Attracting investment in infrangibles

Nelson Charsegun L. Aquino Assurance Partner, PwC Philippines 27 Jan 2017

The role of capital projects and infrastructure (CP&I) spending has never been more important in emerging markets such as the Philippines.

CP&I spending in the utilities, manufacturing and transport sectors will lead the way, following sustained economic activity and more business investments, driven by stronger global demand and improved economic sentiment.

Under the current macroeconomic scenario, higher government revenues will boost public sector capital spending capacity. This means that CP&I spending in the social infrastructure sectors, including healthcare and education, will continue to improve.

How to finance infrastructure projects

As with many governments, infrastructure development poses many challenges, but none is as urgent or as complex as how to finance it. There is a huge gap between the current administration’s ambitious PHP7-trillion infrastructure spending goal and the amount of available public funds for it. By narrowing down that gap, I’m not just talking about looking for sources of financing. It’s embracing the idea of prioritizing, streamlining and renegotiating. The government must think carefully about which projects should stay and which must go; reducing costs; and attracting investments, both from here and overseas.

Multilateral Development Banks (MDBs) and bilateral donors will continue to play an important role in financing infrastructure projects. Aside from financial and technical assistance, MDBs also bring expertise and insurance against political and other risks. That is why MDBs are often needed to attract private investors, since they can take on the role of intermediary for such investors and other sources of capital for the government.

Public-private partnerships (PPPs), which have gained traction under the previous administrations, have been instrumental in bringing in the necessary infrastructure that has helped sustain our economic growth over the years. Through PPPs, additional funds and expertise flow into the government, allowing the government to become more effective and service-oriented. They are able to deliver services with improved standards and in a more cost-efficient manner.

How to make infra projects appealing to investors

Infrastructure projects that give solid revenue streams or repayment structure, as well as contractual and regulatory conditions, appeal to private investors. It makes them confident about long-term returns and government commitments. How can this be achieved?

Improve corporate reporting model

The government has to implement regulations that will make key information available to potential investors.
Improving the existing corporate reporting model will help drive investors toward investments that may have better but less visible long-term prospects. Currently, investors focus much more on investments that bringing in acceptable returns in the short term and are within their risk appetite.

Changing the current corporate reporting model will allow for more information that helps potential investors assess project outcomes. Investors’ key concerns that should be addressed in the next reporting model are the organization’s current and future revenue growth, overall productivity, operating margin and exposure to risks.

Define value for better decision-making

Investors need two things to convince them to put their money in long-term projects. One, they need a more holistic view of how value is created over time. Two, they want to know clearly the risks and key value drivers (i.e., added value that will increase the project’s value).

Publicly share performance measures

Information that helps investors evaluate and monitor a project’s performance must also be improved and be easily accessible.

Historical earnings, while an essential part of reviewing a project’s performance, are not enough. To complete the picture and address investor concerns, metrics that relate to key business drivers, operational risks and management’s plans to mitigate those factors, earnings potential and future cash flow information must be disclosed publicly.

Prepare financial statements properly

Financial statements remain to be a vital part of the overall corporate reporting and a tool in allocating investment and capital. As such, it must conform to globally accepted accounting standards and must be comparable in the context of attracting cross-border capital flows.

How the BOT scheme works

One of the more common local PPP arrangements is the build-operate-transfer (BOT) scheme. During the early years, the private sector entity spends for constructing or upgrading certain infrastructure. Later on, the entity operates it and charges consumers for the public service. Under this scheme:

The entity does not take ownership of the constructed asset. Instead, it recognizes an intangible asset representing its right to be paid for providing construction services. Personally, I am fond of calling this an “infrangible” asset. The amounts capitalized would include the fair value of construction services, any upfront payments directly attributable to the concession, borrowing costs during the construction phase and estimated value of the contractual restoration/upgrade work.

The entity provides more than one service (i.e., construction or upgrade services, operation services) under a single contract. The consideration receivable is allocated based on the fair values of services delivered. During construction, the entity will start recognizing revenue for construction services rendered using the percentage-of-completion method.

The entity will have to wait a little longer and be satisfied with recognizing an infrangible asset. This is unlike traditional business models, where revenues equate to cash inflows in the near term. Actual cash inflows may take a few years after the constructed asset is operational and the entity actually begins charging fees for the public service.

Current accounting guidance on how service concessions are reflected in the financial statements results in complexity and presents practical challenges. It may result in inconsistencies and confusion to investors if the financial statement line items are not understood well.

What it takes to attract investments

Improved corporate reporting models and reliable and standardized financial statements are just two of the many things that can be done to attract investments.

To effectively woo potential investors, the current administration should address long-standing and prevalent problems, such as bureaucracy, lack of transparency, and political, legal and regulatory issues.

Our country is endowed with rich natural resources and highly skilled talent that put us in a competitive position in the global market. The government’s ability to sell investments in infrangibles will be one of the keys to unlocking our full potential.

Nelson Charsegun L. Aquino is an Assurance Partner in the Technology, Information, Communication and Entertainment (TICE) and Methodology Leader. 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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Nelson Charsegun L.  Aquino

Nelson Charsegun L. Aquino

Assurance Partner, PwC Philippines

Tel: +63 (2) 8845 2728

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