PPP in the UK has served up some gift headlines in the past few months – all negative.

There have been a couple of high-profile cancellations in the defence and healthcare sectors – most noticeably the Paddington hospital scheme that worked up £14 million in feasibility costs. There is uncertainty over accounting for PPPs on both public and private books. The NAO has issued a lukewarm report on the value for money of the Norwich and Norfolk Hospital. And there have been a number of schemes pulled due to the withdrawal of bidders.

Investors Chronicle has even attempted to link what the government is alleged to have done with Railtrack and what it plans to do with PPP, and the FT ran a story claiming the Office of National Statistics plans to imminently reclassify PFI debt.

Given the accumulation of bad press, the UK's PPP programme appears to be in trouble. Not so. As the share prices of the majority of sponsors and contractors exposed to UK PPP show, prospects are still good.

True, the share prices of the corporates may be currently suppressed by the uncertainty in the market, but the doomsday PPP scenario regurgitated in the press on almost a daily basis is not supported by bearish share prices or a slow down in deals. And ironically, those PPP sponsors that have had a hard time – notably Jarvis and Mowlem – have suffered due to over-competitive bidding.

"The trouble is," says Darryl Murphy, director, infrastructure at RBC Capital Markets, "PFI suffers from a bad PR machine. Bad news is the most newsworthy news, so any hiccup associated with PFI is jumped upon by the mainstream press. It's very rare to get a report on a PFI success story."

Grey accountancy

All UK PPP market participants Project Finance canvassed give a bullish outlook for the year ahead and beyond, with strong deal flow and many mandates to be won. All but a couple of concerns listed above are unlikely to change market practice at all.

One negative story to be taken up and run by the mainstream press in the first half of 2005 was the supposed demise of PPP on the back of new accountancy regimes. Fears of a wholesale reclassification of PFI in the public books were fuelled when the Financial Times reported that the Office of National Statistics (ONS) was on the cusp of changing the way government accounts for PFI.

These fears were allayed when Len Cook, national statistician wrote in saying that the ONS "had not taken any decision to change the treatment of PFI schemes in the public finances." Rather the ONS will make piecemeal changes to the public finances on a scheme-by-scheme basis.

An ONS news release 20 May, stated: "Conceptually, an element of PFI debts should be recorded within public sector debt... Imputing a reliable estimate of finance lease loans is an extremely complex and difficult matter... As of December, there are nearly 700 separate PFI schemes, with differing characteristics. Each would have to be examined individually."

"I don't think we should be unnecessarily concerned by a reclassification," says Murphy. "The Treasury has always emphasised that PPP is not an accountancy trick, and has always pushed PPP under its mantra of value for money."

A further blow to PPP, according to some sources, is the IFRS accountancy standards imposed upon sponsors of PPP projects that require users of fixed-rate loans to book the opportunity cost on their accounts if the interest rates fall below this level. Headline figures could be altered that on first reading would make sponsor stock less attractive than it otherwise would have been under the old regime.

Although sponsors have approached the IFRS for guidance, any change does not effect their real net position, or cash flow, and is unlikely to have any material impact on market practices.

Healthcare heartache

One piece of news that could make an impression on the market, albeit just in the healthcare sector, was the cancellation of the Paddington Hospital project. Days prior to the announcement of the cancellation several sources, in and close to the government said that the building of new large hospitals by regional trusts was outdated. And that smaller, shorter-life assets were better suited to the provision of modern healthcare.

The demise of the Paddington Hospital scheme – and with it of £14 million in fees – was hailed as a further nail in the coffin for PPP by the left wing press. But more ammunition followed with the release of a lukewarm NAO report on the refinancing of the Norwich and Norfolk Hospital.

"It is possible that these issues – most significantly the possible change in government policy about healthcare provision – could make it harder to get large hospital schemes off the ground," says Laughlan Waterstone, director, SMBCE. "Whilst it's too late to affect St Barts, it will be interesting to see how those hospital schemes of £200 million to £300 million upwards at about the ITN stage progress."

The Norfolk and Norwich University Hospital was the first large hospital PPP scheme and as such its refinancing has attracted a lot of attention. The scheme was won by the Octagon consortium comprising Innisfree Partners (25%), 3i Group (25%), Barclays Infrastructure (25%), John Laing (20%) and Serco (5%). The concession began in January 1998, with the trust paying £37.8 million a year.

In December 2003, two years after the opening of the hospital, Octagon refinanced to take advantage of the maturing market and the fall in interest rates. As with other early PFI schemes, the contract placed no obligation on the sponsors to share any refinancing gains – however, on refinancing, 30% of the £115.5 million upside went to the Trust in accordance with the voluntary code the Treasury had negotiated with the private sector in 2002.

