On March 22, 2010, Arrow Energy Limited (AOE AU) announced its plans to demerge its international coal seam gas (CSG) drilling business and certain Australian assets into a new company to be listed on the Australian Stock Exchange named Dart Energy Limited (‘Dart Energy’). The demerger requires approval from the Australian courts, as well as approval from AOE shareholders. Dart Energy is expected to be listed during late July 2010, and will be led primarily by the existing AOE management team. AOE shareholders are expected to receive one share of Dart Energy for every AOE share held, although the tax status of the transaction was not made immediately clear by the company.

As recently as mid-February 2010, AOE had intended to pursue a partial initial public offering (IPO) transaction for its international business with a view to completing such transaction within the first half of 2010. However, AOE decided to pursue a demerger transaction as part of a strategic restructuring as AOE commences preparations to be acquired by a joint venture company owned by Royal Dutch Shell plc (RDSA NA) and PetroChina Company Limited (857 HK). That said, the demerger is expected to be completed regardless of the outcome of the AOE acquisition.

Dart Energy is expected to hold the following assets: AOE’s international CSG drilling business in China, Indonesia, India, and Vietnam; AOE’s stakes in the Australian-listed shares of Apollo Gas Limited (AZO AU), Bow Energy Limited (BOW AU), and Liquefied Natural Gas Limited (LNG AU); farm-in rights into two of Apollo Gas Limited’s exploration licenses in Australia; A$45 million in cash to be transferred from AOE; and an expected US$25 million loan facility from Shell. Dart Energy’s CSG assets represent potentially interesting investments in markets that are widely expected to increase their gas consumption in the future.

Additionally, Dart Energy is expected to cooperate with PetroChina in future potential CSG opportunities in China, and its management team is currently in discussions to expand its exploration portfolio to Southern Africa and Europe.

On March 4, 2010, UK-based Petrofac Limited (PFC LN) and Sweden-based Lundin Petroleum AB (LUPE SS) announced their plans to merge their UK Continental Shelf (“UKCS”) oil and gas assets into a newly-formed company to be named EnQuest plc (“EnQuest”). Shares of the newly-formed EnQuest would then be listed on both the London Stock Exchange and the Nasdaq OMX Stockholm and distributed to PFC and LUPE shareholders. Following the distribution of shares, current PFC shareholders are expected to hold a 45% interest in EnQuest, while LUPE shareholders would hold the remaining 55%.

The transaction is expected to be completed within a relatively short timeframe. Extraordinary general meetings of both PFC and LUPE shareholders will be held in late March 2010, with a view to listing the EnQuest shares on the London Stock Exchange on April 6, 2010, and on the Nasdaq OMX Stockholm on April 12, 2010. That said, certain conditions must be met before the transaction is completed, such as confirmation from the UK government, as well as approval from both PFC and LUPE shareholders.

The distribution is expected to be tax-free to LUPE shareholders, as well as to PFC shareholders who are residents of the UK. However, PFC stated within its circular document that it does not expect the distribution to qualify as tax-free for US federal income tax purposes. Instead, it is believed that US shareholders that receive EnQuest shares would be treated as receiving a dividend, which would be taxable as ordinary income.

Following the spin-off, EnQuest will be an oil and gas production and development company with six producing oil fields, as well as four undeveloped discovery fields and various exploration assets in the UKCS. Based on the production of the UKCS assets of PFC and LUPE, EnQuest’s average daily working interest production for 2009 would have been 13,620 barrels of oil per day. Additionally, as of January 1, 2010, it is estimated that EnQuest held a total of 80.5 million barrels of net proved plus probable (2P) oil and liquefied natural gas reserves.

On February 17, 2010, CSR announced that its appeal against the Federal Court ruling of February 3, 2010, which rejected its de-merger proposals amid concerns that the split-up of the conglomerate by distribution would compromise CSR’s ability to meet future asbestos liability claims, is scheduled to be heard on March 29-30, 2010. Should CSR succeed in its bid to overturn the original ruling, we believe that the de-merger would likely be executed by May 2010.

We would expect the shares to trade around current levels ahead of the hearing. Our fair valuation for CSR is in the A$1.87-A$2.00 per share range, assuming the de-merger proceeds.

For a detailed analysis of the proposed de-merger, please refer to our Global Spin-Off Report, published on January 11, 2010.

