Introduction
Balfour Beatty's PPP concession portfolio has grown in recent years to become a very significant part of the Group’s business and a major driver of shareholder value. At 31 December 2006, Balfour Beatty had total committed equity and subordinated debt of £304m across 25 projects, five of which were at preferred bidder stage. At that date, £173m had already been invested and £131m is due over the next six years.
Valuations of PPP equity often rely on the use of multiples to produce a proxy cash flow valuation. This produces somewhat crude benchmarks as such an approach takes no account of the time value of money, expected rate of return of the asset, the performance of the asset or the potential for capital restructuring.
In order to provide a more reliable indicator of value, Balfour Beatty has decided to publish its own valuation benchmark for the Group’s PPP investments, based largely on discounting expected future cash flows but without taking into account potential refinancing gains.
2006 valuation
At 31 December 2006, the Directors’ valuation of Balfour Beatty's portfolio stood at £341m, at a weighted average, post-tax nominal discount rate of 8.1%; compared with £289m at the end of 2005 (8.2%). The movement in value arises both through shareholder cash inflows and outflows and through underlying growth in the portfolio arising from the unwinding of the discount from year to year. A 1% change in the discount rate impacts value by approximately £35m.
The valuation method
The valuation does not set out to estimate the market value of the investments in the portfolio, but rather, through the application of a consistent methodology, illustrates movements in underlying values between periods and highlights the impact of intervening transactions. The valuation covers 20 concessions that have reached financial close and five at preferred bidder stage. One of two methods has been used to establish the value of individual concessions.
DCF
The principal method used to value the portfolio is discounted cash flow (DCF). This is applied to the future forecast cash flows to which Balfour Beatty as a shareholder and a holder of subordinated debt is entitled in order to create a net present value (NPV). DCF has been used on 22 of the 25 investments. For projects which have reached financial close, forecast future cash flows are extracted from detailed financial models, updated in line with operational experience and lenders’ requirements. For projects at preferred bidder stage, the current financial model has been used.
The DCF methodology discounts forecast cash flows at differing discount rates depending on the project phase, and therefore the risk associated with the cash flows.
– Any investment cash flows occurring during the construction period are rolled forward at a risk free rate (5%) to the final injection of equity at construction completion.
– Cash flows anticipated to occur during the operations period are discounted back to the beginning of the operations phase at 8%.
– A net present value is calculated at the end of the construction period by deducting the investment cash flows that occur at this time from the value of the discounted cash flows at the beginning of operations.
– The net present value at the end of the construction period is then discounted back to financial close at 12%.
– Any projects at preferred bidder have a scaling factor of 50% applied to the NPV at financial close.
A diagrammatic illustration of the process is shown above.
Book value
For the other three concessions, the current carrying value in the accounts (book value) has been used. Metronet is at too early a stage in its 30-year concessions to forecast cash flows with the same degree of certainty as the majority of the Group’s concessions. In the case of Powerlink, discussions are currently in hand with London Underground over restructuring the concession framework.
Assurance
The calculations underpinning the valuation have been independently checked to ensure that the valuation has been accurately carried out in accordance with the specified methodology. However, the detailed financial models have not been audited.