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On 21’st August 2018, I wrote an article on JAKS to try and better understand it.
Why Business Sense is not enough (JAKS)
The company was selling at RM0.97 then and have since fallen to RM0.5 or so.
Do note this does not mean I am correct. Price movements mean but little in the short term. Whether or not I am right, depends on whether my thesis then was right. Which will take another 2 years at least.
In the meantime, I’ve spent some time to better understand JAKS, the international and Malaysian IPP markets better, along with firming up my understanding of the contracts involved.
Now, let’s see if JAKS is a good investment after a 50% discount.

Overview

Many here are likely to be familiar with this company, as well as a story, but to just refresh, I’ll just pull extracts from KYY’s blog posts.
“JAKS Resources Bhd was awarded the contract to construct two units of 600 megawatts (MW) coal-fired power plant to sell electricity to the Vietnamese Government for a 25-year period in August 2011.
Since the total cost of US$1.87 bil (RM7.76 bil) (based on US$1=RM4.15) is so huge that JAKS could not find any bank to finance the project, the construction of the power plant was postponed several times until JAKS found China Power Engineering Consulting Group Co Ltd (CPECC) to be its joint venture partner in March 2016.
The construction is scheduled to complete in 2020. CPECC is very experienced in conducting survey and designing of power generation and transmission plants. Moreover, CPECC has been playing a leading role in China’s power survey and design industry with about 90% of such work in the country undertaken and completed by the group.
After careful study of the viability of the concession, a consortium of three banks, namely Industrial and Commercial Bank of China, China Construction Bank Corporation and Export-Import Bank of China have expressed preparedness to finance US$1.4 bil (RM5.81 bil) for the entire scheme.
Assurance of project completion
The three Chinese banks accepted the power purchase agreement (PPA) duly signed by the Vietnamese Government as collateral to finance the project. The banks will provide 75% of the funding for the project cost totaling of RM7.76 bil with the balance (25%) to be borne by JAKS and CPECC.
To protect the banks’ interest, the financiers must make sure that the PPA is water-tight and that JAKS and its JV partner must be able to complete the project on time. Both JAKS and CPECC must also be financially sound, otherwise they will not be capable of paying up the remaining 25% of the project cost of RM7.76 bil which amounts to RM1.94 bil.
To ensure that the whole project can be completed satisfactorily, the Chinese JV partner undertakes the full responsibility to complete the construction and operate the power plant for 25 years. JAKS will receive US454.5 mil (RM1.89 bil) during the construction period and 30% share of the independent power producer (IPP) business. The profit of about RM400 mil for JAKS will flow back into the JV company to fund JAKS’ equity portion. In other words, JAKS only needs to fork out RM203mil to own a 30% stake in the power plant. JAKS is also given an option to buy up another 10% of the JV company.
In essence, JAKS is sure to make RM400 mil during the construction period. Upon completion of the power plant project, both JAKS and its partner will enjoy profit every year for 25 years from the sale of electricity to the Vietnamese government.”


Overview of the contract.

Exchange Rate: USD:RM is 1:4.17
Investment in Power Plant: USD 1.87bil (USD:RM is 1:4.17) RM7.8bil
Debt: USD1.4bil (75% of USD 1.87bil) RM5.83bil
Interest Rate: Fixed 6% (Standard Rate given by China and Chinese Banks, except its usually floating)
Concession Period: 25 years
Tax: Zero.

Do note, this is likely to be very rough, as i have close to zero data on the PPA beyond the above.
So, what is the estimated operating earnings of the power plant before tax and Interest expense?
For the sake of simplicity, we’re just going to use the EBIT (Earnings before interest and tax)
EVN (Vietnam Electricity) is the largest power producer in Vietnam. They have 25,884MW installed capacity. It’s a mix of difference sources, but coal is the largest.
Its not as precise as one would like, but you do not need to know the weight of a woman to know if she’s fat. Its accurate enough to determine if its a good investment. If anyone here can get me the EBIT of a Coal Fired plant, that would be great. Because its not like Power Utilities Companies provide segmental information by power generation type.
EVN, have EBIT of VND27,524,822,000,000. That is RM4.9bil.
Prorated over 25,884MW, and extrapolated to the 1,200MW plant being built by JAKS, we end up with operating profit, before tax and interest expense of RM227mil.
This information is taken from their 2016 financial statements, as the 2017 one is not out yet for some reason.
Now this is just an estimate, what does management say? They never gave any figures or details, but indirectly, from KYY’s blog post we find this.
“It is only good in securing the 1,200 MW coal fired power plant in Vietnam with a very good power purchase agreement (PPA). It will have very good profit every year for 25 years. I understand in the first few years, its annual profit will be Rm 200 to 300 million before interest charges, depreciation etc. Moreover, I understand all the profit from the sale of electricity is tax free.”  
KYY was once a 30% shareholder of JAKS and I’m going to assume he has at least spoke with management before making that statement.
These estimates are actually lower than my own estimate, which considers depreciation expense.

