Public-private partnerships can unlock hospitals’ hidden value, especially in challenging times
Tom Mulvihill:
Hello and welcome on behalf of KeyBanc Capital Markets, Cain Brothers, NORESCO, Squire Patton Boggs and Diogenes Capital, we're very happy to be here with you today for this webinar on innovative partnership solutions to accelerate development, transfer risks and incentivize innovation. Partnerships with the private sector can take any number of forms and be structured to meet your organization's goals and objectives. Whether you're looking to build new facilities such as essential utility plant or cancer treatment facility or monetize underutilized assets such as utilities or parking systems, partnerships can help to accelerate development and delivery schedules, allocate risks to the parties best suited to manage them and incentivize creativity and innovation to improve outcomes and reduce costs. This panel will walk through the benefits and considerations of private financing, risk management, payment mechanisms, transaction terms, and other issues healthcare infrastructure owners may want to consider prior to entering into a long-term partnership with a third party. My name is Tom Mulvihill. I'm a managing director at KeyBanc Capital Markets and head of the infrastructure practice. I've got about 30 years of the US Public Finance and project finance experience and very happy to be here with you today.
We'll look to have each of the panelists introduce themselves and then we'll get into some discussion amongst the panelists on our topic today, and we'll reserve some time at the end for Q&A, but please don't hesitate to ask questions as we go. You can utilize the Q&A or chat function, which should be at the bottom of your screen. We're happy to make it very interactive. Additionally, please note if you didn't hear it already, the session is being recorded so you can we'll certainly recirculate or circulate the link afterwards so folks can share it with other colleagues or watch it again. And with that, I would like to ask my panelists to introduce themselves if they could and maybe I'll just first turn it over to Stephen.
Stephen Hill:
Thanks Tom. Stephen Hill. I'm a managing director with KeyBanc Capital Markets focused on advising and executing infrastructure project finance transactions. I've led project financings for non-core assets like campus energy housing and parking for higher education institutions, some of which have included energy service to a nearby academic medical campus or expanding housing and parking for medical students. There's a strong interest from the equity and debt markets to partner with healthcare providers to deliver needed infrastructure improvements and provide an alternative funding source of under restricted capital as compared to accessing the bond market. I'm excited to be here and expand on that further with you today.
Chris Whitley:
Hi, good afternoon. My name's Chris Whitley. I'm a director with Cain Brothers. I've been in the industry here for about eight years and, in that time I've been the senior manager for approximately 9 billion of par amounts for healthcare providers across the United States. I'm very excited to be here. I think that the solutions and the ideas that we're going to present today are extremely applicable to the client base that we serve, and it's something I'm very passionate about. As a background, for me, prior to being an investment banker in the not-for-profit healthcare industry, I was a nuclear submarine officer in the Navy and I worked with a lot of machinery and equipment and so the energy plan aspect particularly is a very interest to me and I look forward to working with everyone on the line here.
Michael Azzara:
Good afternoon. I'm Michael Azzara with NORESCO. NORESCO is a design builder of central utility plants and we also provide operations and maintenance services and other capital improvements in the healthcare and campus energy space. We've performed more than 500 million of work in the healthcare market, including Walter Reed Army Medical Center and the Veterans Integrated Services Network. NORESCO is owned by Carrier Global Corporation and I look forward to participating this afternoon.
Greg Johnson:
Thank you, Michael. My name is Greg Johnson. Hello everyone. I'm a lawyer with Squire Patton Boggs. I work in infrastructure and in particular I'm a P3 lawyer, which means I represent owners, developers, lenders, and investors in public-private partnerships for all sorts of projects. Those include healthcare facilities, educational facilities, and surface transportation. Squire is an international law firm. We've been involved in infrastructure in P3 in the United States and around the world for many years. It's a pleasure to be here today.
Alex Burlingame:
Good afternoon. My name is Alex Burlingame. I'm a partner in the Cleveland office of Squire Patton Boggs. I've been practicing law for about 25 years now. Most of that in the tax-exempt finance space in healthcare and higher education. And so when it comes to structured for finance for healthcare institutions, healthcare systems have spent a fair amount of time advising on how P3 structures can be compatible with existing debt finance structures of healthcare systems and how you can extract benefits from a P3 structure that might not be available otherwise.
David Teed:
Afternoon everybody. My name is David Teed. I am a managing partner at Diogenes Capital. Diogenes Capital is a developer and a sponsor of infrastructure and public-private partnerships. Our experiences mainly in the transportation sector, air, sea and land, so roads and rail airports and seaports. But in our land sector practice, we've done a lot in parking related infrastructure, which includes healthcare, parking. I'm looking forward to today's conference.
Tom Mulvihill:
Well, that's great. Well, thank you all very much for that. And maybe David, we'll just go ahead and get started with you. If you wouldn't mind, maybe give us your thoughts on what are some of the benefits innovative partnerships can provide to healthcare infrastructure owners and service providers?
David Teed:
So the kind of partnerships we're talking about here are agreements between hospitals and private sector developers that enable the hospital to stay focused on its core mission, but to partner with experts to achieve project delivery. The key to these partnerships is that ownership of the asset remains at all times with the hospital while the asset is held by a financing entity for the duration of the project, which is subject of course to the hospital ownership rights. And I'm sure we're going to dig into that further this afternoon. These partnerships can range from financing and construction of new facilities and monetizing existing non-core assets with the idea of recycling that capital or redeploying that capital in the hospital's mission or in new projects. So these partnerships generally come about by the hospital selecting a developer with the appropriate team of experts. So developers will form teams along with capital and other partners who are expert in design and construction.
