Mergers & Acquisitions

Shanghai Electric scores a transformative deal with its purchase of Pakistan power plant

The Chinese company announced on Sunday a US$1.77 billion purchase of a majority stake in K-Electric

PUBLISHED : Tuesday, 01 November, 2016, 7:07pm
UPDATED : Tuesday, 01 November, 2016, 10:05pm

Shanghai Electric Power’s US$1.77 billion acquisition of a majority stake in Pakistan’s K-Electric is another example of Chinese power firms seeking overseas opportunities amid dimming prospect in the domestic market undergoing rapid deregulation, analysts say.

The deal, announced on Sunday, is also a major milestone for the Shanghai-listed firm, the city’s largest power producer, since it would represent its maiden foray into downstream power distribution, and give it a first major presence in the “One Belt, One Road” regions with which Beijing has pledged to strong support for economic cooperations.

Shanghai Electric Power said in its shareholders circular on the acquisition that it aims to double its operating scale in the five years to 2020, with the focus being nations along the One Belt, One Road.

“The lack of profit certainty at home has drawn state-backed power companies to seek outbound investment abroad,” UBS head of Asian utilities research Simon Powell said. “They are driven by rational financial reasons as opposed to mother China using state-owned enterprises to do government-to-government deals.”

He cited the recent failed attempt to bid for transmission and distribution assets in Australia by power distribution behemoth State Grid Corp. and its US$2.3 billion purchase in September of a 29.4 per cent of Brazilian power distributor CPFL Energia as examples of such “going abroad” effort.

Beijing has in the past two years been rolling out progressive reform measures to make the power market more competitive and transparent on pricing, to enhance efficiency and lower costs.

It has broken monopolies on power distribution, revamped transmission tariffs to better reflect costs and instil incentives to cut costs, and subjected generators to price and sales volume competition on a rising portion of their output.

Coincided with weaker power demand growth due to the economic slowdown and a major capacity surplus after a power plant construction boom, utilisation of the nation’s mainstay coal-fired power plants has plunged to their lowest in 38 years.

Many Chinese generators are facing the double whammy of a sharp rise in coal costs in the past six months due to state intervention in coal supply, which further dents falling profit margins.

Shanghai Electric, a unit of State Power Investment Corp. - one of China’s five biggest state-owned generating majors - is relatively small with 9.36 gigawatts (GW) of equity-calculated generating capacity.

That’s about one-eighth the generating capacity of listed industry leader Huaneng Power International. It also has more localised operations compared to its bigger peers.

It made a net profit of 818 million yuan (US$121 million) in the first nine months, down 10 per cent from last year.

Its focus in economic powerhouse Shanghai helped shield it from the worst of the industry downturn. It also has a relatively low net debt-to-shareholders’ equity ratio of 99 per cent at the end of September.

The firm has been one of the most proactive firms in the industry in seeking growth overseas, having completed two small solar power projects in Japan, won some power plant operating and maintenance projects in Iraq and Turkey, and is developing new energy projects in Japan, Turkey, Tanzania, Malta and Mozambique.

In 2014, it spent 330 million euros to buy a power plant in Malta and bought a 33 per cent stake in Enemalta, the main electricity generator and distributor in the southern European island nation.

Monday’s announcement of the acquisition in Pakistan is by far its largest asset purchase, since K-Electric’s assets amounted to around 42 per cent that of Shanghai Electric, and its profit amounted to 78 per cent that of the latter last year.

In the nine months to June 30, K-Electric made a net profit of US$217 million.

K-Electric was a “broken asset” when The Abraaj Group bought 66.4 per cent of it in May 2009, said Omar Lodhi, partner and head of Asia at the Dubai-based private equity firm, in an interview with the South China Morning Post.

“We helped weed out its non-performance oriented culture, build relations with consumers and reduce outages,” he said.

It endured 17 years of losses due to a lack of “performance culture,” before turning in a profit in 2012, he added.

Since Abraaj took control, K-Electric has added 1 gigawatt of generating capacity and saw its average transmission and distribution loss due to theft and other reasons fall to 23 per cent from 39 per cent in 2009. China’s average for such loss is 6 per cent.

Abraaj, 35 per cent-backed by Middle Eastern investors, manages some US$10 billion and invests in a wide array of sectors since it was set up in 2002.

Its investment in K-Electric has surged some fourfold in value since 2009.

K-Electric has 2.3 GW of generating capacity and a large network of transmission and distribution infrastructure that serves 2.2 million customers in Karachi and nearby towns, which together have over 20 million people.

According to Lahore-based power transmission networks operator National Transmission & Despatch’s projection in 2014, the nation’s power demand is forecast to grow by an average annual rate of 9.2 per cent between 2013 and 2020, moderating to 7.9 per cent in the 15 years to 2035.

Pakistan is one of China’s closest political allies. The two nations last year signed US$46 billion worth of energy and infrastructure investment deals, with most of the financing to be provided by China.

Pakistan power generation capacity shortage of 7 GW amounted to 31 per cent of peak demand, and generation cost had been volatile since 37 per cent of output is fuelled by oil, according to a World Bank Group presentation a year ago.

Delays in payment of subsidies by the government for consumers meant over 30 per cent of the industry’s revenues were trapped in “circular debt,” with distributors in arrears in payment to generators, which in turn delayed payments to fuel suppliers.