Description

Summary

PPC (Public Power Corp. – PPC GA) is Greece’s incumbent state-owned electric power utility. Only 1.5 years ago, the company was on the verge of bankruptcy. But following an enormous transformation led by new CEO Georgios Stassis, PPC today is among the world’s most mispriced infrastructure assets (trading at 3.5x FCF) and is likely worth 4-5x its current price. The company is undergoing a slow-motion privatization and several catalysts are likely to highlight this value over the upcoming year.

Background

Brief electricity primer: electricity is generated, transmitted across long distances at high voltages, then distributed at lower voltages into our homes (and sold to us by retail suppliers).

PPC is 51%-owned by the Greek state (soon to change) and operates across the entire chain excluding transmission (which it divested in 2017). It has more than 11 gigawatts (GW) of hydroelectric, natural gas, oil, lignite, and renewable power assets and generates ~50% of Greece’s power. The company also owns HEDNO, the monopoly distribution grid spanning more than 240,000 kilometers in Greece, and its retail division supplies power to ~70% of the country (more than 6 million customers).

History

Early history: In 1950, the Greek government established PPC to utilize the country’s lignite (soft brown coal) reserves to provide low-cost power to its citizens. Although lignite has a low energy content and is highly polluting, it was cheap and abundant and became the primary fuel source for PPC’s power plants. At the same time, PPC constructed several hydroelectric plants to take advantage of Greece’s rivers. Between 1957 and 1963, PPC acquired the other electricity companies in Greece and became the country’s monopoly provider.

Recent history: PPC went public in 2001 following Greece’s entrance into the EU. Its value at the IPO was €2.8 billion, or $2.5 billion, and through 2007, the valuation climbed to €8.4 billion, or $12 billion. But the Great Financial Crisis devastated the Greek economy, and lower electricity demand and weaker power prices resulted in lower revenues. Furthermore, many customers struggled to pay their electricity bills, driving PPC to write off nearly €3bn in receivables. 

In addition to Greece’s internal woes, PPC had to contend with EU regulations. In 2005, the EU had enacted the Emissions Trading Scheme (ETS), requiring polluters to pay a tax on each tonne of carbon dioxide (CO2) they emitted. To allow an orderly transition to the more costly environment, PPC was initially granted CO2 allowances to cover its lignite power plants (which emitted between 1.25-2.0 tonnes of CO2 per megawatt-hour (MWh), compared to natural gas plants that emitted less than half a tonne). But beginning in 2013, no further allowances would be granted and PPC would have to pay the prevailing market price for all its emissions. At the time, each allowance cost €3-6 per tonne, but by mid-2019, the price had skyrocketed to nearly €30 (and today sits at nearly €45). PPC began to hemorrhage cash and teetered on the verge of collapse, but the left-wing, anti-austerity Syriza government that had taken power in 2015 would not allow the company to increase power prices during an election year. PPC was simply a tool of government policy, and expensive electricity bills didn’t win votes. 

In 2019, the New Democracy party led by Prime Minister Kyriakos Mitsotakis won elections and returned to power. Mitsotakis campaigned on a platform of tax cuts, privatizations, and reform of the pension and health care systems. He also argued that PPC’s viability was paramount, with a member of his party proclaiming, “PPC is not just a company. If PPC fails, the entire country fails.”

Management

As with any state-owned company during a government transition, the New Democrat victory yielded new leadership at PPC. In June 2019, Georgios Stassis was announced as PPC’s new CEO to replace Syriza’s 2015 appointee. Stassis was a civil engineer with a master’s degree in finance and had spent his career in renewable energy across Greece, Romania, Bulgaria, Turkey, and Egypt, where he was an Enel regional CEO. In 2016, he was appointed CEO of Enel’s troubled Romanian division.

Enel entered the Romanian market in 2005 with initial success. But over the following decade, the company lost market share to competitors and its relationship with the government deteriorated, resulting in several international arbitrations, tax cases, and even the suicide of the country’s general manager. The Romanian people believed that a big multinational company was profiting off the Romanian people, and the government lowered the returns Enel was entitled to generate. Enel began making plans to divest from Romania, but before formally doing so, the company appointed Stassis as the country’s CEO for one final attempt to improve the situation. Over the following three years, Stassis improved relations with all stakeholders, achieved improved regulation, significantly grew Enel’s customer base, and doubled the company’s earnings. As a result, Enel decided that it would no longer divest from Romania. Stassis’s work did not go unnoticed, and in 2019, he was selected to lead another turnaround, this time in his home country of Greece.

