tackling the viability statement: practical suggestions ... · tackling the viability statement...

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September 2016

Tackling the viability statementPractical suggestions, positive thinking – An update

Contents

About this update 1

Updated illustrative draft statement, examples and comments 2

About this update

This publication is an update to Tackling the viability statement – practical suggestions, positive thinking now that issuers have reported against the 2014 UK Corporate Governance Code (‘the Code’ or ‘the 2014 Code’) for the first time.

Our views have not changed – in fact, if anything, they have been reinforced by what we’ve seen. The most successful disclosures, in our view, are those which:

• Set the formal viability statement in its broader context

• Are clear about which of the principal risks are most relevant to viability

• Explain the most important assumptions that the directors have made, whether these are built into the business plan or part of the stress tests applied to it

We have also continued to test our thinking (and our suggested illustrative statement) on investor organisations, with very positive results. This document reflects their feedback and some refinement of our own views. In particular we have emphasised and added further comments to our illustrative statement on the importance of:

• Focusing more on the ‘real’ long term. Where there is a genuinely long-term aspect to a company’s business model or strategy (examples include many extractive or utility organisations), the disclosures around the viability statement should reflect this.

• Being clear about outcomes. If a company goes into detail about risks or scenarios that could threaten viability, the level of threat they pose should be clear; the standard confirmation of viability is the same for a company with less than a year’s funding in place and the most long-established multinational, so more positioning is needed.

Overall, we have continued to see a steady upward trend in the quality of the disclosures companies have made. But there are still too many examples of boilerplate statements that could have been cut from one annual report and pasted into another, regardless of the nature of the company or the industry. This might, strictly speaking, be ‘compliant’ but it serves little purpose and completely fails to provide insight into risks to solvency and liquidity.

We hope that, whatever their approach in year one, this update will help companies think afresh about the viability statement in year two. As usual, we’d really appreciate your feedback and our contact details can be found on the back of this publication.

How this document works

The document is built around our original illustrative statement, now accompanied by:

• New examples from annual reports published since January 2016

• Some brief additional commentary where our thoughts have been refined

• Statistics on how the FTSE 350 has responded to the viability statement requirement

As we noted above, there has been a continuing upward trend in the quality of viability statements, and we hope that the published examples in particular will encourage more companies to revisit their disclosures in year two.

PwC | Tackling the viability statement | 1

Updated illustrative draft statement, examples and comments

Illustrative statement

Example 1 – Aggreko plc

December 2015 annual report > page 33

Assessment of prospects and viabilityDuring the year, we undertook a comprehensive review of the business in light of our strategic objective to be the number one global provider of power and related solutions that are modular and mobile, see further detail on page 22. Having listened to our customers and been through the business review, it was clear that Aggreko had two mutually beneficial businesses. From 1 August, we split the business into Rental Solutions and Power Solutions. Rental Solutions operates in developed markets, which usually have more transactional and less complex, shorter contracts. Power Solutions has larger, more complex customer requirements, largely operates in emerging markets, and is more geographically spread. The comprehensive review concluded that the key markets within which Aggreko operates are forecast to grow at between 2% and 6%, however over the medium term we expect to grow faster than our markets and deliver margins and returns of around 20%.

Demand for Aggreko’s services is created by events with the nature of the demand differing by country and therefore we address the market through our two business units, as described above. The Rental Solutions business is linked to local economies and commodity cycles and varies in size and nature from country to country whist the Power Solutions business is driven by economic growth, hydro shortages, social pressures, permanent capacity delays/shortfall and ageing power infrastructures.

There are many factors that could affect the growth, both positively and negatively, of Aggreko going forward. These factors are discussed regularly by both the Executive Committee and the Board. The principal risk factors which the Board concluded could affect business performance over the medium term are set out on pages 28 to 33, of which there are 15.

Examples

Two good examples of putting the viability statement in context – really insightful commentary on what really drives the wider prospects for the businesses:

Illustrative disclosures1) Assessment of prospects

The context for the assessment (of prospects)The group’s business model and strategy are central to an understanding of its prospects, and details can be found on pages [x] to [y]. The nature of the group’s activities is long-term and the business model is open-ended. The group’s current overall strategy has been in place for several years, subject to the ongoing monitoring and development described below. The core business of the group has a [x]% share of the [x] market and the related segment has reported an average of £[x]m of EBITDA over the past [x] years.

