Jonathan Kolatch Long Puerto Rico Power Authority: Invest For Kids Chicago ~ market folly

Friday, November 7, 2014

Jonathan Kolatch Long Puerto Rico Power Authority: Invest For Kids Chicago

We're posting up notes from Invest For Kids Chicago 2014.  Next up is Jonathan Kolatch of Redwood Capital who likes Puerto Rico Power Authority ("PREPA").

Jonathan Kolatch's Invest For Kids Chicago Presentation

•    Manages $7B, focus on stress/distress and high yield credit.

Idea: Puerto Rico Power Authority (“PREPA”)

•    Overview of Puerto Rico – a territory of the United States, GDP of $70B.
•    Has problems – recession since 2006. Slow demographic decline. Piling up debt over years.
•    $71B of debt in Puerto Rico. 2/3 is related to central government (general obligation), 1/3 public corporations such as water company, highway authority, etc.
•    PREPA is the Power Authority. Largest municipal electric utility in the USA. Only electric utility in Puerto Rico. 18% of their revenue is not collected. i.e. people stealing electricity.
•    Doesn’t look particularly different vis-à-vis other utilities. 8.8 cents per kilowatt, in the middle of the pack. At a 4.6% ROA, not far out of line. Reasonable well run utility.
 •    PREPA bonds went from above par in FY12 to around ~50, huge divergence and lower than GO bonds.
•    Why does the market hate PREPA? All of their electricity is generated from oil.
•    Politicians target PREPA. Rates at 27 cents per kilowatt hour, pretty high versus the 11 cent avg. Yet it isn’t expensive relative to other islands that use oil.
•    Puerto Rico passed a law allowing entities like PREPA to undergo bankruptcy.
•    Running negative cash flow for many years. Losses plugged by transfers from the state or debt offerings. People bought bonds off the credit quality of Puerto Rico.
•    PRASA and Highway/Transport also burning cash.
•    In regards to the water utility – implemented a 60% rate increase. $400MM increase in revenues. •    Highway – increased gas tax increase from $3 per barrel to $15.3 per barrel or $350MM of increased revenue.
•    Generates currently $750MM in EBITDA, need to raise EBITDA to $1,075MM or a 7% rate increase.
•    1989 was the last time they did a rate increase. No other utility has gone that long without a rate increase.
•    Debt covenants say rates need to be set to keep 1.2x of EBITDA to debt coverage. Contribution in lieu of taxes and capex is subordinated to P&I for PREPA bonds.
•    Thinks an Article I contracts clause will be used/broken.
•    A lot of problems are subsidies to entities like hotels and theft of power.
•    PREPA has four levers to cut cost. (1) convert to natural gas which is a 3 to 7 cent per kilowatt saving; (2) restructure the CILT which has a 0.3 to 1 cent per kilowatt savings; (3) reduce energy theft which is a 1.5 to 2 cent per kilowatt savings and (4) realign the labor force which is a 0.2 to 0.5 cents per kilowatt savings potential. Every 1 cent per kilowatt is worth ~$175MM of EBITDA.
•    Thinks there are gross savings of 4 to 7 cents. Only need half to stay solvent.
•    Recent oil sell-off should lower costs by 2.9 cents per KWh. Only need 1.8 cents per KWh to keep the entity solvent.
•    Timeline – forbearance agreement, next coupon in January and there is a reserve program to pay it. Hard deadline in July 15 when coupon payment is due.
•    Mistreating PREPAs bondholders will severely compromise creditors willingness to believe Puerto Rico’s other promises to creditors.
•    50 cents on the dollar does not leave much downside.

Be sure to check out the rest of the hedge fund presentations from Invest For Kids Chicago here.

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