Dear Sir,

The Cayman Islanders are already some $600 million in debt and $780 million when the $180 million cost of still unfunded pensions are added. Now that the UK is enforcing the current limit on debt and the government is faced with a shortage of funds to pay its employees’ salaries and pensions, it really has little choice but to divest non-strategic assets, so as to prevent a potential credit rating down-grade that would raise its future cost of borrowing. While government control should probably be retained over key profitable assets, such as the Port Authority, Civil Aviation and even the unprofitable ones, such as Cayman Airways, there are still some valuable assets, such as the Stock Exchange and the Water Authority that could easily be leveraged to raise substantial capital.


Water Authority’s assets

The assets of the Water Authority (WA) are the most valuable and the easiest to leverage to obtain best value, thanks to the ideal benchmark comparison provided by the Consolidated Water Company (CWCO). The Cayman Islands government is not involved in any other utility companies, so why is it in the business of making and selling water?

Fresh water is increasingly becoming a precious commodity and companies dealing in water have seen strong investment demand, particularly those operating in a tax free environment, such as CWCO, which currently commands a high price/earnings ratio (PE) of 32.19, with the stock trading at about $18 and a market capitalisation of $260.1 million.

In brief and rounded figures, CWCO has $122.2 million in total assets ($116.5 million net tangible assets), $8.08 million in income and a PE of 32.19; these figures being excerpted from a key data screenshot made on August 3rd. The Water Authority, on the other hand had $46.3 million in assets and $3.7 million in surplus/net income, as reported on pages 306 and 309 of the 2008-2009 Budget.


WA assets valuation
If the Water Authority’s assets were bundled up into a public company trading on the Nasdaq through an Initial Public Offering (IPO) – the same route employed by CWCO to become public – and using the same parameters that currently apply to CWCO, we would get the following valuation:

Based on assets:
CWCO: $260.1 mil/$122.2 mil = 2.13
=> WA: $46.3 mil x 2.13 = $98.6 mil
-Based on net earnings:
CWCO: $260.1 mil/$8.08 mil = 32.19 PE
=> WA: $3.7 mil x 32.19 PE = $119.1 mil

So, if these Water Authority Assets were trading on Nasdaq now, they would likely be worth between $98.6 and $119.1 million, or an average of approximately $109 million of market capitalisation. However, CWCO stock has been trading much higher during the stock market bubble – in fact twice as high, but there is no certainty that this will happen again soon...


CWCO: a resounding success
Admittedly, CWCO is well managed, has expertise producing fresh water efficiently and has been aggressively marketing its services outside the Cayman Islands, where growth is naturally limited. CWCO share price has risen from $5 in 2002 to over $36 in 2007 and now stands at $18 - not counting a 2 for 1 stock split that occurred in July 2005. This means that a shareholder spending $5,000 to buy 1,000 shares in 2002 would have had 2,000 x $36 = $72,000 at the peak in 2007 and still a respectable $36,000 nest egg at today’s date - a 720% increase in 7 years!
No wonder the stock of CWCO is in such demand and fetches such a high PE.


Win-Win for Government
This is why it would make good financial sense for the CI government to IPO say 48% of the stock to retain control of the new public water company as the majority shareholder, thereby raising about $52.3 million cash – less about 10% in underwriting expenses. By keeping 52% of the stock worth some $56.7 million, the government will take advantage of future price increases, which could be substantial, judging by CWCO stock history.

So, the IPO of 48% of WA’s assets would bring in cash more than their $46.3 million book value, while the government would still have nearly $57 million in remaining controlling equity in the new public company: this is clearly a case of having eaten your cake but still having it for an encore...

Of course, if the stock market continues to improve, then even more money can be raised from this operation. However, an IPO will take at least six months to set up, so the decision to proceed should be made without delay. The extra cost of operating a listed public company – audit expenses at CWCO were $326,000 for 2008 – is nothing compared to the ability to raise additional funds for expansion through issuing new shares.


Incentives can do wonders
The change to a performance driven public company would be excellent for the spirit of the WA employees, as their good work could now be rewarded with stock options, as is the case at CWCO, which may explain why Mr F. McTaggart left WA to join CWCO long ago, where he earned over $500,000 in total compensation for 2008 as its CEO. In addition, he has also accumulated some 116,257 shares of stock worth over $2.2 million at $19 per share!


Adding some 30% to profits
CWCO reported 2008 consolidated bulk water sales of 1.05 billion gallons worth some $9 million to WA in the Cayman Islands and $19 million for 3 billion gallons in the Bahamas with a corresponding net income of $3.2 million without breaking it down by location. If the margins were similar in both markets, this implies that CWCO earned around $1 million selling water to WA that it actually makes in WA’s own plants. However, it’s clear from the above figures that CWCO is charging WA some 36.5% more for its bulk water - $0.0086 per gallon instead of $0.0063 in the Bahamas - so CWCO’s profit on bulk sales to WA in the Cayman Islands may well be closer to the $1.5 million mark, depending on the respective plant efficiency, since there is only about 2 cents per kWh (~10%) difference for large commercial consumers...

Driven by a new entrepreneurial spirit, the new company should endeavour over time, based on the existing management contracts with CWCO to operate its own plants, which would add at least 30% to its current bottom line and would have a very beneficial effect on its stock price. In addition, the new public water company would be free to contract outside the island for additional business, as CWCO has done so successfully.


Changing focus and regulations
Under beefed up management, the new public company should become more customer friendly: huge bills that outrage customers so much that they file lawsuits and a CI$21 minimum cost to read a meter, compared to $5 for the same job done by CUC, should become things of the past, as consumers yearn to be treated in a fair and equitable manner.

Then, a special government Authority that supervise all the utility companies should be created along the lines of the ICTA, where the utility companies would fund its operation in order to set rules and investigate complaints, as customers well know that it’s impossible to expect a fair shake when the potentially guilty party is also the judge and jury...


Why is CWCO awash in cash?
While CWCO does not break down the value of its assets by country of operation, it appears that the total depreciated value of its plants and distribution system in the Cayman Islands can be estimated at about $30 million.

Interestingly, some 30% of assets at CWCO are now in cash to the tune of $41 million, including about $13 million worth of secured bonds on which CWCO pays 5.95% interests – even though it now has the right to repay the entire amount from cash on hand with only a small penalty. One cannot help but comparing this $41 million stash to the $46.3 million assets value of WA and speculating whether CWCO is trying to buy out WA’s assets cheaply.

Will our government be tempted to grab some much needed cash quickly and liquidate WA’s assets for around book value, or will it have the fortitude to implement this proposal to best leverage these assets while raising even more cash in about 6 months and keeping a majority stake worth around $57 million in the new public company?

Note: Since this analysis was written on 3rd August 2009, CWCO has reported a large increase in profits and its stock price has briefly reached $19.96 before settling back.

Frank Goelo
Unikay Ltd