Description

Autostrade Meridionali SpA (AUTME)

Thesis Summary 

• This is a unique special situation play where the value will be determined by the outcome of AUTME's two legal cases against the Italian Ministry for Infrastructure and Transport (MIT). 

• AUTME have been operating the expired A3 motorway concession in Southern Italy under transitional arrangements since 2013 while MIT carried out a tender process to appoint a new concessionaire. The new concessionaire has now been appointed and AUTME will be entitled to a takeover payment of €417m when the concession is taken over.

• It recently won a lawsuit which blocked MIT’s attempt to retroactively downgrade its tariff rates going back to 2013 and ordered MIT to agree a financial plan which would net AUTME a further €33m. While this decision is being appealed by MIT to the Italian Council of State, AUTME is highly likely to win this case, particularly in light of the comprehensive one-sided judgment from TAR Lazio and MIT’s breach of EU law.

• AUTME is also appealing MIT’s decision not to award it the A3 concession to the Council of State. While there is an outside chance that AUTME will retain its concession, this appeal is unlikely to succeed. From a shareholder return perspective, it is actually preferable that AUTME lose the concession and wind-up the company.

• There are 3 realistic outcomes in the next 2 years:

• AUTME wins case against MIT and loses the A3 concession;

   

• AUTME wins case against MIT and retains the A3 concession; and

   

• AUTME loses case against MIT and loses the A3 concession.

   

• The expected IRR over the next 2 years is 23% in a conservative base case (or 39% in a more optimistic bull case). There is ~70% downside if AUTME lose the appeal on the financial plan.

Note: The float is €48m and average traded volume is €160k (although there are occasionally larger pockets of liquidity). 

Background 

AUTME is a listed 58.9% subsidiary of Autostrade Per L’Italia (ASPI) and operates an expired motorway concession on the 51.6km A3 motorway from Napoli-Pompei-Salerno in Southern Italy. The company was originally incorporated in 1925 to construct and operate the original Naples-Salerno route. An extension from Pompeii to Salerno was added in the 1960s during Italy’s post-war economic boom. AUTME became a subsidiary of ASPI in 1987.

AUTME’s most recent concession agreement was signed in 2009.  The Grantor was originally ANAS spa (a government concession company), however the Italian Ministry for Infrastructure and Transport (MIT) subsequently took over this role in October 2012. With the 2009 Concession Agreement expiring at the end of 2012, a new call for tenders was published in August 2012. As there was no prospect for appointing a new concessionaire before 31 December 2012, MIT used a provision in the 2009 Concession Agreement to oblige AUTME to continue carrying out ordinary management of the A3 concession under the same terms and conditions as before. Over 8 years later, AUTME is still operating the A3 motorway under these transitional arrangements. AUTME has achieved acceptable financial returns over this period:

When the new concessionaire takes over, AUTME will be entitled to receive a “takeover indemnity payment” for certain investments made during its operation of the concession, e.g. the construction of a 3rd lane along certain portions of the motorway. This takeover payment was valued by MIT at €408m as of 31 December 2017. AUTME’s management now value the takeover payment at around ~€417m.

Disputes with MIT

AUTME has had a long series of disputes with MIT relating to the A3 concession since 2012. I will discuss the most relevant parts in this write-up, but this only scratches the surface of the Kafkaesque administration of this relatively minor motorway concession in Southern Italy.

Financial Plan & Tariffs

AUTME is obliged to provide construction operation and mantainence services on the A3 motorway in return for the right to collect tariffs from users. The level of tolls is set out in the 2009 Concession Agreement, which then is supplemented by various resolutions of the Italian Interministerial Committee for Economic Planning (Comitato Interministeriale per la Programmazione Economica or “CIPE”). Italian concession agreements require the parties to agree a financial plan for the concession which sets out how the level of tolls will be determined and adjusted over a given period. Toll are adjusted in accordance with an agreed regulated formula, taking into account factors like inflation, quality of service, net invested capital, and an allowable return on that capital.

Despite numerous attempts, AUTME was unable to get MIT to sign off on a financial plan for the transitional period after the expiry of the 2009 Concession Agreement. In particular, MIT disputed AUTME’s right to have a financial plan put in place during this period and was reluctant to allow for tariff adjustments. AUTME was ultimately able to obtain a judgment from the Council of State in 2016 affirming its right to have a financial plan put in place which would allow for periodic adjustments to the toll rates. AUTME has also brought a successful series of cases in the local administrative court in Naples (TAR Campania) which quashed MIT’s annual refusals to properly adjust the toll rates. MIT and AUTME have still not agreed a financial plan for the transitional period.

So now is the crucial part. In October 2019, CIPE published a new resolution (CIPE 38/2019) setting out the rules on how tariff rates are to be determined during the period between the expiry of an existing concession and the beginning of a new one.  CIPE 38/2019 provides that, unless otherwise governed by another agreement, the concessionaire is only entitled to a return equal to the ECB refi rate + 1% on its net invested capital during this interim period, as opposed to the 10.11% rate of return expressly provided for in the 2009 Concession Agreement. MIT swiftly instructed AUTME to submit an updated financial plan which applied the reduced rate of return going all the way back to 2013. If this rate is retroactively applied, AUTME would owe MIT ~€132m net of taxes.

