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KDI School of Public Policy and Management

Global Business Management Professor: KIM, Ji-Hong Students: Munoz, Eduardo Hagos, Yared Vujovic, Natasa

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Executive Summary Industry Overview

PRC 1994: Country Analysis

Company Snapshot Current Situation

International Capital Markets

Case Questions Post-Case Analysis



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.

July 1993, Hong Kong

April 1994, NY

August 1994, NY

Aug 1994

October1994, NY

Tsingtao Brewery

US Interest rate jump, control inflation

Shandong Huaneng Power goes Public in NYSE

HPI Announces NY SE

HPI goes public at $20

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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.

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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.

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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.

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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

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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
Ownership after IPO Current Owners
Huaneng International Power development Co (HPIDC) 40.23%

Holders of International Shares - 25%

Local Government & investment Co 34.77%

HPI Inc.
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 An extensive developer of power plants.  One of the world s largest independent power

 Lacks supply chain control (distribution).  No business interruption insurance.  No third party liability insurance.  Transportation problems (coal to plant).  Lack of skilled personnel.

 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.

Unsafe operational practices

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 High demand for HPI securities at NYSE.  Broader international exposure.  Access to many international and institutional

 The business involves uncontrollable risks: Natural disaster Labor disrupt Equipment break down  Plants are geographically dispersed (logistics and control problem).  Environmental protection laws and

investors .
 Exception for Chinese companies to present only

2 year audited financial reports.

 Government support may not last long.

Exception for Chinese companies to present only 2 year audited financial reports.
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Uncontrollable risks and Environmental factors


 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. 
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Instability of stock prices


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


Is a technology oriented stock exchange. A market system guaranteeing investor for the stock once listed. Ensure guaranteed returns. London stock exchange

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Is this the right time for HPI to raise capital overseas, and will foreign investors be interested in investing in this company? Alternatives to a stock offering at this time? What is a reasonable value for 25% of this company? What criteria are important in determining the market for this firm s stock?

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Financial need for growth strategy In need of $4.5 billion (equity $700-860 million) Project expansion: Construction of 6 new power plants Raise cost-efficient funds Economic reform and growth of industry Oversaturation of HK Market

Domestic financing issues Inefficient Self financing Difficulties in International debt capital Banks incapable to meet capital needs Infancy stage of local security market Oversaturation of HK Market

International Investors: YES, 1. Healthy Financials and Profitability of HPI 2. 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 gains 5. Project Return overpowers the Country Risk 6. Latest foreign equipment and technologies use in plants.
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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.

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Pro-Forma Cash Flows


Present Value of Cash Flows

Total Operating Value

Sensitivity Analysis

Assumptions Cash Flows CAPEX Working Capital Growth Rate Inflation Rate Continuing Value Tax Rate Country Risk Company Beta Foreign Currency Case writers estimated based on Exhibit 12 Exhibit 8 (Initial Assets Final Assets + Depreciation) No Changes in WC from sales, Note in Exhibit 12 33% (Average of Implied growth rate of cash flows) 8% (Average of 1989-1994 Hyperinflation) 20% (Growth Rate - Inflation Average) 17.37% Long Term Effective tax rate 8% (1. Delta of MRP of HK vrs US . 2. M&A Course Prof. Cho Lecture) 1.46 (Calculated from given Re of 15%) Case writers converted financials into USD $ from RMB. FX Risk included in country risk

Discount Rate (Exhibit 12 & 13) Rf Rm-Rf 8.09 (US Gvmt LT Bond Oct 1994) 4.73% (S&P 500 LT Market Premium 1926 to 1993 0.56

1.46 17.37% 8% 15% 8%

Tax Country Risk Ke K


11.10% 19.10%

Pro-Forma Cash Flows


Present Value of Cash Flows

Total Operating Value

Sensitivity Analysis

PROFORMA CASH FLOWS 1994 EBIT (+) Depreciation (-) Taxes Operating Cash Flow (-) Delta in NWC (-) Capital Expenditures OFCF 114,232.00 76,278.00 8,725.00 181,785.00 225,000.00 (43,215.00) 590,809.00 (366,086.00) 1995 162,599.00 76,429.00 14,305.00 224,723.00 862,013.00 (583,535.00) 1996 186,751.00 112,562.00 20,835.00 278,478.00 1997 248,589.00 191,829.00 29,175.00 411,243.00 842,931.00 (431,688.00) 1998 334,753.00 262,495.00 20,120.00 577,128.00 451,924.00 125,204.00 1999 462,657.00 282,295.00 25,316.00 719,636.00 298,115.00 421,521.00 2000- CV 556,725.72 339,692.01 30,463.32 865,954.42 358,728.58 507,225.84

Pro-Forma Cash Flows


Present Value of Cash Flows

Total Operating Value

Sensitivity Analysis

Sensitivity Analysis WACC 11.10% 15.00% 16.72% 19.10% 20.00% 2000- Continued Value $9,771,769.83 $3,617,657.66 $2,695,514.47 $1,912,827.33 $1,702,827.88 Total Operating Value $8,942,677.65 $2,812,185.07 $1,900,864.28 $1,133,429.10 $929,268.98

Pro-Forma Cash Flows


Present Value of Cash Flows

Total Operating Value

Sensitivity Analysis

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.

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

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