CIF: Inexus sale boost

There has been another twist in the Challenger Infrastructure Fund sale process. Barely had the ink dried on our recent review—see CIF still offers low-risk upside from 21 Jun 12 (Long Term Buy – $1.19)—and the equation has changed again, with the group announcing the sale of its stake in Inexus to shrewd US listed infrastructure company Brookfield Infrastructure Partners in a deal that we'll discuss shortly.

While the proposed deal puts a cap on the potential upside, it ensures the receipt of some monetary value from the sale of CIF’s sole remaining and highly geared asset, Inexus, which guarantees a better outcome than the liquidation value outlined in Table 1 of the previous review. After the sale, CIF intends to liquidate and return all its cash to unit holders.

The market responded accordingly; the stock rose eight cents yesterday despite trading ex-entitlement its final distribution of five cents.

The deal is complex and subject to the approval of CIF unit holders. Minority unitholders in Inexus (CIF owns 82.5%) must also either exercise or waive their right to match the terms agreed with Brookfield, but this shouldn’t prove an obstacle.

If it clears those hurdles, Brookfield Infrastructure will pay CIF £10m immediately, adding approximately five cents to the liquidation value of the group. While there’s a chance of an extra payment, a matter we’ll get to in a moment, this is the only certain payment on completion of the sale.

Liquidation value increased

With yesterday’s announcement, management estimated that net cash backing after this cash receipt and the deduction of liquidation costs will total $1.34 per unit. Note that this amount also includes the five-cent final distribution that traded ex-entitlement yesterday. If you owned the stock at close of business last Friday then you’ll get that distribution. But if you bought on Monday or later, you won't.

We prefer to think of the liquidation value as the $1.28-$1.29 remaining after the distribution payment that was already ours to begin with. Management intends to pay a large distribution/capital return of roughly $1.28 in September, representing the existing cash balance and £10m proceeds from the sale of Inexus.

But that's not all. Brookfield will pay an additional deferred payment of £25.6m if two conditions are met; (1) Inexus is able to refinance its debt facility which is due to mature in August, and (2) Brookfield receives antitrust regulatory approval from UK authorities.

If the deferred payment is made, an additional distribution of approximately 11 cents per share will be made to unitholders around December 2012. If the second payment is made, total proceeds will be $1.40 plus the aforementioned five-cent distribution.

We’re in two minds about the sale. When selling to a shrewd operator like Brookfield that excels with distressed situations, CIF must leave some value on the table. From our point of view, that's the possible realisation of $1.50-plus through a well-executed recapitalisation of Inexus, as outlined in Table 2 of the previous review.

But, in return, CIF ensures it won’t walk away empty handed from Inexus, nor will it lose money on a poorly executed recapitalisation. And if the banks roll their debts in August, existing CIF unitholders will get a share of the upside. It’s a pretty good outcome.

Management deserves praise for both executing an intelligent sale strategy for LBC Tank Terminals and Inexus, and ignoring their future management fee stream and instead winding up the fund to the benefit of unitholders. They may yet earn more praise for helping Inexus roll its debts, triggering an additional payment for CIF unitholders.

We considered writing an Ideas Lab on the situation. But with the stock trading at $1.29 on an ex-distribution basis, it’s not compelling. At $1.25 or lower we’d get more excited by a short-term trade. For longer-term investors, it’s now a matter of wait and see. We’ve ratcheted down the Sell price in our recommendation guide and slightly increased the Long Term Buy price due to the lower-risk but lower-upside nature of the situation. We're also downgrading a notch to HOLD.

Note: The model Income and Growth portfolios own Challenger Infrastructure Fund securities.