Major developments in 2007

The strategic extension of our investment business into non-PPP investments and PPP markets outside the UK was marked by the completion of our acquisition of Exeter International Airport and the award of preferred bidder status on our first non-UK PPP project – the £90m Institute of Technical Education in Singapore. Core UK PPP growth continued.

In July, the Metronet concessions for the London Underground PPP, in which we had a 20% interest, entered PPP administration. The investment in this project was written off as exceptional. The London Underground PPP was unique and we do not believe that any lasting negative impact on the PPP market will arise as a result of Metronet’s administration.

The market

The UK PPP market remains buoyant and is expected to continue to produce a steady flow of opportunities: in schools through the 14-year Building Schools for the Future initiative; in hospitals, particularly in Northern Ireland, although there has been a reduction in the number of very large hospitals coming to the market elsewhere; and in social housing. In transport, the award of the £1.5bn M25 widening scheme, which is expected in the first half of 2008, is likely to be followed by similar schemes to increase motorway capacity.

In the US, the road and rail transport sector is proving slow to take off, but both the schools and hospital accommodation markets look very promising. On completion of the acquisition of GMH Military Housing, we will become a leading participant in the US military accommodation PPP market. Markets in Germany and South-East Asia are developing steadily.

Strategy

Given its clear competitive advantages and market leading positions, Balfour Beatty will continue to pursue UK PPP bidding opportunities and seek to apply its UK PPP expertise in selected international markets where our UK experience is relevant and where the complexity and size of projects provides opportunity for the construction and service capabilities of the Balfour Beatty Group.

In addition, we will seek to leverage our expertise to pursue selected opportunities through refinancing and carefully targeted acquisitions and divestments in the secondary PPP market and apply the skills we have acquired in PPP to the wider infrastructure market where there are attractive investment opportunities and the ability to generate work for the remainder of the Group.

2007 performance

Profit from continuing operations, before exceptional items, in Investments reduced by £8m to £16m in 2007. This reflected good underlying concession performance, but also substantial and increasing investment in developing our PPP operations in the US, Germany and South-East Asia, in bidding for projects in these markets and for non-PPP assets.

Five PPP projects in the UK, with a total capital value of over £700m and involving equity investments totalling £48m, reached financial close and Exeter International Airport was also acquired in January 2007, involving an £18m equity investment for Balfour Beatty. Preferred bidder status was achieved for four projects, namely Fife Hospital, Islington Schools, the Institute of Technical Education in Singapore and Carlisle Northern Distributor Road.

Barking Power again performed satisfactorily, with profits in line with those of 2006. In its first year of ownership, Exeter International Airport performed at anticipated levels.

Outlook

We anticipate that the operating performance of our concessions will continue to meet expectations in 2008. The UK PPP market remains buoyant and is expected to continue to produce a steady flow of opportunities. Our investment in resources to exploit new PPP markets and in bidding projects is accelerating, the costs of which will impact reported results in the sector in 2008.

Directors’ valuation 2007

Directors’ valuation

Using the same, blended, post-tax nominal discount rate of 8.1% as in 2006, the 2007 Directors’ valuation of our UK PPP portfolio stands at £299m (2006: £341m).

A full explanation of our PPP valuation is in Chairman's statement of the Directors’ report and accounts.

Alternative valuation 2007

Alternative valuation

In response to the increased importance of infrastructure investment, Balfour Beatty is also providing an alternative valuation. This method uses DCF to value the portfolio but applies a single discount rate of 6% to the cash flows, excluding shareholder tax, of concessions which have reached financial close or are at preferred bidder stage.

A full explanation of our PPP valuation is in Chairman's statement of the Directors’ report and accounts.

Hospitals

Consort Healthcare, Balfour Beatty’s branded organisation in the healthcare market, continued to perform well in 2007. Consort’s portfolio comprises interests in nine major hospital projects and a committed equity investment of £123m, of which £7m is at preferred bidder stage.

North Durham, Edinburgh Royal Infirmary, University College London Hospital and Royal Blackburn were already fully operational at the beginning of 2007. At Birmingham Hospital, the mental health facility is due to open in 2008 and the remainder by 2011.

In January 2007, Consort became preferred bidder for the Fife General Hospital and Maternity Services PPP project comprising a new £152m wing at Victoria Hospital in Kirkcaldy, Fife.

In June, Consort reached financial close on the Mid Yorkshire Hospitals NHS Trust’s Pinderfields and Pontefract Hospitals Development PPP Project. The £311m project will deliver a new acute in-patient hospital in Wakefield on the existing Pinderfields Hospital site and a new Diagnostic and Treatment Centre in Pontefract. The new hospitals are due to open in 2009 and 2010.

In September, Consort reached financial close on the £136m Salford Royal NHS Foundation Trust PFI project and the £77m Tameside and Glossop Acute Services NHS Trust PFI project in Greater Manchester. On both projects, Consort will redevelop and provide new buildings on the existing hospital sites.

Consort Healthcare remains a clear market leader in UK PPP hospitals with a proven track record, a differentiated approach and high levels of client satisfaction.

Bids are in preparation for Enniskillen and Omagh (both in Northern Ireland) with a combined value of £405m, along with a number of opportunities in Germany and the UK.

