The German state is in a difficult fiscal situation. National indebtedness is increasing and the Maastricht criteria – which require a budget deficit of less than 3% from public authorities – have been breached.

Public funds are not sufficient to make necessary investments in roads and social infrastructure. Realising such projects implies large funds that German public authorities cannot afford. Therefore, public sector infrastructure projects need fresh financing ideas.

One solution to the problem is public private partnership (PPP), which gets projects moving that would otherwise get stuck in the investment backlog. PPP provides both private sector project expertise within the sphere of the public sector and off-balance sheet investment that is not accounted as deficit under Maastricht because the project risk is transferred to the private sector.

In the past, it was common to solve deficit problems with pre-financing models. However, these financing models did not incorporate efficiency gains. PPP in contrast provides efficiency gains through total life cycle optimisation, making the project less expensive to the public and thereby easing the burden on the public debt. PPP also transfers risks from public authorities to private enterprises thereby getting urgently needed infrastructure projects off the ground at last.

General market conditions

With the start of the A-Model roads programme this year, German PPP is gathering momentum. Hochtief has already gained significant international PPP expertise and is involved in 21 PPP projects in the fields of toll roads and public sector buildings worldwide.

Together with subsidiaries and associated companies, Hochtief is realising or operating 15 highway projects with a total length of some 880 kilometres, 57 schools and one city hall. The projects' value totals Eu8.8 billion – Hochtief's share being about Eu1.5 billion. Hochtief serves as a one-stop-shop to public authorities by covering the whole value chain (design, financing, construction and operation). In terms of international experience, Hochtief is the number one among construction companies based in Germany.

Public sector buildings

PPP models are proving their value in the field of public sector buildings in Germany. Between 2003 and 2005, German PPP market volume in the area of public building was more than Eu1.1 billion. Hochtief is currently realising four projects in Offenbach, Gladbeck, Cologne and Leverkusen. About 50% of the national volume belongs to these projects and thus to Hochtief PPP Solutions, characterising Hochtief as market leader for PPP projects in the public buildings sector in Germany.
"In the field of PPPs at schools, administrative buildings and hospitals alone, we expect a total volume of about Eu20 billion to be put out to tender by 2009," says member of the board of Hochtief, Dr. Herbert Lütkestratkötter.

In North Rhine-Westphalia, nine PPP projects in public sector buildings with a volume of more than Eu380 million, are presently realised or at least in the design phase. Furthermore, in Hamburg and Hesse, public sector building projects with a volume of about Eu950 million are planned or about to be realised. Altogether six states of the Federal Republic of Germany are preparing PPP projects in that segment.

In the toll road sector, the German Federal Ministry for Transport, Construction and Housing (BMVBW) will kick-off five motorway pilot projects in the year 2005 – the A-Models – with an investment volume of approximately Eu1.3 billion.

Hochtief has already realised the Herren Tunnel project in Lübeck, one of the first toll road projects in Germany, opening for traffic in August 2005.

"The PPP market is developing strongly in Germany, we have a sizeable portfolio of projects, and have reached critical mass," says Managing Director of Hochtief PPP Solutions Bernward Kulle. "We wanted to position ourselves more visibly in the market," – leading to the foundation of the Hochtief PPP Solutions GmbH in the beginning of 2005. About 65 experienced employees are working for the organisation.

Efficiency gains

PPP realises infrastructure projects more quickly by shortened design and construction periods. Furthermore, PPP achieves lower life cycle costs as well as improved project operation and maintenance. All of the above results in lower investment and operation costs, leading to significant efficiency gains.

Whether the realisation under PPP models will be more economical is thoroughly audited by the public in the forefront by applying the public sector comparator (PSC). According to the PPP Task Force NRW, efficiency gains between 6.2% in Unna and 15.2% in Monheim could be realised at PPP projects in North Rhine-Westphalia. Hochtief has demonstrated in the past that it can save between 10% and 18% of the budget for the public, as realised on the biggest German PPP project – Schools Offenbach Lot East.

Financing structures in the public building sector

Municipal loans are the conventional type of finance for public authorities in Germany. Although no standardised financing structure for PPP projects has been developed in Germany, up to now, there exist basically two different types of financing models, public sector type loans and project finance structures.

Only recently, project finance has been on the upswing because of changed market conditions and increased fiscal constraints for the public. So far, however, only up to 33% of the contracts have been signed with project finance, 80% still apply public sector type loans, making Germany a developing country in this field.

The project company receives constant monthly payments by the local authority for the performed services. These payments are set aside to cover financing, operating costs, etc. To be able to agree on constant payments with the local council, regular annuity payments (constant monthly payments with a growing repayment and decreasing interest component) are agreed with the lenders. With a separate agreement the bank forfaits (buys ahead) the financing part of the payments by the local authority for the life of the concession.

An advantage for the private party from an accounting perspective is that with a forfaiting structure the debt disappears from the balance sheet of the special purpose company. Furthermore it does not have to be consolidated in the sponsor's balance sheet.

Public sector type loans

Public sector type loans are typically financed under terms and conditions similar to municipal loans. Due to low insolvency risk of municipalities and due to regulations in German banking law, conditions granted to the public are very competitive. In this case, a margin of 20 basis points plus can be achieved.

The prerequisite for obtaining similar conditions as the local authority is a waiver of claims from the local authority to the bank, committing the local authority to pay the bank even in the case of non-performance of the project company. However, the municipality still has all rights against the project company and can reduce the operational component of the monthly payment. To improve the PSC it would be adequate to include the pricing of the waiver as a risk premium. Furthermore, guarantees of the private partner should be included.

