YTL Power - value share or value trap?

Executive Summary

- The management of YTL have a great track record in earning accretive acquisition. 

- The conservation of cash is to fund growth or reduce debt

- Share is trading at a lower band of historical valuation

- Short Term pressure on price in last few months due to reduction of dividend and sale of discounted warrant likely to ease.

- Francis Yeoh thinks YTLP is undervalued and is looking to privatise it

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YTL Power's share price performance has been dismal for the last 12 months, its current price is comparable to those during the 2009 GFC. Is this valuation justified or is the share undervalued?? Is it a value share or a value trap?

Looking at the segmental level one can see that there is a considerable drag on their recent earning. In the FY ending June 2012, total loss attributable to the telecommunication startup is over RM 300 million. 

Taking their most recent Q1 result and extrapolating an annualised figure to estimate their annualised earning for 2013. My expectation is for YTL Power to report an earning of approximately RM 1.3B or 0.18 cents.

A copy of the segmented spreadsheet is available here.

Based on historical Y/E PE range of 9.2 to 11.28, the expected price range would be 1.66 to 2.03. The industry segment PE according to reuters is 14.31, giving a share price of 2.58.  

Based on hsitorical trading range of 10x-16x PE, YTLP's share is worth RM1.8 to RM2.88

A) Factor contributing to price decline

i) STARTUP LOSSES AT YES

As highlighted above, the operational loss attributableYTL Yes contribute to a loss of RM 307 M in the financial year ended June 2012. As of the most recent quarter the loss is RM 61 million (cf. RM 90million+ loss in Q1 2012)

Based on reduction in current quarter loss, I expect the loss attributable to the telco segment to reduce to RM 242 M compared to RM 307 M in the previous year (based on a conservative annualised Q1 loss)

Bestarinet - RM 4.5 billion award

Looking at the revenue increase for the YES segment, one can imply an increase in take-up for the product by the end user. The boost offered to the segment by the 1Bestarinet contract valued at RM 4.5 billion is also expected to help cushion against losses in this segment.

LTE?

Other catalyst for the reduction of loss in this segment could be the implementation of LTE on YTL's network. Currently YTL operates its YES network on the WIMAX spectrum. In the technology war for the 4th Generation network, it appears that WIMAX is losing. The biggest supporter of WIMAX is Sprint Nextel, and they are getting rid of WiMax and switching everything over to LTE. 

Francis Yeoh has conceded the willingness of Yes to roll out the LTE network. Based on other quotes attributable to YES' management, it appear that their is ready for LTE too. P1, whose network operates on WIMAX, demonstrated a live Wimax-LTE TDD network to media during a demonstration in April 2011. YTL operates with the same technology on the same spectrum.

Based on my understanding, the demonstration by P1 illustrate that it is possible based on current technology to have both LTE and WIMAX on the LTE TDD spectrum currently utilised by YTLP. This technology will allow switching between WIMAX and LTE just like current switch between EDGE and 3G.

Hence the current early adoption of Wimax by YTL won't impede their ability to later transition to LTE  (technology being adopted by Digi, Maxis and Celcom) but would rather allow them to switch their LTE network on at a time when they have coverage competitive with the major telco.

Currently Maxis and Digi have an approximate market capitalisation of RM 52 Billion and RM 41 Billion respectively. YTL Power have a market cap of RM 12 B. Ponder on that.

(Yes, Greenpacket have a measly market cap of RM 318 million. But they don't have the financial strength to built up a network that's competitive to the major telco and I think YTL's track record in executing engineering job shows that they have proven execution history.

It is not that unthinkable that with a competitive network, YTLP will gain a sizeable slice of the telco pie from the incumbent thereby creating a new cashflow stream for shareholder willing to invest in this growth story.

The current discount to YTLP's valuation due to the start-up loss will not continue indefinitely. On a worst case scenario, YTLP can discontinue its telco network (thereby stopping the operational losses) and sell its asset (including mobile spectrum). 

ii) DIVIDEND PAYOUT REDUCTION

Dividend has been reduced  to 0.9375 cents/share (3.75 cents annualised) in its latest quarter from a 4 year historical average (2008-2011) of 12.69 cents (based on financial highlight extracted from its annual report above).

Based on historical financial statement and analyst forecast, it is not disputed that YTLP's stable of asset has a track record in cash generation ability. The reduced dividend payout is a management decision and not forced upon them by their inability to generate cash.