Education

Balfour Beatty’s market-leading branded organisation in the UK education market, Transform Schools, continued to perform well in 2007. Transform’s portfolio consists of seven large-scale schools schemes with £48m of committed equity investment, of which £3m is at preferred bidder stage.

Construction and operations are proceeding well at our Stoke, Rotherham, Bassetlaw, North Lanarkshire and Birmingham concessions. In May, Transform was appointed preferred bidder by Islington Council for the £140m PPP concession to deliver eight secondary schools and two pupil referral units under the Building Schools for the Future (BSF) programme. Balfour Beatty will invest £3m in equity in the project, which will be delivered in three phases commencing in early 2008.

In December, Transform reached financial close on the £163m Knowsley Metropolitan Borough Council PPP concession to construct seven new learning centres under the Building Schools for the Future (BSF) initiative. The concession will replace all of the Borough’s existing secondary schools over a three-year period. The project will involve state-of-the-art educational methods and techniques.

Bids are in preparation for Derbyshire, Southwark and Sandwell schools projects, with a combined value of £685m.

Roads and street lighting

During 2007, Connect Roads, Balfour Beatty’s branded organisation in the highways market, performed strongly.

The total committed equity in the roads sector is £68m, of which £5m is at preferred bidder stage.

In April, Connect reached financial close on the 25-year, £36m PFI street lighting concession for Derby City Council. The project involves the replacement of 20,100 lighting columns and 3,200 illuminated signs during the five-year capital investment period.

In November, Connect was awarded preferred bidder status on the £150m Carlisle Northern Distributor Road PFI project by Cumbria City Council. The 30-year concession contract involves the design and construction of a new road and the provision of whole-life operation and maintenance services for a network of roads in the area.

We are one of three groups to have submitted a bid, as part of a consortium of companies, for the £1.5bn M25 widening project, for which preferred bidder announcement by the Highways Agency is expected in spring 2008.

Other bids are in preparation for the M80 road project and street lighting projects in Surrey, Nottingham and the south-east. These projects have a combined capital value of over £600m.

Other PPP concessions

Powerlink and PADCO have upgraded and now operate and maintain London Underground’s high voltage power system. They have also procured and financed new power assets on behalf of LUL. The complex programmes involved in this concession are proceeding satisfactorily.

Aberdeen Environmental Services is responsible for wastewater treatment in Aberdeen. In June 2007, the Stonehaven plant which is now being constructed was incorporated into the project. The operations and performance of the concession are in line with expectations.

In November, Gammon Capital (in which Balfour Beatty has a 50% interest) was appointed preferred bidder for the £90m new Institute of Technical Education (ITE) in Singapore. Financial close is anticipated in the first half of 2008 with the first student intake scheduled for July 2010.

Balfour Beatty has committed £12m of equity to these concessions.

Barking Power

Barking Power in which Balfour Beatty has a 25.5% shareholding and which owns and operates a 1,000MW gas-fired power station in east London, again performed very well, with profits at a similar level to those of last year. For the majority of the year, the station operated reliably at high levels of its capacity. Open market electricity prices, which apply to 28% of the station’s output, were again advantageous.

In the latter part of the year, a steam turbine fault limited the station’s availability. Full service has now been resumed, with the output losses substantially covered by insurance. During the year planning permission was secured for a potential 450MW extension to the station.

Exeter International Airport

Exeter International Airport is one of the fastest growing regional airports in the UK and currently handles over one million passengers per year, with passenger numbers forecast to double by 2016. Balfour Beatty Capital completed its acquisition from Devon County Council in January 2007 for £60m. The acquisition was financed by £30m of Balfour Beatty equity, with £12m of this sum subsequently sold to an infrastructure investment fund.

An airport development master plan is being prepared in consultation with a wide range of the airport’s stakeholders and investment in the airport is developing in line with our acquisition plan, phased in anticipation of continuing increases in passenger numbers. This will eventually include new terminal facilities, aircraft stands and taxiway extensions.

Shortly after the acquisition, Flybe, the largest European regional airline, confirmed its intention to retain its headquarters at the airport and to invest in new technical and maintenance facilities there. The airport serves a strong local and regional economy and is expected to both increase market share and benefit from an increased propensity to fly.

Metronet (discontinued business)

Metronet, in which Balfour Beatty was a 20% shareholder, operated and maintained the Bakerloo, Central and Victoria Lines (BCV) and the sub-surface lines (SSL) for London Underground from April 2003, in a concession planned to run for 30 years.

In June, Metronet made an application for an Extraordinary Review of the incurred and forecast costs for the BCV Line concession. This process was set out under the contract and allowed for an external arbiter to award additional funding to the extent that Metronet could demonstrate that it had acted in an “economic and efficient” manner. An application for the SSL concession was also in preparation.

Given the uncertainties pending the outcome of the Review, the level of unanticipated costs associated with the concessions’ capital programmes and Metronet’s funding position, Transport for London, on behalf of the Mayor, made an application to the Court for the BCV and SSL concession companies to be placed in PPP administration. Balfour Beatty has taken an exceptional charge in respect of Metronet, including the write-off of the equity invested in the Metronet concessions and the profits recognised in respect of these investments in prior years.

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