The board continues to take a conservative approach to the group’s strategy in the core business and the focus is largely on cost control and centralisation. Decisions relating to major new projects and investments are made with a low appetite for risk and are subject to an escalating system of approvals, including short payback periods. Similar controls operate in rela-tion to major new customer contracts.

The group’s focus is particularly on developing the [x] business unit, because of the substantial opportunities in the [digital/US] market. The board has considered the changes in the risk profile of the group that this entails and determined that they are acceptable in the context of the risk profile of the group as a whole: the expected longer term returns mean that there is more appetite for risk, for instance in the form of product development for a market to which the group is relatively new.

2 | Tackling the viability statement | PwC

Example 2 – Moneysupermarket.com Group PLC


Business ModelThe Group has a simple business model – matching customers to the right providers. It uses online services to help customers to compare a wide range of products in one place and make an informed choice when taking out the product most suited to their needs. For our providers, it offers an efficient and cost-effective way to reach a large volume of informed customers who are actively looking for a product. For the majority of our services, we receive a success-based marketing fee from the providers.

This business model operates through the following key principles:

• the Group relies on customer transactions for its revenues and does not have long-term contracted revenue streams;

• customers will continue to see value in shopping around for products and services and will aim to save money by doing so; and

• providers will continue to have strategies of new customer acquisition and will develop products and services to fulfil that strategy.

Of the first 288 FTSE 350 companies to report against the 2014 Code…

98% stated that they had based the period chosen for the viability statement on their strategic planning period


Updated illustrative draft statement, examples and comments (Contd...)

The assessment process and key assumptionsThe group’s prospects are assessed primarily through its strategic planning process. This process includes an annual review of the ongoing plan, led by [the CEO through the management committee] and all relevant functions are involved, including [product and market development, finance, treasury and risk]. The board participates fully in the annual process by means in particular of [annual strategic away-days.] Part of the board’s role is to consider whether the plan continues to take appropriate account of the external environment including [macroeconomic, political, social, technological] changes.

Commentary Focusing more on the ‘real’ long term: this could be where a technology company discusses how it monitors competitor activity and/or the emergence of alternative technologies, even though these are unlikely to have a significant direct effect on the business during the period of the formal viability statement.

The output of the annual review process is [a set of objectives, an analysis of the risks that could prevent the plan being delivered, and a number of financial forecasts]. The latest updates to the strategic plan were finalised in [month] following this year’s review. This considered the group’s current position and the development of the business as a whole over the next [20] years, focusing on the prospects for the [x] business unit in the next [five] years based on the initiatives in the [digital/US] market.

Commentary Focusing more on the ‘real’ long term: where the business model clearly has long-term aspects, maybe involving long-term capital investment plans, we think it’s important that the basis for planning these is also explained. Also, where there is a major long-term risk or uncertainty (like fossil fuel supply for oil and gas companies) it would be helpful for this to be addressed.



Example

Explains how the group plans over its ‘real’ long term business cycle, setting the wider context in which the formal viability statement sits:

Example 3 – Rio Tinto plc


Longer-term viability statement‘Current business planning processes within Rio Tinto require the preparation of detailed financial plans over a three-year time horizon. The Group’s strategy is developed, and capital investment decisions are made, based on an assessment of cash flows over a multi-decade horizon, with financial investment capacity regularly tested to ensure capital commitments can be funded in line with the Group’s capital allocation model. This multi-year planning approach reflects our business model of investing in, and operating, long-life mining assets, whose outputs we sell into commodity markets over which we have limited influence.

The planning process requires modelling under a series of macroeconomic scenarios and assumptions of both internal and external parameters. Key assumptions include: projections of economic growth, and thus commodity demand in major markets, primarily China; commodity prices and exchange rates, often correlated; cost and supply parameters for major inputs such as labour and fuel; and a series of assumptions around the schedule and cost of implementation of organic and inorganic growth programmes.