Transformation

With the entrance of Mitsotakis and Stassis, an enormous transformation began to take place at PPC. First, although the government was still the majority owner of PPC, a new law effectively decoupled the company from the state, allowing it to run as a private enterprise. Restrictions on executive hiring and remuneration were eliminated, procurement practices were modernized, and most importantly, the CEO was formally authorized by the board of directors to adjust power tariffs without a board decision. Furthermore, the government abolished the NOME law that Syriza and the EU had enacted in 2016. Named after its precedent in France, the law aimed to reduce PPC’s dominance in the energy market by requiring it to sell power to competitors at a price below cost. Finally, Mitsotakis surprised the United Nations Climate Action Summit in 2019 by announcing that Greece would entirely phase out its coal power generation by 2028, signaling PPC’s transition to a renewable company and further justifying the selection of Stassis as its CEO (the phase out has since been anticipated to 2025). For the first time in more than a decade, PPC and the Greek government were aligned in their vision to create a sustainable power company for the long-term.  

This alignment could not have come at a better time. In the twelve months through June 2019—just before Mitsotakis and Stassis would take over—PPC had negative €900 million of free cash flow. Given PPC’s newly granted autonomy, Stassis announced an immediate increase in power prices. Because the government had just reduced value-added taxes by an equivalent amount, end consumers would see little change in their final power bills but PPC’s earnings would increase by more than €400 million (the gross increase was closer to €500 million, but some customers would switch to cheaper competitors). At the same time, PPC incorporated a clause into customer contracts that would automatically adjust electricity prices if the CO2 price increased above a certain level. Historically, this had only been the case with medium- and high-voltage customers that represented a quarter of the company’s revenues. In addition, the cancelation of the NOME auctions would save PPC €200 million, and the decommissioning of the loss-making coal plants would increase earnings by €300 million. In total, PPC’s annual cash operating profit would surge from zero to €900 million in a little more than a year (excluding the company’s growth initiatives which would further increase this figure).

At the same time, the amount and nature of PPC’s capital expenditures would also change significantly. Two-thirds of this capex involved mining of lignite and construction of lignite power plants and was completely unproductive given the high cost of carbon. But with the plan to decommission these plants, these investments would naturally be eliminated over the following years. PPC would need to invest only €150 million in the distribution grid each year to replace the €150 million of annual depreciation, plus another €50-100 million in maintenance capex for the conventional generation fleet. In total, PPC would need to spend €200-250 million annually on maintenance capex. After taxes, PPC’s annual FCF before growth capex would jump substantially from negative €900 million to positive €600 million.

PPC planned to invest a large part of this cash flow into new solar and wind generation, which would benefit the company in several ways. First, it would generate a return on its investment by selling power to third party electricity suppliers or to its own supply arm. The latter would be ambivalent between purchasing renewable energy from the market or another division of PPC, allowing PPC to retain the profit margin by internally generating the power. Second, because PPC supplies more electricity to customers than it generates, it must purchase the shortfall from domestic competitors or neighboring countries selling power into the grid. By increasing its renewable capacity, PPC can reduce the cost of this annual shortfall and mitigate the risk of power price increases. And finally, as more renewables with low variable costs enter the grid, they displace more expensive traditional generation and reduce the price of electricity, further alleviating PPC’s shortfall. Hence, what normally presents a single-digit return on capital (renewable investment) becomes magnified into double-digits.

In addition to renewables, PPC also plans to invest significantly in HEDNO, the distribution grid. Most investments in the grid receive a regulated return close to 7%, but certain “projects of major importance” such as smart meters are allowed a premium return (they also reduce the level of power theft in the country by allowing PPC to digitally disconnect delinquent customers). At the same time, PPC’s management has increased the company’s efficiency by collecting overdue receivables and implementing voluntary reduction schemes to incentivize thousands of employees into early retirement.

