Research Notes

Mosenergo: Still Powering Ahead

Before Mosenergo's unbundling in April 2005 its power plants generated 8% of electric power produced nationwide, while MSNG stocks were among the liquid names on the Russian stock market. Interest in the utility company's shares was maintained by strategic investors' rising interest in Moscow-based generating entities and the Moscow government's aspiration to manage Mosenergo's grid assets. The energy concern was literally torn apart and utility concerns in Moscow and the Moscow region have long been a bone of contention for the various shareholder groups.

After the Moscow energy system's unbundling by business operations in April 2005, Mosenergo's shareholders obtained stocks in another 13 utility entities spun off from the Moscow energy system, while shares of Mosenergo itself continued trading on exchanges under the previous brand. But this time the company included only part of Mosenergo assets before its reorganization – generating assets of 17 power plants which will be used for the formation of TGC-3.

At present, given strategic investors' continuing interest in MSNG stocks and excessive attention paid by speculative traders to this stock we expect to see market participants become more interested in the shares of entities established on the basis of Mosenergo and provide our valuation of the fair price for these shares.

Calculation of capitalization	MICEX ticker	Estimated share price, $	Upside, %	Recommendation
Moscow City Power Grid Company	MosESK	0.01536	22%	Buy
Zagorskaya GAES	ZagorGAES	0.01096	1%	Hold
Mosenergo (generating company)	+MosEnergo	0.08030	-46%	Sell
GRES-24	GRES-24	0.00299	-60%	Sell
GRES-4		0.01048		-
GRES-5		0.00717		-
Moscow Regional Power Grid Company		0.02323		-
Trunk Grid Company		0.00187		-
Moscow Thermal Grid Company		0.00731		-
Mosenergosbyt		0.00022		-
Management Energy Company		0.00000		-
Specialized Design Bureau		0.00000		-
Mosteplosetenergoremont		0.00038		-
Mosenergosetstroy		0.00003		-
Total:		0.1603

Taking into account the fact that only four Moscow-based energy concerns hold moderate liquidity, we assign recommendations only to these stocks. Once the liquidity of other Moscow power entities increases, interesting investment opportunities could arise and we advise investors to focus on the share prices which we provide in this research report.

The largest energy system – before and after …

Before unbundling in April 2005 the Moscow energy system was one of the biggest energy enterprises in the Russian Federation, with installed capacity of electric power generation equaling roughly 14,800 MW and heat generation capacity of about 35,000 Gcal. The company was mainly involved in four lines of business:

• Electric power generation and generating facilities;
• Electric power transmission;
• Heat transmission;
• Marketing of heat and electric power.

In accordance with the principles and concept for power industry reform, on April 1, 2005 Mosenergo was broken up into 14 concerns. The company was reorganized in order to divide monopoly and competitive business activities by setting up independent energy entities – generating, power grid, thermal grid, marketing, repair and servicing units.

Thus, after the unbundling the Moscow utility company's brand was retained by the generating assets of 17 power plants with a total installed capacity of 10,700 megawatts, based on which TGC-3, the country's largest regional generating company, will be formed.

Of the 13 entities unbundled from Mosenergo four are generating entities, three are distribution concerns, three are repair units, one is a marketing enterprise and one is a trunk grid entity. Furthermore, a management company was established to act as the sole executive body of the entities unbundled from Mosenergo. We provide a detailed description of the unbundled concerns in Appendix 1.

Table 1. The companies unbundled from Mosenergo in utility industry reform

#	Company	Type of company	Strategic interest
1	Moscow Regional Power Grid Company	Distribution networks	Government of the Moscow region
2	Moscow City Power Grid Company	Distribution networks	Moscow government
3	Moscow Thermal Grid Company	Heat networks	Moscow government
4	Trunk Grid Company	Trunk networks	FGC
5	Mosenergosbyt	Marketing unit	Gazprom
6	Management Energy Company	Management company	Moscow government
7	GRES-4	Generating company	Shareholders of WGC-1
8	GRES-5	Generating company	Shareholders of WGC-5
9	GRES-24	Generating company	Shareholders of WGC-6
10	Zagorskaya GAES	Generating company	Shareholders of Hydro WGC
11	Specialized Design Bureau for Repair and Overhaul	Repair unit	-
12	Mosteplosetenergoremont	Repair unit	Moscow government
13	Mosenergosetstroy		FGC, Moscow government

In line with baseline reorganization principles, after the company's unbundling every shareholder of Mosenergo obtained the same amount of shares in all detached entities and remained the owner of the same amount of MSNG common stocks after the unbundling of concerns as before.