Reflecting the speed and degree of change possible in a number of these parameters, such as Chinese demand, commodity prices, and exchange rates, Rio Tinto has deemed a three-year period of assessment appropriate for the long-term viability statement, consistent with the Group’s detailed planning horizon.’


61% were really clear about the end date of the assessment processOnly


As a result of this focus, detailed financial forecasts were also prepared for the [five] year period to [date], so that [years/months] remains at the time of approval of this year’s annual report. The first year of the financial forecasts form the group’s op-erating budget and is subject to a re-forecast process at the half-year. The second year is in a similar level of detail, and is flexed based on the actual results in year one. Years three to five of the forecasts are extrapolated from the first two years, based on the overall content of the strategic plan.The key assumptions in the financial forecasts, reflecting the overall strategy, include:• [Significant]/[10%] annual growth in the [x] business unit from [year] to [year]• A [significant]/[5%] increase in EBITDA for the group as a whole as a result of the ongoing restructuring of the back-

office functions as part of the centralisation programme

It has also been assumed that refinancing will be available on similar terms to those negotiated in [year] to support the expansion of the [x] business unit.

These key assumptions are reflected in numbers 1, 2 and 3 of the group’s principal risks, which are set out on pages [x] to [y]. The purpose of the principal risks [table] is primarily to summarise those matters that could prevent the group from delivering on its strategy. A number of other aspects of the principal risks – because of their nature or potential impact – could also threaten the group’s ability to continue in business in its current form if they were to occur. This was considered as part of the assessment of the group’s viability, as explained below.




Example

Provides real clarity on the assumptions made by the Directors in the business plan, before the additional stress tests and sensitivities are applied:

Key assumptionsThe key assumptions which underpin our three-year strategic plan to December 2018 are as follows:

1. The key cyclical and policy factors that have recently hurt Pearson (US college enrolments and UK qualifications) should stabilise by the end of 2017 and improve modestly thereafter, helped by new product launches

2. Pearson makes modest market share gains in North America higher education subjects where next generation courseware is being launched

3. US state testing revenues continue to decline through 2017, as current contracts unwind, before stabilising in 2018

4. Professional certification and clinical assessment revenues continue to grow

5. Pearson businesses in China and Brazil benefit from the launch of new products, including the Wall Street English New Student Experience

6. Pearson’s services businesses (for example, online programme management, virtual schools, blended learning in English) continue to grow as new Platforms and products come to market and capitalise on market growth

7. The benefits of the company’s restructuring plan are delivered in full, with minimal disruption to sales, market share and operations from this major programme of change

Example 4 – Pearson plc



74% 22% chose a three year period for the formal statement and

went for five years



2) Assessment of viability

Although the strategic plan reflects the directors’ best estimate of the future prospects of the business, they have also tested the potential impact on the group of a number of scenarios over and above those included in the plan, by quantifying their financial impact and overlaying this on the detailed financial forecasts in the plan. These scenarios, which are based on aspects of principal risks [3, 4 and 5], represent ‘severe but plausible’ circumstances that the group could experience.

The scenarios tested included:

• A serious breach of regulatory requirements in the [US/digital] market as a result of enhanced regulator focus and lack of experience within the group, leading to fines and a loss of reputation among potential customers.

• A [significant]/[20%] shortfall in EBITDA in the [x] business unit, leading to covenant breaches and/or downgraded credit rating (and the knock-on effect on the cost of future capital to fund expansion).



Example

Very clear on the risks most relevant to viability, and on how they were factored into the viability assessment:

For the purpose of assessing the Group’s viability, the Directors identified that of the principal risks detailed on page 37 the following are the most important to the assessment of the viability of the Group:

A. ‘Impact of global macroeconomic developments’, specifically volatility in the prices of gold and silver over a period of time

B. Access to land

C. ‘Potential actions by the government’ which could include a delay in obtaining permits and/or new restrictive regulations

D. Project delivery risks

E. Environmental incidents

It was determined that none of the individual risks, except for prices, would in isolation compromise the Group’s viability. The Directors therefore went on to group principal risks into the following severe but plausible scenarios, in each case determining the risk proximity (how soon could the risk occur) and velocity (the speed with which the impact of a risk will be felt):

Scenario 1

Impact of global macroeconomic developments

Over a period of a year, precious metal prices fall and then remain at a low level for the following four years of the viability period, varying between US$972-US$1,033/oz for gold and US$14.0-US$14.8/oz for silver. To create this impartial projection for the future low metal price environment, an average of the three lowest forecasts from each year of the assessment were used, based on consensus estimates published by Bloomberg at the end of December 2015. This low metal price environment was deemed to be the most significant risk and pervasive across the Company. (Principal risk A).

