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Sale of majority stake in the water utility business

Georgia Capital 5 January 2022 Update
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Georgia Capital

Sale of majority stake in the water utility business

Investment companies
Private Equity

5 January 2022

Price

725p

Market cap

£341m

NAV*

£646m

NAV per share*

1,398p

Discount to NAV

48.0%

*At 30 September 2021 based on a £/GEL rate of 4.2743

Yield

0.0%

Shares outstanding**

46.2m

Code/ISIN

CGEO/GB00BF4HYV08

Primary exchange

LSE Premium

AIC sector

N/A

52-week high/low

485p

725p

1,398p

933p

**shares in issue less unawarded shares in management trust

Gearing at 30 September 2021

Gross gearing

40.8%

Net gearing

31.5%

Fund objective

Georgia Capital focuses on scalable private equity opportunities in Georgia. These opportunities have the potential to reach at least GEL0.5bn equity value over the next three to five years and the company can monetise investments through exits.

Bull points

The majority of the portfolio is exposed to resilient and well-established businesses.

Georgia is likely to continue its secular trend with 5%+ real GDP growth after 2020.

Regular dividend income with growth potential from several portfolio companies.

Bear points

GCAP has just started building its track record of investment realisations.

Concentrated portfolio exposed to a frontier economy is inherently higher risk.

Vaccination rates remain well below Western Europe (although the gap has been gradually narrowing.

Analysts

Milosz Papst

+44 (0)20 3077 5700

Michal Mordel

+44 (0)20 3077 5700

Georgia Capital is a research client of Edison Investment Research Limited

On 31 December Georgia Capital (GCAP) announced it has agreed to sell an 80% stake in its water utility business (held through Georgia Global Utilities, GGU) to FCC Aqualia for a US$180m cash consideration. We estimate the deal values the business at a 13.4% uplift to its carrying value at end-September 2021 (on top of a c 13% uplift in Georgian Lari (GEL) terms that GCAP booked in Q321 vs Q221) and translates into a 2.2pp NAV accretion for GCAP (vs end-September 2021). GCAP will achieve a solid 2.7x multiple on invested capital (MOIC, of which 2.2x realised) and a 20.1% IRR in US dollar terms. GCAP will use US$95.4m of the proceeds to partially fund the redemption of GGU’s US$250m green bond (with the balance provided by FCC Aqualia). GCAP will retain full ownership of the renewable energy assets (now held through GGU).

Valuation of GCAP’s water utility business throughout the investment cycle

Source: Company data. Note: *both the equity value and EV/EBITDA multiple reflect the combined cost of the 25% stake acquired in 2014 and the 75% stake acquired in 2016. **EV/EBITDA multiple estimated by GCAP.

Why consider GCAP now?

Georgia’s economic rebound from the 6.2% real GDP decline in 2020 has been quite remarkable, with reported 11-month growth at 10.7% and growth forecasts for 2021 ranging from 7.7% (IMF) to 10.8% (TBC Capital). Moreover, expectations for 2022 are at 5.0%+ (dependent on the extent of the rebound in tourism revenues). GCAP provides moderately geared exposure to the Georgian economy, mostly through resilient, market-leading businesses in the healthcare services, pharmacy, insurance, water utility, renewable energy and education sectors.

The analyst’s view.

We believe the water utility disposal marks an important milestone on the path to validating GCAP’s private equity investment strategy. It shows GCAP can acquire, develop through value-accretive initiatives and profitably sell portfolio companies to a high-quality international strategic investor. The uplift to end-Q221 and end-Q321 carrying values may also suggest a prudent valuation policy. All this may help narrow the 48% discount to end-September 2021 NAV (or 52% based on the ‘live’ NAV) at which GCAP is trading, which is wider than its pre-COVID-19 pandemic levels of c 10–30% and the discount of UK-listed private equity (PE) peers of c 10–20% (even if the latter discrepancy is partially justified by country-specific risks).

Selling to a high-quality strategic investor

On 31 December 2021, GCAP announced its fully owned subsidiary JSC Georgia Capital has agreed to sell an 80% stake in the water utility business to FCC Aqualia. The acquirer is the fourth and ninth largest water management company in terms of population served in Europe and globally, respectively (according to the latest Global Water Intelligence Ranking from March 2021), servicing close to 30 million people in 17 countries. FCC Aqualia’s two major shareholders are the citizen services group FCC, active particularly in the environmental services, water and infrastructure sectors (51%) and the Australian ethical fund IFM Investors (49%). The transaction is subject to shareholder approval, with the general meeting expected in late January or early February 2022.

