3.1 GOODWILL AND ACQUISITIONS

The table below details the changes in goodwill in 2017:

3.1.1. Changes in 2017

Following is a description of the main changes by type of change:

Definitive accounting for the acquisition of Broadspectrum:

In 2017 additional information was obtained -not available at the date of preparation of the 2016 consolidated financial statements- in relation to the financial statements of Broadspectrum at the date of its inclusion in the scope of consolidation of the Group. This additional information gave rise to the modification (EUR -15 million) of the goodwill arising on this acquisition. Pursuant to IFRS 3.45, this adjustment was made within the measurement period of one year from the acquisition date, which ended in May 2017.

Based on the foregoing, the consolidated statement of financial position as at 31 December 2016 was adjusted. The table below details the effect of these changes on the main affected line items in the Group’s consolidated statement of financial position.

The following table summarises the main aggregates of the acquisition once the changes indicated in the foregoing tables have been made:

Accordingly, in 2017 the Group re-estimated the value of the intangible assets corresponding to the contracts entered into with Broadspectrum’s customers and the contractual relationship with them, which was calculated on the basis of a new, more precise estimate of the cash flows that will be generated by the contracts based on their expected duration and a forecast of the future cash flows in the event of renewal adjusted on the basis of the estimated probability of the renewal taking place. Following this analysis, the measurement of the intangible assets was increased by AUD 60 million (EUR 41 million) and contingencies relating to the performance of certain contracts were re-estimated for AUD 29 million (EUR 20 million). These contingencies are recognised in provisions (EUR 13 million), amounts billed in advance for construction work (EUR 2 million) and amounts to be billed for work performed (EUR -6 million). The overall impact of these effects, net of the related tax effect, was to reduce goodwill by AUD 22 million (EUR 15 million).

Definitive accounting for the acquisition of Pepper Lawson (Webber)

As with the case described above, in 2017 additional information was obtained that was not available at the date of preparation of the consolidated financial statements for 2016, which gave rise to an increase in the provisions associated with certain contracts, due to events already existing at the date of acquisition of the company, amounting to EUR -2 million (net of the related taxes) and the consequent increase in the goodwill recognised. Since the impacts were not material, in this case the comparable information for 2016 was not adjusted and the changes are shown in the “Changes in the Scope of Consolidation and Other” column.

Also, Pepper Lawson was integrated in the business structure of Webber in 2017, and, accordingly, the two companies will be treated as a single cash-generating unit for the purposes of monitoring goodwill.

Changes in the scope of consolidation

Trans-Formers Group

• On 1 June 2017, the acquisition of all the shares of the Polish waste collection and treatment company Trans-Formers Group for EUR 31 million was completed (see Note 1.1, Basis of presentation, Company activities, changes in the scope of consolidation and adjustment). An intangible asset related to the customer portfolio was identified and recognised for EUR 17 million, as were property, plant and equipment for EUR 2 million and deferred taxes for EUR 3 million; which gave rise to goodwill on consolidation of EUR 5 million. In accordance with IFRS 3, the Group has one year from the acquisition date to review the purchase price allocation process.

Grupo Maviva

On 18 July, Ferrovial acquired, for EUR 18 million, all the shares of this Spanish company specialising in high value-added logistics operations, quality control and pre-assembly of components for the automotive industry. An intangible asset related to the customer portfolio was identified and recognised for EUR 7 million, together with deferred taxes of EUR 2 million. This gave rise to goodwill on consolidation of EUR 7 million. The Group has one year from the acquisition date to review the purchase price allocation process.

The provisional allocation of the purchase prices of these acquisitions can be consulted in the following table:

Impairment losses

The only impairment loss recognised in the year, amounting to EUR 29 million, relates to the goodwill on consolidation allocated to Autema (see Note 3.1.2).

Exchange rate effect

As regards the changes caused by the exchange rate effect, the appreciation of the euro against most of the currencies in which the Group companies operate (with the exception of the Polish zloty) had a negative impact of EUR 79 million on goodwill, including most notably the change in this item in the Services Division, where the goodwill decreased by EUR 59 million, due mainly to Amey (EUR -34 million) and Broadspectrum (EUR -24 million). In the Construction Division, the main change due to the exchange rate effect arose at Webber (EUR -18 million).

