Germany has traditionally been wary of involving the private sector in large concessions of public sector assets but a €7 billion military IT concession could signal a changing attitude.

Daniel Schmachtenberg and Kai Krueger of Ashurst's Frankfurt office report on Project Herkules another multi-billion hi-tech concession which shows the best and worst of the relationship between the German public and private sectors.

After its final political approval on Wednesday, signing is now shortly expected for Herkules, one of Germany's most important Public Private Partnership (PPP) projects in the IT sector and the hope of the German IT-industry.

The €7-7.5 billion project comprises the outsourcing of non-military IT technology of the German Federal Armed Forces (Bundeswehr) and includes more than 140,000 workstations, 300,000 fixed-line networks and 15,000 mobiles.

At present, most of Bundeswehr's IT systems are rather antiquated and de-centrally organised.

The strong need for a modernised, centralised IT system for one of Europe's largest military forces requires a top-to-bottom modernisation of large parts of the Bundeswehr IT infrastructure.

Long dry spell of Germany's prime IT PPP in the defence sector

The road to signing has been long and difficult. Since 1997, the German MoD was thinking about modernising the decentralised Bundeswehr IT services and the replacement of its antediluvian equipment.

A European tender was launched in summer 2001 to which two consortiums made a bid. ISIC21, a joint venture of CSC, Mobilcom and EADS was chosen as the preferred bidder in 2003, but negotiations collapsed over financial issues.

After this unexpected deadlock, TIS (a consortium of T-Systems, IBM and Siemens Business Systems) gave the project a new push until, in February 2005, Deutsche Telekom withdrew, when facing substantial problems with its participation in Toll Collect, Germany's motorway toll-charging company.

The other consortium members, IBM, Siemens Business Systems, finally decided to move on but it was only this week that final approval was granted by the German Parliament's (Bundestag) budget committee.

At the end of November it had still rejected the drafts and required certain amendments to ensure a higher influence by the state and the reasonable economic participation of smaller companies to support the middle sized businesses (the German Mittelstand).

Now - finally - contracts are about to be executed.

A special purpose IT company (SPV) co-owned by

• the State (49.9%)
• Siemens Business Systems (50.05%)
• IBM (0.05%)

shall enter into a concession for the period of ten years.

Sixty per cent of the overall commercial volume is said to be handled by Siemens and the remainder by IBM, with the Bundeswehr providing approximately 2,400 experts for the realisation of the project.

Immediately after the approval, there were rumours which companies might be best positioned as hardware providers.

In the course of such development. the overall project volume increased from €6.5 billion to more than €7 billion.

Critics, including the German Federal Court of Auditors, claim that realisation of the project would not only have been about €1 billion cheaper but also much quicker, if it had not been realised by way of PPP.

Supporters argue, however, that some encryption and intranet systems were subsequently added and that the increase of German VAT tax (a refund system in relation to PPP is heavily discussed but has yet to be put in place in Germany) from 16 to 19% as of 2007 need to be taken into account.

PPP in Germany - Rome wasn't built in a day

Further difficulties can be expected in the course of the actual realisation of Herkules, which has yet to start. Indeed, one cannot help but notice that certain large-scale prestige PPP/privatisation projects in Germany including Toll Collect, German ATC, Deutsche Bahn and even the A-models all proceeded less smoothly than expected, were delayed and subject to intense political discussion.

In particular, where aspects of sovereign power are tangent, players in the young but growing German PPP and privatisation market are required to take a rather careful approach.

This sometimes causes astonishment among foreign sponsors and funders with experience in other European PPP markets.

It is fair to say that the German PPP and privatisation market still lags behind UK and other European jurisdictions. In relation to IT outsourcing, only about 22 per cent of the German public sector's expenditure in relation to IT services is currently on PPP or outsourcing, whereas in Great Britain it is already more than 50 per cent.

But in contrast to more mature markets the outsourcing of large scale IT infrastructure - including services and equipment - in Germany, is only at its beginning and a large volume of new business opportunities can be expected if the Herkules pilot IT project turns out to be a success.

Remaining prejudices against PPP and private investments in public infrastructure are likely to erode when the public, politicians and private players get more used to this new concept.

Needless to say, the need for public investment and lack of funds available for public authorities are strong driving forces in Europe's largest economy, supported by the strong will of many market participants.

Therefore the IT sector, as well as the entire German PPP market, is very likely to grow and accelerate in speed. A single swallow doth not the summer make but the going forward of Herkules is a step in the right direction and finally: All's well that ends well.

Daniel Schmachtenberg is senior associate and Kai Krueger trainee in Ashurst Frankfurt's Project Finance Group.