Financial Adviser: 5 Things to Know About Henry Sy, Jr.'s Synergy Grid's Follow-On Offering and How to Profit from It

The company will go public through a follow-on offering.
ILLUSTRATOR WARREN ESPEJO

Transmission system operator Synergy Grid and Development Phils, Inc (PSE: SGP) will be the seventh company that will go public this year via backdoor listing.

SGP will be raising up to P13.8 billion through a Follow-On Offering (FOO) by selling up to 1.1 billion shares to the public at a price of P12 per share.

What is a follow-on offering

A follow-on offering (FOO) typically happens when a listed company issues new shares to the investing public, similar to an Initial Public Offering (IPO) to raise funds for expansion.

The offering period of SGP shares, which will comprise about 27.4 percent of the company, will run from October 26 to November 2 with a target listing date on November 10, 2021.

Prior to the takeover, SGP shares have been speculated actively on low volume turnover with average price ranging from P150 to P484 per share for the past 52 weeks.

SGP shares were suspended last May in preparation for the follow-on offering at last traded price of P395.80 per share with market capitalization of P19.6 billion.

SGP will have an expected market capitalization of P63.2 billion after the follow-on offering.

Bear in mind that when you trade the stock, you are also investing in the business. It may be wise to spend some time understanding the business of SGP and evaluate its growth opportunities.

Once you are aware of the fundamentals of the company, you will have a better handle on the risk and return that you can expect from investing in the FOO.

Here are the top five things every investor needs to know about Synergy Grid and Development Phils’ Follow-On Offering:

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1| Know the structure of the company

SGP is the investment holding company owned equally by Henry Sy, Jr. and Robert Coyiuto, Jr which controls 60 percent of the National Grid Corporation of the Philippines (NGCP).

NGCP is the sole and exclusive operator of the country’s nationwide transmission network linking power generators and distribution utilities that deliver electricity to end-users across Luzon, Visayas and Mindanao.

SGP controls 60 percent of NGCP through its various intermediate subsidiaries, OneTaipan Holdings, Inc. and Pacifica21 Holdings, Inc.

OneTaipan indirectly holds an equity interest of 30 percent plus one share in NGCP through its wholly-owned company, Monte Oro Grid Resources Corporation.

Pacifica21, on the other hand, indirectly holds an equity interest of 30 percent minus one share in NGCP through its wholly-owned company, Calaca High Power Corporation.

The balance of 40 percent ownership in NGCP belongs to State Grid Corporation of China (SGCC), which is the second-largest state-owned enterprise in People’s Republic of China.

SGCC is also the largest electric power company in China serving more than 145 million customers with total revenues of at least $107 billion annually.

Because SGP owns 67 percent each of OneTaipan Holdings and Pacifica21 Holdings that collectively own 60 percent of NGCP, the effective equity interest of SGP in NGCP is 40.2 percent.

After the follow-on offering, the collective ownership of Henry Sy, Jr and Robert Coyiuto, Jr, which are practically equal, will decline to 78.1 percent.

2| Know the financials of the company

SGP-controlled NGCP generates about 94 percent of its revenues from power delivery services, while the remaining six percent comes from system operation and metering services.

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NGCP derives about 46 percent of its revenues from Meralco alone, the biggest Distribution Utility customer in the country, while the balance of 63 percent from other customers, which include electric cooperatives, private and government utilities and economic zones.

Total revenues of NGCP have been growing by an average of three percent from P45.4 billion in 2018 to P48.6 billion in 2020.

NGCP is exempted from paying income tax as granted by its franchise under Republic Act No. 9511. Because of this, it also enjoys huge net profit margins.

The increase in revenues, along with improving net profit margins, which rose from 46 percent to 2018 to 48.2 percent in 2020, enabled SGP to grow its total net income by six percent per year from P20.9 billion in 2018 to P23.4 billion in 2020.

This year, total revenues for the first six months grew almost flat at P24.2 billion, but net income increased by 9.8 percent to P12.5 billion from P11.4 billion in the same period last year due to higher net profit margin at 51.7 percent.

3| Know the risk and opportunities

SGP plans to use the proceeds from the follow-on offering to invest in the NGCP through issuance of the non-voting preferred shares.

NGCP plans to use the funds from SGP to finance its capital expenditure requirements and other related expenses as required by its concession agreements.

NGCP will need to spend P160 billion of capex requirements from 2021 to 2025 to support its large generation capacity additions, while maintaining its system reliability.

SGP has a manageable debt-to-equity ratio of 1.4 times with about 40 percent of its total assets financed by debt.

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This leverage translates to high average return on equity for the past three years at 27 percent, although this year, based on trailing income, its return on equity may be slightly lower at 25 percent.

NGCP has also been distributing dividends regularly for the past three years with a high average dividend payout ratio of 71 percent.

If we assume NGCP to pay only 50 percent of its net income this year, which we project to be at P24.5 billion, we can estimate that SGP, by virtue of its 40.2 percent economic interest, will receive around P4.9 billion.

If SGP will declare the P4.9 billion as cash dividends next year, the dividends will represent a 7.8 percent yield at follow-on offer price.

4| Know the pricing multiples of the stock

If we take NGCP’s last 12 months net income from June 2020 to June 2021, we can estimate its trailing income at P24.5 billion.

By multiplying SGC’s 40.2 percent economic interest in NGCP, we can derive its net income at P9.8 billion.

Using this actual profit figure against SGP’s market capitalization at follow-on offer price, we can estimate its Price-to-Earnings (PE) ratio to be at 6.42 times only, which is attractively very low compared to market average of 18 times.

The other way to price it is by the use of Enterprise Value-to-EBITDA (EV/EBITDA) ratio.

To derive SGP’s Enterprise Value, we can simply add its market capitalization, its total debt and the other controlling interest in NGCP minus cash to get a total of P196 billion.

By comparing this value against its actual EBITDA of P40 billion, we can derive SGP’s EV/EBITDA at only 4.92 times.

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Again, this ratio is appealingly low considering that the average EV/EBITDA of the power industry is around 12.8 times today.

5| Know the intrinsic value of the stock

It has been said that a company creates value for its shareholders when it generates a return on invested capital (ROIC) that is higher than its weighted average cost of capital (WACC).

The higher the residual spread between a company’s ROIC over its WACC, the higher the share price of the stock should be as reflected in its high Enterprise Value (EV) to Invested Capital (IC) ratio.

In theory, the ratio of ROIC-to-WACC should be equal to EV-to-IC ratio so that when a stock’s ROIC-to-WACC is higher than its EV-to-IC ratio, it means that the stock is undervalued, and vice versa.

If we apply this theoretical valuation to SGP, we will find that the stock has ROIC of 11.1 percent against its WACC of only 7.3 percent, which is very good.

An ROIC higher than the cost of capital means the company is healthy and growing, while an ROIC lower than the cost of capital suggests the company is unsustainable and destroying value.

If we take the ratio of SGP’s ROIC-to-WACC, we will derive a multiple of 1.53 times.

At SGP’s IPO price offer of P12 per share, SGP’s projected Enterprise Value is estimated at P196 billion.

If we compare this against the SGP’s invested capital of P272 billion, we will derive an EV-to-IC ratio at only 0.72 times.

Because SGP’s ROIC-to-WACC ratio at 1.53 is higher than its EV-to-IC ratio of 0.72, the stock is deemed very undervalued.

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If we equate SGP’s EV-to-IC ratio to its ROIC-to-WACC ratio at 1.53 times, we should theoretically derive target market capitalization for SGP at P270 billion or P64.2 per share.

 

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