The
M1/M15 Project is an ideal case study project as it shows how a major infrastructure
project can be successfully implemented on a project finance basis, but
also demonstrates that the combination of a major structuring fault and
lack of political support can reverse the fortunes of a project very quickly.
When in 1989
Hungary opened its borders to the west, it required a good motorway
link with Austria and thus the completion of the M1 Motorway between
Budapest and the Austrian border became a high priority. Given Hungary's
high state debt, a number of studies were undertaken in order to analyze
whether a private concession structure would be a viable solution. The
results both indicated that the M1 project could be developed as a 100%
private finance solution and that there would be sufficient interest
to create a competitive international tender. As a result, the Hungarian
Government decided in 1991 to introduce extensive legislation for constructing
toll motorways by way of concessions, to create a specific office within
the Ministry of Transport to deal with concessions and to launch an
ambitious program of motorway construction, starting with the missing
section of the M1 motorway.
By the end
of 1991, financial and legal advisors to the Ministry were appointed
and a pre-qualification procedure was started leading to four international
groups being invited to submit bids (August 1992). Of those four, two
groups were invited to negotiate in parallel the concession contract
and the results thereof were formalized in the submission of improved
bids (January 1993). On the basis of these bids (taking into account
the construction price, the toll rate and the proposed financing package
including the commitment to provide equity), one group was nominated
as preferred bidder and negotiations were concluded in April 1993 with
the signing of the concession contract.
Risk
allocation & funding
The draft concession
contract prepared by the Ministry's advisors offered a good basis for negotiating
a viable concession with a proper allocation of risks. As the construction
of the remaining sections of the M1 did not pose specific problems (no
big structures required, flat land with little ground risk, no particular
archaeological risk, no specific environmental issues), the contractor
was able to broadly accept these risks and offer a turnkey, lump sum and
fixed price for the construction works.
The acceptance
by the private sector of the full traffic risk was driven by a combination
of tender requirements (the Ministry did not want to accept any traffic
risk), competition (showing low projections would mean losing the tender)
and the relatively high traffic flows indicated by the various studies.
The private sector agreed to accept this traffic risk provided that
it would be "free" to set the toll rate, which was translated into fixing
the initial maximum toll rate within the concession contract and allowing
for increases in this rate on the basis of a particular formula that
took into account Hungarian inflation and the devaluation of the exchange
rate between the Hungarian Forint and the currencies in which the project
would be financed. The initial toll rate was determined on the basis
of the revenue maximization principle.
As the traffic
projections indicated high growth during the early years of operation,
the development of a viable financing structure depended on finding the
right combination of an equity/debt structure and loan maturity, whilst
achieving acceptable annual and loan life coverage ratios. Moreover as
the revenue would be in Hungarian Forints, funding in Forints would reduce
foreign exchange risks. Given the financial market for and in Hungary at
the time, these goals were very ambitious. Nevertheless, the participation
of the EBRD in the financing made it possible to raise foreign financing
with a loan maturity of over 14 years (a first in modern Hungary) and to
raise a significant amount in local financing with a similar loan maturity.
The EBRD, created
in 1991 to promote private sector investment in the former Warsaw Pact
countries, played a crucial role in getting the necessary finance raised
as it provided the lenders, but also the investors, with the necessary
reassurance that the Hungarian Government would not turn against the project
once the construction works had been completed and the project would benefit
from a significant cash flow to repay its debt and provide the investors
with an adequate return. Although the cost of bringing in EBRD in financial
terms was significant, without it, it would not have been possible to reach
financial close 6 months after the signing of the concession contract.
Further
developments
Having initiated
the M1/M15 project successfully, the Ministry started tenders for other
motorway projects in Hungary: M5, M3 and M7. Unfortunately, studies
showed that none of these projects could be financed 100% by the private
sector (mostly due to the lack of foreign users). Notwithstanding this
strong and obvious requirement for Government participation, the Ministry
had difficulties in accepting this need. Consequently, reaching financial
close on the M5 project took much longer and the tender offers for both
the M3 and M7 projects were never fully analyzed. This resistance to
find proper PPP solutions for the M3 and M7 projects partly originated
from the internal organization of the Ministry and the opposition of
civil servants to a transfer of traditional public sector activities
to the private sector.
This opposition
to private concessions gathered in strength following the opening of
the M1 in 1996 when it became clear that all traffic projections prepared
by the Ministry, the investors and the lenders were far too optimistic
(traffic in 1996 was only approximately half of that forecast on which
the financing was based). Moreover the toll rate that appeared the highest
in Europe per km traveled, led to the accusation that the concessionaire
was abusing its dominant position at the expense of the Hungarian users
and resulted in a court case against the Concessionaire.
Within this
changing environment, the Ministry "refused to take sides" arguing that
the project it had so vigorously promoted was a private undertaking
which needed to be resolved privately. In December 1996, the EBRD as
security agent, realizing that the financial case for this project as
a private venture did not exist anymore, declared a potential event
of default and the construction works on the M15. It expected that the
concession contract would provide sufficient grounds to threaten the
termination of the contract and thus force all parties to the table
and renegotiate the deal. However it became clear that only under strong
pressure would the Ministry eventually agree to support the project
for an interim period by issuing a letter of credit (the investors also
provided a letter of credit) in July 1997. Albeit all intentions, the
negotiations with the Ministry never really took off prior to the national
elections in 1998.
The unexpected
victory of the opposition, which opposed tolls and other PPP solutions,
the adverse decisions of the courts and the realization within the EBRD
that the concession contract did not provide any protection in an environment
where the Government opposes PPP solutions, resulted in the EBRD negotiating
a deal with the Ministry for taking on the larger part of the debt through
substitution for the Concessionaire. Given the various other interests
of the main shareholders (outstanding debt as a result of drawing the
letter of credit, outstanding construction payments, ongoing operating
& maintenance activities), the investors were forced to agree to
this substitution (which could otherwise not have been implemented under
Hungarian law) and to the transfer of the concession to a special purpose
public sector vehicle.
Conclusion
& comments
Whereas the
Ministry claimed victory: it brought this vital piece of infrastructure
back into Hungarian hands whilst accepting only a part of the debt at
very favorable conditions and could now reduce the toll rates (even
replace them with a vignette), it remains doubtful whether this was
the best solution for Hungary. Certainly, tolls were reduced (and abolished),
but this meant that significant income from foreign sources fell away.
Yes, the road was now publicly owned again, but to take on the M1 debt
meant that the motorway construction budget for at least one year was
completely exhausted. Yes, Hungary had taken its future into its own
hands, but international funding sources dried up (even private funding
of the extension of the publicly and EBRD supported M5 motorway has
become near to impossible). Of the ambitious motorway program outlined
in 1991, only parts were realized by the end of the century and the
early completion of other parts remains doubtful.
The M1/M15
experience shows that even initially successful projects can quickly come
up against disaster. It is true to say that the traffic projections were
the source of all problems. However, the fact that the public sector did
not wish to step in and find a viable PPP solution together with the private
sector caused possibly more harm than good to the Hungarian state and tax
payer. Compared with the M3 project that was implemented as a public concession,
the risk transfer undertaken on the M1 project created significant benefits
to the Hungarian tax payer as:
 |
the construction
was completed on time and within budget, |
|
its operation
and maintenance during the short period thereafter were effective and of
the highest standard, and |
|
during the
critical economic period following its opening to the west, Hungary benefited
from the M1 whilst not contributing to its financing. |
