The world needs more infrastructure than governments can deliver. Long-term projections call for an estimated $57 trillion globally to build new and refurbish existing infrastructure between 2013 and 2030, an amount that governments at any level are unlikely to fund. Yet private investors and companies too frequently fail to fill the gap—even when their coffers are full. As a result, we’ve seen specific projects not getting done—including efforts to privatize an interstate highway in the United States, build an airport in Southern Europe, develop a hospital in Scandinavia, and fund airport services in South America.
There are many reasons why such projects falter, but these four shared at least one: they all failed to attract suitable private-sector investors. Why? As we’ve heard from clients and learned from companies’ informal decline-to-bid remarks, the returns from such projects are often too low relative to their cost of capital.
But if the assumptions about those projects’ cost of capital are wrong, valuable deals may be abandoned at the drawing board for the wrong reasons. We often find this to be the case. Government managers at all levels often assume their own cost of capital to be much lower than that of the private sector, effectively lowering a project’s expected returns. For example, if a bridge project is designed using assumptions of low government costs of capital, the toll on a bridge might only need to be $1—whereas private investors might need the toll to be $2 to cover their cost of capital—even when taking into account greater operating efficiencies that would lower private-sector costs.
The result is that many projects are never started. In fact, as long as returns from government infrastructure projects are structured around assumptions of a government’s cost of capital, a lot of engineering and construction firms (and their capital partners in bidding consortia) tell us they just won’t bid on them. It’s also often one of the reasons stand-alone private-equity funds that invest in infrastructure don’t invest in classic public–private partnerships.
A more thorough evaluation of the economics—especially around assumptions about lower government cost of capital—could move more infrastructure deals forward. With regard to both debt and equity, such assumptions are often misplaced—and often overlook the potential savings that private companies might offer to the often overstretched public purse.