Maximizing Value for Contractors on Sale of Project Concession Stakes

With high barriers to entry and exit, concession-structured projects provide an attractive equity investment opportunity for contractors. This may involve taking either a controlling interest or minority shareholding position in an investment consortium comprised of pure financial investors: infrastructure investment funds, direct investing pension funds, or sovereign funds.

As a shareholder to a concession-structured project, the investment horizon and objectives of a contractor may differ from those of purely financial investors.

In a low-margin construction environment, maximum financial returns to the contractor may be gained through:

  1. Provision of life-cycle operation and maintenance services to the project, where higher long-term margin services can be delivered;
  2. Sale of the holding once the project has achieved steady-state operations, thereby recycling invested equity for deployment in future projects.

The equity value of a project increases materially once the risk of project construction and commissioning has been alleviated and steady-state operations with supporting revenue and resultant EBITDA have been achieved; this may be through availability payments, project patronage, or a combination of both.

Via a pre-emptive rights clause in the shareholder agreement, other project shareholders may have a first right to acquire a contractor’s stake should they wish to exit. Or, the contractor’s stake may be sold via a bilateral negotiation with a potential new owner. The final alternative is to sell through an auction process.

In any of these sale scenarios, it is critical for the contractor to achieve best value for its shareholding, so project assets and liabilities need to be accurately understood and assessed. Insuring the liabilities should be considered when preparing for the sale, where it may help realize such best value. 

Risk validation and transfer solutions that can aid a sale include: 

  • Vendor due diligence/vendor assistance
  • Transactional risk insurance, including representations and warranties/warranty and indemnity insurance and/or contingent risk insurance for known liabilities (including tax matters)

Vendor due diligence/vendor assistance

Insurance vendor due diligence adds value to a planned divestment and helps identify issues that can otherwise negatively influence the efficiency and outcome of a sale process. Well-executed vendor due diligence will help a seller:  

  • Achieve a more efficient sale valuation;
  • Improve upon insurance and indemnity provisions within sale and purchase documentation to achieve an equitable allocation of risk between seller and purchaser;
  • Avoid the risk of a purchaser being exposed to post-completion surprises that may result in negative impact to both parties.

Information is critical in preparation of a share sale. It brings value to the transaction by assisting a contractor shareholder in a project with:  

  • Providing comfort to prospective buyers on contractual insurance compliance;
  • Facilitating a cleaner financial exit from their shareholding by addressing and offering the potential to ring-fence liability risks that would otherwise remain on balance sheet;
  • Freeing up time for management to focus on other crucial areas of a sales process by addressing questions that may be raised by potential purchasers in advance. 

In a typical buy-side due diligence process, bidders generally undertake an exhaustive review of the contractual compliance of the asset’s insurance. This can be a lengthy and time-consuming experience and, with concession-linked projects often subjected to auction processes, can require many hours of management time in responding to questions and providing documents.

By conducting a vendor due diligence process, contractors can pre-empt and proactively respond to prospective questions, thereby helping to provide clarity to purchasers and achieve an efficient and streamlined process. 

More broadly, vendor due diligence can help sellers identify, remedy, and eventually present a clear picture of:

  • Premium allocations/budgets, notably with respect to risk transfer requirements with project grantors
  • Reserve inaccuracies relating to insurance claims
  • Contract language within sale and purchase agreements, including;
    • How does the indemnification wording impact insurance arrangements?
    • Specific wording addressing the treatment of insurance matters prior to and after completion of the sale and purchase
  • Insolvent insurers, and therefore the risk of non-payment of historic claims

Transactional risks insurance

Transactional risk solutions are bespoke, sale-specific insurance policies designed to ring-fence and transfer project liabilities of a share sale and purchase agreement. This helps sellers achieve a cleaner financial exit from a project and can significantly de-risk transactions.

There are two main types of insurable solutions available:

  1. For unknown and unforeseen loss through representations and warranties/warranty and indemnity (W&I) insurance. This relates to the warranties provided by management/sellers in the sale documentation.
  2. For known and quantifiable loss via contingent-specific risk insurance. For example, this might relate to an identified tax risk that could be subject to a different, and negative, interpretation by tax authorities at some point in the future. 

W&I – Motivations for use

Multiple factors drive the use of W&I insurance:

  • It protects against liabilities arising from a breach of the representations and/or warranties set out in an acquisition agreement.
  • It mitigates the seller’s exposure to losses and reduces the need for proceeds of sale to be held in escrow for a long period of time.
  • It has the potential to insure to a much higher limit than is available under contract.
  • Where management teams remain with the business, it can ensure new buyers do not need to directly sue the individuals who provided warranties. 

W&I is typically placed for the purchaser, but coverage may be initiated and structured by the seller, which today is as common as a buy-side initiated policy. 

Limits of insurance typically range from 10 percent to 30 percent of a transaction’s enterprise value, although higher limits can be explored. In light of increasing claims activity, larger limits are generally recommended. 

Contingent risk – Motivations for use

Whereas W&I responds to unknown and unforeseen circumstances, contingent risk policies respond to specific issues identified within a transaction. Such issues, often revolving around the interpretation of tax law, can present a significant roadblock to executing a transaction, with sellers generally unwilling to provide long-term indemnities.  

With this in mind, contingent risk solutions help to:

  • Avoid the need for sellers to provide indemnities and hold cash in escrow over the medium to long term;
  • Unlock transactions that would otherwise not be feasible as such issues often carry a material value that can significantly affect purchase price if uninsured;
  • Provide comfort and clarity to purchasers as to responses to claims, with insurers stepping into the seller’s shoes should a risk materialize.

The contingent risks insurance market continues to adapt to a growing number of deal-specific issues and challenges. Its use is expected to increase in the coming years as sellers and buyers alike seek to transfer identified risks to the insurance market.