TECHNICAL REVIEW OF THE PUBLIC-PRIVATE PARTNERSHIP PRISONS CONTRACTS FOR THE
PPP PRISONS TASK TEAM
8 November 2002

EXECUTIVE SUMMARY
This Report summarises the work of the multi-departmental Task Team comprising officials from the Department of Correctional Services (the Department or DCS), Department of Public Works (DPW) and National Treasury, in reviewing the Public Private Partnerships (PPP) Prison Contracts. The objectives of the Task Team were to understand the existing PPP contracts in order to establish a sound basis for their management, identify areas for renegotiation and establish a framework upon which decision making processes for future prisons could be based.
Part A of the Report is in two sections. The first contains a review of the existing Asset Procurement and Operating Partnerships (APOPS) PPP prison projects, structures, specifications, empowerment requirements, financial structures and risk transfer. The second section explores areas that can be re-negotiated with the Contractors.
Part B is also in two sections. The first is an illustrative comparison of the specifications, operating costs and capital expenditure of the PPP prisons and a few selected public prisons. The second sets out a framework Ė a Prison Feasibility Protocol - by which the optimal method of procuring future prisons can be decided upon by DCS.
Part C concludes the report with a set of recommendations on the way forward.
The main conclusion from this review is that the two PPP prison deals delivered custodial services according to DCSí specifications, with both positive and problematic results.
The notable achievements in the PPP prison deals are:
 
Competitive construction costs.

Construction on time, on budget.
Fast-track delivery (less than two years from contract signature to full operating capacity).
Operating costs per prisoner per day that are broadly comparable with the public sectorís operating costs.
Significant levels of black equity in the Contractors, and significant involvement of black sub-contractors in the deals.
Significantly higher quality facilities than is the norm to date in South African prisons.
Significantly higher levels of service than is the norm to date in South African prisons.
Appropriate allocation of financial, technical and operational risk to the private parties.
The problem areas in the PPP prison deals are:
 
DCS design and operating specifications were too high, based on ideal prison conditions, and the prisons remain driven by high DCS input specifications.

Additional budgetary pressures for DCS, resulting from the lack of feasibility work that should have established DCSí affordability limits prior to procurement.
Relatively high costs of debt due to high base interest rates prevailing at the time of the deals and higher than normal margins charged by Lenders.
Higher than normal return on equities for both projects.
Inability to over-populate the PPP prisons, despite severe overcrowding in DCS system.
The recommendations emanating from these conclusions are that:
DCS, supported by National Treasury, should urgently convene a team, including financial and legal experts, to engage with the Contractors to improve value for money by:

Reviewing standards and specifications.
Amending the fee payment structure.
Considering options for accommodating additional prisoners on a marginal cost per inmate basis.
Negotiating debt funding to improve cash flows and net present value benefits, including considering inflation-linked funding.
DCS should adopt as policy the Task Teamís Prisons Feasibility Protocol for use in assessing the preferred options for procurement of all future prisons.
DCS, supported by National Treasury, should set clear policies, processes and decision making structures for procurement of future prisons.
DCS, supported by National Treasury, should set and publicly announce DCS policy on unsolicited bids.
DCS should plan for the training of key personnel in:
DCS Prison Feasibility Protocol and
DCS Procurement policy, methods and standards.
INDEX
EXECUTIVE SUMMARY *
LIST OF ABBREVIATIONS *
LIST OF ABBREVIATIONS *
INTRODUCTION AND BACKGROUND *
 
PART A: EXISTING PPP TRANSACTIONS *
A.1 OVERVIEW OF EXISTING PPP TRANSACTIONS *
A.1.1 PROJECTS STRUCTURES *
A.1.2 SPECIFICATIONS *
A.1.3 COSTS AND REVENUES *
A.1.3.1 Bloemfontein *
A.1.3.2 Louis Trichardt *
A.1.3.3 Summary of the PPP Projects Funding Structures *
A.1.3.4 Risk Matrices *
A.2 OPTIONS FOR RENEGOTIATION *
A.2.1 OVERVIEW *
A.2.2 CAPITAL EXPENDITURE *
A.2.3 OPERATING EXPENDITURE *
A.2.4 REFINANCING *
A.2.5 RISK TRANSFER *
A.3 CONCLUSIONS AND RECOMMENDATIONS *
A.3.1 KEY FEATURES *
A.3.2 RE-NEGOTIATION OPTIONS *
 
PART B: FUTURE EVALUATION METHODOLOGY *
B.1 ILLUSTRATIVE COMPARISONS OF PUBLIC AND PPP PRISONS *
B.1.1 SPECIFICATIONS *
B.1.2 OPERATING COSTS *
B.1.3 CAPITAL EXPENDITURE *
B.1.4 CONSTRUCTION COST FOR GOVERNMENT *
B.2 OVERVIEW OF TREASURY REGULATIONS FOR FEASIBILITY STUDIES *
B.3 PRISONS FEASIBILITY PROTOCOL *
B.3.1.1 Needs Analysis *
B.3.1.2 Options Analysis *
B.3.1.3 Feasibility Phase *
B.3.1.5 Design Input *
B.3.1.6 Operations Input *
B.4 CONCLUSIONS AND RECOMMENDATIONS *
B.4.1 APPROACH TO FUTURE PRISON CONSTRUCTION AND OPERATION *
 
PART C: RECOMMENDATIONS FOR NEXT STEPS *
 
REFERENCES *
 
ANNEXURE 1: SPECIFICATIONS COMPARISONS *
ANNEXURE 2: CONTRACT DOCUMENTS *
ANNEXURE 3: TERMINATION *
ANNEXURE 4: RISK MATRICES *
ANNEXURE 5: DCS BUDGET 2002/03 *
ANNEXURE 6: GENERIC PPP PROJECT LIFE CYCLE *
 
 
 
LIST OF FIGURES
 
Figure 1: Bloemfontein: Parties to the Contracts *
Figure 2: Bloemfontein: Document Tree *
Figure 3: Louis Trichardt: Parties to the Contracts *
Figure 4: Louis Trichardt: Document Tree *
Figure 5: Bloemfontein Capital Expenditure Structure *
Figure 6: Bloemfontein Annual Revenue Structure *
Figure 7: Bloemfontein Real Indexed Fee Adjusted for "K-factor" *
Figure 8: Bloemfontein Project Funding Cash Flows During Construction Period *
Figure 9: Bloemfontein Construction Stage Funding Structure *
Figure 10: Bloemfontein Project Funding Cash Flows During Operation Period *
Figure 11: Bloemfontein Operation Stage Capital Structure *
Figure 12: Louis Trichardt Capital Expenditure Structure *
Figure 13: Louis Trichardt Fee Structure for Period 1 May 2003 Ė 30 April 2004 *
Figure 14: Louis Trichardt Real Indexed Fee Adjusted for "K-factor" *
Figure 15: Louis Trichardt Project Funding Cash Flows *
Figure 16: Louis Trichardt Project Funding Structure *
Figure 17: Prisons Feasibility Protocol *
Figure 18: Termination Procedure for the two Contracts *
Figure 19: Generic PPP Project Life Cycle *
LIST OF TABLES
 
Table 1: Empowerment Requirements and Monitoring *
Table 2: Bloemfontein Underwriting and Arranging Fee *
Table 3: Bloemfontein Commitment Fee *
Table 4: Bloemfontein Debt Service Interest *
Table 5: Bloemfontein Fee Structure *
Table 6: Bloemfontein Indexed and Fixed Fees *
Table 7: Bloemfontein Financing Terms and Conditions for Construction Period *
Table 8: Bloemfontein Sponsor Equity *
Table 9: Bloemfontein Empowerment Equity *
Table 10: Bloemfontein Financing Terms and Conditions for Operation Period *
Table 11: Bloemfontein Debt Service Payments (period with year ending 30 Sept 2003) *
Table 12: Louis Trichardt Construction Costs Breakdown *
Table 13: Escalation of Fee Payable *
Table 14: Louis Trichardt Fee Structure *
Table 15: Louis Trichardt Indexed Fees *
Table 16: Louis Trichardt Terms and Conditions *
Table 17: Louis Trichardt Debt Service Payments for period 1 May 2003 to 30 April 2004 *
Table 18: Summary of Louis Trichardt and Bloemfontein Funding Structures *
Table 19: Number of Prisoners Expansions *
Table 20: Refinancing Assumptions *
Table 21: Bloemfontein Theoretical Refinancing Benefits *
Table 22: Louis Trichardt Theoretical Refinancing Benefits *
Table 23: Comparison of Private and DCS-Operated Prisons *
Table 24: Comparison with Public Costs *
Table 25: Comparison of Risk Transfer of Construction Costs *
Table 26: Illustrative Comparison: Government Funded Construction Cost *
Table 27: Government PPP Framework, Guidelines and Regulations *
Table 28: Goals and Output Specifications *
Table 29: Typical Design Areas *
Table 30: Operational Input *
Table 31: Way Forward *
Table 32: Specifications Comparisons *
Table 33: Bloemfontein: Shareholders Agreements *
Table 34: Bloemfontein: Design & Construction Agreements *
Table 35: Bloemfontein: Operating Agreements *
Table 36: Bloemfontein: Financial Agreements *
Table 37: Louis Trichardt: Shareholders Agreements *
Table 38: Louis Trichardt: Design & Construction Agreements *
Table 39: Louis Trichardt: Operating Agreements *
Table 40: Louis Trichardt: Financial Agreements *
Table 41: Bloemfontein Termination Clauses *
Table 42: Louis Trichardt Termination Clauses *
Table 43: Bloemfontein Risk Matrix *
Table 44: Louis Trichardt Risk Matrix *
LIST OF ABBREVIATIONS

APOPS

Asset Procurement and Operating Partnership (programme of DPW)

AvPP

Available Prisoner Place

BCC

Bloemfontein Correctional Contracts (Pty) Ltd

BMS

Building Management System

CCTV

Closed Circuit Television

CEOD

Contract Event of Default

CFO

Chief Financial Officer

COD

Contractual Opening Date

CPI

Consumer Price Index

CTA

Common Terms Agreement

D&C

Design and Construction

DCS

Department of Correctional Services

DEOD

Department Event of Default

DPW

Department of Public Works

DRD

Debt Raised Date

EDL

Essential Drug List

FOD

Full Opening Date

JV

Joint Venture

NPV

Net Present Value

O&M

Operating and Maintenance

PDE

Previously Disadvantaged Enterprises

PDI

Previously Disadvantaged Individuals

PPP

Public Private Partnerships

SACS

South African Custodial Services (Pty) Ltd

TA

Treasury Approval

 
INTRODUCTION AND BACKGROUND
South Africaís first two PPP prisons are located at Bloemfontein in the Free State and at Louis Trichardt in Limpopo. The procurement of these deals was initiated in 1997, led by DPWís APOPS and DCS. The contracts with the private consortia were signed in March 2000 (Bloemfontein) and August 2000 (Louis Trichardt). Both prisons were constructed in less than 18 months, and were fully operational by July 2001 (Bloemfontein) and March 2002 (Louis Trichardt).
The projects were planned and procured prior to the establishment of the Treasury Regulations for PPPs, which were first published in May 2000. The strict legal criteria currently in place for ensuring affordability, value-for-money and appropriate risk allocation in PPP deals were therefore not in force at the time when the PPP prisons were procured.
It should be noted at the outset that no comprehensive feasibility study was conducted by DCS or DPW prior to approaching the market for proposals to design, build and operate the two private prisons, thus accounting for many of the problems that have subsequently arose.
It has come to the attention of the National Treasury that the DCS is experiencing significant affordability constraints in meeting its contractual obligations in respect of the two PPP prisons. It appears furthermore, that the DCS output specifications for these prisons set higher construction and operational standards than is the norm for South Africaís prisons, resulting in a lack of parity in the countryís Correctional Services system. In addition, some members of the DCSís original APOPS project team were recruited by the private consortia and now play operational roles in the private prisons. Owing to numerous senior management and staff changes at DCS in the period 1998 to present, there is currently limited understanding within the DCS of the terms of the contracts, and hence limited ability optimally to manage the partnerships going forward. These factors result in the partnership relationships being adversely strained and optimal value not being able to be negotiated.
At the same time, DCS is faced with severe overcrowding in all its conventional prisons, public scrutiny of widespread allegations of corruption and abuse in prisons, and significant budgetary constraints.
In early July 2002, representatives of the National Treasury met with the National Commissioner and the Chief Financial Officer (CFO) of DCS to discuss the difficulties they face in respect of the PPP prisons. The meeting agreed that a joint Task Team would be established comprising representatives of the DCS, National Treasury and DPW to assess the contractual provisions of the two PPP prison projects. The objectives of this Task Teamís assessment are:
 
