Faced with congested highways, deteriorating roads and ineffective water systems, the U.S. no longer can boast the best infrastructure in the world. In fact, according to the World Economic Forum, our overall infrastructure places 12th, with countries like Japan, Germany, the Netherlands and France ranking above the U.S.
Rated a D+ for its infrastructure by the American Society of Civil Engineers (ASCE) in 2017, the U.S. needs an estimated additional $2.1 trillion in investments by 2025
to meet its needs and reduce negative impacts on the economy. While the U.S. spends over $400 billion
annually on public infrastructure, chronic under-investment in infrastructure is estimated to cost the nation almost $4 trillion in GDP and a loss of 2.5 million jobs through 2025, according to the 2017 Infrastructure Report Card
Moreover, the Bipartisan Policy Center
estimates there is $2 trillion worth of infrastructure needs right now. The most pressing needs, according to the ASCE, are centered around the transit sector which faces a $90B rehabilitation backlog; roads and highways, 20% of which are now deemed to be in poor condition; electricity systems with aging assets that are ill equipped to accommodate future growth; and U.S. water ports which are struggling to accommodate increasing vessel sizes and keep up with expansion, modernization and repair of port assets.
Therefore, now that tax reform legislation has left the building, aging infrastructure and lack of investment in new and existing assets is a high priority item for the current Administration.
To begin to address this widespread infrastructure issue, two key challenges must be addressed: identifying how these projects will be funded and by whom. Many states don’t have the required funds to independently make these massive investments nor has it been politically palatable for the states to raise taxes to fund these projects. States are now in a position of trying to deal with a limited allocation of dollars which requires some hard choices on how they fund long overdue deferred maintenance and new projects for the 21st century. These financial funding constraints put states in a very difficult position of deciding in some variation of whether to cut services, increase prices or, but more revolutionary, create an environment of making private investment in public infrastructure assets more appealing. Although these public private partnerships conjure up intense emotions as various advocacy groups question how a state could sell some of its assets, history teaches us that a large part of the U.S. infrastructure was built by private enterprise in the earlier years of this country. Yes, it seems we are back to the future.
The Administration has targeted $200 billion in federal spending in 2018 for infrastructure needs, with the remaining $800 billion expected to be matched by state, local and private funding. An early outline of President Trump’s infrastructure proposal
suggests a plan that is weighted to rural improvements and calls for 10 selective states to receive $10 billion in grants for up to 20% of the cost of one or major projects. The plan would also aim to level the playing field for private investment by expanding private activity bonds and offering up some dollars for innovation as an incentive for states to explore public-private partnerships.
The amount of private equity allocated for infrastructure is expected to increase with estimates indicating that private equity groups intend to play a critical role in North American infrastructure investment. Firms like Blackstone
are aiming to target as much as $40B in infrastructure deals.
P3s hold previously untapped promise
Perhaps even more than private investment, a boom in public-private partnerships (P3s) is expected to play an important role in solving the infrastructure funding challenge. At a time when public spending is decreasing, public-private partnerships offer the opportunities for all parties to negotiate the allocation of risks between the public and private sectors, including leveraging the private sector’s access to multiple financing markets including equity funds, private placements and Private Activity Bonds (PABs).
As Lorraine White, Grant Thornton partner, Partnership Taxation, noted, “Public-private partnerships can be a possible boon for these projects. While $200 billion is already in the budget, the Administration knows more is needed so they will need to outline creative plans like these public-private partnerships to get the job done.”
Public Private Partnerships are well established in Europe, UK, Australia, Canada and South America. The forms they take vary widely based on the business needs of the state and/or municipality but generally speaking a private enterprise takes on the economic responsibility to operate, maintain and expand public infrastructure generally with the states participating in the economics. Though it is expected more opportunities will open up domestically — P3s have begun to catch on in the United States with certain states taking the lead like Texas, Florida, Virginia, Illinois, and Indiana to name a few — the global market offers the longer established partnerships with a number of foreign players interested in U.S. assets.
Barry Grandon, managing director in Grant Thornton’s Transaction Advisory Services (M&A Tax) Group, explained that “Infrastructure projects traditionally have been set up to provide fairly stable cash flows with low growth. While the U.S. capital markets have focused on growth-related assets, the European markets have gravitated towards these partnerships as an asset class because they’re trying to fulfill longer term obligations which include pension obligations. There’s got to be a fundamental mindset shift in order to make public-private partnerships successful in the U.S. which has a lot more to do with economics than tax.”
“There’s got to be a fundamental mindset shift in order to make public-private partnerships successful in the U.S.”
- Barry Grandon, managing director, Grant Thornton’s Transaction Advisory Services
He added, “If you’re trying to attract foreign money to help facilitate these projects, you’ve got to develop a pretty robust policy around infrastructure and change the tax laws.”
The role of states in the solution
On the agenda for the Trump administration is focusing on infrastructure projects and getting more of them funded by states. Of states’ funding options, some aren’t viable in the current tax reform and economic environment. Raising taxes is always a tough sell to taxpayers.
Selling freeways and other assets to an investor halfway across the world is politically unpopular, but so is having poor roads, bad traffic and crumbling bridges. States will take whatever money they are given by the federal government and then find ways to make up the rest.
David Meyer, a partner with Grant Thornton’s Partnership Taxation practice, agreed that public-private partnerships are beginning to catch on in the U.S. “If there’s money to do construction deals, the states are going to be scrambling and will gravitate toward these P3s. The states will likely jump on the money they can get from the federal government and try to set up structures where they can get these infrastructure projects done.”
An infrastructure call to action
With tax reform altering how infrastructure projects will be funded, construction companies have action items to consider in order to keep deals going. Companies will need to change how they do business and how they view domestic and global opportunities.
Three actions items top the list:
- Prepare for the P3 movement
One driver of change is the move to P3 projects, and construction companies would be well served to evaluate opportunities for partnerships, particularly for those projects which align to a discounted cash flow model.
- Revise bid models
Companies will also benefit from revamping existing bid models to reflect financing, funding and tax changes. With the massive changes brought by tax reform, the existing models are likely to be ineffective.
As Meyer explained, “This is the first major tax act we’ve had in 30 years so a lot of construction companies have gotten very comfortable with their bid models. The way they handle taxes is changing very quickly and they will need to rethink their bid models in ways they’ve probably not thought about before now.”
- Revisit the business structure
The business structure of construction companies may very well be in need of an overhaul. Especially for an S-corporation, an analysis of the advantages of reorganizing would be warranted. Grandon explained that “Financial planning and analysis modeling will play an increasingly critical role moving forward. Companies will need to value certain components and asset risks associated with infrastructure projects.”
While tax reform legislation is now a reality, a major infrastructure spending bill is still to come. There’ll be an urgent push by the states to get projects started and completed, and a lot will happen in a hurry. Ready your company now for the upswing.
Not sure where to start? Grant Thornton can help. Reach out to our professionals below.
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