Huaneng Power International Inc.

HUANENG POWER INTERNATIONAL INC.

                Question 1

Is China a Relevant Investment Destination

• One of the largest country and population

• For the period 1989-1993 :

• GNP : 1,6 →3,14

• GDP : 4,4% 13,4%

• Direct investment : amount x 10

• Opening market thanks to political and economic reforms (socialist market economy, modernization, less control)

• Preferential tax treatment and right to buy shares of some listed companies

Key Success Factors

• Need to understand PRC goals and strategy

• Improve production and expansion of capacity to match with raising demand by implementing new technology

• Have relation with national and local government or institutions while being experienced in dealing with foreign investors

• Be protected from unfair treatment (having relation with government + good bargaining power could help)

HPI’s Strengths

• Strong connections with central and local authorities

• HPIDC is a joint venture with Chines government in it and is the major shareholder of HPI

• Local government investment companies own the rest

• HPI’s managers are former top manager of HPIDC or Ministry employees

•  Modern technology, more reliable than the other

• Fast growing targeted market (23% of population )

• Increasing profitability and efficiency

• Respect of time and budget when plant completed

• Geographically expanded plants + exclusive developer in those region

HPI’s Weaknesses

• Insurance Issue :

• Not covered if business interruption

• No third party liability

• Allotment Issue :

• No guarantees that they keep receiving coal, oil, transportation allotment whereas market price much higher

• Skilled Operational Staff Issue

• Risk of shortage of skilled personnel if rate of growth are true → imply high cost of foreign engineers if so

                Question 2

How to Access Financial Markets for HPI ?

• Debt market

• Equity Market

• Type of listing : HK – London – US (ADR Levels)

• Benefits for non-US firm traded in the US

• HPI has a limited internal source of capital due to high control on credit so, accessing to equity or debt market is a good way to raise capital

Debt Market

• Safer investment that attracts lots of investors

• Fixed interest rate

• Interest on bonds are deductible from the income tax return

• Interest payments which must be paid

• Higher risk of default

• Already got an international debt : hard to raise more

Equity Market

• Equity raised do not have to be reimburse (no obligation to pay dividends)

• Opportunity to raise capital

• Access to international investors

• Dilution of old investors power

• Need to reach certain rate of return to pay dividends (more attractive for investors if dividends)

• Additional costs due to registration requirements and listing fees

Which listing ?

• Chinese stock Exchange

• Familiar with PRC companies ( low capitalized internal stock exchanges)

• Amount expected to be raised is too high for China

• Hong – Kong

• Familiar with PRC firms tto ; has an index for it

• Risk to saturate the market by absorbing all the HPI raising equity

• London

• Focused on international trade and no listing premium for firms asking for a large issuance

• HPI issuance may be undersubscribed as they will issue the more they can

Which Listing ?

• NYSE or NASDAQ :

• assumed to be the best place to raise capital for PRC firms and they are technology oriented (NASDAQ) and Chinese companies oriented (NASDAQ)

• Only two years audited instead of three, while highly regulated market (to protect their interest)

• Ability to raise more funds internationally ( more efficient than the other stock exchange markets)

• ADR : negotiable certificate to trade X shares of foreign stock on US Exchange

• Level I : be unlisted but traded on OTC

• Level II : allow to be listed on US exchanges

• Level III : allow to be listed in the US and raise capital through public of ADR

Benefits to be Traded in the US

• Investors appetite of foreign equities increases !

• Investors are eager to expand their horizons in search of opportunities for capital growth

• Level of investment in foreign equities skyrockets since 1992and represents 2 trillion of dollars

                Question 3

Calculation Price

•   Cost of capital can be measured by the WACC (Weighted Average Cost of Capital)

• WACC = re ×(E/(D+E)) + rD× (D/(D+E))(1-T)

• Equity Options:

• Raise equity in Chinese Market

• Raise equity on the Hong-Kong Stock Exchange

• Raise equity in the USA market (NYSE)

• Equity value of HPI (E) = $609. 148 M

• Debt value of HPI (D) = Short term bank loan + Current portion of LT loans = 21.216+ 111.179 = $132.395 M

• Equity + Debt value = $741,543 M

We decided not to include shareholders loan in the debt value as it is not a bank loan. There is little chance that the shareholders will claim for the reimbursement if the company is in financial distress.

• PRC Market:

• Re = 15%

• Rd = 8%

• T = 9%

• WACC = re ×(E/(D+E)) + rD× (D/(D+E))(1-T) = 13.62%

• The Hong-Kong Market

• RE =20.39%http://people.stern.nyu.edu/adamodar/pdfiles/papers/riskprem.pdf)

• RD = 7.75%

• T = 16.5%

• WACC = 17.90%

• The US Market (NYSE)

• RE = Rf + β× Rp

• Rf = 8.09%

• Market premium = 4.73%

• Using the CAPM we found RE = 10.55%

• RD = 6% (US interest rate in 1994)

• T = 15% (US corporate tax in 1994)

• WACC = 9.58%

• The UK Market (LSE)

• RE = 10.66%

• RD = 5.125%

• T = 33%

• WACC = 9.37%

Question 4

What to choose ?

• Price compared to different IPO at the time show that prices are varying between 18,99$ - 19,2$ - 19,3$  and 21,5$

• Knowing strengths of HPI is legitimate to demand a higher price than the price calculated

• We propose a price corresponding to the high estimation of the mean is 20,5$  per ADR

Question 5

Implementation strategy

• We would suggest that HPI issues shares in the market place where the cost of capital is the less expensive. Therefore, we chose among market places in question 3):

• WACC PRC = 13.62%

• WACC HK = 17.90%

• WACC US = 9.58%

• WACC UK = 9.37%

• So we would suggest to go to the UK market

• HPI missed their IPO. By postponing the date of the IPO they have sent a bad signal to investors. This could be the raison why the IPO was as successful as their expectations.

• Maybe they should have issued at a lesser price than $20 because the economic outlooks were gruesome in the US. So investors had no confidence in the stock.

•  Maybe they should have analyzed the economic outlook in the different market places and their cost of capital. That is why we have recommended them to issue on the LSE where the cost of capital is less expensive and where the economic outlooks may be better than in the US.

Question 6

Good To Invest

• Growth opportunity :

•  already have right on 3 plants , mandate to operate plants through PRC

• Emerging sector

• Diversification :

• Invest in security in security uncorrelated with US market

• Emerging market

• Risk Management

• Investment in domestic currency

• Lack of Transparency and Law protection

• Obscure transactions and accounting principles

Question 7

A better environment…

• More transparency in the financial industry in China ➔ Creating a strong banking industry: opening the credit to performing company in China, managing funds …

• Monetary policy: by having a fixed exchange rates system, China is discouraging international investors to invest in China, and therefore to provide Chinese firms with more capital

• Political factors, the Chinese state controls the all Chinese economy which can scare investors to invest in China. Indeed, political uncertainty tends to discourage for investors

• Economic reforms: China should continue to liberalize its economy in order to allow international investors to have access to Chinese market

• Implementation of international accounting standards