April 29, 2007, 6:19 pm

EDN - Edenor

EDN - Edenor

EDN - Edenor plans on offering 15.2 ADS on the NYSE and 4.07 ADS equivalent shares in Argentina at a US dollar price range of $16-$18. 11.4 million of the 19.9 million total ADS offering will be coming from selling insiders. Citigroup and JP Morgan will be co joint book runners on the ipo. Post ipo EDN will have 45.3 million ADS equivalent shares outstanding for a market cap of $770 million on a $17 pricing. IPO proceeds will be utilized to repay debt, capital expenditures and general corporate purposes.

Electricidad Argentina will own 51% of EDN post-ipo.

From the prospectus:

'We are the largest electricity distribution company in Argentina in terms of number of customers and electricity sold (both in GWh and in Pesos) in 2006...We believe we are also one of the largest electricity distributors in Latin America in terms of customers and volume of electricity sold.'

EDN has the exclusive concession to distribute electricity to the northwestern zone of the greater Buenos Aires metropolitan area and the northern portion of the City of Buenos Aires. Electricity distribution area comprises 4,637 square kilometers and a population of approximately seven million people. In 2006, EDN sold 16,632 GWh of energy and purchased 18,700 GWh of energy. EDN purchases 19% of all electricity wholesale purchases in Argentina.

Approximately 2.5 million total customers in 2006. 32% of total energy revenues are derived from residential customers. EDN has averaged 11%-11.5% losses of energy power the past three years. This being power that EDN purchased but did not pass through to paying customers. EDN is reimbursed by the Argentina government for lost energy up to 10% annually.

Regulation - EDN is regulated by the Argentinian government. EDN passes through to customers their cost of energy plus a regulated distribution margin. In January '07 EDN received a a 28% increase in the distribution margin charged to non-residential customers.This is the first margin increase approved for EDN since 2002. The increase was effective retroactively to 11/05. EDN's non residential customers will be charged the retroactive margins monthly over 55 months. The upshot for EDN is that the margin increases they're now able to charge non-residential customers coupled with the retroactive payments mean their gross margins in 2007 should be significantly stronger then historical gross margins. EDN's long term viability is a public company depends squarely on EDN's ability to continue to receive distribution margin increases from the Argentinian government.

Dividends - Since electricity distribution isn't normally a growth business, there is often a pretty significant dividend to entice shareholders. Note though that EDN does not plan on paying a dividend initially. In fact they're not permitted to pay dividends until mid-'08 at the earliest. Expect then no yield here for at least the first year public. All things being equal, a significant negative.

Argentina - During 2001 and 2002, Argentina went through a period of severe political, economic and social crisis. The inflation rate in 2002 reached 41%. Beginning in 2003, the Argentinian economic climate has stabilized and since Argentina has outpaced most of the rest of the world. Inflation still tends to be high in the country with inflation rates topping 12% in 2005 and nearly 10% in 2006. GDP growth has averaged 9% annually since 2003. Argentina's strong economic growth the past few years has boosted electricity demand in the country. EDN estimates that overall electricity demand in Argentina has grown 5.8% annually from 2003-2006.

EDN collects revenues in pesos but their debt is denominated in US dollars. EDN does not hedge for currency risk.


Debt - In 4/06 EDN restructured the bulk of their debt. Note that until this restructuring EDN had been in default on this debt since 2002. Post-ipo EDN will have a substantial amount of debt on the book, approximately $358 million. In a very slim operating margin business, you don't want to see substantial debt on the books. This is particularly the case here in which the slim operating margin is strictly regulated by the Argentina government.

1.3 X's book value in a $17 pricing.

Thanks to a strong economy in Argentina, EDN has been able to grow electricity sold and revenues by 8% - 10% the past 3 years.

Note that EDN seems to consistently be fined substantial amounts of monies. In 2006 EDN was fined approximately $8 million, in 2005 approximately $22 million and in 2004 approximately $12 million.

2006 - Total revenues were $450 million a 9% increase over 2005. Gross margins were 42%. If EDN's retroactive distribution margin increase was in effect for 2006, gross margins would have been a much stronger 57%. Operating margins were a very slim 2 1/2%. EDN has plenty of relatively fixed costs, the only hope they've got of growing operating margins are government regulated increases in the distribution margins. Again if those 2/07 retroactive distribution margin increases had been in place for all of 2006, operating margins would have been 18%. Debt servicing ate up all actual operating margins in 2006. Losses for the year were in the $0.50 range for 2006. Actual numbers look quite different in the prospectus due to 1) a one-time $59 million gain from debt restructuring and 2) $55 million in income tax gain. EDN lost massive amounts of money in 2001 and 2002 and still has substantial tax breaks and refunds assisting the bottom line. Neither of these are operational earnings, so I folded both out.

2007 - Revenues should grow strongly due to 1)the distribution margin increase for non-residential customers; 2) received payments for the retroactive increases covering 9/05-1/07; 3) the continued strong economy in Argentina. I would expect overall revenues in 2007 to increase in the 25% ballpark to $550-$570 million. EDN estimates that the non-residential distribution margin increases alone should account for a 17% increase in revenues. Gross margins will be much strong as well thanks to the the margin increase. Operating margins should approach 19%-20% in 2007. Net margins(excluding income taxes and income tax carryfowards) should be in the 14% range.

Earnings per share(before any income tax refunds from prior years) in 2007 should be in the $1.70 ballpark. Keep in mind these are untaxed earnings. On a $17 pricing, EDN would be trading 10 X's 2007 earnings. The ruling allowing a more favorable distribution margin for EDN shifted them from a money losing operation to a nicely profitable one.

Conclusion - Argentina's economic growth the past fours years has opened the door for an operation such as EDN to come public. The deal only works in range however due to EDN's winning approval of a distribution margin rate increase to non-residential consumers. That approval shifts them into a nice bottom line profit operation. What EDN is not - EDN is not a high growth enterprise. They will experience substantial growth in 2007 due to a couple of one-time factors.In the future(2008 and beyond) I would expect EDN's revenues to by closely tied to Argentina's economic climate. EDN is also not paying a dividend. This is the type of business, electricity distribution, in which I'd like to see a nice slice of the cash flows returned to shareholders. However I do think this deal works in range due to Argentina's strong economic climate in recent years. Investors have been eager to find companies operating in countries growing faster then the US and Europe and EDN fits the bill. I expect this deal to work in range, recommend. One reason I believe EDN will work is that they'll be reporting stronger financials in 2007 then anytime in their operating history. I tend to like ipos that will be reporting very strong quarter first year public and that will be the case here.