Scenario 2

Bench collapse at an open pit mine

A landslide occurs covering the lower pit of one of our mines. Due to the unexpected nature of the event, fatalities occur. Production is gradually then ramped back up and re-established to full capacity. (Singular event).

Example 5 – Fresnillo plc



89% disclosed that they had used stress testing procedures in their assessment of viability


The results of this stress testing showed that, due to the stability of the core business, the group would be able to withstand the impact of these scenarios occurring over the period of the financial forecasts by making adjustments to its operating plans within the normal course of business.

Commentary Being clear about outcomes: This can be a vital message, and a key part of making the annual report as a whole ‘fair, balanced and understandable’: there should be no doubt as to whether the results of stress testing (or the wider assessment) showed a close call or very comfortable headroom.

The group also considered a number of scenarios that would represent serious threats to its liquidity. None of these was considered to be plausible.

3) Viability statement

Based on their assessment of prospects and viability above, the directors confirm that they have a reasonable expectation that the group will be able to continue in operation and meet its liabilities as they fall due over the five year period ending [date].

4) Going concernThe directors also considered it appropriate to prepare the financial statements on the going concern basis, as explained in the Basis of preparation paragraph in note 1 to the accounts.




Example

Discusses well the extent of the potential impact of the scenarios run, rather than relying on a boilerplate confirmation of viability:

‘The scenarios on the previous page are hypothetical and extremely severe for the purpose of creating outcomes that have the ability to threaten the viability of the Group; however, multiple control measures are in place to prevent and mitigate any such occurrences from taking place. In the case of these scenarios arising, various options are available to the Company in order to maintain liquidity so as to continue in operation, such as suspending some or all of the following capital expenditures: Pyrites plant (US$176.3 million), Orisyvo (US$393.3 million), Centauro Deep (US$363.8 million) and Centauro Extension (US$155.0 million), which are described in more detail on pages 50 to 65. A further option available to the Company is the reduction of exploration expenses by up to 50% on an annual basis (USD$71 million annual average). To quantify the impact on the Group’s viability from the expected financial impact and remediation period for each of the above risks, management benchmarked its own experience against publicly available information on relevant and similar incidents in the mining industry.

All scenarios were first evaluated using average metal prices1, and modelled to occur when each scenario would have the most significant impact on cash resources. Once the mitigation plans of deferring capital expenditure had been applied to the extent necessary, there was no threat to the viability of the Group. To create a more stringent test and further challenge the resilience of the Group, all scenarios were then overlaid with scenario one, (low metal prices) and then re-evaluated.

After these had been modelled, the only scenario that caused a certain degree of stress to cash flows was scenario number three in combination with the low metal prices scenario (number one), albeit the Directors consider the assumptions used for this scenario were greatly amplified for the purposes of this assessment. In addition to suspending capital expenditure, a further mitigating action could include a 50% reduction in the exploration budget for the first three years.’

Example 6 – Fresnillo plc



Contacts

As always, we would very much like to hear what you think of our suggestions. To discuss them or any other area of compliance with the UK Corporate Governance Code, please get in touch with your usual PwC contact or one of the central team listed below.

John Patterson

T:+44 (0)1223 552413 E: [email protected]

Patrick Leach

T:+44 (0)20 7804 0315 E: [email protected]

Mark O’Sullivan

T:+44 (0)20 7804 3459 E: [email protected]

This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers LLP, its members, employees and agents do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

© 2016 PricewaterhouseCoopers LLP. All rights reserved. In this document, “PwC” refers to the UK member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details.

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For more on how to implement the risk, viability and going concern aspects of the 2014 UK Corporate Governance Code, visit our website

https://www.pwc.co.uk/services/audit-assurance/insights/the-new-uk-corporate-governance-code-boosting-your-corporate-immune-system.html

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