Hong Kong power IPO less generous than it looks

January 13, 2014

By Peter Thal Larsen

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Li Ka-shing is betting that a generous dividend will lure investors into the spin-off of his Hong Kong power utility. The tycoon has lowered the price range for HK Electric to ensure buyers of the investment trust get a yield of more than 6 percent. But the possibility of market-wide higher interest rates makes that look less than electrifying.

Buying into half of Hong Kong’s electricity duopoly looks a good way to secure a stable income. The business is permitted by regulators to earn a near-10 percent return on its assets – higher than many Western utilities – until at least 2018. As an investment trust, HK Electric comes with a pledge to distribute all its spare cash as dividends.

Based on the company’s forecast dividend distribution for this year, the shares will yield between 6.3 percent and 7.2 percent at the reduced range. Cross-harbour rival CLP offers a yield of just 4.5 percent for a more diversified business. Hong Kong Telecom, also organised as a trust, yields less than 6 percent.

But rising interest rates could affect HK Electric’s financial future, in two ways. First, Li is leveraging up the business: total debt after the spinoff will rise to around HK$48 billion ($6.2 billion) from about HK$36 billion beforehand. Utilities are often highly leveraged, but the debt could jeopardise profitability: HK Electric estimates that if the cost of its floating-rate debt rose by 75 basis points, earnings in 2014 would be 10 percent lower than currently expected. The pool of available dividends would also shrink.

At the same time, higher interest rates would also make yields on on less risky assets, like U.S. Treasury bonds, look relatively more attractive.

Li has already compromised by lowering HK Electric’s price range. His investment vehicle Power Assets will also keep a stake of at least 42 percent rather than cutting back to as little as 30 percent, as it originally hoped. That, and a large investment from China’s State Grid, should ensure the offering goes ahead. Even so, it’s a reminder that juicy dividends no longer hold quite the same allure.

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