• Deconstructing building blocks

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    Armed with significant investor confidence, adequate public coffers resulting from prudent spending over the

    POCHOLO C. DOMONDON

    past six years and a bustling workforce, the new administration after the May 2016 elections announced it would be ushering in a golden age of infrastructure.

    The government has allocated about P8 trillion to infrastructure projects over the next six years to achieve its spending target equivalent to 5.2 percent of gross domestic product (GDP). This will be used to build and augment existing facilities, focusing on transportation and delivery of basic social services, including education and health.

    A substantial number of these projects will be coursed through the public–private partnership (PPP) mechanism launched in 2010, and $4.2 billion worth of contracts have since been awarded. In the PPP pipeline are 61 projects with an indicative total cost of P1.212 trillion, encompassing a wide array of public service sectors such as airports, rails, ports and highways.

    The PPP primarily aims to tap the private sector (i.e., operator), which is sufficiently equipped with available liquidity and expertise, and assist the government (i.e., grantor) in its basic function of delivering public service.
    Private corporations will spearhead the infrastructure projects’ construction, operations and maintenance for a specified concession period. In exchange, they will be compensated based on either use or available capacity of these facilities as nominated by them.

    To further bolster PPP initiatives, the Securities and Exchange Commission and the Philippine Stock Exchange approved the listing of projects on the main bourse toward the end of 2016, a move that is seen as a strong push to knock on capital market doors and augment traditional sources of funding such as loans. With the ability to have direct ownership and equity, it is now incumbent upon individual investors to gain better appreciation of the peculiarities and intricacies of the financial statements of these PPP projects.

    Ghost fixed assets

    In viewing PPP financial statements for the first time, the absence of any reported fixed assets should not come as an immediate shock and leave readers in disbelief that their investments were all for naught.

    Most, if not all, PPP projects will be accounted for under International Financial Reporting Interpretations Committee (IFRIC) 12, Service Concession Arrangement. It is the specific standard applicable to agreements with the government that involve the delivery of public services including, but not limited to, roads, bridges, tunnels, prisons, hospitals, airports, water distribution facilities, energy supply and telecommunication networks.

    The definition of public service will mainly depend on the prevailing laws of each country, so the enumeration may vary per territory. IFRIC 12 presupposes that control over infrastructure assets remain with the government, irrespective of whether construction is financed and undertaken by the private sector; so it’s expected to recognize the corresponding fixed assets in its books. Control is shown by enacting regulations that dictate what services should be provided, to whom it should be offered and at what price, and having residual interest in the infrastructure at the end of the contract term.

    In lieu of property and equipment, private companies will be reflecting different assets in their financial statements, depending on agreed and contracted remuneration scheme. A financial asset (receivables, in most cases) will be recognized if guaranteed with fixed fees by the government, calculated based on capacity and availability. This is more common in infrastructure projects that are social in nature—hospitals, correction facilities and irrigation systems, where the government bears the demand risk. In turn, if payment is variable and determined based on actual use such as toll and terminal fees, an intangible asset will be recorded to reflect the entity’s rights to collect and charge the general public, who are the expected ultimate users.

    Maintenance bubble

    Even at the onset of commercial operations, PPP projects are mandated to reflect repairs and maintenance provisions or liabilities in their financial statements. This should not be interpreted as an admission of structural or technical defect. Rather, it is an acknowledgement of private companies’ obligation to make sure that facilities are retained at a specified level of service and condition for the duration of the concession period.
    Evidently, such infrastructure facilities are susceptible to wear and tear. And most service concession arrangements pass on to operators the responsibility of repairs and maintenance. That is why operators compute the provision by coming up with their best estimate of how much a major overhaul or restoration work will cost, and the discounted value to consider the time value of money. The amount may likewise be capitalized and included as part of intangible asset, especially when these repairs and maintenance are solely shouldered by the operator and not the government. Ultimately, the annual amortization should be charged against profit or loss.

    Getting hold of intangibles

    In the financial statements, intangible assets are reflected as a separate line item that already represents total expenses before the start of commercial operations, including upfront fees paid to the government, construction costs, provision for major repairs and maintenance (as earlier discussed), and even borrowing costs such as interest expense on loans solely secured to fund the PPP project.

    Intangible assets are presented in lump sum with detailed enumeration of its composition. It is not a mandatory disclosure in the financial statements. However, for PPP projects applying for local public listing, the PSE requires such breakdown as part of the company’s supplementary disclosures. This information is certainly valuable in segregating direct technical costs to evaluate the project construction’s efficiency, and to identify procurement expenses incurred to secure the winning bid and financing charges to be repaid throughout the concession period.

    Making the right bid

    Indeed, rallying the capital market helps raise funds needed not only during construction, but also for the entire concession period. It sustains these infrastructure projects in continuously rendering and delivering much-needed public service. This is also a welcome opportunity for the general public to further scrutinize if identified PPP projects are worthy investments using funds directly coming from their pockets. It also confirms if the government has awarded the contract to the rightful bidder.

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    Pocholo C. Domondon is a partner for Assurance, Deals and Corporate Finance and also the Markets co-lead for Priority Targets of Isla Lipana & Co./PwC Philippines. of Isla Lipana & Co. Email your comments and questions to markets@ph.pwc.com. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.

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