We manage the financing, but we partner with people in operations and maintenance, and we also work across different projects with the same teams, but we will also bring in local contractors to round out the team. So there's a development team that's put together, and then the hospital will provide a scope or vision for the desired project and work with the developer team to build the design and the bid specifications to take to the construction market for pricing. And in this phase, the hospital can have as much or as little involvement in the specifications as it wants to. The process results in what's called a development agreement or a design build finance and maintain sometimes called a D B F O M agreement that transfers all of the project risk to the developer team. So that means that construction risk on time on budget two specification is all transferred to the developer team financing risk transferred to the developer team operations and maintenance risk transferred to the developer team, and then the developer team is required to deliver the asset back to the hospital in good condition at the end of the term.
So there's a lot of risk analysis obviously embedded in these processes, and it doesn't force just the deep dive into risk that also into innovation options for construction and for project delivery, which of course includes accelerated project delivery and to optimize all of life costs, lifecycle costs in a DB F O M agreement reside with the developer team. So it has performance risk, if you like, for the life of the deal and performance specifications and defined in great detail on these agreements and failure to meet a performance standard comes with cost penalties that I'm sure we're going to dive into as we go through this afternoon. Interestingly, aside from the efficiencies of having outsourced the project to experts at risk, construction costs are not automatically lower. They can actually sometimes be higher in these kinds of deals as the developer team builds in quality and resiliencies to ensure a lower whole of life cost. And it's the whole of life cost that we measure, and we I'm sure we'll get into as we talk about it, is that as an industry, we would expect that the whole of life cost of a D B F O M project would be as much as 30% lower than traditional procurements. So Tom, I hope I answered, I answered the question.
Tom Mulvihill:
Yeah, no, thank you David. Appreciate that very much. I agree completely. The whole of life approach is certainly something I like so much about these types of innovative partnerships and public private partnerships and the way they work. It's not just focusing on the front end capital portion project. So that's great. Thank you for that. And maybe Michael, we'll turn to you for a minute. We've heard about some of the benefits here. What are some of the considerations that infrastructure owners should be thinking about as they are considering entering into a long-term partnership?
Michael Azzara:
Thanks, Tom. Two of the more important considerations seem to be very basic, but they're often not well understood by project owners. And these considerations are understanding your goals and objectives and picking the right partner. For example, as a healthcare CFO, you may wish to increase the size of your central utility plant and outsource the plant operations and maintenance because you recognize that utility plant construction and maintenance of that plant and operations of that plant is not a core competency. And these alternative project delivery agreements are long-term agreements oftentimes 30, 40, 50 years in duration, true partnerships. Therefore, it's imperative that you select the right partner, so you must evaluate the partner based on their experience with similar asset classes. In this case, central utility plants, not roads and bridge experience or experience with residence halls on university campuses. It seems to be simple, but many times this is overlooked during the qualifications phases of project procurements.
And there are other basic considerations like hiring high quality legal, technical and financial advisors. Tom, these advisors understand the competitive landscape and they can advise based upon precedent deals in your marketplace. And I guess lastly, building a good internal team with diverse skills across legal, technical, financial, and even procurement. These procurements are much more complex and they're very document intensive, and it's critical that your procurement folks have the wherewithal to implement such a procurement and it's critical that you have on your team and identify a project champion who has time to lead this type of effort.
Tom Mulvihill:
Yeah, no, that's absolutely right. I think these are long-term partnerships and it's important to make sure you do your homework before you commence a procurement. I'll, I'll say I have seen in the past where certain infrastructure owners may decide, well, let's put on RFP and see what the market has to say about this. And I don't know that the need for speed there when you're thinking about such long term contracts really pays dividends. And so I agree, Michael, doing your homework up upfront, bringing on good internal team with diverse skills, external folks to support with diverse skills help set these owners up for success. So agree there completely. Maybe Chris, if you wouldn't mind, as our healthcare finance specialist here, maybe touch a little bit on what are some of the challenges the healthcare sector is facing these days and you can touch a little about maybe how some of these partnerships might help address some of those considerations.
Chris Whitley:
Great, thanks Tom. And hello everyone. This webinar is really coming at an appropriate time given the global and US backdrop for healthcare providers like yourselves. This is a challenging environment In the wake of the pandemic and recent trends, healthcare providers have seen several challenges operating cash flow margins are down, expense growth has started to outpace revenue growth. You've got labor costs that have ballooned significantly, and you've got supply costs that have expanded and grown significantly in the wake of inflation challenges. We've got liquidity metrics that have been down significantly over the last year. Balance sheet cushions that may have been developed and built up over the pandemic may have been largely depleted over the last year. You've seen investment declines, what pretty widespread you've seen operating losses, you've seen having to repay the temporary Medicare loans. A lot of challenges leverage metrics that service coverage is starting to decline pretty meaningfully.
A lot of providers are seeing uneven volume trends. There's a lot of challenges in headwinds facing healthcare providers. So this type of solution that we're providing here and discussing here could be really timely for a lot of the folks on the line right now, folks like yourselves that are operating hospitals, you may be thinking, why is this structure, why are these solutions appropriate for me or what's the benefit for me? And in a lot of cases, the challenges I just mentioned might be mitigated partially by a structure like this. Perhaps there's an upfront influx of capital that you're looking for. And oh, by the way, another challenge and another headwind that you're facing right now with elevated interest rates is that the public markets are relatively expensive right now compared to the last recent years of history. You've also seen in the wake of the S V B presents a challenge to liquidity in the bank market.
So healthcare providers that may need capital may find the traditional sources of that capital difficult to access right now and that makes the structures and the solutions that we're talking about even more timely right now. Tom, if I can take two more seconds. I think just to expand on some of the reasons why healthcare operators like yourselves would be interested in this type of solution and structure, other than the things I just mentioned at the core of what you do is you run a hospital over time as you've grown, you may have developed energy plants to meet the needs of your system. You may have made parking lot improvements and things like that, and this could be an opportunity to optimize the use of those assets for your benefit. This could also optimize the time that you as a healthcare provider are spending to run your hospital versus in some circumstances the time you're spending to run an energy plan or to manage a parking lot. So I think there's a lot of really good benefits here. I'm really excited to keep talking about this with everyone hand.
