Stifel has just put out a cogent ‘Contrarian’ note on PFI infrastructure investment funds.

It’s core message is that nationalisation may not happen and that many of us are being far too cynical.

Here’s the key passage from Stifel note about why my worst case scenario – nationalisation – might be overdone:

“There would need to be a UK General Election – the next Election is not scheduled until June
2022 under the Fixed Parliament Act. Whilst the current government could fall or call an
Election, this currently seems relatively unlikely for at least two or three years
·  Jeremy Corbyn or a similar hard-left leaning Labour (or coalition) Prime Minister would need to
gain a majority in the House of Commons.
·  There would need to be a majority in the House of Commons for a PFI ‘nationalisation’ Bill.
Even if Labour had a majority of MPs, it would not necessarily be the case that all would
support all policy proposals given past policy disagreements between Labour MPs. By way of
example we note a report in the
Financial Times dated 17/03/18, that Jeremy Corbyn’s stance
on Russia is opposed by at least three members of his shadow cabinet and more than 30 other
Labour MPs.
·  ‘Nationalisation’ would need to be financed, presumably through higher borrowing. This could
cost a considerable amount of money – potentially between £50bn and £100bn.
·  Investors would need to be compensated for their future loss of income stream. The owners of
the PFI projects through the listed funds include many small private shareholders, private
wealth management firms and pension funds with assets owned on behalf of many employees.
·  Any ‘nationalisation’ would be complicated e.g. break costs on debt and swaps that are in the
PFI project.
·  ‘Nationalisation’ would likely take a number of years to implement.

Given the above, we question how high a priority PFI ‘nationalisation’ would be for an incoming
government, given other priorities and competing spending pressures any new government would be
faced with. We also think that given the next UK General Election is likely to be some years off and the
time it would take to implement a ‘nationalisation’ programme, there may be a ‘natural brake’ applied.
This reflects the fact that many current UK PFI projects are already ten to 15 years old and assuming
that no ‘nationalisation’ takes place for at least another five years, these projects will then be of 15 to 20
years duration. Given most UK projects only have durations of 20 to 25 years in total, we think many
projects will be reaching their expiry date by the time any ‘nationalisation’ can be implemented.”

Now, all of this sounds completely feasible and I don’t dispute that the mechanics of nationalisation will be enormously complicated.

In the good old days, I would have even added that I would have thought that nationalisation would be electorally impossible– Corbyn wouldn’t be able to rely on the votes of enough of his moderate Labour MPs, with a huge majority for Labour a highly unlikely eventuality.

Now, I’m not too sure. Too many moderate Labour MPs look abjectly deflated and most seem to have given up the good fight – they might even have fallen for the McDonnell shtick about seeming “pragmatic”. There’s a sucker (or two hundred born) every day!

My main counter to the contrarian argument by Stifel is thus reduced to three observations:

  • Investors react to fear and anxiety, not always in a rational fashion. Investors will start to build in a significant discount to prices to allow for the long list of possible political permutations. My hunch is that with outfits such as HICL – a good proxy for more general PFI concerns – trading at a discount of “just” 6.5% we might have further to go
  • The tide is turning against privatisation and PFI/PPP beyond the comrades of the Far Left. Many moderate Labour MPs (and dare we say even some Liberal and Conservative MPs) think that too much private sector profit has been made from public sector guarantees. If I were a diehard free-market Tory I think I could mount an intellectually coherent argument for saying that too many PFI/PPP deals have been anti-competitive and allowed the taxpayer to be ripped off. Many of these deals are very far from being a pristine representation of open, free markets, with all sorts of peculiar legalistic definitions protecting excessive profits. On this argument, we might see the pricing environment for PFI/PPP deals tighten considerably. This would NOT support a nationalisation agenda, but it could help underpin a consensus towards a windfall profits charge
  • The bigger macro picture is also surely relevant. Most analysts suggest that infrastructure assets are probably relatively immune to rising interest rates. But if long dated gilts started to yield in excess of 3.5% everything might change – suddenly those 5 to 6% yields from regulated assets might not look so safe.

At this point let’s rewind and think about the bigger picture. What do we think might happen in the event of a Labour win? Sterling would drop like a stone, with a target of $1.10 for the cable and £ for each Euro. That would inject even more inflation into our system. But investors would also calculate that a Hard-Left government would massively increase public spending, bingeing on debt. Inflation expectations would rise markedly across the board and the Bank of England might be forced to raise interest rates sharply to protect our national balance sheet.

Infrastructure funds would clearly benefit from some inflation – through those inflation linkages – but I very much doubt that a Labour government would put up with a sharp increase in charges whilst it was fighting fires on all fronts. The key driver though would be surging inflation and interest rates, a potentially lethal combination for income producing assets that have only limited inflation protection.

Crucially I don’t think that even a fraction of this scenario need necessarily “actually” happen – investors would only need to ‘fear’ that it might happen.

So, overall, I think we infrastructure investor’s need better protection for these potential risks. For the record, I, don’t think a Corbyn win is actually probable or even likely, but it must be seen by any level-headed observer as very possible. I also, clearly, hope that it does not happen. It would be a calamity not only for the country but also for all sensible, moderate social democrats and progressives, putting the Conservative Party in power for decades to come – with the Hard Right in the ascendancy.

Given these risks, I would argue that we need discounts closer to 10% and yields above 6% before we can say, with hand on heart, that ‘its built into the price’.