Octopus VCT 3 plc : Final Results

Octopus VCT 3 plc                          

Final Results

30 November 2016

Octopus VCT 3 plc, managed by Octopus Investments Limited, today announces its final results for the year ended 31 August 2016.

Financial Summary

Key Dates

Annual General Meeting                                          25 January 2017 at 4.00 p.m.

Dividend Payment Date                                         10 February 2017

Half Yearly Results to 28 February 2017               Announced May 2017

Chairman's Statement

Introduction
I am pleased to present the Annual Report of Octopus VCT 3 plc (the Company) for the year ended 31 August 2016.

Performance
During the period the Total NAV Return (current NAV plus cumulative dividends paid to date) of the Company has decreased from 95.7 pence per share at 31 August 2015 to 95.1 pence per share at 31 August 2016.

As a reminder, the NAV (Net Asset Value) excluding dividends is designed to fall to zero over the life of the Company as the annual dividend is paid out and the value of the solar companies gradually reduces over their 25 year operating lives.  Consequently the underlying NAV has decreased from 85.7p per share at 31 August 2015 to 80.1p per share at 31 August 2016.

On a day to day basis, our investments continue to perform in line with expectations. The technical issues experienced at two of the sites are being resolved and revenue is growing back to expected levels. The cost of fixing these sites has been greater than originally budgeted but outperformance from other sites in the portfolio over the summer period has comfortably offset the loss of output at these two sites.

Both the valuation of the Company's investments and its capacity to pay dividends in the longer term are derived from the forecast revenue flows, based on estimates of power prices over the remaining life of the assets.  Since the launch of the Company prices and longer term power price forecasts have fallen and if prices remain at current levels it will not be possible to maintain the payment of a 5p annual dividend.

It should be noted that the smaller than anticipated amount of funds raised for the Company in 2011/2012 and the resulting reduction in economies of scale leaves less margin for protection of the dividend than would otherwise have been the case in spite of close attention to costs by the Manager and your Board.

Dividend Policy and Dividend
The current cash balance held by the Company is sufficient to cover the next dividend of 5p, whilst maintaining a prudent reserve for operating purposes. Therefore, in line with the dividend policy stated in the Prospectus, your Board has proposed a final dividend of 5.0p per share in respect of the year ended 31 August 2016. This dividend, if approved by shareholders at the AGM, will be paid on 10 February 2017 to shareholders on the register on 13 January 2017.

Investment Portfolio

The Company is fully invested in seven companies, each containing an operational solar site. These sites have a range of capacities between 1-2MWp and benefit from either the Feed In Tariff (FIT) or Renewables Obligation Certificates (ROCs), which form part of their revenue stream alongside the electricity they sell on the wholesale market.

There are no plans to make any further investments. The Company has also made two non-qualifying loans to the solar companies from which it earns interest. Due to changes to legislation, no new non-qualifying loans will made in the future.

Key Portfolio Operational Risks
The Company owns a portfolio of fully operational assets, therefore, the number of risks faced is reduced as all core construction phases are effectively complete. Three sites have passed and signed off their final acceptance certificates (full two year performance testing), largely releasing the EPC of their contractual obligations to the site. The other four sites are currently undergoing their final acceptance certificates process. The key risks on the ongoing operations are:

• Power Prices- Revenues are derived from two sources; first, the Government backed subsidies such as the FIT or ROCs and secondly; from selling the wholesale electricity produced by the solar sites. The wholesale electricity revenues, which represent over 40% of the total revenues are variable and will be subject to market forces. The Investment Team uses industry recognised forecasts to predict the electricity prices for the life of the sites. It also mitigates price fluctuations in the short term via forward selling the electricity via Power Purchase Agreements (PPAs) to reduce income volatility. However, it should be noted that long term power price forecasts can rise and fall, and therefore can have an impact on the value or NAV of the underlying solar sites.
• Site Technical Issues- all sites are potentially vulnerable to unforeseen technical issues and, to the extent possible, all equipment is warranted to industry standard levels and the companies have insurance that, in the event of a fault lasting more than 5 days, can be called to claim for revenue losses. Furthermore, once the site has completed its construction contract, operation and maintenance contracts are put in place that incentivise availability and performance levels.
• Weather- all forecasts are based on an assumed level of sunlight each year, however it should be noted that not all years will have an equal amount. Less sunlight reduces revenues received but a prudent approach is taken in forecasting revenue to reduce the likelihood of occurring shortfall against budget.
• Site Market Value - there are a number of drivers in the value of a solar site. Underlying assumptions are continually revised for macroeconomic changes (e.g. inflation expectations), industry specific drivers (e.g. business rates, embedded benefits), in addition to the track record of specific site performance.

