China asset injections: 'golden age is gone'

Huaneng Power International, a Hong Kong-listed power producer, has become the latest company to buy assets from its parents. But investors are starting to fear that Chinese asset injections may be mispriced.

Huaneng Power announced at the end of last week that it was paying around $2.2 billion for what one analyst called “highly-geared coal power assets which face overcapacity concerns”.

In other words, it was not the ideal plan for shareholders in Huaneng.

The move sent Huaneng’s stock tumbling, leading it to close down 2.48% on Monday. The short sell ratio of its stock increased to 30% of total volume on the day, from an average of between 10% and 20% usually.

The deal appeared to make little sense for investors, at least as analysts told it. But few investors would have been shocked by the announcement. Huaneng was not buying the assets from just any company — it was buying from its parent in the latest example of an asset injection by a Chinese company.

These deals, once seen as a way for parent companies to bolster their weaker listed subsidiaries, now risk becoming quite the opposite. Investors and analysts argued the deal is, in essence, a way for Huaneng’s parent company China Huaneng Group to “cash-out”.

“The golden age for China's asset injection story is gone,” said a portfolio manager based in Hong Kong. “While people used to view any kind of acquisition plans from a parent as a positive investment opportunity, now we better do our own homework first."

Huaneng is the latest Chinese company to have taken an asset injection from its parent company in the last month. Two weeks ago, China General Nuclear Power sold three nuclear assets to Hong Kong-listed subsidiary CGN Power, another deal that got a sceptical response from investors.

By the book

The $2.2 billion Huaneng is paying for the coal assets represents a 10 times earnings multiple and a 2.4 price-to-book ratio. Compared to Huaneng Power’s valuation as of 5.8 times earnings and 0.7 times book, the transaction is hugely dilutive.

According to analysts’ calculations, Huaneng's return on equity will also decline from 26% to 19% after the acquisition on the profit forecast provided.

Huaneng reckons its earnings per share could grow 10% after the acquisition. But this looks optimistic given most sector analysts are forecasting flat or even negative sector EPS growth over the next three years.

To sweeten the deal, Huaneng has provided a three-year net profit forecast guarantee to its shareholders. But this only covers five power plants out of the 37 it is buying from its parent, representing roughly 25% of the acquired assets’ capacity.

As Huaneng Power has chosen to fully fund the transaction by cash, it will significantly deteriorate company’s gearing, according to analysts. They have warned about a potential downgrade and a sharp decrease in dividends. 

Analysts estimate Huaneng’s net gearing after the acquisition will rise to around 250% from below 185%. The company could not be reached after multiple attempts to get comment.

CITIC CLSA Capital Markets is the financial adviser to Huaneng.

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