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Morningstar | CK Infrastructure's and Power Assets' Potential U.K. Assets Spin-Off Neutral for Now; Retain FVEs

On the whole we tend to expect CK Infrastructure's, or CKI's, and Power Assets' planned spin-off of its European assets to be positive as we see this as an opportunity for the group to potentially realize market valuations of these holdings. We also see the cash raised as possibly being utilized for new acquisitions with potentially better growth prospects particularly as the next permutation of allowed returns on the U.K. assets could be less attractive. However, the move could negatively impact our narrow moat rating on both Power Assets and CKI as it could dilute their free cash flow from these assets that are generating returns on invested capital above their cost of capital. In addition, the positive outcome would depend on the group's ability to spend cash wisely. So we do see the move as potentially raising risks. At the moment, we lower our fair value estimate to HKD 66 from HKD 68 for CKI but keep our fair value estimate at HKD 58 for Power Assets. The cut in CKI's value reflects the dropping of the planned purchase of APA Group after failing to obtain regulatory approval.

We think this news should have a neutral impact on both stocks for now since media had reported on this potential spin-off previously. CKI has made similar spin-offs in the past with the creation of Spark Infrastructure Fund in 2005 to house its Australian distribution assets and in 2013 in Hong Kong with HK Electric Investments. In both cases, cash received was primarily designated to be used for new acquisitions although in Power Assets' case, the bulk of this was returned to shareholders. Until there are more details, we see limited reaction. The prospect of a special dividend from possible gains made could buoy the share price.

CKI's U.K. utility assets are composed of Northumbrian Water, Wales & West Utilities, UK Power Networks, Northern Gas Networks and Seabank Power. The company also owns rolling stock supplier UK Rails. We expect the spin off to comprise primarily of the U.K. utility assets. Since the announcement mentions European assets, we would not be surprised to see the group's stake in Portuguese wind power generator Iberwind to be included as well as its Dutch waste collection and treatment company AVR-Afvalverwerking. But we would be surprised to see German meter reading company Ista included into the spin-off as Ista was only acquired in 2017 and we suspect CKI's management would prefer to keep Ista directly in order to explore potential expansion opportunities. It's probably too early to get a good gauge on the size of the possible spin-off, but assuming that the main U.K. utility assets, Iberwind and AVR, are included in the listing exercise, we think CKI could raise around HKD 30 billion if it decides to offload half of its current holdings.

Neither CKI nor Power Assets needs the money at the moment since the acquisition of APA Group has been called off. We suspect the group may be looking at another acquisition, but even so, the group has breadth at the moment to finance that without raising capital. Nonetheless, it's not a bad time to offload the U.K. assets given rumblings that the next regulatory reset could lead to lower net returns.