KCRC and MTRC move a step closer to merger

KCRC seeks consent from its bondholders for the proposed merger, while MTRC waits for shareholder approval.
Kowloon-Canton Railway Corporation (KCRC) began the process of seeking consent from its bondholders in Hong Kong on Monday for the proposed merger with MTR Corporation. KCRC has retained HSBC to act as its sole solicitation agent.

KCRC wants to amend certain terms and conditions of the companyÆs outstanding bond issues, including event of default, provision and consolidation clauses. Consenting KCRC bondholders will receive a one-time payment of 0.25% per nominal of the principal.

MTRC, meanwhile, is awaiting approval for the merger from its minority shareholders.

The merger process began in 2004, when the Government of Hong Kong invited both companies to begin discussions about a possible amalgamation. In 2006, it signed a non-binding agreement for setting out a proposed merger for the operation of the companies.

Earlier this year, the rail merger ordinance was passed by the Legislative Council (LegCo) and, in August, the transaction agreement for its implementation was finally executed.

A merger date will be set once both companies receive the consent from their respective bondholders and minority shareholders.

MTRC, which is being advised by Goldman Sachs, UBS and Merrill Lynch, states in its circular that: ôThe merger represents a major milestone in the companyÆs development as one of the leaders of public transportation in Hong Kong.ö

The merger is expected to provide the company with substantial growth through an expanded rail network, increasing its franchised public transport market in Hong Kong from 25% to approximately 40%. MTRC expects its non-fare related revenue to increase by 50.6%, from HK$1.5 billion to HK$2.3 billion, based on an aggregation of the companyÆs relevant revenues for the year ended December 2006.

Further, the companyÆs development land bank from the acquisition of KCRCÆs development rights will increase by 54.3%, from 23.2 million square feet to 35.8 million square feet of gross floor area.

The merger has been structured as a service concession, which allows MTRC to access and operate the KCRC system without assuming the latterÆs existing debt. According to MoodyÆs, KCRC will receive an annual stable lease income of HK$750 million from MTRC.

In July, the ratings agency affirmed KCRCÆs Aa3 issuer and senior unsecured debt ratings, following LegCoÆs approval of the merger.

Moody's also expected to lower KCRCÆs underlying credit strength from level 7 to 8 after the merger is completed. Despite the projected weakening in the companyÆs financial profile in the initial period following the merger, it nonetheless retains a strategic importance to the HKSAR government, says the report.

ôThe change in the underlying credit strength will have no material impact on the current Aa3 rating," states the report.

The underlying credit strength of 8 reflects KCRC's strategically important role in owning existing rail assets. It also takes into account the stable lease to be received by MTRC (rated Aa3/on review for possible upgrade) as well as enhanced supervision and increased board representation by the HKSAR Government.

The absence of rail operating risk and the capped capital expenditures, in conjunction with weakened financial profile also reflects this credit strength.

ôHowever, a reduction of its operating cash flow, which would then be insufficient to cover annual financing costs, and the upcoming debt maturity of $2 billion in 2009/10, highlight the financial and refinancing risks in the post-merger period,ö continues the report.

One mitigating factor is the HK$12 billion to be received from MTRC as an up-front concession payment, and the sale of its property portfolio.

Furthermore, HK$8 billion of committed undrawn loan facilities as back-up liquidity strengthen the companyÆs position, as does the HK$500 million contingent funding from the HKSAR Government.

KCRC is 100% government-owned. MTRC was incorporated in June 2000 and listed on the Hong Kong Stock Exchange in October 2000. It is 76.6%-owned by the Government which is committed to maintaining a minimum shareholding of more than 50% for 20 years from the date of listing, says Moody's.
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