16
infrastructure
investor
may
2014
RISK
Some experiments look under control at
the outset, but end up going badly wrong.
In 1998, when UK developer John
Laing and outsourcing firmSercoGroup
were awarded a £130 million (€157 mil-
lion; $216 million) Private Finance Initia-
tive (PFI) project to build and manage
new headquarters for the National Physi-
cal Laboratory – a cutting-edge facility to
measure time, length andmass – it didn’t
look as if they were out of their depth.
Yet six years later the cash-strapped
joint venture had abandoned the con-
tract, the project was already three years
late, and its backers had altogether lost a
combined £100 million. The main cause
of headaches: the contractors’ failure to
comply with specifications needed for
scientists to carry out their work, including
temperatures controlled within a margin
of plus or minus 0.1 degrees centigrade.
That this episode is still being dis-
cussed a decade later shows how aware
market players remain of the pitfalls asso-
ciatedwith a project’s construction phase.
But equally telling is the fact that, when
asked to recall other construction fiascos,
it takes a while to think of more recent
examples.
“Instances of infrastructure projects not
being built, and where construction com-
pletely failed, remain fewand far between,”
saysMarkWoodhams, a partner andhead
of business development at UK fundman-
ager InfraRed Capital Partners.
A contradiction seemingly arises when
looking at investors’ attitudes to construc-
tion risk. Michael Wilkins, a managing
director at Standard & Poor’s, recalls
prompting the audience at a recent semi-
nar to raise their hands if they thought
construction risk represented the biggest
risk in project finance. Nobody did.
But privately many voice a different
opinion. “Of all the risks, the key one
requiring the most focus, particularly in
greenfield, is construction and its associ-
ated risks,” says Gershon Cohen, director
of infrastructure at UKassetmanager Scot-
tish Widows Investment Partnership.
MULTIPLE FACETS
Part of this apparent contradiction lies in
the ambiguity surrounding the notion of
construction risk.
At its heart, it seems very easy todefine.
“Construction risk is the risk of building
a cash-generating asset on time and on
budget,” says Wilkins. “In many cases, in
the absence of external sources of funds,
until that asset is built you’re not going to
receive the cash flows you need to repay
the debt to lenders and the equity invest-
ment to equity providers.”
Delays and cost overruns can ensue
from a variety of different events. One
potential pitfall is the technical complex-
ity of the project – from its structure
and technological content to ground
conditions and contamination risks. A
straightforward road project, for exam-
ple, becomes much trickier to complete
if it involves digging tunnels through
mountains.
Logistics also have to be carefully
thought through, particularly when
undertaking construction work in com-
plex, urban environments. Woodhams
recalls the example of London tube
upgrades, which can only be carried out
overnight, or hospital extensions, where
new facilities are often being built while
existing ones keep functioning.
In practice these “inherent” con-
struction risks are rarely a reason for a
project to default, says Tim Conduit, a
partner at Allen & Overy. “Construction
risk, in reality, is all about the strength of
your counterparty. Projects tend to fail
Construction risk remains front of mind for many institutional investors.
Matthieu Favas
finds out why they are getting increasingly comfortable with it
How to build confidence
Heathrow Terminal 2
: no lack of market appetite
c o n s t r u c t i o n
