New model for P3s – SH 183
On November 20 2014, the Texas Department of Transportation (TxDOT) successfully closed its innovative US$847.6m public-private partnership (PPP) for the Texas SH 183 managed lanes project with SouthGate Mobility Partners LLC (SouthGate), a Kiewit-led team, that brings to fruition a hybrid gap finance/DBOM (design-build-operations-maintenance) model unique to the US PPP market. By Joseph Seliga, partner, and Stephanie Wagner, associate, Mayer Brown, who advised TxDOT.
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The project, also known as the Midtown Express Project, is located near the centre of the Dallas/Fort Worth Metroplex in North Texas. SH 183 serves as one of the main routes connecting downtown Dallas with downtown Fort Worth and provides both cities with access to the southern entrance of the Dallas Fort Worth International Airport. The highly congested stretch of SH 183 flanking the Dallas/Fort Worth area supports about 170,000 vehicles daily. The project will increase capacity and reconstruct an approximately 14-mile section of SH 183 and portions of SH 114 and Loop 12 in Dallas and Tarrant Counties, with the addition of one managed toll lane in each direction.
SouthGate will design and construct the project for a fixed-price lump sum of US$847.6m, of which US$247.6m will be paid as deferred construction payments that SouthGate must finance during the construction period. SouthGate will also operate and maintain a portion of the project for 25 years after completion. This deal is a first of its kind for TxDOT and for the US PPP market. No procurement process has previously packaged all of the elements of a project in a single PPP deal structure.
Unique PPP structure smooths Texas highway project
Beginning in 2012, TxDOT sought out a private partner to construct an expansion and revitalisation of SH 183. During the procurement process, TxDOT hoped to maximise the value it received through a competitive bidding process. However, after soliciting bids through a traditional toll concession model – in which the private partner would recoup its costs and secure long-term financing for the project through revenue collected from tolls on new managed lanes – it received only a single bid.
Unsatisfied with this lack of competition, TxDOT and its project team considered alternative procurement models. Upon further analysis and after consultation with industry and other stakeholders, TxDOT settled on a never-before-used structure, under which:
* TxDOT would retain all the toll revenues from the project;
* Private partners would be required to submit their construction bids based on a “scope ladder” approach, in which bidders would be incentivised to develop the biggest project for the available funds – under this approach, bidders could offer to complete the required SH 183 base scope and up to four additional components for a bid price not to exceed the US$850m available for the project;
* The initial construction costs of the project would be funded with US$600m in progress payments by TxDOT and the developer would be required to finance the remaining up to US$250m of construction costs during the construction period, with such amounts to be paid by TxDOT in up to five annual instalments beginning on the first anniversary of the date scheduled for substantial completion; and
* The private partner would agree to operate and maintain a portion of the project for 25 years and satisfy certain hand-back requirements at the end of the term and provide performance security for the operations and maintenance work.
Four teams responded to the RFQ for the project in July 2013 and all four teams were shortlisted in August 2013. Shortly thereafter an industry review draft of the RFP, including the draft comprehensive development agreement, was released to the shortlisted proposers, introducing the initial terms of this innovative structure. After a short industry review period, the final RFP was released publicly in early November 2013. This innovative structure generated three competitive proposals that were submitted in April 2014, in time to meet TxDOT’s aggressive procurement schedule.
In its winning proposal, SouthGate committed to completing all four additional components for a construction price of US$847.6m. SouthGate also provided for competitive pricing for the 25-year operations and maintenance period (O&M period). Based on a best-value determination, the project was conditionally awarded to SouthGate by the Texas Transportation Commission in May 2014. Other team members include Plenary Group, Austin Bridge & Road, Parsons Transportation, and Infrastructure Corp of America. Construction is expected to begin in early 2015 with substantial completion scheduled for the second quarter of 2018.
This unique hybrid gap finance/DBOM model delivered design-build and life-cycle cost benefits and utilised an efficient receivables financing structure to facilitate the transfer of gap financing risk to the private developer. No road construction project had previously packaged all of the elements of the TxDOT SH 183 transaction in this type of deal structure.
The standard approach would have resulted in a design/build deal for construction of the road without any finance or operation and maintenance responsibilities, or a design-build-finance-operate-maintain toll concession approach, financed by the private developer through toll revenues (as initially considered by TxDOT), or the long-term obligation of the public entity to make payments to the private developer for the developer’s performance and project costs, including its long-term financing costs.
