PFI isn't all overspend, union disputes and stoppages. If you're in the construction industry, happy days are here, says Elaine Knutt
The£1.5bn first wave of private finance initiative hospitals is no longer the stuff of ideological debate and marathon negotiations. Around a dozen are now slowly taking shape in bricks and mortar.
The first of the major English projects to the finishing post is likely to be Dartford and Gravesham, where contractor Tarmac is due to finish construction by August 2000.
Tarmac and other PFI contractors are understandably relieved to have put£2m-3m bills for bid costs behind them and swapped the lawyers' offices for the construction site.
Instead of grappling with ultra vires and risk transfer, they are back to what they know best: co-ordinating different phases of work, sub-contractors and designers. And, evidently, doing it with some success.
No major problems have been reported on any project in turning 1:200 drawings into detailed designs, and all are reported to be on or ahead of schedule. In fact, as far as the two to three-year construction phase is concerned, PFI appears to be no riskier than other contracts at the risky end of the normal spectrum.
And the rewards can be much higher. At recent financial results meetings, at least two contractors have been predicting returns of
20 per cent a year on their equity investments.
Meanwhile, the consultancy firms advising the contractors - architects, engineers and surveyors - are past the stage where they're working at risk and are enjoying fee levels higher than the norm.
The only cloud on the horizon is the prospect of the rules being re-written - and not in the industry's favour - once the Department of Health publishes its long-awaited guidelines on PFI procurement and contracts.
For many construction firms like Tarmac, Kier and Balfour Beatty, the revenue and risks from PFI hospitals are split across three areas: investing equity in the PFI project company, taking on the actual construction contract, then signing up their facilities management companies as service providers.
'From the start, having three revenue streams has been important,' says Mike Archbold, chief executive of Consort, the Balfour Beatty joint venture company building Edinburgh Royal Infirmary and North Durham hospitals. 'We never saw the equity involvement as just a spin-off of the building contract.'
Contractors such as Kier at Law and Hairmyres in Scotland and Amec in Carlisle have recently predicted returns of up to 20 per cent a year on the equity stakes they hold in the project companies, once construction is complete and revenue starts flowing from the trusts.
Equity financing typically accounts for 10 per cent of the projects' capital value. Mr Archbold is more conservative but still upbeat, predicting that Balfour Beatty will be in line for returns of between 10 and 20 per cent a year.
No one is predicting 20 per cent margins from the construction contracts themselves, but the scope exists to out-perform the
1-2 per cent that is standard in construction.
On the fixed-price contracts between contractors and project companies, the former can 'value engineer' the hospitals to shave costs and boost profits.
Finally, there is the guaranteed regular income from 25 to 30-year service contracts to look forward to, with high potential margins of 5-7 per cent.
However the figures turn out, PFI hospitals look like being good news for contractors' shareholders. Martin Hewes, an economist specialising in the construction sector, says: 'If you're getting a regular stream of income and you don't have a major problem like a cost over-run or a design fault, you should do quite nicely.'
The Major Contractors Group, the trade body for the largest construction companies, is keen to put these figures in perspective. According to MCG director Jennie Price, comparing PFI and average industry returns 'isn't very fair - ordinary construction industry standards aren't good enough'.
She also argues that the value of contractors' equity investments is 'not to be overstated', and that the deals in any case were always structured to be attractive to equity investors.
The long-term risks of providing a PFI hospital are still debatable, but in the short term, many potential problems have not materialised.
For instance, contractors report few slip-ups in translating large-scale drawings into the detailed room specifications required by medical staff.
According to Gary Barnes, director of Law and Hairmyres project company Kier Project Investment, 'the monetary value of any changes to the brief has been insignificant'.
At£151m, Norfolk and Norwich contractor Laing has also found that its pencilled-in construction costings have proved robust.
The only noticeable redesign related to improving access and washroom facilities for disabled people, according to project director David Hunter.
Both he and Mr Barnes find working with the respective trust staff straightforward, although Mr Barnes says their enthusiasm can carry them away.
'They sometimes want to give us all the detail at once. We need to know about partitions - we can leave the blinds until later.'
Most other risks are associated with construction, including disputes with sub-contractors, cost over-runs, labour shortages or industrial action. But here, the contractors are enjoying the flip-side of the projects' long gestation periods. Better than average pre-site preparation has meant relatively smooth progress once the projects get on-site.
'The scope for things going wrong is less than normal,' agrees Consort's Mr Archbold, 'but the penalties if they do are worse'. He is referring to the liquidated damages the contractor would pay the project company if it slips up and the trust withholds payments.
Those penalties are being experienced as above-average stress for Richard Howson, Tarmac's project manager for Dartford and Gravesham. 'I can't say how much they are, but it is more than on a normal project.'
Architects, too, are enjoying higher income than they would anticipate in a traditional hospital contract.
A typical arrangement would be to work on the bid for 50 per cent of the agreed fee with the remainder paid if the deal is signed, but forfeited if the project company loses the bid.
The fee is calculated as a percentage of the construction value - perhaps 2-4 per cent on an average project, but slightly higher on PFI hospitals.
Richard Partington, partner in Dartford and Gravesham designer Paulley Nightingale Architects, believes that a fee uplift of '15-20 per cent' compared with a traditionally funded hospital is justified by the health sector expertise they can bring and the risk they take.
'Fee levels are probably a little better than normal,' agrees Julian Cockayne, director of the Percy Thomas Partnership, architect for projects at Bishop Auckland, Barnet and Law and Hairmyres.
Cost consultant and project management firm Cyril Sweett is involved in 12 of the first-wave hospitals, advising the consortia or in the new business of project monitor for the lending banks.
According to director Patrick Waterfield, fees averaged out over long bids work out no higher than normal, but could improve if the process accelerates.
And with one eye on the returns contractors are expecting, Cyril Sweett is considering setting up its own investment company.
Construction's enthusiasm for PFI hospitals is not hard to understand. As an industry, it is trying to move towards long-term clients with guaranteed income streams, a profile PFI hospitals fit.
Even if forthcoming DoH guidance raises the barriers to winning a PFI contract, there is little chance of the construction industry losing interest in PFI hospitals.