Huaneng Power International Case Final

Huaneng Power International Inc:Raising Capital in Global Markets

KDI School of Public Policy and Management Global Business ManagementProfessor: KIM, Ji-HongStudents: Munoz, Eduardo

Hagos, Yared Vujovic, Natasa

Agenda1. Executive Summary2. Industry Overview

• PRC 1994: Country Analysis

3. Company Snapshot4. Current Situation

• International Capital Markets

5. Case Questions6. Post-Case Analysis

• Exhibits

Sunday, April 9, 2023 3

Raising capital for the construction of new power plants.

Listed at the New York Stock Exchange (NYSE) on October 6, 1994.

Financing $4.5 billion, equity issue to raise $700 - $860 million.

Outside financing as domestic sources insufficient.

Economic reforms encouraged private ownership of state-run enterprises.

Two stock exchanges in infancy, relatively low capitalization and liquidity.

The Hong Kong Exchange offered mixed reception, uncertain success.

US stock exchange offered warm reception, broader international exposure, more institutional investors.

Executive Summary

Shandong Huaneng Power goes Public in

NYSE

July 1993, Hong Kong

Tsingtao Brewery

HPI goes public at $20

HPI Announces NY SE

April 1994, NY

US Interest rate jump, control

inflation

August 1994, NY Aug 1994 October1994, NY

Timeline of IPO


Overview Established in 1949, Communist Party the only legal party from 1994.

National People’s Congress (NPC) set economic policy - Socialist Market Economy.

NPC appointed the Premier of the State Council and other high ranking officials.

State Council, the highest administrative authority of the state, supervised and

coordinated all ministries and commissions, including the power industry.

1970s started experimenting with limited free-market reform.

State Owned Enterprises expected to make profit, changes continued in 1980s and 1990s.

People’s Republic of China


Inflation Issues Rapid growth fueled problems in 1980s and 1990s.

Greater demand caused increase in prices, while the government eased the control, resulting in national

unrest.

Tight control of capital, reducing demand, GNP and inflation at 2.1% in 1990 and 1991.

Reduced control in 1992, inflation in double digits.

Soft correction necessary for attracting and maintaining domestic and foreign investors.

SOEs had the largest slowdown.

Privately owned businesses increasing at 40% per year.



Political, Economic and Legal Climate

Stable but ageing leadership of Deng Xiaoping. No guarantee of successor and government orientation.

FX rate, rapid decrease (40%) due to discrepancy between official and spot rate. Government foreign currency reserves increased by more than 50% in 1994. Almost no trade deficit. No withholding tax on dividends or capital gains earned by foreigners, but no guarantee for

the future. Possibly 20% withholding tax in the future. 10% withholding tax warranted by a treaty with the US.

Legal history shows no acceptance of international court decisions.



Power Industry in PRC - Overview

Organized under the Ministry of Electrical Power. Scarce commodity in industrialized parts. Many new plants needed to accommodate the growing demand. China Huaneng Group to oversee power generation and distribution, with the local government. The Group formed joint venture with foreign investors – Huaneng Power International

Development Corporation (HPIDC). HPIDC was to develop power plants and distribute power in the fastest growing provinces. No direct competition.


PRC Energy Growth


Huaneng Power International: HPI 华能国际电力控股有限公司 Type: Public Founded: 1994 Industry: Power generation Headquarters: Beijing, China Area served: People's Republic of China Parent: China Huaneng Group Employees: 22,899 Administrated by the State Council of the People's Republic of China. Five largest power producers in China: It engages in the development, construction and operation of large power

plants

Company Snapshot

Holders of International

Shares - 25%

Huaneng International Power

development Co (HPIDC) – 40.23%Local Government &

investment Co – 34.77%

HPI Inc.

Ownership after IPO Current Owners


HPI SWOT

Strength An extensive developer of power plants.

One of the world’s largest independent power

producers.

Has full government support.

Uses foreign equipment and technologies.

