What SAGT’s success proves about private infrastructure investment

Concluded in 1999, a private investment in a container terminal had no parallel. We now meet the deal's main architects to understand how it’s relevant for Sri Lanka’s future infrastructure investment
BY SHAMINDRA KULAMANNAGE AND MITHULA GUGANESHAN

Some people are born with more proclivity for deal-making. For Mano Nanayakkara, the government’s then-chief negotiator for the biggest private sector concession to that date, that meant negotiating like a pit bull. Nanayakkara, then-general manager of the Bureau of Infrastructure Investment (BII), ticked all the boxes of a conventional dealmaker: he was boisterous, commanded a larger-than-life presence and always welcomed a fight. In the deal’s final tassel, that conflict was due to a potential $3 million annual income the concessioner stood to gain, which the government’s negotiating team was intent on seizing.

“I told them that since you haven’t counted it as a part of the income, then you shouldn’t mind losing it. So I insisted it’s fair that I keep it,” Nanayakkara recalls the negotiations leading up to the government awarding a concession to a group led by John Keells Holdings and then global shipping line P&O to develop and operate a container handling facility at the Colombo port.

SAGT was initiated in an entirely different era, says Manohan Nanayakkara, chairman of Asia Capital PLC

Somehow, storage rent, paid by a consignee who fails to remove a container within the specified free storage period, hadn’t been reckoned with during the negotiations, and by default, stood to accrue to the JKH and P&O-led investors who were tantalizingly close to striking a deal to develop Colombo Port’s Queen Elizabeth Quay (QEQ) into a modern and efficient facility, almost quadrupling its then container handling capacity to 1.1 million twenty foot equivalent units annually. Nanayakkara’s attempt to seize the estimated $3 million in storage rent, or escalate the deal’s annual fees by an equivalent amount, irked investors who were already complaining that the negotiation was long-drawn.

Nanayakkara recalls that President Chandrika Kumaratunga was ‘really upset’ during the meeting, which was the last he attended with her. “This deal was very important to her and she requested the investors keep the storage rent,” he recalls the events from 1999. He speculates that the investors may have ‘threatened to walk away from the deal’ if the storage rent was denied to them.

Building ahead of demand has maintained Colombo’s position as South Asia’s top port. The port’s second deep water terminal may be built with private sector investment following the twin successes of SAGT and CICT

At first, the government negotiating team’s professionalism, rigor and unconventional strategy weren’t so apparent to the lawyers sitting across the table during the deliberations on the concession, and nine other related agreements over a 10-month long period. When it became apparent, the government team, by design or default, faced a paradox, as much ground had already been ceded by the investors.

“We were more or less playing good cop, bad cop,” reveals Thilan Wijesinghe who, as Board of Investment chairman, oversaw the BII and was ultimately responsible for the negotiations. The paradox was that Mano Nanayakkara’s theatrics flew in the face of conventional wisdom of what and how a government negotiator should approach a deal.

Wijesinghe had been warned of Nanayakkara’s volatile nature by a promoter of the CF Venture Fund, where Nanayakkara was chief executive before accepting the role as BII’s general manager. Wijesinghe, a dealmaker himself as BOI chairman and at investment bank Asia Capital before that, was experienced enough to understand that negotiating isn’t a power struggle won by the most forceful person in the room.

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lthough 16 potential investors expressed interest (and were issued Request for Proposal/RFPs) to develop the QEQ to a modern terminal, only the JKH-led combine submitted a bid, requesting a 50-year lease on the terminal for an annual $2 million rental and offering a 7.5% shareholding to the government-owned port manager, Sri Lanka Port Authority. The government team also comprised young professionals from the then-BII and the Attorney General’s Department.

Although the JKH and P&O combine was the only bidder, the negotiating team dismissed the investors’ financial offer during the first round of negotiations in April 1996. By the time the deal was concluded, the team had managed to reduce the lease term to 30 years, secure a royalty for every container handled at the facility and double the SLPA’s stake in the venture to 15%.