To reach a joint understanding of the output specifications, the costing assumptions, the structure of the project finance, and the risk allocation in each project;

To clearly identify the capital and operational costs of each project;
To identify any features of the contracts which could be re-negotiated with the private partners in order to address the DCSís affordability constraints;
To establish a sound methodological basis to compare all the principal features of the PPP prisons projects with the principal features of existing and recently constructed conventional prisons;
To prepare a report on the above-mentioned for presentation to the Ministers of Correctional Services, Finance and Public Works, and for presentation to the Correctional Services Portfolio Committee.
The Task Team comprises the following members:
Chairperson: Mr NW Tshivhase (CFO DCS)
Secretary: Mr JJ Venter (ASD Financial Planning)
DCS: Adv M Ndziba (Ministerís Special Advisor)
Mr NS Makhani (Director Financial Planning)
Ms J Schreiner (CDC Functional Services)
Ms RST Mthabela (DC Offender Control)
Mr J Maako (Director APOPS)
Mr C Basson (Deputy Director APOPS)
Mr CH Paxton (Director Legal Services)
National Treasury: Mr VH Mbethe (Chief Director)
Dr K Brown (Director Integrated Justice Cluster)
Mr W Mothibedi (Acting Director DCS)
Ms S Lund (Senior Transaction Advisor PPP Unit)
Mr W Krause (SFAO DCS)
DPW: Mr L van Hecke (Acting Director APOPS)
Consultants: Mr T Williams (Director Ignis)
Mr P Chipindu (Associate Ignis)
 
 
PART A: EXISTING PPP TRANSACTIONS
A.1 OVERVIEW OF EXISTING PPP TRANSACTIONS
The Terms of Reference of the Task Team included the need "to reach a joint understanding of the structures of the project finance in each project". This section reviews the project structures, mainly focusing on the Parties to the Contracts and the various agreements, namely:
 
Shareholders Agreements

Operating Agreements
Design and Construction Agreements
Financial Agreements
 
A.1.1 PROJECTS STRUCTURES
The project structures of both the Louis Trichardt and the Bloemfontein contracts have generically similar contractual arrangements, the Department of Correctional Services representing the South African Government, entering into agreements with the contractors, being special purpose corporate entities established for the sole purpose of entering into these contracts. The contractors, namely South African Custodial Services (Pty) Ltd (SACS) for Louis Trichardt and Bloemfontein Correctional Contracts (Pty) Ltd (BCC) for Bloemfontein, have entered into agreements with Lenders as well as Construction and Operation Sub-Contractors. The following diagrams illustrate and present a document tree showing the multitude of intertwining agreements governing the relationships between these parties.
 
Figure 1: Bloemfontein: Parties to the Contracts
 
The project structure includes approximately 38 agreements in addition to the core concession agreement. The various agreements are shown in the figure below:
 
Figure 2: Bloemfontein: Document Tree
Summarised details of the participants and purpose of the above agreements are shown in Tables 33 - 36 in Annexure 2.
 
 
Figure 3: Louis Trichardt: Parties to the Contracts
 
The project structure includes approximately 38 agreements in addition to the core concession agreement. The various agreements are shown in the figure below:
Figure 4: Louis Trichardt: Document Tree
Summarised details of the participants and purpose of the above agreements are shown in Tables 37 - 40 in Annexure 2.
 
A.1.2 SPECIFICATIONS
The Terms of Reference of the Task Team included the need to "reach a joint understanding of the output specifications that informed each project, Ö" This section reviews the output specification as detailed through the Request for Proposals (RFP) documents and compares this to the actual specifications that were finally agreed.
In the absence of a DCS benchmark to any PPP prisons standards of service, the United Nations Standard Minimum Rules for the Treatment of Prisoners was used to provide a broad benchmark on which to base comparisons.
The details of the output specification are shown in Table 32 in Annexure 1. It is possible to summarize the review of the specifications as follows:
 
The prisons were specified as "state-of-the-art facilities" which aimed to be flagships for future prison development.

Building specifications minimum requirements were specified according to Health and National Building Regulations.
The highest level of security was specified with significant penalties for escapes.
Detailed operational standards were specified based on a rehabilitation focus and a unit management philosophy.
 
The operations specifications were based on the following goals:
 
High levels of prisoner activities, including work, education, sport and recreation, were required totalling 40 hours per week.

Medical facilities were structured to maximize on site treatment, reducing escorting costs and risks, with the resulting high level service.
Detailed catering requirements were specified with higher standards than existing facilities, including times of service, meal temperatures, amongst others.
Social services required detailed attention to case management, a number of on site professionals and access to legal assistance.
 
The following are examples of the level of detail provided in the specification:
 
Out of cell activities are based on a minimum 12 hours per day.

Cell sizes of 5.5m2 for single cells and 8.0m2 for double cells based on normal building requirements.
Minimum 5 layers of security protection.
Restrictions on persons to whom telephone calls may be made and recording / monitoring of all calls.
Complaints from prisoners to be responded to within 24 hours.
Cash-free environment.
Implement drug testing program with prevention and treatment.
All bedding material and furniture coverings (including in administration offices) to be of fire retardant material.
Sick inmate to be seen by healthcare worker in 30 minutes.
Provide assistance for Legal Aid including reference library.
One of the key features of the two private prison contracts is their Empowerment requirements both during the construction and operation phases of the projects. Empowerment is split into four distinct parts with minimum quota and monitoring systems requirements and penalties in events of non-compliance as shown in the table below.
Table 1: Empowerment Requirements and Monitoring

REQUIREMENT

BLOEMFONTEIN

LOUIS TRICHARDT

MONITORING

Part 1: Participation of previously disadvantaged enterprises in the contracting entity.

Three Empowerment shareholders, in Ten Alliance Mangaung (Pty) Ltd, Fikile Mangaung (Pty) Ltd and Ikhwezi Community Trust each holding 20% shareholding to make a total of 60%.

South African Custodial Services (Pty) Ltd has got Kensani Consortium (Pty) Ltd as an empowerment shareholder which has 50% equity ownership and voting rights.

Minimum equity requirements for empowerment partners in contract during the concession period.

Part 2: Participation of previously disadvantaged enterprises during the design, construction and operation phases.

Construction
Fikile Projects cc, an empowerment firm participated in the design and construction.
Operation
Vulindlela, an empowerment firm involved in the main operation sub-contract and other PDEís contracted in other services and procurement.

Construction
25 % empowerment obligation of the net capital obligation (R86.33m) was taken up by a previously disadvantaged enterprise, local enterprise and an affirmable business enterprise.
Operation
79% of the services provided to the prison are provided by PDEís.

Schedule N of the Contract strictly specifies the requirements pertaining to empowerment and targeted procurement and in addition Schedule M on Compliance Monitoring stipulates the penalties for non-compliance.

Part 3: The engagement of targeted labour in the execution of the Contract.

Exceeded empowerment requirements.

Of the 517 staff 91% of the staff are previously disadvantaged individuals (PDI), 85% of the managers in control of the prison are PDIís, 46% of the staff are women, 1% of the staff are disabled people and 80% of the staff are from Louis Trichardt.

Schedule N of the Contract strictly specifies the requirements pertaining to empowerment and targeted procurement and in addition Schedule M on Compliance Monitoring stipulates the penalties for non-compliance.

Part 4: Employment empowerment.

Training of staff before opening in July 2001 and continued training for all staff members.

6 week initial training period, job specific followed by multi-skilled training.

 
 
A.1.3 COSTS AND REVENUES
The analysis of the two projects costs and revenues was done using the loan term sheets and related agreements and the underpinning Excel financial models as provided by Kagiso Financial Services. The models as at financial close were;
 
Bloemfontein financial model Prbfn10[1].bbc.xls and

Louis Trichardt Financial model NLTFINALAUGUST (102a).xls.
This section summarises the two projects capital expenditure structures, fee or revenue structures ,operational costs and financing structures, and clearly reveals the considerable differences between the two projects.
 
A.1.3.1 Bloemfontein
 
Bloemfontein Project Capital Expenditure
Figure 5: Bloemfontein Capital Expenditure Structure
 
 
Operator Start-up Costs
These costs are normal start-up Bfn sor ent Equity table below;2apital expenditure requirements in order to accommodate any cost increase.fore had to be hired acosts associated with establishing a company, including costs for the Management, staff hiring and training, system readiness testing and programme development. As the fee structure was based on prisoner places from opening date, all pre-opening operations costs had to be capitalised. Training and staff costs were an important element as new local staff who had not worked in prisons before, had to be hired and trained.
 
Concession Company Costs
These are a combination of staff costs and non staff costs incurred in the day-to-day running of Bloemfontein Correctional Contracts (Pty) Ltd.
 
Fees During Construction
The Fees during Construction are the underwriting and arranging fees for the shareholdersí loans, senior debt, standby facility and equity as well as success and other fees. The following table gives a breakdown of the fee:
Table 2: Bloemfontein Underwriting and Arranging Fee

UNDERWRITING AND ARRANGING FEE FOR

AMOUNT (RíMILLION)

Shareholders' Loan

583

Senior Debt: Variable Rate

9,833

Standby Facility

428

Equity

192

Success Fee and Other Fees

10,906

TOTAL

21,942

The Success Fee and Other Fees can be further broken down into:
 
Professional and Legal Fees: R6,2m

Underwriting and Arranging Fees: R4,7m
 
Commitment Fees
The Commitment Fees during Construction are the fees for the senior debt and standby facility which are paid in periods 2 to 24 on undrawn balances of arranged facilities above.
Table 3: Bloemfontein Commitment Fee

COMMITMENT FEE FOR

AMOUNT (Rí000)

Senior Debt: Variable Rate

2,015

Standby Facility

108

TOTAL

2,123

 
Interest During Construction
Interest during construction is the aggregate of all debt service interest payments and distributions in respect of deferred interest at the end of each period during the construction period.
Table 4: Bloemfontein Debt Service Interest

DEBT SERVICE INTEREST

AMOUNT (Rí000)

Shareholders' Loan

0

Senior Debt: Variable Rate

78,162

Standby Facility

1,869

Total

80,031

 
Bloemfontein Revenues and Expenses
The revenue to the contractor comes from fees paid by DCS for the custodial services rendered and is split into a fixed and indexed component. Figure 6 below shows an annual revenue structure for period with year ending 30 September 2003, being the first full year of operating at full capacity.
Figure 6: Bloemfontein Annual Revenue Structure
The fixed component is related to the debt repayments and the indexed component covers the operating expenses of the contractor. The amounts payable to the private prisons will be distorted by this "K -factor", an adjustment made to the increase in the rate per prisoner per day to achieve a smoothing of returns. The adjustment of the indexed component by the "K-factor" was a requirement in the Request for Proposals made through the following statement in the finance section of the RFP for both contracts;
"The CPI will be adjusted by a factor "K" each year (i.e. CPI multiplied by "K"). "K" can be any percentage and is to be specified by the Tenderers for each year in Table 1".
In respect of the Bloemfontein contract, the "K-factor" starts at 1.00623 increasing over the life of the contract to 1.00789 in year 25. This factor is calculated as the cumulative index of relevant project costs (staff and no-staff) costs relative to CPI. The impact from this is that the rate increases at approximately 1.5% above the inflation adjustment. The "K-factor" adjustment effect on the real indexed fee is as shown in the Figure below:
Figure 7: Bloemfontein Real Indexed Fee Adjusted for "K-factor"

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
The fee structure for the first full operating year is shown in the table below:
Table 5: Bloemfontein Fee Structure

AVAILABILITY FEE

BASE DATE 1 JANUARY 1998

OPENING DATE 1 JULY 2001

1 OCTOBER 2002

Fixed Fee

83.50

83.50

83.50

Indexed Fee

88.50

103.97

132.20

 
The following table shows the calculation of the Bloemfontein indexed and fixed fees as at the opening date:
Table 6: Bloemfontein Indexed and Fixed Fees

COST ITEM

INDEXED Rí000

FIXED Rí000

TOTAL Rí000

DESCRIPTION

Staff Costs

36,877

 

36,877

Management, administration, and other specialist staff, total of 489 staff.