3.1.2. Goodwill impairment tests

A. Services Division goodwill:

Methodology and discount rate

The goodwill of Amey (UK), Ferrovial Services Spain, Broadspectrum and Steel (Chile), amounting to EUR 843 million, EUR 442 million, EUR 358 million and EUR 28 million, respectively, at 31 December 2017 (31 December 2016: EUR 877 million, EUR 435 million, EUR 382 million and EUR 29 million in the case of Amey, Ferrovial Services Spain, Broadspectrum and Steel, respectively), is tested for impairment by using cash flow projections for a five-year period, except in the case of Broadspectrum, for which a ten-year period was used, since this coincides with the projection period used to value the company at the time of its acquisition and is consistent with the model used to value the contracts and the contractual relationship for the purposes of valuing the intangible asset in the acquisition process. The residual value is based on the cash flow for the last year projected, provided this represents a cash flow with no exceptional factors, and the growth rate applied in no case exceeds the estimated long-term growth rate for the market in which each company operates.

Cash flows are discounted using a rate based on the weighted average cost of capital (WACC) for assets of this nature. In order to value companies, Ferrovial uses a risk-free rate usually taking as a reference a ten-year sovereign bond based on the location of the company in question and a market premium of 6.0% (in line with 2016), based on studies of historical long-term and current market premiums demanded (mainly Dimson, Marsh & Staunton, Damodaran, etc.). As regards the risk-free interest rate, it should be noted that the Company considers that the current rate for sovereign bonds in some countries may be artificially low. For the impairment tests the risk-free interest rate used is a normalised rate of 2.0% for the UK (Amey) and 2.5% for Spain (Ferrovial Services Spain), which entails an upward adjustment with respect to the rate for sovereign bonds at 31 December 2017 of 79 basis points in the UK and 94 basis points in Spain. The risk-free interest rate used at Broadspectrum is 3.0% (26 basis points above the ten-year Australian sovereign bond) and the risk-free interest rate used in Chile is 4.4% (the same as the rate for the Chilean ten-year sovereign bond). Additionally, in order to reflect each company’s exposure, portfolios of comparable companies were selected to obtain unlevered betas. The betas obtained were compared with other sources habitually used by analysts and investment banks (Barra Beta, Bloomberg, etc.).

The discount rates (WACC) after tax used to perform the impairment test are presented in the following table:

The approximate discount rates (WACC) before tax in 2017 were as follows:

Main factors that affect the valuation and performance compared with 2016 and budget

The projected flows are based on the latest estimates approved by the Company, which take into account recent historical data. The main factors that affect the cash flow projections of the Services Division are revenue forecasts and the projected revenue margins. These projections are based on four basic components:

• The existing backlog, which offers certainty of a high percentage of revenue in the coming years. In 2017 the backlog was reduced across the board; the hardest hit area was Amey, with a fall of -13.6%, followed by Spain and Broadspectrum with falls of -8.4% and -8.2% respectively.
• Winning new contracts, which is calculated by applying a success rate (based on historical company data and market prospects) to the estimate of the contracts for which bids will be submitted in the coming years.
• The estimate of future margins, which are based on the company’s historical margins adjusted by certain factors that might affect the markets in the future.
• Amey, which had an EBITDA margin of 3.5% in 2017 (compared to 1.5% in 2016), has maintained its strategy for monitoring competitive tendering processes, focusing on operating improvements by withdrawing from contracts with low profitability and implementing the restructuring plan that commenced in 2016, with the aim of recovering historic profitability. The short-term revenue projections used in the 2017 impairment test of Amey were adjusted downwards in comparison to 2016, due to the outlook for 2018, which is marked by Brexit and a competitive environment affected by the precarious situation of its main operators. Current sales volume will not foreseeably be recovered until 2021. The projections envisage EBIT margin remaining stable in the short term and a gradual improvement in the long term up to levels close to 6%, margins that are lower than they were in the years before 2014.
• Ferrovial Services Spain’s performance in 2017 was in line with the budget, with an EBITDA margin slightly lower than that of 2016 (10.4% compared to 10.7%). The projections envisage a continuation of the improvement in the EBITDA margin of recent years up to levels close to 12%, which is lower than the margins obtained in the years prior to 2013.
• Broadspectrum’s performance in 2017 exceeded the budget in both revenue (+15%) and EBITDA margin (5.5% compared to 3.6% in the budget). In the future the company expects to gradually recover from the withdrawal from the immigration contracts.
• Steel’s sales and EBITDA margin were below expectations in 2017. Accordingly, the projections were adjusted downwards.
• The perpetuity growth rate (“g”), which is based on the prospects of the markets and industries in which the Company operates. The rates used are: 2% at Amey, 1.75% at Ferrovial Services Spain, 2.4% at Broadspectrum and 2.5% at Steel. These perpetuity growth rates are in line with the long-term inflation estimates in the UK, Spain, Australia and Chile, respectively. These perpetuity growth rates are in line with the long-term consensus estimates of inflation in the UK, Spain, Australia and Chile, respectively (sources used: IMF, Bloomberg, Economist Intelligence Unit, European Central Bank, etc.).

