Wednesday, 26 September 2018

Power M&A in the Gulf

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The sale of the AES Oasis portfolio was a drawn-out saga but as the power sector grows in importance in the Gulf, it can be seen as an important trailblazer. By Rod Morrison.

Four assets developed by AES and its partner in the AES Oasis joint venture, the Islamic Development Bank Infrastructure Fund under a 68/32 split, were put up for sale in May 2009 – Barka 1 in Oman and Almanakher in Jordan plus the Lal Pir and PakGen assets in Pakistan. Ras Laffan A in Qatar was developed solely by AES and it was decided to sell this holding separately.

AES had decided to pull out of the power development business in the Gulf. Citigroup and HSBC were appointed to advise. Initially, sales price targets were high with US$1bn mentioned, given that the portfolio had free cashflow of US$180m pa. But the sales process proved a lot more complex than expected and the expectations were too high in any case. And just as the sales were agreed, AES received a 15% equity injection from China Investment Corporation – and is now back bidding for Gulf projects.

By the end of 2009, Barka and the Pakistani assets sales had been announced – to Saudi developer Acwapower and Pakistani conglomerate Nishat Mills respectively. But the 370MW Jordanian asset was taken out of the portfolio sale. There were said to be issues with the project’s debt funder JBIC, which wanted the plant to have a year’s operating track record before being sold on. 

This showed up a key issue in the Gulf power market – most power assets are owned by a consortium. In many cases, the owner is a mix of the private and public sectors. Selling individual stakes can therefore be tough. In the case of Almanakher, it is 60% owned by AES Oasis and 40% by Mitsui. And it was not Mitsui that stopped any sale, it was the debt funder linked to it.

With AES’s change of heart over the Gulf, it now appears to be keeping its stake. The Islamic fund has decided to push ahead with selling its stake on its own – now the plant has an operating history. NM Rothschild has been appointed to advise.

The Ras Laffan A asset was held in the more traditional private/public sector joint venture. AES simply sold its 55% holding in this scheme to its public sector partner, QEWC, for US$181m.  The scheme has 756MW of power and 40m gallons a day of desalination capacity.

By contrast, the sales process was simpler in Pakistan where AES Oasis held nearly all the assets, 90% of both AES Lal Pir and PakGen. Nishat Mills paid US$117m for the 362MW and 365MW oil-fired assets, with the sale being finalised in June this year. Luckily for AES Oasis. By August, the two plants were under water due to the natural disaster that hit the country.

The Barka asset, in the end, was the only part of the AES Gulf portfolio sold on the open market. Perhaps surprisingly, given the Gulf power development market has been active now for a decade, there has been little power project M&A activity.

There had been a small asset sale in 2009, when HSBC’s MENA Infrastructure Fund won the competition to buy Suez’s Manah plant in Oman with a bid of about US$40m. The scheme totals 270MW and was one of the first IPPs developed in the region in 1994. In addition, the project includes 180km of transmission lines. Suez sold 33% of project company United Power Company (UPC) and 60% of the operating company.

But Barka is a more up to-date plant, whereas Manah was a one-off in its time. And Barka included both power, 456MW, and desalination, 20m gallons a day. Yet it is interesting that both Manah and Barka are in Oman. Interesting because, under the Omani power procurement model, at least 35% of the project company has to be floated on the local stock market.

AES Oasis held 58% of Barka, with 35% of the equity held on the local stock market and 7% by Multitech. The sale to Acwapower was finalised in August this year for US$205m. Subsequently, Acwa is onselling 8% of the asset to local infrastructure fund Instrata.

The key to the Barka deal, as in all other current Gulf power projects, is the power (and water) purchase agreement. Another reason why there has been little power M&A activity in the Gulf is that the market has been driven by its contractual nature. All the schemes developed over the past decade are backed by long-term contracts from state utilities.

