Monday, June 14, 2010

Keppel Corp's K-Green Trust: Things for Investors to Note

I previously made a brief post on the K-Green Trust, and this post has received a lot of hits since its publication. In this post, I will elaborate on some pointers for Keppel Corp investors to consider when they are thinking about the Infrastructure division of Keppel Corp and the K-Green Trust.
  1. Why Dividend-in-Specie and not IPO? When Keppel was announced as the winner of the NEA's tender to acquire the Senoko Incineration Plant (SIP), it was stated clearly in the Sep 2008 press release that the listing of the KGT was meant to be as an IPO. Later on, when the financial crisis hit, the IPO was shelved due to adverse market conditions. Since then the markets have returned to relative normalcy, however, instead of going ahead with the planned IPO, Keppel suddenly changed the listing structure to a dividend-in-specie and not an IPO. Why did Keppel not go ahead with the IPO? Wouldn't it have made sense to monetise the trust in the equity capital markets so that Keppel Corp would have cash, especially if the market valuation was going to be a higher one than the price Keppel originally paid for the assets? 
  2. What is the value of the Senoko Incineration Plant? The bulk of the value of the trust is in the value of the SIP. The value of the SIP as listed on Keppel's balance sheet is the purchase price that Keppel paid to NEA. "The purchase price of SIP was mutually agreed within the indicative price of S$462 million between KIE and the Singapore Government on a willing-buyer, willing-seller basis." (source: Keppel press releaseKeppel is also investing a further $48 million to upgrade the SIP, bring the net cost of the SIP to Keppel to $510million. This $510 million is for a 15 year PPP contract, meaning that at the end of the contract, subtrust will have ZERO residual value. In contrast, the government originally built by the government for $560 million in 1992 (17 years ago), expecting it to last about 30 years. (source: NEA) Does it make sense for an asset expected to last 30 years and costing $560m, to be worth $462m +$48m after 17yrs of depreciation?  Investors need to ask themselves whether the price that Keppel paid for the project assets is a fair price for the assets. If not, how to determine the value of the assets? 
  3. Independent valuation of the Trust. There is an independent valuation report in the prospectus for the KGT dividend-in-specie (see Appendix F of intro doc). They state that their valuation of the trust is in the range of $674-731 million on an aggregate basis i.e. they do not break down into the valuation of each of the sub-trusts, and that is all they say. They do not state their methodology of valuation (DCF, multiples, book etc.). They do not state the details of their methodology (if DCF, what is discount rate?) They do not break down the valuation into each of the 3 assets. Why? why? why?
  4. Is Yield the correct method for valuation? So far the analyst research reports (all bullish) state their valuation method as depending on the trust yield. Is this the correct method for valuing the underlying projects?
    • Finite life projects with zero terminal value The sub-trusts contain projects which have a finite lifespan with ZERO TERMINAL VALUE. Once the contracts expire, UNIT HOLDERS WILL BE LEFT WITH NOTHING. Is yield the correct method to value such assets? Yield was originally used as a concept to value stable blue chip companies with steady dividends that were expected to be around a long time. In contrast, the KGT has projects that last only 15,20 and 25 year with zero terminal value. Yield valuation was not meant for these kind of projects!
    • Mismatched Life of Assets The biggest project of the 3 is the Senoko plant which has a contract lifespan of only 15 years. The NEWater plant is contracted for 20, while the Tuas DBOO plant is contract for 25 years. That means that there will be a significant decline in the cash flows from the KGT in year 16 and year 21. And ultimately to zero after the Tuas project expires. Isn't the yield concept supposed to describe steady, consistent cashflows that do not diminish to zero???
  5. Capital structure of the Subtrusts The KGT prospectus doc describes the capital structure as "KGT will not have any debt as at the Listing Date which will provide it with an optimal debt financing capacity for future investment opportunities." Is zero debt = optimal capital structure??? LOL. Infrastructure projects backed by PPP contracts are usually leveraged to a significant level, up to 80%. Banks are willing to take this leverage levels because the counter-party to the contracts is the triple A rated Singapore government. So why is Keppel funding the KGT projects with 100% equity which usually has a required rate of return of 15%, when banks are willing to fund the AAA rated projects with term loans  that typically have a cost of debt of 5% max? Is the KGT's zero gearing structure really optimal? And if it isn't, who is getting the short end of the stick???
I could go on and on, but I think readers will get the point. I will not state my conclusions but I think the above questions are plentiful enough for readers to hunt for clues and come to their own conclusions.


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a.nus said...

Very true, same thing crossed my mind. Sold my tiny holding liao.

Even if k-green wants to loan money from bank, how much would the bank be willing to give sia!

catsick said...

Excellent post, to me it seems that when looking at any Singapore yield type investments one must first unravel what you are actually buying, looking at most riets the headline div is far from the real story as the investor is also bearing the cost of lease runoff, fees issued in units so as not to impact the div and convertible debt done to cheapen the financing through the owners of the asset selling options on their equity, In looking at bank research on riets one never sees analysis into the true adjusted yield which is the first thing the investor should want to know, which tells me they are really pandering to the entity for fees rather than "researching"

Peng said...

I was considering buying K-Green at 1.07 now, but after reading your post (which is exceptionally good), I gave up the idea mainly due to the fact the asset will be zero value of the contract terminates in 15-21 years.

Assuming KGreen goes for 15 years at 8cents per year for divident, the total dividend collected will be 1.2, and unit trusts is zero value. Hence, the initiate value of 1.13 is very close to the dividend any inventor is going to receive. What a joke!

Thanks a lot for this great analysis!

Deception said...

Initially NEA wanted to sell away the Tuas South Incineration Plant, however their asking price was too high as it was the youngest among the four at that time. NEA was so happy when this company agreed of S$462 million to acquire their 17 year old rotten plant. Why another $48 million to upgrade SIP? Maybe its Electrostatic Precipitators were not able to keep the emission within the safety requirement? Do you think NEA would be slapping their own face with warning letter as a government agency? Well the much delayed Bag Filter project start to cast the concrete base this year, commission date has yet to be confirm.

KGT has 3 plant assets, 2 of them are losing money and only one had profited in last year report card. Then overall of the 3, KGT managed to squeeze the payout for their investor. If government had employed 3 personnel to operate and maintain one equipment, then KGT would be using one person to operate and maintain 3 equipments. Make a guess either the machine or the human will break down first? The government agencies had history in manage their plant and maybe Keppel trying to buy a shortcut or to prove cost saving? KGT make money when its assets burn waste and treat used water. Wonder if the Trust would hire a fisherman for a operator job or ask a farmer to do welding work?

Ulu Pandan NEWater plant had a death case of their staff in the plant in 2009 and is still pending MOM investigation.

The new incineration plant builded by Keppel in Tuas South was having efficient problem and will be going for modification later. Belgium Seghers sold Keppel an outdated design and the construction of the plant was way over their budget. Basically most of the materials and equipments came from China, some of it were second hand parts, some of them unable to use and became scrap or left in the warehouse.

Keppel approach NEA to appeal they wish to be the one to build and operate the sixth incineration plant, do you think the government would let a company monopoly their market?