Utilities

3,924

 

3,924

Power, water and sanitation, information technology, vehicles and other transport and other utilities.

Insurance

2,626

 

2,626

Insurance premiums to meet minimum requirements.

General Supplies

6,295

 

6,295

Consumables used in operating the facility and providing the services.

Rehabilitation Costs

7,665

 

7,665

Activities in providing a broad range of prison services like education, recreational, religious, social work, workshops, training.

Catering

8,556

 

8,556

These are the services involved in provision of the meals and nutritional services.

Health Care

10,114

 

10,114

Services to provide health care to inmates.

Facilities Management

4,089

 

4,089

Minor and major maintenance and repair of the building and equipment.

Operatorís Costs

80,146

 

80,146

 

Concession Co. Costs

800

 

800

 

Debt Redemption (Incl. Ownersí return)

13,640

 

13,640

 

Debt Service Costs

 

89,238

89,238

 

Total Fees Received

94,586

89,238

 

 

Inmates

2,928

 

2,928

 

Fees / day / inmate

R88,50

R83,50

R172.20

 

Figure 8: Bloemfontein Project Funding Cash Flows During Construction Period
 
Figure 9: Bloemfontein Construction Stage Funding Structure
The above funding structure exceeds the capital expenditure requirements in order to accommodate any cost increase and accommodate the temporary cash flow requirements of VAT.
 
 
Bloemfontein Terms and Conditions
Table 7: Bloemfontein Financing Terms and Conditions for Construction Period

FACILITY

TERM
(Months)

BENCHMARK INTEREST RATE

MARGIN

GRACE PERIOD AFTER C.O.D*
(
Capital and Interest)

COMMENTS

Senior Debt: Variable Rate

24

14.58% (Deferred Start** Swap Rate)

2.25% (nacq)***

24 months (availability period)

Interest capitalised during availability period. Capital repayments begin September 2003.

Standby Facility

24

14.50% nacm**** (Prime)

-2% below prime

24 months (availability period)

Interest capitalised monthly during availability period. Capital repayments begin September 2003.

Shareholder Loans

24

10.00%

6.00% nacq

24 months (availability period)

Interest capitalised quarterly during availability period. No capital repayments.

Ordinary Equity

24

 

 

24 months (availability period)

No repayment.

* Contractual Opening Date which is 30 September 2001, but actually July 2001 due to early completion.
** SACS agreed to exchange floating interest rates with a fixed-interest rate.
*** Nominally annually compounded quarterly. Interest is calculated and paid every 3 months.
**** Nominally annual compounded monthly. Interest is calculated and paid monthly.

 
Bloemfontein Operation Period Financing Structure
Figure 10: Bloemfontein Project Funding Cash Flows During Operation Period
The debt to equity ratio for the project is 89:11. The total equity required by the project, as set out in the financial model is R54 million, (in the form of R13.5 million ordinary shares and R40.5 million shareholdersí loans) ("the Equity"). The nominal and real return on equities (ROE) for the project is 29.9% and 20.3% respectively.
 
The Equity was subscribed as follows:
40% of the Equity (i.e. R21.6 million) was taken up by the sponsors in equal proportions as follows:
Table 8: Bloemfontein Sponsor Equity

SPONSOR

RíMILLION

%

Murray & Roberts

10.8

20

Group 4

10.8

20

TOTAL

21.6

40

The remaining 60 %( i.e. R32.4 million) of the equity was taken up in three equal tranches by the empowerment shareholders as shown in the table below:
Table 9: Bloemfontein Empowerment Equity

EMPOWERMENT ENTITY

RíMILLION

%

Ten Alliance

10.8

20

Fikile

10.8

20

Ikhwezi Community Trust

10.8

30

TOTAL

32.4

60

Figure 11: Bloemfontein Operation Stage Capital Structure
The increase in equity funding between the construction and operations phase is due to the introduction of the empowerment funding. The increased funding provided working capital during the phase-in period up to full operation.
 
 
Bloemfontein Terms and Conditions
Table 10: Bloemfontein Financing Terms and Conditions for Operation Period

FACILITY

TERM (Years) from F.O.D*

BENCHMARK INTEREST RATE

MARGIN

GRACE PERIOD AFTER F.O.D (Capital and Interest)

COMMENTS

Senior Debt: Fixed Rate

13

14.58% (Deferred Start Swap Rate)

2.25% nacq

0

Payments made quarterly for both interest and capital.

Shareholder Loans

25

10.00%

6.00% nacq

0

Payments made as interest and repayments quarterly to shareholders.

Ordinary Shares

25

 

 

0

No repayment.

* F.O.D is Full Operating Date which is 10 May 2002.
Table 11: Bloemfontein Debt Service Payments (period with year ending 30 Sept 2003)

PAYMENT

30 SEP 2003 Rí000

COMMENTS

Shareholders' Loans Interest Payments

658

These payments are subordinated to senior debt repayments.

Shareholders' Loans Capital Repayments

0

Senior Debt Interest Payments

72,625

Mandatory first payments to Lenders.

Senior Debt Capital Repayments

10,844

Mandatory first payments to Lenders.

TOTAL

84,127

 
Bloemfontein Termination of Contracts
A number of events can give rise to the termination of the concession. Table 41 in Annexure 3 details these events, the compensation to be paid as well as the termination procedure which the Department should follow if the Contractor breaches some key termination clauses of the agreements.
A.1.3.2 Louis Trichardt
 
Louis Trichardt Project Capital Expenditure
Figure 12: Louis Trichardt Capital Expenditure Structure
The construction costs are shown in the following table:
Table 12: Louis Trichardt Construction Costs Breakdown

DESCRIPTION

AMOUNT (Rí000)

Site Surveys & Testing

77

Off-Site Utility Upgrade

11,726

Architectural & Engineering Design

23,051

Legal

75

Bidding Process

1,848

Site Development

7,643

Building Construction

252,909

Training

1,000

Testing & Commissioning

685

Insurance & Bonds

1,062

Maintenance Inventory - Spares

500

Contract Oversight / Inspection

2,425

TOTAL

303,000

 
 
Louis Trichardt Revenues
Figure 13: Louis Trichardt Fee Structure for Period 1 May 2003 Ė 30 April 2004
(The first full year of operating at full capacity).
Louis Trichardt Availability Fee: Fixed Revenue
This component of revenue is derived from the product of the number of days per year, the available number of inmate places per day and the fixed component fee of R84.34 per inmate place per day which is escalated to February 2002 prices from a 1 January 1998 base fee of R72.35.
 
Louis Trichardt Availability Fee: Indexed Revenue
This component of revenue is derived from the product of the number of days per period, the available number of inmate places per day and the index component fee which is escalated to February 2002 prices and adjusted (on 1 February and 1 August each year) prices from a 1 January 1998 base fee of R73.06.
As already mentioned the "K-factor" is an increase in the rate per prisoner per day made to achieve a smoothing of returns. In respect of the Louis Trichardt contract, the "K-factor" is 1.06 in year 2, decreasing by 0.01 every second year until it reaches 1.00 in year 14 whereafter it declines to 0.97. These "K-factor" values are hard coded figures in the model and there is no calculation showing how they were derived as done in the Bloemfontein financial model. The result of this "K-factor" is that the fee payable will escalate above the inflation rate at the following rates in the relevant years:
Table 13: Escalation of Fee Payable

YEARS

% ABOVE CPI

2 Ė 3

12.36%

4 Ė 5

10.25%

6

8.16%

7 Ė 9

4.04%

10 Ė 13

2.01%

The impact of the above is that the fee will have doubled in real terms over the 14 years. The fee decreases to a figure 27% above the original fee after year 14. The "K-factor" adjustment effect on the real indexed fee is as shown in the figure below:
Figure 14: Louis Trichardt Real Indexed Fee Adjusted for "K-factor"

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
The fee structure can be summarized as shown in the table below:
Table 14: Louis Trichardt Fee Structure

AVAILABILITY FEE (R/INMATE/DAY)

BASE DATE 1 JANUARY 1998

OPENING DATE 14 FEBRUARY 2002

31 OCTOBER 2002

Fixed Fee

66.25

73.91

73.91

Indexed Fee

73.06

81.51

86.45

TOTAL FEE

139.31

155.42

160.36

 
 
The following table shows the calculation of the Louis Trichardt indexed fees as at the 31 October 2002.
Table 15: Louis Trichardt Indexed Fees

COST ITEM

INDEXED Rí000

DESCRIPTION

Administration

25,581

Management, administration, and other specialist staff, total of 517staff.

Procurement

354

Consumables used in operating the facility.

Operations

35,762

Costs of keeping inmates in safe custody.

Programmes

11,126

Activities in providing a broad range of prison services like education, recreational, religious, social work, workshops, training.

Catering

8,015

These are the services involved in provision of the meals and nutritional services.

Health Care

8,569

Services to provide health care to inmates.

Facilities Management (Maintenance)

6,011

Minor and major maintenance and repair of the building and equipment.

Total Fees Received (Rí000)

95,418

 

Inmates

3 024

 

Fees per day per inmate (Rands)

R86.45

 

 
Louis Trichardt Financing Structure
The project was funded once and there was no splitting of the funding into construction and operation stages. The following is a summary of the project funding structure:
Figure 15: Louis Trichardt Project Funding Cash Flows
The debt to equity ratio for the project is 87:13. The total equity required by the project, as set out in the financial model is R53 million. The nominal and real return on equities (ROE) for the project are 25.1% and 15.57% respectively.
 
Figure 16: Louis Trichardt Project Funding Structure
 
Louis Trichardt Terms and Conditions
Table 16: Louis Trichardt Terms and Conditions

FACILITY

TERM (years from D.R.D*)

BENCHMARK INTEREST RATE

MARGIN

GRACE PERIOD AFTER D.R.D (Capital and Interest)

COMMENTS

Tranche A: Senior Debt

18

15%y.t.m of government bond R157 at financial close

2.50%

20 months (availability period)

Monthly repayments beginning 31/01/2003.

Tranche B: Subordinated debt

18

15%y.t.m of government bond R157 at financial close

2.95%

20 months (availability period)

Monthly repayments beginning 31/01/2003.

Tranche A: Standby Loan

18

(Aggregate of Jibar during period of drawdown)

2.50%

20 months (availability period)

For financing unfunded costs prior to Eng. Decl + shortfall in Debt Service Reserve Account.

Tranche B: Standby Loan

18

(Aggregate of Jibar during period of drawdown)

2.95%

20 months (availability period)

For financing unfunded costs prior to Eng. Decl + shortfall in Debt Service Reserve Account.

* D.R.D is Debt Raised Date which is 14 August 2000
 
 
Table 17: Louis Trichardt Debt Service Payments for period 1 May 2003 to 30 April 2004

PAYMENT

30 APRIL 2004

COMMENTS

Tranche A: Senior Debt Repayment

R 54,2m

Includes both interest and principal.

Tranche B: Subordinated Debt Repayment

R14,7m

This is only a principal repayment, but interest should be paid first.

TOTAL

R68,9m

 
Louis Trichardt Termination Procedure
The termination procedure for both contracts in the event of a CEOD is the same, except for the salient differences in which the events of default are worded in the two contracts. However three key agreements which all have the Department and the Contractors as parties among others, namely the Concession Agreement, Common Terms Agreement and the Finance Direct Agreement regulates the relationships and procedures to be followed should the Department decide to terminate the contracts as shown in Figure 16 in Annexure 3.
 
A.1.3.3 Summary of the PPP Projects Funding Structures
The table below provides a summary of the funding structures and the weighted average costs of capital for the two PPP projects.
Table 18: Summary of Louis Trichardt and Bloemfontein Funding Structures

BLOEMFONTEIN

LOUIS TRICHARDT

Rím

%

Rím

%

Equity

54.0

11

53

13

Debt

437.0

89

353

87

TOTAL

491.0

100

406

100

Base Interest Rate

14.58% (deferred start swap rate)

15% (ytm of R157)

Cost of Debt

2.25% margin

2.50% margin

Return on Equity (including inflation)

Ī 29.9%

Ī 25.1% nominal

Return on Equity (excluding inflation)

Ī 20.3%

Ī 15.57%

Weighted average cost

18.27%

18.50%

 
A.1.3.4 Risk Matrices
Detailed Risk Matrices for both private prisons are included in Annexure 4.
 