Excluding the SLPA revenue from port services to ships calling at SAGT, revenue in 2016 from lease rentals, royalty and dividends stood at $14.05 million, which was close to the forecast revenue of $16.7 million made at the time the deal was concluded in 1999. In the 16 years since 2000, SAGT’s contribution to the government (to SLPA) in lease rentals, royalty and dividends was $182 million, just 9% short of the forecast $200 million for the period. These, however, are only part of the revenue the SLPA earns. Wharf handling, wharfage (for the use of the wharf) and navigation charges from ships calling at SAGT were forecast at $263 million for the 16 years to 2016. SLPA executives were unable to provide earnings from ships calling at SAGT, but the amount is most likely much higher than forecast at the time of leasing the QEQ. This is due to SAGT operating at a far higher capacity than the 1.1 million annual TEU it was designed to handle since construction on all three of its berths were completed in 2014.

Thilan Wijesinghe, chairman and acting chief executive of the Public Private Partnership Unit at the Ministry of Finance, talks about going the extra mile

At its peak in 2010, SAGT handled 1.97 million TEUs, nearly double the capacity it was designed to handle. By 2016, when competition from a new Chinese-funded deep-water terminal at a Southward expansion of the port had eroded its market share, SAGT still handled 1.63 million TEUs, a level still over 50% above its design capacity.

The occupying British developed Colombo’s port so they could export Ceylon’s agricultural produce. Since the British left, Colombo Port’s fortunes continued to be linked to Sri Lanka’s agricultural might and its openness to the rest of the world. During many of these decades, Colombo’s competitiveness in the region remained because the largest ships sailing could enter the harbor. Visionary leadership – building Colombo Port’s first container terminal 30 years ago – geography and canny private investment firmed Colombo’s position as a global shipping hub. In 1979, soon after Sri Lanka adopted market-based economic polices, it established the Sri Lanka Port Authority (SLPA) as the owner, operator and regulator of ports. SLPA’s Managing Director Sarathkumara Premachandra, whose association with the port stretches back decades, contends that it would have perished as a hub without the right kind of capacity to meet evolving demand; the investment by SAGT ‘breathed new life’ into the port.

The completion of the Japanese government-funded Jaya Terminal and introducing containerized cargo to the Colombo Port in 1985 helped it leap to the league of the world’s top 30 container hubs. In the decades since, Chinese, Middle Eastern, Singaporean and Malaysian ambition saw the emergence of giant hub ports around Sri Lanka. Political leadership also faltered here. Without competition, the SAGT-controlled Jaya Terminal was relatively inefficient compared to competitors in East Asia and the Middle East. As a result, the sea port started loosing business to regional competitors due to increasing congestion and sub-par productivity. The private sector-developed port terminal reversed this decline.

When QEQ was expanded into what is now called SAGT between 2000 and 2004, the SLPA decided to deepen the harbor up to 15 meters and reinforce the quay wall of the Jaya Terminal. SLPA Managing Director Premachandra says the improvement of port capacity in this manner was one of the two important outcomes of SAGT being set up. The second improvement was the change in attitudes that took effect. “When a monopoly handles a business, I don’t have to tell you the kind of attitude people develop towards the client. With competition came the change in attitude. These were results of SAGT’s development; if not, Colombo would not have survived as a hub port.”

Efficiency is at a premium in the competition for global transshipment market share and berth productivity – measured as moves per hour of gantry cranes; and CICT and SAGT, Colombo’s private sector terminal operators, compare well against the world’s best. Colombo once again ranks in the global top 25 in container traffic volumes. Eleven of the ports bigger than Colombo are in China (including Hong Kong). Only 13 global ports handle more than 10,000 TEUs annually, according to 2014 data.

In 2016, Colombo handled 5.7 million containers (TEUs), which is forecast to top 6 million in 2017. Building ahead of demand has maintained Colombo’s position as South Asia’s top port. The port’s second deep water terminal may be built with private sector investment following the twin successes of SAGT and CICT.

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ri Lanka’s former ports minister Arjuna Ranathunga said the Port Authority made profits of $73 million (Rs11 billion) in 2016. It was reported that the Port Authority received Rs4.4 billion from SAGT and Rs5.7 billion from CICT. However, the composition of these two payments, totaling Rs10.1 billion, almost equal to the SLPA’s profit, is unclear. Recent SLPA annual reports are unavailable on its website. Private sector capital ought to be the perfect match for public sector projects that governments don’t have adequate resources to prioritize. Besides sea port container terminals, Sri Lanka has funded public infrastructure like power plants with private sector capital.

