Following the successful closures of the M5 and M6 projects, Hungary is being touted as the pacesetter for public private partnership (PPP) transactions in central and eastern Europe (CEE).

However, whether a handful of Hungarian transport deals will prove the catalyst for PPP infrastructure projects in multiple sectors across the region is uncertain. Some non-road deals are happening, but like most PPP markets the road sector looks set to be the major source of business in the short-term.

With the 10 accession states entering the EU last year, there was an expectation that the cohesion and structural funds – some Eu24 billion ($29 billion) – would provide the necessary fillip to a somewhat pedestrian PPP market in CEE.

In particular, certain accession states believed that they could combine these newly acquired funds with PPP structures. This would allow them to raise debt for the 15-25% co-financing required from their own balance sheets to be eligible for the grants. And while there is no clear prohibition to co-financing in theory, it has been difficult to accommodate PPP concession financing within the grant application process.

But with EU commitment to the current grants ending in 2006, the accession states do not have time to put together hybrid deals if they are going to successfully tap the existing grants.

M5 and M6 – how to close deals

Although the PPP deal flow in the region continues to be sporadic, Hungary stands out as the exception that proves the rule.

In December 2004, the M6 motorway project reached financial close, a rapid 12 months after tender. The project – known as Duna Autopalya Koncesszios Reszvenytarsasag – is backed by a 22-year Eu411.1 million loan, together with availability/performance payments from the Hungarian government. An equity bridge of Eu22.3 million is included, alongside a Eu20.7 million VAT facility and a Eu1 million working capital facility. Mandated lead arrangers BayernLB, Commerzbank, KBC, KfW, K&H Bank and Magyar Kulkereskedelmi Bank (MKB) have since launched syndication and banks have been able to lend Eu25 million for arranger status and a fee of 40bp.

The project sponsors and shareholders in the concession company are Bilfinger Berger BOT GmbH (40%), Porr Infrastruktur GmbH (40%) and Swietelsky International Baugesellschaft m.b.H. (20%). Operations will be undertaken by a subsidiary of Intertoll Pty Ltd (which is ultimately owned by Group Five Limited).

The project involves building, operating and maintaining a 58km section of road between Erdi Teto and Dunaujvaros. The 22-year concession includes an 18-month construction period, with the motorway expected to open in March 2006. During operation the concession has a monthly availability fee payment mechanism that deducts amounts for unavailability and performance failures.

The deal followed swiftly on from the groundbreaking second M5 refinancing, which came in at a staggering Eu705 million, having originally been slated for Eu205 million. Syndication for M5 also closed in December, only weeks before M6's refinancing closed. The roll of participating banks – including BancaOPI, Unicredit, Bank Austria, KBC, OTP, AIB, Bank of Ireland, CDC, Depfa, Dexia, IKB, ING, Islandibanki, KfW, Helaba, Mizuho, Natexis, RBS and SMBC – reflected the eagerness with which institutions have been looking to gain a foothold in the region.

What for many of players has been a marketing exercise may be starting to pay off. "I think we can expect the second section of the M6 to be financed really quite soon. The figure, if market rumours are to be believed, is in the region of Eu1 billion," says a source close to the M5 deal.

Asset Hungary

Another PPP project that is expected to attract both banks and sponsors in the foreseeable future is the privatisation of Budapest Ferihegy Airport. In early June, the Hungarian Privatization and State Holding Company Limited (Allami Privatizacios es Vagyonkezelo Rt. (APV)) announced that the tender process would involve the sale of a majority, controlling stake to a strategic buyer or a consortium containing the significant participation of a strategic investor. APV is expected to sell a 75% minus one share stake in the airport, though it could give up the airport's entire share capital subject to legislative changes.

Letters of interest from potential bidders are to be submitted by 28 June, whereas indicative bids have a 29 August deadline, with binding bids expected in early November, APV is hoping to have the transaction closed by the year-end. In addition, a number of measures are being planned to protect the national interest. It is expected that the airport's charges will be subject to economic regulation post privatization, based on the RPI-X model.

Estimates as to deal size are sketchy, though market consensus is a figure close to Eu1 billion. It is expected that UK airport operator, BAA, Copenhagen Airports, and Frankfurt airport operator, Fraport, will be among the bidders. APV has lined up Credit Suisse First Boston and its local subcontractor, Concorde Securities, as financial advisors on the transaction.

"People are falling over themselves to do this deal. The winning bid will not necessarily be the best, but the most aggressive," says a Frankfurt-based banker.

The airport, which operates two parallel runways, will complete the refurbishment of its third terminal shortly. It remains one of the fastest growing capital city airports in the world, having posted a 36% increase in the first quarter of 2005. During the 12 months to 30 April 2005, the Airport has handled some seven million passengers.

Slovakian airports

Slovakia has also come to market with two airport privatisation deals for Bratislava International Airport and the regional airport at Kosice. The first step of the tender process will be completed by late summer, though much of the privatisation process will be concluded by year-end. Slovakia's Ministry of Transport has appointed a consortium led by Austrian Meinl Bank.

The Ministry is looking to transform Bratislava into a major central European airport, while promoting the long-term growth of Kosice Airport as a regional base for eastern Slovakia, northeast Hungary, Poland and Ukraine. Given Bratislava International Airport's proximity to the Austrian capital, it is expected that private operator, Flughafen Wien, will participate in the project.
IMF criticism.