Mosenergo retained ownership and operatorship of the Moscow energy system's core assets which are used for electric power and heat generation, and also holds 47% of the company's aggregate assets before unbundling (estimated at book value). Mosenergo generating company's assets include 17 thermal power plants, or about 10,600 megawatts of electric power capacity and around 34,150 Gcal/h of heat capacity.

Chart 1. The share of assets of each unbundled entity in Mosenergo's total assets

After unbundling Mosenergo generating company still remains the largest among energy entities in the corporate structure of UES in terms of installed capacity of its power plants. At present, it is the only company out of 14 entities, formed on the basis of the former Mosenergo, whose shares trade on the organized securities market.

Securities of Moscow energy entities

Before unbundling Mosenergo was one of the most overpriced concerns in the domestic power industry. Directly prior to the breakup, the company's market cap was $3.16 bln in April 2005 and was 20% higher than our fair price for MSNG shares.

Chart 2. The market of MSNG shares from January-November 2005

Before unbundling stock valuations of Mosenergo generating company, which continued trading under the same ticker of Mosenergo before the breakup, slightly dropped. Nonetheless, Moscow-based generating entities were still overpriced by the market and by the time this research report was completed their stock valuations were nearly the same as those of the unified Mosenergo in terms of capitalization.

As regards 13 companies broken up from Mosenergo, the record date was that when the companies spun off from the Moscow utility company passed state registration, i.e. April 1, 2005. On this day the registrar transferred shares of newly established companies to accounts of Mosenergo shareholders.

At the same time, all newly formed entities submitted documents to the Federal Securities Service to register their securities issues. Only after the financial market watchdog assigned state registration codes to the share issues of the companies broken up from Mosenergo, were the shareholders of these 13 businesses able to execute transactions with these securities.

Thus, at the end of May the Federal Securities Service registered the securities issues of 6 entities unbundled from the Moscow utility company and in early June 7 securities issues of the other companies, established as part of Mosenergo's restructuring, were registered with the Federal Securities Service. As a result, by the time of this research report was completed the shares of all 13 energy enterprises had been listed on Russia's OTC market.

In order to obtain listings for stocks of newly formed companies it is necessary for them to register their issue prospectuses with the regulatory authority. After registration the companies can apply for authorization to float their shares on Russian exchanges, which takes two or three weeks. Directly before Mosenergo's unbundling, its executives assumed that listings for shares of the entities, broken up from Mosenergo as part of its restructuring, would be obtained in September-October 2005.

However, as of early January only 10 out of 13 companies unbundled from Mosenergo had registered their issue prospectuses:

• Moscow City Power Grid Company,
• Moscow Thermal Grid Company,
• Moscow Regional Power Grid Company,
• Mosteplosetenergoremont,
• Zagorskaya GAES,
• GRES-24,
• Mosenergosbyt,
• Specialized Design Bureau for Repair and Overhaul,
• Kashirskaya GRES-4,
• Shaturskaya GRES-5.

Shares of three companies are listed both on MICEX and RTS:

• Moscow Thermal Grid Company
• Zagorskaya GAES
• GRES-24

Shares in Moscow City Power Grid Company are traded only on MICEX and shares in Kashirskaya GRES-4 and Shaturskaya GRES-5 are listed on RTS.

In our opinion, it is economically unviable for all the companies spun off from Mosenergo to prepare their prospectuses. For instance, repair and sales companies possess rather modest assets and it is inefficient for them to incur losses related to prospectus registration, such as expenses for financial consultants. Moreover, companies unbundled from regional energos will be assigned to larger business structures in the future.

However, the advantages for the shareholders of these companies are obvious, since it gives them the chance to continue operations with securities which are illiquid at present. It's noteworthy that in the event that these securities are listed on the organized market, we can expect trading only in shares in generating and grid companies. We would also like to note that sales and maintenance companies have no benchmarks for valuation and most likely the buyer will set the prices.

Moscow generating assets

After registering their share issues, GRES-4, GRES-5, GRES-24 and Zagorskaya GAES shares circulate on the OTC market. However, after these companies were spun off from Mosenergo, the restructured Mosenergo will still account for the bulk of electricity output and TGC-3 will be formed on the basis of this utility concern. After the reform, some 80% of all electricity produced in Moscow and the Moscow region will be generated by Mosenergo, around 7-8% by GRES-4%, nearly 5% by GRES-5, some 2-3% by GRES-24 and roughly 3% by Zagorskaya GAES.