Sarathkumara Premachandra, managing director of the Sri Lanka Port Authority, discusses the transformation within the port

Private capital funding public infrastructure is now referred to as Public-Private Partnerships, or PPPs. During the late nineties, when the SAGT deal was arranged, PPP was not a part of nomenclature. However, SAGT’s success – like with all great PPPs – is due to it addressing a challenge around infrastructure, tight fiscal space, growing demand and jobs.

When PPPs are structured well, infrastructure users also benefit from the innovation and efficiency that private capital brings to the table. However, simply applying private capital to infrastructure gaps isn’t guaranteed to solve problems. In fact, PPPs’ short history is also littered with examples of how some investments have failed to live up to expectations.

The SAGT PPP was challenged at three levels: establishing a case to align financial and other interests of all parties, political interests that sour projects of this magnitude, and poorly negotiated lopsided deals unpopular with users. When it was first proposed to expand the QEQ to ease congestion at the port and maintain its position as a regional shipping hub, the Japanese government had expressed its willingness to finance the development. Mano Nanayakkara recalls an officer of the Overseas Economic Cooperation Fund (OECF), predecessor to Japan Bank for International Cooperation (JBIC), pointing to the port from the vantage of BII’s office at Colombo’s World Trade Centre saying, ‘that is our port,’ in a forceful posturing for Sri Lanka to accept the option of a Japanese loan to develop the QEQ. Nanayakkara, not easily intimidated and quick-witted, countered that it was the port of Sri Lanka he was somehow claiming ownership of. A decade earlier, when the Jaya Container Terminal was completed, the Japanese hadn’t envisioned expanding the QEQ in the same scale that the JKH and P&O combine were proposing.

Visionary leadership – building Colombo Port’s first container terminal 30 years ago – geography and canny private investment firmed Colombo’s position as a global shipping hub

They (the Japanese) altered their master plan to include extensive QEQ expansion, and submitted a proposal similar to that of P&O and JKH. They didn’t want to let go,” according to Waruna Rajapaksa, then a senior financial analyst at the BII. Rajapaksa recalls the bleak security outlook in Sri Lanka in 1995 when the transaction was initiated. Soon, the Asian Financial Crisis unfolded, restricting access to financing, and neighboring India and Pakistan conducting tit-for-tat nuclear tests destabilized in South Asia.

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eeping debt off the government’s balance sheet wasn’t the only criteria to pick private sector financing of the two polar opposite options available for QEQ expansion. Wijesinghe kept BII and the AG department’s team focused on where risks can be managed best. The government’s cost of capital was lower, with access to soft loans – the type Japan’s OECF offered. However, the BII team figured that the lowest cost wasn’t the only measure, and instead, risks should be allocated where it’s best managed. Commercial incentives encourage private companies to meet deadlines, contain construction and operating costs, and make sure customers are happy with the service. In the 1990s, the state-controlled Jaya Terminal, despite its state-of-the-art facilities, was far less productive than those at the best regional ports. The SLPA-managed terminal was strike-prone, and its employees had to be bribed to load and unload containers from ships.

SAGT was estimated to cost $246 million to extend and widen the quay, add new cranes to move containers from ships and stack them on top of each other on the yard, and trucks and other facilities to handle increased volume. A World Bank research study titled ‘Competitiveness of South Asia’s Container Ports’ revealed that SAGT had only cost $154 million to develop, a far lower amount than initially forecast.

Wijesinghe, who now heads a new agency under the Finance Ministry overlooking the government’s PPP strategy, points out that the entire market risk was on the SLPA. “It would have had to operate the terminal to earn revenue. In the P&O-JKH deal, the government was guaranteed minimum revenues and didn’t carry the market risk.”

Unless the government was willing to continue to manage these risks, distracting it from the task of governance, private sector capital was necessary to transfer them.

Those involved with SAGT’s entry almost 20 years ago interviewed by Echelon credit President Chandrika Kumaratunga for understanding why risks were better transferred to private investors. Twenty years before, SAGT’s entry had seen strikes, work stoppages and resistance to change at the Colombo Port, undermining Sri Lanka’s hub ambitions. However, there was opposition to the deal. The port’s chief engineer opposed private investment and preferred the Japanese-funded route. At a crucial meeting chaired by the president, including backers of both financing options, the BII team led by Wijesinghe presented their financial case.

