Description

Thesis

Green EU asset trading at a substantial discount to its value. Fondul Proprietatea’s (“FP”) largest asset, Hidroelectrica, which is Romania’s largest electricity producer and one of the largest hydroelectric energy producers in the world, will IPO by H1.23 at the end of a multi-year process. This unique green EU asset is 80% of FP’s NAV. FP is trading at 30% discount to the stated NAV and at a 40-45% discount on a conservative IPO valuation. FP will sell a majority of its Hidroelectrica position in the IPO and return cash to shareholders. Expect 50%+ return as the discount narrows substantially as the vast majority of FP’s unlisted assets are transformed to cash over the next year.

Investment Summary

Fondul Proprietatea is a Bucharest stock exchange listed closed end fund (FP RO) with a GDR (50 shares) listed in London (FP/ LI). FP owns 24 private companies in Romania and a few listed ones. It has been managed by Franklin Templeton for over a decade. The GDR is in $USD, trades at $20, and the last NAV is over $29. 

FP owns 3 assets which are large enough in NAV to mention:

• The premier asset, Hidroelectrica, currently unlisted, accounts for 78% of FP’s Net Asset Value (“NAV”) and is the only asset that matters for the investment case. FP owns 19.94% of it, with the rest of it owned by the Romanian state. 

• Aeroporturi București is ~4% of NAV, unlisted. This is the operator for the main international airport in Romania (OTP). We think this valuation is low on a COVID-recovered basis and detail it briefly below as part of our upside case.

• OMV Petrom (SNP RO) is a large oil and gas E&P with significant downstream operations and upside from the development of the Neptune Deep offshore project in the Black Sea which is strategically important. It accounts for roughly 5% of NAV, is listed on the Bucharest stock exchange (with a GDR in London), trades at <5x PE and has a substantial net cash position. FP has been selling this position down over time (owns roughly 3% of the company), and this will probably continue. The asset is very cheap but we are just using the listed value here.

• The remaining assets ex-cash account for about 10%, seem reasonably valued, and are not a risk to the thesis.

Hidroelectrica is an irreplaceable asset. It is the country’s largest electric generator accounting for 25-30% of annual power supply, main provider of grid system services (reserve power), the low cost producer (e.g. 130 RON/MWh), and the largest state-owned company. The company has a producing capacity of roughly 6,400 MW with roughly 200 hydro assets. The most important asset complex is Porţile de Fier I (1100 MW) and II (220 MW) on the Danube river but there are other large river installations (Ciunget-Lotru, Raul Mare, Somes, Vidraru, Bicaz) of over 200-600 MW each.  

Profitability is very high. In the last five years, the average EBITDA margin has been 72% in a narrow range of 70-73%, with 80% of it paid out in dividends. The increase in revenue and EBITDA from recent high electricity prices in Europe have been offset by two factors. First, hydrology this year is reduced due to the drought in Europe with production -30% y/y as of H1. For the full year, we expect some volume recovery in H2 for 13.7 TWh of electricity sold vs the average amount of over 16 TWh/yr with a high of 18 TWh. Second, the Romanian government introduced a temporary windfall tax earlier this year at 80% above 450/ MWh (expires in 2023). These regulations are in flux and may change again. The windfall tax was roughly 8% of revenues in H1.22. Despite these two effects, H1.22 EBITDA reached 3500m RON with a 73% margin. For 2022 as a whole, we are assuming 13.7 TWh and 575 RON/ MWh (i.e. 117 EUR, flat realized prices vs. H1), meaning EBITDA will conservatively reach 6,300m RON. 