A.2 OPTIONS FOR RENEGOTIATION
 
A.2.1 OVERVIEW
The Terms of Reference of the Task Team included the need to "identify any features of the contracts which could be renegotiated with the private partners in order to address the DCSí affordability constraints." This section reviews the options that have been identified in terms of:
 
Capital Expenditure

Operational Expenditure
Refinancing
Risk Transfer
Budgeting
 
A.2.2 CAPITAL EXPENDITURE
As both private prisons are now complete and operating at full capacity, there is limited opportunity for renegotiating any items relating to Capital Expenditure. Capital Expenditure incurred has been determined according to the Specifications set by DCS and had been constructed accordingly. In both cases there are no outstanding Capital Expenditure commitments.
The only items offering potential opportunities for economies of scale in respect of Capital Expenditure relate to expansion of existing facilities. During the visits to the prisons, it was indicated that at Bloemfontein two units could be added, similar to the six already constructed, resulting in operational efficiencies and lower costs per prisoner per day.
At Louis Trichardt, no such opportunities exist for expansion of the current facility, but prison cells used for transition and special treatment may now be used on a full time basis and some two inmate cells converted to four inmate cells at little cost, resulting in operational efficiencies and lower costs per prisoner per day.
The above mentioned options would result in increase in the number of prisoners for both prisons, and the table below shows the results of an exercise to determine the potential savings emanating from these adjustments.
Indications were also given by a Lender representative that a replica facility could be constructed on an adjacent piece of land at the same cost of R303 million as the construction price given three years ago. This is effectively a new prison, an option which we are not automatically recommending.
These possible expansions would require extensions to, rather than renegotiations of, the existing contracts. However, given the legal platform that currently exists, an opportunity to increase the size of the prisons and reduce costs may be considered. Legal opinion on the appropriate procurement route for such expansion must be obtained. Thereafter, if appropriate, the current operators should be requested to make formal proposals in this regard.
 
Table 19: Number of Prisoners Expansions

 

BLOEMFONTEIN

LOUIS TRICHARDT

Current Inmates

2928

3024

Potential additions

976

696

Potential total inmates

3904

3720

Capital expenditure required

Yes (Construct 2 additional units).

Limited (Converting transition and special treatment cells).

Current rate/ inmate/day

132.20

86.45

Average rate/inmate/day after expansion

112.37

73.48

Rate/inmate/day for additional inmates

52.88

17.13

 
A.2.3 OPERATING EXPENDITURE
As the two private prisons are at the beginning of their concession life, any reduction in Operating Expenditure would be felt for the entire duration of the Concession Agreement and a review at the present time would therefore maximize any benefits in this regard. As the price paid to the Operator is calculated as a fixed per day rate per prison place available, cost items which lead to savings would need to be identified and the impact on the rate per day calculated.
The Operating Expenditure of the prison can largely be categorized into the following cost drivers:
 
Staff Costs

Utilities
Insurance
General supplies
Rehabilitation
Catering
Health Care
Facilities Management
In each of the above mentioned cost drivers to be examined, the point of departure would need to be the Output Specifications. The Request for Proposal which led to the final contract detailed Output Specifications across all areas of operation and the private operators are bound to these performance specifications.
 
Staff
Staff costs for Bloemfontein comprise approximately 46% of the total operatorís costs and are therefore an area where savings could be achieved. However, the staff expense is a function of the specifications and the impact of these would need to be reviewed in detail.
A number of services were identified, amongst others, as having a direct impact on staffing levels:
 
12 hours out of cell and late lock-up requires two day shifts.

High levels of training requirements for inmates.
Impact of leave and absenteeism on minimum staffing levels.
Extended visitation hours.
Telephone monitoring.
Drug testing (mandatory).
Dedicated search / first response teams (16 employees).
Escorting services.
It was not possible during the course of this review to assess the levels of security necessary to achieve or maintain the Output Specifications in this regard. The Operating Expenditure is a function of the initial Capital Expenditure and while savings could be achieved through lower staff levels, this may result in a compromise of security and safety.
The optimal adjustment in staff costs per inmate per day is most likely to be effectively achieved through increasing the number of prisoners at the prisons as indicated in the table above.
 
Utilities
Utilities comprise about 5% of costs for both Bloemfontein and Louis Trichardt and are unlikely to offer areas for significant savings.
 
Insurance
Insurance comprises about 3% of the costs or R2.6 million in year 2001 value for Bloemfontein. Whilst certain aspects of insurance may be high (for example, R50 million each for Third Party Liability, Motor Liability and Employer Liability), the savings to be achieved would not be significant on a stand-alone basis.
 
General Supplies
Supplies comprise 8% of costs for the Bloemfontein prison. No breakdown of items was provided, but this is an area for review. During the prison visits it was remarked that the need to source a high percentage of supplies from empowerment and local suppliers were increasing the costs.
 
Rehabilitation
The expenditure on rehabilitation probably offers the greatest opportunity for cost savings as these have been specified at a particularly high level. During discussions with both Operators a review of the number of hours out of cell was requested as a reduction in this could lead to significant savings in both security personnel, as well as the costs spent on education programmes and work. In both cases it was indicated that a reduction in out of cell hours from 12 hours to 8 hours per day would result in a reduction in costs, without a significant effect on prisoner well-being.
Information received from Bloemfontein Correctional Contract highlighted certain areas which have high cost implications for the provision of rehabilitation services. These include:
 
6 Case Management Coordinators.

12 hour day requires two day shifts.
Recreational activities require 8 staff members.
10 Social workers.
2 qualified psychologists.
7 teachers and an education supervisor.
12 vocational instructors and a vocational training supervisor, plus costs of materials and external service providers.
14 physical education officers and a supervisor.
Numbers of inmates doing work has impact on supplies, safety equipment and payment of gratuities.
Other items that could be considered for review are issues such as provision of newspapers, visiting hours and other services to prisoners.
 
Catering
After staff and health care costs, the largest single cost relates to Catering at about 11% of operating costs for the Bloemfontein prison and 8% for the Louis Trichardt prison. As with other Operating Expenditure, the Catering function is closely linked to the initial Capital Expenditure and a reduction in costs may not be possible having spent money on capital items. This is particularly applicable to money spent on equipment to ensure that meals are delivered at the requisite temperature, failing which the operator is fined for failing to comply.
A review of the meals provided would need to be undertaken with nutritionists to ascertain whether a reduction in the quantity and/or quality of meals currently being served could be achieved and ascertain the impact of the savings on the per day charged.
 
Health Care
The final area for consideration for negotiation relates to expenditure on medical facilities. In both cases the private operators indicated that in addition to the high levels of specification the risks and costs associated with escorting prisoners to hospitals meant it was often commercially more attractive to have on-site facilities rather than send prisoners to local government or other private facilities. Costs involved with escorting are mainly manpower costs and the risks of escape with penalties of R300 000.00 to be incurred should any prisoner escape. In addition, due to the irregular and unforeseen nature of these visits, staff would need to be on stand-by to provide escorting duties without reducing active staff members within the prison below the required minimum.
Areas within health care which offer opportunities for review include:
 
Use of full-time doctors on site.

The requirement to meet minimum staff levels to counteract absenteeism and leave.
High standards set in relation to medical emergencies (response time is 30 minutes or penalties apply).
On site facilities such as x-rays, dental facilities, theatre, pharmacy, etc.
Based on the escalated Indexed Fee, medical costs at Bloemfontein are about R445 per inmate per month (this compares to about R275 per month spent on public prison inmates for "Health and Physical Care" based on actual prison numbers. The rate per month increases to R453 per month if calculated excluding overcrowding).
Another area of medical expenditure that should be explored for potential savings is the provision of drugs by government from the Essential Drug List (EDL). Provided agreement can be reached on the drugs to be provided and the methodology within which to do this, drug costs could be significantly reduced from the current levels. In Bloemfontein the health facilities have been outsourced to Afrox Health Care and this would necessitate negotiations with the independent service provider. In Louis Trichardt the medical services are provided directly by the operator and this could be more easily negotiated.
 
A.2.4 REFINANCING
Opportunities exist for refinancing the debt. Informal discussions have been held with the Lenders and a view expressed that may result in both cash flow, as well as Net Present Value benefits. However, due to confidentiality and market advantage, the institutions were not willing to disclose the details prior to a formal approach.
However, based on the known market opportunities, an exercise has been undertaken to assess the benefit of replacing the existing fixed payment debt with a CPI linked instrument. The following methodology has been followed to perform the exercise:
The Net Present Value (NPV) of the unexpired period of the Contract, or the outstanding debt was calculated using a discount rate based on the forward rate of the R153 Government Bond as on the 24th of September 2002. Settlement estimates derived on R531.0 million and R556.7 million for Bloemfontein and Louis Trichardt respectively.
The NPV obtained in (1) was then assumed to have been re-tendered to the market as a CPI linked bond debt with a term of 15 years and the annual repayments and NPVís calculated at different inflation rates and margins. The margins used ranged from the full margins as contained in the present contracts, a reduced margin in line with present market trends, and a zero margin, assuming full government borrowing.
Comparison with the original NPV obtained in (1) above and the existing repayment for the same period, R83.3 million and R68.9 million for Bloemfontein and Louis Trichardt respectively was done.
The table below summarises the assumptions used in the exercise:
 
Table 20: Refinancing Assumptions

ASSUMPTIONS

BLOEMFONTEIN

LOUIS TRICHARDT

Original Value (Rímillion)

437.0

353.0

Settlement Estimate (Rímillion)

531.0

556.7

Current Annual Payment (Rímillion)

83.3

68.9

Benchmark refinance date

31 September 2002

31 July 2002

Benchmark Ref. base rate (R153 as at 24th of September 2002)

11.80%

11.80%

Benchmark Ref. real rate (assuming full Government borrowing)

4.50%

4.50%

Margin for refinancing (full)

2.25 %

2.59 %

Margin for refinancing (reduced)

1.75 %

1.75 %

The exercise yielded the following results:
Table 21: Bloemfontein Theoretical Refinancing Benefits

INFLATION %

EXCLUDING MARGIN

REDUCED MARGIN

HISTORICAL FULL MARGIN

PAYMENT 02/03 Rímillion

NPV
Rímillion

PAYMENT 02/03 Rímillion

NPV
Rímillion

PAYMENT 02/03 Rímillion

NPV Rímillion

3.00

50.9

379.3

57,2

426.4

59.1

440.3

4.50

51.7

413.5

58.1

467.8

60.0

480.0

6.00

52.4

451.5

58.9

507.5

60.8

524.0

7.50

53.2

493.7

59.7

554.9

61.7

573.0

Table 22: Louis Trichardt Theoretical Refinancing Benefits

INFLATION %

EXCLUDING MARGIN

REDUCED MARGIN

HISTORICAL FULL MARGIN

PAYMENT 02/03 Rímillion

NPV
Rímillion

PAYMENT 02/03 Rímillion

NPV
Rímillion

PAYMENT 02/03 Rímillion

NPV Rímillion

3.00

53.4

397.7

60.0

447.0

63.3

471.6

4.50

54.2

433.6

60.9

487.3

64.4

514.2

6.00

55.0

473.4

61.8

532.0

65.2

561.4

7.50

55.7

517.6

62.6

581.7

66.1

613.8

The following conclusions can be drawn from the above exercise:
 
As interest rates have fallen and the interest rates were fixed at 14.58% and 15% for Bloemfontein and Louis Trichardt respectively, the settlement value has increased.

All the options yield cash flow benefits.
On an NPV basis there is only a benefit if future inflation is likely to be below 7.5% in all circumstances, except a full government, no margin position.
Benefits under all scenarios can be achieved if inflation is within governmentís long-term targets.
 
A.2.5 RISK TRANSFER
Significant risk has been transferred to the private sector which has been included in the prison design and operational philosophy. Whilst the risk allocation may be reviewed for future projects, a mere reallocation not related to operations or financial structure is not likely to provide any direct value-for-money benefit. Risk has been optimally allocated in the existing contracts.
 
A.3 CONCLUSIONS AND RECOMMENDATIONS
 
A.3.1 KEY FEATURES
This technical review of the two PPP transactions has provided the Task Team members with greater insights into the contents of the contracts between the Government and the two private partners. Key features of the contracts are as follows:
Overall, the deals delivered custodial services according to DCS specifications set out in the Request for Proposals. The PPP prisons projects should be acknowledged as providing value in relation to the construction and the operations costs, empowerment benefits, as well as the delivery of secure facilities, quality services and rehabilitation. The contracts optimally transfer financial, technical and operational risk to the private parties.
 
