| This section of the Operating & Financial Review sets out the Directors’ opinion of the principal risks related to the business of the Group and to the PFI/PPP markets in general. Additional risks and uncertainties not presently known to the Directors, or that the Directors currently consider to be immaterial, may also have an adverse effect on the Group.
1 RISKS RELATING TO THE BUSINESS OF THE GROUP
Availability of investments
The success of the Group depends upon its ability to identify, select and execute investments which offer the potential for satisfactory returns and the continuing availability of cost effective finance to SPCs. The availability of such investment opportunities will depend, in part, upon conditions in the PFI/PPP market. There can be no assurance that the Group will be able to identify and execute a sufficient number of opportunities to permit the Group to continue with the historic rate of expansion of its portfolio of PFI/PPP development projects.
 The Directors’ approach to this risk is to monitor all potential bidding opportunities and to track new market developments both in the UK and overseas.
Capacity of sub-contractors
The Group is dependent upon construction and service sub-contractors for the delivery of PFI/PPP projects. The Group’s ability to invest in, develop and operate PFI/PPP projects could be adversely affected if the construction and service sub-contractors with whom the Group wishes to work do not have sufficient capacity to work with the Group on its chosen projects. In addition, if a sub-contractor’s work was not of the requisite quality or a sub-contractor became insolvent, this could have a material effect on projects managed by the Group and might not only reduce financial returns but could adversely affect the Group’s reputation and reduce its ability to win business in the future. To the extent that John Laing uses a single sub-contractor on a number
of projects, these risks would be increased.
The Directors’ approach to this risk is to monitor the Group’s exposure to individual contractors and to work in partnership with a range of contractors.
Retained construction liabilities
Under the terms of the disposal of Laing Construction in 2001, John Laing agreed to indemnify Laing Construction
in respect of certain liabilities (including contract losses and latent defect liability) on 13 specific construction projects.
At the time of the disposal, provisions were made for the potential liabilities. To the extent that these provisions
prove to be inadequate, John Laing will incur losses.
With regard to all other Laing Construction projects, John Laing has been indemnified by the purchaser of Laing Construction in respect of latent defects arising post-sale. To the extent that John Laing is primarily liable for these defects and the purchaser of Laing Construction is unable to meet its obligations under this indemnity, losses will have to be met by John Laing.
The Directors have received regular and detailed reports on each of the retained construction liabilities and review the level of provisioning against each significant potential liability on a quarterly basis.
Self insurance
John Laing established a captive insurance company which underwrote certain Group risks between 1987 and 2001. The Group has made provisions for unpaid claims and related expenses in respect of reported claims and incurred but not reported claims. In assessing the level of provisions required, the Group has taken into account independent actuarial assessment of historical trends in reserving patterns and loss payments and funding levels of unpaid claims and awards. However, there can be no assurance that the ultimate losses will not materially exceed the provisions made by the Group which could have an adverse effect on the Group’s financial position.
The Directors have commissioned an independent actuarial review of insurance reserves in each of the last three years and have based the reserving policy on the reported findings.
Pension deficit and other post retirement liabilities
As at 31 December 2005, the Group had a gross deficit of £144.1 million in relation to the Group’s pension schemes and post retirement benefit obligations, comprising a £197.3 million gross deficit on its pension schemes, a deficit of £0.5 million in the pension scheme of a joint venture and a £5.0 million gross deficit on its post retirement medical insurance scheme. The value of the pension deficit is highly dependent upon the assumptions used to calculate the pension liability and is likely to vary significantly from year to year. These assumptions include assumptions of long-term future inflation rates, of AA-rated corporate bond yields and of mortality rates of the scheme’s beneficiaries. Should these assumptions prove to be invalid, there is a risk that this deficit could increase.
