Perusahaan Gas Negara, Merge Issue Heating Up

Controversies of PGAS-Pertagas merger plan has been heating up in medias
PGAS and Pertamina have expressed their respective views regarding the merger schemes to the government and has led to a concern to investors whether any decisions to be made is for political rather than national interest. We provide scenarios should any synergies be made between these two prominent SOE companies. Amid political euphoria, we suggest PGAS earnings would not be impacted in the mean-term.

What’s the chronology?
Since 2011, Ministry of ESDM enforced open-access policy in accordance to Ministry of ESDM act no.19/2009 meaning distribution and transmission pipes should be shared together. PGAS has been reluctant to this policy and has asked for postponement of the implementation of the regulation twice (1 Nov’12 and 1 Nov’13) and later argued that infrastructure maturity has to be in place before open-access could be implemented replicating practices from advanced countries.

In contrast, Pertamina has supported this regulation from the beginning and requested access to PGAS pipelines in order to deliver more natural gas to its customers. This has led to disputes between the two prominent companies.

Merger scheme heating up
SOE Ministry has been active in accommodating both parties arguments regarding merge schemes (further details refer to back page) such as: 1.) PGAS merge with Pertagas and the new established firm to be partly/fully controlled by Pertamina. 2.) PGAS to fully acquire Pertagas. We view that the market would react positive should the government announce PGAS to fully acquire Pertagas as it would create a synergy in strengthening the pipeline infrastructure in Indonesia.

Although a comprehensive valuation for Pertagas has not been done, our preliminary analysis indicates that PGAS has a strong balance sheet to acquire Pertagas.

No impact to earnings at least in the near-term
We expect open-access to be an overhanging issue especially during election period. We expect PGAS earnings not to be impacted in the near-term from regulation uncertainties. Although we expect to see political noise regarding national gas policy scrutiny, we suggests PGAS to maintain its dominance in the industry. We maintain our call and TP for the time being.

Full-open Access Still Far From Implementation

Gas liberalization concept set by the government
Since 2011, Ministry of ESDM enforced open-access & unbundling policy in accordance to Ministry of ESDM act no.19/2009 meaning distribution and transmission pipes should be shared together and gas transportation & trading activities should be separated. Pertamina, as the owner of Pertagas supports gas liberalization concept in terms of open-access and unbundling as stated in the government’s act.

However, PGAS suggests that infrastructure maturity has to be in place before open-access and unbundling system could be implemented. This has led to disputes between the two prominent companies.

PGAS: Infrastructure maturity is the key for gas liberalization
Infrastructure maturity means a country’s condition where almost all areas have been reached by gas infrastructure. Several studies shows that Indonesia is still at a premature stage to implement full open-access. As an illustration, Indonesia which has a wider land compared to Italy and more populated, the pipe length only takes into account 7% of what Italy possesses (refer to exhibit 2).

Structures of gas industry
There are 4 type of structures in the gas industry (refer to exhibit 1) of a particular country which are:
1.) Vertically integrated. The upstream and downstream activities is controlled by a single entity and the gas is supplied in a bundled manner.
2.) Natural gas production (upstream) competition. There is competitive Upstream O&G production with many players in the field. However, the downstream level still operates in a bundled manner. Indonesia gas industry lies in this current condition.
3.) Open-access and wholesale competition. There is competitive upstream O&G production with many players in the field and all upstream activities are separated with the downstream level and there is competition in supplying substantial gas volume. There is still several companies using bundling system in this structure, however all pipe infrastructure are used together.
4.) Unbundling and retail competition. This structure is the end point of full gas liberalization with competition from upstream and gas distributor up to household users. Ministry of ESDM act no.19/2009 expresses this type of gas structure in Indonesia, yet not reflected yet and hardly possible to be implemented in a short-time frame.

Regulation issues should not impact earnings at least in the mean-term. We expect open-access not to be fully enforced at least in the short-term partly given election hype this year. Also, based on case studies, it takes decades before a country can fully implement gas liberalization system.

Merge Options of Two Prominent Entities

Several merge options
Back in 7 January 2014, Pertamina and SOE Ministry provided several merge options for PGAS-Pertagas and expects the merger to be completed in Aug’ 14. Yet, we think that the merger schemes to face approval constraints as PGAS minority shareholders would bear dilution burdens. Furthermore, we see that the valuation mispricing is imminent from the potential merge. Given approval constraints in our view, we expect PGAS operations to run as usual in the mean-term. Below are the possible structure options post-merger:

1. Full control by Pertamina with golden shares. This scenario is Pertamina to have a control of the PGN-Pertagas merge with golden shares. It is worth noting that golden shares could have control at least 51% of voting rights.

2. Full-control by Pertamina through majority stake. The scheme is to divert government’s shares in PGAS to Pertamina, then Pertamina would fully control the management of the merged company. With Pertamina in control of the merged companies, Pertamina may encourage open-access yet we still see implementation issues.

3. Similar to 1st scheme without obtaining golden shares. This type of scheme gives equality of voting rights amongst the shareholders. Yet, we think that this scenario will emerge conflict of interests among shareholders.

4. PGAS to acquire 100% Pertagas’ shares valued USD4bn-6bn. We suggest that this type of scheme is the best scheme and would cater to national and shareholder’s interest at the same time. At the same time, the execution of the transaction is much simpler than the scenario 3 as there will be no general offer. PGAS may merge the book of its subsidiary post-acquisition.

PGAS has vast experience in the industry and has adequate funding to proceed with the acquisition. With Pertagas acquired, we suggest that pipeline transportation would expand aggressively throughout Indonesia and would enable consumers to obtain relatively cheap energy. The main hurdle for this scenario would be the acquisition value of Pertagas which is valued by Pertamina amounting to USD4-6bn, translating to 32.5x-48.8x PER based on its 2012 net profit, which we think is too expensive.