Concerns that the winning consortium has overpaid for NSW electricity company Transgrid has prompted wariness about how the partners will generate returns on their investment and in particular the dividend outlook for the sole locally listed participant, Spark Infrastructure.
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In a note to clients, Citi Research warned that the winning consortium has bid a "very high price" especially given the emergence of disruptive technologies which may put future returns at risk.
As a result, it has slapped a 'sell' recommendation on Spark shares, as the company seeks to raise funds from investors to part-finance its portion of the consortium.
There were four bidders for Transgrid with the successful consortium composed of Canadian pension fund Caisse de depot et placement du Quebec (CDCQ) with 24.99 per cent, Hastings (20.02 per cent), the Abu Dhabi Investment Authority (19.99 per cent), Kuwait Investment Authority (19.99 per cent) with the remaining 15.01 per cent held by Spark Infrastructure, which is listed on the ASX.
Spark's experience in running networks in Victoria and South Australia - Powercor, CitiPower and SA Networks, it has a 49 per cent stake in each - is central to the consortium's bid.
The winning bid of $10.25 billion includes stamp duty of $438 million. An additional $134 million of costs were incurred in the bid.
Transgrid also owns some strategic non-regulated businesses, that is, operations which are not subject to government scrutiny over the spending and pricing plans. While small at present, the new owners are expected to ramp up this side of the business as aggressively as they can as they seek to generate a return on their large investment.
High asset multiple
Stripping out the stamp duty and the non-regulated businesses, indicates the winning consortium paid around 1.55 times the regulated asset base for Transgrid. Its regulated asset base is $6.4 billion.
For Spark, this is much higher than the multiple of 1.36 times its shares trade at, relative to its own regulated asset base, Citi said. It is also higher than the price paid by CKI for Envestra, the South Australian utility of 1.4-1.5 times.
"We find it hard to be positive around long-term value given the high price paid," Citi warned its clients.
"We previously rated Spark Infrastructure as 'neutral' based on the risk of overpaying for NSW assets," Citi said, and the resulting limit to dividend per share growth in spite of significant distributable cashflow coverage.
"We now cut our target price by 5 per cent to reflect a higher risk business from materially higher gearing."
Spark is raising $405 million from investors via a 5-for-34 rights issue priced at $1.88, a discount to the last traded share price of $2.06.
Costs need to come down
Transgrid, as the operator of the high voltage transmission network, which links power stations to electricity distributors such as Ausgrid and Endeavour Energy, which are also being privatised, is exposed to the downturn in power demand that has emerged over the past five years.
To justify the high price paid, the winning consortium will need to take costs out of Transgrid quickly, analysts said.
This may be comparatively easy since unlike its private sector counterparts in other states, Transgrid's spending appears to have been subject to less financial rigour. Offsetting this, under the terms of the sale transaction, labour shedding restrictions are in place until 2020.
The Australian Energy Regulator has squeezed Transgrid's planned spending between 2015-18 although given the fall in interest rates has been generous in the interest rate assumptions, allowing borrowing costs of more than 6.6 per cent.
That generosity prompted criticism on Thursday.
"The new owners have obviously worked out that they will realise returns on their equity investment well above the regulator's theoretical returns," consumer advocate Hugh Grant said.
"They will achieve this due to a combination of the regulator providing very generous cost of capital allowances (WACCs), and incorrectly applying those excessive WACCs to an artificially inflated asset base."