VCT Qualifying Status

PricewaterhouseCoopers LLP provides the Board and Investment Manager with advice concerning ongoing compliance with HMRC rules and regulations concerning VCTs.  The Board has been advised that the Company is compliant with the conditions laid down by HMRC for maintaining approval as a VCT. 

A key requirement is to maintain at least a 70% qualifying investment level. As at 31 August 2016, 88.6% of the portfolio, as measured by HMRC rules, was invested in VCT qualifying investments. The Board is confident that the 70% target will be maintained on an ongoing basis.

Annual General Meeting

The Directors look forward to meeting as many shareholders as possible at our Annual General Meeting on 25 January 2017, to be held at the offices of Octopus Investments Limited, 33 Holborn, London, EC1N 2HT. The AGM will start at 4.00 p.m.

Outlook
Over the preceding six month period there has been a slight recovery in oil and gas prices in the short term, partially due to the depreciation of Sterling, resulting in higher UK price expectations of international coal and gas supplies. However, world oil and gas prices remain depressed and the negative impact of low energy prices has affected the power generation industry as a whole. The decline in electricity prices has reduced revenue generation and the value of electricity generators.

We expect UK power prices to remain depressed in the wake of the current over-supply and demand slump for global energy. This has impacted forecast revenue generation and overall asset value, and hence the Company's ability to deliver a NAV plus cumulative dividends paid of 110p per share at the 5 year point. As a reminder, the 110p comprises the sum of four annual dividends of 5p each and a targeted NAV of the solar assets of 90p at the 5 year point (i.e. 5p x 4 + 90p = 110p).

As it stands today, and as highlighted in the half yearly report ended 29 February 2016, achieving a 90p NAV at the 5 year point is most unlikely and would require energy price forecasts to increase materially in the short term. Other key reasons that should be noted as to why the target is unlikely to be met include the drastic FIT reductions implemented by the Government in late 2011 (the Fund Manager reduced fees in an attempt to offset the reduction), as well as the impact of relatively higher running costs as a result of the lower than anticipated funds raised at the outset.

The recent well publicised announcements by the Government in respect of ending the various subsidy regimes for large scale solar PV in the UK may have a positive effect on the value of the existing portfolio of assets given that there is now a limited supply of 'green' energy to meet increasing demand. As noted in the half yearly report, the valuations of the assets has been updated to reflect this positive uplift, with the two ROC sites having their discount rate lowered in line with the market.

Finally, the Board is mindful that investors will pass through their five year VCT qualifying period over the course of Spring and Summer 2017. Whilst the fund was established as a VCT with a 25 year limited life, the Board is aware that some investors may wish to realise their investment earlier, once outside their five year VCT holding period. Due to the sub-optimal size of the portfolio, the Company's ability to satisfy any such requests risks having a significant detrimental effect on the value for remaining shareholders. The Board is therefore considering options to provide an equitable liquidity solution for all, once all shareholders have passed through their five year VCT qualifying holding period. This may include an orderly wind up of the VCT through the sale of its assets and the return of capital to shareholders. 

The conclusions of these deliberations will be communicated at the earliest opportunity and shareholders will be invited to vote on the Board's recommendations as appropriate. In the meantime, in order to protect the interests of all shareholders, the Board has decided to suspend the share buyback facility in the intervening period. All shareholders will have passed through their five year holding period in September 2017 by which point I expect to be in a position to make recommendations for the future of the VCT and the provision of liquidity to shareholders. An update will be provided in the interim report. 

Gregor Michie
Chairman
30 November 2016

Investment Manager's Review
Personal Service
At Octopus we have a dual focus, on managing your investments and keeping you informed throughout the investment process.  We are committed to providing our investors with regular and open communication. Our updates are designed to keep you informed about the progress of your investment.

