Ideas & Debate

How to study the KenGen bond offer

Kengen-bond

KenGen managing director, Mr Eddy Njoroge (left), and other officials launch the infrastructure bond: The power firm is seeking Sh15 billion for expansion.

Less than three years after its landmark initial public offer (IPO) that raised Sh26 billion, KenGen, Kenya’s largest power producer, is back asking investors for Sh15 billion through a public infrastructure bond offer (Pibo) to fund its expansion.

With the bond offer being the first corporate bond directly targeting retail investors — 20 per cent of the offer — many are unsure on whether to go for the bond and pocket a stable 12.5 per cent return per annum or buy more equity in hopes of the quick return of market stability or euphoria that characterised equity trading at the NSE in 2006.

Key question
With the equity or bond question taking centre stage, most investors seem to have forgotten a key question: Is any form of investment in the company backed by fundamentals?

KenGen’s history and that of the power industry as a whole has been chequered. Being a critical industry, the government, through the ministries and agencies, is the final decision-maker on all key matters.

While this arrangement was beneficial in the past, given the government’s ability to fund both KenGen and Kenya Power and Lighting Company (KPLC) (either directly or loan guarantees from international lenders), this model is no longer sustainable given the urgency of funds needed to set up capacity to meet increasing power consumption.

So, if government funding is no longer adequate, how about use of internal funds to power expansion like all other companies? Despite being the custodian of 75 per cent of Kenya’s total installed power generating capacity, KenGen operates as a price taker since power pricing is determined mainly by government agencies.

This in itself erodes the firm’s ability to be self-sustainable, leaving it dependent on external funding for its projects. Putting this into context, in addition to the Sh15 billion to be raised through Pibo, KenGen expects to raise an additional Sh102 billion over the next five years (Sh88.5 billion in borrowing and Sh14 billion through two rights issues).

Therefore, as long as KenGen’s power pricing is determined by third parties and the government cannot be counted on to provide timely funding, the future cash generating ability is tied to its ability to raise external funds to build target power generation mix that will see it become less dependent on hydro-electricity.

With geothermal and wind cited as key sources that will lead to the country’s power security — currently 65 per cent of KenGen capacity is hydro — this means that all providers of capital (both equity and debt) are betting on the firm’s ability to raise more funds to sustain its operations.

Risk to current capital providers is further compounded by rising financial leverage, at a point when KenGen’s operations are under strain due to poor hydrology and increased issuance of long-term licences to Independent Power Producers (IPP) and Emergency Power Producers (EPP) whose capacity payments warrant preferential power purchase agreements under the current merit of dispatch.

Back to the earlier question: Should one invest in the KenGen’s shares or bond? In answering this question, the investors should consider certain fundamentals.

Security liquidity: buy stock. Though bond will be electronically traded at the NSE, overall corporate bond trading remains low & small investors bear pricing weakness compared to institutional investors.

Return volatility: buy bond; it is less risky. Investors looking for stable returns have a certain coupon payment of 12.5 per cent. Borrowing from past trading on corporate bonds, where bonds are traded at par, initial principal is likely to remain intact.

Sums available for investment: varies per investor. Minimum investment on the bond is Sh100,000 against Sh 1,300 needed to buy 100 shares at current market prices.

Asset class: buy bond. Form a liquidity and coupon perspective – assuming an average duration of 6.25 years, KenGen’s Pibo fairs better than current listed corporate bonds. On the other hand, for KenGen’s share low ROE and dividend yield, fair poorly compared to other listed manufacturing companies.

Going concern
Finally, if one looks at KenGen as a going concern expected to remain profitable into the future, translating into a higher share price and improving dividend payout, then there is a strong case to buy its shares in place of the bond that offers a fixed return for an average duration of 6.25 years.

Interestingly, with the buck stopping with the government (KenGen’s majority shareholder), to ensure that the power generator remains afloat for obvious economic and social reasons, doesn’t it seem like all capital providers are actually providing funds to the government and, therefore, bearing more or less the same risk?

Mr Mwangi is a research analyst at African Alliance Kenya Securities.