ENN cancels acquisition plans of China Gas through consortium

Moody's gave the move a thumbs up.

Moody's Investors Service has todayconfirmed the Baa3 issuer and senior unsecured ratings of ENN Energy
Holdings Limited.

The ratings outlook is stable.

The rating action concludes Moody's review of ENN's ratings for downgrade, which was initiated on 13 December, 2011 after its announcement of plans for a partial acquisition of China Gas Holdings Limited.

Here's more from Moody's

Today's action follows ENN's announcement that it will not proceed with its offer, which would have involved acquiring the outstanding shares and options of China Gas through a consortium formed with China Petroleum and
Chemical Corporation (unrated).

"For ENN, this cancelation removes the risk of a material financial and liquidity deterioration that would have resulted from the transaction. The deal would also have exposed ENN to execution risk related to both the consolidation of China Gas and the refinancing of related loans", says Ivan Chung, a Moody's Vice President and Senior Credit Officer.

"ENN's management now plans to use excess cash earmarked for the acquisition to repay short-term debt, thereby improving its balance sheet position. Accordingly, adjusted Debt/EBITDA will improve to around
3.0x-3.2x and RCF/Debt to around 18%-20%. Both these levels are consistent with the Baa3 ratings, although at the weaker end", says Ivan, also ENN's international lead analyst.

"We expect that ENN's city gas distribution business will continue to grow and perform well, given favorable industry dynamics, such as the government's advocacy of greater natural gas consumption, the company's
increasing upstream gas supply and transmission capacity, as well its cost advantages, and the efficiency of natural gas as an cleaner energy source", says Kai Hu, Moody's local market analyst for ENN.

"Its expected annual cash flow from operations of around RMB 2.5 -2.8 billion over next two years will be sufficient to cover normal capital spending. ENN could also afford moderate-sized ad hoc acquisitions (i.e.
less than RMB2 billion), without significantly damaging its credit profile", adds Hu.

"We consider that ENN remains interested in acquisition opportunities and will keep its cash balance higher than its normal operating needs so as to be positioned to take advantage of potential opportunities. But as its
close peers are stronger in terms of their standalone financial profiles and/or parental backgrounds, it is difficult for ENN to find another target of similar size to China Gas", says Hu.

ENN's Baa3 issuer rating is underpinned by its dominant position in the piped-gas sector, including geographically diversified operations, a large market presence -- often involving monopoly positions -- in gas distribution for over 30 years, and favorable industry trends that offer good growth potential.

Nevertheless, the ratings are constrained by its high risk appetite, the risks associated with China's evolving regulatory framework -- i.e. potential delays in cost pass-through materialize if the government raises upstream tariffs -- and the volatility in cash flow due to the one-off nature of connection fee income.

ENN's subsidiary level debt/total asset ratio reached 18% at end-2011. Given that the company has a track record of reducing this ratio, Moody's expects that it could decrease the weight of its onshore subsidiary debt such that structural subordination would not be a material issue for the bonds. However, if the subsidiary level debt/total asset ratio is consistently higher than our notching trigger of 15%, then we would apply notching on its senior unsecured bond ratings.

The rating outlook is stable, reflecting Moody's expectation that ENN's revenue and cash flow generation will also remain stable because it is likely to manage its expansion in a prudent way. The possibility of upgrade pressure is limited, given that the constraints to its rating will continue over the medium term.

However, over the longer term, such pressure could emerge if ENN can (1) generate more recurring revenue from its gas sales; or (2) demonstrate a disciplined approach to growth, i.e. its growth is supported by increased market penetration instead of acquisitions; or (3) show meaningful and stable free cash flow to deleverage its balance sheet.

The financial metrics Moody's would look for in terms of an upgrade include: Debt/EBITDA below 2.0x and RCF/debt above 30% on a consistent basis.

Downgrade pressure could arise due to (1) a deterioration in the operating environment, such as because of unfavorable changes to the regulatory framework; or (2) sharp declines in profit or cash flow due to an inability to pass-through gas costs or any significant loss of connection fee income; or (3) aggressive debt-funded capital expenditure or investments.