-VE
Payback period

Concession period
 Advantages of PPP
7

 A key advantage of having the private sector provide public

services is that it allows public administrators to concentrate on
planning, policy and regulation. The private sector, in turn, is
empowered to do what it does best, and in particular improve the
efficiency and quality of service.
 Increase funding for infrastructure
 PPPs financed by the private sectors allow the spreading of
the project cost for the public over a longer period of time,
in line with the expected benefits (savings on vehicle
operating cost, on travel time, on accidents). Public funds are
thus freed up for investments in sectors were private
investment is impossible or inappropriate.
 Advantages of PPP
8

Source EGIS
 Advantages of PPP
9

 Introduce private sector efficiencies

 The lifecycle approach allows the private sector to
achieve efficiencies in the following four main areas:
 Work planning and organization.
 Optimization of lifecycle costs.
 Risk management.
 Innovation.
 Advantages of PPP
10

Source: National Audit Office

 Advantages of PPP
11

 Encourage public sector reform

 A PPP program can serve as a catalyst for public-sector reform in
a number of different ways
 Transparency and accountability.
 Procurement skills.
 Management.
 Contestability.
 Reduce risk for the public sector
 Several other possible advantages of PPP are cited below,
their actual occurrence and magnitude depending on the
characteristics of the particular PPP project.
 Improve level of service, Promotion of economic and social growth,
Transfer of modern technology.
 PPPs and Other Financing Approaches
12

 Debt-based financing means borrowing from future generations to fulfill

the needs of the present generation.
 Resource-based financing means raising funds through rent-seeking for
the natural resources, such as land and minerals.
 Privatization/PPP investments are usually off the governmental balance
sheet because the most important risks, including cost, demand, and
operation risks, are transferred to the private sector.
Debt-based
financing

Resource-based Privatization/Public
financing Private Partnerships
 PPPs and Other Delivery Approaches
13

PSP 私营部门拥有资产，并
政府部门负责投资、经 运营，承担全部风险；
营、并承担全部风险 政府进行规制

传统模式 PPP 私有化

分阶段平 服务 管理 部分私 完全私

总承包 租赁 联营体 BOT类
行承发包 外包 外包 有化 有化
privatization
设 供 施 DB BT 交 DBMM O&M TOT BLOT BTO DBO BOT DBFO BOOT BBO BOO 剥
计 应 工 钥 离
特许经营类
Design-build EPC 匙
100％ 参与程度 100％
公 私
共 风险分担 营
部 部
提供者 政府角色 规制者
门 门

public sector private sector

 PPP Modalities
14

PPP项目

Yes No
是 否
存量项目

Brown project
引入资金 引入管理
是
Funding needed 否 是
Management needed
否

改扩建 MC/LOT/O&M 引入资金 BT

是
Rehabitate 否 是
Funding needed否
ROT TOT 期满移交 LOT

是 Transfer or not 否

BOT BOO

2024/7/3
PPP Modalities
Source World bank
 PPP Modalities
16 Source World bank
 PPP Modalities
Source World bank
17
 PPP Modalities Source World bank
18
 Where is PPP appropriate?
19

 PPP seem likely to be appropriate if:

 Service outcomes can be clearly specified and measured.

 There exists the potential, and the incentives to introduce, design
innovations and operational changes that can raise efficiency.
 Payment mechanisms are devised that give the operators the
motivation to maintain service quality.
 Value for money is able to be demonstrated, after allowing for
costs of project development and costs of monitoring the contract.
 An integrated service can be provided with close working
relationships and good communication between service providers.
 There are transparent accountability procedures and a due
regard for the public interest.
 PPPs in the UK and France
20

In the UK, fully privatized projects account for approximately 65%, traditional
government investment projects account for about 20%, and projects using various PPP
models account for around 15%.

2024/7/3
21

• In France, the concession

model is widely used for
user-fee-based
infrastructure projects,
with approximately
12,000-15,000 projects
to date.
• Since 2004, in the field
of government-paid
social welfare projects,
a total of 578 projects
have been implemented
through partnership
contracts.
• What’s the different
between PFI and
Concession?
2024/7/3
 The Selection of PPP Types
22

Concession vs. PFI

Concessions PFI
Risk transfer Vendors take most of the Some critical risks (e.g., demand
risks. risk and operation risk) are
burden by local governments.
Private Design, finance, construction, Design, finance, construction,
involvement maintenance, core and non- maintenance, and non-core
core service operation service operation
Payment schemes Paid by end-users (with Paid by local governments
possibility of subsidies) based on the availability of
based on the usage of infrastructure and public
public services. facilities.
PUBLIC PRIVATE PARTNERSHIPS:
PPP IN CHINA
 PPP in China
24

Phase 1: 1984-2002, Exploration

and Rise: Focused on transportation,
energy, water, and waste treatment
with foreign investment; long and
costly early planning stages.
Phase 2: 2003-2008, Stable
Promotion: Dominated by municipal
utilities, especially sewage treatment;
led by private and state-owned
enterprises; use of public
competitions, mature processes and
models.
2024/7/3
 PPP in China
25

Phase 3: 2009-2013, Fluctuating Development: Impact of the financial crisis and the
4 trillion yuan stimulus; state-owned enterprises dominated; diversified financing.
Phase 4: 2014-2017, Boom: Intense activity, wide scope, frequent policy issuance,
surge in PPP projects. By the end of 2020, a total of 8,745 PPP projects had been
awarded, with a cumulative capital investment of RMB 14.8 trillion.

