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17.07 2012 11:44:46

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In anticipation of growth in RAB tariffs

by Konstantin Marchenko

The details of a merger between FGC UES and MRSK Holding have become known. Russian Energy Minister Alexander Novak cited the transition to a single share in the holding company’s capital as one of the possible options. If this option is exercised, between USD 700 bn and USD 3 bn could be spent on the buyout of minority shareholdings. The ministry has until October to thrash out various options to merge the two companies.

The buyout of shares from minority shareholders is lucrative for the government, given the low price of the shares at the present time.  The government gets the opportunity to privatize the united company in the future at a more advantageous price. However, this option does not resolve problems with the attraction of investment resources for the distribution grid system. A FGC UES program for 2012-2014 entails capex of RUB 504.8 bn, while MRSK Holding’s  capex program for 2012-2015 has a RUB 902 bn budget. The problem can be solved in the following way:  the state raises its holding in the united company and concurrently, lowers its stakes in MRSK Holding subsidiaries. This scheme allows for the attraction of the funds required for the distribution grid sector.

The Energy Ministry has suggested privatizing one of MRSK Holding subsidiaries. A possible privatization may take place as early as the first quarter of 2013. Privatization is to take the form of a pilot project. In case of its success and demand for the shares from private investors, MRSK Holding will privatize its other subsidiaries. Given this, the first privatized company should reflect the prospects of the entire industry. This company should not necessarily lead the way in profitability terms, but it must not be the worst performer in the industry either. The choice of a subsidiary for privatization is yet to be finalized.

According to a stance adopted by the ministry, the main goal pursued in privatization is to draw in a strategic investor for the industry. It is worth noting, while commenting on this decision, that it is not the best time now for privatization of electricity distribution companies, which are vividly undervalued. It is evident that the governmental measure is intended to raise the necessary financing for the investment program rather than earning income on the sale of the asset.

The main hurdle for these projects lies in the former activities by the government. The transition to the RAB tariff system promised electricity grid companies extra revenues and the funds invested in the distribution grid system were to be rewarded with a rise in the tariffs, pegged to the set rate of return on the capital invested. However, the RAB tariffs were then reduced by hand. Unless the tariffs are raised back to the target levels stated earlier, the advent of private investors at the industry is out of the question. Moreover, even the raised tariffs will not create a booming demand for MRSK shares. After being once deceived, investors will think twice before entering anew into a game with the government.

The news is undoubtedly positive for FGC UES and MRSK Holding shares. The planned growth in RAB tariffs will increase the profits of these companies regardless of how this decision will impact the behavior of strategic investors. It is almost for certain that the tariffs will be lifted before the year-end, but they will not be increased before September 1, the date for a second stage of tariff hikes in the housing and utility sector. 

The target price for FGC UES shares is RUB 0.42 per share, with an upside potential of 84%. The target price for MRSK Holding common shares is RUB 3.83, with an upside potential of 120%.

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