This is a good model for developing projects and creating competitive tension between the bidders and their suppliers. But it is not so good for creating market flexibility. Indeed, a recent report from consultant Booz Allen pointed this fact out – and recommended a less contractual and more merchant style market be adopted with a greater range of non-baseload plants to be developed.

The PWPA in Oman is shorter than most other power markets in the Gulf at 15 years. This presented a significant challenge to any bidder. Barka’s PWPA runs out in 2018. In addition, Barka has its own unique characteristics following a refinancing of its project finance loan in 2006. Under the loan’s terms, a cash sweep of 95% of the revenues after debt service kicks in from 2012 to 2017, leaving just a “trickle” dividend for the owners from 2012 onwards.

But post-2017 Acwapower decided, in its bid evaluation, that while the Omani government has talked about moving to a more deregulated market, a fully merchant market would not be put in place. And indeed, on the existing power assets in the country, it believes the PWPAs could be renegotiated and extended.

This would provide big upside potential for Acwapower and the other investors, post-2018. By then the project debt would have been fully paid off and the project company would have the freedom to negotiate a new tariff structure – with no banks to worry about. And perhaps with a new PWPA, leverage could be reintroduced.

Acwapower International’s chief financial officer Rajit Nanda said it was the robustness of the Omani power sector law that went along way to providing comfort to Acwa’s bid. In addition, Acwapower carried out a third-party market study to understand the tariff potential in case a merchant market was established, “which established the competitiveness of the Barka plant in the Omani grid”.

Acwapower could, of course, have chosen to restructure the project debt to increase dividend flows now. But the loan, which has US$240m remaining to be paid off, is very cheaply priced at 65bp stepping up to 90bp from the pre-credit crunch days. It has a debt service cover ratio of 1.2x. Credit Agricole arranged the deal.

Given the contractual nature of a PWPA backed deal, various change of control constraints were required in order for Acwa to buy the plant. The sale process took some time – eight months from the time it was announced in December 2009. Consents were needed from the Omani Authority for Electricity Regulation, the project finance lenders, the local stock exchange, given that the company is quoted, and from the customer, the Oman Power & Water Procurement Company (OPWP). In addition, AES Oasis had a company holding structure offshore on the Cayman Islands.

An important feature of Gulf power deals is the operations and maintenance (O&M) component. Some investors have recently discovered that their equity returns were lower than they would have assumed due to the fact they were not involved in the O&M side of the deal. With the Gulf power procurement model producing tight bidding situations, the long-term O&M area is one that can still leave some juice for developers.

On Barka, the project company is responsible for the O&M. But Acwa wanted to use an owner-operator model instead, whereby the O&M is carried out by a separate company that it will own 100%. Acwapower is currently establishing a new subsidiary to undertake the O&M and all the existing O&M employees will be transferred to it with no adverse impact on their monetary benefits.

By buying Barka and obtaining the O&M presence, Acwa now has a foothold in Oman, one of its key target markets. Indeed, it could have been a double strike for the company this summer in Oman as Acwa fought hard for the Barka 3 and Sohar 2 power deals. But in the end these went to GDF Suez (see separate article in this supplement). GDF was pushing equally as hard for B3/S2, and indeed the Manah sale occurred because Suez was required to sell the asset before bidding for the new bigger 1,500MW scheme.

Acwa, however, lives to fight another day. It will be bidding for the next Omani scheme, the 1,500MW Sur asset. Suez will be precluded from bidding. But nevertheless the competition will be tough. And guess what, one of the bidders will be AES.

It can be expected that more asset sales will take place in the Gulf power market. NM Rothschild is expected to send out an info memo on the Almanakher Islamic fund sale shortly, once various reports on the plant’s first year in operation have been completed. That will be a fairly small sale given it will be for 28%.

But after that, it is possible that the merger of GDF Suez and International Power could lead to the need for asset sales in the Gulf. The new company might need to rationalise its portfolio in countries where there is an overlap – such as Oman and Abu Dhabi.

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