2024/7/3
 PPP in China
26
10000 100
Phase 5: 2017-Present,
Project number
Regulation: Ministry of Finance Early terminations 80

Accumlated project number

8000

cleared non-compliant projects,

6000 60
strengthened performance %

management and control, 4000 40

leading to project withdrawals 20

2000
by local governments.
0 0
2014 2016 2018 2020
Year

• In 139 low- and middle-income countries, about 4.5% of PPP projects awarded
between 1984 and 2021 were terminated early (World Bank, 2022).
• Notably, in China, approximately 15.2% of PPP projects awarded between 2014
and 2020 were terminated early (Ministry of Finance of China, 2022).
2024/7/3
 PPP in China
27

• Lessons from China’s PPPs

2024/7/3
 Finance-oriented (PPP 1.0)
28

Economy  Finance-oriented (PPP 1.0): design

a operational framework:
financial viability, capital structure,
a concession period, government
Cost
guarantees, pricing mechanisms,
concessionaire selection, risk
management, and performance
management.
Cost
Finance
 Efficiency-oriented (PPP 2.0):
VFM

Time Quality
incentivize contracting parties to
Efficiency achieve high efficiency in cost,
time and quality.
VFP

Society Environment
 Sustainability-oriented (PPP 3.0):
Sustainability
incorporate social, environmental,
and debt sustainability.
 “Public-Public Partnership”
29

 The proportion of state-owned enterprises (SOEs) is too high (currently about

75%), causing a severe crowding-out effect on private enterprises. It is
recommended that SOEs focus on social welfare projects, while private
enterprises concentrate on economic and highly operational infrastructure.
 The PPP model requires enterprises to have multiple capabilities, so various types
of enterprises should strengthen cooperation. Currently, joint ventures only
account for 33%.
Private
19%
Private JV
4%
48%
Private and SoE JV
7%
SoE JV
22%
SoE
2024/7/3
 The Excessive Use of PFI in China
30

In the UK, economic infrastructure projects are mainly provided through privatization,
while social projects are handled through PFI. In China, economic PPP projects have taken
up a significant portion of what would typically be considered social PPP projects.

Transportation Health
Municipal

Transport

Education

Defense

PFI in China PFI in the UK（HM treasury, 2017）

PUBLIC PRIVATE PARTNERSHIPS:
THE PPP CYCLE
 The PPP cycle
32

 PPP Project Selection

 Due Diligence and Feasibility Studies
 Procurement
 Contract Award
 Contract Management
 The PPP cycle (Road project)
33

Source World bank

 Stage 1: PPP Project Selection
34

 a long list of public sector projects is prepared to fulfill

national/local infrastructure needs through a Needs Analysis
usually within a National Plan, Sector program or other public
sector identification process.
 Projects are identified, ranked and prioritized. The best
projects will have the highest potential for PPP based on e.g.
strong economic and social need, good financial viability with
no or minor fiscal subsidy needed, risks are manageable and
few major negative environmental and social impacts etc.
 The most appropriate projects are selected for detailed
Feasibility Studies.
 Stage 1: PPP Project Selection
35

 Selection criteria:
 Likely Financial Viability and Fiscal Support
 Readiness and Risk
 Socio Economic Benefits
 Regional Development
 Sector Network Role Importance in Sector Plan
 National Integration and Security
 Land Acquisition
 Environment/Resettlement
 Impact on Export Earnings
 Safety
 Project Type/Cost
 Demand
 Stage 2: Due Diligence and
36
Feasibility Studies
 Contracting Authority carries out Feasibility Studies.
 Government Authority reviews adequacy of study.
 Based on (i) if no fiscal support/subsidy needed,
Contracting Authority tenders the project.
 Or (ii) if fiscal support needed, Government’s Central PPP
authority assesses request, and socioeconomic justification
and fiscal support and suggests any modification (amount,
type of subsidy etc.).
 Government Authority assesses project according to
fiscal space and project risk criteria, agrees on support
and passes a project that meets its criteria back to the
Contracting authority for implementation.
 Stage 2: Due Diligence and
37
Feasibility Studies
 Stage 2: Due Diligence and
38
Feasibility Studies
 Stage 2: Due Diligence and
39
Feasibility Studies
 Basis for Lenders in Project Financing
 health of project structure
 commercial plan
 future revenue stream
 Financial Model
 Financial inputs and outflows
 Project risks and uncertainties
 Project sensitivities to a given risk
 Off-take purchase, revenue failure and cost increase
 Financial Viability
 Debt-to-Equity Ratio
 Higher debt-to-equity ratios mean increased lender exposure to
project risk.
 Higher equity results in greater project "ownership" by shareholders
and increases their incentive to ensure project success.
 Stage 2: Due Diligence and
40
Feasibility Studies
 Self-financing ability indicates what percentage of the
construction cost can be recovered through the net revenues
earned in the operation period, subject to the financing
conditions of the capital market and the equity holders’
requirements of the return to their investments.

NPVR
SFA = ×100%
NFVC
 where NPVR is the net present value of the net revenues in the
operation period at the end of the construction period;
 and NFVC is the net future value of the construction costs at the
end of the construction period.
 Stage 2: Due Diligence and
41
Feasibility Studies
 Debt Service Cover Ratio
 DSCR measures the cash flowing into the project and
available to meet debt service after deducting operating
expenses against the amount of debt service due in the
same period.

 Lenders often requires a DSCR of 1.2 to 1.6.

 Lenders often restrict the distribution of profits and require
the establishment of reserve accounts.
 Stage 2: Due Diligence and
42
Feasibility Studies
 Loan Life Cover Ratio
 LLCRexamines the net present value of future project
income over the maturity of the loan against the amount of
debt plus interest.

