Meridian Energy sale likely to take place in the next 10 weeks

According to the Government's privatisation timetable, the sale of 49 per cent of Meridian Energy will occur some time in the next 10 weeks.

However, for that to happen, there must first be a resolution of Meridian's big problem with its biggest customer, the Tiwai Point aluminium smelter, owned by Rio Tinto subsidiary Pacific Aluminium.

Meridian chief executive Mark Binns has talked a good game on this one, claiming defensibly, if rather bravely, that losing the smelter as a customer would help the largest hydro-electricity generator in the country because it could sell its juice more profitably elsewhere.

With PacAl required to give somewhere between five and six years' notice of its intention to wind down and close the smelter, Binns reckons there would be time for a grand shakeout among the existing players in the electricity sector, and Meridian's low-cost hydro power would be a big winner.

Owners of gas fields, gas contracts and gas and coal-fired power stations, like state-owned Genesis Energy, would probably take the greater hit. So would Contact Energy, with its large gas exposure.

Either way, Binns still has a problem. The smelter accounts for around 45 per cent of Meridian's total revenue. It would clearly be preferable to have a new smelter contract in place rather than try to float a minority stake in the company with such a large source of uncertainty unresolved.

However, if a new deal is signed, Meridian and the Crown still have a problem. Any new electricity contract to service the smelter will be at a lower average electricity price, is most unlikely to extend forward 18 years, as the current contract does, and may even change the terms on which the smelter can give notice of intention to quit production.

Given the size of the smelter in Meridian's revenue line, that can only mean one thing: Meridian is worth less than previously assumed.

The last publicly available, independent valuations of Meridian for the Crown Ownership Monitoring Unit were published in December 2011. Macquarie Equities put a value of $6.531 billion on Meridian, making it by far the most valuable trading entity in the Government's portfolio. Meridian itself plumped for a round $6.5b.

But both those valuations were pumped up by at least $500 million because they included the forward value of the then undisputed new smelter contracts, which were signed in 2007 but only came into effect in January this year.

In between, there was a global financial crisis, a collapse in aluminium prices, and a rash of highly efficient, new smelting capacity was built in China.

Clearly, whatever the renegotiated contract is worth, it's not going to be worth what those 2011 valuations assumed. Add to that the fact the Government would be crackers not to pull out a hefty dividend pre-float, based on Meridian's recent sale for around $600m of its half-share of the massive Macarthur wind farm in Australia.

The inescapable conclusion is that if the Government is to part-sell Meridian, it will need to do a balance sheet writedown first, probably extending to some hundreds of millions of dollars. That could still leave Meridian worth around $6b, and able to deliver perhaps $3b to the Crown's coffers.

But from a political, let alone a seller's perspective, a pre-float writedown is undeniably untidy. It hands a gift to Opposition parties, which will see it as evidence the sale is not only wrong, but is also at the wrong time.

It will undoubtedly make the listing price for Meridian lower than would otherwise have been the case, although there could yet be upside in that. For retail investors, who were scared off the Mighty River Power float in part by the Labour-Greens policy, Meridian shares may appear more attractively priced than MRP's.

The under-performance of the MRP share price, which has traded for most of its two months on the NZX at below the issue price of $2.50 a share, has been the cause for rueful reflection among ministers. Creating a more compelling proposition to attract a bigger retail investor pool for Meridian, is all the more important as a result.

The electricity companies, at the right price, remain steady yield stocks for a conservative investor. But the MRP float and now the Meridian float's challenges demonstrate assets once portrayed as cash cows, in fact, come with baggage. After years of rising demand and electricity prices, the market is now flat and price rises are hard to push through. Proposed changes to transmission charging could also hurt both Meridian's and MRP's earnings.

All these factors should depress the Meridian issue price. Whether that makes it an attractively priced buy or a scandalous fire sale will depend entirely on your point of view.