Case Study

Huaneng Power International Inc.:

Huaneng Power International’s (HPI) intention to raise funds through a share offering in the US
illustrates that global capital markets nowadays attract all sorts of players, even from developing
economies. Only a decade earlier, the thought that an independent power producer (IPP) from
mainland China (People’s Republic of China: PRC) would seek to list its shares in New York was
unthinkable, if not laughable. However, as Huaneng is about to discover, investors are a fickle
bunch and need a lot convincing that the company offers good investment prospects. Only recently
has the company reduced its target price due to poor market conditions.
The key question facing HPI’s senior management is whether the new offer price and choice
of listing exchange still makes change in light of recent market events. In particular, it important
to gain a better picture of what the institutional investor community thinks about the upcoming
offering. HPI’s investment bankers are upbeat but what else would they be? So, it is really
the persuasiveness of the lead underwriter (Lehman Brothers) and investor sentiment that will
determine the ultimate success or failure of offering. Given the recent experience of Shandong
Huaneng Power (SHP), Huaneng’s sister company, it will be an uphill battle.
Presentations espouse the perspectives outlined below (underwriter’s roadshow, presentation
to investment committee) and address selected issues. You also might want to consult stock
prices (Google Finance, MSN Investor, Bloomberg, etc.), filings from EDGAR and material by
Standard and Poor’s on Huaneng and IPPs asavailable over the respective websites.

1. Analyze the market that Huaneng serves and the risks that the company and, ultimately, its
shareholders face. What is an independent power producer? How do they operate and what
are their economic and financial risks?

(a) What are the prospects for electricity generation in China and, in particular, for Hua-
neng?
(b) How is electricity priced and sold in the PRC? In light of the Californian experience,
what are the risks for Huaneng?
(c) To what extent are risks of concern to investors? How do they affect the outlook of HPI
and the share offering?

2. HPI intends to offer new shares through an ADR (American Depository Receipt) to be listed
on the NYSE. What is an ADR and how common are they?
 (a) What are the advantages and disadvantages to Huaneng to raising capital in the US?
From a risk management perspective, what might the advantages be? From an opera-
tional perspective, can you think of any disadvantages?
(b) What would be alternatives to a stock offering? To raising funds in the US? Why could
the money not be raised domestically? What other exchange might be a good candidate
for a listing?
(c) What is the incidence of currency risk (FX exposure) on Huaneng? Its American share-
holders?

3. From a purely discounted cash flows perspective, what are the important value determinants
of HPI’s upcoming offering? How would you estimate Huaneng’s cost of capital?

(a) Where could you get appropriate risk-adjusted ROE and borrowing cost data from?
Careful with pure-play comparisons and beta calculations (unlevering and relevering).
(b) How could you translate accounting based information into actual cash flow expecta-
tions? What are potential pitfalls?

4. How would you value the company? Consider alternative valuation approaches and arrive at
a consensus opinion.

(a) What is the impact of offering only 25% of the company? What is a reasonable target
price range for this stake?
(b) What criteria are important to determine the market for HPI’s stock? What are the
benefits and drawbacks for Huaneng of a large investor base? How could the issue be
made more attractive for investors?
(c) To what degree does the recent experience of Shandong Huaneng Power help? How
could you use their share price and financials to better gauge market sentiment and fix
the offering price?

5. What are the attractions of participating in HPI’s share offering to US based institutional
investors? From a portfolio allocation perspective, what factors favor investing in Huaneng?
What factors argue against such a step?

(a) What are advantages to investors of trading in ADRs rather than the underlying stock?
Can you avoid currency exposure by buying ADRs rather than the underlying shares?
(b) What risks are investors buying into when they acquire Huaneng shares? To what extent
can they cover themselves against these risks?

6. Using modern information sources, follow up on the ADR offering. What has happened to
HPI’s stock price since then (compare to SHP and other comparator indices)? How would you
assess the decision to go public in the US from the perspective of a US institutional investor
and HPI, respectively? With hindsight, was HPI a good investment?

2
Option A
Working for HPI’s lead underwriter for the global tranche (Lehman Brothers), you are about to
make presentations to institutional investors (road show). Market conditions have become signifi-
cantly more difficult than when you first planned the offering. Addressing the issues raised in the
first 4 questions, you have to convince a skeptical investor community about the merits of investing
in a Red chip company. The stakes are high for everybody!

Option B
You are a senior financial analyst (buy side) working for a prominent emerging markets mutual
fund. Having recently heard the Lehman roadshow on Huaneng, you are presenting the evidence
for and against participating in the share offering. Focusing on the last 4 questions, you need to
make a recommendation to your fund’s investment committee comprised of senior fund managers
and your company’s senior officers. The pressure is on!