 LLCR is forward looking and made periodically throughout

the life of the debt.
 Stage 2: Due Diligence and
43
Feasibility Studies
 Equity at project risks includes only that part of the equity,
which is exposed to the long-term project risks, especially
market risks. For example, it does not comprise that part of the
equity that is provided by an equity holder who is part of the
construction consortium of the project and that is recovered
from earnings on the construction activities.
EPR
EPR = E − ω × CT REPP =
E
where EPR = equity at project risks; REPP = ratio of equity at project
risks; E = the amount of total equity;
ω = the profit margin on the construction activity; and C = total
T
construction cost. Zero or negative EPR or REPP means that there is no
equity at project risks.
 Stage 2: Due Diligence and
44
Feasibility Studies
 Rate of Return
 The equity rate of return indicates the value of project
return on equity over time and against other cost
considerations.
 Shareholders may receive benefit from other areas of the
project, which will not appear in the equity rate of return.
 Stage 2: Due Diligence and
45
Feasibility Studies
 Technical viability will be connected to economic and
financial viability:
 Appropriateness for the host country's market and systemic needs
 Efficiency gains: capital cost, O&M costs, equipment life,
durability, training requirements, output/usage degradation.
 Lenders prefer proven rather than cutting edge or untested
technology.
 The capacity of the technology and its appropriateness for the
project.
 Technical merits of the design and the technology to be used.
 Technical review by project company vs. by an independent
expert
 Stage 2: Due Diligence and
46
Feasibility Studies
 Site issues relevant to technical viability:
 nature of the proposed site
 local consent and license requirements
 local climate conditions
 local and associated infrastructure
 environmental standards applied by national and local
authorities
 cost and delay involved in the importation of equipment
and materials;
 availability of local personnel
 cost and availability of equipment, materials and spare
parts for construction and operation
 Stage 2: Due Diligence and
47
Feasibility Studies
 Socio-Economic Cost-Benefit Analysis (SCBA)
 Project rationale, benefits and quantitative assessments.
 Must include environmental impacts statement that
defines all major impacts, proposed mitigation and the
broad estimate of mitigation costs (for input to the
economic project cost).
 Social Impacts; Must identify all social impacts and
resettlement, proposed mitigation and their related
costs (for input to the economic project cost).
 Analysis of Individual Cash Flows
48
Free
FCF used for NPV Cash Year
Flow
(IRR) analysis
(FCF)

Sales
Revenue

Anatomy of FCF Year

for project finance Input cost
Operating
Construction cost
Taxes
Costs
Net investment
(in maintenance)
 Stage 3: Procurement
49

 Procurement under PPP means procurement of the

(highest ranked) bidder under a transparent, fair
and accountable procurement system. Procurement
entails;
 Prequalification of bidders (RFQ)
 Bidding, including Request for Proposals (RFP), and;

 Subsequent negotiations and award of contract.

 Stage 3: Procurement
50

Source World bank

 Stage 3: Procurement
51

 Documents to be submitted by bidders

 Technical proposal
• Operating program and costs
• Maintenance program and costs
• Environmental protection plan.
 Financial proposal
 Cash flow projections
 Formal bid
 Legal proposal
 Acceptance of terms of the contract,
 Draft shareholders’ agreement, consortium agreement, joint venture agreement or a
similar contract
 Letter of conveyance signed by the authorized representatives of the company or
consortium submitting the bid.
 Term sheets of other main contracts could also be requested (construction contract,
operation & maintenance contract, insurance, etc.).
 Draft Contract
 Stage 3: Procurement
52

 Evaluation criteria
 Evaluation criteria will cover (i) compliance of the bids
to the tender specifications, (ii) feasibility of the
proposals, (iii) costs and benefits of the proposals for
the public entity.
 Evaluation rules
 The first step (validation) of the evaluation consists of
checking compliance of the bids with the technical,
financial and legal specifications of the bidding
documents.
 The second step (financial evaluation)
 Stage 3: Procurement
53

 Financial evaluation criteria

• Toll rate for the first year of operation (usually, a toll rate
escalation formula is also provided),
• State subsidy required,
• Duration of the concession,
• Income guarantee requested from the State,
• Revenue offered to the State for existing infrastructure
facilities,
• Total income from the concession,
• Degree of risk commitment that the bidder assumes during
the construction stage,
• Quality of the technical offer
 Stage 3: Procurement
54

 Preparing a draft contract: The draft contract

should include different kinds of information:
 Technical information
 • Description of the site location and access to the site,
 • Detailed scope of work with responsibilities entrusted to the
private contractor and those kept by the contracting authority,
 Financialand Economic Information
 Information on project planning
 Timetable for completion of the construction works,
 Time-related requirements for project operation and
maintenance services.
 Stage 3: Procurement
55

 Technical information
• Design documents and plans for any rehabilitation or development works
included in the contract,
• Description of the site location and access to the site
• Feasibility study,
• International and national standards governing the expected services (works,
maintenance, operation),
• Performance indicators for operation and maintenance with a clear definition
of control and measurement methods, as well as performance requirements,
• Environmental impact assessment study (if any) and a detailed description of
the environmental constraints during all project phases,
• Quality assurance requirements,
• Documents to be provided by each party during the contract,
• Assistance and facilities to be provided by the government and contracting
authority,
 Stage 3: Procurement
56

 Financial and Economic Information

• A schedule allowing the bidder to present its financial offer in a clear, standard
form, which will be included in the future contract,
• Contractor’s mode of payment and participation in project financing,
• Penalties in case of contractor’s default and guarantees,
• Performance bonds,
• Risk allocation,
• Formulae and price indices to be used for the adjustment and review of
contractor’s payments,
• The currency of bids and contract,
• Contractual requirements as regards subcontracting,
• Information about rules and regulations governing foreign exchange remittance
(if international firms are to be involved),
• Nature, amount, period of validity and other principal terms and conditions of
security and warranties.
 Stage 4: Contract Award
57