The JKH-P&O consortium proposed to increase annual container handling from around 250,000 TEUs to 1.1 million TEUs, whereas the Japanese proposal envisaged capacity of around 750,000 TEUs. “We ignored the macro benefits and analysed the options based on cost per TEU. Interestingly, the Japanese proposal was 2.2 times more expensive due to the padded-up construction and operating costs,” says Wijesinghe. Once the presentations were concluded, the president addressed Ports and Shipping Minister M H M Ashraff and said, “Minister, this looks like an open  andshut case!” alluding to the point that picking the private sector proposal was in the country’s best interest.

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ublic Private Partnerships work best when the funded infrastructure generates a stream of revenue. For a port, revenue comes from ships, importers and exporters. In a power plant, the sale of the electricity to consumers generates revenue, and on a highway, vehicles pay a toll. PPPs work less well when returns need to be enhanced with public subsidy. In the case of SAGT, the SLPA earns an annual lease rental of $2 million a year (adjustable to the US inflation rate), $3 royalty for every container handled anddividends for its 15% share ownership in the company (half of this share ownership was granted free to the SLPA, while it invested for the rest of it at the project’s outset).

All stakeholders are served well when a PPP’s structure aims to minimise risks. Investors then demand a lower risk premium because the operation is more predictable, regulations clear and disputes settled easily. Committed PPPs also perform poorly when private capital cannot gauge or reasonably bear risks.

On a PPP, how much risk can be pushed to private contractors will often depend on the project’s cash flows, and the certainty of revenue meeting forecasts.

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nly part of Colombo’s success is due to its location – a halfway point in the shipping route between Asia, Europe and the Middle East. Crucially, in a region plagued by instability, inefficiency and weak infrastructure, Colombo has been a safe haven. Sri Lanka is home to 0.25% of the global population, and contributes 0.18% to global trade by value, and 12% of the world’s container shipping tonnage calls at the Colombo Port. Of more than a dozen containerised ports west of Port Klang in Malaysia and east of Salalah in Oman, only Colombo has the

Waruna B.C. Rajapaksa, executive vice president of John Keells Group, says SAGT generated around 1.6 million TEUs in 2016

capability to dock the largest container vessels sailing the high seas today. Colombo has flourished by building a bigger port and investing in rapid-loading equipment to efficiently manage giant new generation ships. Romesh David, a JKH veteran and now chief executive of SAGT, gestures while chatting during the photo session for the story. “You can see the real potential from up here,” he points to the Eastern section of the new Colombo South Port, where the harbor basin has been partially reclaimed from a new container terminal. “This should have been completed four years ago,” he says.

Development at Colombo’s new South Port, completed with Asian Development Bank funding and where the Colombo International Container Terminal (CICT) is located in the middle, has stalled due to a process to select a developer being halted.

“Every time we faltered in building capacity, the port kind of froze and we had stultified growth. We are in a capacity-led business. If you look at our neighbours, Singapore and Dubai, they are creating capacity 20-30 years into the future.”

The south harbor expects to add 10-12 million TEUs (including CICT) to meet future demand growth. “Essentially, we’ve struggled since 2005 as a result of faltering privatisation and public private partnership programmes. Infrastructure became purely a government undertaking.”

David, who has witnessed JKH transform from an agency-led business to a diversified business with many joint ventures, is relieved that private capital may be an option for infrastructure development in the future, but is bemused about delays in the East Container Terminal bidding process.

“This port is 80% transshipment, and this is the most mobile of businesses. This can be moved by the lines anywhere from Colombo,” he says.

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ollowing a six-year stint at BII, Waruna Rajapaksa joined John Keells Holdings in 2002, three years after the SAGT deal had been finalised. JKH agreed to his request that he not deal with anything related to SAGT in his role heading special projects. In 2014, 12 years after joining JKH, Rajapaksa was appointed to the SAGT board. During an interview, Rajapaksa only commented about his time at BII when the SAGT negotiation took place. He recalled how, at times, the JKH and P&O consortium was critical of the long-drawn-out negotiations. “They were oblivious of the internal stakeholder issues we had to deal with. In fact, they even complained to the president several times,” he said.