On February 10, 2010, CSR announced that it would appeal against the Federal Court ruling of February 3, 2010, which rejected its de-merger proposals amid concerns that the split-up of the conglomerate by distribution would compromise CSR’s ability to meet future asbestos liability claims. CSR’s response highlights the value of the de-merger strategy over other options such as the sale of Sucrogen.

We understand that the Federal Court is expected to advise CSR on the timing of the hearing of the appeal on February 17, 2010. CSR has indicated to us that the appeal hearing could take place as early as late February 2010, but may be some weeks after that depending on the Federal Court’s work load.

As anticipated, the shares have weakened since the February 3rd ruling, but should find some support at current levels ahead of the appeal hearing (our fair valuation for CSR in the A$1.87-A$2.00 per share range, assuming the de-merger proceeds).

For detailed analysis of the proposed de-merger, please refer to our Global Spin-Off Report, published on January 11, 2010.

On February 11, 2010, Hong Kong-based conglomerate, Swire Pacific (19 HK), capitalized at c.HK$128 billion (US$16 billion) announced that it has submitted a plan to the Hong Kong Stock Exchange for the spin-off and separate listing of its property division, Swire Properties. Based on the information provided, should the proposal move forward, the spin-off will likely be executed by way of a distribution in specie to qualifying Swire Pacific shareholders (in order to assure entitlement), in combination with a global offering for subscription by the public. However, it is intended that Swire properties will remain a subsidiary of Swire Pacific, suggesting that between 25% and 49% of the Swire Properties will be floated. At this stage, there are few details on the proposal and its prospective timeline, although there are some suggestions that the spin-off could occur by the end of the second quarter of 2010.

Swire Properties is a very significant component of the conglomerate, whose other interests embrace the aviation, beverages, marine services, and trading and industrial sectors. In 2008, Swire Properties accounted for 73% and 74% of Swire Pacific’s attributable earnings and book value, respectively. Swire Properties is one of Hong Kong’s leading landlords and property developers, spanning the office, retail, residential, and hotels sectors. As of June 2009, Swire’s completed investment portfolio totaled c.16.5 million square feet, of which more than 60% was represented by prime office space (see details below). While approximately 90% of its portfolio is located in Hong Kong, Swire also has significant property interests in Mainland China, as well as hotel assets in the USA and UK. In addition to its completed portfolio, the company has 7.4 million square feet under or pending development. The bulk of this gross footage (6.4 million square feet) is represented by commercial and hotel developments in Mainland China.

With reference to Finland-based Kemira Oyj’s proposed spin-off of its decorative paints business, Tikkurila Oyj, announced on February 9, 2010 (see our Flash report of the same date), we would like to advise our subscribers that the proposed distribution of Tikkurila shares will be subject to Finnish dividend withholding tax. In Finland, there is an effective tax rate of 19.6% on dividends (i.e., 70% of dividend income is deemed taxable capital income and is subject to a capital gains tax of 28%).

On February 9, 2010, MQA began regular way trading (i.e., normal T+3 settlement), closing at A$0.715. This represents a c.79% discount to pro forma NAV of A$3.35 per share, while Intoll (ITO AU) is trading at a c.31% discount to its pro forma NAV of A$1.71 per share. As we pointed out in our Global Spin-Off Report on the Intoll/MQA split, published on January 22, 2010, there are good reasons to suggest that MQA deserves to trade at a steeper discount to its NAV than Intoll, notably its higher leveraged toll road assets and consequent refinancing risks. However, the appropriate level of discount to MQA’s asset value is highly subjective, bearing in mind that the application of higher discount rates applied to discounting the cash flows from MQA’s investments should already reflect the risk relative to Intoll’s assets (i.e., the average discount rate applied by MQA is c.380 bps above the average rate applied by Intoll). Taking this into account, it could be argued that a c.50%-60% discount to NAV, equivalent to the largest discounts at which the now defunct Macquarie Infrastructure Group (MIG) historically traded, would be a more appropriate valuation level for MQA. This would imply a share price of A$1.35-A$1.70 per share based on MQA’s reported NAV as of December 31, 2009.

