Macquarie Korea Infrastructure Fund targets $1 billion IPO

Existing Investors still pondering how much to sell.
Macquarie Korea Infrastructure Fund (MKIF) has started pre-marketing the first Korean road infrastructure play to list in Seoul. The Macquarie Securities and Merrill Lynch led deal is likely to raise between $700 million and $1.3 billion, although the final deal size will depend on how much existing investors decide to sell.

Primary shares are expected to account for about $500 million, enabling the deal to hit its minimum 20% freefloat requirement. On top of this, six investors are said to have expressed an interest in cashing in part of their holdings. There will also be a 15% greenshoe.

At present, about 70% of the deal is expected to be offered to international investors in the form of GDRs, with the rest earmarked for a domestic offer led by Good Morning Shinhan Securities and Samsung Securities. The final split will be determined closer to the launch of the official road show early next week.

Following on the heels of the highly popular offering from Korean department store operator Lotte Shopping last month, MKIFÆs shares will listed both in Seoul and London.

One of the fundÆs selling points is the steady income stream generated by the toll roads in its portfolio. This is expected to continue climbing thanks to the construction of more roads, higher tolls and the overall growth in the Korean economy.

However, observers say a more important selling argument lies in MKIFÆs growth potential as projects currently under construction become operational and it continues to invest in new infrastructure projects. Syndicate analysts also note the potential for improved returns through more efficient capital management.

The fund is expected to pay at least 90% of its future net profits as dividends as it has ôtax flow-through status.ö This means it does not have to pay tax on dividends if it distributes at least 90% of its after-tax profit to shareholders. Based on syndicate estimates of the fundÆs equity valuation this could translate into a dividend yield of 3.6% to 4% in 2006 and 3.8% to 4.2% in 2007.

In 2005, the fund paid a dividend yield of 5.6%, or Won102.8 billion, although this included Won29.6 billion in one-off gains from the sale of investments and accumulated revaluation gains

The projected yield would be attractive versus a local stock market average of 2.2%, but less appealing than most international infrastructure funds, which on average pay just over 4%. It is also generally lower than the dividend yields paid by other utilities and consumer stable stocks in Korea, which in 2005 generated a yield between 2.9% (Kepco) and 7.8% (KT Corp).

ôThe relatively low yield is because of MKIFÆs exposure to greenfield projects, which are not yet mature enough to generate sufficient cash to cover their interest payments,ö one analyst notes. ôAs these projects proceed into ramp-up and maturity, we believe interest income will increase and distributions will follow.ö

The fund has provided subordinated and senior debt to many of its concession projects to ensure a cash yield for MKIF during the construction phase and a more stable revenue stream overall.

As these projects mature and get a more stable and predictable cash flow, there will be scope for the fund to increase its valuation and total returns by refinancing some of its existing debt at more favourable rates, analysts say.

Other forms of capital management that could come into play almost immediately would be to gear up at the holding company (i.e. the listed unit), which currently have no debt at all, even though Korean regulations allow up to 30%.

The fund also has the ability to increase the gearing at its various concession companies, or to refinance the existing loans at the concession companies that are currently provided by MKIF with external borrowing. Syndicate research suggests that such changes could add 5% to 10% upside to the base case market cap valuation of Won2.2 trillion to Won2.6 trillion ($2.24 billion to $2.65 billion).

The Government Employees Pension Fund is currently the largest investor in the fund with 22.2% of the shares, followed by The Military Mutual Aid Association with 15.9% and the Korea TeachersÆ Pension with 9.6%. The Shinhan Group holds a combined 15% and Macquarie International Holdings has 5.1%.

Established in January 2003, MKIF is the largest private investor into public infrastructure assets in Korea under the governmentÆs 10-year Private Participation in Infrastructure programme, which includes about 180 existing and future projects worth a total of $45 billion.

The government has planned for Won13 trillion private infrastructure investments in roads between 2002 and 2011 and according to the Korea Highway Corporation, the length of completed expressways is expected to grow by 5% per year between 2004 and 2009.

MKIF has so far invested, or made commitments to invest, in more than Won1.9 trillion ($1.94 billion) in 14 assets, consisting of 13 toll roads or tunnels and one railway with a weighted average remaining concession period of more than 25 years.

Nine of the assets, accounting for 60% of the total asset value, are operational and five are still under construction. The fund is also currently assessing another six projects, which it may close in the coming six months, including four expressways, one bridge and part of Busan New Port.

The assets are managed by a 50-50 joint venture between Macquarie and KoreaÆs Shinhan Financial Group, which combines the latterÆs local knowledge and expertise with MacquarieÆs experience in creating investor value through active management of infrastructure assets in other markets such as Australia and Singapore.

However, the fund will continue to pay a performance fee to the manager when the fund becomes a listed entity, which will have the effect of lowering the potential distribution to shareholders. The fee will equal 20% of any quarterly return on the shares above 8%.

Government guarantees of a minimum return and a cash compensation if the concessions are terminated early give MKIF a lower risk profile than other infrastructure funds, but will also lower the potential dividend payout, analysts say.

Under the concession agreements, it is expected that government-guaranteed revenue, which currently account for about 80% of the valuation of the fund, will grow at an average inflation-adjusted compound annual growth rate of 7.6% until 2015.
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