In 2013, Nigeria undertook a review of the method it uses to calculate its gross domestic product. By rebasing its revenues to include sectors such as its national film and mobile industries, until then ignored by the statistics, the country saw the size of its economy nearly double to $510 billion overnight.
What Balfour Beatty attempted in the first half of this year may have been on a different scale – but its effects were no less impressive. Should the UK developer have stuck with the way it carried out its Directors’ Valuation (DV), an indicator of the value of the company’s public-private partnership (PPP) portfolio, it would have seen it decrease from £766 million (€960 million; $1.2 billion) to £721 million between December 2013 and June 2014 (mostly due to asset disposals).
Yet the changes it carried out on its valuation methodology instead led it to report a jump in DV to £1,051 million – a 46 percent uplift compared with applying the former one. The company’s UK portfolio, which at £801 million still represents the bulk of its assets, saw its valuation restated upwards by 63 percent.
So what prompted Balfour Beatty’s executives to make such a drastic move? “From the outset the DV was intended to be a relatively conservative valuation. By using a consistent methodology, analysts, investors and shareholders could look at the relative movements of the DV year on year to help them in forming their own judgment of what the portfolio was really worth,” explains Ian Rylatt, chief executive of Balfour Beatty Infrastructure Investments.
Towards the end of last year, however, it became obvious that the disconnect between DV and open market value was growing larger. Discrepancies were exposed by disposals of assets by the firm – most notably its interests in the University Hospital of North Durham PPP and Knowsley Building Schools for the Future project, sold in June for a consideration 82 percent above DV.
“Over time the disconnect became so large that it left the market having to make its own assessment, with a far greater degree of uncertainty about where the true value was. So we started to think about improving the methodology so that it kept showing relative movements but also brought the DV far closer to more realistic current market expectations,” says Rylatt.
Changes to valuation techniques applied to three main areas. The company first updated its cash flow assumptions to better reflect future cost savings, largely in terms of lifecycle, insurance and concession management costs. It also updated its macroeconomic assumptions, such as inflation, interest on cash balances and UK corporation tax rates. Changes to the long-term inflation assumption had the most material impact, with a flat rate of 3 percent used across the UK portfolio.
But the real breakthrough came when it took a more granular approach to discount rates. “In the previous method we used blanket rates, on a similar basis to other industry players, to arrive at a Directors’ assessment of the value of our investment portfolio,” Rylatt recalls.
Balfour Beatty has quite a large and complex portfolio, he says, and its 63 assets are all at different stages in their life cycles. “The new method takes a more individual approach to assessing the value of each investment and better recognises where each is in its development and better reflects changes in risk profiles over time.”
As such, the company applied a range of discount rates across its UK portfolio, varying between 8 percent and 9.5 percent. Low-risk availability projects, or demand-based projects with proven operational performance, were discounted at the lower end of the range; the opposite held true for projects with higher volume or performance risk. The weighted average rate used for the UK portfolio was 8.1 percent.
Rylatt reckons the revaluation helped the market better gauge the value of Balfour Beatty’s portfolio. It also answered a broader strategic objective for the firm, he argues. “The review re-emphasised to the market that we were not just selling out of our investments. We still see investments as a very strong value generator for the group.”