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Private Finance Initiative - Treasury Contents



Written evidence submitted by Dexter Whitfield, Director, European Services Strategy Unit, and Adjunct Associate Professor, Australian Institute for Social Research, University of Adelaide

SALE OF EQUITY IN PFI COMPANIES

EXECUTIVE SUMMARY

1.  Government monitoring of the sale of equity in PFI companies is inadequate, infrequent and under-estimates the scale of transactions. Meanwhile banks and construction companies are extracting large profits from what is ultimately publicly financed investment.

2.  The sale of equity is significantly higher than that the sales identified in the HM Treasury PFI equity database and estimated by the National Audit Office. The ESSU PPP Equity Database identifies:

—  240 PPP equity transactions involved 1,229 PFI projects (including multiple sale of some projects) valued at £10.0 billion.

—  Average profit was 50.6% (compared to average operating profits in PFI construction companies of 1.5% between 2003-09).

—  £517.9 million profit from a sample of 154 PFI projects. If the same level of profit were maintained for the 622 PPP project equity transactions the total profit would be £2.2 billion.

—  Profits could be as high as £4.2 billion if the same level of profits is obtained by the sale of secondary funds as in the direct sale of equity in PFI companies.

—  Two sectors had higher than average profits, health (66.7%) and criminal justice (54.9%) with transport (47.1%) and education (34.1%) below average.

—  An increasing number of PFI projects are registered in tax havens.

SALE OF PFI EQUITY AND GROWTH OF THE SECONDARY MARKET

3.  There are basically two types of PFI equity transactions. Firstly, SPV shareholders selling equity in individual projects or in a group of projects. Secondly, the sale of secondary market infrastructure funds that have a portfolio of PFI equity stakes in SPVs. In both cases the partial or full ownership of equity in the SPV transfers to a new owner. PFI equity ownership also changes when a construction company is subject to a takeover or merger, however, the value of PFI assets will normally be reflected in the overall takeover price and will not be identified separately.

4.  The PFI contract will normally impose a restriction on the sale of equity prior to the completion of the building works and commencement of the service. Once operational, contractors can sell their equity and are only required to inform the authority within 30 days of any change of ownership. Refinancing and the sale of PFI equity comprise the secondary market.

5.  Some PFI companies have a policy of retaining ownership of equity in SPVs whilst others recycle their investments by selling equity to help finance new PFI projects. Four trends are evident in the secondary market:

—  portfolio building by some construction companies;

—  recycling and profit-taking by other construction companies;

—  growth of joint ventures between PFI construction companies and banks, infrastructure funds and pension funds; and

—  growth of secondary market infrastructure funds (listed and unlisted).

GOVERNMENT ADOPTS "HANDS-OFF" ATTITUDE

6.  Although public sector consent and profit sharing is required when PFI projects are refinanced, there are no requirements when the equity of PFI companies is sold. The Treasury has regarded the sale of PFI equity as a transaction solely between private companies in which the government has no involvement. It argues that a change in the equity ownership of the project is part of the normal takeover or merger of companies and is different from refinancing projects. The National Audit Office (NAO) position is:

"In general, the shareholders of a project company are allowed to trade their PFI shares freely, as they would any normal shares of a limited company. Only occasionally would a public authority have a say in such trades, such as a right to consent (not unreasonably withheld) in certain Defence contracts. The public authority is not a party to such trades and does not share in any proceeds. It is therefore important that the expected return to the shareholders over the course of the whole contract be carefully scrutinised during the contract tendering" (House of Lords, 2010b).

LONGER-TERM CONSEQUENCES IGNORED

7.  The NAO recognises that the risk of the consolidation of PFI equity could lead to "…disproportionate market power, and particular asymmetry of power over small public authorities tendering and managing single PFI contracts. We would be concerned if we started to see a few consolidated owners dictating contract and commercial terms. We do not have evidence that this is happening" (ibid). It concedes that "…the lack of visibility over the secondary market it is difficult to ascertain the effects that the secondary market has had to date" (ibid).

8.  The Treasury and NAO are either unaware, or have decided to ignore, the excessively high profit levels obtained in PFI equity transactions. The NAO assumes that the growing secondary market will have little or no effect on PFI projects, services users, staff and public bodies. However, Global Auction of Public Assets raises a number of important issues about the potential effects of the sale of PFI equity and the growth of secondary market infrastructure funds:

—  invalidation of value for money claims because high profit levels appear to indicate significant overpayment for risk transfer;

—  allocation of benefits from operational efficiencies;

—  privatisation of gains from publicly financed investment and development;

—  erosion of democratic control;

—  increasing secrecy;

—  acceleration of the marketisation of public services; and

—  longer-term implications of the growth of secondary market funds and the potential effect on the delivery of core services (Whitfield, 2010).

