21 September 2005
Nairobi — Audit firm Pricewaterhouse- Coopers has warned in a confidential report that sophisticated institutional investors may find KenGen shares unattractive if a revision of the tariffs and terms under which the company sells electricity to the Kenya Power and Lighting Company is not done before the offer of shares to the public.
The power giant, one of the most valuable parastatals in terms of profits, is planning to off-load by the end of the year, 30 per cent of its shares in one of the largest privatisation transactions in the country's history. It is expected to raise for the state coffers, a whopping Ksh10 billion ($135million)
PWC, which has been retained by the government as advisers on the transaction, argues that potential investors may be reluctant to put their monies in shares of the company if they are not able to predict its future revenue streams.
Currently, KenGen does not have a long term contract stipulating the tariffs it will receive from KPLC - its only customer. As a matter of fact, the two companies have been operating under terms of a power purchase agreement signed for the first time as far back as 1999 and that was originally meant to last for only two years.
Although the agreement has been extended and modified several times, the tariff remained more or less at the same level until April this year when the government prevailed upon KenGen to reduce it from Ksh2.36 per KWh to the current level of Ksh1.76 per KWh.
In its report, PWC says that without a long term power purchase agreement, it will be difficult for incoming investors to assess KenGen's future revenue streams with a reasonable degree of certainty.
The audit firm says that the uncertainty about future tariff levels is accentuated by the fact that KenGen has in the past agreed to reduce its tariffs to help KPLC resolve its financial difficulties.
It adds that when sophisticated institutional investors compare KenGen's situation with that of its peer electricity distribution companies, they unlikely to be impressed.
The report further argues that the absence of a long term power purchase agreement may also affect valuation, pointing out that investors were likely to value KenGen's shares at lower valuation multiples than applied to similar generating companies with long term power purchase agreements in place.
In the worst case, it would mean that certain investors, particularly institutional investors, would choose not to participate in the offer," it says.
The reports adds, "We strongly suggest that KenGen should finalise a fully-timed power purchase agreement before the offering for sale even if the effective date of the new agreement is set at some point in the future."
But the managing director of KenGen, Mr Eddy Njoroge, told The EastAfrican that while the company was yet to sign a long term power purchase agreement, the issue was not as critical as assumed by the advisors. He said the agreement in place was good enough to guarantee predictable incomes to potential investors.
He added that the PWC report was a draft reflecting the very initial impressions of the advisors which were subject to review after further discussions and that they were yet to produce a final report which would include some of the issues raised in the draft report.
The advisers have also recommended several other changes which, in their view, will need to be made in the company's share capital structure to make the planned Initial Public Offer more attractive to institutional investors. Two specific issues are raised in this regard. First, is the status of a huge government debt which was converted into equity in the year 2003, and second, a large number of preference shares which the company owns in KPLC.
In September 2003, the government, through a cabinet resolution, approved the conversion of debt amounting to Ksh15.8 billion) ($210m) into equity in the company.
The debt is currently classified under shareholders' equity as "funds awaiting allotment of shares." However, KenGen has so far not allotted the new ordinary shares to the government. PWC says that the allotment of Ksh15.8 billion ($210m) new ordinary shares at par value will require the company to increase its authorised share capital by 787,804,241 ordinary shares.
The transaction advisers have recommended that the company allots 100,000 new ordinary shares at a premium to the government in lieu of the Ksh3.5 billion ($47m) of the debt. The balance of the debt of Ksh12.3 billion ($166m) they suggest, should then be used by the government to purchase the company's preference shares in KPLC, paving the way for the company to assign its rights to the preference shares to the government.
PWC says that the government committee which is steering KenGen's privatisation has accepted the recommendations and written to the Ministry of Energy asking the government to accept the recommendations and approve them.
The shares owned by KenGen in KPLC arose from a separate cabinet resolution in September 2003 which approved the conversion of Ksh12.3 billion ($166m) that was owed to KenGen.
The shares do not have voting rights and are redeemable at the option of the issuer (KPLC). They can only earn a dividend before July 1, 2009 and only if KPLC makes a post tax profit of Ksh2.8 billion ($37m)
Also featuring in the report is the issue of transfer of assets on separation or generation from transmission and distribution of electricity.
PWC says that when the exercise was undertaken by the government between 1997 and 2000, not all titles to the generation assets were transferred to KenGen even though the company took "ownership" of the assets. The advisers say that the situation needed to be regularised and concluded before the offering for sale of KenGen shares.
Included in the list of hurdles which PWC says have to be cleared before the IPO is the matter of the KenGen staff pension fund. The company operated a joint defined benefit scheme, the KPLC Staff Retirement Benefits Scheme, with KPLC until December 31, 2000.
Thereafter, the two companies agreed to go their separate ways and to apportion the assets of the KPLC pension scheme and the accrued liabilities as at December 2002.
Consequently, KenGen registered its own defined benefits scheme for its employees. An actuarial valuation for the apportionment of assets and the accrued liabilities between KenGen and KPLC was done and assets assigned to the two separate schemes.
However, the assets assigned to KenGen Pension Scheme at the time of the split have not yet been transferred to the scheme. PWC has noted in its report that the KenGen pension scheme does not have access to income generated by assets assigned to it.
PWC reveals that an actuarial valuation of the KenGen pension scheme as at December 31 2002 revealed an actuarial deficit of Ksh1.16 billion ($15m) and the level of funding for retirement benefits obligation at 52.9 per cent.
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