APA Group: In pursuit of electrification
About the author:
- Author name:
- By Nathan Lead
- Job title:
- Senior Analyst
- Date posted:
- 15 October 2021, 9:30 AM
- Sectors Covered:
- Infrastructure, Utilities
- Downgrade from ADD to HOLD, after considering APA’s takeover proposal for AST.
- At this stage, we struggle to see value accretion from the takeover and related funding structure.
- 12 month target price set at (login to view) during takeover period.
We await progress on APA Group’s (ASX:APA) takeover proposal for AusNet Services (ASX:AST), with the next step being the Takeovers Panel’s ruling re: APA’s access to due diligence.
AST owns regulated energy networks in Victoria (85% of FY21 EBITDA from electricity transmission & distribution). AST’s key shareholders are Singapore Power (32.1%) and State Grid Corp. of China (19.9%).
Over the last five years, AST has invested >$4bn of capital (hence 4.6% pa CAGR of the RCAB across FY16-21) but delivered minor earnings and cashflow growth (regulated revenue resets impacted by low interest rate environment).
APA’s offer for AST
APA is offering $1.82/sh cash plus 0.0878 APA shares for each AST share, which implies $2.58/sh at the current APA price. Brookfield’s bid is $2.50/sh all-cash. Conditions of APA’s bid include due diligence access, completion of a four week due diligence period (vs 8 weeks for Brookfield), and ACCC approval.
The proposed bid aligns with APA’s investment strategy that now includes electrification. It is being pitched on the basis of creating an Australian flagship energy infrastructure business, pursuit of decarbonisation opportunities nationally, and free CF per share accretion (which we struggle to see strong justification).
APA expects to fund the cash component ($6.97bn+costs) with a mixture of existing cash, debt, and an equity raising of c.$1.5bn. It continues to target BBB/Baa2 credit ratings, which we believe currently requires a min. 9% FFO: debt.
The acquisition will decrease APA’s exposure to gas infrastructure (mostly unregulated) and increase its weighting to regulated electricity networks that typically deliver lower returns than APA’s existing activities but at arguably lower risk (exc. regulatory resets). Upon acquisition of AST we estimate that regulated revenue will increase from 8% to 41% of APA’s revenues (FY21PF basis).
APA’s offer values AST’s equity at c.$9.9bn (1.57x EV/RCAB). Our revised standalone valuation of AST’s equity is c.$7.7bn (1.32 EV/RCAB), close to the pre-bid market cap prior to Brookfield’s bid being announced. Given this value difference and the acquisition funding structure, there is a c.$3.2bn NPV gap to be bridged in order for the bid to have zero impact on our per share APA valuation.
We have not yet identified sources that are significant enough to bridge the above value gap. It could be that APA has insights into AST that generates a standalone value for AST above what the listed market gave it credit for. Cost synergies might be greater than we’ve assumed ($25m/yr is 2% of merged cost base).
There may be more funding capacity (removal of AST’s A-/A3 credit rating constraint on debt and 10% cap on annual capital raised) than we’ve estimated. Debt costs might be better (but both firms stagger debt maturities over time, AST’s c.$6.3bn senior debt will be repriced 25 bps higher due to rating cut, and we think APA will need to redeem AST’s c.$1.7bn hybrids).
Tax shields (interest and depreciation) may be higher than expected, albeit both firms were likely to see lower tax in the short term.
Forecast and valuation update
Our forecasts remain on an ex-AST takeover basis. EBITDA downgraded across FY22-24F to reflect a slower assumed NGI ramp-up. Tax payment timing adjusted.
Standalone valuation lifts 5cps to (login to view), due to forecast changes.
Greater clarity on sources of value and free cashflow per share accretion arising from proposed AST acquisition.
Investors apply a greater risk premium to APA to risk for overpaying for assets in order to pivot its asset portfolio away from its concentration on gas infrastructure.
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