At the largest PPP project in Germany to date – Schools Offenbach Lot East – public sector type loans were applied. In October 2004, Offenbach awarded Hochtief the contract for refurbishing and managing schools in the district's eastern part. Hochtief now finances, refurbishes, and operates 49 schools located in that area. The project comprises a total of 282 buildings with an area of 287,870 square metres.

The turnover of the project is about Eu410 million, the PSC was Eu500 million, saving 18% to the public. The local authority has agreed to a waiver of claims against Westdeutsche Immobilien Bank, which provides the financing on the basis of local municipality loan conditions.

Since January 1, 2005 the special purpose company Hochtief PPP Schulpartner GmbH has been operating the schools. During the first five years the company will invest Eu100 million into extensive refurbishment and modernisation measures. After three years, refurbishment of 40% of the buildings and outdoor facilities will already have been completed. Hochtief will ensure that teaching at the school carries on smoothly until 2019.

Project finance

Project finance is the financing of a commercial and usually legally definable self-refinancing economic entity of limited duration where the bank takes the underlying project risk. The lender focuses on the cash flow and the assets of the projects as a security for the repayment of the loan. Unlike public sector loans, in project finance the SPV is the lending entity. In general, 90% are financed by project finance debt and accordingly around 10% by equity. In the case of project finance, a margin of around 100 basis points can be achieved.

Costs and risks

Although the costs for project finance structures are slightly higher than for public sector type loans it is the only financial and contractual structure that allows adequate risk distribution. An extensive due diligence is conducted by the financing bank in order to mitigate those risks. As a general principal of efficiency each party should take those risks that it can influence. This is the most cost efficient way to structure the inherent risks. As the costs for the due diligence are independent of the size of the project volume, project finance schemes are typically used mainly for larger PPP transactions.

The first PPP project in a major German city is realised under a fully-fledged project financing scheme is about to be closed in Cologne. In previous PPP projects, the local authorities always agreed to a waiver of claims against the lender. The turnover of the project is around Eu125 million.

Hochtief achieves efficiency gains of 10%. The debt-to-equity ratio is 10 to 90%. Hochtief invests some Eu34 million on extensive refurbishment and modernisation measures. The remainder is contributed by the KfW IPEX Bank, which receives interest and repayments from the monthly fees paid by the local authority to the project company (cash flow), meaning a direct participation by the bank in the project risk.

Together with the special purpose company, Hochtief PPP Schulpartner Köln P1 GmbH & Co. KG, Hochtief finances, refurbishes and operates seven schools at five different locations in Cologne. At two locations, the works comprise construction of new and extension of existing buildings. Construction is scheduled to start in June 2005 and be completed after 21 months. Hochtief will operate the schools for nearly 25 years.

Toll roads

In general, it takes more than 20 years from the initial planning for a road project to receive the required funds in Germany. Therefore, the extension of the road infrastructure does not keep up with traffic growth and has also led to the development of two different road models – the A- and F-Models.

However, PPP in the German road market is also proceeding slowly, despite the fact that private financial support accelerates project funding and thereby also project realisation. In the beginning, 14 projects were planned with the F-Models. Up to now, only two of them have been realised. And the A-Model programme has only just begun.

The collection of tolls from users for bottleneck F-Model projects like bridges or tunnels is allowed by German law. The revenues of the concessionaire are based on collected tolls. Such models are usually applied when they offer significant distance and time advantages to the users. After a certain time period – usually about 30 years – the concession is transferred back to the state.

F-Models

The Herren Tunnel in Lübeck is a typical example of an F-Model as private investors realise the project in partnership with the city of Lübeck. In Lübeck, two traffic arteries regularly cause traffic jams. The problem with the heavily frequented national road B104 and the Trave waterway is that once the decayed bascule bridge of the river Trave is opened, vehicle traffic breaks down. The Herren Tunnel shall prevent these interruptions. The BMVBW, however, was only committed to the financial means for a new bridge structure (Eu89 million). For the additional costs of a tunnel preferred by the city of Lübeck, an alternative solution was found: public private partnership.

The investment volume for the Herren Tunnel amounts to a total of Eu161 million. This amount is raised by way of subsidies from the BMVBW, equity of Herrentunnel Lübeck GmbH & Co. KG (HLKG) (Eu18 million) as well as bank loans (Eu54 million).

HLKG finances, builds and will operate the new tunnel starting from August this year. HLKG is owned in equal shares by Hochtief and another partner. The tunnel will be operated and maintained over the entire 30-year concession period. For its services, HLKG receives the toll charges paid by tunnel users regulated by the "Mautverordnung" issued by the BMVBW.

Works on the Herren Tunnel started in fall 2001. The two tubes have an interior diameter of 10.4 metres and are 780 metres long. After the end of the concession period in 2035, the tunnel will be handed over free of charge to the city of Lübeck in a sound condition.

A-Models

A-Models comprise the extension of German motorways from four to six lanes. Under these models, a private concessionaire receives the concession for a certain motorway section from the state. Afterwards, the concession company is responsible for the extension, maintenance as well as operation of the motorway. Subsidies up to 50% of the investment are granted to the private party, the remaining investments have to be secured by private funds via a part of the shadow tolls generated from heavy trucks, which are charged for the section.

Since the operation of the toll collect system for heavy trucks on German motorways, the development of A-Models has gathered speed. In March 2005, the BMVBW started the invitation to tender for the first pilot project including the section from Munich to Augsburg at the A8. It has a length of 37 km and will be maintained and operated for 30 years. The other four projects will be put out to tender in the coming months. Hochtief is looking forward to fostering future infrastructure projects in Germany and abroad.