Generating companies unbundled form Mosenergo will be integrated into new large horizontally integrated business structures – wholesale generating companies (WGCs). GRES-4, GRES-5 and GRES-24 are to become part of WGC-1, WGC-5 and WGC-6, while Zagorskaya GAES is to be assigned to Single Hydro-WGC.

Considerable investor interest in the Moscow generation segment stems from such factors as high per capita income and higher-than-average economic and consumption growth pace for the country. In addition, a large proportion of commercial electricity consumers and low consumption price elasticity makes it possible to create a more favorable economic environment for electricity producers.

Growing electricity demand could result in the fact that power shortage of the Moscow energy system could exceed 10,000 MW by 2010 and balloon to 14,000 MW by 2020. According to the Mosenergoproekt research institute's experts, annual electricity consumption growth in the Moscow region is some 5%. In addition, generation capacity growth has considerably lagged behind the rise in consumption. In order to resolve the problem of electricity shortage, it will be necessary to commission over 10,000 MW of new generating facilities by 2010.

We believe this information underscores a serious flaw in the Moscow energy system which, due to strong electricity demand in the region, is rapidly becoming obsolete. Competition from independent utilities will grow in the future, while extensive depreciation of fixed assets will require considerable investments in upgrade.

Competition in the Moscow region will grow and major players in the Moscow energy system will be Mosenergo, GRES-4, GRES-5 and GRES-24. Electricity supplies from their generating rivals in other regions will be limited by throughput capacity of the trunk grid and according to Mosenergo management, will not top 10-15% of all electricity consumed by Moscow and the Moscow region.

Both Russian and foreign companies are interested in building utilities in Moscow. At present, investors are not overly concerned about the high cost of erecting power facilities. Both Russian (Tekhnopromexport) and foreign companies (Italian Enel and Turkish Zorlu Energy) are poised to invest in the Moscow generation segment.

We believe that competition from independent utilities is a negative for Mosenergo where obsolete fixed assets will require considerable investments in upgrade. In order to keep the existing generating facilities afloat, Mosenergo will be forced to spend some $100 mln on restructuring on an annual basis.

Moscow grids

As part of Mosenergo's restructuring, two distribution grid companies were unbundled – city and regional – and a trunk grid company which is to be integrated with FGC.

The state's stake in trunk grids after the formation of the target industry structure is complete will be at least 75%. For this reason, minority shareholders are only marginally interested in this company, in contrast to Moscow distribution grids.

The Moscow government has long been eyeing Moscow distribution grid assets. Previously this have rise to controversies with Mosenergo's portfolio and minority strategic investors. The major reason behind the conflict was reluctance of the company's shareholders to assign control over grid assets to the Moscow government in the absence of objective market reasons for assigning assets to the local authorities.

However, it was clear that the Moscow government had no intention to give in, especially after the energy crisis in the region. Previously, local authorities reiterated their aspiration to boost control over important infrastructural utilities assets. The Moscow government took precise steps in order to gain controlling stakes in Moscow Thermal Grid Company and Moscow City Power Grid Company in line with previously achieved agreements with UES.

News that UES and the Moscow government are in fact planning to establish a company to manage all Moscow grids was made public immediately after the spring 2005 power outage in the Moscow region. All the Moscow power grids were valued at over $6 bln. The Moscow government expected to gain at least 50% in the company.

From the standpoint of the Moscow government, the Management Company will be the best way to gain control over Moscow grids. To begin with, experience and professional level will be accumulated for managing power grids and then as the local authorities consolidate grid assets, management efficiency will be improved.

At its September meeting UES BoD approved the decision to establish on a parity basis Moscow Management Energy Company (MMEC). Moscow City Power Grid Company, Moscow, Moscow Thermal Grid Company unbundled from Mosenergo and Moscow United Energy Company owned by the Moscow government were to be assigned to its management.

MMEC's meeting of founding members was held on September 30. The company's charter was signed by both parties. Shareholders of the two city grids companies unbundled from Mosenergo as part of the reform and Moscow United Energy Company (MUEC, 100% owned by the Moscow government) at their AGMs approved assigning to MMEC functions of the sole executive body. In December 2005, the functions of the sole executive body of grid companies unbundled from Mosenergo and Moscow United Energy Company were assigned to MMEC.