AUTME refused to submit such a financial plan and secured a successful judgment from the administrative court in Rome (TAR Lazio) in February this year. The TAR Lazio delivered as one-sided a judgment as you will find:

• confirming that applicable rate of return is 10.11% as agreed by the parties in the 2009 Concession Agreement, and not the rate set out in CIPE 38/2019;

   

• quashing MIT’s requests for the financial plan to be re-calculated in line with CIPE 38/2019;

   

• confirming that MIT is in breach for not agreeing a financial plan for the years following the expiry of the original concession; and

   

• ordering MIT to adopt a financial plan in line with the provisions of the 2009 Concession Agreement.

MIT has since appealed TAR Lazio’s decision to the Council of State (a hearing date has not yet been set). AUTME’s management estimate that MIT owes them a further €50.6m gross of taxes as of 31 December 2020 if the TAR Lazio decision is upheld by the Council of State. I estimate that this would amount to ~€33m net of corporate and regional taxes. As mentioned above, AUTME would owe MIT ~€132m net of taxes if they lose (or €177m gross of taxes). It is worth noting that this potential receivable will increase as AUTME continues to operate the concession. The reverse is also true because the potential liability to MIT grows if AUTME earns more than the allowable return under CIPE 38/2019.

The Council of State is practically the final court of appeal for administrative matters in Italy. However it should be noted that AUTME will also have further recourse to the EU courts and potentially the European Courts of Human Rights in the (unlikely) event that MIT succeeds in its appeal.

Probability of Winning the Case against MIT: 75-90%

MIT are highly unlikely to succeed in their appeal in the Council of State for a number of reasons:

• TAR Lazio’s decision in February was definitive and extremely one-sided. The judgment focused in particular on the wording of CIPE 38/2019, which expressly states that the reduced rate of return applies only where there is no other agreement in place between the parties (“ove non diversamente disciplinata dagli atti convenzionali”). The judgment also noted that the stated intention of CIPE 38/2019 was to introduce a general safeguard measure that was without prejudice to specific contracts already in force. The 2009 Concession Agreement, which MIT used to oblige AUTME to continue operating the concession, contains an express provision that the applicable rate of return is 10.11% (subject to some allowable amendments over time). It will be extremely difficult for MIT to convince the Council of State to interpret these clear legal provisions otherwise and overturn TAR Campania’s decision. 

   

• Aside from the specific provisions of the legal documents, the application of CIPE 38/2019 would likely breach general Italian legal principles. In a 2012 note, MIT expressly stated that AUTME was to continue operating the concession in accordance with the terms of the 2009 Concession Agreement. AUTME was legally obliged to continue operating the concession on that basis. MIT then unilaterally decided to change this arrangement many years later by retroactively adjusting the tariff rates downward. This would breach the principles of legitimate expectation and non-retroactivity in Italian law.

   

• Outside of Italian law, MIT’s proposed measure likely breaches fundamental principles of EU law, such as free movement of capital, legal certainty, legitimate reliance and non-retroactivity (amongst others). It is important to note that, if unsuccessful in the Council of State, AUTME would have recourse to the EU Courts as EU law takes precedence over domestic Italian law.

   

• The European Commission has recently sought clarifications from the Italian government for similar unilateral and retroactive measures taken against ASPI for suspected breaches of EU law.

(https://www.bloomberg.com/news/articles/2021-01-29/eu-seeks-clarifications-from-italy-over-autostrade-legal-dispute)

• The 2019 measure was undertaken while Giuseppe Conte’s coalition government was in power and can been seen in the context of the Five Star Movement’s aggressive campaign to strip the Benetton family of their control of Italian motorway concessions. The new Italian government, led by former ECB President Mario Draghi, will be far more deferential to the principles of EU law and the concerns of the European Commission.

   

• AUTME may even have further recourse to the European Court of Human Rights (ECHR) for unlawful breach of its fundamental property rights.

AUTME have an extremely strong case here. I believe their probability of winning is at least 75% and is likely much closer to 90%. It is highly doubtful that anyone other than a government department without proper skin in the game would bring such a case all the way to the Council of State after the TAR Campania judgment. Of course, there is always some level of risk in litigation, particularly in Italian courts where rogue decisions can happen. However even this risk is mitigated by ultimate recourse to the European Courts (both EU and ECHR) and the fact that a more pro-EU government is now in power.

Award of New Concession

MIT’s tender process has been extremely protracted (even for Italy), with delays caused by a series of legal actions and challenges over the past 8 years (many brought by AUTME itself). Please refer to the appendix for a more detailed timeline of this absurdly long tender process.

The long delay has actually worked out quite nicely for AUTME as it has enabled it to continue operating the concession for way longer than it ever should have. This will be particularly fortuitous if the Council of State ultimately affirms AUTME’s right to receive the 10.11% rate of return during the transitional period.

