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Last updated: July 17, 2011 6:50 pm
Li Ka-shing, the Hong Kong tycoon nicknamed “superman” in his home town, has had his ups and downs investing in the UK.
The $14.6bn windfall from the sale of Orange to Mannesmann in 1999, and the $9bn profit he logged when Vodafone bought his Indian telecoms investment in 2007, are just a couple of highlights from his celebrated career.
But a blot on his record is an early foray into 3G mobile phone services, which took more than eight years to record its first operational profit.
The question today is whether he is making a costly mistake by paying racy multiples for utility companies in one of western Europe’s most mature markets. “There’s certainly a risk of overpaying,” says Robert Miller-Bakewell, a former equity analyst who covered the sector for two decades.
Less than a year after a consortium led by Cheung Kong Infrastructure, Mr Li’s investment vehicle, snapped up EDF’s UK power grids for £5.8bn, CKI last week made an indicative cash offer to buy Northumbrian Water in a deal that would give the FTSE 250 company an enterprise value of £4.7bn.
It is the latest sign that the supposedly dull UK utilities sector remains a big draw for CKI – despite its base in one of the world’s fastest-growing economies and the demand for funds for large projects across Asia.
The company’s UK operations almost doubled their contribution to group profits last year, to HK$1.18bn (£95m). A purchase of Northumbrian, which made a net profit of £122.5m last year, would give CKI’s bottom line a further boost.
“A lot of people are putting money into emerging markets – he’s basically doing the reverse,” Mr Miller-Bakewell says of Mr Li.
And Mr Li is willing to stump up for the privilege: whereas listed UK water companies trade on average at 5 per cent above their regulated asset base (the main valuation metric in the sector), CKI has pitched its indicative 465p-a-share bid for Northumbrian at a premium of almost 30 per cent.
The deal – which people close to the situation believe has the support of Ontario Teachers’ Pension Plan, Northumbrian’s biggest shareholder with a 27 per cent stake – seems so generous that another bidder would appear unlikely.
While it may come as a surprise to some domestic observers, one great attraction for CKI is the UK’s system of utility regulation. In the case of water, Ofwat lays down every five years what the regional monopolies can charge customers.
The industry’s previous settlement with Ofwat was widely seen as generous to the utilities. But to the chagrin of some investors, a new pricing regime in place for more than a year is, analysts agree, significantly tougher than its predecessor.
Mr Li’s confidence in the system puts him at odds with some influential locals. One of the UK’s best-known fund managers, Neil Woodford at Invesco Perpetual – which was until last year the largest equity investor in the UK’s listed water companies – accused Ofwat of behaving like “Robin Hood” in its most recent pricing review.
Explaining his decision to make £400m worth of disposals in Severn Trent and United Utilities, Mr Woodford complained at the time that the industry regulator’s new pricing regime had resulted in an “unacceptable” risk for investors. “It’s going to be a challenging time for these companies,” he warned.
The potential risks for CKI are further underscored by the recent woes of Southern Water, which was bought four years ago by a consortium led by JPMorgan, Australian fund Challenger and UBS, which paid a premium of more than 30 per cent to its regulated assets.
Southern has since run into cash flow troubles, which has prompted Moody’s to cut its credit rating. The company blames Ofwat for imposing a harsh pricing review that resulted in a £160m revenue shortfall.
One way that companies can boost returns is by outperforming the regulator’s assumptions on capital and operational spending. Yet analysts struggle to see how Northumbrian can manage its operations more efficiently under alternative ownership.
“There’s not a lot he can do to Northumbrian that can improve the returns,” Mr Miller-Bakewell says.
Analysts say it is also unlikely that CKI will be able to win large operational synergies between Northumbrian and CKI’s other UK infrastructure assets.
Yet despite talk of overpaying, the RAB premium CKI has offered for Northumbrian is similar to those that other infrastructure funds have paid for UK utilities over the past five years, according to Credit Suisse research.
Such investors have long coveted the accompanying inflation-linked investment returns, which match their long-term liabilities.
“They’re probably looking at this at a 10- or 15-year play. They’re willing to take the long-term view, which could involve accepting a lower return in the short term,” says Angelos Anastasiou, analyst at Investec. “The idea is to make up for it over the longer term.”
The steady income from assets such as Northumbrian should help offset some of the more volatile businesses in the Li empire, which takes in property, retail and ports operations on the mainland. Many analysts expect EDF and Northumbrian to be followed by other infrastructure acquisitions in Europe and the US.
Currency changes – the Hong Kong currency can buy roughly 20 per cent more pounds than before the global financial crisis – should also make UK assets relatively attractive to CKI.
And in spite of its base in Hong Kong, CKI’s view of the benefits of water sector regulation is at least based on direct experience. Since 2004, it has owned Cambridge Water – though to avoid a referral to the Competition Commission under the sector’s stringent merger rules, CKI is expected to sell Cambridge for about £70m to HSBC, which is likely to sell it on.
As Lakis Athanasiou, analyst at Evolution, puts it: “They’ve got no excuse for saying, ‘We didn’t understand what we were getting into’”.
Additional reporting by Anousha Sakoui
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