Spark Infrastructure Group (ASX: SKI, OTC: SFDPF) describes itself as “a specialist infrastructure fund.” Included in its “investable universe” are regulated water, electricity and natural gas transmission and distribution businesses in developed-market jurisdictions.

Australia is the geographic focus for the short term, but Spark will invest in any of the enumerated infrastructure provided the particular asset offers predictable earnings and reliable cash flows. Management prefers that its targets be subject to “independent and transparent” regulation but is flexible when it comes to assets that are covered by long-term contracts with reliable counterparties.

Its current portfolio includes 49 percent interests in two entities that control three power companies: SA Power Networks, which was formerly known as ETSA Utilities, and Victoria Power Networks, the holding company for CitiPower and Powercor Australia that recently changed its name from CHEDHA Holdings Ltd.

Spark’s 49 percent interest in SA Power and Victoria Power represent an estimated AUD3.8 billion of regulated asset base (RAB) as of June 30, 2012. 

Before we go any further, we must note that ownership of Spark by US investors is limited to “qualified purchasers,” which the Securities and Exchange Commission defines, in relevant part, as individuals “who own not less than USD5,000,000 in investments.”

The “qualified purchaser” standard is more exacting than the SEC’s “accredited investor” standard, which includes, in relevant part, those with “individual net worth, or joint net worth with the person’s spouse, that exceeds USD1 million at the time of the purchase” as well as those “with income exceeding USD200,000 in each of the two most recent years or joint income with a spouse exceeding USD300,000 for those years and a reasonable expectation of the same income level in the current year.”

Because Spark has advised that it “may require an investor to compete a statutory declaration as to whether they are an ‘Excluded US person’” we are going to add the stock to the Aggressive Holdings rather than the Conservative Holdings.

We’ve decided to make the addition because, though the great majority of AE subscribers are US-based investors, we do have a number of readers in foreign jurisdictions that don’t have similarly onerous burdens on cross-border investing. Please advise through the “Comments” tool below if you encounter any difficulty in the execution of buy orders for the stock.

As for the merits of Spark Infrastructure as an investment, the power companies in which it holds interests are all stable from a regulatory perspective, with no resets until 2015; growing, with the overall RAB expanding 4 percent in the first half of 2012 and 9.3 percent for the 12 months to June 30, 2012; and building wealth, with the interim distribution for 2012 up 10.5 percent and management guiding to 3 percent to 5 percent annual growth through 2015.

Spark recently internalized the management of its assets, achieving significant cost savings in the process.

In September 2012 CitiPower finalized a three-year, AUD335 million bank facility to roll over debt with a February 2013 maturity. In July 2012 CitiPower placed AUD194 million of bonds in the US private placement market.

And in November 2012 SA Power priced AUD300 million of unsecured, medium-term notes (MTNs) in its domestic market, consisting of a AUD150 million floating-rate issue due Oct. 9, 2017, and  AUD150 million increase to the company’s existing Sept. 7, 2017, fixed-rate  issue.

Spark’s “asset companies” have no further debt refinancing requirements until September 2014.

Net debt-to-RAB at the asset-company level was 81.8 percent as of the mid-year 2012 report and is on track to reach approximately 75 percent by year-end 2015. Spark Infrastructure in its own right has very little debt, with standalone net gearing of 2.1 percent and a “look through” rate of 58.5 percent.

Moody’s rates Spark Infrastructure Baa1 with a “stable” outlook. S&P rates SA Power, CitiPower and Powercor A- with “stable” outlooks.

Equity investment is projected to grow over time as RAB grows and gearing falls, expanding by 14 percent on a compound annual growth rate basis over the current regulatory period to 2015 based on Australian Energy Regulator (AER) funding principles. Capital invested earns the regulatory return from “day one.”

