Spin-off of HEC (Hongkong Electric Company): Power Assets Holdings (PAH) plans to spin off 50.1–70% of its subsidiary HEC in 4Q13, with an IPO by the end of 2013.
Financial Impact: The spin-off is expected to raise HKD45–65bn in cash and book a disposal gain of HKD30–50bn, which could be used for overseas M&A.
Valuation Change: The spin-off could increase PAH's fair value by approximately 6–12%, with a yield of 6.0–7.0%.
Rating Change: The report downgrades PAH from Outperform (2) to Hold (3), with a revised target price of HKD63 from HKD75.
Investor Recommendation: Investors are advised to switch to CKI (Cheung Kong Infrastructure), unless CKI announces plans to privatise PAH.
Main Points
Immediate Benefits of the Spin-off
Value Unlocking: The spin-off is expected to unlock value from the Hong Kong power business.
Cash Generation: PAH will raise significant cash, potentially HKD45–65bn, and record a disposal gain of HKD30–50bn.
Enhanced Financial Flexibility: The cash will support future M&A opportunities.
Long-Term Concerns
Unclear Remit: After the spin-off, PAH may lack a clear business identity, as it will remain focused on overseas energy assets, which are similar to those of its parent CKI.
Competition with CKI: The similarity in business assets could lead to more competition between PAH and CKI in the overseas M&A space.
Risk of Idle Cash: If PAH fails to use the cash for meaningful M&A, it could result in a loss of value.
Key Risks
PAH's Future: Uncertainty about PAH's role post-spin-off.
M&A Performance: Whether PAH can effectively use the cash for strategic acquisitions.
Interest Rates and SOC Return: If interest rates rise or SOC return is revised downward, HEC's valuation could be affected.
Financial Highlights
Revenue and Profit Forecasts (HKDm)
Year to 31 Dec
2013E
2014E
2015E
Revenue
10,553
10,677
10,803
Net Profit
10,535
10,747
10,953
Core EPS (FD)
4.936
5.036
5.132
Valuation Metrics
Metric
2013E
2014E
2015E
PER (x)
13.1
12.8
12.6
Dividend Yield (%)
4.6
4.7
4.8
PBR (x)
2.0
1.9
1.8
EV/EBITDA (x)
12.3
11.2
10.3
ROE (%)
16.1
15.4
14.8
Earnings Revisions
The Bloomberg consensus has revised up 2013 and 2014 EPS forecasts by 4% and 2%, respectively.
The deferred UK tax gain and operating efficiency improvements at UK Power Networks are expected to drive further revisions.
What We Like About the Deal
Unlocking Value: Spin-off of HEC could enhance the fair value of PAH by 6–12%.
Financial Flexibility: Raising cash for future M&A.
Disposal Gain: Recognition of a one-time gain of HKD30–50bn.
Risk Management: Preparing for potential reductions in SOC returns in 2018.
Spin-off Deal Structure and Timetable
Spin-off Structure: HEC will be listed as a business trust named HK Electric Investments, with PAH as the trustee-manager.
Timetable:
Oct-13: Shareholder circular issued.
Nov-13: Extraordinary General Meeting (EGM) to seek approval.
Dec-13: Completion of the global offering of HK Electric Investments.
Shareholder Approval: High likelihood of approval, as CKI (PAH's parent) owns 38.89% of PAH and is expected to support the deal.
Key Assumptions and Calculations
HEC's Valuation: Based on a yield range of 6.0–7.0%, HEC's fair value is expected to be HKD80–69bn.
PAH's Value Post-Spin-off: PAH's value is projected to increase by 9–12% (HKD14–15bn), resulting in a fair value of HKD156–154bn.
HEC's EV/EBITDA: Estimated at 11.0x to 9.4x.
Key Ratios
Metric
2013E
2014E
2015E
Net profit margin
99.8%
100.7%
101.4%
ROE
16.1%
15.4%
14.8%
Free cash flow yield
3.7%
3.1%
2.9%
Company Profile
PAH Overview: A utilities conglomerate with a 38.89% stake in HEC.
Overseas Assets: Includes power-generation, power-distribution, and gas-distribution businesses in the UK, Australia, Mainland China, New Zealand, the Netherlands, Canada, and Thailand.
HEC's Role: HEC is one of the two integrated power utilities in Hong Kong, with 3.7GW of installed capacity under a SOC agreement with the Hong Kong Government.
Conclusion
The spin-off of HEC is seen as an opportunity for PAH to unlock value and improve its financial flexibility.
However, the lack of a clear remit and potential overlap with CKI's business profile raise concerns about its long-term prospects.
The report recommends investors switch to CKI unless there are further developments indicating a privatization plan for PAH.