Currently YTLP despite its investment into YES, managed to increase its cash pile to over RM 10 Billion (as at Sept 2012). Analyst believe that the management is conserving the cash for more M&A opportunity. 

As outsider, we are unable to ascertain what is the true intention of the management in conserving the cash. 

However,  YTLP was previously known to be a reliable dividend counter, having changed its payout outlook, investor with preference for dividend yielding stock would have been abandoning the stock in drove, further contributing to the price decline. 

However, for investors with a longer time horizon and a growth focus. The conservation of cash by YTLP for M&A is a positive growth signal given their track record for earning accretive acquisition.

Potential target for cash utilisation by YTLP? - (purely speculative)

Jordan Oil Shale Project

In Dec 2010, YTLP announced a JV with Eesti Energia of Jordan to jointly develop an oil shale project in Jordan. The total project cost is US$5 billion and YTLP have a 30% stake in the JV. 

The total exploration and production rights under this concession agreement gives a 40+10 years exploration and production right to 2.3 billion tons of oil shale. 

There don't seem to be much update on this Jordanian project since but based on the information available on the partner's website it appear that the project is ongoing. The first operational phase of the project will be a Oil Shale Fired Power Plant for 460W to be operational by 2016 - see recent news. 

YES
Already ongoing, but yet the cash pile is growing.

Train to Singapore?
Long shot. YTL have been dreaming about this rapid train service since 2006. A preliminary costing of RM 8 billion was then provided by YTL. It has been reported that a feasibility study is being conducted by SPAD and the report will be submitted to the government in Q1 2013.

No guarantee that the project will be given the green light and even if it does whether YTLP will have a position in the consortium to develop the project. However given the closer G2G relationship between Singapore and Malaysia in recent time, it is certainly possible and since YTL have a proven track record in managing/executing the ERL project - they will be given a seat on the project.

iii) SALE OF WARRANT TO YTL SHAREHOLDER @ RM 0.20 (RM1.21 CONVERSION PRICE)

- In the 3 months prior to the announcement of warrant entitlement, YTLP shares was trading at a range between RM 1.70  to RM1.82. 

- On 18 Sept 2013 YTL announced an offer to sell up to 733,079,172 warrants in YTLP to its existing shareholder at a 61% discount to the 5 days weighted average market price of RM 0.513. 

- The entitlement date is 2 October 2012.

- In the 3 months since grant of warrant to YTL's shareholder, the share price of YTLP fell to a low of RM1.50 finding support. 

- The conversion price of the warrant is RM1.21 on a 1:1 ratio. 

- The sudden supply of discounted warrant will place a downward pressure on the price of its mother share even without any change in its operational outlook. 

IV) INDEPENDENT POWER PRODUCER EXPIRY

The PPA is likely to expire in 2015. So far, YTLP has been unsuccessful in its bid for any of the new PPA and even if it succeed, the terms are likely to be less favourable than it is now. 

Based on my 2013 earning estimate of RM 200 million, the discontinued earning from the PPA in 2015 is likely to be offset by reduction in losses by the telco segment. 

B) Potential catalyst?

Other than those highlighted in discussion above (reduce losses from YES, Jordan, M&A), another obvious catalyst for YTLP would be its exposure to GBP. 

Revisiting the segmented earning result above, it would have been clear that Wessex concession's earning contribution has been declining over the last few years (approximately 20%). At the same time GBP has fallen from 35% since 2008.

CONCLUSION

- The management of YTL have a great track record in earning accretive acquisition. 

- The conservation of cash is to fund growth or reduce debt

- Share is trading at a lower band of historical valuation

- Short Term pressure on price in last few months due to reduction of dividend and sale of discounted warrant likely to ease.

- Francis Yeoh thinks YTLP is undervalued and is looking to privatise it - 

News Report - 1, 2,

My personal opinion is that YTLP is very cheap by historical standard. It has got proven execution record, earning accretive acquisition, strong/consistent cashflow generation ability. Its current market cap of RM12 Billion is extremely undemanding!

Given Yes' potential to be a full fledge telco, it should be given a higher PE given its growth potential.

If I were a conspiracy theorist, I would believe the reduction in dividend and the flooding of cheap warrants is an attempt by the management to push lower the price to allow for a cheaper privatisation! However, given the religious nature of its management, I would doubt they will resort to such unethical tactic to defraud the average retail investor.