IFC spends bread on Filipino water

The IFC yesterday announced a $50 million equity and debt investment in Manila Water.

Water may not be a sexy investment in most parts of the world, but in Manila the IFC clearly begs to differ. The private sector investment arm of the World Bank, has just sunk $50 million of loans and equity into the Ayala-controlled Manila Water.

The water and sewage company has a 25 year concession that encompasses an area of Manila holding 5 million people, of which it serves around 85%. Adding to the mix it plans a $70-100 million domestic IPO next year.

Domestic IPOs in the Philippines are not frequent. The last IPO was in 2002 - a $121 million deal for Bank de Oro - and the IPO before that few can remember. So Manila Water's IPO will be a fairly major event for the Philippine capital market - turning water into wine for some local investment bankers.

And there is no market in Asia that needs IPOs more than the Philippines. To put this in perspective, the Philippines total market capitalization is only $19 billion - the lowest in Asia by a considerable stretch. And likewise its daily turnover is also the lowest at $21 million, compared with the two most liquid markets, Korea ($2.4 billion) and Taiwan ($2.3 billion).

In the case of Manila Water the company plans to raise new equity through an IPO in the first quarter of 2005. Currently Ayala owns 52.7% of the firm, with the UK's United Utilities owning almost 19% and Mitsubishi owning a further 10.7%.

After making its investment, the IFC will own almost 9%.

"From our perspective this is very much a growth stock," says Vipul Bhagat, the country manager of the Philippines for the IFC. "It is a business that is traditionally characterized as being a recurring, somewhat dull business, but this is an emerging market and the industry is rapidly growing. The number of water connections that are added each month are significant. We are looking at this company as a growth stock and our hope is that is the way investors are going to look at it as well."

He says of next year's equity offering, "This will be one of the larger IPOs from the Philippines in quite some time."

Bhagat points out that the IFC tends to invest for 5-7 year timeframes and says the multilateral first formed a relationship with the utility through lending. Last year it made its first $30 million loan to Manila Water. Its most recently signed loan carries a 15 year tenor.

"It's our longest tenor loan in the Philippines, and possibly the region, for a private company," he says, adding of the equity investment, "We had a strong relationship from our existing exposure and what we bring to the table with our equity investment is the same corporate philosophy and such values as corporate social responsibility. We don't take equity investments lightly."

Ayala Corporation's managing director, Antonino Aquino says, "We've started off the activities necessary for an IPO. We have assigned our investment advisors, ING and the Bank of the Philippine Islands. A couple of government approvals are still necessary. But we would expect to be ready by the early part of next year."

Aquino says that in order to facilitate sufficient liquidity around 20-25% of the company will be sold on the public market. "It should be both a dividend stock and a growth stock," he adds.

The history of the company is reasonably short, Aquino narrates. "About six years ago the government water utility decided to privatize its water operation in Manila. That was because it was losing something like two thirds of the water it was producing either through physical problems or theft. They realized they would need private investors to renew the pipeline network and upgrade the water facilities around Manila. Manila Water is one of the two concessionaires."

He adds: "In the past six years we have invested $300 million or so. Over the next four years we have to invest $400 million - or $40-50 million a year to eventually upgrade the pipeline network. So we have to continue to be bankable by making sure our operating cashflows continue to be positive and make sure our equity position continues to be healthy - and the equity infusion from IFC contributes towards that goal."

On the issue of profitability he says: "The company last year made $20 million. The first year had a negative EBITDA, but by 2000 we were EBITDA positive. Our compound growth rate was in the 30% range. Our own internal target is that this year we'll see a 10-15% improvement. In 2005 we have an approved tariff adjustment and would expect to [see profit] at $35 million. So it's a healthy growth."

Under the government's concession scheme the company gets a return of 10% on every dollar invested. However, because it is allowed to borrow offshore at much lower rates it is able to leverage up its returns.

"At this point in time the return on equity is between 25-30%. That is not the long term proposition. But we would hope it will settle down into the high teens."

He adds that the gearing ought to remain at 60:40 as "We don't want to push the envelope too much."

Manila Water he says is very sensitive to the issue of customers thinking the water is becoming too expensive. "We want to ensure that the net tariff is no more than 3-4% of the take-home income gained from the minimum wage in Manila. The world standard is 5%. But we know the moment it goes beyond that level we are going to start having problems on the collections side."

Aquino says that proceeds from the IPO will be used to continue to enhance its pipeline network in Manila. "In addition we might look at extending our expertise to other cities in the Philippines. We are looking at Cebu."

When asked about recent changes at ING and how that might affect the firm's status on the IPO he replies: "We appointed them as our investment bankers before the Macquarie deal happened and our term of reference with them does not include underwriting. That still needs to be discussed and decided."

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