As for Spark’s current assets, SA Power is South Australia’s only significant electricity distributor, delivering electricity over about 87,500 kilometers to more than 825,000 customers throughout approximately 178,200 square kilometers. It operates its distribution network under a 200-year lease from the South Australian government, which commenced in January 2000.

The SA Power Network is one of the most reliable in Australia, with a 99.98 percent System Average Interruption Duration Index (SAIDI) network availability rating.

It’s the fifth-largest electricity distributor in the Australian National Electricity Market (NEM). ETSA Utilities changed its name to SA Power Networks effective Sept. 3, 2012.

CitiPower owns and manages the electricity distribution network servicing Melbourne’s central business district (CBD) and inner suburbs, delivering electricity to more than 300,000 customers.

These customers include some of Australia’s largest companies, public transport systems and sporting venues. CitiPower is also recognized as the most reliable electricity distribution business in Australia, with a SAIDI rating of 99.99 percent.

In addition to providing electricity to many of the major government and private sector offices, CitiPower also supplies energy to many of Melbourne’s landmarks, including Federation Square, the Melbourne Cricket Ground, The Victorian Arts Centre, Victoria and the home of the Australian Tennis Open, Rod Laver Arena.

Powercor owns and manages the largest electricity distribution network in Victoria, delivering electricity to approximately 722,000 customers across 65 percent of the state comprising 27 percent of Victoria’s electricity users. Powercor has a 99.97 percent SAIDI network availability rating.

Victoria Power Networks, the holding company for CitiPower and Powercor, changed its name from CHEDHA Holdings Ltd effective Dec. 12, 2012.

The other 51 percent interest in each of SA Power and Victoria Power Networks is held by Cheung Kong Infrastructure and Power Assets Holdings, which are part of the Cheung Kong Group, one of Hong Kong’s leading multinational conglomerates.

In 2012, Spark lost a competitive process for the long-term lease of the Sydney Desalination Plant, eventually won by a consortium including the Ontario Teachers’ Pension Plan Board and Hastings Funds Management, which paid AUD2.3 billion for the asset.

Describing Spark’s participation in the bidding to The Australian, Managing Director Rick Francis noted, “As we went through the process, a number of risks were mitigated which to a certain extent, put it in the hands of pension plans, and it became a cost of capital exercise.” In other words, bigger players with access to even cheaper capital were able to outbid Spark.

But management exercised discipline in not chasing an asset.

Spark–along with a host of global infrastructure investors–will be an active participant when and if the government of New South Wales decides to sell its three power distributors and transmission network that comprise TransGrid. Bidding is expected to approach AUD30 billion, according to Infrastructure Partnerships Australia. The state government has reiterated that this is unlikely to occur before the next local election in 2015.

These assets are a good fit with Spark’s existing businesses, to which management will be able to bring operational synergies as well as regulatory, design and engineering expertise. Mr. Francis has said that depending on deal size Spark would welcome a co-investor.

Regulated revenue during the first half of 2012 (Spark reports financial results according to a calendar-year schedule) was up 19.1 percent to AUD805.8 million, with aggregated EBITDA up 16.3 percent to AUD635.2 million. Flat electricity sales volumes and working capital timing issues were offset by higher distribution tariffs.

Standalone first-half operating cash flow per security of AUD0.06 per share fully covered the distribution of AUD0.0525. Management has established a target payout ratio of approximately 80 percent of standalone operating cash flows across the current regulatory period to 2015.

SA Power had to fund the impact of the Solar Photo-Voltaic Feed-in tariff scheme implemented by the South Australian government, where demand for that scheme has far exceeded their expectations. Significant tariff increases came into effect in South Australia as of Jul. 1, 2012, which should drive cash flow higher in the second half of the year.

All three companies should benefit from the recovery of revenues related to regulator-approved growth capital spending for network improvements, security supply, the rollout of smartmeters and other efforts to improve service for customers.

All three also continue to invest in the renewal and expansion of their networks to maintain and, where possible, enhance asset performance and reliability.

