MSc in Finance

Raising capital in Global markets
Romain Boujiot Jen Huki Jhon Hitterman

You have been hired as an international investment banker by a large U.S. institutional investor who is considering purchasing HPI stock. Provide an analysis of: i) China as an investment destination ii) key success factors iii) HPI’s strengths and weaknesses.

World's largest country by population (nearly 1/5 of the world's population)
Total Population (millions) Growth rate Source: EIU Country Report. September 9. 1994 1989 1,126 1990 1,139 1.15% 1991 1,156 1.49% 1992 1,173 1.47% 1993 1,185 1.02%

Largest country of Asia, one of the largest of the word: 9 596 961 km2 One of the largest economies in the world: since 1978, the Chinese economy had expanded at an average rate of nearly 9%.
GNP at current market price (Rmb billion) Real GNP growth Source: EIU Country Report. September 9. 1994 1989 1,599 4.4% 1990 1,77 4.1% 1991 2,024 8.2% 1992 2,404 13,00% 1993 3,138 13.4%

Since the late 1970s, China set up reforms to open its market.

 

In the late 1970s: the government relaxed its control over many industries to move

from a centrally planned economy to more of a market-oriented one. In the 1980s: in order to facilitate modernization and encourage foreign investment and the import of advanced technology, China began establishing special zones for foreign investment: Special Economic Zones (SEZs) . The original four were Shenzhen, Zhuhai, Shandou, and Xiamen.

In the 1990s:

◦ The government wanted to move toward a socialist market economy. Under the planned economic system, the state was determining production and pricing. In a market economy, the state creates a stable and competitive economic environment through the application of laws and regulations. ◦ The government allowed foreign investors to manufacture and sell a wide range of goods on the domestic market, eliminated time restrictions on the establishment of joint ventures, allowed foreign partners to become chairs of joint venture boards, and authorized the establishment of wholly foreign-owned enterprises. ◦ The government granted more preferential tax treatment for Wholly Foreign Owned Enterprises and contractual ventures and for foreign companies, which invested in selected economic zones or in projects encouraged by the state, such as energy, communications and transportation. ◦ The government authorized some foreign banks to open branches in Shanghai and allowed foreign investors to purchase special "B" shares of stock in selected companies listed on the Shanghai and Shenzhen Securities Exchanges.

Partly due to these reforms, since 1988, the amount of Direct Foreign Investments has almost been multiply by 10.
Direct foreign investments (M$) Growth Source: Jetro, Financial Times, June 27, 1996 1988 3,194 1989 3,392 6.19% 1990 3,487 2.80% 1991 4,366 25.20% 1992 11,007 152.10% 1993 27,515 149.97%

 Strong relationship with national and local governments  A market leadership ◦ Invest with the right partner which to have: ◦ Be an investor of a powerful industrialized country in order to:  Have a strong bargaining power  Be protected from unfair treatment  Gain from advantages from a strong currency and large stock exchanges .  Experience in dealing with foreign investors. a foreign investor needs to: ◦ Understand PRC main strategic goals and needs:  Modern technology to improve the power's production  Foreign capital to faster the growth in the economy  Expand the capacity in the power sector to meet the increase in demand. To invest in China.

600 kilometers among five coastal provinces -Far from coalfields regions -Primitive transportation infrastructures Insurance issue: -No business interruption insurance -No third-party liability insurance Allotments issue: -No guarantees that the company would continue to receive transportation. -HPI's managers are former top management of HPIDC and Ministry employees Reliable plants: Using modern technology from abroad. Plant completed on time and within budget Sustainable profitable activity: HPI as the exclusive developer of new planned plants in provinces in which it currently operates. coal and oil allotments.Strenghts Strong connections with central and local authorities: -HPIDC. Guaranteed rate of return on electrical generating assets . 31% of the national GDP Weakenesses Geographical dispersion of HPI's power plants: -1. -Local government investment companies own the remaining shares. and market prices are much more higher Skilled operational personnel issue: -If the expected rates of growth in electrical production materialize. more reliable than the average PRC power plant Fast-growing targeted market: 23% of the population.High cost of foreign engineers HPI increasing profitability and efficiency: Net profit margin has grown by 1. a Chinese government-foreign joint venture. the company could face a shortage of skilled operational personnel .1 pts. is the major shareholder (54%) of HPI.

