Pacific Hydro is
currently attempting to have itself taken over, but questions are being
raised about its most profitable operation, the Bakun power project in
the Phillippines, otherwise known as Luzon Hydro. This link
takes you to a very interesting World Bank document which seems to
provide a little more informative than what Pacific Hydro has been
telling the Australian market.

It is lengthy, but if you dig
deeply it does describe many of the components of the contract for
Pacific Hydro. For instance, it discloses that:

  • Total capital cost was US$147million of which US$44 million was equity (see table 9).
  • The capital recovery charge only applies for ten years (see page 100 – in the annexe: project profile for Bakun).
  • There is a six-year tax waiver (see table 5)

The
last two are important as it suggests Pacific Hydro might be front
loading its earnings because the capital recovery fee will soon
disappear and it will soon commence paying tax at Philippines corporate
tax rate of 32%.

In 2003-04 Pacific Hydro declared
a profit contribution from this plant of $23.7 million out of a total
net profit (before non recurring items) of $31.2 million. That is 76%
of the total earnings and a ridiculously good return on a US$22 million
equity contribution (Pacific Hydro only owns 50%).

It arises
because in reality what is occurring is that the contract is paying
down capital on the plant (the capital recovery fee) but Luzon, and
therefore Pacific Hydro, recognise this as revenue. Depreciation on the
other hand is expensed over the 25 year long term of the Build Own
Operate Transfer (BOOT) contract.

In the opinion of some Pacific
Hydro critics, who may well be short the stock in a volatile takeover
environment, this constitutes front loading its earnings. Perhaps we’d
all be better informed if Pacific Hydro could explain the following:

  • When does the Phillippines tax holiday end?
  • When does the capital recovery fee revenue cease?
  • What share of Luzon Hydro revenue has the capital recovery fee constituted?
  • Why has this not been more fully explained in the past?

We put this scenario to Pacific Hydro spinner Clare Laffan this morning who replied as follows:

The front ending of the Bakun tariff is well
known and the reduction reflects the paying down of debt from the
project financing. The original banking model was designed to keep
annual cash generation pretty stable throughout the project.

Managing director Jeff Harding, who owns 946,000 shares and 1.1 million options, did a fairly detailed interview with Corporatefile when the last results came out in February that you can read here. There’s some talk about el nino hitting earnings and a legal dispute over Luzon, but none of the points made above are raised.

Check out the latest half year results here
and go to note 11 for a detailed explanation of a legal battle between
Luzon and Transfield over the design and construction of the project.
Each party is suing the other for more than $40 million.

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Peter Fray
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