Tom Mulvihill:
Great. Yeah, thanks Chris. Yeah, we've heard both Steven and David use the term non-core assets and services, and I think that does get right to it. These are critical infrastructure assets that are necessary for healthcare providers to provide to perform their mission, but nowhere in mostly these spokes mission statements, does it say parking or energy. And over time, what we've seen with a lot of a variety of different infrastructure owners has been that because it's not core to the mission, it may not always get the attention or it may not get the funding that it needs. So deferred maintenance can tend to become an issue in these sectors, as you know, right? Key hospital facilities get priority. So our thoughts are by bringing in folks who do parking every day, who provide utilities every day, and it's their core competency that makes them potentially good partners for the healthcare infrastructure owners who can just look to that partner to help them. So these are all been great concepts and great discussion. I think maybe Steven, if I could ask you to maybe make it a little more tangible and hit on a few case studies and just where else are we seeing these types of projects might not be in the healthcare space, but I think there's a good relationship I'm sure between some of these other sectors and healthcare.
Stephen Hill:
Sure, thanks Tom. Yeah, we have seen institutions similar to yourselves start to identify non-core assets like parking, utilities, other buildings that are not mission critical and partner with the private sector who does have that expertise to improve performance and customer experience in a way that really unlocks value for the healthcare provider. We've seen a lot of examples to date in the higher education markets. Wanted to hit on a couple. The first is Fresno State University in California, which partnered with MERIDIUM , an infrastructure private equity Fund and NORESCO in February, 2021 to deliver a new central utility plants on campus and provide energy efficiency upgrades. Construction is currently in progress and the contract includes 30 years of routine and major maintenance obligations from the private partner. The private partner brought financing, so they raised debt and equity to finance the new central utility plant and there are no payment obligations from the university until the plant is operational and providing service to the campus.
As David mentioned, these projects do include KPIs and there are performance deductions where the private partner does not live up to its end of the bargain and deliver the service as specified within the detailed contracts. Another example is Eastern Michigan University, which just announced last week, a 50 year partnership with CentTrio and NORESCO to manage and make capital investments in. Its on-campus utility system. This includes requirements of the private partner to identify, deliver and finance capital improvements to support the university's energy transition goals in return for the right to operate the utility system over the 50 year concession, the private partner is making 115 million upfront payments to the university, which is being used to defeat debts, improve the university's liquidity positions. As Chris alluded to, some of the headwinds within the healthcare market have also hits the higher education markets and the proceeds were also being used to invest in an endowment. So we've seen examples of how universities have delivered innovative solutions to address infrastructure needs, but also identify non-core assets and extract value from those assets which can be used as an unrestricted source of capital to improve liquidity or address other needs on its campus.
Tom Mulvihill:
Great, thank you for that. Steven. Greg, it'd be great if we could turn to you and again, trying to put more meat on the bones in terms of really talking specifics about what P3s are and how they work. I don’t know if you can expand on some of this discussion for us.
Greg Johnson:
Well, thank you very much. I'd be happy to try again, I'm Greg Johnson. I'm Squire Patton Boggs and I'm a lawyer and like all lawyers, I look at these transactions from the perspective of how rights and responsibilities and risks are allocated between the parties. How clearly do the documents reflect the objectives of the owner, how good of a job do they do in delivering to the owner over the lifecycle of the asset, the benefits that the owner expected to have and that the sponsors proposed? What are the circumstances that arise if there are non performances, if KPIs are not met, they're in construction operation whenever it may be. And so all of these things are embedded in documents that are entered into by a public owner, a sponsor usually operating through a special purpose entity created exclusively for this project. It's lenders, it's equity investors, and perhaps a E P C contractor or an operator or other third parties that come together to form a part of a team.
Now that sounds like a complicated structure and there are some moving pieces, but I think as Steve has indicated, there's a substantial amount of experience in the marketplace and frankly on this panel, on how these deals can be achieved and operate successfully for the benefit of healthcare institutions and other public owners. Now we've, we've used a number of different terms as we've described the structural relationship, and one of them is a D B F O M design, build, finance, operate, and maintain. That's sort of the classic definition of a P3 project delivery method, and it's important to view these in that context. It's a delivery method, it's a process and a structure to give you the owner of the facility, the benefit of what you've negotiated for now, it's to be distinguished from what I'll call a conventional delivery method such as design, bid build where all of the control over the design and structuring of the financing and everything lies with the owner and contract bids go out to a private sector party and a party comes in and builds it, and when it's done, they hand over the keys and they're gone.
And that works oftentimes it has worked over the years and many circumstances, but one of the benefits of A D B F O M is that partnership and it's really a partnership, not just a arms length negotiation of a construction contract, but a partnership between the public side. And I use public to include all owners in this case and a private team that's in the deal for the life of the project. And that has a number of important benefits. If your team knows that it's going to be operating and maintaining this facility for 30 years, your team is going to be very mindful of those considerations as they design and construct the facility. Because guess what? They won't be turning the keys over to you when they're finished. They'll be living with that project. And if the documents are drafted appropriately, there'll be very strong performance guarantees and penalties if KPIs are not met.
So the benefit of long-term involvement of your private sector partners in the early stages of the project, in the design of the project, in the structuring of the financing, in the solicitation of what are called ATCs, alternate concepts about construction or financing, the procurement process often involves an interactive program between the private side and the public side where the private side is able to make suggestions and improvements and the public side says, well, we'll take that or we won't take that. So it's a highly interactive arrangement designed to create best value. A key consideration, a very important consideration in structuring these deals is risk identification and risk allocation. And there is never too much time that's spent in structuring a deal and thinking about those issues. Every project has risks. Some are obvious, some become apparent over time, but to the extent that your team can help you identify risks associated with the project and make decisions about who bears that risk for the life of the project, some are always transferred to the private side.