The sale will be conducted as a two-stage transaction, with FCC Aqualia initially acquiring a 65% stake in GGU, a holding company for GCAP’s water utility business and the operational assets of its renewable energy business. This stake represents an 80% economic interest in the water utility business. The second stage will follow the redemption of the existing US$250m bond (planned in July 2022) issued by GGU in July 2020. This will be financed by FCC Aqualia and GCAP, with GCAP providing a US$95.4m shareholder loan to GGU. Subsequently, the renewable energy business will be spun off from GGU in September 2022, allowing GCAP to recover full ownership of GGU’s renewable energy assets while FCC Aqualia will reach an 80% stake in GGU. Moreover, FCC Aqualia granted GCAP a put option on the remaining 20% stake, which is exercisable in 2025 or 2026 (at a normalised last 12 months, LTM, EV/EBITDA multiple of 8.25x). In turn, GCAP granted FCC Aqualia a corresponding six-month call option exercisable from the date of the expiry of the put option in 2026 (at a normalised LTM EV/EBITDA ratio of 8.9x, in line with the multiple at which the 80% stake is being sold as per GCAP’s estimates).

The deal means that GCAP’s management is delivering on its strategic priorities even ahead of the timelines initially communicated during the capital markets day (CMD) in November 2020 as GCAP’s aim was to sell one of its large portfolio companies within 18–24 months after the CMD.

Successful value creation during the holding period

The water utility operations cover a regulated monopoly in Tbilisi and the surrounding area, providing water and wastewater services to 1.4 million residents (more than one-third of Georgia’s population) and c 36,000 legal entities. Additionally, it includes the operations of hydro-power plants with an aggregate capacity of 149MW, with c 50% of the generated power used for water supply purposes and the rest being sold on the market to third parties. From the acquisition of the initial 25% stake in GGU in 2014 to end-September 2021, the business posted a revenue and EBITDA CAGR of 6.7% and 11.4%, respectively (see Exhibit 1). At the same time, its EBITDA margin improved from 44.8% in 2014 to 59.2% in the 12 months to end-September 2021 (or 60.5% if Q420 was adjusted for the new tariffs).

Exhibit 1: Water utility business’s revenue (GELm) and EBITDA margin

Exhibit 2: Water utility business’s CAPEX 2014–2020 (GELm)

Source: Company, Edison Investment Research; Note: *If the new water tariffs were applied retrospectively, the water utility business’s total revenue in 2020 and Q420-Q321 would be GEL174m and GEL194m respectively, while its EBITDA margin would be 56.6% and 60.5% respectively.

Source: Company



Exhibit 1: Water utility business’s revenue (GELm) and EBITDA margin

Source: Company, Edison Investment Research; Note: *If the new water tariffs were applied retrospectively, the water utility business’s total revenue in 2020 and Q420-Q321 would be GEL174m and GEL194m respectively, while its EBITDA margin would be 56.6% and 60.5% respectively.

Exhibit 2: Water utility business’s CAPEX 2014–2020 (GELm)

Source: Company



Over 2017 to 2019, GGU embarked on an extensive capital expenditure agenda to develop new, and upgrade existing, water and wastewater utility infrastructure (Exhibit 2). This allowed the company to realise significant operating efficiencies, including a reduction in the consumption of self-produced electricity by c 45% or 144GWh from 2015 to 2020, freeing capacity for market sales (GGU’s energy revenue grew at a 13.0% CAGR between 2014 and LTM to end-September 2021). These investments also translated into an increase in the regulatory asset base, which enhanced the earnings potential of the business amid the new 2021–2023 water tariffs that the local regulator approved in December 2020, translating into 38% higher allowed water revenues. The tariffs were set at a level that allows the business to recover unearned revenues in the last regulatory period (2018–2020), particularly from the 13% y-o-y decline in water supplies in FY20 amid the COVID-19 pandemic (mainly due to lower demand from corporate clients, because residential demand remained stable throughout the year). The new tariffs assume a return on investment of 14.98% (with reference to GGU’s regulatory asset base), in line with the business’s mid-term target return on invested capital of 13–15%. We also note the business may have benefitted from an increase in electricity prices following the local market deregulation in 2019.

Capital expenditures in the water utility business declined to more normalised levels in 2019 (and should reach a run-rate of GEL80–100m pa, according to the company), contributing to positive free cash flow generation. In response to COVID-19, the business pursued a cash accumulation and preservation strategy (in line with the rest of GCAP’s portfolio). GGU also successfully issued a US$250m five-year green bond with a 7.75% coupon in July 2020 (of which US$155m was allocated to the water utility operations), despite the pandemic turmoil. As a result, it had a cash buffer of GEL49.8m at end-September 2021.

