Snowy float sure to spark interest - Business - Business - smh.com.au

THE Government may be having all kinds of trouble trying to work out how and when it will move to full privatisation of Telstra but the foundations are set for a speedy sale of one of Australia's engineering showpieces, the Snowy Mountains Hydro electricity asset.

The $3 billion IPO is set down for May and trading is set to start by the end of June. As marketing hasn't officially started yet, we haven't got the sales story that will argue the case about why we should buy shares.

It's a float that will capture the interest of the baby boomers that learnt about the great engineering feat in the Snowy Mountains at school, when the scheme was being built. As retirees, this group is always on the lookout for generous-yielding asset plays.

And had the NSW Government not stepped in and decided to limit the number of shares any person or organisation can buy, then Snowy Hydro would be a pretty attractive investment for anyone's portfolio.

One needs only to consider the AGL/Alinta takeover frenzy to see that there would be plenty of corporate interest in Snowy Hydro if others were allowed to buy it.

Without any prospect of a takeover premium, this stock's share price will only ever reflect its expected earnings growth.

This is an interesting story in itself. The general sales pitch will be that Snowy Hydro is an efficient energy producer with fabulous infrastructure that cannot be duplicated and one that produces and sells electricity at higher margins than other electricity generators.

The margin premium is the result of selling much of its power at peak times, which generally attracts a higher price. It sells at times when usage is high, such as in the early evening or on hot days when everyone turns on their air conditioning.

The reason it can sell at peak times is because its production is flexible. Unlike coal- or gas-fired electricity generators, Snowy Hydro's water-power generation can be turned on and off at the flick of a switch and send electricity down the line to retailers within 90 seconds.

But it doesn't sell the majority of its electricity into this peak spot market. Most of it is sold to electricity retailers like AGL and Sydney Electricity, which buy it to hedge their future supply needs without paying the spot price.

To manage the risks associated with producing and selling electricity and smooth its revenue, Snowy uses a variety of financial instruments. Swaps and options are typical of these derivative instruments but they are transacted within prescribed markets and credit risk limits.

However, revenue and earnings can still be somewhat volatile, with its net profit in 2005 of

$147 million well down on the $158 million it earned in the previous financial year.

It will be hoping that the hot summer we have just experienced sent a few more consumers out to buy air conditioning units.

There is undoubtedly a natural growth in the use of electricity that outpaces GDP but there is also quite a number of levers to manage to maximise revenue.

This is why the chief executive, Terry Charlton, talks about other ways to achieve growth within the electricity generation market. He reckons that expanding hydro-based capacity has limited potential but points to gas-fired peaking plants as the way to go. They cost $200 million to $300 million each and further investment in them is a reason for seeking outside funding via a stock exchange listing.

Charlton also talks about additional capital being needed to continue to develop the Snowy Mountains Scheme. He points out that parts of the scheme are 40 years old and must be maintained and in some cases replaced if the plant's performance and reliability are to be maintained.

"This is critical infrastructure with replacement value well in excess of $4 billion so it deserves tens of millions of dollars spent on it each year to stay in peak condition," he says.

Thus it seems that this company cannot be sold as a traditional infrastructure asset. It has risk and as such it will not be allowed to gear up to the levels usually associated with infrastructure assets.

It will also have some thirst for capital. In this respect it's more akin to an AGL or an Alinta - but won't trade on their current 18 times earnings multiples because there is no takeover potential.

However, the pricing of this float will have to be finely pitched. Too much and the investors will be disappointed and blame the Government - not a vote winner. If sold too cheaply it will be viewed as a waste of taxpayers' money.