This is an Update Bulletin to our M&A Infrastructure Insights, a bi-monthly industry focussed publication keeping you informed of the most pressing issues, major developments and cutting- edge trends in Australian infrastructure.

FEDERAL INCENTIVE AGREED FOR STATE PRIVATISATION OF ASSETS

In November 2013, the Commonwealth government proposed an incentive payment that would be used to encourage State (and Territory) governments to sell their public assets and recycle that money into new infrastructure that would facilitate economic growth.

Last Friday (2 May 2014), the State and Commonwealth governments signed the National Partnership Agreement on Asset Recycling to provide incentive payments to the States that privatise their State-owned assets and reinvest sale proceeds in new economic infrastructure.

The agreement seems clearly designed to get States to move quickly a limited pool of available capital and a first-come, first-served entitlement.

VALUE OF INCENTIVE PAYMENTS

It was suggested in November 2013 that the value of the incentive payment might be equal to the corporate tax that the new private owner of the asset pays to the federal government upon acquisition. This amount would then be returned to the relevant State government as a tax-equivalent incentive payment, compensating the state for forgone National Tax Equivalent Payments.

In late March 2014, Federal Treasurer Joe Hockey instead stated that the incentive payment would be set at 15 per cent of the sale value of the State assets sold, which, in principle, is reflected in the final agreement. A much simpler solution, particularly given that brown-field assets are unlikely to have the same tax profile under private sector ownership that they would have had under government ownership (that is, they will pay less corporate tax). The precise entitlement is to 15% of the proceeds received by State from the sale of asset(s), multiplied by the proportion (expressed as a percentage) of proceeds to be reinvested by the State in additional infrastructure.

Last Friday Prime Minister Abbot took the position that the broad details of the plan would be revealed in the federal budget on 13 May 2014 – importantly indicating that there would be scope for individual agreements to be negotiated with the States.

HOW THE AGREEMENT WORKS

The agreement between the State and Commonwealth is created under the Intergovernmental Agreement on Federal Financial Relations. The agreement provides the basis on which the Federal Government will make payments to State Governments in order to incentivise them to divest State-owned assets.

Some interesting features of the arrangements:

  • The agreement started on Friday 2 May, and will expire on 30 June 2019.
  • States don’t have to avail themselves of the top-up facility. Certain statements made indicate that some of the States will think further about whether to apply for the incentives, whereas the Victorian Government has already tied this incentive to the planned divestment of Port of Melbourne. (More on this below.)
  • The Commonwealth Government will create an “Asset Recycling Pool” (no details of the amount involved are currently available, presumably to be released on budget day). Funds will be released on a ‘first-come, first served basis’.
  • Funding from the Pool will be additional to existing Commonwealth funding to the States.
  • State Governments will have two years to agree with the Commonwealth assets to be sold and the eligible additional infrastructure investment. That is not a lot of time to identify the new infrastructure, particularly considering that the sale of assets and the construction of additional infrastructure must commence on or before 30 June 2019.
  • To be eligible for funding from the Pool, infrastructure projects must demonstrate a net positive benefit, enhance long-term productive capacity of the economy, and where possible provide for enhanced private sector involvement in both funding and financing of the infrastructure (that is, explore user-funding models rather than State payments).

The agreement on its face does not limit the form of privatisation (long term leases are specifically mentioned as being acceptable) nor the type of State-owned assets covered. We have seen just yesterday the Victorian Government sell Rural Finance Corporation to Adelaide & Bendigo Bank for expected net proceeds of $400m, and clearly indicate they expect the incentive will be available to the Victorian Government. We should probably expect that the States that like the arrangement will explore a whole range of assets that perhaps few naturally think of as ‘State-owned assets’. Why should, for example, a minority stake in a joint venture, loan book, surplus real estate, etc, not be within the program? Care will, however, need to be taken to ensure there is not mismatch between the incentives to privatise and the incentives to select infrastructure projects and ensure that the selection criteria for each are not confused.

The payment methodology is interesting, and clearly is structured to get quick buy-in from the States. Payments are made in two instalments: 50% of the total estimated payment – initially based on the book value of the asset as the estimate of sale proceeds, and an initial forecast of the proceeds to be reinvested by the State in additional infrastructure. That payment is made at “Milestone 1” – which occurs upon commencement of the tender process (for example, the issue of the EOI) and other government processes required ahead of the sale, as well as commencement of planning and approvals for the additional infrastructure.

The final (adjusting) payment is made at completion of the sale of the asset and commencement of construction of the agreed infrastructure (called Milestone 2).

IT’S ALL IN THE SCHEDULE...

The relevant State and Commonwealth will agree a schedule which will apply in relation to a particular privatisation and allocation of proceeds to eligible infrastructure. That schedule will set out the details of the arrangements and conditions imposed. This is perhaps where there will be some flexibility to agree particular arrangements with different State and Territory Governments. Schedules will be made public, but this will not apply to commercially sensitive information.

SOME THOUGHTS

There is a limited time frame, and whether the impetus to sign-up quickly and commence the planning and approvals process for new infrastructure is consistent with good, long term infrastructure planning needs to be carefully scrutinised and monitored. One would expect more public comfort if the new additional infrastructure had been in the planning stages for some time. The Productivity Commission in its draft Report on Public Infrastructure found that “institutional and governance arrangements for the provision and delivery of much of Australia’s public infrastructure are deficient and are a major contributor to poor outcomes”. It is important that the proposed timeframes of the agreement do not erode the development of careful project selection and provision and delivery of projects.

How many additional infrastructure projects that are ‘ready to proceed’ reflect a private sector funding model (which is one of the eligibility criteria)? Perhaps the larger question here is how important is that criteria it applies “where possible” – in practice will States be able to divert sale proceeds to, for example, public road infrastructure? Again this perhaps reflects the flexibility enshrined in the agreement and the ability of a particular State and the Commonwealth to negotiate what is in the State’s economic interest.

The incentive is being offered at a time when the competition for good infrastructure assets suggests that assets will transact at a value in excess of book value. The top- up formula is, in this regard, quite clever in that initially the State and Commonwealth agree the estimated sale proceeds (based on book value, absent a better estimate) and the proportion – expressed as a percentage – of sale proceeds of net assets that will be reinvested in agreed infrastructure. So the ‘premium’ received will simply be proportionally allocated to the agreed infrastructure – but of course that presupposes that the new infrastructure identified by the State requires that additional funding.

If we look at the recent Port of Newcastle divestment, the basic relevant figures seem to be: initial estimate of sale proceeds – $700m, commitment to allocate $340m to revitalisation of Newcastle CDB’s (including a light rail), an eventual sale price of $1.7bn, and a net figure after sale costs of $1.2bn being eventually allocated to Restart NSW. So how would that transaction have been managed under the incentive arrangements? Relevantly,

  • Would the urban renewal all constitute eligible infrastructure?
  • It seems difficult to see how the $1.2bn ‘premium’ which is allocated to Restart NSW would attract the 15% top-up, since the thrust of the agreement is about identifying and agreeing, prior to privatisation, the specific economic infrastructure to be developed.

One thing is clear – States will work hard at structuring the arrangement so that they benefit from the intense competition and high multiples they expect will be offered for their assets.