KOT ADDU IPO ON FEB 21-24

Road show/media campaign to pull massive crowd of investors

By AMANULLAH BASHAR
Feb 21 - 27, 2005

Road shows for public offering of 20 percent (176 million shares) of Kot Addu Power Company (KAPCO) are currently being held in all major cities of the country to widen the base of public share holding in the state-owned entity.

Though the road shows and publicity campaign both in print and electronic media may help attract the investors, yet the current price of KAPCO shares i.e. Rs65 perhaps could be the real charm for the investors to put their money at a massive scale in the forthcoming shares.

There were strong feelings amidst the market players that the government's offer for sale of 20% (176m shares) of KAPCO is to receive a euphoric investor response on the back of compelling valuations, an extremely attractive dividend yield and a lucrative shareholder cash-flow stream throughout the life of the project.

A multi-fuel power plant and the largest IPP in Pakistan, the flat trend of the scalable portion of KAPCO's capacity payments and semi-annual indexation to the rupee/US$ parity and US inflation are to drive the company's earnings and dividends.

For the financial years 2004-05 and 2005-06, the cash dividend per share is respectively expected at Rs7.15 and Rs7.45 with the application of corporate taxation to lower the dividend flow from FY07 onwards. KAPCO's plant efficiencies and insurance coverage minimize operational risk and the multi-faceted relationship with WAPDA assures adherence to the Power Purchase Agreement (PPA) and Settlement Agreement over the life of the project.

Assuming 13.5% discount rate and 3% annual rupee depreciation, the fair value for KAPCO is Rs53, 77% upside potential from the offer price. Offering a 23.8% prospective dividend yield and placed at a PER and EV/EBITDA multiple of 3.5x and 2.5x respectively, the public offering is expected to shape a massive rocketing in KAPCO's share price.

The government is offering 10% of KAPCO's shares along with a green shoe option of another 10% at Rs30/share, placing the total offering at approximately 176m shares.

The KAPCO is the country's largest Independent Power Producer (IPP) and a multi-fuel power plant running on a combination of fuels, including furnace oil, gas and High-speed diesel (HSD). Presently, WAPDA and International Power are KAPCO's two shareholders, respectively holding 64% and 36% stake in the company. The public offer is being made from WAPDA's shareholding in KAPCO.

EDGE

A major advantage of KAPCO over other IPPs is that its scalable portion of the capacity purchase price is to remain flat from year three onwards. This is a very important aspect as this portion of the tariff governs shareholder returns and invariably dividend payments. The scalable portion is a part of the Capacity Purchase Price (CPP), which is a payment for the available Net Capacity of the plant. The CPP is not dependent on the amount of power delivered to WAPDA and is indexed to inflation and hedged against rupee depreciation.

CASH FLOWS

KAPCO's cash-flows and dividend stream are to mark a steady growth on the back of the indexation elements, which primarily include the rupee depreciation and US CPI. For KAPCO's projections, we have assumed 2% annual US CPI and 3% annual rupee depreciation throughout the life of the project.

Tanvir Abid, one of the leading market analysts estimate KAPCO's FY05 and FY06 dividend per share at Rs7.15 and Rs7.45 respectively. Post FY07, the levy of corporation taxation will lower KAPCO's earnings and dividend stream, though the company will benefit from the tax shield arising out of the financial charges.

Currently, the hype in share trading continues to mount at Karachi Stock Exchange where the KSE-100 index has consolidated its position to create history by hitting the landmark of 8000 points probably as soon as official trading of 176 million KAPCO shares takes position of the trading counter.

Though there were some feelings that technical correction is due now yet the sentiments were still high reflected despite a note of cautious signalled by the market pundits.

Market experts were of the view that the craze for investment in stocks has taken its roots deeply at the grass root level to such an extent that even housewives are keen in investing in the share trade and usually seen submitting their applications at the bank counters for every fresh public offering through stock exchange. The persisting trend of investment in share market ratifies the government's idea "Privatization for the Public" seems to be the best seller, at least in the current scenario.

MINIMAL OPERATIONAL RISK

KAPCO's plant efficiencies and insurance coverage minimize operational risk and the multi-faceted relationship with WAPDA assures adherence to the PPA and Settlement Agreement over the remaining life of the project. Post resolution of disputes, WAPDA's relationship with all IPPs, including KAPCO portrays an extremely healthy picture with WAPDA honoring all of its commitments on time.

POTENTIAL

Having bond-like return characteristics, the Dividend Discount Model (DDM) is the best approach to value IPPs. The fact that KAPCO's cash flows can be projected with relative ease and that there is virtually no earnings growth in real terms also support the use of DDM as the first-choice valuation model. Under our base case indexation assumption and taking 13.5% as the discount rate, the DDM fair value of KAPCO is Rs53, indicating a 77% upside potential to the Rs30/share public offer price.