 Negotiations with the Private Sector

 The bases of negotiation will be:
• Experience, which will build up over time.
• The feasibility study which sets out the key parameters of the project including
the business case and provides the basis for the RFP.
• The Bid Documents which set out the bidders’ conformity (or otherwise) with the
requirements of the RFP.
 The main negotiating items can include:
• Land acquisition and costs
• Project investment costs
• Tariff
• Concession period
• Risk bearing/allocation
• Renegotiation options on specific items
• Other items specific to the particular project
 Stage 5: Contract Management
58

 There are generally 3 stages in the development of

Contract Management:
• Procurement Stage: Rules are established for the life of
the Contract.
• Development or Construction Stage: From award of
contract to the start of output based revenue. (This may
be divided into two phases i.e. from contract award to
construction commencement and construction).
• Delivery Stage: Provision and use of contracted services.
 Stage 5: Contract Management
59

 Contract management tasks during the

Procurement Stage
 thelaying of foundations for the future partnership,
However, good relationships should not be at the
expense of the government’s rights and expectations
under the contract.
 The contract must allow for monitoring of performance
against which payments will be made. Monitoring and
auditing processes should be made clear even at the
bidding stage
 Stage 5: Contract Management
60

 The Construction Development Stage

• Design of the new facility or clarification of services to be provided
• Integration of new facilities into existing facilities
• Maintaining ongoing monitoring including site access and rights to raise
issues
related to contractual failures and non compliance
• Delays or changes to the construction program
• Variations if any requested by the contracting authority
• Determining readiness for occupation/operation
• Any construction defects
• Property and planning issues
• Staffing issues
• Risks borne by the contracting authority
 Stage 5: Contract Management
61

 The Delivery of Services Stage

• Definition, implementation and operation of the
contracting authority’s
monitoring system
• Handling of a settling in period
• Monitoring contracted services
• Transfer of Contract back to Government or Rebidding
PUBLIC PRIVATE PARTNERSHIP:
CAPITAL CASH FLOW
 Capital Cash Flow Method
63

 Computing capital cash flow:

 Take Net Income (builds in tax shields directly)
 Add depreciation and special charges,
 Add interest
 Subtract change in NWC and
 Subtract incremental investment.
 Discount capital cash flow with unlevered cost of equity to
arrive at firm value.
 Equity value can be derived by subtracting risky debt value.
 Advantages:
 Incorporates effect of changing leverage.
 Avoids calculation of “debt” discount rate. Assumes tax shields are at
similar risk as whole firm.
 Cash Flow Analysis
64

 Indicators to select Project

 Net Present Value (NPV)
 Internal Rate of Return (IRR)
 Modified Internal Rate of Return (MIRR)
 Profitability Index (PI)

 Comparing two projects with NPV and IRR

 Issues on Cost of Capita
 Analysis of Individual Cash Flows
 Net Present Value (NPV) I
65

Financial Agreement (Closing)

t=5 t = 10 t = 20 t = 30 t = 40
Free
cash flow Year

Salvage
Sank
Value
Costs
Sank cost does not affect
cash flow analysis because
Cash
it is an existing fact
out flow
regardless of the
investment decision
t=0 (it is not incremental costs).
Example
t=1
- CF2
t=2 Present value of PV =
cash out flow at t=2 (1 + r ) 2

Present value of
CF10
PV = (1 + r ) 10
Present Value cash in flow at t=10
 Net Present Value (NPV) II
66
Present value of
PV0 = - CF0 cash out flow at t=0
 Negative value because they
- CF2 Present value of are cash out flow
PV2 = (1 + r) 2
 cash out flow at t=2


CF10 Present value of
PV10 = (1 + r) 10 Positive value because they
cash in flow at t=10 are cash in flow


Net of all present value of cash out flow and
all present value of cash in flow is:

NPV = PV0 + PV1 + PV2 + PV3 +  + PV42
- CF1 - CF2 CF10
= - CF0 + (1 + r ) 1 + (1 + r ) 2 +  + (1 + r )10 +  +(1 + r )42
CF42
42
CFt
= tΣ= 0 t
As long as this value is positive, the project will produce
(1 + r) more cash than necessary to repay debt and dividend.
 Net Present Value (NPV) III
67
 Implication
 Positive NPV: the project will generate more cash than the necessary amount to
repay debt to banks and deliver dividend to shareholders, the excess cash solely
to the project’s shareholders.

 Zero NPV: the project will generate exactly the necessarily amount of cash to
repay debt to the banks and deliver dividend to shareholders.

 Negative NPV: the project cannot generate cash to repay debt to banks and
deliver dividend to shareholders.

 Weak point of NPV is that it produces only absolute values.

 $1 million investment and $1 thousand investment could, theoretically, produce
the same NPV values.

Based on: Financial Management, Eugene F. Brigham and Michael C. Ehrhardt, 2008
 Internal Rate of Return (IRR)
68
 Method
 IRR is defined as the discount rate that assumes NPV is equal to zero.
N
CFt
IRR = Σt = 0 (1 + r) t = 0
 Implication
 IRR is useful when investors assess the project against their hurdle rate, which is a
cost of capital.
 IRR > Hurdle Rate: the project will produce more cash than the necessary amount to
repay debt and deliver dividend to shareholders.
 IRR = Hurdle Rate: the project will produce the exact amount of cash to compromise
investors’ cost of capital.
 Weak points of IRR
 It applies the project’s IRR to the reinvestment of cash in flows
 When there are more than one change from cash out-flow to cash-in flow, or from cash-
in flow to cash out-flow in the projection, the value of IRR are more than one: calculator
would simply indicate “error”
 Modified Internal Rate of Return (MIRR) I
69

Financial Agreement (Closing)