The development and operating specifications set by DCS were too high for South African conditions. Government was serious about providing high levels of correctional services when it entered into these deals but they were not preceded by the essential feasibility studies to establish appropriate standards and affordability limits. In respect of the fixed cost obligation, this was somewhat mitigated by the reallocation of funds from the DPW budget to the DCS budget in financial years 1999/2000 and 2000/2001 which now form part of the base-line DCS budget. DCSí budgetary pressures remain.
The Capital Expenditures for both prisons follows the operating philosophies that were drawn from the Specifications, hence the prisonís buildings and facilities are designed superior to any DCS prison.
The Operating Expenditures of the prisons are driven by the high levels of service specified in the two contracts. Savings to the Department can only be realised through negotiating with Contractors on new, lower levels of service, as well as building two new units at the Bloemfontein prison and increasing the number of prisoners for the Louis Trichardt prison, adjustments that will ensure significant economies of scale.
The project structures of the two PPP prisons are similar, and generally follow the traditional structures of project finance deals, with differences mainly in the transaction documentation linking the various parties and funding structures.
Conspicuous in the two deals is the high effective interest rates applicable to the loan facilities. The effective rate is a function of the base rate and margins used. The base rate at the time was significantly higher than is presently the case and was fixed at the time as part of the structure of the deal. The margins are in the normal to upper end of the current market for similar risk PPPs. However, in view of the fact that the PPP market has subsequently matured in South Africa, there is room for renegotiation for better rates.
The return on equities of both projects are above the normal range and together with high costs of debt give very high weighted costs of capital. The fact that these were the first South African PPP deals provides some reason for the high costs of capital as the market for project finance was still in its infancy and higher returns were required as they perceived this to be high risk investment. With a maturing market, required returns on equity for future projects would be expected to be lower.
The payment for the facilities and the services has been structured as a fixed fee covering the debt obligations and a variable fee covering operations. The latter increases by inflation plus a "K-factor" being a real increase above inflation. In the case of the Bloemfontein prison, the "K-factor" is approximately 1.007 or a real increase of 1.5% per annum. The Louis Trichardt "k-factor" starts at 1.06 decreasing to 0.97, resulting in real increases of up to 12% per annum in the early years. Bidders were required by DCS (in the Request for Proposals document) to calculate this ĎK-factorí and include it in their bid price.
The risk transferred to the private partners seems to be the optimum and any attempts to lower or increase the risk transfer would lower the value for money to the Department.
An illustrative comparison between public and private prisons (reflected in Part B of this Report) shows that the ultimate Capital Expenditure or construction cost of a conventionally procured prison is generally significantly higher than the original estimate, indicating the cost of construction risk that is transferred to the private party in a PPP deal.
On an Operational Cost basis, the rate per prisoner place per day for public prisons is between the costs at the two private prisons based on actual inmates but is significantly higher when the impact of overcrowding is removed. (See Part B of this Report) These comparisons are based on number of broad assumptions, as accurate directly comparable data is not available. The extent of the differences, the underlying assumptions, and the conclusions in this regard would need to be substantiated with more comprehensive and scientific methods, which are beyond the scope of this review.
The impact on DCS of the PPP prisons projects has been exacerbated by the overcrowded conditions in all public prisons, primarily as a result of the number of awaiting trial prisoners they have to house due to problems in the judicial systems. The PPP prisons contracts do not permit overcrowding.
Prison PPPs involve the long term procurement of custodial services for Government, and DCSís objective should be to maximize value for money in these deals. A true partnership approach and spirit between DCS and the Contractors is therefore essential for success going forward.
 
 
A.3.2 RE-NEGOTIATION OPTIONS
Based on the conclusion that a number of aspects of the private prison projects can be renegotiated to improve value for money, it is recommended that the Department, supported by National Treasury, should urgently convene a team, including financial and legal experts, to engage with the Contractors to improve value for money by:
 
Reviewing standards and specifications.

Amending the fee payment structure.
Considering options for accommodating additional prisoners on a marginal cost per inmate basis.
Negotiating debt funding to improve cash flows and net present value benefits, including considering inflation-linked funding.
 
PART B: FUTURE EVALUATION METHODOLOGY
B.1 ILLUSTRATIVE COMPARISONS OF PUBLIC AND PPP PRISONS
 
B.1.1 SPECIFICATIONS
In order to obtain a better understanding of the nature of the two private prisons, it is important to try to compare these to the public prisons. Such a comparison must however be made with due regard to the very large differences in the level and quality of service offered by the two private prisons with that offered by any DCS-operated prison. The reasons for the differences include:
 
Significant overcrowding in DCS prisons of approximately 70%.

The age of the existing DCS prisons.
Profile and mix of inmates at an institution.
Rehabilitation and recreation facilities.
Medical facilities.
Limited DCS resources.
DCS Prison designs based on a lock-up and punish philosophy rather than rehabilitate and reintegrate approach.
Capex / Maintenance.
Staff.
Experience / Skills / Training.
Geographic factors relating to construction costs.
DCS budgeting which is not structured on cost centres.
Any attempt to compare public and private prisons on a quantitative cost-by-cost basis would therefore be meaningless, without simultaneously comparing the qualitative aspects in terms of both magnitude and scope. The table below provides an overview comparison of two public and the two private prisons. Malmesbury is chosen because it is a DCS-operated prison perceived closest in the quality and scope of incarceration to the PPP prisons, and Grootvlei, mainly chosen because the Task Team visited the prison, and is situated adjacent to the BCC prison. Importantly however is the fact that both public prisons include medium security facilities whilst both private prisons are strictly maximum security.
 
Table 23: Comparison of Private and DCS-Operated Prisons

PUBLIC (DCS)

PRIVATE

MALMESBURY

GROOTVLEI

BLOEMFONTEIN

LOUIS TRICHARDT

Classification or Types of Prisoners

Medium

Maximum / Medium

Maximum

Maximum

Actual Number of Inmates

Med A
1 311

Med B
451

Max
1 981

Med
365

2 928

3 024

Design Number of Inmates

Med A
1 010

Med B
207

Max
918

Med
266

2 928

3 024

% Overcrowding

45%

98%

Nil

Nil

Total Number of Inmates per cell

Different cell types exist.

Different cell types exist1.

Strictly 2 and 4 man cells.

Strictly 2 and 4 man cells.

Number of Correctional Officers

328

381

487

517

Number of inmates per officer

5.4

6.2

6.0

5.8

Health Care Programs, e.g. Primary Health Care etc.

Programmes as per PPP prisons are not presented because of a lack of resources.

Programmes as per PPP prisons are not presented because of a lack of resources.

Comprehensive program*.

Comprehensive program*.

Social Programmes

Programmes as per PPP prisons are not presented because of a lack of resources.

Programmes as per PPP prisons are not presented because of a lack of resources.

Comprehensive program*.

Comprehensive program*.

Maintenance

DPW is Responsible for maintenance.

DPW is Responsible for maintenance.

Comprehensive BMS*.

Comprehensive BMS*.

Security Level (whether 3, 4 or 5 level)

2 Levels

1 Level

3 Level

3 Level

Age of the prison

5 years

10 years

1 year

8 months

Education Programs

Programmes as per PPP prisons are not presented because of a lack of resources.

Programmes as per PPP prisons are not presented because of a lack of resources.

Comprehensive program*.

Comprehensive Programs*.

 

PUBLIC (DCS)

PRIVATE

MALMESBURY

GROOTVLEI

BLOEMFONTEIN

LOUIS TRICHARDT

No of escapees

From 1995 there were 11 escapes.

From 1995 there were 93 escapes.

None since opening in July 2001.

None since opening in February 2002.

Cost of escapes (PPP penalties)

R3.3 million

R27.9 million

Nil

Nil

Time out of cells

No structured day programs with 1 hour minimum.

No structured day programs with 1 hour minimum.

Structured day programme with minimum 12 hours.

Structured day programme with minimum 12 hours.

No of newspapers per prisoners

None

None

1 newspaper per 15 prisoners (200 per day).

2 newspapers per 72 prisoners (84 per day).

Any CCTV, central monitoring etc.

CCTV & Central Monitoring.

None

CCTV & Central Monitoring.

CCTV & Central Monitoring.

Any adjacent prison farm

None

One

None

None

Prison shop and money free environment used

Yes, but no money free environment technology.

Yes but no money-free environment technology.

Yes, but strictly money free environment.

Yes, but strictly money free environment.

 
B.1.2 OPERATING COSTS
In order to compare the two private prisons costs with those of the public prisons, the costs set out in Annexure 5 show key cost aspects of the DCS 2002/3 budget in total and in rands per prisoner per day. This budget however includes all the DCS prisons, including maximum, medium, youth centres, awaiting trial, etc. This is done because there is no ring-fenced public prison budget available where its operational costs alone can be determined with certainty.
Excluding costs not related to the operation of public prisons (such as the Ministerís costs, new construction capital, community corrections and the APOPS expenses), the following comparison is obtained:
Table 24: Comparison with Public Costs

COST DESCRIPTION

PUBLIC (R/inmate/day)

PRIVATE (R /inmate/day)

BUDGET 2002/03

BLOEMFONTEIN OCTOBER 02

LOUIS TRICHARDT OCTOBER 02

Staff Costs

 

51.54

 

Administration

35.54

-

23.18

Offender Control / Security / Operations

41.22

-

32.40

Health and Physical Care

4.24

14.14

7.76

Rehabilitation / Development Programmes

5.62

10.71

10.08

Facilities Management / Maintenance

1.80

5.72

5.45

Utilities / Power / Water / Sanitation

0.16

5.48

-

Catering / Nutritional Services

5.09

11.96

7.26

General Supplies / Procurement

-

8.80

0.32

Insurance

-

3.67

-

Concession Company Costs / Fee

-

1.12

-

Debt Redemption / Returns

-

19.06

-

Total per Prisoner per Day

93.67*

132.20**

86.45**

Total number of Prisoners

172 048*

2 928**

3 024**

* Including 70% overcrowding.
** Not overcrowded.

The table above shows that there are differences in the operating costs per prisoner per place on the public versus private prisons using this comparison. The public cost of R93.67 including overcrowding is comparable to the current Louis Trichardt cost of R86.45 but 41% less than the Bloemfontein cost of R132.20. The Bloemfontein total cost per prisoner per day of R132.20 is higher due to having had three six-monthly increases since opening in July 2001.
The overcrowding factor in public prisons is an important consideration, implying that if the public prisons were not overcrowded and the DCS operating budget remained the same, the cost per prisoner per day would be considerably higher than at present and considerably higher than the PPP prisonsí costs per prisoner per day.
 
B.1.3 CAPITAL EXPENDITURE
The designs of the two private prisons are very different although they were built on almost identical output specifications and operating philosophy with construction costs of R303 million for Louis Trichardt and R270 million for Bloemfontein. The differences in the two private prisons and the differences between public and private prisons are the result of various factors, including amongst others:
 
Different dates of construction

Geographical diversities
Different operating philosophies
Types and mix of inmates
Capacity differences
Use of superior technology and design
Inclusion of staff housing in some public prisons
Different security levels
DCS does not have a cost centre focus and PPP operators have different cost centre allocation structures
Functions and costs split between DCS and DPW
Historical procurement problems created inefficiencies
The above factors make it difficult to compare public and private prisons construction costs and hence construction costs per inmate. However, if one is aware of the above mentioned factors and appreciates the superiority of the designs and operating specifications of the private over public prisons, a rather rough comparison can be made.
It is in this spirit that the following comparison of the construction costs of a few selected public prisons against private prisons was made. The table below compares the original budgets to the final costs of selected public and the private prisons.
Table 25: Comparison of Risk Transfer of Construction Costs

PRISON

OPERATED BY

CONSTR. DATE

INMATE CAPACITY

ORIGINAL BUDGET (RíMILLION)

FINAL COST (RíMILLION)

% BUDGET

REASONS

Bloemfontein

Private

03/00

2 928

270

270

100%

Fixed price contract.

Louis Trichardt

Private

08/00

3 024

303

303

100%

Fixed price contract.

Kokstad

DCS

11/00

1 440

232

360

155%

Increase due to civil works.

Empangeni

DCS

06/00

1 392

195

200

103%

Increase due to escalation (Haylet Formula).