We believe that changes in the management structure of the Moscow utilities assets could positively impact the social aspect of energy systems' operations, while this could depress the corporate and investment characteristics of power grid companies due to reduced market cap of companies for minority shareholders.

Valuation

According to Mosenergo's separation balance sheet as of December 31, 2004, the bulk of asset value of regional energos (87%) is concentrated in the company's generating and grid assets.

Our valuation of the company's grid and generating assets unbundled from Mosenergo is calculated on the basis of data from our valuation models based on the company's assets and data of valuation of new companies in the industry.

We used the following multiples in our valuation of the company's generating assets:

Table 2. Valuation multiples for generating companies

	P/output, $/MWt-hour	P/IC, $/MWt	P/book	EV/IC, $/MWt
Multiples for HPPs	52.59	197,01	1.91	199,17
Multiples for generating companies	45.64	159	2	167,13

We used the following input data for valuation of distribution grids:

Table 3. Data for valuation of grid companies

	Transferred electric power, MWh	Length, km	Book value,$	Net debt, $
Moscow Region Power Grid Company	39,618,139	74	809,718,401	-4,348,460
Moscow City Power Grid Company	33,036,861	51,3	430,267,955	-589,478
Trunk Grid Company		3,1	85,003,674	-143,319

We used two approaches to calculate the possible amount of electric power transferred through distribution grids. They are:

1. We used historical data on distribution of electricity and power by Moscow grids, where 52% of produced electricity is transferred through a regional company's grids and 48% through a city company's grids;

2. Moreover, we used information about electricity production by Moscow generating facilities and weighed the total output in proportion to the length of the company's distribution grids in the total length of Mosenergo's distribution grids.

Our valuation of distribution grids is based on the following multiples which characterize the market for shares of 23 distribution grid companies which trade on the organized stock market:

Table 4. Value multiples of distribution grid companies.

Multiple	P/output	P/km	P/book	EV/book
Value	26.58	2,029	0.86	0.89

We used the following multiples to assess the value of a trunk grid company:

Table 5. Multiples of value of trunk grid companies.

Multiple	P/book	EV/km
Value	0.5	20,264

In accordance with the restructuring plan for the Russian power industry the trunk transmission lines located in the entire territory of the Russian Federation will be assigned to the Unified National Energy Network, the owner and operator of which will eventually be a single transmission company – Federal Grid Company. For this reason, the shares of trunk grid companies hold less investment appeal for portfolio investors.

Our valuation of other companies spun off from Mosenergo is based on the P/book=0.5 multiple, which is typical for distribution grid companies in the industry and so far unbundled regional energos. Due to the lack of information about these companies' order portfolios and the structure of future electric power market, data about book value of assets are the only information available for use as a valuation benchmark.

Table 6. Aggregate data on valuation of Moscow energy companies

	Company	Market cap valuation, $	Target price per share,$
1	Mosenergo (generating company)	2,268,398,349	0.08030
2	GRES-4	296,019,316	0.01048
3	GRES-5	202,456,307	0.00717
4	GRES-24	84,399,054	0.00299
5	Zagorskaya PSPP	309,600,084	0.01096
6	Moscow Region Power Grid Company	656,137,952	0.02323
7	Moscow City Power Grid Company	433,941,463	0.01536
8	Trunk Grid Company	52,731,282	0.00187
9	Moscow Heat Network Company	206,389,468	0.00731
10	Mosenergosbyt	6,140,498	0.00022
11	Management Power Company	1,899	0.00000
12	Specialized PCB For Repairs and Reconstruction	75,78	0.00000
13	Mosteplosetenergoremont	10,669,066	0.00038
14	Mosenergosetstroy	888,932	0.00003
	Total:	4,527,849,451	0.1603

According to our estimates, generating facilities account for 67.7% of the value of Moscow energy assets and distribution and trunk grids account for 27%. In our opinion, after being listed on stock exchanges, these shares will hold the strongest investment appeal for portfolio and strategic investors.

Simon Birg

* Short overviews of equity research reports and sector reports are posted on the website http://www.finamrus.com with a 1-day delay after their full versions are emailed to the company’s clients. To get overviews on the day of their release, please contact your manager at Finam to sign up for full versions of research reports.

Sector: Power Utilities, Heat Generation
Company: Mosenergo

All Research Notes >>