In February of last year, MIT finally awarded the A3 concession to the SIS consortium (a joint venture between Spanish infrastructure company Sacyr and Italian holding company Fininc). AUTME then unsuccessfully appealed this decision to TAR Campania. It is now bringing a final appeal to the Council of State with a hearing date set for 28 October 2021. 

Probability of Retaining the A3 Concession: 10-20%

AUTME’s chances of success in this appeal are not particularly high and the probability is likely not greater than 20%. It is generally quite difficult to overturn the results of a tender process in the absence of manifest error or fraud. The arguments put forward by AUTME’s lawyers in the TAR Campania case were fairly unconvincing, focusing on alleged technical errors in SIS’s bid, such as the calculation of personnel expenses, VAT, and operating costs. It is unlikely that the Council of State will overrule the MIT’s decision and the TAR Campania ruling with weak technical arguments such as these.

You might question why AUTME is still pursuing this concession when it could just realise the €417m takeover indemnity payment and wind-up the company. Rightly or wrongly, I believe that management’s ultimate aim is to continue managing the A3 motorway as it has been doing since the 1920s. History and heritage matter in Italian business and this would be seen as a preferable option to cashing-in the takeover payment and winding up the company. Running this case also may give AUTME some strategic leverage over MIT and allow them to extend its operation of the concession by delaying the handover to SIS even further.

Potential Outcomes & Expected Returns

In my view, there are 3 realistic outcomes here:

1. AUTME wins case against MIT and loses the A3 concession;

    

2. AUTME wins case against MIT and retains the A3 concession; and

    

3. AUTME loses case against MIT and loses the A3 concession.

I do not believe that the scenario whereby AUTME loses the case but retains the A3 concession is a realistic outcome. AUTME would not be a financial position to discharge the €132m liability to MIT in this scenario. With a €245m outstanding loan to Banco di Napoli, it will not have enough cash to pay the €132m without receiving the takeover payment or raising significant amounts of equity. While it may be possible to work out something with creditors/shareholders, I see the most likely outcome in this scenario being that AUTME concedes the A3 concession and uses the takeover payment to set off its liability to MIT. 

Taking all these scenarios together and assuming it takes 2 years for everything to play out, we get a 23% expected IRR in a conservative base case and 39% expected IRR in a bull case. While the Council of State should deliver its judgments within 12 months, I am conservatively using a 2 year period to allow for any further delays.

Base Case

Base Case Assumptions:

• 75% probability of winning financial plan case against MIT & 20% probability of retaining the A3 Concession.

• In Scenario 1, AUTME liquidates for €55.37 per share in 2 years (NAV of €49.37 + €6 in earnings)

• In Scenario 2, AUTME is worth €35.65 in 2 years (€9.65 pay-out from MIT case + €6 in earnings, + remaining concession business worth €20).

• In Scenario 3, AUTME liquidates for €8.05 per share in 2 years (NAV of € 7.05 + €1 in allowable earnings under CIPE 38/2019)

Bull Case

Bull Case Assumptions:

• 90% probability of winning the financial plan case against MIT and 10% probability of retaining the A3 Concession.

• In Scenario 1, AUTME liquidates for €57.37 per share in 2 years (NAV of €49.37 + €8 in earnings)

• In Scenario 2, AUTME is worth €47.65 in 2 years (€9.65 pay-out from MIT case + €8 in earnings, + remaining concession business worth €30).

• In Scenario 3, AUTME liquidates for €8.05 per share in 2 years (NAV of € 7.05 + €1 in allowable earnings under CIPE 38/2019

NAV Calculations:

NAV calculations are adjusted from the 2020 financials.

As mentioned above, the receivable/liability arising from the financial plan case with MIT is likely to change as AUTME continues to act as interim concessionaire. I have accounted for this in my model by assuming that, over the remaining 2 years of transitional operations, AUTME will be allowed €3-4 eps per year if they win the case and €0.5 eps if they lose.

Other Considerations

• AUTME’s majority shareholder ASPI is currently the subject of a high-profile takeover battle. A government backed consortium of Blackstone, Macquarie & CDP (the Italian State Investment bank) has submitted a bid, as has Florentino Pérez’s infrastructure company ACS.

   

• The takeover of ASPI is unlikely to trigger a mandatory offer for AUTME as the materiality thresholds in Art 45 of the Italian Consolidated Finance Act are unlikely to be satisfied.

   

• AUTME’s largest minority shareholder, Praude Asset Management, has been significantly increasing its stake in the company in recent months.

   

• The key value driver here is the outcome of the Council of State appeal case on the financial plan. There is also a risk that AUTME management have not correctly estimated the cash flows arising from this case or the takeover payment. Furthermore there is always risk in litigation - the old Wall Street adage “never buy into a lawsuit” still applies.

   
• If AUTME ultimately has to go to the CJEU or the ECHR, the payout to shareholders will be substantially delayed.

Appendix – Timeline of A3 Tender Process

Catalyst

 Italian Council of State decision.