Emthonjeni

DCS

05/98

640

122

124

102%

Increase due to escalation (Haylet Formula).

Malmesbury

DCS

11/97

1 217

134

190

142%

Increase due to civil ground works and escalation.

The results clearly demonstrate that the private prisons were built more cost effectively than any of the public prisons. They also show the disparities between the budgeted costs of public prisons and the final costs, whereas the private prisons contractors where bound to their initial price. Substantial overruns were made on Kokstad and Malmesbury, a risk the government avoided and passed on to the contractors in the construction of the two private prisons. In addition to the construction overruns for the Kokstad prison, the prison completion was long delayed resulting in a construction period of 48 months. In contrast, the bigger PPP prisons, besides costing less, were built in only 18 months.
 
B.1.4 CONSTRUCTION COST FOR GOVERNMENT
The table below illustrates an example whereby the government fully borrows and constructs a prison for R300 million with various assumptions on cost overruns, debt, construction period and capacity of the prison. As shown in the results section of this table, the payment per inmate per day of R74.70 is comparable to the fixed fees of R83.50 and R73.51 for Bloemfontein and Louis Trichardt prisons respectively.
Table 26: Illustrative Comparison: Government Funded Construction Cost

ASSUMPTION

AMOUNT

Construction Amount (Rímillion)

300

% overrun

15.0%

Base Interest rate

15.0%

Inter-government margin

1.0%

Debt period

15 years

Construction period

24 months

Vat rate

14%

Number of prisoners

3 000

RESULTS

Capital Expenditure (Rímillion)

393

Pre-operating interest (Rímillion)

63

Total Debt (Rímillion)

456

Annual payment (Rímillion)

82

Rate per inmate per day (Rands)

74.70

 
B.2 OVERVIEW OF TREASURY REGULATIONS FOR FEASIBILITY STUDIES
The Terms of Reference of the Task Team included the need to develop "a robust methodological framework within which it will be possible to compare cost and value-for-money to government between procuring custodial services via a PPP arrangement and operating a prison under conventional means". This section provides a summary of the key Treasury regulations with regard to feasibility study methodology, as well as a methodological framework for future prison PPPs.
 
 
PPP Regulatory Framework
Although the decision for a national or provincial government department to enter into a Public Private Partnership arrangement rests entirely on its own business case and strategic objectives, three key documents produced following the work of a Cabinet-appointed Interdepartmental Task Team in 1997, sets frameworks, guidelines and most importantly, Treasury Regulations for departments which have made decisions to enter into these arrangements. The table below gives an overview of the purpose of each of these documents.
Table 27: Government PPP Framework, Guidelines and Regulations

DOCUMENT

PURPOSE

Strategic Framework for Delivering Public Services

  1. Addresses key constraints to the successful implementation of PPPs.
    Identifies a package of legislative, regulatory and institutional reforms to strengthen the enabling environment.

Treasury Regulations for Public Private Partnerships (Issued in terms of the Public Finance Management Act [PFMA] of 1999) Regulation 16 last updated May 2002

Regulates PPPs to ensure that accounting officers remain fully accountable for the outcomes of departmental functions performed under PPP arrangements. All PPP deals are required to demonstrate: Affordability, Value-for-Money, and Appropriate risk transfer.

Guidelines for Public Private Partnerships

Sets procedures on sound practices to be followed when preparing, procuring and implementing PPP arrangements.

 
The PPP Unit within the National Treasury oversees all PPP transactions undertaken by through the PFMA by:
 
enforcing compliance with the PFMA Act;

assisting departments in the preparation, procurement and implementation of PPPs;
providing technical and financial advice throughout the PPP project cycle; and
assisting departments in project management, economic and financial analysis, negotiation and legal processes pertaining to PPPs.
 
The PPP Project Life Cycle
Figure 17 in Annexure 6 depicts all the phases within a PPP procurement process, and shows Treasury approvals at clearly defined milestones in the generic PPP project life cycle, coupled with the necessary Treasury Approvals (TA). "Treasury approval is only required in those stages that affect expenditure control and the prudent use of state resources "(Guidelines for Public Private Partnerships, Dept of Finance, May, 2001). The following approvals are needed:
 
Demonstration of Affordability through a Feasibility Study, TA I

Demonstration of Value of Money, TA II (A and B)
Approval of Documents for Financial Closure, TA III
While all the abovementioned approvals are equally important, this section only focuses on the processes leading up to TA I as this approval determines whether a project could be formulated as a PPP, and is a key process that was not undertaken for the two Prison Contracts under review, as the Legislation did not exist at the time they were procured.
 
B.3 PRISONS FEASIBILITY PROTOCOL
Figure 17: Prisons Feasibility Protocol
B.3.1 PRE FEASIBILITY PHASE
 
B.3.1.1 Needs Analysis
The needs analysis should devolve from the Department of Correctional Servicesí (DCS) strategic and operational plans and must receive significant attention at the highest levels within the Department. The needs analysis forms the foundation of a process which may lead to a decision to build and operate a new prison. It is therefore imperative that the needs drivers are workshopped and definitively understood from the very beginning. Examples of needs drivers are:
 
overcome overcrowding in prisons;

provide adequate facilities to match the forecast growth rate of the prison population;
cater for certain categories of prisoners, for example maximum security or medium security;
meet the minimum standards imposed by new international and domestic rules for treatment of prisoners;
meet the demands of new legislation affecting the provision of correctional services;
contain increased criminal activity in certain geographic regions of the country;
reduce the backlog in prison accommodation infrastructure and correctional services in the country; and
provide any other needs identified as necessary for the provision of adequate correctional services in South Africa.
Once the needs have been robustly researched they should be prioritised and grouped to obtain a better understanding of their relative importance and how they may impact on the development of options.
 
B.3.1.2 Options Analysis
The objective of the options analysis is to undertake a broad search for possible solutions to the needs that have been identified and agreed. Each identified option should be described in some detail and reference should be made as to how a particular option could meet the identified needs. The options analysis should also contain a preliminary risk assessment to be used in making comparisons between the identified options. The next step would be a detailed evaluation of the options and an assessment of their ranking. The output of the options analysis is a limited range of possible solutions to meet the needs. These selected, or identified, options will be subjected to further detailed assessment during the feasibility phase of the evaluation process.
 
B.3.1.3 Feasibility Phase
 
Step 1: Determine Outcomes for the Preferred Option
Having identified and evaluated the most likely options these need to be developed to a stage where specific outcomes relating to each option are clearly understood and documented. The following are examples of some broad outcomes that may be determined to be important goals for a project:
 
Keep inmates in custody.
Maintain order, control, discipline and a safe environment.
Provide conditions for inmates to an agreed standard and meet their identified requirements, including health care.
Provide Structured Day Programmes to allow inmates to address offending behaviour and learn to lead a full and responsible life.
Help inmates prepare for return to civil life and community.
Deliver prison services using resources provided by Parliament with maximum efficiency.
Promote community involvement.
More details on each of the seven goals mentioned alone can be found in Table 32 on specifications in Annexure 1.
 
Step 2: Determine Output Specification
The agreed outcomes will provide the base for the formulation of an initial output specification. The output specification must be developed to such a level of detail to provide a potential bidder with sufficient information about the Departmentís requirements to facilitate the preparation of a comprehensive input specification which can be costed. Clearly formulating these output specifications enables the Department to evaluate whether the proposed solution can meet the desired outcomes and can be practically implemented.
Table 28: Goals and Output Specifications

TYPICAL GOALS

POSSIBLE OUTPUT SPECIFICATIONS

1. Keep inmates in custody

This goal could be achieved by specifying central control, number of prisoners per cell, supervision, security during visits, escorts, special category prisoners, roll checks, amongst others.

2. Maintain order, control, discipline & a safe environment

This goal could be achieved by specifying and regulating remedy deficiencies, grievance procedures use of force, financial transactions repairs, maintenance, and drug control measures, amongst others.

3. Provide decent conditions for inmates and meet their needs, including health care

This goal could be achieved by specifying admission times, personal hygiene, clothing, bedding, cell equipment, meals, healthcare and other requirements.

4. Provide Structured Day Programmes

This goal could be achieved by specifying Structured Day Programme, Times of unlocking, activities, time outdoors, social work services, religion, work, education training programmes, physical education library, psychologists, amongst others.

5. Help inmates prepare for return to community

This goal could be achieved by specifying legal rights representation, official visits, and unofficial visits, amongst others.

6. Deliver prison services within clearly formulated legal and policy frameworks

This goal could be achieved by way of Strategic Development Plans, Personnel Policies, Equal Opportunities, Drug & alcohol free work-place, Conditions of Service, Uniforms, Recruitment & selection and Training.

7. Promote community involvement

This goal could be achieved by encouraging community to participate in prison, encouraging prison to participate in community, formal & informal community development, targeting employment to local community, and enacting local public relations policy.

Step 3: Base Design and Operation Input Specification
The feasibility study base input specification is prepared as a comparative foundation for the Public Sector Input Specification and the Private Sector Input Specification. A significant amount of resources must be applied in the development of the input specification since these specifications will determine the capital, lifecycle and operating costs to be used in financial modelling.
 
B.3.1.5 Design Input
The agreed design will impact the capital costs, lifecycle costs and the operating costs as well as the construction methodology to meet the output specification. Design also has a direct influence on the timing of the facility construction, which in turn determines how quickly the operations phase can commence. This clearly has financial consequences based on the time value of money.
Some typical design areas include:
Table 29: Typical Design Areas

Housing Section
Unit
Perimeter security
General security
Assessment facility
Special treatment centre
Admissions / transfers
Laundry services
Workshops

Physical & recreation centre
Visitation centre
Education, training, support & library services
Prison shop
Health care centre
Religious centre
Electrical
External works & landscaping

 
B.3.1.6 Operations Input
The operating philosophy should guide the design. It is important that the facility operations planning forms part of design development process. Some of the operations issues to be considered include:
Table 30: Operational Input

OPERATIONAL INPUT

DESCRIPTION

Staff

Management, administration, and other specialist staff with different skills have to be employed to provide services.

Utilities

Power, water and sanitation, information technology, vehicles and other transport and other utilities would be included here.

Insurance

Insurable risks have to be estimated to safeguard the investment, but only if the prison is operated and constructed by the private sector.

General Supplies

These are the consumables used in operating the facility and providing the specified services.

Rehabilitation

These are the activities in providing a broad range of prison services like education, recreational, religious, social work, workshops, and training.

Catering

These are the services involved in provision of the meals and nutritional services.

Health Care

Services to provide different levels of health care to inmates.

Facilities Management and Maintenance

This involves the minor and major maintenance and repair of the building and equipment.

 
Step 4: Public Sector Input Specification
The public sector input specification is based on the base design and operations input specification. It forms the benchmark against which any private sector input specification will be tested for Affordability and Value for Money. The public sector input specification represents the scenario where DCS, as owner, constructs the prison and operates the prison. There may a certain level of outsourcing inherent in this model but very limited risk transfer takes place.
 
Step 5: Private Sector Input Specification
The private sector input specification is based on the base design and operations input specification. This input specification must capture the full cost implications of the private sector constructing, operating and managing the prison.
 
Step 6: Capital Cost, Lifecycle Cost, Operating Cost
The public sector and private sector input specifications, once fully developed, are separately costed in detail with respect to capital cost, lifecycle cost and operating cost.
 
Steps 7 and 8: Shadow Project Bid
The costing of the public sector and private sector input specifications will result in base cost structures for the two alternative implementation routes.
 
Step 9: Costed Risk Adjusted
The public sector model must be risk adjusted to bring it onto a comparable basis with the private sector cost model. The costed risk adjustment focuses on quantifiable differences which can be reduced to a cost.
 
Step 10: Probability Risk Adjustment
The public sector model will also carry a number of risks that cannot be readily quantified yet intuitively have cost implications. These risks are dealt with on a probability basis to determine an expected value to be included in the cost model.
 
 
Steps 11 and 12: Unitary Model
The public sector and private sector costed projects form the bases of comprehensive financial models to estimate the prepaid to the Contractor. This fee will be benchmarked against the Departmentís available budget to determine Affordability.
 
Step 13: Available Affordability Budget
The Departmentís available budget for the identified project is established.
 
Steps 14 and 15: Affordable Project?
The public sector and private sector project unitary payments are compared to the Affordability Budget to show that they are Affordable within each year of the project life. If in any particular year the required project payments fall outside the project Affordability envelope the particular procurement option is deemed unaffordable and must be re engineered to bring it within the Affordability envelope.
 