NEW DATABASE

9.  The ESSU Database was compiled from Stock Exchange Regulatory News Service and Company Notices and Press Releases; Company Interim and Annual Reports & Accounts; UK Companies Houses filings; Infrastructure fund share prospectuses; Construction and PFI company websites; HM Treasury PFI equity holders database; Partnerships UK Database; Securities & Exchange Commission 8K filings for US stock exchange companies; and financial, construction and infrastructure journals and web sites.

10.  There are significant problems regarding access to, and the quality, of equity transactions in PFI companies. Many publicly listed companies will issue a Regulatory Notice or Stock Exchange announcement disclosing the acquisition or disposal of PFI equity, but in some cases companies consider the transaction is not of material financial interest. Privately-owned companies and private equity funds have no comparable disclosure requirements. A company may report the details of an equity sale or acquisition in their interim or annual report, but may not indicate the price, level of profit nor to whom they sold their shareholding. There is no common practice or standard requirement.

11.  The SPV shareholders usually have pre-emption rights, which allow them the right to acquire the shares of other shareholders who want to sell their equity.

GROWTH OF PFI EQUITY SALES 1998-2010

12.  The Database records 222 UK equity transactions between 1998-2010 covering 622 PFI projects. The annual rate of PFI equity transactions, not surprisingly, increased rapidly between 2000-04 during the formative years of the secondary market. There are inevitably variations in the number, and the total value, of transactions on an annual basis, reflecting the completion of PFI projects, recycling decisions of PFI contractors depending on their contract win-rates and secondary market funds seeking to expand their portfolios. The financial crisis appears to have had a minimal effect on PFI equity transactions.

Table 1

ANNUAL RATE AND VALUE OF UK PFI DIRECT EQUITY SALES
YearNo of equity transactions No of PFI projects (includes those with multiple equity sales) Value of equity sold (£m)
(No of transactions)
Estimated total value based on average (£m)
199811 3.4 (1)3.4
199911 n/an/a
200056 n/an/a
2001515 117.4 (4)146.7
200233 n/an/a
20031630 135.6 (8)271.2
20043395 190.6 (14)449.3
20053859 306.3 (16)727.5
200635127 1,431.7 (24)2,087.9
20072166 401.8 (16)527.4
20081692 333.0 (8)666.0
20092960 370.4 (20)537.1
20101967 586.7 (14)796.2
Total228 6223,876.9 6,212.7

Sources: ESSU PPP Equity Database, 2011

SECTOR DIFFERENCES

13.  Health and Education PFI projects account for half of individual PFI equity project sales between 1998-2010—see Table 2. Transport, primarily roads and motorways, public transport and street lighting projects account for just over 10% followed by criminal justice - prisons, courts, remand centres—with 9%.

Table 2

INDIVIDUAL PFI EQUITY TRANSACTIONS BY SECTOR 1998-2010
SectorNo. of PFI projects in equity transactions %
Health—hospitals and health centres 16626.7
Education—schools and collages148 23.8
Transport—public transport, roads & street lighting 6510.5
Criminal Justice—prisons, courts, remand centres 579.2
Waste/Water172.7
Defence142.2
Housing—rehab of council estates & MoD housing 101.6
Leisure101.6
Misc355.6
Unknown10016.1
Total622 100.0

Source: ESSU PPP Equity Database, 2011

PFI PROJECTS SOLD MULTIPLE TIMES

14.  The ESSU PPP Equity Database records 370 PPP projects in which equity in the SPV has been sold. For example, the equity in the Barnet Hospital PFI project was subject to five transactions as HSBC Infrastructure increased its equity from 30% to 100%. The Calderdale Hospital PFI company was involved in nine equity transactions between 2002-10 (Whitfield, 2011).

Table 3

PFI PROJECTS IN MULTIPLE SALE OF EQUITY
No. of PFI projectsNo. of transactions
2671
592
243
104
45
36
17
18
19

Source: ESSU PPP Equity Database, 2011

SALE OF SECONDARY FUNDS

15.  Thirteen sales of secondary market funds between 2003-10 had a total value of £3.1 billion and involved an additional 607 PPP projects (Table 4).