Octopus Investments Limited was established in 2000 and has a strong commitment to both smaller companies and to VCTs.  Octopus also acts as Investment Manager to seven other VCTs and currently has over £6 billion of funds under management.  Octopus has around 500 employees

Portfolio Review

The Company has invested in a portfolio of seven individual solar companies, each of which owns and operates a solar site in the 1-2MWp range. The first five sites have all been accredited for the FIT and have just passed their fourth full year of operation since commissioning. The remaining two sites were accredited under ROCs and are at their three and a half year point of operations.

During this period, the Board approved to engage Quintas Energy as the new asset manager. Octopus will continue to be the investment manager and work closely with Quintas Energy to monitor the overall operations of the solar companies. Overall, this has had a positive financial impact to the valuation. The investment manager believes that the companies will receive a better service and enable Octopus to drive asset optimisation projects for the sites.

Over the previous period three sites, Debes which owns a FIT site, Delambre and Huygens which own the two ROC sites, had experienced technical issues during the financial year. For all three sites, they experienced technical difficulties during the period. For the Huygens site, the issue was rectified before the summer months, as a result, the site was able to generate electricity 5% above budget during the last six months. However, when considering the overall performance for the whole financial year, the site produced 21% less electricity compared to budget. The other two sites were affected to a much less extent in revenue loss. At Debes, the site was operating around 89% of capacity and Delambre at 91%. The lower than anticipated performance has had a negative impact to the valuation of these companies. The investment team continues to closely monitor the issues and working with the new asset manager to ensure all issues are resolved.

Other than the abovementioned issues the portfolio of seven sites has overall been performing in line with expectations since the start of operations due to good PPA terms.

Company Performance
Between 31 August 2015 and 31 August 2016, the NAV has decreased, as would be expected. This is primarily due to the payment of the 5p dividend in January 2016. The table below shows the movements between the two periods:

It should be noted that the fixed running costs of the Company have been proportionately higher due to the smaller than anticipated fundraise into the VCTs in 2011/2012. However, we continue to review costs in order to keep these at a minimum and ensure the potential NAV is optimised.

Company Outlook

The Board is mindful that investors will pass through their five year VCT qualifying period over the course of Spring and Summer 2017. Whilst the fund was established as a VCT with a 25 year limited life, the Board is aware that some investors may wish to realise their investment earlier, once outside their five year VCT holding period. Due to the sub-optimal size of the portfolio, the Company's ability to satisfy any such requests risks having a significant detrimental effect on the value for remaining shareholders. As such, the Board is currently considering options to provide an equitable liquidity solution for all, once all shareholders have passed through their five year VCT qualifying holding period. This may include an orderly wind up of the VCT through the sale of its assets and the return of capital to shareholders. 

For the assets, the key risk is the impact of long term power prices which have dropped during the past year, despite slightly recovering because of the depreciation of the Sterling. Unfortunately, there is little that can be done in the immediate term, apart from negotiating better purchasing power agreements for electricity generated. The team have explored the possibility of extending the asset life beyond the current 25 years. However, this option would not have significant positive impact to the NAV. The team continue to investigate ways in which we can optimise or enhance the existing portfolio to create more value through technical improvements.

As previously mentioned, the Government has effectively ended subsidies for new solar PV projects in the UK. This has the potential to increase the value of existing assets in the portfolio given there will now be a finite amount available in the market, and investors have become increasingly interested in such asset classes due to their relatively predictable income and established technology. During the period we have monitored the market closely and have adjusted the discount rates for the two ROC sites according to market trends, which has had a positive impact to the valuations.

We continue to monitor the renewables sector on a regular basis and the discount rates used to value the solar sites within the Company's portfolio are in line with market practice seen at present.  Any changes to discount rates used by market participants in the future may cause us to change the discount rates we use to determine fair value of the investments.

If you have any questions on any aspect of your investment, please call one of the team on 0800 316 2295.

Matt Setchell
Octopus Investments Limited
30 November 2016

Investment Portfolio

All solar companies within the portfolio saw changes in valuations due a number of factors including, cash distributions made up to the VCTs, updates to the long term energy forecasts, both site under and over performance, changes in rates and tax assumptions. These are reflected in the above movements for the period.