Step 16: Value for Money?
Value for Money is assessed once a project has passed the Affordability test. The Value for Money test seeks to demonstrate any uplift in value to the Department by following a private sector procurement strategy. Sufficient proven Value for Money must be delivered in relation to the public sector procurement route to justify the service delivery through private sector means.
 
Step 17: Implementation
An Affordable project with the best Value for Money will form the basis of tender documentation. If Value for Money cannot be established then feedback into the output specification is required to redefine the level to which the project outcomes are achieved or the actual definition of the outcomes themselves need to be adjusted to make a project Affordable and have it deliver Value for Money.
 
Steps 18, 19 and 20: Procurement Strategy
The implementation decision will determine the procurement strategy.
 
B.4 CONCLUSIONS AND RECOMMENDATIONS
 
B.4.1 APPROACH TO FUTURE PRISON CONSTRUCTION AND OPERATION
In order to ensure that the DCS achieves its mandate and in so doing, utilises the scarce resources of the Government in the most efficient manner, it is recommended that:
DCS recognises the importance of the concepts of affordability, value for money and full life-cycle risk management;

All prison projects be clearly defined in terms of design and operating output specifications based on the desired outcomes for the institution;
DCS affordability constraints be clearly identified, and output specifications modified to cater for these, before any procurement of further prisons, whether PPP or conventional;
Accounting standards be developed that can compare and monitor cost-centre expenditure for all prisons;
Rules be established to deal with DCS staff movement during any future PPP procurements;
Policy on unsolicited bids be adopted and publicised; and
The Department adopt as policy the Task Teamís Prisons Feasibility Protocol for use in assessing the best procurement option for future prisons.
 
 
 
 
 
PART C: RECOMMENDATIONS FOR NEXT STEPS
The Task Team recommends that the following programme be adopted by DCS as a way forward:
Table 31: Way Forward

TASKS

TASK OWNER

TARGET START DATE

  • Engage contractors to improve value for money by:
    Reviewing standards and specifications.

    Amending fee payment structure.
    Accommodating additional inmates.
    Negotiating debt funding.

DCS supported by
National Treasury and
Financial and Legal Advisors

1 December 2002

Adoption of the Feasibility Protocol for all future prison projects

DCS

1 December 2002

Setting of clear DCS policy, processes and decision-making structures for procurement of future prisons

DCS supported by National Treasury

1 December 2002

Setting and public announcement of DCS policy on unsolicited bids

DCS supported by National Treasury

1 December 2002

  • Training of key personnel in:
    DCSís Prison Feasibility Protocol and

    DCSís Procurement policy, methods and standards

DCS supported by National Treasury

March 2003

 
 
REFERENCES
Department of Correctional Services and Department of Public Works Ė Kutama Ė Senthumule PPP Prison Project (Louis Trichardt) Transaction Bible; August 2000.
Department of Correctional Services and Department of Public Works Ė Mangaung PPP Prison Project (Bloemfontein) Transaction Bible; January 2001.
Department of Correctional Services and Department of Public Works Ė Kutama Ė Senthumule PPP Prison Project (Louis Trichardt) Transaction Bible, Close-out Report; June 2001.
Department of Correctional Services and Department of Public Works Ė Mangaung PPP Prison Project (Bloemfontein) Transaction Bible, Close-out Report; January 2001.
Department of Correctional Services Annual Report. Pretoria, South Africa; 2001.
Department of Correctional Services Website: http://www.dcs.gov.za
CDC Website: http://www.cdc.gov
Correctional Services Act of 1998. Pretoria; 1998.
Private and Public Prisons: Studies Comparing Operational Costs and/or Quality of Service, Letter Report 08/16/96, GAO/GGD-96-158.
Prison Privatisation in South Africa: Issues, Challenges and Opportunities; KC Gover, Institute for Security Studies; 2001.
Private Prisons in Australia, Trends and Issues in crime and criminal justice, No 36, RW Harding; 1992.
National Treasury: PPP Guidelines, 2001.
United Nations Department of Public Information: Standard Minimum rules for the treatment of Prisoners; New York, 1984.
 
 
 
ANNEXURE 1: SPECIFICATIONS COMPARISONS
Table 32: Specifications Comparisons
 
 
 
 
 
 
ANNEXURE 2: CONTRACT DOCUMENTS

Table 33: Bloemfontein: Shareholders Agreements

AGREEMENT

PARTIES TO THE CONTRACT

BRIEF EXPLANATION

Sponsor Support Agreement

Sponsors
Sponsor Shareholders
BCC

The Sponsors undertakes to protect the Lenders in respect of Empowerment, Equity Holdings, Subordination of their claims to those of Lenders, etc.

Shareholder & Equity Subscription Agreement

Shareholders
Empowerment Parties
BCC

This agreement regulates the equity participation, distributions and dividends, management of BCC and empowerment provisions.

Shareholders Agreement

Each empowerment party
Each relevant Empowerment Shareholder
Empowerment Lenders

Agreement regulates the participation of all shareholders of each empowerment company in terms of distributions, subscriptions, ownership and directorís appointments, etc.

Loan & Preference Share Agreement

Each Empowerment Shareholder
Empowerment Lenders
Sponsors

This agreement facilitates funding for the empowerment shareholders to obtain equity loans from empowerment Lenders who in turn acquire preference shares in the empowerment companies.

Pledge & Share Agreement ifo Investec Bank

Shareholders
Investec Bank

Each Shareholder pledges and/or cedes the shares to the extent required by Investec Bank.

Pledge & Share Agreement ifo ABSA Bank

Shareholders
ABSA Bank

Each Shareholder pledges and/or cedes the shares to the extent required by ABSA Bank.

 
 
Table 34: Bloemfontein: Design & Construction Agreements

AGREEMENT

PARTIES TO THE CONTRACT

BRIEF EXPLANATION

Construction Direct Agreement

DCS
BCC
Construction Subcontractor (CSC)

Agreement whereby the CSC gives direct warranties to the DCS in respect of proper completion, exercising appropriate skills, insurance requirements, liquidated damages, etc.

Construction Sub-Contract

BCC
CSC

This agreement regulates the "pass through" of the Contractorís obligations to the DCS in relation to the design, planning and construction of the prison.

Construction Completion Guarantee Agreement

Construction Guarantor
Lender

The Guarantor (Murray & Roberts Holding Companies) guarantees the performance by the Contractor (BCC) of its obligations to the Lenders.

Construction Performance Guarantee Agreement

Construction Guarantor
BCC

The CSC guarantees to the Contractor due performance of its obligations under the Construction sub-contract.

 
Table 35: Bloemfontein: Operating Agreements

AGREEMENT

PARTIES TO THE CONTRACT

BRIEF EXPLANATION

Operating Direct Agreement

DCS
BCC
Operating Sub-Contractor (OSC)

The DCS secures right against the OSC through direct warranties / indemnities in favour of the DCS.

Operating Sub-Contract Agreement

BCC
OSC

This agreement governs the "pass through" of the Contractorís obligations to the DCS in relation to the operation of the prison.

Management Services Agreement

BCC
Murray & Roberts Manager

This agreement regulates the duties of the management company to provide headquarter and administrative assistance to BCC until the end of the construction period.

 
 
Table 36: Bloemfontein: Financial Agreements

AGREEMENT

PARTIES TO THE CONTRACT

BRIEF EXPLANATION

Finance Direct Agreement

DCS
BCC
Lenders

Regulates Lenders / DCS direct relationship and provides the former with the right to "step-in" to the Contractorís obligations.

Rand Term Facility Agreement

Lender
BCC

Regulates the terms of provision of the agreed proportion of debt of R437 million by the Lender.

Standby Facility Agreement

Lender
BCC

Regulates the terms of provision of the additional funding should this be required by the Contractor.

Inter Creditor Agreement

Funders
Lender
Trustee

Regulates the relationship between the Funders and Lender in respect of the Funding Agreement.

Rand Term Funding Agreement

Funders
Lender

Regulates the terms of provision of matching advances by Funders to Lender, subject to the Lender making advances to BCC through the Rand Term Facility Agreement.

Standby Funding Agreement

Funders

Regulates the terms of provision of matching advances by Funders to Lender, subject to Lender making advances to BCC through the Standby Facility Agreement.

Security Cession (Insurances)

BCC
Lender

Security from BCC to Lender in respect of any insurance other than an Insurance Proceeds required for facility replacement.

Security Cession (Monies)

BCC
Lender

Security from BCC to Lender in respect of any project revenues.

Security Cession (Project Documents)

BCC
Lender

Security from BCC to Lender in respect of BCCís right, title and interest in and to the project documents.

Suretyship (5 x Shareholders)

Each Shareholder
Lender

Security from each shareholder to the Lender whereby they bind themselves as sureties and co-principal debtors for all debts from Lenders.

Pledge & Cession Agreement (5 x Shareholders)

Each Shareholder
Lender

Agreement whereby each Shareholder agrees to cede and pledge all shares and benefits in BCC to the Lender.

Common Terms Agreement

Lender
BCC

Regulates the manner in which debt provided through the facility agreements is made.

Account Bank Agreement

Account Bank
BCC
Lender

Regulates the manner upon which accounts of the Contractor must be maintained and ensures that the Contractor does not misuse project funds.

 
Table 37: Louis Trichardt: Shareholders Agreements

AGREEMENT

PARTIES TO THE CONTRACT

BRIEF EXPLANATION

Sponsor Support Agreement

Wackenhut Corrections Corporation (SA)(Pty) Ltd
Wackenhut Corrections Corporation (WCC)
Kensani Corrections Pty Ltd
SACS
Inter Creditor Agent
CGM

The Sponsors undertake to the Inter Creditor Agent obligations in respect to retention of shares, subordination, etc.

SACS Shareholders Agreement

Kensani Corrections Pty Ltd
WCC SA
WCC
SACS

This agreement regulates the equity participation, distributions and dividends, management of SACS and empowerment provisions.

SACM Shareholder Agreement

Kensani Corrections Pty Ltd
WCC SA
Fidelity Services Group
SACM

Similar intentions as to the SACS Shareholderís agreement.

Kensani Shareholders Agreement

Kensani Corrections Pty Ltd
WCC
WCC SA

Similar intentions as to the SACM Shareholderís agreement.

 
 
Table 38: Louis Trichardt: Design & Construction Agreements

AGREEMENT

PARTIES TO THE CONTRACT

BRIEF EXPLANATION

Construction Direct Agreement

DCS
SACS
CGM
[Trust]

CGM gives direct warranties to DCS in respect of proper completion, exercising appropriate care, compliance with SA Laws.

Construction Sub-Contract

SACS
CGM

Regulates the "pass through" of SACS obligations to the DCS in relation to the design, planning and construction of the prison.

Construction Financing Direct Agreement

Lenders
Kensani Consortium
Trust
CGM
SACS

CGM warrants that the prison will be fit for purpose, achieve engineers declaration, in time and within the fixed price of R303 million.

Construction Sub-Contractor Joint Venture Agreement

Group 5
Concor
Makhosi
Mposa
NKN
Shumisanani

Regulates the duties and relationships of the CSC joint venture.

 
Table 39: Louis Trichardt: Operating Agreements

AGREEMENT

PARTIES TO THE CONTRACT

BRIEF EXPLANATION

Operation Direct Agreement

DCS
SACS
SACM
KCM
Royal
Trust

The DCS secures rights against the OSC through direct warranties / indemnities in favour of DCS.

Operating Sub-Contract Agreement

SACS
SACM
KCM
Royal

This agreement governs the "pass through" of the Contractors obligations to the DCS in relation to the operation of the prison.

Strategic Support Service Agreement

Kensani Corrections Management
SACM

 
Table 40: Louis Trichardt: Financial Agreements

AGREEMENT

PARTIES TO THE CONTRACT

BRIEF EXPLANATION

Finance Direct Agreement

DCS
SACS
Inter Creditor Agent
Lenders

Lenders regulate their arrangements with the DCS in respect of financing of the project and appointment of a substitute entity.

Tranche A & B Base Facility Agreement

Lenders
SACS for "A"
Kensani Consortium
SACS for "B"

Regulates the terms of provision of the agreed proportion of debt by the Lenders.

Tranche A & B Standby Facility Agreement

Lenders
SACS for "A"
Kensani Consortium
SACS for "B"

Regulates the terms of provision of the agreed proportion of standby debt by the Lenders.

