Should you buy Meridian Energy?

The New Zealand government is moving ahead with its planned program of selling state assets to raise up to NZ $5 billion for spending on new schools and hospitals. The latest asset to be put on the block is Meridian Energy, the country’s largest electricity producer with over 30% of the market.

The company will have a market capitalization of up to NZ $4.6 billion, depending on the final share price, and is expected to list on the ASX on 29 October under the ticker MEZ. But does it represent a golden opportunity for investors?

While New Zealand residents get first bite of the IPO and some extra sweeteners like a capped price and the chance to pay for shares in two installments, many investors will still be feeling bruised by the previous government listing of Mighty River Power (ASX: MYT) in May this year.

Shares in Mighty River opened at $2.17 per share and quickly sank 14% to $1.86. They have yet to fully recover. The Meridian IPO price appears to mirror the range Mighty River was set at when the two are compared by their indicative listing price to earnings (p/e) ratios. Based on forecast 2014 earnings Meridian comes in at 20.5-24.6, while Mighty River was 20.5-24.4.

The price will offer a gross dividend yield of 7.4%-8.9% according to the offer document, which is 70-80% of the company’s free cash flow. That is certainly an attractive prospect against the low interest being offered by cash bank accounts.

However there are a number of risks around long-term performance. The largest of these is the potential closure of the country’s Tiwai Point aluminium smelter in 2017. The smelter is owned by Rio Tinto (ASX: RIO), which claims it is no longer viable to operate, and which was granted NZ$30 million by the New Zealand government to keep the plant running. The smelter consumed 41% of Meridian’s total energy production in the last five years, so if it does close there will be a major hole in the company’s earnings.

Meridian appears to have some limited avenues for growth in the form of electricity price increases and further development of renewable production. For example the company has teamed up with AGL Energy (ASX: AGK) on its Macarthur Wind Farm, the largest in the Southern Hemisphere.

Foolish takeaway

The New Zealand government is again taking advantage of strong markets on both sides of the Tasman with the listing of Meridian Energy. Income investors may jump at the chance for a strong dividend, but long-term, growth-focused investors looking for a great price won’t find much to get excited about.

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Motley Fool contributor Regan Pearson does not own shares in any company mentioned.

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