It is important to note that the vast majority of production is forward sales (e.g. 75% in ‘21), with the rest being day-ahead and balancing sales. Thus, a lot of the power for ‘22 was sold in ‘21 at lower prices. Romanian forward prices for 2023 as shown by OPCOM are currently 870 RON/ MWh but the day-ahead and balancing sales are done at much higher prices. Romanian forward electricity prices have historically been tightly correlated with the German forwards, which are currently much higher (400-500 EUR/MWh for ‘23) and do not drop to the low 100s EUR for years. Conservatively assuming that realized prices stay unchanged for ‘23, but with production increasing (to still below average), they sell 15.5 TWh and get to an EBITDA of over 7,000m RON (continued windfall taxes), 15% growth y/y, which is mostly due to the rebound in hydrology. This is probably a reasonable EBITDA estimate for the next couple of years. At this level, we think Hidroelectrica will generate roughly 5,200m RON in profit, or $1.85/GDR for FP. So at the current FP price you’re getting one the largest green electricity producers in the EU, with net cash, for 11x PE by itself, plus stakes in more than two dozen other companies. Verbund (VER AV), the best EU comp for Hidroelectrica, is currently trading at 14x PE on ‘23 with a 5 year average of 28x.

Maintenance capex has been low (<200m RON/yr). The company has had various capacity-expansion plans over the years which would require increased capex but execution against these targets has lagged. Even assuming capex goes to 500m RON/yr, a potential dividend next year could be over 5,000m RON.

At the IPO, FP will sell the vast majority of its stake in Hidroelectrica, e.g. at least 15% of the 20% they own. This IPO will be oversubscribed given the scarcity of 100% pure renewable hydro assets in Europe. All of our conversations point to strong investor demand for this asset. The large consortium of banks involved suggests the same (names leaked in the Romanian press include Citigroup, Morgan Stanley, Jefferies, Erste, Barclays, Unicredit, Bank of America, UBS). The shares may trade initially just on the Bucharest stock exchange (a political decision), though FP and investors are pushing for dual listing in London, which will eventually happen. You can buy close to a pure-play exposure in Hidroelectrica today either via the FP GDR or the local FP stock in Romania, at a large discount. Combined liquidity is admittedly low at <$2m/day. 

Management

Franklin Templeton has managed FP since 2010. They have done a good job over the years, led by an excellent local team, using both a cooperative attitude of encouraging professional management appointments and educating the political leadership, but also lawsuits along the way to keep the state in check and preserve the shareholder value. A recent example of this was fighting a bureaucratic decision (using incorrect land valuation assumptions) to attempt to increase the share capital for Baneasa airport (a smaller subsidiary of the main airport asset), which would have diluted FP’s shareholding in the asset. 

Through a combination of constant buybacks, tender offers, and distributions (regular and special dividends), they have maintained a 15-20% annual distribution yield to FP shareholders over the years. The total return for local FP shares is roughly 6x since Templeton started managing the fund. They have been pursuing the IPO of Hidroelectrica for a number of years and received the government’s final go-ahead in April ‘22, in line with a commitment deadline of 6/23 which the government made to the European Commission during COVID in the country’s Recovery & Resilience Plan. Templeton has also pursued a correct strategy of revaluing Hidroelectrica more often, and higher, in the last year, to converge the existing NAV to a more reasonable and likely IPO valuation.

The CEO of Hidroelectrica, Bogdan Nicolae Badea was appointed in 2017. He is an engineer by training and came up through the political ranks in the PNL party and had various positions in the energy sector prior to Hidroelectrica. He is an able technocrat and a good manager. We think he knows the business well, presents well, and has discussed regulation and political risk honestly in the past. The current coalition government has supported the listing and gave the final green light earlier this year. The PNL party is pro-EU and a consistent ally of the US. Generally all parties want a more developed capital market and increased foreign investment, and view the listing of Hidroelectrica as a potential stepping stone. 

In terms of shareholders, 16% of FP is owned by 2 large Romanian pension funds. They will be large natural buyers of the Hidro IPO. 9% is owned by Silver Point. 6% is owned by the Romanian Ministry of Finance which took this stake earlier in ‘22 in advance of the IPO (by paying for prior unpaid shares of the Romanian state). 

