BUY OR SELL-Will the tap run dry for Malaysia's Puncak?

KUALA LUMPUR, March 24 (Reuters) - Malaysian water firm Puncak Niaga Holdings (PNHB.KL) is at the centre of a political battle between the federal government and national opposition.

Its shares have fallen 10.5 percent since Selangor state, the country's richest and ruled by the opposition, offered $852 million for Puncak's water treatment and distribution units on Feb. 13 in an attempt to avert an unpopular 37 percent water tariff hike. The company is now worth just $325 million.

Malaysia's broader stock index .KLSE is down 3.6 percent over the same period.

The offer for 100 percent-owned Puncak Niaga Sdn Bhd and its 70 percent-owned Syabas unit was rejected as it was based on just 1 times book value of its water related assets and did not assume any liabilities. [ID:nKLR427743]

Puncak has since opened talks with Pengurusan Aset Air (PAAB), a federal government agency, and analysts expect the outcome to be a friendly negotiated takeover of the assets.

Puncak's executive chairman, Rozali Ismail, has close ties to the United Malays National Organisation (UMNO), which heads the National Front coalition that has ruled Malaysia for 51 years, and could be awarded the management contract to the Selangor assets it is to sell.

PAAB has undertaken similar restructurings in Johor, Melaka and Negri Sembilan states and, to be consistent, would use a similar pricing benchmark of 1 times net book value for Puncak's water assets, analysts say.

LEAKY

Selangor's water industry is fragmented, with too many firms facing the huge capital needed to upgrade ageing infrastructure, hence the demand for tariff hikes. Governments, responsible for ensuring water is affordable, want to keep tariffs low.

"We don't hold any Puncak Niaga shares because we looked at how the industry was structured and it wasn't something we were comfortable with," said Abdul Jalil Rasheed, head of equities at Aberdeen Asset Management's Malaysian unit.

"Structurally, there's a problem with the framework and, with (takeover) discussions ongoing ... with the government, which means you need to give some sort of concession, it becomes an area of concern. We don't know how it's all going to pan out."

RHB Investment Management is similarly cautious.

"The water sector has been an area of concern for us," said managing director Sharifatul Hanizah Said Ali, who oversees $2.2 billion in assets at RHB, part of Malaysia's fourth-largest lender, RHB Capital Bhd (RHBC.KL).

O&M SWEETENER?

If Puncak agrees to sell its assets to PAAB, it may be awarded the operations and maintenance (O&M) contract for water services in Selangor, where it will lease the assets from PAAB at a mutually agreed rate over a 30-45 year period.

"Puncak's experience and perceived expertise should tip the award of an O&M agreement in its favour," said Chong Lee Len, analyst at Affin Research. "That could be seen as both a sweetener and catalyst in restructuring Selangor's fragmented water industry," said Chong, who has a 'reduce' call on Puncak as the stock is trading above her fair value assumption.

Affin Research believes PAAB may pay up to a 20 percent premium for Puncak's assets, valuing a deal at 1 billion ringgit ($275 million) or 2.60 ringgit a share including the potential management contract. The stock currently trades at 2.86 ringgit.

Malaysian investment firm TA Asset Management "is not negative" on Puncak as the water industry will withstand economic hardship, its chief investment officer Choo Swee Kee said.

"Obviously we look at the business and the model is quite resilient especially during the current downturn," said Choo, who helps manage up to $499 million at TA, which holds about 0.2 percent of Puncak shares.

Choo expects Puncak to get a reasonable price for its assets, adding: "If they get to manage the state's water services, then that's positive, too."

Puncak's net profit is forecast to jump more than fivefold this year to 135 million ringgit ($37.1 million), according to Reuters Estimates. (Reporting by Julie Goh, Editing by Ian Geoghegan)