Dated article: The risk and why Brazil utilities on long term down trend
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http://www.glasslewis.com/blog/energy-sh...overnment/
December 3, 2012 by Vanessa Iriarte
On September 11, 2012, the Brazilian government announced that it would end the practice of automatically extending 20-year, hydropower generation and transmission concessions expiring between 2015 and 2017 and would renew those concessions earlier than expected under Provisional Measure 579 (MP 579), a measure which requires utility companies to abandon free pricing and reduce electricity prices for industrial and residential consumers.
Dilma Rousseff, Brazil’s president says the lower energy costs mandated by MP 579 will decrease production costs, decrease inflation, encourage investment, boost productivity for business, increase employment and guarantee growth. However, the new terms of the concessions will likely cause several of Brazil’s largest utility companies to suffer significant decreases in profitability and EBIDTA and investors may experience a long-lasting detrimental effect on shareholder value.
Under the new concessions consumers will no longer pay charges that utility companies have been passing on to them in order to recoup investments in energy infrastructure. Instead, the Brazilian government is offering monetary compensation (“indemnity”) to those companies that renew their concessions for any amounts not yet recouped to generate breakeven EBIDTA. Seems like a fair deal, right?
Several of the utilities do not agree. First, the indemnity payments offered by the government may not be enough to avoid companies from generating zero to negative EBIDTA, to offset investment and asset impairments, and ultimately to generate enough cash for future investments and net income to continue paying dividends (which would be a severe blow particularly to preferred shareholders). Based on government valuations, companies deciding to renew their concessions under MP 579, such as Eletrobras, would be forced to receive indemnity payments as much as 50% less than the book value of their assets. Not only is the compensation offered by the government a long way off from values necessary for companies to remain profitable and generate shareholder value, the indemnity amounts derived by the government for each company are not supported by a public economic rationale, leading several companies to hold out and fight for more compensation.
The market does not agree either. Since the terms of MP 579 were published, the trading prices of Brazilian utilities have decreased across the board. To date, some companies have seen common share prices drop by between 20% to as much as 50% and preferred share prices by 20% to as much as 60%. It is apparent that investors believe the long-term value attributable to these companies have been diminished as a result of MP 579.
Electric utility companies with concessions expiring between 2015 and 2017 – Companhia Paranense de Energia (Copel), Centrais Eletricas Brasileiras – Eletobras, Companhia Energetica de São Paulo (CESP) , Cemig Geração e Transmissão (CEMIG) and Companhia de Transmissão de Energia Elétrica Paulista (CTEEP) – have until next Tuesday, December 4, to decide whether or not to renew their concessions under MP 579. So far, only Copel and Eletrobras have decided to renew their concessions and called an extraordinary meeting to allow their shareholders to vote on the matter. Conversely, CEMIG, Brazil’s second largest power generator has adamantly decided not to extend three of its concessions under MP579 and CTEEP has decided to reject the proposed renewal altogether. These companies have not called extraordinary general meetings to approve the proposal.
Although the Brazilian government has set a date for electric companies to agree to renew their concessions, Congress has yet to finalize its review of MP 579 and there is no stated deadline as to when this will occur. Further, it is unclear as to how many and which, if any, changes will be made to MP 579. As such, it cannot be assumed that shareholders will vote on the renewal with complete and finalized terms approved by Congress nor can it be assumed that companies will be fully aware of what they are signing if they agree to renew before MP 579 is approved, another point of contention against renewing concessions.
Due to the significant impairment and loss of shareholder value that is forecasted for Eletrobras if it decides to renew its concession agreements, it is one of the most critical meetings to follow. Barclays issued a report about the downside risk of the concessions renewal on the Company’s common and preferred shares. According to Valor Económico, Barclays estimates that both common and preferred shares could reach an all-time low of R$1 within 12 months if concessions are renewed, compared to previous estimates of R$29 per preferred share and R$20 per common share before MP 579. The steep drop in shareholder value is largely due to Barclays profit loss forecast of 30% for the next year as a result of imposing lower tariffs, and consequently, a slash in dividends.
Moreover, there is a serious question as to the potential conflicts of interests with the proposal, which is mandated by the federal government and which directly and indirectly controls 79.5% of Eletrobras’ total voting share capital. Although we recognize the government’s significant level of ownership, we reasonably question the ability of a majority of the current board members to vote in a manner that is aligned with those of minority shareholders and not merely vote in line the Brazilian government. We note that the chairman of the board, Márcio Pereira Zimmerman, is the minister of energy for the federal government of Brazil. Further, five of the eight members of the board, excluding the chairman, were represent and hold important and influential roles within the Brazilian federal government. AMEC, the Brazilian Association of Capital Market Investors, also considers this conflict of interest stating that “any decision designed to renew Eletrobras’s concessions must be taken exclusively with a view to the interests of the company – and not at the will of the regulator or controlling shareholder.” Further, according to Valor Economico, Eduardo Duvivier Neto, a minority shareholder of Eletrobras, will petition the Brazilian Securities and Exchange Commission to prevent the government from voting on this issue.
In a public announcement on November 26, 2012, AMEC urges all shareholders and fiduciaries of investments of public Brazilian energy companies to exercise their rights and participate in the meetings regarding the renewal of concessions. They also argue that, in the case of Eletrobras, the decision to renew the concessions and accept the new terms of MP 579 will have a significant impact not just on the profitability of the company, but on its very survival.
MP 579 will continue to be challenged by companies and activist investors to amend its terms, increase indemnity values and to protect shareholder interests. On November 30, 2012, just four days before the deadline to renew, the government agreed to increase the total indemnity offering from R$20 billion to approximately R$29.87 billion as a result of the strong opposition by several of the public utility companies despite its stated commitment to not to budge on MP 579.
Given the scope of the parties affected positively or negatively by MP 579, this is a crucial vote for foreign and domestic shareholders of Brazilian companies.
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