Privatisation offer on the table

• Hyflux and Mitsui joined hands, seek delisting of HWT through exit offer priced at S$0.78, 17% premium to 30-day VWAP of S$0.67

• We advise unitholders to accept the offer as capital gain would otherwise be limited, owing to HWT’s inability to source DPU-accretive growth

• Exit offer valuation looks attractive, unitholders will still receive 1H10 DPU payout of ~2.3Scts

Hyflux finds new partner to propel growth. Hyflux today announced – as part of the “Galaxy JV” formed with Mitsui & Co to pursue growth in China’s water sector – the intention to make an exit offer and acquire 100% of the shares of Hyflux Water Trust, and delist it thereafter. Hyflux already owns c.31% of the Trust and will own 50% after delisting, with Mitsui owning the other 50%. Hyflux will fund the acquisition by the sale of 50% interest in another 4 completed plants to Mitsui. The delisting is conditional upon 75% shareholders approval at EGM and is expected to complete by end-2010.

Capital raising vehicle not efficient enough. We believe this is in the best interests of Hyflux, as the Trust had proved to be ineffective as a capital recycling vehicle, especially after the financial crisis rendered funding difficult for the Trust without an adequate scale of operations. Also, the Trust was increasingly looking at a pipeline of projects from Hyflux with long gestation periods, which would not be DPU-accretive for the Trust’s investors. Thus, organic growth options for the Trust remained limited, capping share price performance, investor interests and liquidity.

Exit offer looks attractive though. The exit offer price of S$0.78 is at par with the IPO price, and offers about 14% upside over current price. We view the pricing as fair, given that is at the higher end of dividend yield trading band of 6%. We thus, advise investors to accept the offer. Unitholders will still receive 1H10 DPU payout of around 2.3Scts when HWT releases 2010 results next week.

Hyflux and Mitsui to take Hyflux Water Trust private

Offer, at 78 S’pore cents a unit in cash, values the trust at about S$235m

HYFLUX Limited and Mitsui & Co of Japan are pairing up to take Hyflux Water Trust private at 78 Singapore cents a unit in cash – the same price as when it listed in November 2007. The offer values the trust at about S$235 million.

If the delisting goes through, the trust’s assets – some 18 water treatment plants in China – will be folded into a new joint venture company called Galaxy Newspring, which will also invest in and develop water plants in China. Galaxy will be equally owned by Hyflux and Mitsui, the Japanese trading giant.

Galaxy is also buying four water treatment plants in China from Hyflux with a combined capacity of 165 million litres a day for US$53.1 million. Hyflux will book a S$6 million gain from the transaction.

The tie-up and the proposed delisting marks a change in the way Hyflux operates in its capital-intensive line of business.

Hyflux Water Trust was originally set up as a way for parent-sponsor Hyflux to quickly recycle capital from completed water treatment plants, freeing up its balance sheet for new projects.

But HWT has found it tough-going since its inception, with depressed unit prices driving up yields and new fund raising more difficult than expected amid the global recession.

The four water treatment plants to be purchased by Galaxy were rejected by HWT because they were not yield accretive, Hyflux said. The trust has returned 11.54 cents a unit in distribution since 2008, a return of about 5 per cent, Hyflux said. Based on its listing price of 78 cents, the trust’s yield was 6.4 per cent in 2008 and 6.9 per cent in 2009, but its units have traded under 70 cents for most of the past two years, which has driven its yield up.

The financial crisis of the past two years has also made it tough for the trust to raise funds to take completed plants off the books of its parent-sponsor, lengthening the borrowing process and reducing speed to market, chief executive officer Olivia Lum told analysts and reporters yesterday.

Only last December Hyflux inked a similar deal with Japanese engineering company JGC Corp. The two set up a 50-50 joint venture which bought Hyflux’s flagship 100,000 cubic metre-a-day desalination plant in Tianjin, netting Hyflux a S$12 million divestment gain.

The collaborations with its Japanese partners are seen as a better and quicker way to take on and divest projects and would also provide greater assurance of project financing, analysts say.

From 2006 to 2008, the company rapidly signed contracts for new wastewater plants in China at a rate of three or four a quarter and had 39 in the country by March 2008. Deals there have slowed since as access to financing in China and concerns over whether the trust could take on additional assets have hampered new deals and the company hopes the new system of joint ventures will allow it to take on more and bigger projects.

In North Africa, Hyflux has seen strong new orders from Algeria and the company has hopes of a billion-dollar contract to build desalination plants in Libya.

Trading in Hyflux was halted yesterday for the announcement, with both companies rushing to close a deal before Mitsui announces its results today. Hyflux, which will report half-year results this Thursday, owns just under 32 per cent of the water trust and has undertaken to vote in favour of the deal at a shareholders’ meeting to be called.

The price offered is a 14 per cent premium over HWT’s last traded price on Friday of 68.5 cents, and a 16.6 per cent premium over its volume weighted average price over the past six months.

