Mar 9, 2011

How flipping equity in P3s boosts profits and ends up with the projects being run from Channel Islands tax havens


Just like good stilton cheese, public private partnerships (P3s) were imported to British Columbia from the United Kingdom.  And like good stilton, in the UK P3s are starting to smell.

In 2003, as part of its privatization agenda, BC’s government created Partnerships BC as a private company owned by the Ministry of Finance.  Partnerships BC’s triple mandate was to advise on the use of P3s, to manage P3 processes and then to evaluate their success.

One of the first things Partnerships BC did was to take on its sister organization, Partnerships UK, as a consultant.  Today, much of the P3 agenda in BC is built on the model developed in the United Kingdom.  Partnerships BC’s favored model of a P3 is to see private companies design, build, finance and operate (DBFO) public services and infrastructure in contracts that last longer than 30 years.  The government owns the building, but the company gets a 35 year contract with a rich revenue stream as its asset.

P3s (they are called private finance initiative or PFI in the UK) had more than a decade head start in the UK.  As a result, while the projects in BC are still in their infancy, PFI projects in England are mature and some of their flaws are becoming obvious.

Last month one British hospital terminated a P3 signed in 2003.  If the deal had continued the hospital would have had to pay more than £30m to the company. The UK Treasury Department is pushing P3 companies to give up some of their profits on the projects.  The Commercial Secretary to the Treasury said last month:

 We owe it to the taxpayer to eliminate wasteful practice and gold plating in contracts.

The level of profits from the deals is coming under scrutiny.  Although almost always profitable, P3 companies found two ways to dramatically increase their takings.  First, P3 companies borrow 85% to 90% of the money needed to build a project.  The amount they pay to borrow the money is based on the risk of the project and in most cases, almost all of the risk is at the construction phase.  After construction, companies often refinance at a lower borrowing cost and the savings go straight to their bottom line.  This led to profit levels that were considered unconscionable even for P3s so the UK government stepped in and now recovers a share of any profits obtained through refinancing.  Partnerships BC learned this lesson from the UK and their contracts contain this refinancing provision.  At least some of the Alberta P3s do not contain this clause in their contract.

Second, P3 companies used equity flipping to increase their profits.  While most of the money for projects is borrowed, P3 consortia often put in 10% to 15% of the needed money as their own investment – equity in the project.  Just as the cost of borrowing goes down when the construction phase risk disappears, the value of the equity goes up.  In some cases it goes up a great deal.  And while there are provisions to help the government capture some of the value of refinancing, there are no provisions to capture any of the profits from the sale of that equity.

Researcher Dexter Whitfield has studied equity flips in P3s.  He found equity transactions involved 1,229 P3 projects (including multiple sales) valued at £10.0 billion.  The average profit on these transactions was more than 50%.  Whitfield obtained this information from corporate reports.  The UK government does not keep adequate information on the deals.

Here in BC we have not seen this number of equity flips, but unlike the UK, it is still early days for P3s here.  The information we do have suggests we can expect the same thing.

The Abbotsford Hospital was the province’s first big P3, constructed after negotiations with a single bidder.  The hospital contract was awarded to the Access Health Abbotsford consortium. ABN Ambro was the original financing partner. However, in 2005 Macquarie Bank, which had been a financing partner in a competing group, bought 81% of both the Abbotsford P3 and the Vancouver General Hospital Diamond Centre P3 for $529 million (American). In 2007 Macquarie sold its assets on to John Laing for an undisclosed amount.  In 2010 John Laing sold the projects on to the John Laing Infrastructure Fund, an investment company located in the British Channel Islands in the tax haven of Guernsey. 

The Sea-to-Sky highway, constructed for the Olympics, was the province’s largest road P3.  The S2S Transportation Group consortium got the contract in 2005 with Macquarie North America Ltd as the financial advisor and financial participation from Macquarie Essential Assets Partnership.  In December 2010 Macquarie Essential Assets sold its stake in the project to a group of investors led by Fiera Axium Infrastructure.  At the same time Macquarie sold Edmonton’s Anthony Henday Drive Southeast Leg Ring Road.  Fiera Axium is also involved in Montreal Hospital P3s. 

The Kicking Horse Canyon project involved upgrading 26 km of the Trans Canada Highway near Golden.  The Trans-Park Highway Group, led by Bilfinger Berger BOT Inc. got the contract in 2005.  In 2010 Bilfinger sold 50% of its investment to the HSBC Infrastructure Company Ltd.  HSBC also acquired 50% of North West Anthony Henday Drive on the outskirts of Edmonton, Alberta from a subsidiary of Bilfinger.  HSBC paid approximately £65.9 million for the two investments.  Like John Laing Infrastructure Fund, HSBC is located in the tax haven of Guernsey.

In six years the Abbotsford hospital project changed hands four times, presumably with profits being made in every transaction, with ownership ending up in a tax haven.  We have no idea how much those profits were because the BC government does not require the release of that information.  We do know that in the UK, on average, profits were in the order of 50%.

In the UK Parliament’s Public Accounts Committee has started to take a far more critical look at these projects.  In its most recent report the Committee said,

We found no clear and explicit justification and evaluation for the use of PFI in terms of value for money.

Why does it matter if companies make huge profits selling on their P3 investments?  First of all if they make huge profits, it means the public paid too much in the first place for the contract.  Second, with each sale at higher prices the new owner has an increased interest in driving down the cost of operating the project.  That means reducing services and the quality of services for the public.  Finally we need to ask, do we really want to see our public services and facilities turned into poker chips in the international finance market?

What is clear is that in the UK, public bodies are locked into multi-decade contracts that provide enormous profits for P3 companies.    As more information becomes available and as more of our growing list of P3s is subject to asset flips, the same issues will make themselves clear here.  And, as in the UK, we will pay for it for decades.