Philippine government to sell 40% of geothermal energy unit

PNOC Energy Development will kick off the roadshow for the international portion of its up to $380 million initial public offering today, in what will be the first privatisation in the Philippines in 12 years.

The government is looking to sell up to 40% of PNOC-EDC, a wholly-owned subsidiary of Philippine National Oil Company that produces approximately 60% of all geothermal energy in the country. The sale is part of ongoing government reforms within the power industry which ultimately aims at full privatisation.

It comes at a time of an improving economy and strong gains in the broader equity market, which has prompted international investors to take another look at Philippine stocks.

The indicative price range pitches the company at a reasonable valuation and, according to people familiar with the pre-marketing phase, the offer is meeting with a good response in Asia as well as in Europe and the US.

The IPO comprises between 4.2 billion and 5.2 billion shares, of which 50% will be secondary paper sold by the government. The other half will be new shares sold by the company to raise money for new drilling equipment and to upgrade its existing equipment. The shares are offered between Ps2.50 and Ps3.20 apiece, for a total deal size of Ps10.5 billion to Ps16.6 billion ($210 million to $333 million). Including the greenshoe, which will amount to 15% of the final number of shares, the total proceeds could rise to $383 million.

The deal will be the second largest IPO in the Philippines after conglomerate SM Investment Corp’s $528 million offering in March 2005, even before the exercise of the greenshoe. Based on the exchange rate at the time, oil refiner Petron raised about $400 million in an IPO in 1994, although in local currency terms that deal amounted to only Ps10.4 billion.

PNOC-EDC will have a valuation of between $750 million and $1 billion at the time of listing, depending on how many shares it ends up selling. 70% of the shares will be sold to international investors through CLSA as sole bookrunner. The remainder will be offered to domestic investors with the help of BDO Capital & Investment Corp, Development Bank of the Philippines, ING Bank and Land Bank of the Philippines.

According to a source, the price range will value the company at 6 to 7.5 times its projected earnings for 2007. By comparison, First Generation, which did an IPO in February this year, trades at about 11 times next year’s earnings.

PNOC-EDC’s focus on geothermal power puts it in a fairly unique position among the country’s power producers, however, and the fact that it is operating a renewable energy source also makes it a possible target for investors attracted by the “clean and green” concept. From a revenue perspective, the environmentally friendly power production makes the company eligible to sell carbon emission credits.

The company produces geothermal steam which it sells to Napocor and independent power producers who use it to produce electricity. The amount of energy it produces is enough for the production of 1,148MW of electricity. The company currently contributes 18% of the power produced by Napocor.

Starting from 2007, PNOC-EDC will also be taking over the electricity production of the IPPs that are now its customers under 10-year build, operate, transfer agreements. By the end of 2009, the company will have taken over about 500MW worth of electricity production capacity.

This, says one observer, will have a positive impact on PNOC-EDC’s earnings. At the same time, the company is looking to increase its production of geothermal steam and develop additional new power plants on its own with a combined capacity of about 500MW, giving a further boost to the bottom line.

In 2005 the company had a net profit of Ps9.9 billion ($200 million), although part of this was due to one-off items. The company makes more than $100 million per year in recurring profit, according to the source, which will benefit investors in the form of steady dividends. It hasn’t made a commitment as to what percentage of its earnings it will distribute, however.

The Philippines is the biggest producer of geothermal power after the US. It is also a country where the government is trying to encourage the development of environmentally and economically friendly energy resources to meet an increasing demand for power and to reduce the dependence on imported energy sources. This includes PNOC-EDC’s geothermal plants, which have a lower operating cost per megawatt of installed capacity than most of the country’s fossil fuel plants.

Analysts forecast that demand for power in the Philippines will grow by 4%-6% per year depending on the region and the Department of Energy projects peak power demand to increase by a CAGR of 8.4% from 8,525MW in 2004 to 19,064MW in 2014.

While the growth prospects for individual Philippine companies like PNOC-EDC may be solid and the stock market is the third best performer in Asia this year (not counting Vietnam and China where international investors have limited access only) with a gain of more than 30%, the country makes up only a minor portion of the regional indices. According to analysts, this means there is no real obligation for fund managers to include Filipino stocks in their portfolios. Together with the always present political risk, that could be a hurdle for some potential investors to get over.

The IPO price will be fixed after the US close of December 1 and the trading debut on the Philippine stock exchange is scheduled for December 13.