Cost of capital→
Free
cash flow Year

Sank
Costs N-t
(1 + r )
Cash 1
(1 + r ) t
out flow

← Cost of capital
Present Value Future Value
42 Future value of all cash in flows
(1 + MIRR) =
Present value of all cash out flows
 Modified Internal Rate of Return (MIRR) II
70
 Method
 MIRR is defined as the discount rate that forces the present value of cash in flows
(CIF) to equal the present value of cash out flows (COF).
N
N
COFt Σt = 0CIFt (1 + r )N - t
Σ
t=0 (1 + r ) t = (1 + MIRR) N
FV of cash in flows
PV of cash out flows =
(1 + MIRR) N

 Implication
 MIRR is better than IRR because it reinvest the cash-in flow by using the cost of
capital which is more realistic. Thus, MIRR tells more accurate profitability of the
project.
 MIRR > Hurdle Rate: the project will produce more cash than the necessary amount to
repay debt and deliver dividend to shareholders.
 MIRR is better than IRR because it allows more than one changes in plus and
minus signs in cash flow projection.
 Profitability Index (PI)
71
 Method
 PI is another way of using NPV by dividing PV of future cash flow by initial
investment.
Generally: N
Σt = 1 CFt
PV of future cash flows (1 + r) t
PI = =
Initial investment CF0
For the example cash flow projection: 42
Σ CFt
PV of future cash flows t=4 (1 + r ) t
PI = =
Initial investment 3
Σt = 0 CFt t
 Implication (1 + r )
 PI tells the relative profitability of the project by indicating the value of the
future cash flows par dollar of initial investment. When PI > 1, the project should
be accepted. When PI = 1, this basically means NPV = 0 and MIRR = Hurdle
Rate.
 Comparing two projects with NPV and IRR
72

Project A Project B
$500 $400 $300 $100 $100 $300 $400 $600
t t
-$1000 Cost of capital: 10% -$1000 Cost of capital: 10%
NPV: $78.82 IRR: 14.5%
MIRR: 12.1% PI: 1.08 NPV: $49.18 IRR:
11.8%
NPV MIRR: 11.3% PI:
$400 1.05
Project B
$300 Crossover rate A conflict between NPV and IRR when
$200 (1) Project size differences exist
Project A (2) Timing differences exist
$78.82 $100
$49.18
$0 Take NPV rather than IRR. The logic is
5% 10% 15% r % That NPV selects the project that adds
-$100 7.2% 11.8% 14.5% most to shareholder’s wealth.
 Other Important Indicators
73

 Debt service coverage ratio

Annual FCF
=
Annual debt service (principal and interest payments) ）
 Loan life coverage ratio
NPV of FCF during the life of the debt
=
Outstanding debt
 Project life coverage ratio
NPV of FCF for the entire project life
=
Outstanding debt

 Debt-to-equity ratio
Outstanding debt
=
Outstanding equity
 Issues on Cost of Capita
74

 Decreasing Debt/Equity Ratio

 For calculating NPV for a project within a company or for a company’s valuation, generally
WACC (weighted average cost of capital) is used.
CF1 CF2 CFn
NPVC = - CF0 + (1 + WACC) 1 + (1 + WACC) 2 +  + (1 + WACC) n

 In case of project finance the outstanding debt constantly declines and debt/equity ratio
keeps changing throughout the project life.
CF1 CF2 CFn
NPVP1 = - CF0 + (1 + WACC1) 1+ (1 + WACC2) 2 +  + (1 + WACCn) n

in which weight of debt is constantly adjusted

WACC = (weight debt x cost debt)(1 – T) + (weight capital x cost equity)

NOPAT1 + tKDD1 NOPAT2 + tKDD2

or NPVP2 = - CF0 + [1 + (Rf + βa x Rp)] 1+ [1 + (Rf + βa x Rp)] 2 + 

[NOPAT: Net Operating Profit After Tax, t: tax rate, KD: debt cost,
D: debt outstanding, Rf: risk free rate, βa: asset beta, Rp: risk premium] Tax shield
Adjustment
 Issues on Cost of Capita
75

 Reliability of CAPM in Project Finance Situation

 Both NPVP1 and NPVP2 in the previous slide involve the concept of
CAPM (capital asset pricing model) to get debt, equity and asset beta,
which would not work appropriately in case of project finance for
several reasons:
 A country where project is located may not have integrated/efficient market
 Data would be not available for market risk premium
 An ideal instrument represents the risk free rate would not be available
 CAPM may not able to incorporate all risks associated with the project
 CAPM does not consider asymmetric down side risks
 Required return on debt may different between construction and operating
periods
 What if there is single purchaser located in other country?

 What to do?
 Analysis of Individual Cash Flows
76
Free
FCF used for NPV Cash Year
Flow
(IRR) analysis
(FCF)

Sales
Revenue

Anatomy of FCF Year

for project finance Input cost
Operating
Construction cost
Taxes
Costs
Net investment
(in maintenance)
 Tariff Structure and Adjustment
77
Mechanism
77

 Principle of Tariff Design: The general principle of

tariff design is to ensure that the promoter can
recover production cost and earn a reasonable rate
of return.
 Design of Base Tariff Structure:
 Tariff Structure and Adjustment
78
Mechanism
 Tariff Structure and Adjustment
79
Mechanism
 The toll rate is adjusted according to inflation risk,
exchange rate risk and demand risk.

