Research Notes

New SPOs of Gencos – TGC-1 and TGC-8

In September-October 2007 UES intends to offer investors stocks of TGC-1 and TGC-8 as part of the second string of SPOs at gencos. Positive results of the first auctions to place/sell additional stocks of generating companies (WGC-3, WGC-5, TGC-3 (Mosenergo) and TGC-5) point to strong demand for Russian generating assets. SPOs to be launched by TGC-1 and TGC-8 should arouse investors’ interest, as the coverage area of TGC-1 is very promising in view of the integration with the Scandinavian market Nord-pool. Also, TGC-8 will not also be left aside, since the company operates in the country’s southern regions, including the Krasnodar region which is expected to increase energy consumption in light of the 2014 Winter Olympic Games in Sochi.

We expect that the gencos will float additional shares above their current market prices which presently stand at $0.00133 and $0.00107, respectively. We also expect that investors will reassess prospects of TGCs and, to be more precise, assets involved in heat generation and distribution. The thermal generation business could be quite profitable. Furthermore, regulatory authorities are more inclined to sanction thermal tariff hikes than those in electric power. Cash flows of this segment, in our view, are more stable than in the electricity generation industry, since whereas the electric power market is assigned to competitive areas of business and consumers may switch from one supplier to another, heat generating activities in the regions are often carried out only by one category of enterprises – TGCs.

TGC-1 is known to stop accepting applications from potential investors willing to pick up its SPO shares on September 14. TGC-1 is to float additionally issued shares and along with the SPO the state-owned stake in the genco will also be divested, in the aggregate some 62% of the company’s upsized charter capital. TGC-1’s SPO could set higher benchmarks for the assessment of Russian generating facilities. Right now, the market values TGC-1 at $3.9 bln or $680 per kW of installed capacity. In view of the stiffened competitive struggle for TGC-1, the company’s stocks could be easily floated 15% above their current stock valuations, with kW of installed capacity valued at $780.

Moreover, TGC-8 is also expected to start accepting applications from investors willing to buy SPO shares (plans are to float such an amount which is necessary to execute the company’s investment program estimated at $900 mln) in September. Lukoil-affiliated structures, e.g. its subsidiary Promregion-Holding, should be interested in acquiring TGC-8 securities. Earlier the Promregion-Holding chief executive said that his company will not block the genco’s SPO, should its procedure remain transparent. At that time, Promregion-Holding representatives voiced the intention to buy the entire SPO of TGC-8. There is an impression that with the end of its restructuring in sight the energy holding seems to be taking more active steps to pursue its primary target – to maximize the market value of companies for shareholders. Conflicts of interest among WGC and TGC minority shareholders are inevitable and controversies could emerge among various groups of minority shareholders. Be that as it may, these disputes should push up the value of genco stocks.

We showed our recommendations on TGC-1 and TGC-8 stocks below:

Company	Ticker	Current price, $	Year-end target price, $	Upside/downside potential	Recommendation
TGC-1	TGKA	0.00133	0.00166	25%	Buy
TGC-8	TGKH	0.00107	0.00148	38%	Buy

We are optimistic about TGC-1’s prospects. According to our estimates made using the DCF method, the year-end target price for TGC-1 commons is $0.00166. which implies 25% upside to the closing price on September 11. We assign a Buy recommendation to TGC-1 shares.

We are upbeat about TGC-8’s prospects, whose installed capacity we estimate at $467 per kW against the genco sector average of $525/kW. According to our estimates, the year-end target price for TGC-8 commons is $0.00148, which implies 38% upside to the closing price on September 11. We assign a Buy recommendation to TGC-8 stocks.

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Simon Birg

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Sector: Power Utilities, Heat Generation
Company: TGC-1, TGC-8

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