Voluntary termination of a concession, worked three ways: base-case IRR make-whole, market value, and the current forecast at the base-case rate.
Compensation on a PPP voluntary termination is usually senior debt outstanding, plus breakage costs, plus an equity amount whose definition decides the result. On an illustrative project terminated after eight years, with 310.0 of senior debt and 14.0 of breakage, equity receives 92.6 under a base-case IRR make-whole, 89.1 at market value discounted at 7 per cent, and 72.3 if the current forecast is discounted at the 10 per cent base-case IRR. The spread, 20.3, is more than a fifth of the equity claim.
Worked in full in The Infrastructure Investment Analyst by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Public authorities terminate PPP and concession contracts for policy reasons, to bring a service in house or to restructure a portfolio, and some contracts give them the right to do so at will against compensation. The contracts typically make the senior lenders whole and then compensate equity on one of a few bases: the amount that delivers the base-case equity return, the market value of the equity, or the value of the remaining distributions at a contractual rate. UK standardisation guidance (SoPC4, later PF2) is a common reference point and allows more than one of these. The wording varies by country and by contract; the arithmetic of each basis does not.
| Input | Value |
|---|---|
| Equity invested at financial close (share capital and shareholder loans) | 60.0 |
| Base-case equity IRR | 10% |
| Concession | 25 years |
| Distributions years 4 to 8, actual | 5.0, 5.5, 6.0, 6.5, 7.0 |
| Distributions years 4 to 8, base case | 6.5, 7.0, 7.5, 8.0, 8.5 |
| Current forecast, years 9 to 25 | 8.0 rising 2% a year |
| Base-case forecast, years 9 to 25 | 9.25 rising 2% a year |
| Senior debt outstanding / swap breakage | 310.0 / 14.0 |
| Secondary market discount rate for this kind of asset | 7% |
The project has underperformed: it has distributed 30.0 against 37.5 in the base case, and the current forecast runs 13.5 per cent below the base case for the rest of the term. The 7 per cent secondary rate is illustrative.
The equity amount is whatever lump sum, paid at termination, lifts the equity IRR to the base case, given what has actually been distributed.
E = equity × (1 + IRR)8 − Σ distributiont × (1 + IRR)8−t
= 60.0 × 1.18 − 36.1 = 128.6 − 36.1 = 92.6
In Excel, with equity in B1, the IRR in B2 and distributions for years 1 to 8 in C1:C8: =B1*(1+B2)^8-SUMPRODUCT(C1:C8,(1+B2)^(8-ROW(C1:C8))).
Had the project distributed on its base case, the make-whole would be 83.4. The extra 9.2 is compensation for past underperformance: the authority pays for distributions the project failed to make. That is why some contracts cap this basis, or adjust it for distributions that should have been made.
E = Σ forecast distributiont ÷ (1 + market rate)t, years 9 to 25 = 89.1 at 7%
The forecast is the current one, 160.1 of distributions in total, not the base case. The rate is what a buyer of the equity would accept today, often set by reference to secondary transactions or an independent valuation.
Discounting the current forecast at the 10 per cent base-case IRR gives 72.3. It honours the original return target but not the original cash flows, so the investor bears the underperformance and gains nothing from the fall in market yields since financial close, here from 10 to 7 per cent.
| Equity basis | Senior debt and breakage | Equity amount | Total paid | Equity IRR realised |
|---|---|---|---|---|
| Base-case IRR make-whole | 324.0 | 92.6 | 416.6 | 10.00% |
| Market value at 7% | 324.0 | 89.1 | 413.1 | 9.59% |
| Current forecast at 10% | 324.0 | 72.3 | 396.3 | 7.46% |
| Discount rate | Market value | Against make-whole of 92.6 |
|---|---|---|
| 6% | 96.0 | Higher |
| 7% | 89.1 | Lower |
| 8% | 82.9 | Lower |
| 10% | 72.3 | Lower |
The two main bases cross at a discount rate of 6.48 per cent. Below it, market value pays more than the make-whole even for an underperforming project, because the fall in required returns since financial close is worth more than the cash flows lost. Above it, the make-whole protects equity. An investor can therefore tell from today's secondary yields which basis it would prefer, and an authority which basis makes a termination expensive.
Valuing the termination on the base-case cash flows. Discounting the base-case forecast, rather than the current one, at 10 per cent gives about 83.6, an amount that corresponds to none of the contractual bases here: 9.0 below the make-whole and 11.3 above the forecast-based figure. The second mistake is forgetting that the senior debt component moves with interest rates too: swap breakage, 14.0 here, can be a cost or a receipt depending on rates since close, and it sits ahead of equity. The refinancing gain calculation uses the same base-case IRR logic, and the remaining distributions come from the CFADS after debt service.
This illustrates mechanics only. Termination provisions differ by jurisdiction, sector and contract generation, and compensation on other grounds is calculated differently. On contractor default it is often based on the market value of the contract or a retendering, which can leave equity with little or nothing and does not always cover senior debt in full.
Read the equity definition first, then compute: 92.6 under a base-case IRR make-whole, 89.1 at a 7 per cent market rate, 72.3 for the current forecast at 10 per cent, on top of 324.0 for the lenders. The Infrastructure Investment Analyst covers concession valuation and diligence, and the free workbooks for the book carry its toll road case live.
A lump sum paid at termination that brings the equity investors' IRR up to the base-case figure, given the distributions actually received. In the illustrative case it is 60.0 times 1.1 to the power 8, or 128.6, less 36.1 of distributions compounded at 10 per cent: 92.6, including 9.2 for past underperformance.
It depends on secondary yields. In the illustrative case market value pays more than the 92.6 make-whole when the discount rate is below 6.48 per cent, for instance 96.0 at 6 per cent, and less above it: 89.1 at 7 per cent and 82.9 at 8 per cent.
Typically yes: compensation on authority voluntary termination usually covers senior debt outstanding and breakage costs before any equity amount. In the example that is 310.0 of debt and 14.0 of swap breakage, 324.0 in total, which sits ahead of the equity's 72.3 to 92.6 depending on the basis.
This article is one calculation from The Infrastructure Investment Analyst. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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