The NAO report published in June 2005 found that the Trust continues to pay a premium on the financing costs compared to current deals, but the benefits of a new hospital have been received earlier than many other communities and spiralling construction inflation has been avoided. Although the Trust received £34 million of the upside, as a consequence of the refinancing its risks on termination have increased.

The NAO also noted that it may have been possible to improve the original deal with greater competition and better defined requirements in the closing stages, but the Trust was not convinced.

This was pounced on by the left wing press. In June, George Monboit writing for the Guardian stated that the Octagon consortium had, "legally walked off with an additional payment of £73 million by exploiting the gap between the financial risk the government said they had taken on and the risk they had really shouldered." This criticism, apart from being incorrect – just because a risk did not in fact materialise does not mean that it wasn't borne – is frustrating for PPP practitioners.

Windfall profits or bust

"It's impossible to enter into a dialogue with those ideologically opposed to the concept of PPP," says Martin McCann, partner at Norton Rose. A particularly vehement opponent is the public-sector trade union, Unison. A favoured criticism of Unison's is that the PPP market is flawed – there are not enough bidders to take on large and complex projects, too many firms make large profits and the few that fail end up costing the taxpayer dear.

However, this seems somewhat detached from reality. The free-market sword cuts both ways – while some companies will make healthy profits, others will be too competitive in their bids and struggle.

"The fate of Jarvis [which has posted losses from its PPP operations and sold them off], shows just how strong the market is," adds McCann, "The assets were purchased at a good price and the projects have to date been successfully completed. Criticism from the left is all well and good but if one is asked, does PPP work – the principal answer is a function of what is the alternative?

"There were of course criticisms of traditional procurement i.e. that government spent a fortune in litigation arising from disputes in responsibility between the design and build contractor and the other contractors. Under PPP there is more of a focus on the delivery of services rather than assets. Further, given tightening budgets, it gives governments funding flexibility. If one looks at the growth of this initiative across the world governments clearly see it as a very useful alternative to standard procurement."

A common criticism is that of profiteering, but any windfall tax on equity sales is likely to be avoided by the Treasury while it continues to focus on value for money via limiting risks to authorities on refinancing, and lowering bid costs through bundling and strategic partnership agreements. "Limiting returns by imposing a one-off tax or sharing mechanism creates a bit of a vicious circle, as equity will price in any increases in risk so that a reasonable rate of return is obtained," says Alan Gillman, EVP at Skanska BOT UK.

Despite the recent application note (see Refinancing box) the government is likely to encourage refinancings rather than equity sales as an alternative because the public sector has a share in the upside.

There have been instances when the market has become oversaturated on the supply-side, with too few bidders chasing too many tenders. Gillman adds: "There was a notable instance of a period around 12 months ago in Scotland, where a batch of tenders were put out to market with some failing to attract any bidders whatsoever. Ensuring healthy competition is more a question of timing of release of projects by the public-sector, rather than a flaw in the market. The Scottish example can be explained away by the general election and the signs are that the market is now more aware of, and can plan for, the available opportunities."

Such are the prospects for UK PPP, particularly the strategic partnership models of LIFT and Building Schools for the Future (BSF), new entrants are entering the market. There are new property specialists working on LIFT deals, but the most notable new entrant is German heavyweight contractor Hochtief. Hochtief recently got a foothold through the acquisition of some of Jarvis's assets and is targeting £4 billion of deals.

The strategic partnership model features the private sector working with, rather than for, the public sector as a co-shareholder. An NAO report – often the touchpaper for press PPP antipathy – has recently issued a positive report on the delivery of a £1 billion strategic partnership programme to refurbish GP practices.
"It's rather disappointing that the perceived success of the strategic partnership model has remained below the radar of the mainstream press," says Murphy.

Education and health continue to be the most promising sectors. The market has picked up after a slight hiatus in deal flow in the UK market generally around the general election and registered as a dip in deal volume in the Dealogic 2005 half-year tables (search 'Dealogic Tables').

The irony of SPAs is that although they are effective at lowering bid costs by bundling small assets together across a rolling mandate, from a free-market perspective they limit competition.

While the UK is pushing for greater value for money by fine tuning the balance between bid costs and competition between bidders with SPAs such as BSF having an increasing role to play, there is still room for improvement on traditional PPP schemes.

"PPP in the UK has not seen a great reduction in lead times," says Weston. "This is principally due to clients asking for scope of works that are knowingly unaffordable against budget and contractual terms that are ever-tightening. Although there are standardised contracts in place, in practice no two projects are sufficiently similar to avoid detailed negotiations. And thirdly, project-by-project greater risks are incrementally transferred to the private sector – this is not the optimisation of risk transfer but shifting as much risk to the private sector as possible and it's contrary to value for money."

"What the Treasury should focus on, is why, transport projects in Scandanavia for example have far shorter lead times," adds Weston.