ngpl

http://www.theage.com.au/business/poor-arithmetic-to-hurt-prime-infrastructure-20100131-n6kf.html

Poor arithmetic to hurt Prime Infrastructure
DAVID SYMONS
February 1, 2010


A NOVEMBER equity raising of $1.8 billion has not reversed negative market sentiment towards Prime Infrastructure, the recently rebadged Babcock & Brown Infrastructure.

While most of the debt-laden basket cases of 2009 bounced hard after completing recapitalisations, Prime closed on Friday at $3.72, down 27 per cent on the recapitalisation share price of $5.08.

Two pieces of bad news have contributed to the security price falls. A disputed stamp duty assessment could set the group back $46 million, while the December announcement of a regulatory review of Prime's highest value investment, Natural Gas Pipelines of America (NGPL), has shaken analyst valuations.

The review by the Federal Energy Regulatory Commission (FERC) will assess whether the returns generated by NGPL are ''unjust and unreasonable''.

The FERC alleges that NGPL generates returns of around 24 per cent, double the 12 per cent allowable following a 1996 rate case.

While the FERC review is in its early stages, its impact could be substantial. After reviewing FERC's initial filings, UBS downgraded its valuation of NGPL by 38 per cent, or 69 cents per Prime security, leading to a price target for Prime of $3.90.

However, one free thinking fund manager believes that the outcomes of the review may not significantly affect NGPL. In an analysis titled ''When regulators can't do math: gas pipeline edition'', Bronte Capital fund manager and blogger John Hempton argues that ''the FERC stuffed up.

It simply got the math wrong because it does not understand rates of return and depreciation - a staggering oversight for a body charged with regulating pipelines.

''Worse - on the math presented - the rates on the NGPL should be increased in order to allow for the FERC mandated 12 per cent return.''

At the heart of Hempton's complex mathematical analysis lies a simple principle, that pipeline returns can only be assessed over the life of the asset and not at a snapshot in time. It is inevitable that if annual profits are constant over the life of the project, but are compared with the written-down book value of a pipeline late in its life, the returns will appear high despite meeting benchmarks only over the longer term.

Prime has not commented on the legitimacy of Hempton's thesis, but with NGPL's own cost and revenue analysis set to be made public later this week, investors would do well to keep a close eye on company filings as a worst-case result looks to be priced in to Prime securities.