HICL comments on PFI/PPP situation – HICL Infrastructure has released interim results covering he six months ended 30 September 2017. The highlights from these are that the NAV total return for the period was 8.9%, HICL is on track to hit its 7.85p dividend target this year and is targeting 8.05p for the year to 31 March 2019 and 8.2p for the year after. New acquisitions in the period included Affinity Water and High Speed One. There is also a statement that “The Investment Adviser has not seen a material impact from the current UK political environment on the valuation of investments in the portfolio.”
Compensation on termination
Given the elevated level of political risk to the company in the UK 9see next section), HICL has made a comment on the potential effect of the early termination of their PFI/PPP projects. They say that, as of 30 September 2017:
- “The Group’s portfolio includes 115 investments in PPP projects and demand-based assets (structured as concessions with public sector counterparties) which have a combined portfolio value of GBP2.6bn;
- 99 of the Group’s investments, comprising GBP2.4bn of portfolio value (UK-only: 88 investments, GBP1.9bn of portfolio value) are in PPP projects and demand-based assets that have contracts where either a) the public sector counterparty has no right to voluntarily terminate or b) where the public sector counterparty has a right to terminate, compensation payable would be calculated by reference to the prevailing market value of the investment;
- 16 investments, comprising GBP0.24bn of portfolio value (UK-only: 10 projects; GBP0.18bn of portfolio value), are in PPP projects that have contracts where the compensation payable by the public sector on voluntary termination is calculated by reference to formulas rather than to the market value of the investment.
- In the current market, as at 30 September 2017, we estimate that the difference between the Group’s valuation of its investments in PPP projects and demand-based assets, and the compensation contractually payable in the hypothetical event of voluntary terminations across the Group’s portfolio, represents approximately 4% of total portfolio value.”
Political risk
The manager comments “With a wide range of public sector counterparties, political risk is inherent in HICL’s business model and consistently has been a key risk faced by the company.
The use of PPPs (of which PFI is one example) to procure capital investment in infrastructure in the UK has, at various times since HICL’s IPO, been subject to negative political comment. Most recently, there has been political comment suggesting that a future UK government could contemplate terminating some existing PPP projects. Typically, public sector counterparties are entitled to voluntarily terminate a PPP contract and, if this occurs, project companies have a corresponding right to receive compensation. For the majority of HICL’s investments in UK PPP projects, this compensation is contractually based on market value which would, we believe, be equal to the prevailing value of the asset in the portfolio.
We are aware of recent commentary comparing a) the compensation payable by public sector counterparties in the event they choose to terminate PPP contracts, with b) the value attributed to investments in those PPP projects on the balance sheets of listed infrastructure companies. We caution against drawing firm conclusions from analysis based on scenarios that are unrealistic and extrapolated to precisely quantify the effects of portfolio-wide voluntary termination. For a number of years InfraRed has selectively acquired and disposed of investments on behalf of HICL in order to manage the exposure of the Group to voluntary termination situations where compensation is not equivalent to the prevailing market value of investments.
There have also been suggestions in recent months that a future UK government may consider taking utilities, including water companies, back into public ownership. There is a need to balance the interests of consumers and those of investors. According to Water UK, over GBP150bn has been invested in the industry since privatisation and customer satisfaction levels are around 90% according to the independent water consumer watchdog. While future public ownership is a possibility, some comfort can be taken from the reasonable assumption that any future government will take a pragmatic approach to its overall infrastructure investment programme and seek to preserve the relationships that enable this.”
Warning about construction contactors and facilities managers
“Following several recent profit warnings from UK-based construction contractors and facilities management service providers, counterparty exposure more generally is also of particular note for the Risk Committee and the Board. While this risk is diversified within HICL’s portfolio across a range of subcontractors, a number of possible scenarios have been assessed by the Investment Adviser as part of its ongoing risk evaluation and asset management work. Contingency plans are in place to ensure continuity of operations if one or more of the Group’s PPP projects are affected by the failure of a subcontractor.”
Problems with some projects
“As previously reported, some projects experience operational challenges and have on occasion incurred deductions. These are usually reclaimed from the relevant subcontractors but deductions have occasionally adversely impacted the Company’s investment cashflows. On a portfolio basis, the impact of these deductions has been immaterial.
A small number of project companies are considering initiating litigation against particular construction subcontractors in respect of enforcing the contractors’ obligations regarding the diligent rectification of construction defects. This is an example of how the PPP project companies in which the Group invests enact their duty to ensure that clients and other stakeholders have use of facilities that are constructed to the relevant standards and which are of appropriate quality.
On a regular basis, the Investment Adviser reviews and reports to the Risk Committee on the portfolio’s counterparty exposure to both the operational supply chain, and the providers of bank deposit accounts and interest rate swaps. In light of recent profit warnings from certain counterparties (and a deterioration in their balance sheets) a reduction in the valuation of between GBP5m and GBP10m has been taken as at 30 September 2017.
The following provides updates on some previously reported challenges in the portfolio:
- There continues to be a number of actions to resolve alleged building defects and operational issues at a hospital PPP project, and as previously reported, progress is slow. The value of the investment in the portfolio is in the range of GBP0-5m.
- Negotiations continue with respect to the compensation due to the Group from a school PPP project which was voluntarily terminated by the local authority client during the previous financial year, which has certain construction defects outstanding. Third party mediation is underway to agree a resolution to both parties’ satisfaction. The value of the investment in the portfolio is in the range of GBP5-10m.
- Progress on the commercial settlement negotiations regarding a road PPP project with a number of operational issues and construction defects has been slower than expected due to difficulties in finalising a settlement. If an amicable settlement cannot be agreed, court action will be resumed. The value of the investment in the portfolio is in the range of GBP0-5m.”
HICL : HICL comments on PFI/PPP situation