Valuation Overview
Due to the nature of assets owned by the portfolio companies being UK based solar sites with 25 year revenue streams, they are considered to be limited life assets. Consequently, they are expected to gradually decrease in value to zero over their productive life. This is because the Government backed revenue streams only extend to 25 years (for FIT projects), and the planning permission, lease length and design life of equipment are also based on the same timeframe. As the number of years of revenue production reduces, the value of the assets is expected to decline. In addition, after each dividend is paid out you should expect to see the NAV decrease accordingly at the following valuation by an equivalent amount.

However, it should be noted that, in addition to the expected decline over time, the NAV may fluctuate slightly year-on-year. This is because the valuation is also based on the expected future revenues from selling the electricity generated by the sites, which is impacted by factors such as the level of sunlight in any particular year.

Valuation Methodology
Until payment of the first dividend in early 2014, each company had been valued at cost. In February 2014, the first valuations were performed using a non-cost approach and also taking into account dividends paid out by each company up to that point. This methodology has continued to be used for the valuations in this period.

Future estimates of fair value are based on the Investment Manager's assessment of market value, which is based on a Net Present Value (NPV) approach. This NPV is calculated by estimating the rate of return an incoming investor may require, and using this rate to discount the value of future cash flows into present value terms.  

Any cash and accrued revenues owed to the company, less any debt or loan interest owed by the company at the time of valuation, is then added to this NPV to provide a final valuation of the equity in the company.

Investment Portfolio
Adala Solar Limited
Adala Solar constructed a 1.2MWp solar site near Congresbury in Somerset in July 2012. The site has been fully operational for over 4 years and is receiving revenues from the FIT, as well as the sale of the electricity it produces on the wholesale market.

Akycha Power Limited
Akycha Power constructed a 1.0MWp solar site near Newport on the Isle of Wight in July 2012. The site has been fully operational for over 4 years and is receiving revenues from the FIT, as well as the sale of the electricity it produces on the wholesale market.

Daubree Energy Limited
Daubree Energy constructed a 1.2MWp solar site near Cullompton in Devon in July 2012. The site has been fully operational for over 4 years and is receiving revenues from the FIT, as well as the sale of the electricity it produces on the wholesale market.

Debes Energy Limited
Debes Energy constructed a 1.2MWp solar site near Tiverton in Devon in July 2012. The site has been fully operational for over 4 years and is receiving revenues from the FIT, as well as the sale of the electricity it produces on the wholesale market.

Delambre Energy Limited
Delambre Energy constructed a 1.9MWp solar site near Ivybridge in Devon in March 2013. The site has been fully operational for around three and half years and is receiving revenues from the sale of the ROCs, as well as the sale of the electricity it produces on the wholesale market. However, due to some poorly installed cables during construction, and the subsequent insolvency of the EPC, this company has taken on an additional liability for rectification works.

Huygens Energy Limited
Huygens Energy constructed a 1.8MWp solar site near Cullompton in Devon in March 2013. The site has been fully operational for around three and half years and is receiving revenues from the sale of the ROCs, as well as the sale of the electricity it produces on the wholesale market. Rectification works were completed over the winter of 2015 and it returned to being fully operational in the summer of 2016.

Lacaille Energy Limited
Lacaille Energy constructed a 1.1MWp solar site near Crediton in Devon in July 2012. The site has been fully operational for over 2 years and is receiving revenues from the FIT, as well as the sale of the electricity it produces on the wholesale market.

Income Statement

• The 'Total' column of this statement is the profit or loss account of the Company; the supplementary revenue return and capital return columns have been prepared under guidance published by the Association of Investment Companies
• All revenue and capital items in the above statement derive from continuing operations
• The Company has only one class of business and derives its income from investments made in shares and securities and from bank and money market funds

The Company has no recognised gains or losses other than the results for the period as set out above. Accordingly a Statement of Comprehensive Income is not required.

*Held at fair value through profit or loss (FVTPL)

The statements were approved by the Directors and authorised for issue on 30 November 2016 and are signed on their behalf by:

Gregor Michie
Chairman
Company No: 07744056