(Fitch Ratings, 28.Jan.2021) — Ecopetrol’s (BBB-/Negative) non-binding offer for the Colombian government’s 51.4% stake in Interconexion Electrica (ISA, BBB+/Negative) ratifies the company’s close linkage with the government, according to Fitch Ratings. Although Fitch does not expect the transaction to impact Ecopetrol’s ratings, as they will continue to be equalized with those of the Republic of Colombia given their strong linkage, this transaction will delay the company’s deleveraging strategy, as it will increase consolidated pro-forma gross leverage by 0.5x to approximately 3.1x from Fitch’s previously expected recovery to 2.6x for 2021.
Fitch currently rates ISA on a stand-alone basis given the relative moderate linkage with the Colombian government and moderate strategic importance for the country resulting from the company’s size and extensive offshore operations. Should the proposed transaction materialized, Fitch’s approach for rating ISA would change from a government related entity (GRE) to a parent and subsidiary linkage with Ecopetrol, as Fitch does not typically applies its GRE methodology when rating subsidiaries of government entities.
This change in rating approach could be neutral to negative for ISA as Ecopetrol has the same credit quality as the Colombian government but may increase pressure on dividends from ISA. Fitch expects the new owner to continue maintaining ISA’s operational independence, given the very limited potential operational synergies. ISA has historically distributed approximately 50% of its net income as dividends, and Fitch expects this to continue. Nevertheless, ISA may be able to sustain a moderately higher dividend pay-out ratio, given its strong credit metrics and low business risk.
On a consolidated basis, Fitch believes the proposed transaction will have a moderate impact on Ecopetrol’s credit metrics. Fitch estimates Ecopetrol’s pro-forma consolidated 2021 gross leverage, defined as total debt to adjusted EBITDA, will be 3.1x in 2021, up from our current expectation of 2.6x. On a consolidated basis, the proposed acquisition will add $1.7 billion of EBITDA from ISA and roughly $6 billion of debt in 2021, as Ecopetrol would consolidate ISA after acquiring the government’s 51% interest.
Through 2023, Fitch estimates that pro-forma gross leverage will average 2.9x and net leverage will average 2.4x. On a stand-alone basis for Ecopetrol, the proposed transaction would have a relatively similar impact for its credit metrics since the company expects to fund a portion of the transaction with an equity issuance and the balance with either cash on hand or debt, while its cash flow from dividends would increase by approximately $180 million per year as estimated by Fitch using ISA’s historical dividend distribution.
Operationally, Ecopetrol’s bid for ISA could diversify its business from a traditional energy company with upstream, midstream and downstream operations predominately in Colombia, to a more diversified energy and utility company. ISA has a low business risk profile in regulated businesses across seven countries in Latin America. Fitch expects that in December 2020, around 70% of consolidated revenues came from investment-grade countries, namely Colombia, Peru and Chile, while Brazil represented 30%.
The electricity transmission business, which historically has represented the bulk of ISA’s consolidated cash flow generation, contributed 80% of EBITDA in 2020, excluding construction activity. There is uncertainty regarding how Ecopetrol’s overall business will benefit from this acquisition and how the operations will be integrated.
On Jan. 27, 2021, Ecopetrol announced it submitted a non-binding offer to acquire 51.4% of ISA owned by the Republic of Colombia through its Ministry of Finance. If accepted, Ecopetrol is expected to finance the transaction, which could be close to $3.5 billion at ISA’s current market cap, through an equity issuance that would reduce the government’s ownership in the company to no less than 80% as well as cash on hand and debt issuance. Per the company, the transaction between Ecopetrol and the government qualifies as an inter-administrative agreement and thus is exempt from law 20 of Act 226/1995 and therefore will not be required to make a public tender offer to ISA’s existing minority shareholders.