In the first half SA Power, CitiPower and Powercor invested a total of AUD368.9 million, a 4.6 percent increase from the prior corresponding period.

The AER has approved capital expenditure over the current five-year regulatory periods, which will drive growth in the RAB of the respective companies at 8 percent per year.

Along with its first-half earnings announcement Spark reaffirmed its previous full-year distribution guidance for 2012 of AUD0.105 per security. The interim distribution of AUD0.0525 per security for the six months to Jun. 30, 2012, represents a 10.5 percent increase from the AUD0.0475 paid as an interim dividend in 2011.

The company also reiterated its medium-term distribution growth target range of 3 percent to 5 percent per year to 2015, “subject to business conditions.” Spark has a target payout ratio of approximately 80 percent of cash flow through 2015.

Spark has delivered a solid distribution, supported significant organic growth in its assets and explored external opportunities consistent with its strategy and risk profile during this period of global economic uncertainty.

Over the past couple years Spark has internalized its management structure, increased its financial flexibility, simplified its corporate structure and established a sustainable and growing distribution profile–with the payout fully supported by operating cash flows.

Spark Infrastructure trades on the ASX under the symbol SKI and on the US over-the-counter (OTC) market under the symbol SFDPF.

Spark Infrastructure, a new addition to the AE Portfolio Aggressive Holdings, is a buy on the ASX using the symbol SKI and on the US OTC market using the symbol SFDPF under USD1.80.

Based on its essential-service profile and management’s approach to building and running the business Spark Infrastructure under normal circumstances would qualify as a Conservative Holding. However, in acknowledgement of the restrictions on US ownership described above, we are including it in the Aggressive Holdings.

We reiterate our request that you keep us apprised of your efforts to purchase the stock. Should circumstances suggest that AE subscribers are unable to establish positions we will, of course, remove the stock from the Portfolio.

Eight analysts that cover Spark rate the stock a “buy,” while five rate it “hold.” There are no “sell” recommendations on the stock.

Spark held up relatively well during the Great Financial Crisis, though it did slide from near AUD2 per share on the ASX in early 2007 to a low below AUD0.90 in early March 2009. During the five years from Feb. 8, 2008, through Feb. 8, 2013, the stock posted a local-terms total return of 54.7 percent, besting the S&P/ASX 200 Index, which was up 10.5 percent during the same time frame, and the S&P/ASX 200 Utilities Index, which was up 27.6 percent.

The US dollar total return for that period was 78.2 percent, while the S&P 500 Index was up 27.5 percent and the S&P 500 Utilities Index was up 16.7 percent.

Institutions own more than 40 percent of the shares outstanding. Despite the restrictions on ownership by individuals, 29.6 percent of shares are held in the US versus 33.3 percent in Australia.

Spark Infrastructure’s financial year runs from Jan. 1 to Dec. 31. It reports full financial and operating results twice a year; it typically posts first-half results in late August, with full-year numbers out in late February. It will report 2012 results on Feb. 25, 2013.

Interim dividends are typically declared several weeks ahead of management’s report on first-half results. Final dividends are usually declared in January, though the specific amount of the payment is announced along with full-year results.

Spark’s most recent interim dividend of AUD0.0525 per share was paid Sept. 14, 2012, to shareholders of record on Sept. 5, 2012. Shares traded “ex-dividend” as of Aug. 30, 2012.

The final dividend in respect of 2011–AUD0.525 per share–was paid March 15, 2012, to shareholders of record on March 6, 2012. The “ex-dividend” date for this payment was Feb. 29, 2012.

Dividends paid by Spark Infrastructure are “qualified” for US tax purposes. Based on the “fiscal cliff” compromise reached in Washington, DC, in early January dividends will be taxed at Bush-era rates of 5 percent to 15 percent for investors’ first USD450,000 a year of income for couples and USD400,000 for single filers. Above that the maximum tax rate is 20 percent.