Pi = Pi-1 + ∆ I ( fi I ) + ∆ E ( fi E ) + ∆ Q ( Qi )

where, Pi = the toll rate in year i ; ∆ I ( fi I ) = the toll rate adjustment due to the inflation ( fi I ) in
year i and θ = the tolerance of allowed fluctuation in inflation; ∆ E ( fi E ) = the toll rate
adjustment due to the currency exchange rate ( fi E ) in year i ,
 Tariff Structure and Adjustment
80
Mechanism
  fi E 
P δ
 i-1 i  E + α − 1 [0 ≤ fi E < f rE (1 − α )]
 fr 
(fi I - θ ) 
∆ I ( fi I ) = Pi-1 ∆ E ( f i E ) = 0 [f rE ( 1- α ) ≤ fi E < f rE ( 1+ α ) ]
100

− Pi-1δ i  fi E - α − 1 [f rE (1+ α ) ≤ f i E < +∞ ]
E

  fr 

  Qi-1 
− Pi-1  e − (1 − β )  [0 ≤ Qi-1 < Qie−1(1- β )]
 Q 
 i −1

∆ Q ( Qi ) = 0 [Qie−1 ( 1- β ) ≤ Qi-1 < Qie−1 ( 1+ β ) ]


− Pi-1  Qi-1 e − (1 + β )  [Qie−1(1+ β ) ≤ Qi-1 < +∞ ]
  Qi −1 

where, α = the tolerance of allowed fluctuation in currency exchange rate and δ i = the
component rate of base price relating to exchange rate; ∆ Q ( Qi ) = the toll rate adjustment due to
the annual demand ( Qi ) in year i , Qie−1 = the expected annual demand in year i − 1 and β = the
tolerance of allowed fluctuation in annual demand.
PUBLIC PRIVATE PARTNERSHIP:
VALUE FOR MONEY
 Value for Money
82

 Value for Money (VfM)

 Capital Appraisal Guidelines and Value for Money
 What is Value for Money ?

 Four steps Value for Money test

 What is Value for Money ?
83

83
 Value for money is a process of comparing estimated costs using two
delivery models to determine which is the better value proposition

Model #1 – Traditional Model #2 – Alternative

Procurement Financing Procurement (‘AFP’) -
(Public Sector Comparator Adjusted Shadow Bid
‘PSC’)
The estimated total project costs The estimated total costs
that would be realized with the expected with the alternative
traditional procurement model. Adjusted Shadow Bid model.
 What is Value for Money ?
84

Value for Money

Ancillary Costs Ancillary Costs

Risks Retained
• The cost difference between
Risks Retained
Model # 1 and Model # 2 is
Financing
Financing
Costs
the estimated Value for
Costs
Money
• AFP costs: Financing,
Infrastructure Ontario
Base Costs overhead, Project advisors
Base Costs (includes Risk ‘Shadow Bid’ or
Premium)
‘Preferred Bid’ • Key AFP benefit: Risk
transfer
• The savings achieved through
PSC AFP risk transfer more than offset
Base Costs Financing Costs additional AFP costs
 Value for Money Test
85

 First Formal PPP Value for Money Test: PPP

Procurement Assessment
 Purpose: to assess whether, and in what form, a PPP arrangement has
the potential to offer a value for money solution for procuring the
project. For example, Design Build and Maintain (DBM), Design Build
Operation Maintain and Finance (DBOMF), Concession, etc.
 Focus: project characteristics （ qualitatively ）
 Sufficiently large scale;
 Potential for risk transfer to the private sector;
 Potential to be output based;
 Potential for revenue generation.
 Value for Money Test
86

 Second Formal PPP Value for Money Test: On

Completion of the Project-Specific PSB
 Purpose: to determine whether, in light of the quantifications in the PSB,
the conclusion reached in the PPP Procurement Assessment still holds.
 Focus: Some of the issues that were considered qualitatively in the PPP
Procurement Assessment will be quantified in the PSB.
 If, having compiled the PSB, the Sponsoring Agency can proceed with the PPP
procurement process.
 if not, the Sponsoring Agency should review the procurement option chosen
and decide that a different procurement method should be pursued ; or that
the project should be abandoned.
 Value for Money Test
87

 Third Formal Value for Money Test: Tender

Evaluation stage
 Purpose: to compare the highest ranking bid with the PSB, allowing for
the differing impact of taxes, etc., in order to quantitatively assess
whether the highest ranking bid offers a potential value for money
solution.
 Focus: In this value for money test the highest ranking bid is compared
to the PSB to help assess, from a purely quantitative perspective,
whether it has the potential to deliver value for money. ---“Value for
Money Comparison”
 Comparison of the overall impact on the Exchequer of the PSB to that of the
highest ranking bid
 Analysis of the Driver(s) of the Value for Money Outcome
 Value for Money Comparison Template
88
Source Compháirtíocht Phoiblí Phríomháideach
PSB Cash PPP Bid Cash
Flows Flows
(PV basis) (PV basis)
(I) Exchequer Outflows (incl. VAT):
(a) PV of Public Sector Benchmark (excl. Third Party
X1 -
Income)
(b) PV of all payments to the Private Sector Partner - Y1
Total Exchequer Outflows X Y
(II) Exchequer Inflows:
(c) Gross VAT (X2) (Y2)
(d) Corporation Tax - (Y3)
(e) Rates and Levies (X3) (Y4)
Table continued on next page →
 Value for Money Comparison Template
89

(f) Third Party Income / Revenue Share to

(X4) (Y5)
Exchequer

Total Exchequer Inflows (X) (Y)

(III) Non-Cash flow Adjustments:

(g) Risk Adjustment X5 -

(h) Residual Value Adjustment - Y6

(i) Material Tax Reliefs Adjustment - Y7

OVERALL IMPACT ON THE EXCHEQUER i.e. I + II

X Y
+/- III
 Key VfM drivers include:
90

 Optimum risk allocation between parties

 Focus on whole life cycle costs
 Use an outputs specification approach
 Rigorously executed risk transfer
 Sufficient flexibility
 Sufficient incentives within procurement structure
 Sufficient skills and expertise in both public and private sectors
 Managing scale and complexity – keeping costs in proportion
to project size
 Value for Money Test
91