Volumes show no signs of picking up

At a Glance

• Generates distributable cash flow of 1.16Scts per unit – down 19% q-o-q – lower than estimates

• Weak water treatment demand at industrial parks compounded by seasonal and one-off factors

• Cut FY10-11 DPU estimates by 6-13%.

• Maintain HOLD, TP revised down slightly to S$0.68

Comment on Results

Downside risks prevailed. Water treatment volumes were weak in 1Q10, falling 12% q-o-q, owing to seasonal weakness caused by the CNY holiday period, a temporary closure at one plant, as well as the lack of any noticeable pick up in activity at the industrial parks despite the broadly improving economic conditions.

Water tariff receipts of S$6.9m (up 3% q-o-q) were somewhat boosted by the minimum offtake payments for the closed plant, but core operating margin dipped further to 35% vs. 37% in 4Q09. Interest expenses were lower in 1Q10 owing to the lower prevailing SOR benchmark, but could increase, going forward. The Trustee Manager is currently negotiating a refinancing agreement for the existing US$66m credit facility (expiring in February 2011), which would carry a higher interest spread.

Outlook & Recommendation

No waivers from Sponsor any more. The DPU subordination period ended in FY09, and as such we expect FY10 DPU to fall significantly short of the 5.42Scts paid out in FY09. Given the continued weakness in volume demand, and the absence of any kickers for the rest of FY09, we cut our FY09-10 DPU estimates by 6-13% respectively to 4.7-5.4Scts. This implies a FY10 DPU yield of 7% at current prices, which we view as fair. Maintain HOLD. Our DDMbased TP (WACC 9.5%) is revised down slightly to S$0.68 to reflect the lower DPU estimates.

Management ruled out any acquisitions over the next 6 months. The strategy now is to acquire completed plants only when they reach a certain level of operating maturity. Expansion works at four plants are ongoing, and should complete in FY11. Till then, treatment volumes and cash flows should remain largely flattish.

No pick up in utilisation rates yet

At a Glance

• 3Q09 distributable cash of S$3.5m in line with expectations – equates to 1.16Scts in DPU
• 2H09 DPU guidance maintained at 2.86Sccts – can be met with partial waiver from sponsor, Hyflux
• However, utilisation rate stays flat at 45%; management indicates muted demand growth over next 2-3 quarters
• Maintain HOLD in the absence of catalysts, TP S$0.65.

Comment on Results
With the addition of a new plant at the end of June’09, average treatment volumes picked up 10.2% from 234,000 cu m/day in 2Q09 to 258,000 cu m/day in 3Q09. This translated to a 10% q-oq rise in tariff receipts – from S$6.9m in 2Q09 to S$7.6m in 3Q09.

Operating costs were again well controlled, and net operating income was 17% higher q-o-q at S$3.2m. However, this did not translate to a growth in distributable income  which stayed largely flat at S$3.5m for the quarter, implying a DPU of 1.16Scts for 3Q09. Higher interest expenses and the absence of interest rate swap gains resulted in this flat q-o-q performance.

Outlook & Recommendation
As we have highlighted before, DPU payout for 2H09 is protected by the Sponsor’s waiver, whereby Hyflux will subordinate its share of distribution entitlement to the extent required to ensure that 2H09 DPU projection of 2.86Scts is achieved. We estimate Hyflux may have to waive about 45-50% of its entitlements in 2H09.

However, we believe FY10 DPU may take a dip, in the absence of any such waiver. Going forward, management indicated that growth in demand for water treatment would be muted over the next 2-3 quarters, as new industries are not likely to be established in the industrial parks (where HWT operates) in the near-term, following the global slowdown. Acquisitions will be the key growth driver, but we do not foresee any action before 2H-FY10. Thus – in the absence of any positive near-term catalysts – we continue to maintain our HOLD call on the stock, TP unchanged at S$0.65.

HWT Q3 distributable income surges 27.9%

HYFLUX Water Trust (HWT) yesterday said distributable income for its fiscal third quarter rose 27.9 per cent to $3.49 million from $2.73 million in the year-ago quarter.

Available distribution per unit (DPU) was 1.16 cents (Q3FY2008: 0.91 cent), in-line with the trust’s target DPU of 2.86 cents for the second half of the year (after taking into account subordination and waiver, to the extent necessary, of the sponsor Hyflux Ltd’s distribution for its initial portfolio of water-treatment plants and undertaking relating to certain newly acquired plants).

For the nine months to Sept 30, DPU was 3.48 cents this year, compared to 2.4 cents last year.

The increase in cash available for distribution was mainly attributable to an increase in income from operating and maintenance work and finance income increasing, HWT said.

Operating and maintenance income rose 74 per cent to $4.9 million while finance income was up 65 per cent at $1.8 million.

The quarter’s results took into consideration foreign exchange loss of $2.1 million, from a gain of $1.7 million in the year-ago quarter.

‘Including the first half’s distribution, HWT is expected to meet the full year forecast DPU of 5.42 cents,’ said Gary Kee, chief executive officer of the trustee-manager.

HWT closed yesterday at 67 cents a unit, up half a cent.