Strategy & Operations » Leadership & Management » A private sector initiative.

The Private Finance Initiative, or PFI, which has been rebranded by the present government as the Public Private Partnership, is on a roll. Sceptics may keep warning that it will end in tears and a mountain of debt for the next generation, but nothing seems to dampen the enthusiasm of the participants. Not only are new projects coming onto the market all the time, but, at the moment, the appetite for them among private sector contractors and backers seems bottomless. Moreover, the concept is ready to take wing beyond the confines of the public sector, as PFI private-sector-to-private-sector deals seem increasingly feasible. In some senses, of course, private sector PFI is already a reality in the shape of outsourcing deals. That said, outsourcing agreements, whether their subjects are IT, vehicle fleets or anything else, have tended to be short-lived when compared to mainstream PFI deals of 25 to 30 years’ duration. Boards currently have enough difficulty predicting what is going to happen next year, so thinking 15 to 20 years beyond the present decade tends to strike the vast majority of companies, no matter how large they are, as wildly blue sky. Yet at the same time, many of those in the public sector who have considerable experience of PFI see no intrinsic reason why the underlying logic of PFI should not work just as well in a private-sector-to-private-sector context. John Matheson, finance director of the Edinburgh Health Trust, has just successfully concluded the Trust’s second PFI deal, for a 60 bed care of the elderly facility called Ellen’s Glenn. To be built on the site of the old Southfields hospital, the project follows on directly from the Trust’s innovative Ferryfields Hospital project. According to Matheson, the principle of “sticking to one’s knitting” (in the Trust’s case this is providing health care, not facilities management, cleaning and catering services) can be seen as something that both the private and the public sectors have in common. “I would have thought that this was absolutely a vehicle for private-to-private partnerships as well as for the usual public/private alliances. Look at British Airways, for example,” Matheson points out, “it no longer feels it to be necessary for it to own its own aircraft.” In Matheson’s judgement, and that of just about everyone who has anything to do with PFI, the crucial element in a PFI-style deal is the emphasis on risk sharing. “It does not matter whether you come at this from the standpoint of a private-to-private deal, or a public-to-private deal, you can’t look to transfer 100% of the risk or the deal will end up unviable,” he warns. But when such deals are properly thought through, and the service element and risk apportionment have been balanced, PFI makes sense from everyone’s perspective, Matheson claims. Following a recent merger between Edinburgh Health Trust and the East Lothian Trust, and with two PFI deals already concluded, he can see another half a dozen projects that would be appropriate for PFI. Tony Randle, the partner in charge of the legal firm Dibb Lupton Allsop’s PFI unit, agrees with Matheson. “We absolutely do see a direct parallel between outsourcing in the private sector and PFI deals. The aim in both has been to develop a set of contractual procedures and operating techniques that will free a management team to concentrate on its chosen core business, while still benefiting from the efficiencies of external specialist operators,” he argues. “One might anticipate, for example, a deal in the retail industry that could rival the scale of public sector PFI deals,” he speculates. Randle points out that there is no intrinsic reason why any of the major food retail chains, to take them as an instance, should be in the business of owning and maintaining store floor space. Their core business, it would seem, is food retailing and customer relationship management. A deal that saw one of the major retailers selling and leasing back, with a service element, of all its stores, would rival anything in the public sector. As yet, of course, this is mere fantasy. But already word has it that some companies are looking at more innovative, PFI-like approaches to office space. ICL broke considerable ground on this front recently by seeking a PFI deal for all 130 of its UK properties. That deal, originally negotiated with Nomura, fell through, but according to ICL director of commercial operations, Richard Reed, who heads up ICL’s PFI initiative, some 17 other bidders have since come forward and it could yet come to fruition. Reed explains that the initiative started in January 1998, when ICL chief executive Keith Todd introduced his “New World” policy. This envisaged a totally new working environment, with standardised open plan office accommodation and standardised desks. It also mandated a “New World” image for the company’s buildings, rather like that in place in the latest glass and steel business park campus approach. “Much of our property portfolio in the UK was unsuited to the kind of technological infrastructure required by today’s PC-based working. Some of it could be upgraded to meet our specifications, much of it could not. Our plan was to move to four major campuses, consisting of perhaps three or four 40,000 square foot buildings, using an ICL village approach. Plus there would be satellite offices as required around the UK. The plan set a four-year time-frame for fully implementing the move out of our present premises and into a modern environment consonant with our New World conception,” he explains. In order for a PFI-style deal to be worth considering, it would have to meet certain specific criteria laid down by ICL. The