GCAP to achieve a 2.7x MOIC/20.1% IRR in US$ terms

FCC Aqualia will pay US$180m in cash for the 80% stake in the water utility business, implying a fair value of the entire business of US$225m. We estimate this represents a c 13.4% uplift to its last carrying value in GEL terms at end-September 2021, translating into a c 2.2% uplift to GCAP’s overall NAV at end-September 2021. We also note GCAP revalued upwards the water utility business by c 13% in GEL terms in Q321 on the back of an 8.5% q-o-q increase in LTM-adjusted EBITDA, coupled with a c GEL26m reduction in net debt amid higher cash level from strong revenue generation (supported by the new water tariffs, higher consumption of corporate clients and increased electricity sales). Hence, the deal-implied value of the business represents a solid c 30% uplift in US$ terms (c 27% in GEL terms) to the end-June 2021 carrying value, which also happens to be the last available external valuation of the water utility operations prepared by Duff & Phelps. Overall, the revaluation of the business since end-June 2021 added c 5.8pp to GCAP’s NAV in GEL terms, according to our calculations. It is also worth noting that the US$180m exit proceeds represent c 21% of GCAP’s last reported NAV but c 39% of its current market capitalisation (given the wide discount to NAV).

The exit results in a solid 2.7x MOIC and 20.1% IRR in US dollar terms (including both realised and unrealised gains) achieved since acquisition. GCAP acquired GGU at a blended LTM EV/EBITDA multiple of 4.3x, while the exit multiple estimated by GCAP stands at 8.9x (see the chart on page one). This is despite the GEL depreciation versus the US dollar in recent years, with returns in local currency at 3.7x and 27.8%, respectively. The realised MOIC is 2.2x in US dollar terms and 3.0x in GEL terms, which includes GEL97.1m from dividends received since acquisition. The receipt of cash proceeds will have a positive effect on GCAP’s leverage, with a pro-forma leverage ratio at end-September 2021 at c 19.6% (vs the actual leverage at 25.4% as per GCAP’s calculations) assuming a cash settlement as if it had been at end-September 2021 and a US$95.4m shareholder loan to GGU for the financing of the redemption of the renewable energy bond (as discussed above). The allocation of the remaining balance is subject to GCAP’s board review, expected to take place in Q122 and may include share buybacks, deleveraging, lending to portfolio companies and potential new private equity investments.

General disclaimer and copyright

This report has been commissioned by Georgia Capital and prepared and issued by Edison, in consideration of a fee payable by Georgia Capital. Edison Investment Research standard fees are £60,000 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2022 Edison Investment Research Limited (Edison).

Australia

Edison Investment Research Pty Ltd (Edison AU) is the Australian subsidiary of Edison. Edison AU is a Corporate Authorised Representative (1252501) of Crown Wealth Group Pty Ltd who holds an Australian Financial Services Licence (Number: 494274). This research is issued in Australia by Edison AU and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. Any advice given by Edison AU is general advice only and does not take into account your personal circumstances, needs or objectives. You should, before acting on this advice, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If our advice relates to the acquisition, or possible acquisition, of a particular financial product you should read any relevant Product Disclosure Statement or like instrument.

New Zealand

The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

United Kingdom

This document is prepared and provided by Edison for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "FPO") (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document.

This Communication is being supplied to you solely for your information and may not be reproduced by, further distributed to or published in whole or in part by, any other person.

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Edison relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. This report is a bona fide publication of general and regular circulation offering impersonal investment-related advice, not tailored to a specific investment portfolio or the needs of current and/or prospective subscribers. As such, Edison does not offer or provide personal advice and the research provided is for informational purposes only. No mention of a particular security in this report constitutes a recommendation to buy, sell or hold that or any security, or that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

Frankfurt +49 (0)69 78 8076 960

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London +44 (0)20 3077 5700

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United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

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United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

General disclaimer and copyright

This report has been commissioned by Georgia Capital and prepared and issued by Edison, in consideration of a fee payable by Georgia Capital. Edison Investment Research standard fees are £60,000 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2022 Edison Investment Research Limited (Edison).

Australia

Edison Investment Research Pty Ltd (Edison AU) is the Australian subsidiary of Edison. Edison AU is a Corporate Authorised Representative (1252501) of Crown Wealth Group Pty Ltd who holds an Australian Financial Services Licence (Number: 494274). This research is issued in Australia by Edison AU and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. Any advice given by Edison AU is general advice only and does not take into account your personal circumstances, needs or objectives. You should, before acting on this advice, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If our advice relates to the acquisition, or possible acquisition, of a particular financial product you should read any relevant Product Disclosure Statement or like instrument.

New Zealand

The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

United Kingdom

This document is prepared and provided by Edison for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "FPO") (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document.

This Communication is being supplied to you solely for your information and may not be reproduced by, further distributed to or published in whole or in part by, any other person.

United States

Edison relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. This report is a bona fide publication of general and regular circulation offering impersonal investment-related advice, not tailored to a specific investment portfolio or the needs of current and/or prospective subscribers. As such, Edison does not offer or provide personal advice and the research provided is for informational purposes only. No mention of a particular security in this report constitutes a recommendation to buy, sell or hold that or any security, or that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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