Some frankly are better retained and better managed by the public side because they're the best ones to do it. But in any event, however those risks are allocated, that risk allocation and risk responsibility and performance obligations associated with it need to be reflected in the documents. There need to be performance guarantees, and if those things are structured properly, a P3 delivery mechanism can be a very successful method of obtaining the benefit of a project. Just a couple of final thoughts before one, it's been mentioned before, but it cannot be mentioned too many times. You as the public owner of the project remain the owner of the project. There are private parties who will maybe have a concession or a ground lease or a project development agreement or something else that will give them rights to come in and do what it is they are supposed to be doing.
But unless you're looking at a privatization or a full monetization of the assets with loss of control, in most every one of these circumstances, you are in a situation where you will continue to be the owner and you will continue to have managerial control over most all aspects of the project. So D B F O M design, build, finance, operate and maintain might not have the O in that sequence, meaning you may be the formal operator and it may be a D B F M, but all of these are fig factors and considerations that can be structured at the time the project's put together. Much more can be said about this, but we'll leave it for there and hope questions will be available. I'll be happy to answer them.
Tom Mulvihill:
Great. Yeah, thank you, Greg. Yeah, that is an important point in these partnerships. This is a partnership and the infrastructure owners remain the infrastructure owners. They may transfer some element to control to the private party, but they regulate that control through those contracts and those agreements. And so those are very important points. And also I think what's important here is these partnerships are great delivery and financing tools. As Greg mentioned, they're not funding tools necessarily on their own right. They're still a need for there to be funds made available and that can be in the way of allowing the private party to charge third party user fees such as parking, so then that third party, so then the private party can have some funding through those user fees, but ultimately there's got to be some funding made available to the project and to the private party. And maybe David, I'll switch to you for a moment and we've talked a little bit about some new construction projects, some monetizations. Can you maybe talk a little bit about what the difference is between those two and maybe an example that you want to share that would be great.
David Teed:
So in the infrastructure world, there are greenfield projects and there are brownfield projects, examples of greenfield projects. They're new projects, there are new roads, new bridges, new tunnels, airports, convention centers or in our case a hospital facilities of the various different kinds that we've been talking about. And a greenfield project would not typically have revenue associated with existing revenue associated with it. Brownfield projects are existing assets that could be monetized and typically do have revenues that support that monetization transaction. So to use the language of the day, the D B F O M contract that Greg was just talking about would typically apply to a greenfield project. A brownfield project would more likely be a monetization. And a monetization is a project where the revenues from that existing asset are given a value that can be reflected in the form of an upfront payment to the hospital, will inevitably also include the transfer of operating risk and capital maintenance risk away from the hospital to the private development.
And that sort of monetization enables the redeployment of that capital, if you like, into healthcare mission, into the construction of new projects onto the balance sheet to address leverage and debt issues that Chris was talking about earlier or even to fund acquisitions in some cases. So there is a difference between greenfield and Brownfield, and that's sort of how we think about things. To give you a couple of examples, there's a greenfield project that we are working on currently with a hospital where they want a new facility built. They have an excellent credit rating on their own, but they wouldn't prefer to stick to their knitting, to their expertise and to engage for the private developer to deliver this new facility. And so we are working through a design build, finance, operate and maintain transaction with that hospital to deliver the project and to operate the project and to finance the project.
To contrast that greenfield example with a couple of brown fields, we did do a parking monetization with the Ohio State University. Now that may sound like a university deal, but the university has 12 hospitals and clinics on it and is building more, and in fact it's much more of a healthcare deal than it is a higher ed deal. And in that transaction we gave the Ohio State University a 483 million dollar upfront payment. They used that money to invest in their endowment fund and through the proceeds from that investment, they have plans for hiring tenure fact faculty and provide scholarships and other core mission activities. And we on the other hand, receive not only the right to collect the revenue, but also the obligation to maintain those parking assets over the life of the transaction and to return those parking assets in good working order at the end of the term. So that's an example of a brownfield. A similar brownfield we've done recently is with the University of Toledo, which also has its own medical center. So that's another academic medical center kind of a deal where we gave that university, I think 60 odd million up and we've assumed the obligation is to maintain that parking system for a term of 30 plus years. So that's an example of a Greenfield and Nebraska.
Tom Mulvihill:
That's great. Thank you David. And you know what I really like? There are a lot of different models. I think the one of the running jokes is if you've seen one kind of one P3, you've seen one P3, right? They're all different structures and flavors and really all are designed to really meet the owners goals and objectives. That's really what this is all about. And what I like a lot about the University of Toledo project, and I do think there's a lot of, I do think the higher ed sector is a fair sector for the healthcare market to look at. There's a lot of similarities, certainly when it comes to having a primary basis of being a not-for-profit for many healthcare institutions. And what's the accounting impact? What's the financing impact, the ratings impact? I think a lot of that is very similar between healthcare and higher ed.
So I think showing some higher ed examples here, in my humble opinion I think is relevant. But for the University of Toledo, what I like about that is it's different from other monetizations that I've been a part of where it's really just a one-time upfront payment in exchange for control over an asset for a long period of time. Here there is an upfront payment and there's some initial CapEx that was provided, but then there's sharing in those revenues over the life of the transaction and there's an optimization of the asset so that there's better outcomes over the life. It's not just a kind of one shot type of monetization. It is a partnership that tries to improve the value of that asset because frankly, parking is often what the first thing and the last thing folks see when they come on campus. And so having something that's really done in a kind of best in class approach I find can provide a lot of value. But thank you David for that. Maybe Steven, we'll, we'll continue to dig in a little bit on maybe some other transactions structure details maybe on how these deals are put together. That's something you can share with us.
