CitySpring Infrastructure Trust - Prime access to Asian infrastructure

! Buy into Temasek’s access to the infrastructure sector
We initiate coverage of CitySpring Infrastructure Trust (CitySpring) with a Buy 2
rating and a price target of S$1.40. We believe CitySpring’s sponsor Temasek,
with its strong presence in Asia, could help it identify acquisition opportunities in
the region’s infrastructure sector. The trust has started out with assets that in the
medium term have bond-like cash flow and an effective gearing rate (debt/total
capital) of 40%, which is lower than typical infrastructure funds.
! Market not pricing in acquisitions
We believe the current unit price reflects the fair value of CitySpring’s existing
businesses and does not price in potentially accretive acquisitions, which limits
downside potential while paying about a 5% yield.
! Execution on acquisitions is a key risk
The unit price could remain rangebound if the trust is unable to deliver on accretive
acquisitions. Furthermore, competition for infrastructure assets continues to
intensify with the high level of liquidity, raising the likelihood of CitySpring
overpaying for acquisitions.
! Valuation: Price target of S$1.40
Our DCF-derived price target is based on 7% COE, 2% terminal growth for City
Gas, and a 12% premium to the base valuation of S$1.25, assuming accretive
acquisitions. Our target yield of 4.3% implies a 145bp premium to 10-year bond
rates (based on CitySpring’s dividend guidance of six cents). We assume gearing
will rise S$200m in FY10.

Summary and investment case
CitySpring is the first infrastructure business trust set up in Singapore with
sponsorship from Temasek. Its initial portfolio comprises 100% of City Gas
Trust, the sole producer and retailer of town gas, and 70% of SingSpring Trust,
the sole supplier of desalinated water in Singapore.
! Participating in Asia’s likely boom in infrastructure spending: According
to World Bank estimates, Asia will require US$250bn pa over the next five
years to fund new infrastructure investment and to maintain existing
facilities. We believe that CitySpring will aim to participate in this growth by
acquiring infrastructure assets that provide regular and predictable cash
distributions as well as the potential for capital growth.
! Infrastructure is an important asset class: We believe demand for
infrastructure stocks and funds is real and driven by: (1) aging populations;
(2) pension funds looking for long-duration assets to match growing
liabilities; and (3) the emergence of infrastructure packagers and use of
gearing. The supply of infrastructure assets is from: (1) government
spending; (2) government budget deficits; and (3) privatizations (for more
details, refer to Q-Series®: Infrastructure & Utilities—Asset bubble,
structural change or fundamental re-rating?).
! Growth strategy—Acquisitions, active asset management and portfolio
management: CitySpring will rely substantially on growth via acquisitions.
This will be facilitated by the strong track record of Temasek in investing in
Asia, and likely continued strong growth in the infrastructure sector. We
understand that management is at an advanced stage of negotiations relating
to the acquisition of a variety of assets and aims to benchmark itself with the
growth of other similar funds (that have growth at over 50% pa in the initial
five years). The trust will also aim to maximize value via asset management
and portfolio management (by optimizing capital structure and managing
risks related to interest and FX rates).
! Advantage of Temasek: We believe Temasek is a strong existing player in
the infrastructure industry, with major infrastructure investments in unlisted
power plants in Singapore (PowerSeraya, Senoko Power, Singapore Power
and Tuas Power) worth S$6.7bn. Temasek also has stakes in Keppel Corp
and Sembcorp Industries (worth about S$8.8bn), which are partly engaged in
the infrastructure business, and provide Temasek with ample experience in
managing such assets. Further, we believe Temasek’s strong presence in
Asia (total investment of S$101bn in companies in Singapore and around the
region) will enable it to identify further acquisition opportunities.
! Strong management: As Temasek’s flagship infrastructure trust, we believe
CitySpring will receive the personal attention of Temasek’s senior
management. The board of directors includes Margaret Lui, currently
responsible for the investments and portfolio management for Temasek in
the infrastructure, industrial and engineering sectors. The CEO of Olam,
Sunny Verghese, is the chairman. Fai Au Yeung, CEO for the trust, has
extensive experience in the privatization of infrastructure assets globally and
fund raising and other external restructuring exercises of such companies,
particularly in Asia.

! Good quality of initial assets: CitySpring owns 100% of City Gas and 70%
of SingSpring (balance of 30% being held by Hyflux). City Gas is currently
the sole producer and retailer of town gas in Singapore (we believe its
monopoly will expire in 2016), while SingSpring is the country’s fourth
water tap and hence a strategic infrastructure with firm contracted revenues
to 2025. We believe incomes for both assets might decline after the
monopoly-like periods end, and we take this into account in our valuation.
! Performance fees benchmarked to an MSCI utilities index rather than
absolute: CitySpring’s performance fees are 20% of total returns delivered
in excess of total returns of the MSCI Asia Pacific (ex-Japan) Utilities Index
(rebased in Singapore dollars), which indicates management’s confidence in
outperforming the sector. The index has delivered compounded total returns
of 18% over the past three years, but a much lower 5.5% over the past five
years. The base fee is 1% (minimum of S$3.5m) and is comparable with
other such funds listed in Singapore (for example, Babcock & Brown
Structured Finance Fund).
! Focus on utilities, transportation/logistics, and communications: The
trust’s focus is utilities (including facilities for recycling, treatment,
distribution of water as well as facilities for the generation, transmission,
distribution and supply of electricity and gas), transportation / logistics
(including toll roads, railways, storage terminals, airports and seaports), and
communications (including broadcast transmission, infrastructure, satellite
systems and terrestrial wireline and wireless networks).
! Valuation: Our DCF based price target of S$1.40 is based on 7% COE, 2%
terminal growth for City Gas and assumes a 12% premium to base valuation
of S$1.25 assuming accretive acquisitions. Implied yield of 4.3% at our price
target translates to a 145bp premium to 10-year bond rates (based on
CitySpring’s dividend guidance of 6 cents and the current bond yield of 3%).
We do not expect significant capital appreciation due to contraction of yield
premium; rather it would be due to some organic growth and via accretive
acquisitions. We also assume that CitySpring will fund the conversion cost
of S$200m for Citygas’s customers (to change from town gas to natural gas)
via debt and that it will continue to use this debt facility, earning a spread of
about 5% over the cost of debt.
! Unit price weak since hitting high of S$1.58: We believe the unit price has
been weak due to negative newsflow over the cS$60m in performance fees
and also due to lack of any acquisitions being announced. The 1% base fees
charged by CitySpring are in line with that of infrastructure funds in
Australia (including Singapore-listed Macquarie International Infrastructure
Fund (MIIF), which charges 1.5%). The performance fees charged by
CitySpring are also similar to those charged by infrastructure funds. Also, all
this was known at the time of the IPO and fundamentally, we believe the
more important reason for the poor unit price performance has been lack of
acquisitions. We expect that if the trust can deliver on reasonably priced
acquisitions, the unit price could increase. Asian Development Bank projects
nearly US$250bn of annual infrastructure spend in Asia over the next five
years and even with a 5% share, there could be US$1bn of acquisitions
annually.