Acquisition highlights need to expand abroad
It was just weeks ago when parent company China Huaneng Group won a tender to buy Singapore's Tuas Power with a S$4.23 billion (HK$23.82 billion) bid. China Huaneng handed over full payment to the vendor, Singapore's sovereign investment house Temasek Holdings, on Monday last week.
Less than 24 hours after the transaction was completed, Huaneng Power International (HPI) - the nation's largest listed power producer by capacity - announced that it had signed a letter of intent to take over the entire Singapore utility from the parent company, marking its first foray overseas.
The apparent swiftness of the act has caught some market watchers by surprise. Rarely does a state-owned entity make such quick decisions on a major investment - unless it is planned or premeditated.
But reading between the lines of the company's financial results for last year, one should not be surprised.
The move underscores a desperate need for mainland power producers to diversify from the domestic power market, where price controls are putting a cap on earnings growth.
Apparently endorsing the leader's overseas move, rival Datang International Power Generation's chairman Zhai Ruoyu said on Thursday that his company - the largest power producer for the Beijing-Tianjin-Datang area - also is scouting for assets globally, especially in Southeast Asia.
Domestic electricity consumption has been growing at about 15 per cent a year, to the envy of peers in mature markets such as Singapore, where power demand expands at just 5 per cent to 6 per cent per year. Even so, the tariff system is such that it is understandable why mainland producers are keen to go overseas.
An anti-inflation tariff freeze by Beijing since July 2006 has substantially squeezed the profit margins of mainland power producers.
Last year, they were still able to maintain or raise profits by commissioning major new plants and saving on coal costs via more efficient means of power production.
But as the tariff freeze drags on and coal prices rise faster this year, 17 analysts polled by Thomson Financial are projecting a 5.24 per cent decline in net profit this year for HPI and a mere 3.2 per cent growth for Datang in their median estimates.
This is despite HPI projecting an output growth of 15.6 per cent, and Datang, an increase of 18.4 per cent for this year.
These analysts have taken a dim view as they expect coal cost per unit of power output to climb between 12 per cent and 18 per cent, whereas an upward adjustment in tariffs remains highly uncertain as Beijing seems bent on taming inflation, which is at a 12-year high.
Last week, Citigroup head of regional utilities research Pierre Lau changed his tariff increase assumption for this year to zero, even though earlier in the year, he expected one in the third quarter.
After HPI announced its final results for last year, he cut his forecast on its net profit for this year by 23.4 per cent to 4.39 billion yuan (HK$5.1 billion).
Edmond Lee, JP Morgan's head of utilities and infrastructure research, cut his profit estimate for HPI in mid-March by 26.6 per cent to 4.61 billion yuan. Given the bleak industry outlook, HPI's proposed acquisition is unlikely to be able to do much to spur profit growth.
According to Mr Lau's report, China Huaneng's acquisition price was 26.4 times Tuas' net profit last year. It also represented US$1.2 million per megawatt (MW) of capacity, 140 per cent above HPI's US$500,000 per MW.At about US$3 billion, the acquisition price is much higher than the US$2 billion estimated by the market last year when bids were first invited by seller Temasek.
Mr Lau estimated HPI's proposed acquisition would add 8 per cent to its generation capacity but only 4 per cent to its profit, which will be offset by higher interest expense on the bank loans needed to finance the purchase.
Still, HPI chairman Li Xiaopeng takes a more philosophical view of the acquisition.
'For both HPI and its parent, overseas acquisition is a long-term strategy,' he said. 'This acquisition will help HPI accumulate overseas management experience and expand its overseas market share,' he said. 'What's more, Singapore is politically stable and has a more mature and transparent power market.'
Besides overseas acquisitions, the nation's major power producers are also diversifying into coal mining and related businesses as they seek to control fuel costs.