Impairment test results

The value of Amey resulting from application of this impairment test model is 225% higher than its carrying amount (2016: 231%). In the case of Ferrovial Services Spain, the buffer is 66% (2016: 49%). The value of Broadspectrum is 78% higher than its carrying amount.

The value of Steel resulting from application of this impairment test model is 6% higher than its carrying amount (2016: 146%). The reduction in the size of the buffer is due mainly to a downward adjustment of the projections owing to the fact that operating margins were lower than expected in 2017.

The residual value after the projection period represents approximately 83% of the total value at Amey, 71% at Ferrovial Services Spain, 81% at Steel and 62% at Broadspectrum.

Sensitivity analysis

Sensitivity analyses are performed on this goodwill, mainly in relation to the EBITDA margin, the perpetuity growth rate and the discount rate, so as to ensure that possible changes in the estimate do not affect the recovery of the goodwill recognised.

The main sensitivity factor in these impairment tests is the EBITDA margin. Accordingly, the carrying amount would equal the valuation disclosed if the EBITDA margin projected on the residual value were reduced by 314 basis points at Amey, 382 basis points at Ferrovial Services Spain and 179 basis points at Broadspectrum, thereby leaving the assumption of perpetuity growth (“g”) at 1%.

Another relevant sensitivity factor is the perpetuity growth included in the residual value. In this regard, Amey, Ferrovial Services Spain and Broadspectrum, in a scenario in which the projected margins remain the same and assuming a zero-perpetuity growth rate, there would be no impairment.

Lastly, a pessimistic scenario combining the two factors was taken into consideration, with a perpetuity growth rate of 1% and a reduction in the EBITDA margin included in the residual value of 100 basis points compared to the base case. The valuation disclosed in this scenario evidences a buffer over the carrying amount of 123% in the case of Amey, 40% in the case of Ferrovial Services Spain, and 23% in the case of Broadspectrum.

The valuation of Steel disclosed a smaller buffer and, accordingly, a small variance in the projections could give rise to impairment.

B. Construction Division goodwill (Webber and Budimex):

Methodology and discount rate

The goodwill of Webber (US) and Budimex (Poland) amounted to EUR 127 million and EUR 70 million, respectively, at 31 December 2017 (31 December 2016: EUR 143 million and EUR 67 million, respectively).

The impairment test methodology used for Webber was similar to that described above for the Services companies and included a discount rate (WACC) after tax of 8.9% (compared to 8.7% in 2016) and a perpetuity growth rate of 2.0% (same rate as in 2016). The risk-free interest rate used to calculate the WACC was 2.4%, the same as the rate of the ten-year US bond at 31 December 2017.

The approximate discount rate (WACC) before tax was 10.6% in 2017 (compared to 12.1% in 2016). It is important to bear in mind the reduction in the federal tax rate in the US from 35% to 21% approved in December.

In the case of Budimex, since it is listed on the Warsaw Stock Exchange, the goodwill was tested for impairment by ascertaining whether the closing market price at 31 December 2017 of Budimex shares was higher than its carrying amount plus the allocated goodwill. The test did not evidence the existence of any impairment.

Main factors that affect the valuation and performance compared with 2016 and budget

The projected free cash flows are based on the latest estimates approved by the Company, which take into account recent historical data. The main factors that affect the cash flow projections of Webber are revenue forecasts and the projected operating margins. These projections are based on four basic components, similar to those described in the preceding section on Services (the existing backlog, the obtainment of new contracts, the estimate of future margins and the perpetuity growth rate). It should be noted that the projected operating margins are lower than the historical margins of recent years, in line with average margins in the industry. The perpetuity growth rate used was 2%, which is similar to long-term inflation forecasts for the US without considering actual economic growth.

Impairment test results

The value of Webber resulting from application of this impairment test model is 59% higher than its carrying amount (compared to 23% in 2016).

The residual value of Webber represents 40% of the total value after the explicit projection period.

The quoted market price of the Budimex share at 31 December 2017 was 491% higher than its carrying amount (compared to 321% in 2016).

Sensitivity analysis

A sensitivity analysis was performed on Webber’s goodwill, particularly in relation to the profit from operations, the discount rate and the perpetuity growth rate, so as to ensure that possible changes in the estimate do not have an impact on the possible recovery of the goodwill recognised.