Table 4

SECONDARY FUND EQUITY SALES IN UK
OwnerSold to No of PFI projectsPrice £m
Grosvenor House Group plc (2003)n/a 5 (estimate)4.0
Babcock Brown and Abbey National (2003) Star Capital Partners, Bank of Scotland and AMP Capital Investors 23n/a
Infrastructure Investors LP (Barclays, Societe Generale and 3i) (2005) 3i Group31150.0
HSBC Infrastructure Ltd and HSBC Infrastructure Fund (2006) HSBC Infrastructure Company (HICL). PFI assets transferred to new listed company. 15250.0
Investors in the Community Ltd (2007)Trillium (Land Securities) 167.4
PFI Infrastructure Company (2007)Infrastructure Investors LP

(Barclays, Societe Generale and 3i)

22156.0
Star Capital Partners, Halifax Bank of Scotland, AMP Capital Investors (2007) Trillium (Land Securities)79 927.0
Land Securities plc (2008)Land Securities launches Trillium Investment Partners, a PPP Joint Venture 100 (estimate) n/a
3i Group plc (2009)Placed in market n/a60.8
Land Securities (2009)Telereal 108750.0
Telereal (2009)Victorian Funds Management Corporation (Australia) and Transport for London Pension Fund 108n/a
Infrastructure Investors LP - Barclays acquire Societe Generale (31.7%), 3i (31.7%) and Fleming (4.9%) (2009) Barclay Private Equity Integrated Infrastructure Fund 84558.6
John Laing (2010)John Laing Infrastructure Fund (John Laing has 23% stake) 16242.3
Total (13 transactions) 6073,106.1

(10 transactions)

Source: ESSU PPP Equity Database, 2011

16.  When the sale of equity in individual and group transactions is combined with the transfer of ownership when infrastructure funds are sold, the total number of equity transactions increases to 240 involving 1,229 PFI projects, including multiple transactions of some projects (Table 5).

Table 5

TOTAL OF PFI EQUITY AND SECONDARY FUND EQUITY SALES
YearNo of transactions No of PFI projects (includes multiple sales) Value of equity sold (£m)
(No of transactions)
Estimated total value based on average transaction (£m)
Sale of PFI equity228 6223,876.96,212.7
Sale of secondary funds12 6073,106.1 3,727.3
Total2401,229 6,983.09,940.0

Source: ESSU PPP Equity Database, 2011

17. Joint ventures between PFI companies and infrastructure funds accounted for about 10% of equity sales. The sale of secondary funds accounted for only 5% of transactions but nearly half (49%) of PFI project equity sales.

PROFITS FROM PFI EQUITY SALES

18.  The ESSU Database contains 63 transactions involving 154 PFI projects, where the sale price and profit from the equity transaction, are identified from reliable sources. The total value of equity sold was £1,026.6 million with £517.9 million declared profit (50.6%). The transactions were spread across the 2003-10 period with a diversity of construction companies and infrastructure funds, types of project, geographic location and size of project (Whitfield, 2011).

19.  There are wide differences in the average profit rates between sectors with the average profit being 50.6%. Two sectors have higher than average profits, health (66.7%) and criminal justice (54.9%) with transport (47.1%) and education (34.1%) below average. The 'multiple' category in Table 6 includes transactions covering a number of different types of assets and where the total profit was stated for a group of projects.

Table 6

PROFIT ON SALE OF PFI EQUITY IN UK (INCLUDES MULTIPLE EXAMPLES)
SectorNo of PFI transactions No of PFI projectsValue of equity sold (£m) Total Profit (£m)Average % profit
Health1418 129.386.366.7
Education68 47.816.334.1
Transport812 101.848.047.1
Criminal Justice615 122.467.254.9
Housing11 5.24.280.8
Waste/Water11 12.08.066.7
Leisure15 6.55.686.2
Defence22 9.312.5134.4
Multiple2493 587.7269.045.8
Total63154 1,022.0517.150.6

Source: ESSU PPP Equity Database, 2011

20.  If the same profit level of the sample of PFI projects were maintained for the 622 PFI projects involved in equity transactions, the total profit would be £2.2 billion.

21.  Similarly, if the same rate of profit was achieved in the sale of secondary funds, the profit from PFI equity sales would be a further £2.0bn, giving a total profit of £4.2 billion

22.  The rate of profit achieved by PFI construction companies is exceedingly high with two companies achieving over 70% (Lend Lease Corporation and Balfour Beatty) and four companies over 50% (John Laing, Interserve, Kajima Partnerships and Kier Group). Table 7 includes only the PFI equity transactions where profit information was available (none declared a loss) and does not reflect the full performance of PFI equity investment by these companies.

