Huaneng shows the power of WTO

A Chinese power acquisition using an international valuation model shows that Beijing is serious about reform.

The recent acquisition of Shandong Huaneng Power (SHP) by Huaneng Power International (HPI) shows the China really is gearing up for membership of the World Trade Organization (WTO). The deal ûannounced on Tuesday û will see HPI pay a one-time cash payment of Rmb1.34 for each SHP share (or $8.09 per American depositary share). This represents a 92.9% premium over the average price of SHP's shares over the previous four weeks. The total amount of the deal is Rmb5.8 billion ($699 million), which will be funded by HPI's internal cash reserves and cash flows generated this year. HPI might also raise some additional local currency loans from Chinese banks.

The deal is remarkable on two fronts û both stemming from China's overall attempts to upgrade its economy. First, the deal is being driven by the China Huaneng Group, a large-scale state-owned enterprise under the control of the State Power Corporation of China, which is the majority shareholder of both companies. As such the deal has the explicit approval of the State Council.

With impending WTO entry, China's state power market will be thrown open to foreign firms, such as Enron. These foreign firms with all their capital, technology and management expertise will be very tough competitors. So this deal is the first in a general consolidation of the Chinese power market to create state power champions. The larger the company the better its economies of scale. For financing purposes, larger companies can get better credit ratings and so have better access to debt finance and equity investors. Indeed, HPI plans to add a Chinese A-share listing to its present New York and Hong Kong listings.

International valuation methods

The second effect of China's new international focus is the use of international valuation methods when the deal is structured. Typically, Chinese companies are valued on a PRC book value basis, which is usually way off international standards. In this case, however, the two companies were valued on a discounted cash flow basis which the international shareholders find much more acceptable.

At Rmb1.34 a share, HPI is paying a slight discount to SPI's net asset value of around Rmb1.40 a share. But it is also paying much less than the Rmb1.86 a share that a traditional Chinese valuation would have produced. This should make the deal much more acceptable to the international investors in HPI which own 26.5% of the company. These investors û as well as the 27% of SHP's investors that are international û have to approve this deal by a majority at an EGM to be held within the next 90 days.

The markets have reacted very favourably to the deal. Not surprisingly, the value of SHP's shares has shot up to the around the offer price û a jump of over 70% in one day's trading. HPI's share price has also risen almost 20% in the day and a half since the announcement, to HK$3.475 a share. Institutional reaction has also been positive with Salomon Smith Barney and CSFB both raising their forecasts and reiterating their buy ratings on the stock. Credit rating agency Standard & Poor's has affirmed HPI's triple-B foreign currency rating.

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