My Estimate

EBIT: RM227mil
Interest Expense: RM350mil (RM5.83bil X 6%)
Net loss: RM123mil per annum initially

Management/KYY Estimate

EBITDA: RM200mil to Rm300mil
Interest Expense: RM350mil (RM5.83bil X 6%)
Depreciation: RM312mil (RM7.8bil divided over 25 year concession)
Net Loss: RM472mil to RM372mil per annum initially

Now do note this does not take into accounts certain things such as,
  • Potential additional capex from transmission lines.
  • Potential escalating power rates, which should be higher than the escalating maintenance cost.
  • Jaks power plant is as efficient as the average EVN plant from the get go.
  • This a BOT (Build Operate Transfer). How much of the debt can they transfer to the government?

The reality.

Koon Yew yin made this statement in one of his blog posts
“In my 60 years’ experience in the construction contracting industry, I have never seen such a juicy contract as Jaks’ power plant contract. As an independent power producer selling electricity to the Vietnamese Government at a profitable rate for 25 years.”
I think the reality of the situation is likely to be a little different. Chinese companies are never known for giving the other party a good deal, unless forced to.
My current line of thinking is, JAKS won a PPA contract that they cannot build or finance. Therefore, they sold it to a CPECC for a 30% stake. Which they had to pay RM203mil in cash for, with the balance of RM400m to be covered by the expected construction paper profit.
The banks are willing to loan the money, because in their view, they should be able to get interest serviced for 20 years at minimum. I have no idea how the loan is going to be repaid, given the estimates above, but I’m guessing it can be rolled forward for a long time, or in perpetuity.
It’s a Chinese bank after all, and being essentially part of the Chinese government, profit is not really the number one motive. The real goal is one belt one road, and projects to take up the overcapacity of state owned companies in China.
CPECC is willing to do it (other than because it’s essentially part of the Chinese government), is because of the banks funding and taking most of the risk.
They get to build that project, and have their staff run the plant for 25 years. Putting some of that overcapacity to work.
Despite the expected losses, they may be allowed to still pay dividends. Over 25 years, they may potentially recoup their equity stake and more.
As this a BOT, if they can transfer the debt. We can forget about the debt, compound the interest and just throw it to the Vietnamese government to figure out at the end of the 25 years. But i doubt they will allow this.
But if the interest needs to be paid yearly, I would have no idea how the company will be able to pay dividends.
Now, on that line of thinking, it sounds like the kind of contract a China company would give you. It’s a very very hard line.
Except… If one were to calculate using my scenario.

Best Case Scenario

Now, lets play with the mathematics for this. Using the best case scenario, which is my estimate, which is roughly RM350mil higher than management’s or KYY’s. We get this.
EBIT: RM227mil
Depreciation: RM312mil
Therefore,
EBITDA: RM539mil
Interest Expense: RM350mil (initial figure, reducing balance)
Capture
A minimum of RM457,503,094.46 needs to be paid every year for 25 years in order for the debt to be repaid.
This gives about RM82,846,817 worth of dividends payable each year to the shareholders. Discounted at 5%.
The entire thing is worth RM1.2bil. With Jaks portion of 30% being worth RM360mil.
Far below the RM603mil (cash plus paper construction profit). But RM157m higher than cash paid.
IRR on the cash paid of RM203mil is about 11.42%.
Do note this is the absolute best case. Its RM312m in cash higher each year than the figure given by KYY. The returns looks too damn good to be true.



Conclusion

At the current price of RM0.5 per share, the market capitalization of JAKS is RM278m.
The company has equity of about RM843m.  Removing out the investment in JV, the property and construction division has equity of about RM652m
As it does not have any significant hidden assets such as large pieces of land held at extremely old valuations. We can take this as the RNAV.
The prop dev and construction company are selling for 42% of RNAV. And in exchange for paying this price for a prop dev and construction company that has
  • A mediocre track record
  • Bad capital structure, high debts with current liability exceeding current assets.
  • Outstanding legal issues along with looming LAD charges
  • Potential cash calls and right issues.
And most importantly, your opportunity cost, considering the sheer amount of opportunities available in BURSA now, whether in property development, trading, export etc etc
You will be getting a flyer on a stake of a power plant in Vietnam that will in our best case scenario, using earning estimates RM350m higher than management, that is worth RM360mil if discounted at 5%.
Is it worth it?
Well, if management made a mistake, and they meant the figures shown above. Then its a yes.
But i dont think so. No idea, unless they give verbal confirmation or we see a copy of the PPA.
As always if you feel I made an error, or have a very different perspective, Let me know.

Disclaimers: Refer here.

https://choivocapital.com/2018/12/06/what-if-you-got-a-50-discount-jaks/
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