Specifically, a pessimistic scenario was taken into consideration with a perpetuity growth rate of 1% and a reduction in the profit from operations of 50 basis points. The value disclosed in this scenario evidences a buffer of 40% over the carrying amount.

On this basis, the valuation disclosed would equal the carrying amount if the reduction in the margin with respect to the projection was of 265 basis points, thereby leaving the assumption of perpetuity growth (“g”) at 1%.

Lastly, it should be stated that in a scenario in which the margins remain the same but assuming a zero perpetuity-growth rate (compared to 2.0%), there would be no impairment.

At Budimex, due to the significant buffer of the quoted market price over the carrying amount, the company believes that there is no evidence of impairment.

C. Toll Road Division goodwill:

Methodology and discount rate

The goodwill of the Toll Road business at 31 December 2017 amounted to EUR 141 million (31 December 2016: EUR 170 million). This goodwill arose on the merger transaction performed in 2009 by Ferrovial, S.A. and Cintra, S.A., and corresponds to the acquisition of the percentage of ownership of the non-controlling shareholders of Cintra. The goodwill arising on the difference between the acquisition price of the ownership interest and the carrying amount thereof was allocated by calculating the difference between the fair value of the main shareholdings in concession operators held by Cintra, S.A. at that time and the carrying amount thereof, adjusted by the percentage acquired.

The recoverable amount of the toll roads was calculated as the higher of fair value less estimated costs to sell and value in use. The recoverable amount of concession operators with an independent financial structure and limited duration was calculated by discounting the cash flows expected to be received by shareholders until the end of the concession term. The Group considers that value in use must be obtained using models that cover the entire concession term, as the assets are in different phases of investment and growth and there is sufficient visibility to use a specific economic and financial plan for each phase during the concession term. Therefore, no residual value is considered to exist in these valuations. The projections were updated based on the historical evolution and specific features of each asset, using long-term modelling tools to estimate traffic, extraordinary maintenance, etc.

To calculate the discount rates shown in the table below, the cost of equity was estimated using the CAPM model. For this purpose, a normalised risk-free rate usually referenced to a 30-year bond, taking into account the location of each concession operator, a beta coefficient reflecting the company’s leverage and risk, and a market premium of 6.0% (the same as in 2016) are used. The table below shows the discount rate after tax used for each asset in 2017 and 2016.

The approximate discount rates (WACC) before tax in 2017 were 12.3% at Autema (2016: 12.7%) and 12.0% at Ausol (2016: 12.6%).

Main factors that affect the valuation and performance compared with 2016 and budget

The main factor affecting cash flow projections of the toll roads are the revenue projections, which differ depending on whether the operator bears the demand risk (in which case the intangible asset model is used) or whether the grantor bears the demand risk and makes payments for capacity availability (in which case the financial asset model is used).

If the operator bears the demand risk, its revenue depends on traffic volumes and toll prices, which are generally updated with inflation. Of the two toll roads with goodwill, the intangible asset model is applied at Ausol, while the financial asset model is used at Autema, since the demand risk is assumed by the Catalonia Autonomous Community Government.

Traffic projections are prepared using long-term modelling tools that use data from public (or external) sources to estimate traffic in the corridor (which depends mainly on the growth in the population and car ownership) and the level of toll road capture.

Valuation projections and models begin with the budget for the following year approved by management. Any variances in traffic volumes in the year under way are taken into consideration when the initial budget and the long-term projections are reviewed. In 2017 Ausol’s revenue grew by 8.5% compared with 2016 and 2.2% compared with the budget.

In the case of Autema, a project classified as a financial asset, the uncertainties relate to counterparty credit risk and possible penalties arising from the service.

Impairment test results

In the case of Ausol, the valuation evidences a buffer of 334% over carrying amount (compared with 250% in 2016).

In 2017 Autema recognised impairment of goodwill amounting to EUR 29 million. The economic and financial model used for the impairment test is based on a scenario in which the lawsuit against the Autonomous Community Government of Catalonia is won and the Economic and Financial Plan of the concession approved by the Autonomous Community Government of Catalonia in Decree 137/1999, of 18 May, is applied. This model envisages a delay in the collection of the collection flows from the Autonomous Community Government of Catalonia until the resolution of the lawsuit, and this is the reason for the aforementioned impairment.

Sensitivity analysis

In the case of Ausol, a more pessimistic scenario was built, taking into consideration a revenue 10% below budget. The value disclosed in this scenario evidences a buffer of 220% over the carrying amount.