Managing megaprojects: How joint ventures help companies share the risk and reward
A $2 billion highway in Arizona, a $1 billion tunnel in Seattle, a $4 billion LNG liquefaction facility in Louisiana, a $2 billion light rail extension in Canada — all of these projects fall under the category of "mega." The U.S. Federal Highway Administration defines megaprojects as major infrastructure projects that cost more than $1 billion, but in that definition, the FHWA includes large-cost projects that attract a great deal of public attention or political interest because of community, environment or budgetary impacts.
Using that wider definition, many other high-profile projects would qualify as well, such as the $530 million contract the team of Mortenson Construction and Welbro Building Corp. scored to build the Gaylord Rockies hotel and conference center in Aurora, CO. And there are plenty of these huge projects popping up across the U.S.
Megaprojects on the rise
Lawrence McLaughlin, a partner and chair of the Real Estate Department at Honigman Miller Schwartz and Cohn, said the increase in large projects is one of the realities of a recovering industry. "What we have been seeing over the last couple of years is ramping up of the construction industry and projects after a bit of a lull. So we are seeing more activity," he said.
And the dollar value of these projects keeps increasing as well.
Stuart Binstock, president and CEO of the Construction Financial Management Association (CFMA), said one of the reasons for that upward march in cost could be the fact that many government agencies that used to split up or "unbundle" large infrastructure projects into smaller sections — enabling more modest players to participate — are rethinking that strategy and beginning to award these projects via a single-bid process again.
"I think it’s all because of the cost. I think the contract costs would increase if you’re going to have to manage five contracts as opposed to one," he said.
However, if you look at the big names involved in many of these giant construction joint ventures — Turner Construction, Mortenson Construction, Skanska, Fluor — these formidable construction companies have the talent pool and financial resources to tackle even the largest of projects on their own. And while a joint venture between two large companies is nothing new, why would a company that can go solo choose a joint venture?
The experts agree that the reasons companies choose to form a joint venture usually fall into one or more of four categories:
- Risk allocation
- Bonding capacity
- Smoother entry into a new geographical area
- Benefits of another company’s expertise
Spreading the risk and increasing bond capacity
McLaughlin said that even though huge projects hold the possibility of considerable profits, the construction business is still a risky pursuit. "On some of these very large projects, (a joint venture) is a way for the contractors to control the amount of liability and risk that they're taking on by having a joint venture partner share in the transaction," he said.
Andrew Richards, a partner at the New York law firm of Kaufman Dolowich Voluck, said, "You want to spread the risk."
Bonding capacity is another deciding factor. Most public projects, and large private ones as well, require the contractor to provide payment and performance bonds, a type of insurance policy that guarantees all the bills on a project will be paid and that the project itself will be completed.
"One of the issues for even a Turner and some of these big companies is bonding capacity," Binstock said.
McLaughlin added, "The larger projects will eat up more of a contractor's bonding capacity because there is a limit to how much work (a surety company) will bond. If they take on some of these projects 100%, without a joint venture partner, it can then preclude them from being able to qualify on other projects to the extent that their bonding capacity is eaten up."
Bonding capacity is a "big driving force" in the decision to take on a joint venture partner, Richards said.
"Even though a Turner or Tishman or an AECOM has big bonding (capacity), they also have a lot of projects in play, and it’s not unlimited bonding capacity," Richards said. "They have a (bonding) program which gives them up to X dollars at any one point in time, and, when they take on a project, they only have Y dollars left."
New markets and varied expertise
Another factor that might encourage a joint venture on a certain project is when a large contractor takes on a job in a new market.
Binstock said, in that scenario, it’s common for a national company to partner with a local contractor who is more familiar with the area.
"The one who’s based locally already has a lot of the relationships with the subs, the engineering community, the architectural community, and is better attuned to some of the political issues that might arise on a big project," Binstock said.
Partnering with a company familiar with the project turf is especially important in a city like New York, according to Richards.
"There’s a lot of red tape in New York, and, if you’re from out of town and you haven’t done a job here yet, you’re really doing yourself a disservice by not partnering up with a local contractor," he said. "A lot of contractors will come from out of town and do a public works (project) in New York, and they’ll get their head handed to them because they don’t understand how these agencies really operate."
Collaborating with a smaller contractor can also be the result of minority or local participation requirements on publicly funded jobs. Subcontractors usually fill these requirements, but some projects require participation at a joint venture partner level.
"One of the ways for a big GC to meet those requirements," Binstock said, "is to partner with a local minority contractor. That can help them go a long way towards meeting their minority and local requirements."
But the bigger company is not the only beneficiary of such an arrangement. McLaughlin said the smaller company wins, too.
"It becomes a mutually beneficial arrangement where the larger company is able to take advantage of the knowledge and the local connections of a smaller company, and the smaller company is able to benefit from taking on a job it might not otherwise qualify for," he said.
Finally, some companies tackle large projects together to take advantage of each other’s technical expertise.
"If you’re doing a big road project, and there are some bridges in the middle of the road project, and you’re primarily a road builder, you probably want to partner with somebody who has the technical expertise to build a bridge," Binstock said.
JV agreements or 'divorce papers'?
In a perfect world, all joint ventures would end on a successful note, but, unfortunately, that’s not always the case. In a recent, high-profile dustup, the Massachusetts Bay Transportation Authority cleaned house of all lead contractors on its now-$3 billion Green Line extension debacle, and the joint venture of White-Skanska-Kiewit is set to wrap up some work on the project, as well as the joint venture.
"What most people don't realize in these situations is that the joint venture agreements are, in reality, divorce papers," McLaughlin said. "Nobody ever needs to go back and read a joint venture agreement if everything is great and everybody's making money. You only need (to revisit) these agreements when things go wrong and either the project falls apart or problems arise that erode profitability."
Even with the inevitable problems inherent in the construction business, megaprojects are only going to increase as long as construction costs keep rising, according to Richards.
McLaughlin said he believes public-private partnerships, or P3s, will play an increasingly significant role in megaprojects. P3s allow a private company or group to collaborate with a public entity and assume much, if not all, of the financing and construction risks, as well as long-term maintenance.
"I think it's moving in that direction," he said. "It's been talked about for a long time, but I think it's getting more and more attention as a viable structure and a way to allocate risks and rewards."