Debt markets. What are the benefits for a non-US firm that decides to list on a US exchange? . (In the US between different ADR levels) ii. domestically within China and internationally. what type of listing is suitable for Huaneng to pursue? i. deal with: a. London and the US. b.HPI wants to access financial markets. In particular. What are the options available to the firm? Provide pros and cons of available options in particular. listing in Hong Kong. Equity markets: i.e.

the company must pay them). Increase the number of investors: opportunity to raise new capital. HPI can access financial markets through debt or equity markets. Debt markets Deductible interests. Dilution of the old investors control.  HPI has limited internal source of capital due to tight controls on credit. Fixed interest rate (opportunity cost). . Bonds are generally a safer investment Interest payments (unlike dividends. Equity raised do not have to be reimburse. Additional costs due to reporting requirements registration costs and listing fees. No obligation to pay dividends. Increase in the company's risk of default. Advantages Equity markets Disadvantages Need to reach a certain rate of return in order to obtain enough cash to pay dividends. even in difficulties. Access to international investors.

Has always been focused on international trades US Stock Exchange NYSE and NASDAQ: promoting themselves as the best place for PRC firms to raise international capital. Index for PRC firms Has never absorbed such Chinese large issue Mixed reception for PRC firms issuance => the market could be saturated to absorb all the HPI equity raising. NASDAQ: Technology-oriented stock exchange and market guaranteed by its market maker. The SEC requires from PRC Companies only tow years audited earnings instead of the usual three years.Advantages Chinese Stock Exchanges Completely familiar with PRC companies Disadvantages Low liquid and low capitalized internal stock exchanges => the amount HPI wants to raise is too high for these markets Hong Kong Stock Exchange Familiar with PRC companies for more than one year. . NYSE: mixed reception of Shandong issuance. London Stock Exchange One of the world's largest stock exchange. NYSE: has already Chinese funds and companies among its listing. Competitive for small issuances No listing premium for firms asking for large issuance => HPI issuance may be undersubscribed.

      One of the largest and more efficient market in the world for trading stocks Strong regulatory environment Governance model which prevents controlling shareholders to extract private benefits from the corporation Ability to raise more funds internationally in the future and at lower cost Highly liquid secondary market for company shares Attraction of a listing premium: often. benefits of being listed in NYSE offset listing costs .

Level I Allow a foreign company to have its shares traded on the OTC US market. (listed) Level III Allow a foreign company to be listed on major US exchanges and to raise capital through a public offering of ADRs. bank representing a specified number of shares (or one share) in a foreign stock that is traded on a U. (unlisted) Allows the issuer to raise capital through a public offering of ADRs in the US. Rule 144A Not registered with the US Securities and Exchange Commission Not subject to US reporting requirements. Does not allow the issuer to raise new capital. (unlisted) Level II Allow a foreign company to be listed on major US exchanges. but allows for exemption under Rule12g 3-2(b) from full SEC reporting requirements. Filing an F-6 and 20-F registration statements Complying with the SEC's other disclosure rules: submission of its annual report (prepared in accordance with US GAAP) Same requirement than for Level II Submitting a Form F-1 to the SEC to be allowed to raise money. (listed) Allow a foreign company to create restricted shares to be privately placed with institutional investors. .S. Allows to raise capital but only from Qualified Institutional Buyers (not from Retail investors). Program type Requirements Filing of an F-6 registration statement. exchange.S. Does not allow the issuer to raise new capital. Comments Can only be traded over-thecounter and cannot be listed on a national exchange in the US. ADR: A negotiable certificate issued by a U.

reflecting 100-fold growth since 1980. . The level of US investment in foreign equities now exceeds more than $2 trillion.   US investors are eager to expand their horizons in search of new opportunities for capital growth. with a strong growth between 1992 and 1999. The appetite for foreign equities continues to increase as investors seek geographic and sector diversification.

.What is the right cost of capital for the various Equity options? Measure and explain the cost of capital for each equity option.

.     Raise equity in Chinese market Be listed and raise equity in USA markets (NYSE) Be listed and raise equity on the Hong Kong stock exchange (HKSE) Be listed and raise equity in UK (LSE) The right cost of capital for the equity options is the Weighted Average Cost of Capital (WACC) in each of these markets.

433 V = E + D = $ 11.4653 T=Effective Corporate Tax Rate = 9% All figures in 000$. for year 1994. E D WACC  Ke   Kd   (1  T ) V V .228 E/V = 0.464.5347 D/V = 0.995 D = Debt Value = $ 533.Ke = cost of equity Kd= cost of debt E = Equity Value = $ 612.

Cost of Debt = 8% . Interest on long term debt are assumed at a 8% cost.   The cost of debt does not depend on the market.

   The cost of equity depends on the market where the shares are issued and listed. Ke  R f   L ( RM  R f )  Rf = risk free rate  RM  R f =market risk premium  L = Leveraged Beta for HPI . The Cost of Equity need to be calculated for each market. The company's stock price will bear a systematic risk with respect to that market.

