Lagos State Government 2013 Bond Offering Investment Case Our recommendation for the current tranche of NGN87.5bn Lagos State bond is based on analysis of the current yield environment of the comparable FGN bonds of similar maturity. The Lagos Fixed Rate bond (series 2) under NGN167.5bn programme was initially issued at a coupon rate of 14.5% with initial value of NGN80bn in Dec 12. The current offering is rated by topmost rating agencies; Fitch as BB-, A by GCR and A+ by Augusto & Co. The bond is secured and guaranteed by sinking fund from a combination of ISPO (Irrevocable Standing Payment Order) and 15% statutory deductions from the IGR (Consolidated Debt Service Account- CDSA). We consider the positive economic fundamentals of Lagos State as an Issuer and the viability of the State in terms of revenue generation as likely positives for allay of credit risk. We note however that liquidity risk still remains a downside to the issuance. We are comfortable with the sources of revenue for repayment plan given that c.70% of revenue comes from IGR. In our view, this presents viability and less dependence on FAAC allocation. Our outlook on interest rate is stable given the current policy stance of the CBN in terms of price and exchange rate stability. Yields on FGN bonds may assume a downward trend in the medium to long term given the expected liquidity into the financial system between now and 2015. We recommend a 1.5% premium (max) to the current yield on 7Y FGN bond instrument as the appropriate yield at which investors can bid for the current LASG 14.1% 23, Nov 2019 bond instrument. This in our view should be suffient to compensate for the credit and liquidity risks plus the downward outlook on yields. See Page 4 for Analysts Certification & Disclaimer Note
Highlights of the Offering Proposed use of Proceeds Lagos state government plans to deploy the proceed from the current bond issuance to the financing of infrastructure projects currently 100% on-going. Specifically, the State intends to deploy the proceeds into reconstruction of Lagos-Badagry dual carriage way, blue line rail project, acquisition of assets and liabilities of LCC, water project etc. Recommendation Instrument Implied Price Advised Yield IRR 16% FGN JUN 2019 Current 113.36 Current 12.60% 6.37% LASG 14.5% 23, Nov 2019 1015.80 14.10% 7.25% We compared Lagos State bond to the currently running 7-Yr FGN bond and by relative valuation using the Internal Rate of Return (IRR), the Lagos bond has a higher IRR value of 7.25% against the FGN s 6.37%. In our view, this compensates for the higher risk the instrument carries. We recommend, based on our analysis of liquidity and credit risk as well as interest rate outlook and the current yield environment that investors bid with a max premium of 1.5% to the current yield on a comparable FGN 7-Yr FGN bond. Therefore, we recommend a yield of 14.10% at an implied clean price of NGN1015.80 per unit. 2 P a g e
Yield on 7-Year FGN Bond vs. Coupon Run Rate on Lagos State Government Bond 16.0% 15.0% 14.0% 13.0% 12.0% 11.0% 10.0% 9.0% Yield on 7Yr FGN Bond Lagos 7Y Bond Coupon 8.0% Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Source: FMDA, Meristem Research Attractions: Economic Fundamentals of Lagos State Current population size >21 million and current growth rate of 6 8% (vs. Nigeria: 2.5-3%). UN estimates that Lagos State will be the 3rd largest mega city in the world by 2015, after Tokyo in Japan and Bombay in India. Most financially viable and economically active State in Nigeria. Nigeria s financial, commercial and industrial nerve centre. Economic hub of West Africa Fastest growing city in Africa. 7th fastest growing city in the world. State s own internally generated revenues (IGRs) are >70% of its total revenues. Commercial hub for c.60% of Nigeria s total industrial investments and foreign trades. State contributes c.30% (c. US$75bn) of Nigeria s GDP Over 80% of the top banks in West Africa are headquartered in Lagos. Home to the 2 largest power distribution companies (Discos) representing 50% of all revenues from Discos. 3 P a g e
Analyst s Certification and Disclaimer This research report has been prepared by the research analyst(s), whose name(s) appear(s) on the cover of this report. Each research analyst hereby certifies, with respect to each security or issuer covers in this research that: (1) all of the views expressed in this report accurately reflect his or her personal views about any and all of the subject securities or issuers (the Issuer); and (2) no part of any of the research analyst s compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst(s) in this report. Research analysts compensation is determined based upon activities and services intended to benefit the investor clients of Meristem Securities Limited (the Firm). Like all of the Firm s employees, research analysts receive compensation that is impacted by overall Firm profitability, which includes revenues from other business units within the Firm. (3) each research analyst and/or persons connected with any research analyst may have interacted with sales and trading personnel, or similar, for the purpose of gathering, synthesizing and interpreting non-material non-public or material public market information. As at the date of this report, any ratings, forecasts, estimates, opinions or views herein constitute a judgment, and are not connected to research analysts compensations. In the case of non-currency of the date of this report, the views and contents may not reflect the research analysts current thinking. This document has been produced independently of the Issuer. While all reasonable care has been taken to ensure that the facts stated herein are accurate and that the ratings, forecasts, estimates, opinions and views contained herein are fair and reasonable, neither the research analysts, the Issuer, nor any of its directors, officers or employees, shall be in any way responsible for the contents hereof, and no reliance should be placed on the accuracy, fairness or completeness of the information contained in this document. No person accepts any liability whatsoever for any loss howsoever arising from any use of this document or its contents or otherwise arising in connection therewith. Important Disclosure Analysts Compensation: The equity research analysts responsible for the preparation of this report receive compensation based upon various factors, including the quality and accuracy of research, client feedback, competitive factors, and overall firm revenues, which include revenues from, among other business units, Investment Banking. Legal entity disclosures: Meristem Securities Limited is a member of The Nigerian Stock Exchange and is authorized and regulated by the Securities and Exchange Commission to conduct investment business in Nigeria. Copyright 2013 Meristem Securities Limited. All rights reserved. This report or any portion hereof may not be reprinted, sold or redistributed without the written consent of Meristem Securities Limited. 4 P a g e
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