Table 7

MAJOR SELLERS OF PFI EQUITY IN UK BETWEEN 1998-2010 (BASED ON TABLE 5)
CompanyNo of PFI projects Sale value
(£m)
Profit
(£m)
%
Carillion plc24278.8 114.140.9
John Laing22170.3 100.659.1
Interserve plc1570.3 37.953.9
Lend Lease Corporation11 14.711.578.2
Costain Group plc837.1 16.242.9
Serco Group plc779.9 16.020.0
Balfour Beatty plc5 37.827.071.4
Kajima Partnerships6 30.218.059.6
Kier Group plc426.1 14.756.3

Source: ESSU PPP Equity Database, 2011

23.  The profits in PFI projects contrast sharply with construction operating profit rates of the same contractors. These have remained low throughout the last decade. The average operating profit in UK construction/building activities for four major PFI construction companies (Balfour Beatty plc, Carillion plc, Costain plc and Kier Group plc) was 1.5% between 2003-09 (Company Annual Reports).

USE OF TAX HAVENS IN PFI EQUITY TRANSACTIONS

24.  The equity in 91 PFI projects is owned by secondary market infrastructure funds located in tax havens (Table 8).

Table 8

PPP INFRASTRUCTURE FUNDS LOCATED IN TAX HAVENS
CompanyTax haven No of PFI assetsPFI projects
HSBC InfrastructureGuernsey 33Substantial stakes in hospitals, schools, police stations, Home Office Headquarters, London.
John Laing Infrastructure FundGuernsey 19Range of schools, social housing, hospitals, courts, police stations and street lighting projects.
3i Infrastructure Fund (3i Groups owns 33.2%) Jersey18Norfolk & Norwich University Hospital (26.0), Alpha Schools, Highland (50.0), Elgin Infrastructure Fund (joint venture with Robertson Group)
International Public Partnerships (formerly Babcock Brown Public Partnerships) Guernsey14100% shareholding in schools and criminal justice PPP companies.
GCP Infrastructure Fund Ltd - Gravis Capital Partners Jersey74 investments in Grosvenor PFI Holdings and 3 in Investment in Leisure Infrastructure Investors Ltd
Total91

Source: ESSU PPP Equity Database, 2011

TRANSFER OF PFI EQUITY ASSETS TO CONTRACTOR'S PENSION FUNDS

25.  At least five companies, Interserve, Amec, John Laing, Costain and Vinci, transferred PFI equity to their pension funds in lieu of cash payments or the transfer of other assets. The pension funds records ownership of the asset in its accounts and receives future dividends (Whitfield, 2011).

RECOMMENDATIONS

1.  The standard PFI contract should be re-written to include a ceiling imposed on the level of profits that can be extracted from PFI equity together with a requirement that the public sector should have a 50% share in any profit above a specified level.

2.  A new value for money methodology should be devised to take account of the profiteering in PFI equity transactions and the other flaws in the current evaluation methodology.

3.  New transparency and disclosure requirements should be introduced as a matter of urgency requiring more expansive notification about equity sales.

4.  The Treasury PFI database should be significantly extended to include historic and future PFI equity sales, be publicly available and regularly updated.

5.  The National Audit Office and Treasury should research the longer-term effects of the growing secondary market.

6.  Ultimately, the negative effects of the PFI equity secondary market can only be solved by the termination of the PFI programme combined with new regulatory controls on existing projects.

June 2011

REFERENCES

Adetunji, J (2011) A Very Private Partnership, The Guardian Public, 17 January 2011.
http://www.guardianpublic.co.uk/private-sector-profiteering-from-ppp

HM Treasury (2009) PFI Equity Holders—November, London.
http://www.hmtreasury.gov.uk/ppp_pfi_stats.htm

House of Lords Select Committee on Economic Affairs (2010a) Private Finance Projects and Off-Balance Sheet debt, Vol. l, HL Paper 63-1 and HL Paper 63-ll, 17 March, London.
www.publications.parliament.uk/pa/ld200910/ldselect/ldeconaf/63/63i.pdf

House of Lords Committee on Economic Affairs (2010b) Government response to Report on Private Finance projects and off-balance sheet debt, HL Paper 114, April, London.
www.publications.parliament.uk/pa/ld200910/ldselect/ldeconaf/114/114.pdf

National Audit Office (2006) Update on PFI Debt financing and the PFI Equity Market, HC 1040, Session 2005/06, April, London.
http://web.nao.org.uk/search/search.aspx?Schema=&terms=Update+on+pfi+debt

Whitfield, D (2010) Global Auction of Public Assets: Public sector alternatives to the infrastructure market and Public Private Partnerships, Spokesman Books, Nottingham.
www.spokesmanbooks.com/acatalog/Dexter_Whitfield.html

Whitfield, D (2011) The £10 billion Sale of Shares in PPP Companies, ESSU Research Report No 4, January, Spokesman Books, Nottingham.


 
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© Parliamentary copyright 2011
Prepared 10 August 2011