Valuation

Our base case for FP is $32/share, or +60% from the current $20 GDR price. The Hidroelectrica IPO catalyzes the closing of the discount to NAV as close to 90% of NAV will be in cash and publicly-listed stocks, which FP will distribute to shareholders. We hold all other investments at the July ‘22 NAV values, but increase Hidroelectrica by 15% to 14.5B RON, which is 11x EV/EBITDA on our ‘22, or 10x on our ‘23, plus cash. In terms of Hidroelectrica multiple, the best comp is Verbund (VER AV), which has >1x net debt/EBITDA, and is currently trading at the lows of its historical ranges at 12x EV/EBITDA on ‘22, vs. a normal of range in the high teens, in part due to the same windfall tax uncertainty. Because of the broad reach and political consensus around these taxes, and Romania’s membership in the EU and NATO, it seems to us that Hidroelectrica has roughly the same geopolitical risk as Verbund at this point, thus a further discount is not warranted.

Looking at it on an installed basis in dollar terms, our base case values Hidroelectrica overall at $14.2B EV which is $2200/kW (capacity of 6400 MW), or roughly half of Verbund’s valuation which is approximately $4,200/kW ($37B EV on 8,300 installed MW of hydro which is 93% of production).

Our upside case for FP is $37.5/share, or +85% vs. the current GDR price. In this case, we make two changes to the July ‘22 NAV values. First, we value Hidroelectrica at 13x EV/EBITDA on ‘22, as EBITDA grows double digits next year, there is a scarcity of pure renewable assets, and the company has a net cash position. Second, we mark up the airport by 90% for an incremental ~4% of NAV. Pre COVID, airport traffic was growing +HSD% per year (~15 million passengers) and the asset was generating close to 600m RON of EBITDA. At a reasonable 11x of this recovered EBITDA (EU comps with significant leverage trade at 9-13x), their 20% stake is easily worth 1.32B RON, or ~2x the last NAV mark of 700m RON. (As another data point, the NAV mark on the airport was over 1.0B RON at the end of 2019.) The airport will also eventually be IPOed but plans were derailed by COVID. 

Nuclearelectrica is another Romanian state-owned utility which operates 2 nuclear reactors and supplies 20% of the country’s electricity needs. This company is listed on the Romanian stock exchange (SNN RO) but we do not think it is a good comp for Hidroelectrica. It trades at much lower multiples as it has two significant problems. First, reactor 1 will undertake a 2-3 year maintenance shut-down, starting in 2026 or 2027, which will cost close to 2B EUR and take 10% of the country’s electricity supply offline, and this will be a substantial benefit for Hidroelectrica. Second, they are planning the build out of 2 more reactors (units 3 and 4), with another multi-billion dollar price tag. An interesting tidbit though: Nuclearelectrica stock price is up 6x over the last five years (since 12/17) vs. Hidroelectrica’s NAV increased only 3.5x over this period.

Risks

• Political changes. This is a day to day risk but it’s significantly mitigated as the coalition government has committed to the IPO and signed a deal with the EU to get it done by H1.23

• Realized prices/ MWh fall due to either further changes in windfall taxes or forwards coming lower. Mitigants: Windfall taxes are already implemented in Romania and are in the realized prices and results so far for ‘22. Our forward price assumptions are flat at ~117 EUR/MWh, well below forward prices for several years. Upside from production from a very low ‘22 hydrology year drives all of our incremental gain in ‘23

• Geopolitics: Romania is in NATO and the EU. Not a significant risk.

• RON exposure: you can hedge out the RON or, cheaper, the EUR, as electricity prices in the country are driven by the European market

Catalyst

Catalysts

• Hidroelectrica IPO is planned by Q1.23. A large consortium of banks was just approved in early September. Roadshow in Romania is going on now. Monetization of stake to cash and return to shareholders closes the discount to NAV. Note that the discount was close to 0% for most of 2021

• Pre-IPO, continued buybacks/ tender, and special dividends with excess cash at Hidroelectrica and other portfolio companies. Likely continued increases in Hidroelectrica NAV