 Fourth Formal Value for Money Test: Just Prior to

Contract / Financial Close
 Purpose: in privately-financed PPPs / PPPs procured using Negotiated
Procedure, a final test is carried out (a) to examine the effect of any
negotiated changes in the contract terms when the project has been
procured using the Negotiated Procedure, and (b) to assess the impact
of any changes in the interest rate(s) and/or discount rate.
 Focus:
 impact of any negotiated changes in the contract terms
 impact of any changes in Interest Rates and/or Discount Rates
 Project management
92

 Project management
 Performance management
 Regulatory framework

 Critical success factors

PUBLIC PRIVATE PARTNERSHIP:
PERFORMANCE MANAGEMENT
 Performance Management
94

 Design Performance Management System linking

performance to compensation:
 Develop Key Performance Indicators (KPIs)
 Punctuality and reliability
 Customer satisfaction
 Cleanliness and general facility maintenance
 Access and security
 Determine weightings for KPIs
 Determine penalty levels for KPIs (performance targets, penalty
thresholds)
 Determine maximum penalty amounts
 Performance of PPP Projects
95

 The performance levels of

PPP projects begin at the
most basic specification
level of material and
processing and range
through system-wide
performance measures.
Moving from one level to
another in the model
involves the transfer of risk
through a contract
between the agency and
the designer, builder, or
operator, depending on
how the project delivery
system is defined.
 Performance of PPP Projects
96

Performance of PPP Projects is output-specification-based!

 Performance of PPP Projects
97

Service provider Authority contract

management team
Baseline setup:
Modify baseline
Perform service KPIs

Self monitor Audit of Performance

The flowchart of performance performance evaluation
proposed
performance
Record and report
monitoring system performance
(PMS) Compare performance
against baseline
Yes
Apply for
payment
Fail to meet baseline

Is the failure a
Monthly monitoring meeting persistent long-term Yes
issue?

Is the failure because

Meet baseline baseline is no longer
Negotiate and agree performance appropriate?
levels and actual payment due No
No

Payment
Payment made
deduction
 Comprehensive KPIs for General PPP
98
Projects

 (1) Result-oriented objective measures:

• Time performance

• Cost performance

• Profit and financial objectives

• Scope of rework

• Safety performance

• Environmental performance

• Productivity

• Pollution occurrence
YEUNG et al. (2007, 2008 and 2009)
 Comprehensive KPIs for General PPP
99
Projects
 (2) Result-oriented subjective measures:
• Quality performance

• Professional image establishment

• Client's satisfaction

• Customer's satisfaction

• Job satisfaction

• Innovation and improvement

YEUNG et al. (2007, 2008 and 2009)

 Comprehensive KPIs for General PPP
100
Projects
 (3) Relationship-oriented objective measures:
• Litigation occurrence and magnitude

• Dispute occurrence and magnitude

• Claim occurrence and magnitude

• Introduction of facilitated workshop

YEUNG et al. (2007, 2008 and 2009)

 Comprehensive KPIs for General PPP
101
Projects
 (4) Relationship-oriented subjective measures:
• Trust and respect

• Effective communications

• Harmonious working relationships

• Long-term business relationship

• Top management commitment

• Employee's attitude

• Reduction of paperwork

YEUNG et al. (2007, 2008 and 2009)

 The Regulatory Framework
102

 Regulation in a PPP context is about economic regulation,

tariffs, licenses, provision and market control in general, not
technical regulation.
 Embedded Regulators – A regulatory organization that is comprised of
one or more offices or functional groups within a ministry that compiles
information, conducts analyses and makes recommendations on
regulatory issues to the minister.
 Separate Regulators – A separate organization that gives regulatory
advice to a higher authority (e.g. a minister or via a minister to the
president) but does not necessarily take a final regulatory decision.
 Independent Regulators – an organization set up outside of a ministry
that has final authority over licenses, tariffs and service quality.
 The Regulatory Framework
103

Source: GRIDLINES NOTE N°23 - May 2007, Anton Eberhard

 PPP Policy Framework
104

Source World bank

 PPP Policy Framework
105

 A specific PPP framework would include;

 The legal and regulatory framework,
 Procurement guidelines,
 Model PPP contracts, and
 Risk Management Framework,
 Financial guidelines (Tariffs, payments and Government
support),
 The Project Cycle and the role of Advisors,
 Technical design and service standards,
 Institutional and Approvals Framework (Including Dispute
resolution mechanisms).
 Critical Success Factors for PPPs
106

 Favorable investment environment

(1) Stable political system;
(2) Favorable economic system;
(3) Adequate local financial market;
(4) Predictable currency exchange risk;
(5) Predictable and reasonable legal framework;
(6) Government support;
(7) Supportive and understanding community;
(8) The project is in public interest;
(9) Predicable risk scenarios;
(10) The project is well suited for privatization; and
(11) Promising economy.
 Critical Success Factors for PPPs
107

 Economic viability
(1) Long-term demand for the products/services offered
by the project;
(2) Limited competition from other projects;
(3) Sufficient profitability of the project to attract
investors;
(4) Long-term cash flow that is attractive to lender; and
(5) Long-term availability of suppliers needed for the
normal operation of the project.
 Critical Success Factors for PPPs
108

 Reliable concessionaire consortium with strong technical strength

(1) Leading role by a key enterprise or entrepreneur;
(2) Effective project organization structure;
(3) Strong and capable project team;
(4) Good relationship with host government authorities;
(5) Partnering skills;
(6) Rich experience in international PPP project management;
(7) Multidisciplinary participants;
(8) Sound technical solution;
(9) Innovative technical solution;
(10) Cost-effective technical solution;
(11) Low environmental impact; and
(12) Public safety and health considerations.
 Critical Success Factors for PPPs
109