Looking at MQA’s pro forma net asset valuation, more than 80% of MQA’s NAV (ex. cash) is comprised of three toll road assets (APRR, M6 Toll and Dulles Greenway). In this respect, the key valuation driver for MQA is the refinancing risk associated with the company’s principal assets. It is important to emphasize that all such risk is contained within each individual asset alone. MQA is unleveraged at the corporate level and the asset level debt is non-recourse to MQA. Moreover, the debt is non cross-collateralized and has no cross-default provisions, leaving each asset to stand or fall on its own merit. Of the principal assets, the M6 Toll and APRR give MQA the biggest refinancing challenges.

APRR – MQA owns an effective 20.37% stake in Autoroutes Paris-Rhin-Rhone, a 2,234-kilometer (c.1, 388 miles) motorway network located in eastern France, which is the fourth largest tolled network in Europe. MQA’s investment in APRR (ARR FP), which is publicly-listed on the Euronext Paris Stock Exchange, is held through a participation in Eiffarie (a consortium led by French construction group Eiffage), which holds a c.81.5% stake in APRR. Debt in MQA’s French investment is held at the Eiffarie and APRR levels. In terms of refinancing risk, Eiffarie/APRR debt represents MQA’s most immediate challenge with more than 60% of the investment’s debt profile or €6.17 billion (on a 100% basis) maturing over the next three years, including €3.8 billion of Eiffarie level debt maturing in February 2013. However, this challenge should not prove to be insurmountable for the following reasons:

1) APRR is very cash generative with net debt (including Eiffarie debt) to EBITDA currently at a reasonably salutary 8.8x. Cash generated is currently being retained at the asset level under a mechanism built into debt agreements known as a cash sweep, whereby a portion of free cash flow is mandatorily ‘swept’ to pay down debt principal with the remainder being available to distribute to equity. Cash distributions to MQA from Eiffarie/APRR have been dropping since fiscal year 2007 as more cash has been retained at the asset level for debt repayment purposes. MQA is not expected to see any cash distribution from its French investment over the next three years as all the cash is likely to be retained within Eiffarie/APRR due to the upcoming debt repayment schedules. However, this and an improved credit market environment should strongly reduce refinancing risks. In fact, it is envisaged that Eiffarie will refinance its €3.8 billion debt facility in 2012, before its maturity in February 2013.

2) Another potential refinancing solution is for the Eiffarie consortium to sell down its stake in APRR to European institutions. In this respect, it is worth noting that the APRR’s current market value of €5.9 billion is almost quadruple the asset value implied by MQA’s DCF valuation as of June 30, 2009.

M6 Toll – This 100%-owned 42 kilometer (c.26 miles) toll road in the UK potentially represents MQA’s biggest refinancing challenge. M6 Toll is a highly leveraged asset with a net debt to EBITDA ratio of c.22x as of June 30, 2009 (the last reported figure), although the debt service coverage ratio is comfortable at over 2x, as a result of the low interest swap rate for the facility (there is a 30 year-fixed interest rate swap for the facility, charging 1% per annum until December 2010, increasing thereafter by 50 bps each year to 8.5% in 2025, then an ongoing rate of 7.92% per annum until the end of the term in 2036, with a 37 bps credit swap margin fixed over the entire term). The asset’s total net debt of £1.03 billion (including a capex facility of £30 million) is due to mature on August 23, 2015. While this still more than five years away, MQA’s current valuation appears to suggest that the market is painting a gloomy picture, with some suggesting that MQA will have to use its own cash to deleverage the asset. If so, we believe this an overly pessimistic view on at least two counts:

1) Certainly, we would agree that if MQA had to refinance M6 Toll’s debt today, it is certain that the banks would not be accommodating without the requirement to deleverage the asset. However, it is well to remember that refinancing of the asset is not due for another five years hence, and chances are that the operating and credit environments will improve from the prevailing one, characterized by a UK economy mired in its deepest recession for decades, as well as one in which the global credit markets have been shut tight for much of the past fifteen months.

Traffic performance at M6 Toll, a relief road for the Midlands section of the M6 motorway (the UK’s longest motorway), has been underwhelming recently (down c.10% in fiscal year 2009, and down c.2% year-on–year in the July-December 2009 period), reflecting the very weak UK economy as well as upgrade work to nearby stretches of the M6 motorway. Nevertheless, both revenue and EBITDA generation have demonstrated resilience (both were down by only c. 2% in fiscal year 2009) with traffic decline largely offset by toll increases and improved operating efficiencies. Since fiscal year 2005, M6 Toll revenue and EBITDA have risen at an annual compound growth rate of c.7% and c.11% respectively. The M6 Toll, which is currently running at less than half its capacity, should eventually benefit from a recovering UK economy and the completion of the upgrade work to the M6 motorway next year.

