• Acquires 50% stake in UK solar power assets

• Cheap entry into UK renewable market

• Debt restructuring could drive near-term turnaround of assets

• Re-affirm BUY at unchanged DCF-derived target price of RM16.80/share. 4% yield is attractive

Acquiring UK solar assets. Tenaga announced it is purchasing a 50% stake in Vortex Solar for GBP86m (RM474m). Vortex Solar in turn, through a wholly owned vehicle, will acquire Terraform Power’s (Terraform) UK portfolio of 24 operating solar farms (operating asset) entailing 365MW net capacity. The other 50% of Vortex Solar is owned by the renewable energy private equity arm of EFG Hermes (a large Egypt investment bank). The acquisition is expected to be completed by 3Q17. Terraform is a unit of SunEdison, which filed for Chapter 11 early 2016. The operating asset sale was via competitive bidding and EFG Hermes was one of the front runners for it. Terraform still has a remaining 11MW of solar capacity in the UK after the transaction, which it also intends to sell to reduce debt. The operating assets have useful lives of 30 years, entail average age of 2 years and are backed by 15 year PPAs.

Earnings accretive. According to Terraform’s site, the transaction is valued at an EV USD580m comprising the equity consideration of GBP172m (USD212m) and ~USD368m of net debt sitting at the operating assets. According to Terraform, the transaction of USD580m is based on 16x FY16F EV/EBITDA, implying an EBITDA of USD35m-36m. However, the operating assets are generating small net losses of ~USD5m given high interest cost.

Cheap entry. While the acquisition’s valuation of 16x EV/EBITDA is at a premium to Tenaga’s own valuation of 7x EV/EBITDA; on a per MW basis, the consideration of USD1.6m/MW is much lower versus industry cost of around USD2.5m/MW for a new solar project, which implies an attractive entry for Tenaga. Other than outright accretion of earnings and returns, indirectly, Tenaga gains: (1) Improved access to the UK renewable market for future RE market expansion (2) Platform to acquire knowledge and experience in RE technology. Our back of the envelope calculations (pending further financial details) suggest that the new asset will enhance our valuation of Tenaga by an estimated 9sen/share to ~RM16.90/share, or a marginal 0.5% (this is a considerably small transaction relative to Tenaga’s RM79b market cap).

Taking advantage of cheap borrowing cost. A measure to turn around the operating asset’s bottomline among others, is to restructure the operating asset’s debt given very low cost of debt now vs. the 4.3% cost of debt the operating asset is currently incurring. Our ballpark estimates suggests at a 2% borrowing cost (based on the UK 30yr bond yield), the operating asset can halve its annual finance cost from USD16m to around USD7m and bottomline in turn, can swing into a profit of ~USD3m. Tenaga is likely to equity account for the operating asset’s earnings and unlikely to consolidate its net debt.

Looking for new capacity abroad. In the larger scheme of things, Tenaga is targeting to derive 5GW of net capacity from overseas operations by 2025 from the current 2GW net capacity from India and Turkey. Of the 5GW target, 250MW is targeted to comprise of RE capacity which Tenaga has met with the acquisition of the UK assets (comprising a net 182MW based on Tenaga’s 50% stake), with the remaining overseas RE capacity of 70MW coming from Tenaga’s recent acquisition of GAMA Enerji in Turkey and GMR Energy in India. As a comparison, Tenaga currently has ~13GW capacity in Malaysia.

Tenaga is targeting overseas investments to account for 20% of earnings by 2025 and for EBIT to grow at 10% annually from RM8b in FY15 to RM20b by FY25. Currently, contributions from overseas operations are negligible. While these are long-term targets, the moves underpin our view of the need for Tenaga to expand abroad for: (1) Better growth potential given plateauing growth in Malaysia at just 2%-3% per annum (2) Better returns from overseas generation projects – mostly in the teens at least, versus single-digit returns in Malaysia. Most importantly, Tenaga’s balance sheet is underutilised (at 0.3x net gearing, one of the most under-geared utilities in the region) and it is timely to reinvest into new growth opportunities.

Recommendation. We re-affirm our BUY call on Tenaga at unchanged DCF-based TP to 16.80/share for now with potential upside bias from this acquisition. We like Tenaga for: (1) Dividend catalyst on the back of FCF yield of ~7% over FY17F/18F, a relatively under-geared balance sheet at 0.35x and the upcoming capital optimisation exercise (2) Overseas expansion provides scope for stronger growth in the mid-term (3) Strong earnings visibility post-ICPT implementation. Capital management, M&As and the resolution of its RM2b tax issue with the Inland Revenue Board are key catalysts over the next 12 months.

Source: MIDF Research - 9 Jan 2017