We are re-rating Mosenergo shares from Hold to Sell as the current price per share has considerably exceeded the target range and due to the release of official data on the fair value of the holding’s stocks, by an independent appraiser.
The major factors underpinning our negative recommendation for Mosenergo shares are as follows:
- the target price for the company’s shares has been considerably exceeded;
- negative results of the independent appraisal of the fair value for Mosenergo shares for the equity buyback from the shareholders as announced by the energy holding’s top management. The results of the independent appraisal reduce the ability of Mosenergo BoD to buyback the company’s equity above market price. Earlier we considered such a scenario as quite feasible.
- agreements with the Moscow government about additional stock issues of the network companies formed on the basis of Mosenergo’s assets, which impairs the value of these assets.
At the same time, we are upgrading the target price for the company’s shares from $0.061 with a year-end-2003 outlook to $0.069 with a year-end-2004 outlook.
Change of recommendation
We retained our Hold recommendation on Mosenergo shares even though the market value of the company exceeded the target price for quite a long time.
The reason for this was associated, primarily, with expectations that management would buyback a 10% equity stake on the market before the company held an AGM devoted to the restructuring issue.
We assume the offer is fuelled by a major strategic investor striving to accumulate a large stake within a short term with minimum impact on the market price. We believe that Gazprom, which holds a 16% interest in Mosenergo, could be a prospective investor.
In this case it would make sense to set the buyback price per share slightly higher than the current market price to enable Mosenergo to buyback a significant stake on the market.
Ernst&Young was appointed independent appraiser to estimate the fair value of Mosenergo shares so that the company’s BoD could determine the buyback price per share.
According to Mosenergo’s press release, Ernst&Young submitted an official letter and valuation report to the company. The fair value of Mosenergo’s shares was found to be $0.06.
Nevertheless, the Mosenergo management considered the results to be undervalued. Then Arkady Yevstafiev, Mosenergo CEO, went public and announced that $0.07 per share was an acceptable price. The share price is likely to rise, since it is Mosenergo’s BoD which has the final say in setting the buyback price. Otherwise, we believe the buyback option makes no sense. The current market price is higher than the buyback price. Moreover, the management has repeatedly stated its intention to buyback a significant stake.
In view of such independent appraisal results, we are less and less upbeat about arbitrage opportunities for this offer. We believe the risks associated with the share buyback at a price higher than the market price, outweigh the possible gains which a shareholder could score from the buyback.
High risk exposure, combined with the fact that the company’s shares are now fundamentally overvalued, has prompted us to downgrade our recommendation assigned to the Mosenergo shares from Hold to Sell.
Valuation
We estimate the fair value of the company’s shares by a separate valuation of Mosenergo’s business areas, as discussed at length in our seminal equity research report entitled “From Monopoly To Monopoly”.
We split businesses of energy companies into regulated and unregulated in terms of state regulatory authorities’ ability to intervene in the company’s activity.
We assume that, despite the formation of a free electric power market, the electricity production business will be regulated for hydroelectric power plants (GES) as far as using excess GES profits from electric power sales is concerned.
Electric power transmission and distribution activities along with thermal energy production and transmission are also attributed to the regulated business.
We attribute electric power generation activities at thermal power plants (state district power plants (GRES) and cogeneration plants) to the unregulated business of energy companies.
“The regulated segment” consists of all the company’s regulated business areas, while “the unregulated segment” entails all its unregulated business components.
The results of our previous valuation of Mosenergo shares value with year-end-2003 outlook are given in the table below. For details, see the report entitled “From Monopoly to Monopoly” dated September 3, 2003.
Market cap valuation
| | mln $ | % |
| Unregulated segment |
| Electric power production at cogeneration plants |
872 |
45 |
| Regulated segment |
| Electric power transmission and distribution |
325 |
17 |
| Thermal production and transmission |
652 |
33 |
| Electric power production at GES |
107 |
5 |
| Total |
1,956 |
100 |
| Company’s net debt |
235 |
|
| Total fair market cap |
1,721 |
|
| Target price per share, $ |
0.061 |
|
UES BoD approved the strategy of Mosenergo restructuring at the beginning of 2004. In line with this strategy, the company will be broken up into 14 companies with the same equity structure. Then the Moscow and the Moscow region government will exercise an option to increase their equity stake in network companies up to the controlling interest.
But before additional equity issues are made in favor of Moscow government and the Moscow region, Mosenergo and UES shareholders will be entitled to swap their network company shares in Moscow government shares and Moscow region shares into other newly established company shares. In our opinion, this minimizes risks of value losses for these shareholders.
Mosenergo’s AGM is likely to be held in June, with the company restructuring issue on top of the agenda.
Thus, we can observe a considerable decline in risks over the company’s restructuring compared to the period of the previous target price valuation for Mosenergo shares (September 2003).
We can also note a fair amount of headway in overall industry restructuring since September 2003, such as establishing the rules for and launching the free electricity market, signing orders on the formation of inter-regional network companies (IRNC) and inter-regional distributing companies (IRDC), drafting TGC structure for the government and its discussion with the minority shareholders of UES and regional energos, as well as greater clarity on WGC auctions.
In line with our method of valuation for company shares, while changing the time horizon for target price (from year-end-2003 to year-end-2004) we re-rate the fair value of Mosenergo’s shares by assigning a discount ratio (13%).
| Previous target price per Mosenergo share, $ | Discount ratio, % | New (current) target price per Mosenergo share, $ |
| 0.061 |
13 |
0.069 |
Recommendation history
Dmitry Skryabin
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Sector: Power Utilities, Heat Generation
Company: Mosenergo
All Research Notes >>
0.168
1.32
