CGN Power deal gets sceptical reaction

CGN Power’s asset injection from its parent has not been taken well by investors. They have questions about how to value the assets and worry about the impact on leverage.

Concerns about value and technological uncertainty have put a cloud over a $1.49 billion plan by China General Nuclear Power Corp (CGNPC), to sell three nuclear assets to its Hong Kong-listed subsidiary, CGN Power.

CGNPC, the country's biggest nuclear power operator and the largest builder of nuclear power facilities in the world, announced on Monday that CGN Power would acquire 61% of CGNPC-owned Fangchenggang Nuclear, and 100% of CGN Engineering and Lufeng Nuclear.

While on the face of it the valuation is fair, according to analysts, the reality is many of the assets on the table are months or years away from operating and dogged by technological concerns and worries over electricity demand.

One analysis dubbed the plan a "raw deal" for CGN Power's minority shareholders.

The problem is that only one of the nuclear plants, plants included in the deal, under  Fangchenggang, is operating so far – and that made a loss in the first half of 2016.

A second plant for Fangchenggang is due to open later this year, with two more to follow in 2022. Lufeng's two plants, in Guangdong province, will also not open until 2022. And although nuclear plant-builder CGN Engineering has been highly profitable in recent years, analysts fear those profits could dry upas China's breakneck nuclear construction slows down.

“Investors were excited about these kind of asset injection plans two years ago when CGN Power first went public in Hong Kong,” said a portfolio manager based in the city. “We thought this news could have a kick to the sluggish stock price. However, it seems like the market took this deal pretty badly this time.”

Indeed, CGN Power's stock fell 2.5% on Monday after the announcement. According to Hong Kong Stock Exchange data, short selling turnover surged to 50% of trading volume on Tuesday, up from an average of 10% to 20% for the stock.

And analysts were equally negative.

“We believe the proposed acquisition of assets from the parent company is a raw deal for CGN Power’s minority shareholders,” CLSA analysts wrote in a research report.

“Low utilisation levels and direct power sales at lower tariffs will put pressure on returns earned by the Fangchenggang project in Guangxi province, which made a loss in first half 2016.”

As for CGN Engineering, they expressed concern that "the best period for nuclear power construction – at least in the medium term – is behind us".

A question of value

On paper, the deal is value accretive as CGN Power stock trades at 1.5 times book value, while the transaction is done at a price-to-book ratio of 1.2 times.

However, the fact many of the nuclear power stations involved are years away from going into operation have left analysts unsure how accretive it really is.

“We believe the key risk for CGN Power is the uncertainty of its 3G nuclear technology, with potential cost overrun, delay in power plants operation and technology uncertainty,” according to a UBS research report.

The deal will also add to CGN Power's debt burden; its net gearing now is 156%.  

“Proposed acquisitions have total assets of Rmb65 billion ($9.7 billion) and equity of Rmb10 billion. While we do not have the details about debt on the books of the assets being acquired, even if we assume that only Rmb35 billion of debt from target companies will be consolidated, net gearing of CGN is likely to go beyond 200% with these acquisitions and the company may have to issue equity to fund them,” according to CLSA's research report.

Founded in 1994, CGNPC describes itself as market leader in clean energy with total assets amounting to $70 billion. It has 35,000 employees globally, according to the company website.

In 2014, CGN Power, the only listed nuclear platform of CGNPC, raised $3.15 billion in an initial public offering in Hong Kong with exceptionally strong demand from investors. The public offer was 287.3 times oversubscribed, and was priced at the top end of the price range.  

The stock price surged 30% in two days after listing before peaking at HK$ 5.5 in the middle of last year, double the IPO price of HK$2.78. It then fell significantly to HK$2.03 early this year due to a surplus in China's electricity supply, expensive valuation and potential delays to its projects.   It closed at HK$2.32 on Wednesday.

The purchase must be approved by an extraordinary general meeting, with minority shareholders having the power to reject it.

First Shanghai Capital is the financial adviser for The Independent Board Committee, made up of non-executive directors, and the independent shareholders.

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