31% annual return on equity (M25 project, UK)
Sources: National Audit Office analysis; HM Treasury PFI database; Connect Plus (M25) financial accounts
A bit of history
In 2008 Highways England (the post-Soviet equivalent of the Highways Authority) announced a tender for a 30-year PPP contract to extend two sections of the M 25 (London Ring Road) and maintain/operate
125-mile section of the road, including the huge Dartford Crossing.
The total capital investment cost of the project was about
1 billion pounds.
The winning bid was a special design company
Connect Plus, which was established by four shareholders: planners and builders Balfour Beatty and Skanska bought a 40% stake each, and consultants Atkins and French engineering group Egis bought 10% each.
At the start of the project, these four shareholders invested in the company’s share capital at what they call par, and then provided equity loans to the Connect Plus project company for a total of £200 million during the construction phase. The rest of the initial investment was in the form of loans from banks.
According to information provided by the National Audit Office, over a 6-year period from 2009-10 to 2015-16, a total of £113 million in interest on the loans and £44 million in stock dividends (payments began in 2013-14) were paid to shareholders.
In 2016-17, the two original shareholders, Skanska and Atkins, sold their stakes, which totaled 50 percent of Connect Plus’ share capital, for
Given the timing of cash flows, the annual rate of return was estimated to be about thirty-one percent (including interest, dividends and sale proceeds) over the eight-year period from 2009-10 to 2016-17 on investments (share repurchases and shareholder loans) of just over £100 million.
In 2018 and Balfour said it also sold a 20 percent stake in the Connect Plus project company to private equity firm Dalmore Capital for £165 million.
Highways England estimates that between 2017-18 and
2039-40, Connect Plus will generate an average of about
£350 million a year (a total of £8 billion). This helps pay for ongoing operations and maintenance work, provide a return to shareholders, and pay off bank loans, which currently total about £1 billion…
Recall that Highways England, a state-owned company, pays Connect Plus a flat fee, calculated, adjusted for inflation, based on affordability and a set of performance measures set forth in the agreement.
Like most PFI projects, Connect Plus bears the risk that the costs required to maintain the road may exceed the payments received from Highways England, and that the timing of required costs may differ from estimates.
Connect Plus ceded most of the key risks associated with the O&M contract deductions to its contractors for the remainder of the concession term.
The O&M contractor is a joint venture comprised of Balfour Beatty Civil Engineering Ltd. (Balfour Beatty), WS Atkins Ltd. and Egis Road Operation UK Ltd.
If you look closely, again, it’s what they call «all our own.»
In July 2018, already new shareholders decided to issue
20-year bonds worth £889 million.
But that’s another story…
Since the signing of the agreement in 2009, Connect Plus has carried out work to upgrade more than 100 km of London’s main ring road, the M25 freeway.
This work was completed in 2015. According to the agreement, Connect Plus must maintain and operate the road network for the remainder of the concession period.
The M25 highway network includes a 200-kilometer ring road around London, about 200 kilometers of radial trunk roads and several complex structures, including the Dartford Crossing, which crosses the River Thames east of London. The network’s trunk roads facilitate access to Heathrow, Gatwick, Stansted, Luton and London City airports.
This example shows that in some PFI PPP deals equity investors can get high investment returns, especially when the shares were sold after the construction and commissioning of the facility.
So what accounts for these high returns?
А. That the new investor who bought shares in the project company is prepared for a low but risk-free return because the project is already in the operating phase with a lower level of risk (the risk of construction and the first periods of operation are behind them), or
Б. The project, in this case the highway upgrade, is more profitable than originally projected.
By the way, a high return on the stock of a special project company, does not mean that costs for the public sector have gone up. We will discuss this separately at our APMG PPP International PPP training program.
What to do?
It’s very tempting for the state to, as of tomorrow, immediately
(i) put limits on the return on shares in PPPs, or
(ii) put limits on the amount of shares that can be sold, or
(iii) develop some mechanism for the distribution of profits derived from the sale of equity capital.
But such a rambling action can also scare away investors…