Independence: Yes, I do own IPS shares
Independent Power Southern Africa (IPSA) Plc is the first dual-listed share on both the AltX and the AIM (London’s AltX equivalent) and its business is “…to develop, own and manage power generation plants in southern Africa”. Essentially, IPSA has two distinct businesses that it runs simultaneously that feed off each other: it develops power plants for sale or use in its second business, the operation and management of these plants. Of these plants, IPSA specializes in making clean gas-fired power plants that are more environment friendly than the old “dirty” coal power plants of Eskom.
South Africa needs both of these businesses desperately due to its economic growth drawing on an increasingly shallow power grid of the useless Eskom legacy, Coega and its hefty future power needs, and the (quoted ad nausium) World Cup.
IPSA listed on the 19th of October this year at 560c, briefly went up to 755c on the 24th of the same month, and then came down to its present range of 590c to 600c. So, basically it hasn’t moved listing…after issuing R31million shares at 562c and then a further R36million was raised by a share issue for cash to Stanlib at 605c per share.
This latter issue is above its present market price…interesting…
So, what we have here is a dual-listed company with solid blue chip shareholders who are subscribing for significant numbers of shares at a very small discount and, in the case of Stanlib, a premium to the market…this was one of the factors that put it on my radar as a possible www.smallcaps.co.za buy.
IPSA is trading at 41.75 pence on the AIM and with a pound/ZAR exchange rate of 1:13.73, that makes it’s South African rand price of the AIM listed shares 573c (=13.73×41.75). When I asked the CEO of IPSA, (the impressive) Mr Peter Earl, about this arbitrage anomaly his explanation was the following: “…there is little trading in the UK (i.e on the AIM) since most of the shares are firmly held by blue chip institutions and few (UK) private shareholders know anything about power in southern Africa. That is the domain of people like Moore Capital, Fidelity and Tudor Capital who are among our more high profile shareholders.”
This makes sense, as if some company were to list on the AltX that specialized in power in, say, Ukraine…then I would probably shy away from it, as I know nothing about that country! Also, reading between the lines of Mr Earl's statement gives you a picture of a lot of blue chip interest in IPSA…interesting…
This aside, I was worried about IPSA’s exposure to adverse forex movements, namely the Rand/Dollar and Rand/Pound rates. As it imports most of its equipment into South Africa for its power plants, this is a critical factor. Earlier in the year the weakening of the rand hurt IPSA profits, but, Mr Earl assures me, that the recent strengthening in the rand has neutralized this effect. Of course, once all the parts are here and the plants are up and running, these are projects that are ZAR in nature and the exchange rates do not matter anymore. Its really just the startup phase that is open to forex risk.
You’ll notice I haven’t gone into any number or forecasts or used any valuation models…this is because IPSA doesn’t have any numbers to work with yet. AIM doesn’t allow its companies to provide forecasts (obviously to stop misleading the market) and the JSE released IPSA from having to make one, because of the conflict with the AIM rules.
This, of course, makes it hard to value IPSA and adds a layer of prediction risk that most shares don’t have. Could it be for this reason that it is trading so low…?
My method of valuation of IPSA is based on a wide fundamental analysis of the sector and its management and a comparison with another power plant company with “..significantly the same management…”: namely, Rurelec Plc.
Firstly, Rurelec Plc has basically the same business as IPSA, except it is based in Latin America. It even has (mostly) the same management, so serves as a good predictor of the future of IPSA (I.e. if they can do it there, why not be able to do it here?) Looking at Rurelec’s financial statements you see that it is generating nice growing profits and shows a healthy balance sheet that weathered the startup years and the risks of importation etc.
So, it looks like the Rurelec Model works (which is a spin-off of the IPC Model)…just can it work in South Africa? Well, without getting too technical about the different economies, I think Rurelec’s success is (at least) a definite positive sign for IPSA’s future.
Secondly, I could go into great depth about the power sector that Eskom dominates in South Africa…but this seems to be unnecessary. Unnecessary, as I (skeptically) see this sector as run mainly by political forces that are subject to political decisions etc. Also, IPSA works on a contract basis, thus, it either wins contracts or it doesn’t…which gives rise to 'contract risk'. What counts in IPSA’s favor with tenders for contracts is the speed with which they can get a clean-fuel efficient power plant up and running. This is because they don’t order the part (with a resulting lead of months or even years), but simply dismantle existing plants and reassemble them where they are needed.
So, ignoring the political risk of the power sector, I feel confident that IPSA will win significant tenders due to its speed and the depth of its management skills.
This leads to my third pillar of analysis: management. I added up all of managements experience in the energy sector, and the IPSA team has a combine total of nearly 100 years of experience there, ranging from private equity, to Rurelec, to Russian projects…very impressive, indeed. What I also like about management is that they had/have a collective 24.3% ownership of IPSA at the date of listing. So, they have a strong financial interest in making IPSA work for us minorities.
There is one major aspect of IPSA that—until now—I have left out of this research paper: their projects. IPSA looks at a 10 – 15 years project life with an Internal Rate of Return (IRR) of at least 20% pa. and writes up a backward and forward contract with the customer(s) and the supplier(s), locking in pricing. Present projects are: Newcastle (that provides gas-fired steam to the Karbochem plant) that should begin producing profits early next year and is entirely equity funded; a Coega power plant or two that IPSA has signed a memorandum of understanding over; and Elitheni at East London that will use clean-coal technology to provide power to the Western Cape.
Other potential projects include, but are not limited to, a power plant in Durban and one for the Royal Swazi Sugar Corporation.
All of these projects have both 'contract risk' and 'political risk' attached to them, but I feel that these risks are nothing new to the experienced management team and IPSA should work in the long-run.
Of course, once IPSA is past the startup phase, it is going to be very cash-generative, should move into profits very quickly, thus it could become a significant dividend play. This was conceded to me by Mr Earl in his email wherein he stated that “…we aim to get to first dividend as quickly as possible…”.
It all sounds very good to me; risky, no doubt, but with a potentially large upside.
Overall–although IPSA does have significant risks– the fact that lots of local and foreign blue chip investors are putting their money into it, the high potential power sector that it’s in, and its strong management team makes IPSA a SmallCaps.co.za buy.