Cost of equity = 15%. .  In the Chinese market. the allowed rate is 15% on equity financed net fixed assets.

stern.nyu.16% (Hong Kong Monetary Authority) Market risk premium: Hong Kong Hang Seng Index Market Premium 1969-1993 =13.      Risk-free rate: the interest rate on long-term government bonds is used as a surrogate for risk free rate.1305=15. Exchange Funds Bills and Notes Hong Kong 5-year (oct.17% . The Hong Kong Government does not issue government bonds.537 Cost of Equity=0.0816+0.edu) D D/E ratio of HPI = 0.537x0.05% Unlevered beta of Chinese firms involved in the power industry = 0.30 (pages.87  L  U (1  (1  T )  ) E Levered Beta of HPI = 0. the HKMA's Exchange Fund Bills can be viewed as such.1994) = 8. However.

41% U  L  L  U (1  (1  T )  D ) E .52 D/E ratio of Electrical Power Generating Industry in U.0809+0.73% Beta of Electrical Power Generating Industry in U.49 Cost of Equity = 0.87 1  (1  T )  E Levered Beta of HPI = 0.S=1.01 Unlevered Beta = 0.2709    D D/E ratio of HPI = 0.09% Market risk premium: S&P 500 LT Market Premium = 4. LT Bond Yield (oct.     Risk Free rate: U.49x0.S. 1994)= 8.S=0.0473=10. Govt.

49 (assumed to be the same than the US one) Cost of equity = 0. Government bonds (oct. 1994) = 8.084+0.Pablo Fernandez.84% (Bank of England) Market risk premium: difference between the geometric average of the return of stocks and the geometric average of long-term bonds for UK (1970-1996): 4. 2004) Levered Beta of HPI = 0.    Risk Free rate: 5-year UK. historical and expected .0461=10.66% .61% (Market risk premium: required.49x0.

Cost of Debt China Hong Kong U.K. US markets should be the best destination to make the new issue of equity.41% 11.S.17% 10. U.S.49% 8.95% 9.    Cost of Equity 15% 15.08% 8% 8% 8% 8% U.66% WACC 11. . market provides the lowest cost of capital.41% 10. Hong Kong and Chinese markets provide higher cost of capital.

You have to convince HPI’s bearer of the price at which they should issue the shares? What is a reasonable share price? Why? .Now imagine you are HPI’s investment banker and you are proposing an ADR on the NYSE.

95%.1994 EBIT Depreciation Capital expenditure Operating Cash Flows Taxes Free Cash Flows Discounted Cash Flows Firm value Debt Equity value Price per ADR 1995 1996 1997 1998 1999 107242 76428 -225000 -41330 5836 -47166 -43291 24562274 533433 24028841 19. WACC found for US Growth rate: 8% (since 1978. the Chinese economy had expanded at an average rate of nearly 9%) .22 162599 76429 -628000 -388972 14305 -403277 -339742 186751 112562 -905000 -605687 20835 -626522 -484456 248589 191829 -912000 -471582 29175 -500757 -355401 334753 262495 -535000 62248 20120 42128 27443 462657 282295 -344000 400952 Terminal value 25316 375636 42703882 224597 25533124 Figures from forecasts provided in exhibit 12 Figures for 1994 have been doubled to represent the whole year Discount rate: 8.

3 16. Taking the multiple to estimate the value of HPI’s ADR.45 HPI valuation Price using P/E ratio 19.35 1.36 Earnings per ADR for HPI  Selection of IPOs with an offer similar to HPI's one. .5 15.2 13.3 13.  Estimation of the average Price Earnings ratio of recent IPOs by PRC firms in foreign markets. Company Exchange P/E ratio Shandong Huanheng Power Dongfang Electrical Tianjin Bohai Chemical Yizheng Chemical Fibre Beiren Printing Shanghai Petrochemical Tsingtao Brewery NYSE Hong Kong Hong Kong Hong Kong Hong Kong Hong Kong Hong Kong Mean 14 12 11.2 11.

Taking those multiples to estimate the value of HPI’s ADR.S.2 11. Utilities European Utilities Mean Earnings per ADR for HPI Book value/ADR HPI valuation Price using P/E ratio 21. International Power Generating Group Asian Power Products South American Utilities U.27 2.4 14.54 P/E ratio 15. Independent Power Products U.67 Price using P/B ratio 18.1 10.47 1.64 1.  Estimation of the average Price Earnings and Price to Book ratios of international power generating group.96 1.24 2.45 9.2 1.99 .S.86 P/B ratio 2.6 23 14.