Stephen Hill:
Sure. And we did prepare a transaction or commercial structure diagram that would be helpful to share on screen just to provide more context to how these transactions typically come together in terms of relationships among the partners and some of the documentation requirements. So what you're seeing on screen is an indicative commercial structure for a partnership project where the healthcare provider will enter into a long-term project agreement or concession agreement or D B F O M agreement with a private developer. That private developer is typically a special purpose vehicle that's created for the sole purpose of delivering its responsibilities under the project agreements. That developer is often owned by equity members, or as Tom and David referenced with the University of Toledo example, that could be an asset manager where that entity is responsible for performance but not necessarily taking an equity stake in the project.
The developer would also be responsible for raising project finance debt. So this debt would be non-recourse to the parties, non-recourse to the healthcare provider and backed and secured by the obligations of the project agreements. The developer for a greenfield project would often enter into a dropdown design build agreements with a contractor to build the infrastructure assets as well as a maintenance agreement with the o and m provider to fulfill the operations and maintenance requirements for a Brownfield project. There may not be a specific upfront construction aspect to it, so there may just be a long-term o and m agreement, or it may be accompanied by specific kind of discreet to be formed CapEx work that would be entered into under a separate agreement. We see flexibility within this mechanism for different types of projects. So where you have projects that have its own revenue stream i. e. parking or specific buildings that have their own revenue stream or housing student housing in the context of higher education, those projects can pass the obligation to collect those revenues, maximize those revenues to the developer, where the developer will ultimately take that revenue risk.
Oftentimes in that structure, we do see compensation back to the infrastructure owner in the form of an upfront payment or sharing of long-term revenues with the infrastructure owner for assets that do not generate its own revenue streams such as utility systems, there would be long-term payments from the healthcare provider to the developer. Think of those, it's the term often used as availability payments, which are long-term performance based lease payments. So as we mentioned before, the project can include specific performance requirements. So oftentimes there's very detailed appendices within the project agreement, which spells out the obligations of the developer to deliver a certain level of performance. And if that performance is not achieved, then there are KPIs and the ability to hold the developer a single entity feet to the fire in the form of reductions to the payments to these availability payments for performance that does not live up to the project agreement requirements. We'll see developers be creative with how they approach financing these projects. Developers will be very sophisticated and how they compete to win these projects. They will explore funding opportunities through the Infrastructure act or through the Inflation reduction Act that could be applicable for the projects and the benefit of the healthcare provider. They're also accustomed to working with various different debt financing markets, the tax exempt markets, the taxable private placement markets, the bank markets to structure solutions that best meet the funding of the project.
So I'll pause there and see if there are any questions as it relates to the commercial structure. Please feel free to add those to the chat feature, but wanted to provide some context in terms of how these transactions typically come together.
Tom Mulvihill:
Great. Yeah, thank you for that Steven. And maybe just I'll add a little bit here. This is the more fulsome structure outlay. As I mentioned, there's a lot of variations to the theme and as Steven mentioned, sometimes there may not be a design builder. Sometimes the maintenance provider is only doing long-term maintenance including lifecycle maintenance and is not doing operations sometimes there's also not an equity member. The University of Toledo deal that was referenced earlier was itself a 501c3 tax exempt structure and the debt there of the developer, it was a hundred percent debt financed, was structured in a way to the owner to University of Toledo. And so they got the project finance non-recourse structure in place. So it's not their debt and it's the developer's debt, but it was all tax exempt in that case, even though tax exempt bond proceeds were used to make this concession payment. Once the university received the concession payment, they didn't have any restrictions on how they used that money. So even though the money was raised from tax exempt bonds, its use was for a concession payment and when they received that concession payment, they're free to put that on their balance sheet and improve their liquidity or do other things with it, build new projects. So we think there's, again, there's a lot of flexibility in these structures and they are able to be tailored to meet your polls objectives ultimately.
Greg Johnson:
Tom, can I add just a comment to all this?
Tom Mulvihill:
Please.
Greg Johnson:
This is Greg Johnson. This is a wonderful diagram and I think it does an outstanding job of illustrating to people the basic structure of how these arrangements come together, particularly in a single building or single facility context. We've also seen the application of this delivery mechanism to campus-wide improvements or life science center improvements. And so one ought not view this as designed solely for a single building. It can be employed on a much broader basis. And comment number two, in addition to all these lines and boxes, which are very important, there are a variety of performance guarantee instruments in the picture. That design build agreement on the lower left is usually a guaranteed maximum price guaranteed time delivery contract, which is subject to a lot of discussion in these deals typically, but is backed by parent guarantees in many cases, performance and payment bonds and recourse to third parties whose boxes aren't even yet on the screen here. So it's important to remember, I think for folks considering this, that when you structure these the right way, there are a lot of ways to get recourse to ensure performance of this delivery mechanism. And those are always a topic of discussion.
Tom Mulvihill:
Excellent. Thank you very much for that, Greg. Okay. Unless there are any other comments on the structure diagram here, maybe Michael I could turn to you for a moment and touch a bit on campus energy. Obviously a big topic that we're hearing across healthcare and higher ed and we'd just love to hear you talk a little bit more about that.
Michael Azzara:
No, I'd be glad to. Tom. I think our viewers would be interested in really why the healthcare markets and the university colleges and universities, why they choose to do these deals. And I would say a campus energy project on a healthcare campus or university campus, they typically include central utility plants and distribution systems and co-generation systems and multiple drivers. Sometimes the drivers are just renewable energy and resiliency. Sometimes a driver is the really decarbonization and electrification moving away from fossil fuels and they can many times include in building energy efficiency measures. At the same time motivations from the C F O perspective, a lot of times preservation of capital, focusing on your core competencies, improving operating budget, predictability or budget certainty to be put another way, reducing your maintenance responsibilities or addressing the deferred maintenance needs across your healthcare campus. I touched on resiliency and reliability.
