APA Group: In pursuit of electrification

About the author:

Nathan Lead
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.   

Event

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.  

Strategy

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).   

Analysis

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.   

Price catalysts

Greater clarity on sources of value and free cashflow per share accretion arising from proposed AST acquisition.

Risks

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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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

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