Given the buoyancy of the Hungarian market in relation to the rest of the region, it is surprising that its PPP policy has come in for some criticism. In mid March, the International Monetary Fund (IMF) published its 'Hungary – 2005 Article IV Consultation Concluding Statement' in which it stated: "Though attractive in accelerating needed infrastructure development – while deferring budgetary capital expenditures – the use of public-private partnerships (PPPs) should proceed with great caution. PPPs do not reduce the fiscal stimulus. They represent a burden for future fiscal budgets, reducing their flexibility. When used primarily as a financing tool, they add to public costs because of the premium typically required on private returns and value for money is not ensured. PPPs also render difficult the evolution of public debt and the interpretation of budget trends and their macroeconomic impact."

Similar charges were levelled at the UK PFI market at the end of last year, when banks were accused of profiteering and projects denounced as not providing sufficient value for money. Bankers, however, have long grown used to this kind of criticism and are taking it in their stride.

"Whether the deal is done using government funding or using project finance is largely irrelevant, as infrastructure capital investment inevitably creates a financial burden which will ultimately be met by the state or subsidised by the user," says Richard Games, executive director, WestLB. "It is well known that the baseline project finance fees and margins are higher than government bonds, however the rationale for doing a project finance deal is down to numerous factors and should not be solely judged based on execution cost alone. PPP transactions have consistently demonstrated delivery of assets on time and to budget with the overall lifetime cost of the asset substantially lower than for traditional public procurement."

Despite its detractors, Hungary looks to be forging ahead even with smaller-sized infrastructure transactions. Two prison projects are currently in the market. The Eu40 million complex at Szombathely in western Hungary will house 700 inmates and is expected to be completed at the end of 2006. It is likely that the private entity will provide the infrastructure, while the government will undertake the services. There is, however, a possibility that the private entity will provide all services. The second project, at Tiszalok in eastern Hungary, is currently being put out to tender and is expected to come into service by the end of 2007, whereupon service fees are expected to top Eu76 million per annum.

The Czech Republic is also considering its first PPP transaction for a prison, though the current legislation prohibits the private sector from operating prisons. The government is expected to approve the proposals for the DBFO in August, with construction starting in 2007. The maximum-security complex, once fully operational in 2009, will house up to 500 inmates. The Eu36 million deal will have a 25-year tenor.

However, prison deals are notoriously unattractive to investors. And whether or not a deal comes to market may depend on a pipeline of other deals in the sector. "Prison deals, for instance, may be quite hard to place, because sponsors will need to know that there are a fair number of deals in the pipeline. If a country puts only one prison out to tender, does it really justify the bidding costs?" asks Ian Andrews, partner at Linklaters in London.

Disappointing jurisdictions

Whether other jurisdictions will benefit from Hungary's PPP success is difficult to determine. What is certain is that many jurisdictions in the region face a number of hurdles, both at municipal and governmental level, that need to be overcome before PPPs can be implemented.

According to Vivian Nicoli, senior banker, Municipal and Environmental Infrastructure, European Bank of Reconstruction and Development: "Authorities have been reluctant to proceed with PPPs due to various factors, including the perceived complexity, high costs, intense resource requirements and long preparation schedules of PPPs, and the potentially negative perceptions of voters regarding private sector involvement in a sector that is perceived to satisfy a basic need."

Moreover, the drive for EU funding has come at the expense of either capital investment or efficiency gains from the private sector. Nevertheless, supranational organizations like the EBRD have responded to these challenges by securing technical assistance funding to assist local authorities in developing PPP projects, as well as encouraging open and competitive selection procedures.

Polish indecision

But for many western players in the region, Poland remains the most disappointing jurisdiction of all. Apart from signing its first PPP project – the Eu840 million A2 motorway – in 2000, there has been a distinct lack of vitality in terms of PPP.

Moreover, rumours abound that PPP will be dropped from the political landscape altogether in favour of short-term contractor schemes. This is unlikely, given the upcoming elections in October. "All decisions are on hold until the elections, which should give the decision makers enough time to decide what they want to do," says a project financier. Even so, many believe that Poland in the short-term will be prone to government-funded upgrades, rather than strict PPPs.

There is light, however, on the horizon. In December, the $36 million financing for the Baltic Container Terminal (BCT) expansion in Gdynia was finally syndicated. Bank Austria and Bank BPH acted as lead arrangers, and were joined at co-arranger level by DVB Bank with a final take of $16 million. Though small in size, it expected that a number of these deals will come on stream for more terminals on the Baltic – states bordering the Black Sea are also said to be looking closely at these types of projects.

Slovakia has also been slow to develop, mainly due to some of the negative experiences encountered by Hungary and the Czech Republic. Nevertheless, there is now talk of the government wanting to tender the D-1 highway project between Bratislava and Kosice. The estimated Eu1 billion project, which is expected to be launched at some point next year, may be divided in to three separate projects. However, certain political considerations that still obtain which will have to be resolved before bids can be submitted.

If Hungary continues with what has now become a successful PPP programme, other jurisdictions are sure to follow. But these states will have to overcome the protractions and setbacks, which have been the hallmark of deals in the region, in order to attract the right sort of funding.
In the first instance, however, western European banks and sponsors will continue to look to roads and only then other infrastructure. Though there are always the exceptions. "If you've got a well-regarded sponsor and if there is a clear need for the asset, provided the transaction is big enough it's not difficult to get these deals done," says Games.

It remains a question of scale: the more deals that are closed, the more likely investors will be attracted to region. In the meantime, roads will continue to be the sector of choice for those wanting to do PPPs. Andrews concurs, "If you want real PPP, then the most obvious sector at present is transport".