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 release) Keppel 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.

K-Green Trust: Keppel Corp pulls a fast one past the Research Analysts

A couple of research analysts have released their research notes on keppel corp's K-Green Trust. Keppel recently released the listing documents for the KGT, which you can find here. It is interesting to note that both the research reports I have found so far are bullish on the KGT, and both suggest significant upside to the listing valuation.

My personal take on the KGT is that it is a structured finance vehicle (not unlike a CDO) meant to house junk project assets that Keppel does not want to have on its balance sheet. By hiving off the 3 project assets (Senoko & Tuas Waste-to-energy plants, Ulu Pandan NEWater plant) into a business trust, Keppel can obfuscate the substance of the assets and divest it to the fools in the market who haven't got a clue what they are buying into.

And, judging by the comments of the research analysts, it appears they have been comprehensively fooled. They have completely missed the substance of what is going on here and are acting as cheerleaders to what in my opinion is fundamental destruction of shareholder value by the Keppel Corp management.

I am very interested to see what more analysts think of the KGT and if any of them will actually call Keppel out on what is actually going on here. But judging by what happened with structured finance vehicles in the USA in the years past, I doubt any of the analysts have the brains to figure it out. And even if they do, none of them will have the guts to call Keppel out on its bullshit.

Update: I have elaborated significantly on my thoughts of the KGT here.

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Lim & Tan Securities

Based on projected distribution of 3.91 cents for 6 months and 2 days in 2010, and 7.82 cents for ye Dec ’11, the yield at $1.13 would be 6.82% (annualized) and 6.95% respectively. As a comparison, City Spring offers a trading yield of 7% at 60 cents (DPU of 4.2 cents). Note however two key differences between the two:

• KGT is Singapore-centric whereas 50% of City Spring is accounted for by Basslink in Australia;
• KGT is debt free vs City Spring’s high gearing, which has implications for KGT’s growth strategy going forward.

We believe KGT is attractive. KGT’s listing is expected at end June, and results from the distribution-in-specie by Keppel Corp on the basis of 1 KGT unit for every 5 Kep C shares, valued at 22.6 cents per Kep C share.

Kim Eng Securities

The listing price for Keppel Corp’s Keppel Green Trust (KGT) has been set at $1.13 per unit. Keppel projects a DPU of 3.91 cts for the remainder of FY10and 7.82 cts for FY11. This generates a yield of 6.82% in FY10 (annualised) and 6.95% in FY11. We see fair value of KGT at $1.53, with the implied yield of 5% derived from a highly stable cash flow.

Morning Bulletin 27 January 2010
Top Ideas

23-ct dividend in specie from KGT distribution
Shareholders will receive one K-Green Trust (KGT) unit for every 5 shares as a dividend in
specie. 50.5% of the trust will be distributed to shareholders. The effective value per unit is
therefore S$1.16. Financial details such as expected DPU, earnings and yield will be
forthcoming over the next few weeks, with a listing by 2Q10. We expect the terms to be
attractive, and to provide long-term, regular and predictable distributions to its unitholders. We
also estimate that KGT’s listing could see up to 40% upside from its base NTA valuation of
S$750m.