The ultimate SH 183 structure is not dependent on toll revenues and does not involve long-term payments to the private developer for its construction and financing costs. It instead relies on progress payments provided by TxDOT and short-term construction financing provided by the private sector during the construction period.
Under the agreement, progress payments are payable pursuant to the maximum payment schedule, which provides that only US$600m of the total US$847.6m will be available to SouthGate by month 25 after issuance of NTP 1. Starting in month 26, SouthGate may satisfactorily perform work that entitles it to payment amounts in excess of the amounts then allowed under the payment schedule.
When one of these deferred payments has been earned by SouthGate, TxDOT will issue a certificate setting forth the amount earned and the payment date based on the maximum payment schedule. Once certified, such amounts are no longer subject to set-off or deduction. The remaining US$247.6m will be available in five annual payments beginning on the first anniversary of the scheduled substantial completion date for the project (the first four payments for US$50m and the fifth payment for US$47.6m).
To facilitate a receivables-style financing of these costs, SouthGate has been granted the right under the agreement to sell or assign its rights, title and interests in and to payment of the certified deferred payments to any person from whom SouthGate obtains financing to complete the initial design and construction work or has committed to purchase the deferred payment certificate to provide funds for such work. Proposers were not obligated to provide committed financing at bid submission; however, SouthGate is obligated to finance the deferred construction payments either on-balance sheet or through a third-party in accordance with the agreement.
TxDOT will make separate payments to SouthGate for the routine and life-cycle maintenance (including hand-back requirements) of a portion of the project over the 25-year O&M period. These operations and maintenance payments are subject to offset for liquidated damages incurred by SouthGate for failures to comply with its operations and maintenance obligations.
Given the payment and short-term financing structure for the project, there is no equity investment to provide an O&M period performance buffer as typically is seen on other types of PPPs. To replace this equity buffer, the developer must provide a security package to TxDOT worth US$100m through an approved combination of a parent guaranty, an irrevocable letter of credit or payment and performance bonds as security for satisfaction of the developer’s obligations during the O&M period.
This innovative structure includes not only design and build responsibility, but also short-term gap construction financing and long-term operation and maintenance responsibility, all in a single agreement.
Finally, as described above, the SH 183 bid process was novel by inviting private partners to compete on a “scope ladder” for the construction of additional project components within the available public funds amount, which expanded the footprint of the project beyond its base scope.
For purposes of proposal evaluation, a bidder’s proposal was first ranked by the number of additional scope components included in its base bid (with more components being higher ranked) for a price not exceeding the US$850m limit. Then the price proposal and total proposal score (combining the technical score and the price score) were evaluated only against other bidders (if any) that bid the same amount of project scope (ie, with the same ranking).
The bidder with the lowest adjusted bid price in a ranking category (ie, among other proposers with the same amount of project scope) would receive the highest price score for that ranking and the bidder with the highest total proposal score in the highest ranking (ie, with the largest project scope) would be considered the best value proposer. Further, if only a single bidder were able to provide the largest amount of project scope within the US$850m limit (as was the case on SH 183), then this single bidder would be considered the best value proposer.
Under this bid model, SouthGate was able to win the procurement by submitting a proposal that included the maximum scope (the required base scope plus all four additional components) for a total design and construction price of US$847.6m, while the other two proposals included only two additional scope components. This is one of the first US PPPs to utilise the scope ladder approach. This structure incentivised technical innovation and competitive pricing, which ultimately delivered maximum value while shifting the risks associated with those additional components onto the private partner.
TxDOT has already met a number of project success benchmarks: encouraging competition for the SH 183 procurement, keeping significant risk in the private sector, maximising the project scope within available public funds and maintaining an aggressive project schedule with an on-time procurement and 3-1/2-year construction completion schedule.
Looking beyond the SH 183 project, it quickly became apparent that this hybrid gap finance/DBOM (design-build-operations-maintenance) model offers an attractive alternative transaction structure for future TxDOT procurements, as well as future public-private partnership projects beyond road construction in Texas and other states. Now a reality, the SH 183 transaction structure is a truly innovative and game-changing solution with a wide range of applications for future public-private partnerships.