The level of contribution towards funding the deficit which the Company has agreed with the Trustees of the Group’s pension fund for the 2006 financial year is £10.0 million. The Company proposes to increase this contribution rate by 3.0% per annum, subject to regular review, to address the deficit over time. There is a risk that this increased funding rate may prove insufficient to address the deficit and/or that the Trustees or the Pensions Regulator may require the deficit to be addressed over a different time period to that currently agreed by the Company and the Trustees, in which case there may be a material impact on the Group’s financial position.
The Directors have appointed independent actuaries to advise the Company on a funding strategy that is designed to address the deficit over a reasonable period and to comply with the Regulator’s draft guidance. The Company has reached agreement with the Trustees on the funding strategy.
Deferred tax asset
The Group recognises a deferred tax asset in respect of future pension contributions, including the contributions towards funding its pension deficit. The Group makes the following key assumptions in this respect:
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that group relief will remain available; |
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that the Group will earn sufficient taxable profits against which to claim a tax deduction for pension contributions; and |
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that HM Revenue & Customs application of tax legislation relating to pension contributions remains unchanged in practice. |
There is a risk that the deferred tax asset, relating to the pension deficit, which stood at £58.7 million as at 31 December 2005, may be overstated if the assumptions made by the Group prove to be invalid.
The Directors review the forecasts of future taxable profit on a regular basis so as to satisfy themselves that the deferred tax asset reflects future contributions on which tax deduction should be achieved.
Rail franchise
The Group has a 20-year train operating franchise on the Chiltern Line under which poor performance could lead to increased costs. Furthermore, failure to meet certain franchise obligations could lead to a reduction in the franchise term. Should either of these risks prove to be the case, they could have an adverse effect on the Group’s financial results. During 2005 the Chiltern Line operations were adversely affected by the collapse of third party development works at Gerrards Cross. The Group is indemnified against additional costs and loss of past and future revenues in relation to the development works. While the developer has admitted liability there is a risk that the negotiations on quantum might lead to a dispute that has to be litigated. If such litigation does not result in full compensation for lost revenues, the Group’s future results might be adversely affected.
The Directors monitor operating performance on a regular basis, including performance relating to franchise obligations. The Group has appointed legal and forensic accounting advisers to assist with assessment of the quantum of the compensation claim.
Reputation
John Laing’s projects often involve activities in the public sector, providing facilities and services that are used by members of the public. To the extent that the Group failed to provide a facility or service to the appropriate standard, or there occurred a major health and safety incident, this could generate adverse publicity and have an adverse effect on the Group’s reputation and its ability to win new business.
The Directors have implemented health and safety policies that help to mitigate against any such major health and safety incident. The Board receives regular reports on health and safety issues and monitors trends very closely.
Future funding
The existing financial resources available to John Laing, including bank facilities, are sufficient for the Group’s foreseeable requirements, that is, until at least June 2007. After that time, the Group’s funding requirements will depend on many factors and, to the extent that available financial resources in the future are insufficient to fund its activities, John Laing may need to raise additional funds or facilities. No assurance can be given that additional financing will be available or that, if available, the terms of such financing will be favourable to John Laing. If adequate funds are not available to satisfy its requirements, John Laing may be required to curtail its operations, refinance its outstanding obligations, forego investment and acquisition opportunities or sell assets.
The Board monitors actual and forecast cash flows each quarter. It operates a policy of ensuring that financial resources are maintained to satisfy committed and likely future investment requirements on PFI/PPP projects that have achieved financial close or are at the preferred bidder stage.
Liquidity
The majority of investments made by the Group comprise unquoted interests in PFI/PPP Project Companies which are not publicly traded and are often subject to restrictions on transfer and may, therefore, be difficult to realise at the value attributed to such investments by the Directors, or at all.
The Company’s planning assumes that a market for realising value from these investments has developed and will be sustained and the valuations attributed to such investments will increase. Should this not be the case, this could adversely impact the value expected to be realised over time from the current portfolio and consequently the ability of the Group to participate in new investment opportunities.
The Board monitors trends in secondary market values and sales are transacted when the conditions are considered to be optimal. |
