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August 2018

THE NEXT DECADE OF P3 PROJECTS: Winners, Losers, Opportunities, and Impacts

That the market for public-private-partnership (P3) projects has exploded in the United States over the last 20 years is not news to anyone involved in the construction industry. Similarly, there is nearly universal consensus that the trend towards P3 projects in the U.S. will continue unabated in the medium-term future. Numerous papers have addressed why this is so, and have described the advantages P3 projects offer public owners versus traditional project delivery methods. The purpose of this article is not to retread these already well-worn paths. Rather, the question addressed here is: what impacts will the continuing trend of P3 projects have on the construction industry? Every change in any market has winners and losers, and growth in P3 projects will similarly benefit some industry participants and harm others. The last two decades of P3 projects in the U.S. give us ample information to forecast what will happen as the P3 trendline continues to climb.

1. P3 Project Size Favors Incumbents.

The U.S. DoT lists the following in-progress or recently-complete transportation P3 projects:

The contract value disclosed by the DoT for these projects is:

State

Project

Contract Value

Colorado

Central 70

$1.271B

Florida

I-4 Ultimate

$2.877B

Indiana

State Street Redevelopment

$2.645B

I-69 Section 5

$560M

New Jersey

Goethals Bridge Replacement

$1.436B

North Carolina

I-77 Express Lanes

$636M

Ohio

Southern Ohio Veterans Memorial Highway

$646M

Pennsylvania

Pennsylvania Rapid Bridge Replacement Program

$1.118B

Northampton County Bridge Renewal Program

$37.5M

Texas

North Tarrant Express 35W (Segments 3A and 3B)

$1.638B

Virginia

Elizabeth River Tunnels

$2.089B

Transform 66

$3.724B

 

Taken as a whole, these projects paint a clear picture of the likely medium-term future of P3 projects: large-value contracts for significant scopes of work. With the exception of Pennsylvania’s (comparatively) tiny $37.5 million Northampton County Bridge Renewal project, the smallest active DoT P3 project has a disclosed contract value of $560 million. These 12 projects have an average disclosed contract value of $1.556 billion.

These projects illustrate something already well-known about P3 projects: they tend to be among the largest public projects in terms of contract value. However, as P3 projects become more popular and more common, the average contract value of a P3 project should decrease. The Northampton County Bridge Renewal Program in Pennsylvania is indiciative of this—ten years ago, few would have predicted a P3 project with a $37 million total price tag. And while this project will probably be an outlier for the near future, an overall trend towards smaller project sizes (smaller being relative, as the next-smallest P3 project tracked by DOT has a price tag of $560 million) should be expected. Somewhat counterintuitively, this trend will likely be most beneficial for the largest contractors, and most problematic for regional contractors. Several factors drive this result.

1. Captive Concessionaires Cut Capital Costs.

Many major P3 industry players now have related entities who specialize in concessionaire financing.1 Access to in-house financing expertise and relationships lowers the cost of raising capital inherent in most P3 projects. Whereas smaller contractors will need to find and team with a financier (who will expect to take their own profit and overhead cut from any contract ultimately awarded), major contractors will be able to turn to a known and experienced team, whose profit and overhead expectations should be lower than an outside financier, given the role the captive concessionaire is intended to play. Put differently, the captive concessionaire should be satisfied with breaking even, provided that their work enables the related contractor entity to win the project.

2. Selective Sureties Limit Viable Players.

Most P3 projects continue to require bonding by the contractor. Sureties learned some hard underwriting lessons during the 2008 crash, and bond program size restrictions, project size restrictions, and project-level underwriting are still rigorous among the major surety companies. The result is that even global contractors find it necessary to form joint ventures to pursue P3 projects, so that the bonding and indemnity obligation is spread among the carrying capacity of several different contractors. The restrictions are necessary from the sureties’ point of view—they expect indemnity opportunities that equal or exceed the quantum of the bond they are posting, and few contractors of any size can comfortably guarantee an indemnity recover of $1 billion or more.

These same restrictions will create very difficult barriers to entry for regional contractors. It’s one thing for 3 global contractors to JV together to pursue a $1 billion project—there should be sufficient money to cover each partner’s overhead expenses and profit expectations. If six regional contractors have to JV together to pursue the same project, the odds of each of them getting sufficient profit and overhead recovery to justify the effort is significantly smaller. Every time you cut the pie, you lose some to crumbs. The more times you have to cut the pie, the more you lose. Surety underwriting restrictions will continue to benefit global contractors at the expense of regional contractors.

2. Design-Build Delivery Presents Barriers to Entry.

Most P3 projects are delivered via design-build, with varying degrees of involvement/restriction by the owner and its consulting designer. While the design-build delivery mechanism is a natural fit for P3 projects, its use has at least two predictable results.

First, design-build delivery for projects of typical P3 size can only be designed by a handful of design firms. With prime design contract values exceeding (often far exceeding) $50 million for designs to be delivered within a narrow time window (again, often 18 months or less), even major national design firms find it necessary to partner with competitors to deliver designs on-time and on-budget. Based purely on available manpower, even significant regional design firms will find themselves unable to muster the resources necessary to serve as the prime designer.

The issue of risk raises an even thornier problem. Contractors teaming with designers pre-bid often expect designers to assume some risk arising from their preliminary, pre-bid design development. Depending on what the parties actually agree to, this risk can easily run into 8 figures, a result that would bankrupt all but the top tier of designers nationally, and which makes these projects unpalatable many companies who would otherwise be qualified and capable of executing them.

Second, the perils of bidding on a design-build P3 justifiably scare away many contractors who would otherwise be able to perform the work. The owner and financier/concessionaire aggressively (and often successfully) downstream virtually all the risk associated with the execution of the project. Since many P3 projects continue to be primarily heavy civil, horizontal work, project-side risk is formidable, hard to precisely quantify, and opportunities for mitigation are frequently minimal. Those firms who have built expertise in the past 20 years are well-positioned to leverage that experience to maintain places of prominence even as the market expands.

3. The P3 Bidding Process Allows Owners to Pick Favorites.

P3 projects, in contrast to traditional sealed, lump-sum, design-bid-build projects, need not be awarded to the lowest responsible bidder.  Rather, P3 projects are usually awarded on an RFP basis, in which price is only one of the factors considered. While the award must still be made based on an objective evaluation of known criteria, the owner is left with a great deal of discretion in its decision. Once again, incumbency and experience means that the rich are likely to get richer. In an RFP competition between a national contractor who has executed a dozen prior P3 projects and a regional contractor who has never executed a P3 project before, the owner can scarcely be faulted for awarding to the more experienced contractor.

4. Conclusion

The last 20 years of construction in the U.S. have been marked by consolidation in both the contractor and designer industries, and the entry into the U.S. by foreign contractors with substantial P3 and design-build experience. Regional contractors and designers have been under constant pressure. As the use of P3 deliveries increases, these trends are going to continue. It remains to be seen whether market pressure will lead to a series of regional-level consolidations aimed at creating new entities capable of competing for major P3 projects, or whether regional firms will react by adapting either to other market sectors (like non-public work) or new project roles (like subcontractors). It also remains to be seen whether state and local governments will take more aggressive action to mandate the use of local contractors in the execution of major projects. What can be said with certainty is that, in the absence of major market changes, the next decade of P3 work should look at lot like the last decade—involving the same players, competing for the same projects, and maintaining (and likely growing) their market share even as the overall size of the market expands. __________________________________________________________________________

1 As just one example, Hochtief Solutions AG is the captive concessionaire entity for the Hochtief/Dragados family of companies.

Construction

John Benjamin Patrick



Construction

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