Had a profitable operations history.

Offers attractive investment due to its success

( HPI & HPIDC).

Priority in the allotment of coal and oil supply.

☞ Profitable history and a LIP producer.

Weakness Lacks supply chain control (distribution).

No business interruption insurance.

No third party liability insurance.

Transportation problems (coal to plant).

Lack of skilled personnel.

☞ Unsafe operational practices


HPI SWOT

Opportunity High demand for HPI securities at NYSE.

Broader international exposure.

Access to many international and institutional

investors .

Exception for Chinese companies to present only

2 year audited financial reports.

☞ Exception for Chinese companies to present only

2 year audited financial reports.

Threats The business involves uncontrollable risks:

Natural disaster

Labor disrupt

Equipment break down

Plants are geographically dispersed

(logistics and control problem).

Environmental protection laws and

regulations.

Government support may not last long.

☞ Uncontrollable risks and Environmental

factors


Capital Markets for PRC Companies

Hong Kong Securities Market

The Hong Kong security market:

•The market saturated with PRC companies.

•The market may not absorb the issued security.

•The fluctuating demand of companies security.

•Investment banks and buyers negotiate stock prices.

“☞ Investment banks problem ”

Commitment of the Hong Kong stock exchange (1994):

Established Hang Seng China Enterprise Index .

Target the announcement of 20 new PRC firms.

PRC stocks fell 20% in Hong Kong market.

Hong Kong stocks firms stock price increases.

“☞ Instability of stock prices”


Capital Markets for PRC Companies

US Securities Market

• Offers greater potential in terms of size & valuation.

• Best for emerging market investment (IPOs).

• US dealers promoting NYSE and NASDAQ in PRC.

• Large market and an alternative.

• American Depository Receipts (ADRs).

NASDAQ: National Association of Security Dealers Automated

Quotation.

Is a technology oriented stock exchange.

A market system guaranteeing investor for the stock once listed.

Ensure guaranteed returns.

☞ London stock exchange


Question 1: Is this the right time for HPI to raise capital overseas, and will foreign investors be interested in investing in this company?

Question 2: Alternatives to a stock offering at this time? Question 3: What is a reasonable value for 25% of this

company? Question 4: What criteria are important in determining the

market for this firm’s stock?

Case Questions


Financial need for growth strategy Domestic financing issues

In need of $4.5 billion (equity $700-860 million)

Banks incapable to meet capital needs

Economic reform and growth of industry

Project expansion: Construction of 6 new power plants

International Investors: YES,1.Healthy Financials and Profitability of HPI2.Ownership Structure (HPIDC majority control)3.Prospective growth of stock value (Driven by PRC’s energy needs)4.Tax Holiday: Reduced withholding tax to US investors for dividends and capital gains5.Project Return overpowers the Country Risk6.Latest foreign equipment and technologies use in plants.

Inefficient Self financing

Difficulties in International debt capital

Raise cost-efficient funds

Infancy stage of local security market

Oversaturation of HK Market

Oversaturation of HK Market

Q1: Raise capital overseas: Timing


Q2: Alternatives to Stocks

NO, The company already is using the maximum amount of internal generated funds

and debt. The funds necessary to finance the expansions will require a stock offering.

The alternatives to stock, are listed below, but not apply to the current conditions of this

company, due to the following reasons :

Alternatives: Debt Financing (Corporate Bonds, Bank Loan, Term loans, Private

placements,)

Increases leverage, and changes company debt structure.

Cash Liquidity issues and Risk of Bankruptcy

Local banks do not have capital needed, international banks may not accept

the risk.

