AFTER several delays, 1Malaysia Development Bhd (1MDB) is finally ready to submit the listing of its power generation assets to the Securities Commission Malaysia for approval. This follows the appointment of a management team to head the soon-to-be-listed unit.

According to industry sources, bankers will be making the submission to the SC over the next couple of weeks with plans to complete the US$4.5 billion fundraising exercise by early January.

The unit, dubbed 1MDB Energy, will be helmed by Datuk Mohd Nazri Shahruddin, who last week resigned from Tenaga Nasional Bhd as vice-president of new business and major projects, giving only 24 hours’ notice. His appointment as 1MDB Energy’s CEO is effective from Oct 1.

Another name that has emerged as 1MDB Energy’s top management is former Malakoff Corp Bhd director Datuk Mark William Ling Lee Meng as president, say industry sources.

They add that Tang Kee Meng, from boutique management consultancy firm Mendel Capital, is joining as CFO. Tang gained some experience in the power sector when he was vice-president for investments at Khazanah Nasional Bhd.

Coming into 1MDB Energy as its chief operating officer is Mohamed Nor Ali, who also resigned from Malakoff last week. He had joined the latter company six months ago when it acquired Sime Darby Energy Sdn Bhd’s Port Dickson power plant.

The proposed listing of 1MDB’s power generation assets came under intense public scrutiny after it reportedly overpaid for power assets it acquired at RM12.5 billion, using a portion of the RM42 billion of debt it raised. 1MDB’s financials for the period ended March 31, 2014, have yet to be released, but for the financial year ended March 31, 2013, the state-owned fund booked writedowns for goodwill impairment amounting to RM1.2 billion for the acquisition of the power generation assets.

Packaging the IPO

First of all, most of the debt used to acquire the power generation assets will be retained at 1MDB group level, say sources. This means the listed vehicle will be a relatively “clean” entity, unencumbered by excessive borrowings.

1MDB will simply offer a portion of its shares in the public float and use the proceeds to pay down its borrowings.

The catch is that the yields on its power generation assets are relatively low, given the price paid for them. Hence, 1MDB will have to market the IPO on potential earnings growth from incoming projects as well as the scarcity of assets in a similar class, which will attract institutional investors.

The reason for which 1MDB has been in the limelight this year will also be the catalyst for the IPO — the company has secured about RM17 billion worth of projects this year alone that will see its installed capacity increase from 5,570mw to over 9,620mw by 2021.

Keep in mind that by January next year, more than 80% of 1MDB’s capacity will be over 11 years old, a quarter of its total capacity will be over 16 years old and 20% will be over 20 years old.

Meanwhile, the newest plant in the group’s stable — the 1,400mw Jimah Power Station — has been struggling to operate at maximum capacity and repeatedly shut down for repairs over the past year, resulting in expensive penalties.

Last month, 1MDB was awarded on a direct basis a 2,000mw combined cycle gas turbine plant worth an estimated RM6 billion. The award was heavily criticised because its commercial operation date (COD) — scheduled for 2021 or seven years ahead — is unusually long.

Prior to that, the state-owned fund was awarded a 50mw solar project, also on a direct basis. Earlier this year, 1MDB won the controversial award for Project 3B — a 2,000mw coal-fired power plant worth an estimated RM11 billion — in an open tender.

This slew of projects makes a strong case for earnings growth in the future. Note that power generation stocks are not typically valued as growth counters because the earnings of power plants tend not to vary much.

In fact, power projects in Malaysia are usually valued on a discounted cash flow basis since their earnings are relatively secure with Tenaga as the guaranteed off-taker of power produced. On top of that, power projects receive predetermined capacity payments to cover the cost of capital expenditure. On the other hand, the earnings upside potential is limited.

In 1MDB’s case, the catch is that investors will have to wait nearly four years for its next plant to be completed, that is, if everything goes according to plan. Recall that the first phase of Project 3B, which has been renamed Jimah East, has a scheduled COD of October 2018. The second phase is due in April 2019. At the moment, 1MDB is still working towards the financial close of the project that will see it issue some RM8.4 billion worth of sukuk.

This means that new investors will be exposed to the execution risk of the RM11 billion project.

In a recent interview with The Edge, Tenaga pointed out that it was concerned about 1MDB’s ability to deliver Jimah East on time. Substantial delays to the 2,000mw of capacity would be catastrophic to the grid’s reserve margin, it said.

On top of foregone revenue, the maximum liquidated and ascertained damages (LAD) that can be imposed for a delay of more than six months are estimated to be around RM220 million.

“At this stage, the project (Jimah East) has not breached any scheduled deadlines. Even if it is delayed, the LAD shouldn’t be a big issue because 1MDB Energy will simply claim back-to-back LAD from its contractors to reduce the financial impact. This is normal in most projects. When the developer doesn’t get paid, the contractors don’t get paid and everything ends up in arbitration,” explains a source familiar with the project.

The main reason Jimah East is expected to be delayed is the land reclamation that needs to be done on the site. As land takes time to settle, several industry players say the scheduled delivery of the plant in only four years is ambitious. They feel adding another year to the project is more realistic.

1MDB and Tenaga forging ties

Tenaga’s relationship with 1MDB has been improving over the past few months, and Nazri’s move to the latter’s energy unit should make things easier.

A year ago, Tenaga had bid against 1MDB for Project 3B, although it had put in a relatively uncompetitive offer — the highest — that raised eyebrows. At present, the utility company is preparing to negotiate with the 70:30 joint venture between 1MDB and Mitsui & Co to take an estimated 20% stake in the project, say sources, with the Japanese conglomerate giving up its equity interest to Tenaga.

Tenaga also recently teamed up with 1MDB’s wholly-owned subsidiary Powertek Bhd to sign a memorandum of understanding with Bangladesh Power Development Bhd on the development of a 1,320mw coal-fired power plant in Maheshkali, Cox’s Bazar, Bangladesh.

Keep in mind that 1MDB and Khazanah, Tenaga’s largest shareholder, are technically sister companies — both are wholly owned by the Ministry of Finance.

This raises questions about Tenaga’s independence when it comes to imposing penalties on 1MDB if it has a stake in the project. Furthermore, there is talk in the market that 1MDB is seeking to extend the COD of Jimah East by one year to avoid penalties, although this has been strongly denied by 1MDB’s management.

“Other than Tenaga’s board of directors, any change to a PPA (power purchase agreement) will require the approval of the Energy Commission. Tenaga’s board is very strong and independent and will fight to uphold the sanctity of the contract. If the PPA says the COD is October 2018, 1MDB must deliver by 2018 or face the consequences.

“Nazri’s appointment to 1MDB Energy won’t change that. Just look at Malakoff and its delayed plant (the 1,000mw coal-fired Tanjung Bin 4). Its CEO is the former boss of Tenaga but it isn’t getting any extension,” says an industry observer.

This article first appeared in The Edge Malaysia Weekly, on October 06 - 12, 2014.

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