That's a major reason that you'd look towards a campus energy project. And then like we talked about, reducing risk, usually risk of implementation, operational risks, financial risks. There's a lot of lot to be said for on budget date, certain completion with very strong financial penalties if the mark is not hit. So that gives you some sense of why we're looking at campus energy and really campus energy can be used to either monetize the central utility plan asset that is in good condition or constructing a new central utility plant distribution system to replace a system that has reached the end of its useful life. And that goes to the greenfield Brownfield discussion that David walked us through.
Tom Mulvihill:
Yeah, certainly decarbonization is getting a lot of attention these days. We see a lot of infrastructure owners with net zero goals by 2040 or 2030 or whatever the timing is. And there's still a lot of questions about how do you do that transition. And for a lot of owners they recognize that just operating what they have is oftentimes a challenge and a chore, never mind trying to build something new that makes them more sustainable or produces their carbon footprint. So bringing in that specialist, that private party that does do this every day can be a good benefit for that. So thank you. Maybe Alex, we can turn to you for a moment on kind, what are some of the healthcare specific legal considerations that some of these that infrastructure owners might want to be thinking about as they consider these long-term partnerships?
Alex Burlingame:
Sure. Well there are a lot of 'em, but I think they're kind of four kind of key points. I'll try and keep brief here. One is just to emphasize having a practice that plays on both sides of traditional healthcare finance and P three is that a working group on a P3 transaction is complimentary to your debt team and their experience in higher previous system financing. So when you engage people like you see on your screen now, people like key particularly you know, want people who understand both traditional tax exempt healthcare finance and P3 so that they are able to work with lawyers like myself in pre-planning for these projects. And so the second thing I would point out is that many healthcare systems have what is called a master trust indenture or other legal documents that contain their standard batch of operating and financial covenants that they live with every quarter, every year.
And the benefit of a structure like this, whether it is from a monetization that brings a payment upfront or from an alternate way of building something, is that in this type of economic environment that Chris mentioned earlier, it can provide relief on some of these existing covenants, whether it's debt service coverage, liquidity days, cash on hand, because it could put money on your balance sheet and if it involved a payment stream, maybe it is not treated as a debt in a contractual sense and provide the health system with relief that way. Also, others have mentioned flexibility and the challenging environment in terms of just constructing a project these days and how that works. And with this type of arrangement that may provide some more flexibility in who you use and how quickly it can be done. The thinking out loud, depending for the CFOs and CEOs and legal officers on the line, many times in the traditional financing structure involving tax exempt debt that may come with requirements to use prevailing wage, it may be come with requirements to use certain types of contracts, maybe contractors, maybe local contracting and depending on your locale that may or may not be a real benefit for you in this environment with as sort of financial pressures and sometimes challenging construction timelines.
And then I suppose last I would mention it is it, and this is building off the complimentary nature of this team, it's also an opportunity for pre pre-planning future legal documents, not just for a P3 transaction, but other debt for those of us who work regularly in the tax exempt world. We know bankers with traditional financial advisors, bankers, underwriters, like he are always evaluating existing covenants and whether replacement debt documents should be put in place. And so this group is particularly well positioned to advise on not only the project you have in front of you today, but the project that may be coming down the road in a year or two year, two years or three years. And the last point I was thinking about it, particularly as I was hearing some of the key people talk and Chris is in the back of my head, I know there also some other third parties that are evolved in any type of project and financing would be people like rating agencies and outside auditors. And so I just, I'd be curious for your thoughts on just in terms of timing, communications and how they would look at transactions like this.
Chris Whitley:
Yeah, definitely. I think, and Steven, I think, you know, you've got experience on the university side and the higher education side is actual evidence of the interactions with the radio agencies. I think the short answer is that the underlying healthcare credit is going to play slightly into the rating of that structure that Tom showed on the block diagram, the actual corporation that's brought up to borrow the debt, which is different than the underlying hospital. So I think the underlying fundamentals of the hospital certainly will weigh into that decision, but ultimately it's the new entity that's being rated and it's not the hospital that's being rated.
Stephen Hill:
Just to expand on that, and Chris, I think you hit the nail in the head. I think there's kind of two aspects to the rating process. One is any impacts to the hospital provider. I'm not aware of any innovative partnerships or P3 transactions which have resulted in a downgrade to the infrastructure owner, but there is the need to position the transaction to your rating agency touchpoints ahead of the transaction just to demonstrate the goals and objectives of the project, why you're entering into the project and what you hope to achieve from the long-term partnership. I think the second aspect is the project itself. So ultimately the project company that developer will likely approach the rating agencies to get the project financed debt rated. Oftentimes we've seen infrastructure owners like universities require the developer to get the project finance debt investment grade rated, but it's very clearly not a legal debt of the hospital. And that rating process would focus on the project financing, which would be the responsibility of the developer entity.
Tom Mulvihill:
Great, thank you all. That's great. We do have a question, so thank you very much. I think this combination of energy and legal here, so there's a question about where does the risk lie for unforeseen state or federal legislative changes that may make material alterations to the way a central utility plant would have to be operated. So emissions changes for example, what happens in these transactions and who, who's responsible for it. So maybe that's a bit of a jump ball, but if someone wants to take a start on that and others can jump in, that would be great.
Greg Johnson:
Well, I, I'll take a start. I'm sure Michael has some thoughts about it too. Regulatory risk is one of those issues that gets talked a lot about in structuring a project document. Certain types of regulatory risk are often retained by the public owner, things that cannot be adequately anticipated and priced because the developer will look at risk and say, I'm willing to take any risk that I can understand that I can price because that'll be reflected in my proposal. External risk, a change in Washington, it's pretty rare that general regulatory risk of an environmental nature that's unknown and unqualified would be taken by a developer or an operator. That said, there are certain types of emerging regulatory requirements that can be evaluated and may appropriately be pushed off on a developer. If the developer is in a position to say, okay, here's our phased capital plan for dealing with these issues. We know what it's going to take in five years or seven years or whatever, and we're going to factor that into our program and we're going to price that, that's risk. We can take measure and then you'll, you the owner will have to evaluate how good a job we're going to be doing and what the cost is for us to do it.