SummaryPro

-Forma Cash

Flows

WACC

Presen

t Value of

Cash

Flows

Total

Operating Value

Sensitivity An

alysis

Q3: Valuation of HPI

Assumptions

Cash Flows Case writers estimated based on Exhibit 12

CAPEX Exhibit 8 (Initial Assets – Final Assets + Depreciation)

Working Capital No Changes in WC from sales, Note in Exhibit 12

Growth Rate 33% (Average of Implied growth rate of cash flows)

Inflation Rate 8% (Average of 1989-1994 – Hyperinflation)

Continuing Value

20% (Growth Rate - Inflation Average)

Tax Rate 17.37% – Long Term Effective tax rate

Country Risk 8% (1. Delta of MRP of HK vrs US . 2. M&A Course Prof. Cho Lecture)

Company Beta 1.46 (Calculated from given Re of 15%)

Foreign Currency

Case writers converted financials into USD $ from RMB. FX Risk included in country risk

Discount Rate (Exhibit 12 & 13)

Rf 8.09 (US Gvmt LT Bond Oct 1994)

Rm-Rf 4.73% (S&P 500 LT Market Premium 1926 to 1993

Βi 0.56

βHPI 1.46

Tax 17.37%

Country Risk 8%

Ke 15%

Kd 8%

WACC 11.10%

WACC + CR 19.10%

PROFORMA CASH FLOWS

1994 1995 1996 1997 1998 1999 2000- CV

EBIT 114,232.00

162,599.00

186,751.00 248,589.00 334,753.00 462,657.00 556,725.72

(+) Depreciation 76,278.00

76,429.00

112,562.00 191,829.00 262,495.00 282,295.00 339,692.01

(-) Taxes 8,725.00

14,305.00

20,835.00 29,175.00 20,120.00 25,316.00 30,463.32 Operating Cash Flow 181,785.00

224,723.00

278,478.00 411,243.00 577,128.00 719,636.00 865,954.42

(-) Delta in NWC -

- - - - - - (-) Capital Expenditures 225,000.00

590,809.00

862,013.00 842,931.00 451,924.00 298,115.00 358,728.58

OFCF (43,215.00)

(366,086.00)

(583,535.00) (431,688.00) 125,204.00 421,521.00 507,225.84


Pro-

Forma Cash

Flows

WACC

Presen

t Value of

Cash

Flows

Total

Operating Value

Sensitivity An

alysis

Sensitivity AnalysisWACC 2000- Continued Value Total Operating Value

11.10% $9,771,769.83 $8,942,677.65

15.00% $3,617,657.66 $2,812,185.07

16.72% $2,695,514.47 $1,900,864.28

19.10% $1,912,827.33 $1,133,429.10

20.00% $1,702,827.88 $929,268.98


Pro-

Forma Cash

Flows

WACC

Presen

t Value of

Cash

Flows

Total

Operating Value

Sensitivity An

alysis

SummaryPro

-Forma Cash

Flows

WACC

Presen

t Value of

Cash

Flows

Total

Operating Value

Sensitivity An

alysis


The Value of 25%: $475 Million. ADR Price: $15.21 to $22.50


Factors to consider in raising capital overseas

• Company Potential - consistent record of growth over several years.• Market Size -large enough to attract institutional investors.• Market competitive - strengths and weaknesses.• Share structure issues - equality and debt capital. • Sector Performance - company and performance of existing companies. • Management and board of directors• Corporate structure and governance• Percentage subscription - amount of security offered as IPO. • Future Prediction and Forecast • Internal controls - corporation must have internal controls, systems and procedures.

Q4: Market for firm stock


One year after IPO 1995: Less than $10 Current Stock price: $21.97

Post-Case Analysis


Thank you


Security valuation of HPI

HPI wants higher valuation than competitors’

Uses more efficient foreign technology.

Had a profitable operations history.

Diversified operations. Greater growth potential.

Good relationship with the government.

Lehman Brothers suggests P/E ratio of 30.

Issue price between $22.5 & $27.5.

About 15.5 – 19.0 times expected 1995 earning.

At prospectus, issue price set at $20.

About 14 times expected 1995 earning.

The valuation of the HPI stock per share

☞ Stock price depends on company’s performance and market condition.

Huaneng Power International Case Final

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