melua update

A happy and safe 2009 to all on this fine forum. I’ve dealt with my brother who was not supposed to post anything beyond the initial BBI/BEPPA value post. Not impressed and apologies to anyone that he offended under my username. I have no interest in what anonymous internet users believe or don’t believe. The trip was wonderful. I arrived home on Friday and glad to be back in the warm weather. I am more interested in giving some updated thoughts on BBI/BEPPA so here we go.

There are really two methods to assign fair value to a utility stock like BBI. I have looked at “NAV” using Sum of Parts valuation (see previous threads in November/December) and FCF (free cash flow) and either method confirms BBI is seriously undervalued.

Net Asset Valuation (NAV) is approximately $1.30 based on an average EBITDA multiple for their assets of 11. This is supported by recent asset sales, namely Powerco and Euroports.

The net asset value as per BBI’s balance sheet takes into account depreciated historical cost of assets built or historical prices paid upon acquisition of assets. This valuation “may” be inaccurate because of the current market conditions with credit still pretty well frozen. Credit in Europe is still frozen. Banks are hoarding cash and not lending. The consumers are also not wanting to borrow. The situation is bleak. If this continues into 2010/11, BBI “could” be in trouble when it comes to refinancing at the asset level even though their free cash flow covers interest comfortably. If BBI have trouble refinancing in 2010/11 with their quality infrastructure assets, then indeed the world will be in an ugly state.
Moody’s has reduced its credit rating on BBI’s corporate debt to B2, five notches below investment grade. Such a low credit rating makes it difficult to refinance debt via the capital markets (as it shrinks the pool of potential lenders) and also increases the cost of debt markedly. It also raises a potential issue of reducing the credit ratings at the asset level. I expect operating cash flow priority will be given to debt repayment over repayment of the hybrids in order to restore the credit rating. Therefore, any dividend will be welcome in the next two years but not expected. A small dividend in 2010/11 is not out of the question if corporate debt is paid down to minimal levels. Let’s see the interim results on Feb 25 first. Then we will know more.

I continue to believe that the BEPPA at a price close to parity with BBI is a tremendous value entry point into BBI if you desire exposure to the BBI story. BBI at less than 5c was a steal and mentioned numerous times in November, however, BEPPA sit senior to ordinary BBI units in a wind-up scenario (not for one moment do I think that is happening but you never know what the financial world will be like in 12 months time) and in dividend payment priority. Its dividend yield is very high at current market prices around 13c in the dollar, paying BBSW +115 basis points on a face value of $1 and although the dividends are currently not being paid they are not lost but are instead deferred and COMPOUNDED, and the BEPPA price should converge on the payout value ($1.04+) as 2012 approaches on the assumption that BBI remains financially viable. BEPPA really seem compelling value at such a small premium to BBI. If you buy them treat them like gold.

Moving onto the SPARCS which dargie rightly refers to as an issue although I do not see it as a huge problem.

Pg 19 of the October investor pack shows the SPARCS liability. The full value is NZ$115.952M, and the notes to the balance sheet shows that half of this is considered a current liability consistent with the conversion timing.

It is a tough call on how BBI will handle the SPARCS maturing but they do have options. The options available to BBI are as follows:

1. Refinance with senior debt (as did DUET, ASX code: DUE), although this would be difficult / expensive / unlikely given the current credit rating,
2. Encourage SPARCS holders to remain with better terms (ie. far higher margin) on SPARCS,
3. Use operating cash flow or asset sale proceeds to meet redemption or
4. Convert into BBI units

Clearly, the last option would not be palatable to BBI security holders because of the dilutionary impact on BBI. I cannot see Directors choosing this option. I see Option 3 as most likely. If you can buy SPARCS they are cheap but liquidity is terrible. They trade on the NZ exchange but it’s impossible to buy volume and nearly impossible to buy any. Ditto for the NZ listed bonds.

Regarding asset sales, the company are doing exactly what they said they would at the AGM. They have made part sales of assets (Powerco and Euroports), both above book value. A sale of 100% of DBCT at an EBITDA multiple of 11 or above would give them enough surplus cash to extinguish corporate debt and also provide cash to deal with SPARCS. See Page 16 of the October Investor Pack. There are ZERO corporate debt commitments beyond 2012/13.

On to free cash flow which is probably a more accurate reflection of BBI’s position rather than NAV since the market remains unconvinced that BBI’s assets have not been impaired. I disagree with the market but I have to accept the market’s current reluctance to value BBI at what I do. They are the facts. The market will not value BBI according to NAV. I’d be happy with half NAV or even half FCF.
From the Investor Pack and taking into account the sale of Powerco and Euroports, I have ascertained that the following free cash flows per annum apply:

Powerco $10M
IEG: $33M
CSC: $3M
NGPL: $50M
AETD: $36M
DBCT: $115M
PD Ports: $45M
Euroports: $27M
Westnet Rail: $41M
Cap ex maintenance: -$60M

Total free cash flows of 300M. Therefore free cash flow per BBI security equals 12.5c. A conservative cash flow multiple of 6 gives a valuation for BBI stapled securities of 75c.
These figures are derived from the 2007/08 results and subsequent asset sales but a clearer picture will emerge when we see the half yearly accounts on February 25.

The average of 6 was taken using the following utility companies trading on the ASX:
SPN, DUE, SKI, APA, CIF, ENV and VIR.

BBI is currently trading on a P/FCF ratio of 1 which in comparison to other utilities, is a discount of 84%. Do the risks with BBI warrant an 84% discount?

NAV values BBI at $1.30
FCF values BBI at 75c.
Market values BBI at 12c.

Who is right? Time will tell but I’ll stick with somewhere between the factual fundamentals analysis of NAV ($1.30) and FCF (75c) rather than an inefficient, terrified, panic driven market price of 12c. The market was very wrong at 2.5c and it is still very wrong at 12c, in my opinion. I’m extremely comfortable with the massive “average down” by buying BBI in volume below 4c and I am happy for those on this forum that also accepted the panic sellers’ generosity in November. Despite my earlier purchases at higher prices, I am in the black with an average entry price of 7.5c. I have subsequently sold a few and bought BEPPA when the price of BEPPA was below, at parity or only slightly above BBI. I still have many more BBI than BEPPA but as opportunities present themselves, I’ll keep buying BEPPA and funding those purchases by selling BBI. BEPPA holders are owed a tick over 3c in distributions already. As each quarter passes by, those accumulated payments keep compounding and consequently the price of BEPPA will eventually put a decent gap over BBI. There may then be opportunities to switch back into BBI. I recall selling some BEPPA at around 11c and buying BBI at under 4c. That was a fantastic arb and whilst I don’t think you will see a 3/1 ratio again, there may still be opportunities to arb BBI/BEPPA in the next twelve months.

I also believe we will see the Australian Govt and local major banks join forces to ensure that local companies who are not in breach of debt covenants are able to successfully roll over their debts when they fall due. We will hear more on that in the next few months as the situation in Europe worsens. I did meet with some friends in Vienna who are in the banking system in Austria and after spending a few hours with them over lunch, I came to the conclusion that the situation with the European banks is indeed much more serious than I had previously thought. Dargie has been spot on about the banks/frozen credit and it does pose a potential problem when BBI try and refinance at the asset level but BBI has time on its side for now. What happens over the 12 months is unknown. That’s another reason to own BEPPA in addition to BBI.