 Sound financial package

(1) Sound financial analysis;
(2) Investment, payment, and drawdown schedules;
(3) Sources and structure of main loans and standby facilities;
(4) Stable currencies of debts and equity finance;
(5) High equity/debt ratio;
(6) Low financial charges;
(7) Fixed and low interest rate financing;
(8) Long-term debt financing that minimizes refinancing risk;
(9) Abilities to deal with fluctuations in interest/exchange rates; and
(10) Appropriate toll/tariff level(s) and suitable adjustment formula.
 Critical Success Factors for PPPs
110

 Appropriate risk allocation via reliable contractual

arrangements
(1) Concession agreement;
(2) Shareholder agreement;
(3) Design and construct contract;
(4) Loan agreement;
(5) Insurance agreement;
(6) Supply agreement;
(7) Operation agreement;
(8) Offtake agreement; and
(9) Guarantees/support/comfort letters.
PUBLIC PRIVATE PARTNERSHIP:
SUCCESSES AND FAILURES
 Transaction Hazards
112

All PPPs are subject to common transaction hazards (Fig. 1), which
could determine the success or failure of PPP projects.

Transaction
hazards

Uncertainty Asset Information contract

specificity asymmetry incompleteness
 Transaction Hazards
113

 Uncertainty means it is impossible to exactly describe the existing state

of a PPP and forecast the future outcomes thereof, frequently referenced
as risk.
 Asset specificity measures the degree to which an asset supports a
transaction and can be redeployed to alternative uses and users without
loss of productive value.
 Information asymmetry refers to a situation where a government may not
be able to discern the true capacity of the private sector and the actual
costs at the procurement stage.
 Contract incompleteness occurs because PPPs are usually complex and
long-term (20-30 years) contracts.
 Governance of PPPs
114

Table 1. The Impacts of Governance Mechanisms on PPP Performance

Transaction Governance
Impacts on performance
hazards mechanisms
Resolving uncertainties ex ante, but causing transaction
Cognition
costs and optimism bias
Uncertainty
Resolving uncertainties ex post, but causing opportunistic
Flexibility
behaviors

Encouraging relationship-specific investments, but the

Safeguards
costs of safeguards as burden borne by all taxpayers
Asset
specificity
Maintaining the confidence of the private sector in
Credibility
making relationship-specific investments
 Governance of PPPs
115

Table 1. The Impacts of Governance Mechanisms on PPP Performance (continued)

Transaction Governance
Impacts on performance
hazards mechanisms
Revealing private information about contractors in the
Competition bidding process and reducing collusion and corruption of
Information the government
asymmetry Increasing accountability because the government can
Transparency monitor the private sector’s performance and the public
can hold the government accountable
Using as signals to the government the capabilities of the
Reputation private sector, its products and services, strategies, and
Contract
prospects in comparison to competitors
incompleten
ess Reducing opportunistic behaviors and encouraging
Trust
collaboration
 Governance of PPPs
116

Insights
 Cognition and flexibility complement each other to reduce the hazard
of uncertainty in PPPs but they cannot simply substitute for each other,
due to their respective costs.
 Safeguards reduce the hazard of asset specificity, but excessive
safeguards could be harmful to PPPs. Moreover, the credibility of
government is essential for the effectiveness of safeguards.
 Transparency and competition complement with each other to reduce
the hazard of information asymmetry in PPPs.
 Reputation and trust reduce the hazard of contract incompleteness in
PPPs, but reputation cannot function in the absence of a competitive
procurement process.
 Renegotiation and Early Termination
117

Renegotiations and early terminations are very normal nowadays

in PPP projects.
In Latin America, 75% of the water-concession contracts (with a

sample of 1,000 contracts) were renegotiated within an average

of 1.6 years.
According to the Private Participation in Infrastructure (PPI)

Database of World Bank, 334 out of 4874 projects in

developing countries were early terminated.

Renegotiations and early terminations are flexibilities which

should be integrated into agreements to deal with contingencies
in the long-term concession period.
 Renegotiation and Early Termination
118

Contingencies UK AU India World USA Canada China Hong

Bank Kong
Relief events √ √ √ √
Compensation √ √ √ √
events
Force majeure √ √ √ √ √ √
Default events √ √ √ √ √ √ √ √
Change in law √ √ √ √
Change in service √ √ √ √ √ √ √
Refinancing √ √ √ √ √
Change in control √ √ √
 Renegotiation and Early Termination
119

Contingencies Recommended flexibilities

Relief events Remedy; time delay; insurance
Compensation Remedy; time delay; compensation
events
Force majeure Renegotiation; early termination
Default events Remedy; monetary deductions; step-in rights or
replacement of sub-contractors; early termination
Change in law Cost mitigation; renegotiation
Change in Pricing pre-specified changes; renegotiation
service
Refinancing government consent and audit; gain sharing; early
termination
Change in Lock-in period; government consent
control
 Renegotiation and Early Termination
120

Procedures:
 Renegotiation and Early Termination
121
 Renegotiation
122

Renegotiation in practice: Guasch et al. (2008) found high

percentages of renegotiation in PPP projects in the transportation
sector (54.7%) and the water and sanitation sector (74.4%) in
Latin America and the Caribbean (with a sample of 1,000
contracts).
 Early Termination
123

Early termination in practice: the Private Participation in

Infrastructure (PPI) Database of World Bank shows that 334
out of 4874 projects were early terminated.
 Challenges
124

Problems raised by renegotiation :

• Driving factors
• Decision-making problem
• Private sector: Initiate a renegotiation or not?
• Government: Accept a renegotiation or apply an early
termination?
• Compensation
• Toll adjustment
• Subsidy
• Contract extension
• Impact on stakeholders
• Private sector: Financial impact
• Government: Impact on Value for Money
 Thanks
Q&A
Email: kevinxiong@tongji.edu.cn