Directors' valuation of the investments portfolio

The Group continued to make substantial investments into the portfolio with £102 million of cash invested into projects in 2015. This reflected continued success in targeted sectors with nine new projects being included in the Directors’ valuation for the first time, as well as further investment in existing projects. The nine new projects include a project which achieved preferred bidder in 2014 but wasn’t included in the Directors’ valuation until financial close was achieved in 2015.

The Group continued its strategy of realising value through selling mature investments generating £145 million in aggregate at pricing consistent with the Directors’ valuation. Cash yield from distributions amounted to £82m. For the tenth year in succession the portfolio generated cash flow to the Group net of investment.

In overall terms, the Directors’ valuation fell slightly to £1,244 million at 31 December 2015 with the number of projects in the portfolio increasing from 66 to 71.

The Directors’ valuation has been undertaken using the revised methodology introduced in 2014. This produces a valuation that more closely reflects market value and which consequently changes with movements in the market. For each project, cash flows are forecast based on progress to date and market expectations of future performance. These cash flows have then been discounted using different discount rates depending on project risk and maturity, and reflecting secondary market transaction experience. As in previous years, the Directors’ valuation may differ significantly from the accounting book value of investments shown in the accounts, which are produced in accordance with International Financial Reporting Standards rather than using a discounted cash flow approach.

Portfolio valuation December 2015

Value by sector

Sector

No. projects (2014)

2015 £m

2014 £m

Roads

13 (13)

412

467

Healthcare

4 (4)

137

225

Schools

7 (8)

76

102

Student accommodation

5 (3)

69

28

OFTOs

3 (3)

40

82

Waste & biomass

4 (3)

40

14

Other

4 (4)

28

25

UK total

40 (38)

802

943

US military housing

21 (21)

355

322

Healthcare

2 (2)

5

4

Student accommodation

4 (3)

26

9

Other

4 (2)

18

2

North America total

31 (28)

404

337

BBIP fund

 

38

20

Total

71 (66)

1,244

1,300

Portfolio valuation December 2015

Value by phase

 

Stage

No. projects (2014)

2015 £m

2014 £m

3+ years post construction

23 (18)

413

405

0–3 years post construction

23 (26)

539

723

Construction

20 (19)

218

137

Preferred bidder

5 (3)

36

15

BBIP fund

 

38

20

Total

71 (66)

1,244

1,300

 

Portfolio investment, divestment and distribution since 2006

 

2015 Portfolio investment, divestment and distribution since 2006

 

UK portfolio

In 2015 five new projects in the health, OFTO, student accommodation and biomass sectors were included in the Directors’ valuation for the first time, increasing the value by £28 million. These included preferred bidder status on a student accommodation project at Sussex University, the Humber Gateway OFTO and a Primary Care PPP project in Ireland, the start of construction on an open market student accommodation project in Glasgow and financial close on a waste wood biomass project in Welland. Significant investment was made in the Gwynt y Môr OFTO, the Welland biomass project, the student accommodation projects in Edinburgh and Glasgow and into the fund managed by Balfour Beatty Infrastructure Partners (BBIP). Total investment amounted to £88 million.

The secondary market remains strong and the Group continued its strategy of realising value from mature investments. The business sold 80% of its interest in the Thanet OFTO as well as its entire interest in the Edinburgh Royal Infirmary, Newcastle BSF schools and Greater Gabbard OFTO projects for an aggregate £145 million. The proceeds received from these sales were consistent with the Directors’ valuation. The business continues to preserve interests in projects with strategic clients and those that offer further value to the wider Group through the provision of future lifecycle and maintenance work. Strong demand for infrastructure investment allied to a shortage of supply in the secondary market is expected to underpin pricing for the foreseeable future. With the largest primary infrastructure portfolio held by any contractor in the UK, the Group remains well placed to benefit from these market dynamics.

Operational performance movements resulted in a £100 million reduction in value. The most significant components of this were lower inflation (in the year, as well as forecast), lower forecast deposit interest rates, higher actual and forecast lifecycle and management costs and an increase in the assumed tax burden for potential purchasers. The changes to inflation reflect a lowering of forecast inflation which now steps up through 2016 and 2017 before reverting to a long-term assumption of 3% thereafter. The long-term interest rate assumption has been lowered from 3.5% to 2.75% in response to the continuing policy of near zero interest rates adopted by the Bank of England and the resulting impact on long-term rates forecast by the financial markets. In line with government announcements the corporation tax rate has been reduced from 20% currently to 19% in April 2017 and to 18% from April 2020.

The Group’s investment in the fund managed by BBIP is included in the UK portfolio and amounted to £38 million at December 2015.

 

Valuation – The portfolio value at a range of discount rates

UK portfolio*

 

 2015 UK Valuation

 

Discount rates applied to the UK portfolio range between 7% and 14% depending on project risk and maturity. The implied weighted average discount rate for the UK portfolio (excluding BBIP) is 8.3% (2014: 7.8%). The increase during 2015 reflects the impact of selling mature operational projects with lower discount rates whilst investing in new projects where construction has yet to be completed and which are valued using higher discount rates. A 1% change in the discount rate would change the value of the UK portfolio (excluding BBIP) by approximately £95 million.

In 2015, the OECD BEPS project delivered its recommendations in relation to the tax deductibility of interest expense, including the potential for a ‘public benefit’ exemption. A number of governments are currently considering their response to these recommendations. The UK Government has consulted extensively in order to understand the views of the infrastructure industry. At this stage any impact on the Directors’ valuation remains uncertain as is the timing of any changes to legislation. Balfour Beatty will continue to actively engage with the UK Government and to monitor developments in this area.

 

North American portfolio

In North America, the business acquired investments in three residential housing developments at Coppell and Dallas-Fort Worth (both in Texas) and at Rogers in Arkansas, achieved financial close on a student accommodation project for the University of Texas at Dallas and commenced a further phase of accommodation at the University of Iowa. These projects increased the value of the portfolio by £17 million. Overall investment in existing and new projects in the portfolio totalled £14 million during the year. Operational performance movements increased the valuation by £13 million. This increase arose predominantly from the annual budget settlement for the military housing portfolio, particularly the inflation adjustment for housing rental allowances which feeds through to the fee income and equity returns from individual projects. The Indianapolis justice facility which was at preferred bidder stage was cancelled by the procuring authority just prior to financial close and has therefore been removed from the valuation.

Discount rates applied to the North American portfolio range between 7.5% and 10%. The implied weighted average discount rate for the North American portfolio is 8.2% (2014: 8.1%). A 1% change in the discount rate would change the value of the North American portfolio by approximately £58 million.

 

Valuation – The portfolio value at a range of discount rates

North American portfolio


2015 NA Valuation

 

 

Movements in value 2014–2015 £m

 

2014

Equity invested

Distributions received

Disposal proceeds

Unwind of discount

New project wins

Operational performance

FX movements

2015

£m

UK

963

88

(56)

(145)

64

28

(100)

(2)

840

North America

337

14

(26)

29

17

13

20

404

Total

1,300

102

(82)

(145)

93

45

(87)

18

1,244