Michael Azzara:
And I would concur with Greg's initial opinion, unknown regulatory risk would have to be retained by the owner.
Tom Mulvihill:
And that's a general comment I would say for these partnerships. If there's an unlimited unforeseeable risk, if you want to try to transfer that from the owner to the private party, I'm not sure that's good value. So that's something that you'd want to talk through with your consultants. And if it's hard to really put a good probability and a valuation to that one risk item, then that just starts to layer in contingencies, which can just reduce the benefit of doing a transaction like this and that.
Greg Johnson:
Right? You're overpaid before anyone thinks though that that's a bad factor. Remember that what the risk we're talking about is risks that the owner would retain without doing this deal. I mean, there are risks in having a university energy plant and these are the sorts of things that can happen down the road. Question is which of those risks can be appropriately transferred to the private sector because they are better able to anticipate them, manage them, account for them. And what frankly is going to be the price for doing that risk allocation is also value and price allocation. And if you try to push too much risk off on the private sector, your deal's going to become non-competitive because it's going to be an excessive and unwarranted risk factor in the deal that you don't want to pay for and the developer doesn't want to charge for. So again, upfront risk evaluation, very important.
Tom Mulvihill:
Great, great. And I know we're up on our time here, but oh, sorry, was there something else? I know we're coming up on our time here and David, maybe I just ask one more of you. We heard Michael give us some thoughts around what are some of the broader capabilities on the energy side of a partnership program. Maybe if you wouldn't mind touching on some topics of other things that can be included into some of the parking transactions and some newer concepts that might be relevant in a parking context. I think you're on mute.
David Teed:
I will try and answer your question as quickly as I can In the time we're talking about a series of envisioning processes that take place during the scoping phase of these kinds of projects. And in the parking transactions, what we're trying to do is develop a parking vision and a set of shared assumptions that we're going to take into the structuring of the transaction. And the starting point with this vision, of course, is the brand. If parking is the first and last impression that a patient and a visitor has in coming to the hospital, then that's really the first and last touch point with the brand, the hospital. And so thinking about the brand gets wrapped up in how we might think about deferred maintenance, how we might think about new buildings, how we might think about traffic flow, the aesthetics of the campus, new technologies that can be brought to bear.
And in that context, we can be talking about things like EV charging stations, we can be talking about fleet electrification for shuttles that are bringing remote parkers closer to the front door. We can be talking about solar canopies that will address some of the things that Michael was talking about earlier in terms of energy sustainability and decarbonization goals. The whole new technology opportunity in parking is kind of exciting and plays very much into the patient experience. And those things should be part of the shared assumptions that I mentioned earlier. And then I think there's also an issue today more than ever with employee retention in the healthcare space and employees typically get pushed to remote parking so that visitors and patients can access the front door a lot easier. But that experience of parking someplace out in the cold and waiting for a bus can be dealt with a whole lot better than it often is. And that plays directly into employee retention. So a lot of different ways to think about that. Tony,
Tom Mulvihill:
Great. Thank you for that. And thank you all very much for your time. I also want to say thank you to Armand. Armand's been helping us out. He didn't get to do his introduction early on, but he's been supporting us and helping put the webinar together today. So thank you Armand. Appreciate that very much. Unless there are any other last comments, I think we can leave it there.
Chris Whitley:
Tom, I would just like to encourage our audience if you do have any additional follow on questions, please reach out to us. I think you should have Tom's contact info, my contact info, Armand or Stevens as well, or anyone on the panel here. But we'd love to entertain any follow on conversations with you and we hope that you benefited greatly from this webinar.
Tom Mulvihill:
Great. Agreed. All right, well thank you all. We'll leave it there. Have a great rest of your day and a great rest of the week. We'll talk soon. Thank you.
The sky-high inflation of the past 18 months has hit healthcare organizations’ financials particularly hard. Public-private partnerships (P3s) can help by offering innovative partnership solutions that leverage opportunities to accelerate development, transfer risks and incentivize innovation.
The sky-high inflation of the past 18 months has hit healthcare organizations’ financials particularly hard.1 The higher cost of living has compelled patients to put off elective procedures, which account for as much as 60% of hospital2 revenue. Meanwhile, inflation has made everything from tongue depressors to MRI machines more expensive. Add staff shortages and high labor costs into the mix and it’s no surprise that the American Hospital Association labeled 2022 “the worst financial year for U.S. hospitals and health systems since the start of the COVID-19 pandemic.”3 The outlook for the rest of 2023 isn’t much better.4
While businesses in many other industries can respond to economic headwinds by diversifying revenue streams, reducing expenses and maximizing efficiency,5 hospitals are limited both by their operational complexity and by debt covenants that can limit6 operational flexibility. But public-private partnerships (P3s) can help healthcare institutions unlock value over the long term. P3s are used by public entities, like hospitals and universities, to outsource essential but non-core aspects of their operations to private businesses.
On a recent webinar, Thomas Mulvihill, Managing Director and Group Head of Infrastructure Finance and Public-Private Partnerships at KeyBanc Capital Markets (KBCM), talked with P3 experts from the legal, financial and energy sectors about the ways innovative partnership solutions can accelerate development, transfer risks and incentivize innovation. Mulvihill was joined on the panel by Michael Azzara, Senior National Account Executive at NORESCO; Alex Burlingame, Partner at Squire Patton Boggs; Stephen Hill, Managing Director, Infrastructure Finance & P3 at KBCM; Greg Johnson, Partner at Squire Patton Boggs; David Teed, Managing Partner at Diogenes Capital; and Chris Whitley, Director, Not-for-Profit Healthcare Investment Banking at Cain Brothers.