Using an assumption of about half the historic growth rate in EBITDA, say 5%-6% per annum, to the start of fiscal year 2016 (when refinancing is due), would imply an EBITDA of c. £70 million in fiscal year 2015, and a net debt to EBITDA of 14x to 15x. This would probably still be viewed as a little above the comfort level for financing institutions, but there is also a cash sweep mandated in the terms of the debt facility starting from August 2011, which we estimate could pay down c.£150 million of debt, reducing the ratio to c.12x-13x by August 2015. According to our calculation, this would yield an initial interest rate cover in the 1.5x-2.0x range (based on swap rates of 4%-5%, which would be in line with terms incorporated in the existing swap agreement). This level of leverage, therefore, could be received more willingly by the banks. In a more benign environment, MQA could of course try to sell down its 100% stake in M6 Toll to further deleverage the asset.

2) MQA’s management has told us that there are no sacred cows in its portfolio and that it would not deleverage an asset with MQA’s equity unless it would be value accretive. Consequently, in the absence of an improvement in operating performance by M6 Toll or if MQA found it difficult to refinance the asset’s debt on reasonable terms, MQA would simply walk away from the asset. In these circumstances, there would be no impact on MQA other than a write down of the equity value of M6 Toll, which is valued at £202 million in MQA’s latest reported portfolio valuation.

Our earlier premise that a c.60% discount to MQA’s pro forma NAV may be a more appropriate valuation is backed by a second approach. In this approach, we have assumed zero equity value for all of MQA’s assets other than its non-investment balances (i.e., cash) and its stake in APRR, which has visible value as it is publicly-listed. However, we conservatively value APRR using MQA’s last reported DCF valuation in euros, translated at the current exchange A$/€ exchange rate. The A$406 million APRR valuation is only one-fifth of the current market value (A$1.9 billion) of MQA’s APRR stake. Consequently, we arrive at a NAV for MQA of A$1.35 per share, equivalent to a 60% discount to the reported pro forma NAV of A$3.35 per share.

While we can expect volatile trading in MQA shares to continue in the short term, we maintain our view that the stock represents a relatively cheap option on improving global credit market conditions and a bet on the eventual successful refinancing of MQA’s assets. Our analysis indicates the share price offers significant upside (c.89% to our target price of A$1.35 per share) from current levels.

As of February 9, 2010, Intoll (A$1.175 per share) was trading just below our fair value range of A$1.20-A$1.40 per share. We would consider putting Intoll on our BUY recommendation list if the stock falls below A$1.15 per share, for a potential return in excess of 20%.

On February 3, 2010, Australia’s Federal Court rejected CSR’s de-merger proposals at its first court hearing amid concerns that the split-up of the conglomerate by distribution would compromise CSR’s ability to meet future asbestos liability claims. CSR, perhaps surprised by the ruling, has stated that it will review the judgment and consider all legal and commercial aspects of the matter.

The bottom line is that the de-merger of Sucrogen has abruptly been put on hold indefinitely, while CSR considers its options. These may include:

1) Appeal the ruling – However, this would probably take time, and with CSR believing that it has already given prudent and comprehensive consideration to the matter in its due-diligence, there is no guarantee that an appeal would result in a different outcome.

2) Sucrogen guarantees asbestos liability claims – Under this scenario, Sucrogen would be required to provide additional coverage on future potential asbestos claims (as was the case with Rinker, even though Rinker was incorporated in 1981, long after the last supply of asbestos to the US by any CSR company in 1966). However, this would have the effect of reducing Sucrogen’s appraised valuation.

3) Sale or IPO – CSR could go down the route of selling Sucrogen to a trade buyer or via an initial public offering. Sucrogen has already attracted interest from at least one potential suitor, China’s Bright Food Group. However, even allowing for the premise that the sale of Sucrogen would be less tax efficient to both CSR and its shareholders than a de-merger, there could be a restriction on the distribution of any proceeds to shareholders in light of the Federal Court’s concern about future asbestos liabilities.

4) Status quo – The rationale for the de-merger in the first place is to facilitate better recognition of the value of CSR’s portfolio of disparate businesses. In this respect, doing nothing, changes nothing.

