The Meridian sale process has started.  The prospectus was issued on Friday and the retail offer opens next Monday with pricing announced on 23 October and listing of installment receipts on 29 October.  Meridian has a number of positives and negatives.  On the positive side Meridian has very good power generation assets which are 100% powered by renewable sources such as water and wind. This means they don’t have any fuel costs and have very little marginal cost to generate power. Meridian also has a strong balance sheet and has relatively little need for future capital investment so will produce strong cash flows and dividends to investors.  Meridian will also benefit from the potential change in the pricing of power transmission in New Zealand although this is not likely till post 2016.

The biggest risk is the Labour – Greens power policy which is looking to reduce power prices for New Zealand consumers by $500m to $700m p.a..  The policy is targeting hydro generators in particular, so Meridian potentially has a lot to lose.  Broker research estimates that this could reduce earnings by over 25% which could lead to similar falls in the share price.  Another negative is that current power supply exceeds demand meaning that power prices are likely to be relatively flat over the near-term and if there was a large fall in demand, such as Tiwai shutting down, power prices could fall.  Meridian’s earnings are also impacted by weather although the share price can be resilient to short-term weather related impacts.

The deal structure also has positives and negatives.  The deal is structured so that investors pay $1 upfront and then have an additional payment in 18 months time.  The installment receipt structure is like an interest free loan of approximately 40% of an investors share holding.  The actual benefit depends on how much you value the loan but is roughly equivalent to a three to four percent discount. The negative of the structure is that if the share price falls you still must repay the original amount.

In summary the Meridian issue has a number of positives and negatives and we would encourage investors to read the prospectus and get comfortable with the risks and decide whether they are being appropriately rewarded in terms of return.  The good news for investors when compared to the Mighty River Power listing is that some of the risks are taken into account with a lower initial valuation.

Jonathan Windust

Portfolio Manager

Milford continually assesses companies on their suitability for inclusion in the range of Milford Funds.  This assessment is not appropriate for individual investors.  Milford continues to consider the Meridian offer.