The Chapman's Peak Drive financing, which closed in August, looks like providing the latest template for the south African PPP market. It utilises support mechanisms aimed at sharing the risks between the public and private sector in a manner that has made the project attractive to investors and lenders. Aside from providing a template, the closing of this deal has also marked a series of firsts for South Africa - it is the first limited recourse finance deal to close under the procedural framework of the PPP Unit, the first PPP provincial toll road to close and the first PPP to close in the Western Cape province.

Chapman's Peak is a 10km stretch of road on the Atlantic seaboard linking Hout Bay and Noordhoek. The genesis for the deal lies in a number of accidents on the road that made the government aware of the need for both repair and active management of the stretch. The decision to bring in the private sector was made in late 2000 after government realised that it would not be able to undertake the project within its budget. In May 2002 the Entabeni ('on the mountain') consortium was announced preferred bidder to design, rehabilitate, finance, operate and maintain the road for a 30-year period.

The consortium, led by construction group, Concor, comprised Haw & Inglis and empowerment groups Thebe Tourism Group and Marib Holdings. However, just before close, Thebe exited because it could not meet its equity commitments. Close went ahead nonetheless, although the Western Cape government, not wanting empowerment ownership levels affected as a result, has given Entabeni an 18-month period to find a suitable replacement empowerment partner, failing which penalties will be imposed.

The SPV will be responsible for the construction of 1.5km of rock-fall catch fences, two concrete canopies, a 155m half tunnel and two toll booths. This is the first time that rock catch fencing technology and half tunnelling will be used in South Africa. Systems to monitor rock-fall activity and weather conditions also being installed. The technical solution adopted was not the cheapest alternative but government selected it for the high level of safety it provided and for its aesthetic appeal. The base case revenue line could not support this technical solution on a stand-alone basis and therefore government had to provide a grant. The private sector is taking full responsibility for safety within agreed specifications and government has agreed to take the risk of certain freak incidents that may occur outside of these set specifications as affordable disaster cover was not available.

Rand Merchant Bank is arranging R69.1 million ($9.8 million) in financing for the R155 million project, R16.5 million is being made available as equity and the government is providing a R70 million grant. RMB is providing a twenty-year CPI-linked loan, which has been structured to meet the cash flows of the project. The NPV benefit to government is an estimated R450 million in the form of capital works and operations.

Close was expected by the end of last year but a number of issues arose that delayed closure to August 5 this year. The tax treatment of the government grant resulted in much confusion and nearly caused the deal's collapse. There is currently no legislation in South Africa governing how such a government grant is taxed and debate arose as to whether the grant be treated as capital, which is tax-free, or as income, which is taxable. The decision taken was that the grant be taxed as it is essentially risk money and therefore cannot be classed as capital. Lenders and borrowers declared that the project would not be bankable if the grant was taxed in the hands of the project. The solution adopted was for government to make its contribution upfront for the early works contract - the design and reconstruction of the road. This contract was signed by government and contractors outside of the concession agreement and the grant was thereby taxed appropriately, but not in the hands of the project. However the concessionaire still takes on associated risks of the early works contract once it is handed over. "Finding a means to deal with the taxation on the government grant was an important lesson taken from this project and one that can be taken forward for future projects," points out Trevor Williams, director at Ignis, financial advisors for the Western Cape government on this project. According to Brigette Baillie, at Webber Wentzel Bowens, legal advisor to both borrower and lender, government is in the process of developing legislation on the taxation of government grants, which should come into effect by the end of the year.

Revenue to support the project is to come from toll payments. However, traffic levels are greatly affected by tourism. It is estimated that core commuters using the road account for about 50% of the 4,000 average daily vehicles but traffic levels are expected to rise between 10,000 and 12,000 vehicles a day during the December holidays as a result of tourists. "As tourism levels are variable and outside the control of the concessionaire, government undertook to take on some risk in this regard. It has agreed to provide interest-bearing subordinated funding in the event that coverage ratios fall below one as a result of traffic shortfall. If ratios improve and are greater than one then government will expect repayment before shareholders do," explains Williams. There were environmental issues that had not been finalised at the time of closing but these will not have any impact on construction although they may affect the commencement of tolling within the road reserve. In the event of this, government has agreed to pay for any revenue lost as a result.

Although this deal is by no means large, the groundwork it has laid for some sizeable PPPs in the pipeline is notable, especially for those that will require some kind of government grant.

Chapman's Peak Drive

Status: Closed 5 August 2003

Description: Concession to design, rehabilitate, finance, operate and maintain Chapman's Peak Drive

Concession period: 30 years

Concession awarder:

Western Cape provincial government

Sponsors: Entabeni (comprising Concor, Haw & Inglis and Marib Holdings)

Bank debt: R69.1 million

Arranger: Rand Merchant Bank

Lead & Financial advisor to government: Ignis Project & Finance Solutions

Legal advisor to government:

Hofmeyr, Herbstein & Gihwala

Legal advisor to lender and borrower: Weber Wentzel Bowens

Tolling advisor to government: Intertoll

Technical advisor to borrower and lender: Electrawatt

Traffic advisors to the government: Jeffares & Green

Traffic advisors to the lender and borrower: Stewart Scott