The panel started off with an overview of P3s in healthcare and some of the benefits these partnerships can bring to infrastructure owners and service providers.
What are public-private partnerships in healthcare, and how can they help in the current economic climate?
Public-private partnerships in healthcare are long-term agreements between hospitals and private sector entities through which outside experts take on responsibility to operate and maintain existing non-core assets such as parking lots or energy systems – or design, build, finance, operate and maintain, in the case of new facilities – enabling the hospital to stay focused on its core mission. Capital generated by these partnerships can be redeployed by the hospital to serve its core mission or fund new projects.
“P3s give you an opportunity to optimize the use of assets for your benefit, while reducing the time you, as a healthcare provider, have to spend running an energy plant or managing a parking system,” said Cain Brothers’ Whitley.
While many P3s are executed to monetize or provide for the operation and maintenance (O&M) of existing facilities, others support the financing and development of new projects.
Brownfield vs. greenfield
A brownfield P3 project monetizes or optimizes a facility that’s already built. Revenues from that existing asset are given a value that can be reflected in the form of an up-front payment to the hospital. These agreements also include the transfer of operating risk and capital maintenance risk away from the hospital and to the private partner.
Greenfield P3s, on the other hand, fund and support new construction. These agreements are normally written in the form of a design, build, finance, operate and maintain (DBFOM) contract and are initiated when a hospital identifies and selects a developer and related experts. Once that developer team is formed, the hospital will provide a scope or vision for the desired project and work with the team to build the design to specifications of the hospital. A DBFOM agreement transfers substantial project risk to the developer team.
“Construction, financing and O&M risk is all transferred to the developer team, as well as the responsibility of delivering the project on time, on budget, and to specification,” said Diogenes Capital’s Teed. “The developer team also assumes all costs related to the asset for the life of the agreement.”
Built to last
This approach often results in the facility being built to higher quality standards. “With a conventional delivery method, when the building’s done, they hand over the keys and they’re gone,” said Squire Patton Boggs’ Johnson. “With a DBFOM partnership, they design and construct the facility knowing that they'll be living with that project for the next 30 years.”
NORESCO’s Azzara added that the developer team may spend more money up front to ensure lower costs over the long term. “Construction costs can sometimes be higher in these kinds of deals as they build in quality and resiliencies to ensure a lower whole-of-life cost,” he explained. “The whole-of-life cost of a DBFOM project can be as much as 30% lower than traditional procurements.”
While P3s come in two basic flavors (greenfield and brownfield), individual agreements are tailored to meet the needs and priorities of the healthcare provider. “There’s a saying in the industry, ‘If you’ve seen one P3, you’ve seen one P3,” quipped Mulvihill. “They're all different structures designed to really meet the owner’s goals and objectives.” As a result of this custom tailoring, P3s in healthcare tend to be complex to structure but ultimately yield benefits over the long term.
Mobilize a capable team to support long-term P3 success
Whether greenfield or brownfield, a P3 will involve the allocation of rights, responsibilities and risks over an extended period of time. Johnson noted that these agreements must also clearly spell out the objectives of the owner, the benefits the owner expects to receive from the partnership and the repercussions for the partner if those expectations aren’t met. All of these “moving parts” mean that any hospital considering a P3 should first assign an experienced internal team that’s capable of negotiating and implementing such an agreement.
“These procurements are complex and very document intensive,” said Azzara. “It’s critical that your people have the wherewithal to implement such a procurement and that you identify a project champion who has time to lead it. You should also hire high-quality legal, technical and financial advisors who understand the competitive landscape and can advise you based upon precedent deals in your marketplace.”
Azzara also recommended taking sufficient time to understand the institution’s goals and objectives and pick the right partner. “As a healthcare CFO, for example, you may wish to expand your central utility plant,” Azzara added. “These alternative project delivery agreements can be 30, 40, even 50 years in duration, so it’s imperative that you select a partner who has experience with central utility plants, not roads and bridges. It seems simple, but many times this is overlooked during project procurements.”
Finally, Johnson pinpointed risk identification and allocation as a very important consideration in structuring these deals. “Every project has risks,” said Johnson. “Some are obvious, some become apparent over time, but to the extent that your team can help you identify risks associated with the project and make decisions about who bears that risk for the life of the project, that will be crucial.”
P3s: A tool for resiliency now, and the long term
While they do require time, expertise and due diligence, P3s can help healthcare organizations address the current challenges facing the industry and the economy as a whole, while better preparing them to both make the most of the eventual economic recovery and mitigate the effects of the next downturn.
“The benefit of a structure like this,” explained Squire Patton Boggs’ Burlingame, “is that, in this type of economic environment, it can put money on your balance sheet.”
To learn more
Please reach out to our KeyBanc Capital Markets experts:
Tom Mulvihill, Managing Director and Group Head of Infrastructure Finance and P3
Stephen Hill, Managing Director, Infrastructure Finance and P3
Chris Whitley, Director, Not-for-Profit Healthcare Investment Banking, Cain Brothers
Visit www.key.com/p3
KeyBanc Capital Markets is a trade name under which corporate and investment banking products and services of KeyCorp® and its subsidiaries, KeyBanc Capital Markets Inc., Member FINRA/SIPC, and KeyBank National Association (“KeyBank N.A.”), are marketed.
Securities products and services are offered by KeyBanc Capital Markets Inc. and its licensed securities representatives, who may also be employees of KeyBank N.A. Banking products and services are offered by KeyBank N.A.
Securities products and services: Not FDIC Insured • No Bank Guarantee • May Lose Value
Please read our complete KeyBanc Capital Markets disclosure statement.