Buy UK, sell China

Li Ka-shing: Trading Asian growth for UK torpor sounds like an unfashionable investment idea. But that seems to sum up the strategy being pursued by Li Ka-shing. The Hong Kong entrepreneur is selling Chinese ports and is making preparations for a possible bid for E.ON’s UK power networks. But Li’s contrarian stance isn’t so illogical.

Mature, low-growth power distribution businesses can still be lucrative. Li recently offered $5.6 billion for the E.ON assets, the UK’s Sunday Times newspaper has reported. At that price, the post-tax return on acquisition would be a tidy 11 per cent. A tax credit from Li’s UK telecom business can be used to reduce future tax bills elsewhere in the group. Hutchison Whampoa, which controls Cheung Kong Infrastructure (CKI), had $1.9 billion deferred tax assets as of June 30. Another acquisition in UK can make sure those UK tax credits get fully used.

Li’s empire has the firepower for the deal. Assuming he can fund roughly 57 per cent of the consideration with debt, or 4.6 times 2010 Ebitda (in line with the leverage he applied to EDF’s UK power assets), $2.4 billion of equity would be needed. CKI has $1.3 billion cash on hand. Hutchison, which is raising $6 billion through a Singapore initial public offering of ports, can provide additional ammunition.

There would also be some industrial logic. Li has a good operational track record in UK. The two networks can share costs of management and technology with Li’s three existing UK power networks. Their bargaining power with suppliers might increase.

True, such a transaction would have its risks. Li’s significant share of UK’s infrastructure assets, including power, gas and water, may raise eyebrows. Li could control close to half of electricity distribution in the UK after the deal, according to BNP Paribas. And, UK power assets are getting more expensive. The European Utility Index has risen eight per cent since late July, when Li clinched a deal with EDF. Li may get drawn into a costly auction.

Still, value, leverage and synergies explain why Li thinks the risks are worth it — and why a slight re-weighting from HK to the UK might just pay off.