While the valuation analysis incorporated in our Global Spin-Off Report on the planned de-merger, published on January 11, 2010, suggests a fair value in the A$1.87-A$2.00 per share, we expect the shares to do little better than drift and most likely weaken in the short term in the face of CSR’s current strategic dilemma.

On February 2, 2010, Cable & Wireless plc (CW/ LN) released its expected timetable for the completion of the proposed de-merger of its Worldwide unit.

February 2, 2010 – Publication of prospectuses for Cable & Wireless Communications Plc and Cable & Wireless Worldwide Plc.

February 25, 2010 – EGM to seek shareholder approval for de-merger.

March 22, 2010 – Listing of Cable & Wireless Plc shares replaced by Cable & Wireless Communications Plc shares.

March 25, 2010 – De-merger becomes effective.

March 26, 2010 – Trading in the shares of Cable & Wireless Worldwide Plc on the London Stock Exchange commences.

In its announcement, Cable & Wireless confirmed that agreement with the company’s pension trustees has been reached. The agreement calls for the pension assets and liabilities to be fairly evenly split between two de-merged entities. As part of the agreement, Cable & Wireless will contribute £105 million (indicating a further £30 million top-up on the £75 million already announced in November 2009, which is lower than most in the market had expected) toward the aggregate pension deficit of £305 million as of September 30, 2009. There is also a £200 million contingent funding agreement split between the two companies.

Management has also reiterated earlier EBITDA guidance for the separated units for fiscal year ending March 31, 2010. In terms of dividend policy, management confirmed that the combined dividend to be declared by the de-merged companies for fiscal year 2011 will be maintained at £0.095 per share, the same level as previously announced for fiscal year 2010, which represents a 6.5% prospective yield based on the prevailing share price of the bundled entity.

Cable & Wireless also announced a US$500 million bond issue, which completes the c.£1 billion refinancing package announced in November 2009 as part of the de-merger process. At the date of de-merger, Communications is expected to have net debt representing c.0.8x its fiscal year 2010 EBITDA guidance of US$880-US$900 million on a consolidated basis, while Worldwide will be virtually unleveraged.

Cable & Wireless is a UK-based telecommunications company with global operations contained in two operating divisions. The Worldwide unit has core operations in the UK, Continental Europe, and Asia, where it provides IP, data, voice, and hosting services to large enterprise, reseller, and carrier customers. The other operating division, which will make up Cable & Wireless Communications, is a full-service telecoms provider that operates through four regional business units – the Caribbean, Panama, Macao, and Monaco & Islands.

Under the terms of the proposed de-merger, Cable & Wireless shareholders will receive one share in Cable & Wireless Communications Plc and Cable & Wireless Worldwide Plc for every Cable & Wireless Plc share held. We intend to produce a detailed analysis of the prospective de-merger in the near future.

On January 25, 2010, Macquarie Infrastructure Group (MIG) began trading ex-MQA and the special dividend of A$0.10 per MIG share, and closed at A$1.25 per share, valuing the company (to be renamed Intoll from February 2, 2010) at c.A$2.83 billion/c.US$2.5 billion. This effectively values Intoll at a c.27% discount to pro forma NAV of A$1.71 per share. This valuation is within our expected initial trading range of A$1.20-A$1.40 per share, representing a peer-like 20% to 30% discount to NAV.

Macquarie Atlas Roads (MQA) began deferred settlement trading on the Australian Stock Exchange (normal T+3 trading in MQA begins on February 9, 2010), closing its first day at A$0.615 per share (equivalent to c.A$0.12 per MIG share), valuing the stock at c.A$278 million/c.US$250 million. This represents a discount in excess of 80% to pro forma NAV of A$3.35 per share. While the stock price is expected to be highly volatile in the coming weeks (we would anticipate an overhang of stock from risk-averse MIG shareholders as well as funds restricted by MQA’s size), we believe that MQA at this value offers a reasonable entry point for investors with a high risk tolerance as it represents a relatively cheap option on improving global credit market conditions and a bet on the eventual successful refinancing of MQA’s assets. The degree of justifiable discount to its NAV is a highly subjective judgment, but a c.50%-60% discount, equivalent to the largest discounts at which MIG has historically traded, would imply an MQA share price of A$1.35-A$1.70 per share, a more than doubling of the share price from initial trading levels.

For a more detailed analysis of the prospective restructuring of MIG, please refer to our Global Spin-Off Report, published on January 22, 2010.