Why the opportunity exists

PPC is transforming from a company on the verge of bankruptcy to one that will soon generate close to €1 billion of annual cash operating profit, but investors have paid little attention. Given its troubled past, Greece is off the radar of most investors. For those that do invest in Greece, many have been burned before (fool me once, shame on you; fool me twice, shame on me). Furthermore, utilities have been considered “widow-and-orphan stocks” thanks to their stability and annual dividends. In contrast, there was a chance PPC wouldn’t be able to keep its own lights on, let alone make a dividend payment.

Finally, if an analyst did decide that a nearly bankrupt, state-owned, coal-burning power utility in Greece was the right idea for the next investment committee meeting, there was a reasonable chance he or she wouldn’t be heard. In 2015, Norges Bank released a list of companies to be excluded from investments for ESG reasons—a list that included PPC. Norges and the funds in which it invests are required to follow this list, while others do so for best practices. It is ironic that PPC remains on this list today, as there is perhaps no company in the world undergoing such a radical environmental transformation.

Valuation and catalysts

Excluding the losses from the lignite plants (which are being decommissioned), PPC’s generation assets earn more than ~€200m of FCF. The earnings are stable because most of them receive a regulated return (oil-fired plants) or are the lowest cost producers of electricity (hydroelectric). In addition, PPC’s renewables currently earn ~€30m of FCF and this figure will triple in 2 years.

HEDNO (the distribution grid) earns ~€200m of FCF on a €3bn regulated asset base. 49% of the asset is currently for sale and will likely fetch a value between 1 and 1.2x equity RAB, or €3-3.6bn (an implied EV of €4.5-5.1bn given €1.5bn of debt). A premium to the RAB is likely because: 1) HEDNO has significant capex requirements which are allowed a regulated return between 6.7-8.2% in a zero-interest rate environment (high capex is good for regulated utilities), 2) HEDNO’s earnings are growing because of these investments, 3) HEDNO will have 8 years of regulatory certainty, and 4) several similar transactions have been completed globally at a significant premium to RAB. There are 9 potential bidders currently in the data room, including Macquarie, KKR, Blackrock, CVC, and others.

PPC’s supply division earns ~300m of FCF but this can fluctuate depending on power prices. PPC is largely protected given its vertical integration. However, when prices fall, PPC earns more money because it sells more power than it generates and must purchase the shortfall from the grid. The market structure is evolving in Greece and the new “target model” allows PPC to enter bilateral contracts and hedge against price increases which will reduce the volatility in the earnings of the supply division.

After interest and taxes, PPC is generating more than €600m of FCF (before growth capex and associated earnings growth) on a market cap of €2bn (a 30% FCF yield). Although the company has €3.4bn of net debt, the partial sale of HEDNO is likely to generate between €1.5-1.8bn of cash and materially reduce the debt. The addition of other liabilities/assets to the enterprise value are not material: the increase to the EV from employee/environmental provisions and a normalization of working capital are mostly offset by excess real estate PPC owns, real estate that will be given to the government to extinguish environmental provisions, as well as potential compensation regarding lignite (from the EU relating to the early shutdown of the lignite assets akin to Netherlands and Germany, and from the Greek government relating to running loss-making lignite to ensure security of supply).

In addition to the partial privatization of HEDNO, other catalysts include: the continued decommissioning of the lignite plants (which will reduce ongoing losses, elucidate PPC’s profits, and expand the investor base), the aforementioned EU/government compensation, the initiation of a dividend (typical for utility assets), and the overall privatization of PPC (currently 51% state-owned—34% by the State and 17% by the Greek privatization fund).

There is little reason a European utility with low-cost positioned assets, regulated earnings, and several high ROIC growth initiatives (renewables, HEDNO, etc.) should sell for 3.5x FCF. At a more appropriate multiple of 12-15x on FCF of €600-750m, PPC’s equity would be worth €8-10bn compared to €2bn today. 

Risks

There are many risks to investing in unionized, state-owned tangible assets in a country with a history of mismanagement and an underdeveloped power market. Above all else, PPC’s relationship with the government must be carefully monitored. Relationships can fray, governments can be voted out, and what one hand giveth, the other [can] taketh away. But beyond creating a fair market environment, the current administration has not done PPC any additional favors. If all goes according to plan, PPC’s €600m+ of annual cash flow will represent an uninspiring 3.5% return on its gross asset base of €17 billion (but an attractive return for us if we can purchase these assets for €2 billion).

Catalyst

Partial sale of HEDNO, continued decommissioning of lignite, government compensation, dividend initiation, overall privatization