Access arrangement final decision Envestra Ltd 2013–17 Part 2: Attachments

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Equity raising costs

Service providers incur equity raising costs when they need to raise new equity from outside the business. The AER's equity raising cost benchmark allows for costs in the form of dividend reinvestment plan costs and seasoned equity offerings. A prudent service provider acting efficiently would incur equity raising costs. Accordingly, the AER provides an allowance to recover an efficient amount of equity raising costs where a service provider's capex forecast is large enough to require an external equity injection (to maintain the benchmark 60:40 debt to equity ratio).
Broadly, the AER's method applies the cash flow analysis in the post–tax revenue model (PTRM) to determine the required benchmark equity raising cost associated with forecast capex. This approach adopts the "pecking order" theory of capital structure. This theory predicts that an efficient service provider will seek to raise capital starting from the lowest cost forms and moving to higher cost forms as the lower cost forms are exhausted.^⁴³⁹
Based on the need for any dividend reinvestment plans and seasoned equity offerings, the AER assigns transaction unit costs for each form of equity funding. They are based on the AER's empirical review in assessing the benchmark costs for raising equity finance:^⁴⁴⁰

The AER considers that these unit costs represent the efficient costs required to raise equity in current market conditions because they have been suitably estimated by the AER^⁴⁴¹ and ACG,^⁴⁴² and subsequently reviewed.^⁴⁴³
The AER considers that this method represents the approach that a prudent service provider acting efficiently would apply in raising equity, given its particular capital raising requirements. This is because the method:

assumes that service providers first use the cheapest sources of equity
takes account of all the likely sources of equity
takes account of the requirements of a prudent service provider acting efficiently, by using the inputs and outputs of the PTRM as found by the AER to be efficient.
The AER’s draft decision for Envestra outlines the AER's equity raising cost method more fully.^⁴⁴⁴

The AER adopted its preferred equity raising cost method in its draft decision for Envestra. It determined that no equity raising costs were required for Envestra’s Victorian network.^⁴⁴⁵ However, Envestra had an equity requirement of $1.56m (real 2012) resulting in an allowance of $0.02m (real 2012) for its Albury network.^⁴⁴⁶ Envestra’s revised proposal also adopted the AER’s preferred method and Envestra did not comment on this method.^⁴⁴⁷ The AER therefore agrees with Envestra’s revised proposal and the AER will adopt its preferred equity raising cost method for this final decision.
The AER has used the updated PTRM inputs and outputs to estimate the costs and total allowance for Envestra. Table 4 .40 to Table 4 .43 show the cash flow analysis calculated in the PTRM for Envestra's benchmark equity raising cost. Table 4 .40 and Table 4 .42 set out (in nominal terms) the derivation of the required new equity for the service provider. The second part of the cashflow analysis (in real terms) derives the benchmark allowance for raising this equity and is set out in Table 4 .41 and Table 4 .43. These tables demonstrate that Envestra does not require an equity raising cost allowance based on the level of forecast capex for its Victorian and Albury networks.

The AER has applied its updated equity raising costs method along with the updated PTRM inputs and outputs to determine that Envestra requires no benchmark equity raising cost allowance for its Victorian and Albury networks.

Table 4.40 AER’s final decision cash flow analysis for Envestra Victoria benchmark equity raising cost ($million, nominal)

Cash flow analysis	Total ($million, nominal)	Notes
Dividends	57.49	Set to distribute imputation credits assumed in the PTRM (70 per cent).
Dividends reinvested	17.25	Availability of reinvested dividends, capped at 30% dividends paid.
Capex funding requirement	428.56	Forecast capex funding requirement (including half year WACC adjustment).
Debt component	213.59	Set to equal 60% of annual change in RAB.
Equity component	214.98	Residual of capex funding requirement and debt component.
Retained cash flow available for reinvestment	230.97	Exclude dividends reinvested.
Equity required	-16.00	Equals equity component less retained cash flows.

Source: AER analysis.

Table 4.41 AER’s final decision cash flow analysis for Envestra Victoria benchmark equity raising cost ($million, 2011–12)

Cash flow analysis	Total ($million, 2011–12)	Notes
Equity component	194.75	Residual of capex funding requirement and debt component.
Retained cash flow available for reinvestment	209.62	Exclude dividends reinvested.
Equity required	-14.87	Equals equity component less retained cash flows.
Dividends reinvested	15.49	Availability of reinvested dividends, capped at 30% dividends paid.
Dividend reinvestment plan required	0.00	Required reinvested dividends.
Seasoned equity offerings required	0.00	Required seasoned equity offerings (SEOs).
Cost of dividend reinvestment plan	0.00	Required reinvested dividends multiplied by benchmark cost.
Cost of seasoned equity offerings	0.00	Required SEOs multiplied by the benchmark cost.
Total equity raising costs	0.00	Sum of costs of dividend reinvestment plan and SEOs. To be added to the RAB at the start of the access arrangement period.

Source: AER analysis

Table 4.42 AER’s final decision cash flow analysis for Envestra Albury benchmark equity raising cost ($million, nominal)

Cash flow analysis	Total ($million, nominal)	Notes
Dividends	3.57	Set to distribute imputation credits assumed in the PTRM (70 per cent).
Dividends reinvested	1.07	Availability of reinvested dividends, capped at 30% dividends paid.
Capex funding requirement	6.71	Forecast capex funding requirement (including half year WACC adjustment).
Debt component	1.89	Set to equal 60% of annual change in RAB.
Equity component	4.82	Residual of capex funding requirement and debt component.
Retained cash flow available for reinvestment	5.63	Exclude dividends reinvested.
Equity required	-0.80	Equals equity component less retained cash flows.

Source: AER analysis.

Table 4.43 AER’s final decision cash flow analysis for Envestra Albury benchmark equity raising cost ($million, 2011–12)

Cash flow analysis	Total ($million, 2011–12)	Notes
Equity component	4.35	Residual of capex funding requirement and debt component.
Retained cash flow available for reinvestment	5.12	Exclude dividends reinvested.
Equity required	-0.77	Equals equity component less retained cash flows.
Dividends reinvested	0.96	Availability of reinvested dividends, capped at 30% dividends paid.
Dividend reinvestment plan required	0.00	Required reinvested dividends.
Seasoned equity offerings required	0.00	Required seasoned equity offerings (SEOs).
Cost of dividend reinvestment plan	0.00	Required reinvested dividends multiplied by benchmark cost.
Cost of seasoned equity offerings	0.00	Required SEOs multiplied by the benchmark cost.
Total equity raising costs	0.00	Sum of costs of dividend reinvestment plan and SEOs. To be added to the RAB at the start of the access arrangement period.

Source: AER analysis

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