first consideration is that any PFI supplier would have to enable ICL to shorten the planned move cycle from four to three years. Second, the deal would have to be structured in such a way as to enable ICL to realise certain balance sheet advantages. Lastly, it should directly save ICL money. “Our aim was to outsource our entire property portfolio and for the supplier to provide us, in return, with a fully serviced set of properties, of the kind that met our specifications, for a unitary charge on a monthly or quarterly basis,” Reed says of the plan. What made the deal difficult for prospective suppliers, was that just 1% of ICL’s properties are freehold. All the rest are leasehold, with a broad spectrum of termination dates. The idea would be for the supplier to take on board all the risks associated with managing this property portfolio and then carry out the new build for ICL on a serviced lease basis. The potential value of the deal, according to Reed, is somewhere around the £900m mark, and ICL would like to structure the whole thing as a 10 year contract. Reed is not certain that the right deal can be struck. However, as he points out, ICL has already thoroughly explored the alternative, which would be to manage the process of extricating itself from all its leasehold obligations across all its properties, and then contract with various construction companies to build new properties. “Since we can see our way through managing this whole process ourselves, although property is not our game, it seems to us that a company that specialises in property management should be able to do the whole thing significantly better. This seems to me to indicate that there should be scope for this kind of contract,” he says. John Watt, director at Arthur Andersen’s corporate finance team, is less convinced that PFI-like contracts can migrate successfully from public to private sector. The obvious candidates, he admits, are companies such as ICL or even British Gas, which have significant property holdings in office space. The model there, he suggests, is the well publicised Prime contract, under which the DSS has put a huge property portfolio under PFI. The private sector, he says, is taking note of the pack in which government is leading the way in finding ways of using its assets more creatively under the Wider Markets Initiative. He, too, points out that everything comes down to how the risk/reward relationships are structured in each deal. Government and local government have had some sharp lessons to learn about risk apportionment, and private sector companies will have to learn the same lessons, he suggests. “Originally in government there was a great deal of talk about risk transfer,” he says, “with departments being encouraged to pass everything across to the private sector. What they found when they tried this was that the cost involved in the contracts went through the roof. Now it is all about government retaining certain risks that it is better placed to manage. What this would mean in private-to-private deals is still very unclear.” Rather than PFI moving into the private sector, Watt sees an ever-increasing role for it across both mid-range and large government projects. “One trend we are definitely seeing is that where consortia were the norm, with construction companies getting into long-term partnerships with facilities management companies, we are now seeing the large construction companies looking to capture more of the ‘soft services’ revenue streams for themselves, by growing their own FM companies,” he says. Andrew Bond, communications director at construction management specialist Bovis, agrees. “We definitely see added-value areas of business such as facilities management as offering real opportunities for growth for us,” he says. Bovis, he points out, already has modest-sized FM operations to support its PFI and private sector construction businesses in the UK and Australia. And the company is now looking to expand these operations. “Right now, there is a real enthusiasm among financial backers for government and local government PFI deals. As the market matures, everyone gets a better understanding of what the risk factors associated with these projects are, and of the partnering arrangements they entail,” he says. Moreover, the market for PFI is expanding, he says. Quite apart from the largely untried and untested appetite of private sector companies for PFI deals, Bond sees very significant opportunities for international PFI projects. “We were doing Build Operate Transfer deals in Malaysia in the early part of this decade, before PFI was formalised here,” he notes. “Australia calls these deals BOOT contracts, short for Build, Own, Operate Transfer. PFI has provided new opportunities for construction companies at better margins than the traditional construction market. It is also attractive since it gives us the security of income over a 30-year project that is just not there on a short term building project, no matter how large that project may be.” Anthony Read, the partner in charge of PFI contracts at Edinburgh law firm Burness, says that while there is plenty of money around to back public sector PFI deals of all kinds, he doubts that there is any impetus for private sector deals along similar lines. “There is no incentive other than a ‘sticking to the knitting’ philosophy, because private sector companies are free to raise capital to finance whatever ventures they want to get involved with. Nothing we are doing or that we see in Scotland, which has led the way in PFI work in the UK, reflects any enthusiasm for private sector PFI,” he says. “By contrast, public-private partnerships are on an absolute roll right now.” And that enthusiasm shows no sign of waning.