Besides the influential port engineers, trade unions, and posturing policymakers and politicians, all of who’s financial and other interest had to be aligned, the then-leader of the opposition and current prime minister addressed a letter to Thilan Wijesinghe about a private operator possibly monopolizing the port to the detriment of the government’s own SLPA-controlled Jaya Terminal. Touchy public opinion makes for jumpy politicians. The deal’s complexity, not unusual in PPP agreements, and the three-year-long negotiation can result in confusion. BII dealmakers endeavored to keep stakeholders informed, but the sheer number of moving parts makes such a task an exercise in catching up. Wijesinghe responded to the then-leader of the opposition with a six-page explanation about the proposed concession agreement, the main document granting the lease, and the scope of nine other agreements also being negotiated which addressed, among other things, the fear that all ships will be diverted to SAGT on some priority basis.

Romesh David, chief executive of South Asia Gateway Terminals

The harbor master decides which terminal a ship will call, even if the shipping line has been signed up by a terminal. SAGT’s advent also had the potential to alter the SLPA’s role in the port. Instead of being the owner, regulator and operator of ports, the SLPA now sees itself as a landlord. It owns the ports and, so far, remains the regulator. However, following the SAGT terminal being developed as a PPP, it struck a similar agreement with a Chinese company for CICT. There is vast gray area in most people’s minds about PPPs and what constitutes privatisation. Anxieties about privatizing essential services, like electricity, water and transport, are universal. In contrast, PPPs or the privatisation of seaports and airports aren’t as controversial as ones involving utilities and transport infrastructure. A lot ultimately depends on what the public has become used to. The romanticised view of agriculture over millennia here will make PPPs involving water controversial, unlike in the UK where public attitude to private water companies is quite relaxed. However, private ownership in telecom and electricity generation is widely acceptable here, as is the landlord-model for port capacity development.

Sri Lanka’s approach to future PPPs, a strategy being crafted by the unit headed by Thilan Wijesinghe at the Ministry of Finance, will succeed if he is able to navigate as deftly as he did the BII decades earlier. SAGT’s enduring success is due to its ability to align financial and other interests of all stakeholders, including SLPA employees and even secure bi-partisan political support.

The second challenge that SAGT overcame, and PPPs of the future must deal with, are opportunistic politicians intent on capitalizing on public anxiety to kill these initiatives or drain support for them. Third, government capacity to negotiate complex deals, extracting reasonable long-term value for people, will reinforce the role private capital can play in developing and replacing creaky infrastructure.

Amali Rajapakse a senior infrastructure specialist at the World Bank, based in Colombo, was also at the BII when the SAGT concession was under negotiation. The World Bank, in a study on how PPPs can be used to accelerate infrastructure investments, suggests that the success of SAGT can be replicated in other sectors. It says, during 1995 to 2015, private sector investment in Sri Lanka totaled $4 billion across the transport, telecom and electricity sectors.

As part of its support to Sri Lanka, the bank is assisting to build the government’s capacity for PPPs. Rajapakse says the process underway aims to prioritise projects and sectors where PPPs can be fast-tracked. “The formation of the PPP unit at the Ministry of Finance came as a recommendation from the bank, to which the government was vey responsive.”

The World Bank highlights that overreliance on public finance, lack of project prioritisation, multiple agencies with overlapping functions, limited institutional capability, overreliance on unsolicited proposals, limited debt market capacity to finance infrastructure projects and land valuation as challenges to PPPs here.

Amali Rajapaksa highlights advancing developments in the future through public private partnerships

“The idea is to build capacity to handle larger and more complex transactions, and we (the World Bank) will help with technical support,” Rajapakse says. To improve the PPP framework, policy, institutions and legal processes all need working on.

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uring the first call, I assured her not to worry and that I would ensure he isn’t aggressive in his dealings,” says Thilan Wijesinghe, about a phone call from the president to express concerns about Mano Nanayakkara’s aggression and possible delaying of the deal. “However, on the other hand, I encouraged Mano to extract more value from the deal,” he confesses. A few months later, President Kumaratunga called to say the negotiations were taking too long. Wijesinghe had to placate her and bought more time for the negotiating team led by Nanayakkara to continue haggling for better terms.

“I knew what she was going to say when the third call came. I asked her for three more weeks. She refused and requested Nanayakkara be removed from the negotiation table. The game was up. We closed the deal and signed the agreements.”

A dejected Nanayakkara quit the BII following his removal from the negotiating team. However, the results of that deal, far ahead of its time when it was concluded, have vindicated him over time.

Reminisces Nanayakkara, “I liked the cut and thrust of the negotiation, and I wasn’t easily intimidated. That’s why we were so successful.”

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