Infra

Question 1

8. How would you value a midstream company, such as an oil & gas pipeline operator?

Answer 1

Forecasts are based on the company’s gathering capacity, utilization rate, and average gathering fee, with OpEx based on both capacity and volumes processed; CapEx is linked to
maintenance needs for existing pipelines and any expansion efforts.
You can still use a traditional DCF model and multiples such as TEV / EBITDA, but you could also use a Dividend Discount Model since MLPs distribute high percentages of their Distributable Cash Flow.
Also, you could look at slightly different metrics and multiples, such as Distribution Yields, Cash Available for Distribution (CAFD), and P / CAFD; these are important because different amounts might be distributed to the different investor groups (see below).

Question 2

9. How does the MLP structure used for many midstream companies in the U.S. affect their
   valuation?

Answer 2

There are no corporate-level taxes if the company complies with the MLP requirements in the U.S., which changes the valuation, and the General Partner / Limited Partner split means that the distributions for each group might differ.
Therefore, the company might be worth different amounts to different groups depending on the rules around these distributions, which are specified in the partnership agreement.

Question 3

1. Can you explain the main verticals within power & utilities and how valuation differs?

Answer 3

One common split is regulated utilities for electricity, gas, and water, independent power producers (unregulated), and multi-utilities that do a bit of everything.
Unregulated independent power producers are standard companies that buy fuel/raw materials, turn it into electricity, and sell it; some of the metrics differ, but the valuation
multiples and approach (e.g., a basic DCF) are the same.
Regulated utility companies are quite different because they operate based on a Rate Base (Net PP&E with some adjustments), have an allowed Debt / Total Capital Ratio, and an allowed ROE, so they must “back into” the utility rates they are allowed to charge based on that. You can still use a DCF to value them, but alternative multiples, such as TEV / Rate Base and TEV / Power Capacity (in $ per MW), are common; multiples such as P / BV and P / TBV are also important due to the Equity contribution to the Rate Base.

Question 4

3. What advantages do multiples such as TEV / Rate Base or TEV / Power Capacity provide over TEV / EBITDA?

Answer 4

Essentially, these multiples let you analyze power & utility companies based primarily on their ability to distribute and transmit electricity/gas/water, independent of their capital structures, operational spending, and local regulations.
Yes, TEV / EBITDA is supposed to be “capital structure-neutral,” but it’s not quite that way in this sector because companies’ Net Incomes are constrained by their Equity and Authorized ROE – which reflects capital structure and regulatory decisions. EBITDA is strongly linked to Net
Income as a result.
EBITDA might be better if you do want to factor in these issues because they are important value drivers for the comparable companies in your set.

Question 5

4. Suppose you are valuing a regulated multi-utility company that distributes electricity, gas,
   and water. If you built a Sum-of-the-Parts valuation for it, which segment would you expect
   to be valued at the highest multiples?

Answer 5

It’s impossible to answer this question without knowing each segment’s Rate Base, capital structure, and Authorized ROE.
Generally, you would expect the segment with the highest ROE to be valued at the highest multiples because a higher ROE means margins and growth can be higher.
If these numbers are similar for each segment, you would expect the one with the lowest operating costs to be valued at the highest multiples because it has more scope to increase its rates eventually.
You would also have to factor in each segment’s expansion plans and CapEx requirements because, as in other sectors, higher growth in the fundamentals (Rate Base and Power Capacity) should drive higher valuations.

Question 6

5. Would you expect an independent power producer (IPP) to be valued at higher or lower multiples than a regulated utility focusing on distribution?

Answer 6

It depends on the current market environment. If power prices are relatively high and fuel costs and sources are reasonable, the IPP will benefit disproportionately because it is not constrained by an “Authorized ROE” and can charge whatever rates it wants.
But when power prices fall, or fuel prices increase by more than electricity (i.e., the “gross utility margin” or “spark spread,” “dark spread,” or “quark spread” falls), IPPs tend to do poorly because the lack of regulated prices hurts their profits.
In short, IPP firms tend to have higher Betas than regulated utilities.

Question 7

1. How does Project Finance differ from Corporate Finance?

Question 8

2. Walk me through an acquisition model for a “brownfield asset” that already exists.

Answer 8

You start by making assumptions for the purchase price, start/end dates, and timeline, including “flags” for different operational phases.
Then, you forecast the revenue, expenses, and cash flows, which are linked to drivers such as the electricity generated, ore mined, or traffic throughput, and you focus on the “Cash Flow Available for Debt Service” (CFADS), defined as EBITDA – Cash Taxes – Maintenance CapEx +/-
Change in Working Capital +/- Reserve Contributions and Withdrawals.
Next, you size and sculpt the Debt, typically based on a minimum Debt Service Coverage Ratio (DSCR) or Loan Life Coverage Ratio (LLCR). You “back into” the starting Debt based on the Debt Service in each period and its maturity (i.e., the date on which the balance should reach $0).
Finally, you calculate the returns by deducting the Debt Service from the CFADS to determine the Cash Flow to Equity in each period; the IRR and MOIC calculations are based on these numbers and the initial Equity investment.