Inter Creditor Agreement

Lenders
Trustee

Regulates the relationship between the Lenders and Trustee in respect of facility agreement.

Security Session (WCC)

WCC
RMB Ltd

Security from WCC to RMB in respect of the obligations of SACS payable under the WCC Guarantee.

Security Session (Kensani)

Trust
Kensani Corrections

Security from Kensani Corrections to the Lenders (through the Trust) in respect of the obligations of SACS.

Notarial bond

Trust
SACS

Security from SACS to the Lenders (through the Trust) in respect of the debts provided through the facility agreement.

Cession of Claims

Kensani Consortium
SACS

SACS cedes all rights, title and interest claims in respect of the Tranche B Facility Agreements.

RMB Cession

SACS
RMB

SACS cedes all shares and benefits in the Project to RMB.

Pledge by WCC

WCC
Trust

WCC cedes or pledges all its ordinary shares in SACS to the Trust, i.e. Lenders.

Trust Guarantee Agreement

Trustee

Irrevocable guarantee issued by the Security Trustee in favour of the Inter Creditor Agent, in respect of the obligations of the Borrower under the Facility Agreements.

Counter Indemnify Agreement

SACS
Trustee

SACS indemnifies and holds the Trustee harmless against any liability arising from issuing the Trust Guarantee.

WCC Guarantee

WCC SA
Trustee

WCC SA issues this guarantee in favour of the Trustee in respect of the obligations of SACS under the Facility Agreements.

 

AGREEMENT

PARTIES TO THE CONTRACT

BRIEF EXPLANATION

Parent Company Guarantee

Concor Holdings (Pty) Ltd
SACS

Guarantees offered by parent companies for all CGM joint venture construction partners in favour of SACS in respect of proper performances and indemnifying SACS against any liabilities arising from any failure by CGM to fulfil any of the guaranteed obligations.

Makhosi Holding (Pty) Ltd
SACS

Group Five Construction (Pty) Ltd
SACS

Corporate Guarantees

WCC
Trust

Guarantees issued in favour of the Trust in respect of payment into the Rectification Account of 50% of amounts which may be payable by SACS.

Kensani Corrections
Trust

Guarantee and Direct Agreement

WCC
WCC SA
BOE Merchant Bank Ltd
SACS

WCC
WCC SA
FirstRand Bank Ltd
SACS

Account Bank Undertaking

FirstRand
RMB
DCS

Appointment of SACS bankers and regulates its obligations on monitoring the accounts to ensure SACS does not misuse project funds.

Golden Share Agreement

SACS
Trustee

Trustee undertakes to SACS that it shall not issue unnecessary default notices and shall reasonably demand exemption of the preference shares.

Security Session (SACS for Dept)

SACS
DCS

SACS cedes all rights, claims, entitlements or other interest in and to the Indemnity Account and the Construction Insurance Account in favour of the DCS.

Performance Guarantee

Standard Bank
SACS

A guarantee by Standard Bank in favour of SACS from the CSC in respect of its performance.

 
 
ANNEXURE 3: TERMINATION
 
Table 41: Bloemfontein Termination Clauses

TERMINATION CLAUSES

COMPENSATION PAYABLE: CONSTRUCTION STAGE

COMPENSATION PAYABLE: OPERATION STAGE

COMMENTS

    • Clause 44.1Contractors Events of Default (CEOD)
      This clause lists the relevant CEOD which can give rise to termination with the Department executing its rights to terminate subject to the procedures set out in the Finance Direct Agreement.
      The CEOD are failure to:
      Comply with operational standards within the Contract.

      Obtain Engineers Declaration.
      Provide 400 AvPP within 3 months from date of Engineers Declaration.
      Maintain 2928 AvPP after 6 months from Full Operation Date for a continuous period exceeding 30 days.
      Pay amounts due to Department within 30 days of demand.
      Obtain Department consent before "Change of Control".
      Have relevant insurance.
       
      In addition the following are also CEOD:
      Insolvency or similar events occurring; and

      A CEOD according to CTA occurs, lenders decide to accelerate debt.

No compensation payable.

80% of Lender liabilities; less:
Rectification costs;
Payments incurred by the Department in exercising its powers pursuant to the Correctional Services Act; and
Amounts payable to third parties upon termination of the Contract.
((i), (ii), and (iii) are capped and may not exceed R15 million in 1 January 1998 terms).

Although almost similar to the Louis Trichardt deal, the Contractorsí events of default also include the phase in period and the capping of the Compensation for lenders liability is higher R15 million versus R7,5 million for Louis Trichardt.

 

TERMINATION CLAUSES

COMPENSATION PAYABLE: CONSTRUCTION STAGE

COMPENSATION PAYABLE: OPERATION STAGE

COMMENTS

Clause 44.3 Departments Events of Default (DEOD)
The DEOD are failure to;
Pay a material and disputed sum for more than 60 days after demand;

In addition, the compulsory acquisition or expropriation of the Prison/Site by the Department or SA Government is also an event of default or nationalization of the Contractor or shares in the Contractor.

100% of Lenders liability; plus
A sum equal to the value of the nominal issued share capital and the value of shareholder loans in the Contractor;
The sum equal to the Contractorís costs of terminating agreed project contracts(including professional costs); and
The equity return shareholders would have achieved if the contract had continued to its term.

100% of Lenders liability; plus
A sum equal to the value of the nominal issued share capital and the value of shareholder loans in the Contractor;
The sum equal to the Contractorís costs of terminating agreed project contracts (including professional costs); and
The equity return that the shareholders would have achieved if the contract had continued to its term.

 

 
 
Table 42: Louis Trichardt Termination Clauses

TERMINATION CLAUSES

COMPENSATION PAYABLE: CONSTRUCTION STAGE

COMPENSATION PAYABLE: OPERATION STAGE

COMMENTS

  • Clause 44.1 Contractors Events of Default (CEOD)
    This clause lists the relevant CEOD which can give rise to termination but the Department executing its rights to terminate subject to the procedures set out in the Finance Direct Agreement.
    The CEOD are failure to:
    comply with operational standards within the Contract;

    obtain Engineers Declaration;
    provide 3024 AvPP within 3 months from date of Engineers Declaration;
    maintain 3024 AvPP for a continuous 3 months;
    pay amounts due to Department within 90 days demand;
    obtain Department consent before "Change of Control";
    carry out its obligations to repair insurable damage within 24 months.
    In addition the following are also CEOD:
    insolvency or similar events occurring;

    a CEOD according to CTA occurs, lenders decide to accelerate debt.

No compensation payable.

80% of Lender liabilities, less:
Rectification costs.
Reasonable payments incurred by the Department in rectifying and taking over the prison.
Payments incurred by the Department in exercising its powers pursuant to the Correctional services Act.
Amounts payable by the Department to third parties upon termination of the Contract.
((i), (ii) and (iii) capped and may not exceed R7.5 million in 1 January 1998 terms).

Although almost similar to the Bloemfontein deal, the CEOD do not include the phase-in period and the capping of the Compensation for Lenders Liability is R7.5 million versus R15 million for Bloemfontein.

 

TERMINATION CLAUSES

COMPENSATION PAYABLE: CONSTRUCTION STAGE

COMPENSATION PAYABLE: OPERATION STAGE

COMMENTS

Clause 44.3 Departments Events of Default (DEOD)
 
The DEOD are failure to:
Pay the Contract Fee, 30 Days after payment is due;

Meet its obligations which are unremedial for 60 days or more after receipt of written notice from the Contractor.
In addition, the compulsory acquisition or expropriation of the Prison / Site by the Department is also an event of default.
 
 

  1. 100% of Lenders liability plus:
    Issue price of Contractor share capital and balance of shareholder loans.
    The equity return shareholders would have achieved if the Contract had continued to its term (less payments made or due in respect of the initial equity).
  • 100% of Lenders liability plus:
    Issue price of Contractor share capital and balance of shareholder loans.
    The equity return shareholders would have achieved if the Contract had continued to its term (less payments made or due in respect of the initial equity).
  • The Contract Fee non-payment is clearly an event of default in this contract, whereas this is not clearly spelt out in the Bloemfontein Contract.

    Figure 18: Termination Procedure for the two Contracts
     
    ANNEXURE 4: RISK MATRICES
    Table 43: Bloemfontein Risk Matrix
    Table 44: Louis Trichardt Risk Matrix
     
    ANNEXURE 5: DCS BUDGET 2002/03
     
     
    ANNEXURE 6: GENERIC PPP PROJECT LIFE CYCLE
    Figure 19: Generic PPP Project Life Cycle
     

    Decision to explore entering into PPP project, prioritising the projects and including them in the budget process

    The decision to explore entering into a PPP project is based on the needs of the particular department and requires that the proposed project:
     
    fits strategically with the vision and objectives of the Department;

    is affordable;
    capacity exists within the Department and outside; and
    there is sufficient market demand for the service.
    Once the Department is convinced the proposed PPPs meet the above criteria, they should then be planned and incorporated into the Medium Term Expenditure Framework (MTEF) budget planning processes, both individually and in relation to the governmentís overall budgetary planning.
     
    Define the selected project, undertake an options analysis and select type of PPP
    Once the department has satisfied itself that there is indeed the possibility of procuring PPPs, and has appropriately planned the PPPs into the budget, it should then proceed with the selection of a multidisciplinary team, including a transaction advisor to take the process forward, led by an accounting officer or project champion from within the department.
    The project team will then define the project into an output specification detailing what service it requires from the private sector. The project team should then undertake an options analysis, which should be a broad based assessment of all options available for procuring the service, culminating in the selection of the most appropriate form of procurement. Each option should ideally look at the following elements:
     
    Technical viability

    Legal constraints
    Financial viability
    Overall Recommended Option
     
    Preparation of a Feasibility Study
    After determining the options, a detailed feasibility study should be carried out by the same project team which seeks to:
     
    establish whether the project is in the public interest;

    strengthen the strategic and business case for the project;
    determine whether it is financially viable;
    confirm that it complies with all relevant laws and regulations;
    determine the factors that will make it attractive to private investors;
    prepare a comprehensive assessment of its value for money; and
    assess the affordability of the project.
    The Feasibility Study must also confirm that there is a robust and commercially attractive project through which appropriate risk transfer takes place. It must be robust and comprehensive enough to act as a benchmark against which potential future bids can be tested. Some key aspects that make up the Feasibility Study are discussed below.
     
    Value for Money
    According to the Treasury Regulations, a PPP provides value for money if the net cost of private provision of the departmental function for a higher or equivalent standard of service delivery is lower than the net cost of departmental provision for a similar service.
    In order to determine the value for money the feasibility analysis must determine the cost to a department to provide the function being considered for a PPP. One of the most useful tools recommended by the Treasury Regulations is the Public Sector Comparator (PSC), which is used to compare whether private sector bids for the relevant services will offer value for money to the public sector.
     
    Public Sector Comparator (PSC)
    The PSC estimates the cost of providing an equivalent service in the public sector and is used to benchmark proposed private sector provision of services offered to the public.
    In order to compute a PSC, the project team should begin by ring-fencing the proposed government service. This is done in order to separate those costs that are associated with specific services provided by the public entity, including amongst other costs:
     
    capital costs, plus development costs (if any);

    operating costs;
    salaries and staff complement;
    municipal charges; and
    taxes and others.
    The data, as determined above is fed into a financial model built around historical and proper assumptions. Various adjustments to cater for levels of services, hidden marginal costs, financing costs, risk transfers and other economic and social benefits emanating from PPP are then made to the ring-fenced cost as obtained above in order to obtain an adjusted PSC for each of the project years.
     
    Affordability
    In line with the requirements of the National Treasury Guidelines the feasibility study seeks to demonstrate that the selected option is affordable. The affordability hurdle is achieved when the annual cashflows arising from the risk adjusted PSC financial model are less than the projected annual cashflows as contained in the existing government department budget for the procurement of the services. In other words "A PPP is affordable when the expected financial commitments can be accommodated within the departmentís existing budget and the relevant treasuryís projections of the budget beyond the MTEF period".
     
    Treasury Approval I (TA I)
    The final feasibility report demonstrating affordability and an initial value for money will then be approved by the relevant departmental authority, preferably the Deputy Director General or higher. This approval will lead to the granting of Treasury Approval I in terms of the Regulations of the Public Finance Management Act.