2 per ADR and the highest is $ 21. Government support).99  The lowest price estimated is $ 19.50 per ADR. the company is in a position to command better prices than other comparable firms. slightly above PRC comparable firms. due to its dominant market position. ambitious growth plans.DCF Price per ADR   $19. attractive Chinese economy. . which is in range with the different prices we found but which is.36 Multiples Comparable with International Groups Using P/E ratio Using P/B ratio $21.22 Comparable with recent IPOs Using P/E ratio $19. Knowing the strengths of HPI (largest power firm in PRC.5 per ADR.54 $18. We propose a price of $ 20.

how and why HPI should have proceeded with the issue.What implementation strategy would you suggest? Present your recommendation on whether. .

◦ Missing out on expansion plans because of a lack of capital could affect the future growth of the company. .$860 million is being raised in form of equity offerings HPI needs to explore international markets to raise funds due to: ◦ Internal sources are unable to fulfill debt requirements.5 billion to finance its development plans $700 . ◦ Domestic stock exchanges are incapable of raising such an amount of money.   HPI needs $ 4.

17% 10.S.95% 9.S. U. equity markets.49% 8.41% 11. HPI should issue ADRs through the NYSE because it already has Chinese funds and companies among its listing .08%    The lowest cost of capital is offered by US Stock Exchanges.K. 8% 8% 8% 8% Cost of Equity 15% 15.66% WACC 11. HPI should issue ADRs in U.41% 10. The cost of capital for each equity option available to Huaneng is as follows: Cost of Debt China Hong Kong U.

 Takes longer to establish. HPI wants to raise capital ◦ Level I and Level II does not allow to raise capital. low cost to establish. no SEC registration  But: low visibility. no GAAP reconciliation required. and enables to reach only institutional investors  ADR Level III: ◦ HPI should raise capital through a public offering of ADRs of Level III.  Due to the difficulties Shandong faced when the company raised equity and listed on the NYSE. requires SEC registration and full GAAP reconciliation for financials. it only enable the company to expand its investor base. HPI should use the option which provide the highest visibility and liquidity. most expensive to establish  But: highest visibility and increased liquidity . ◦ Level III and rule 144-A enable the company to raise capital:  Rule 144A DR:  Easy and quick to establish.

traders. 2 or 3 program Review draft registration statement or offering memorandum Coordinate with all partners to complete program implementation steps on schedule Prepare and issue certificates and/or direct registration statements Announce DR program to market (brokers. ◦ Provide custodian and depositary with notices of annual and special stockholder meetings and corporate distribution (dividends and right offerings). ◦ Execute US-focused investor relations plan. media. The depositary bank takes care of key action such as: ◦ ◦ ◦ ◦ ◦  HPI will have to: File Form F-6 if Level One. including disclosure and reporting.  HPI needs to choose a depositary bank. and corporate governance requirements. legal counselors and an investment bank. retail / institutional investors via news releases and internet  HPI’s accountants will have to: ◦ Provide depositary with notices of stockholder meetings and corporate distributions. ◦ Comply with any applicable regulations. ◦ Reconcile HPI’s financial statements to US GAAP ◦ Review registration statement .

facilitating the dialogue between HPI and its shareholders. ◦ Provide custodian and depositary with notices of annual and special stockholder meetings and corporate distribution (dividends and right offerings). including disclosure and reporting.  The depositary will play a key role. More especially. . HPI will have to: ◦ Provide depositary with notices of stockholder meetings and corporate distributions. ◦ Comply with any applicable regulations. ◦ Execute US-focused investor relations plan. and corporate governance requirements. and coordinating closely with the HPI’s custodian in China on the issuance and cancellation of depositary receipts and underlying shares.

would you have recommended to buy stock in this company at all? At what price? Why? .As the investment banker of the institutional investor.

 Growth Opportunity: ◦ A mandate to develop and operate large coal-fired power plants throughout the PRC. ◦ HPI would be the exclusive developer of all new greenfield coal-fired plants throughout the PRC. . ◦ HPI has Already acquired the rights to three plants currently under developement. a well known brand in the power industry. ◦ Spin-off of HPIDC .

Kutan & Zhou (2006) . ◦ Investment realised in domestic currency ( no exchange risk) “We find negative correlation between host (US) market returns and those of the ADRs at NYSE. ◦ Emerging market with high potential returns. possibility to invest in a security uncorrelated with the US market.” in Determinants of Returns and Volatility of Chinese ADRs at NYSE . US shocks have no significant impact on the conditional volatility (risk) of the ADRs. Diversification  Risk Management ◦ For US investor. Also. These results suggest that the ADRs offer significant diversification benefits to US investors.

Lack of transparency: ◦ In term of accounting principles ◦ Obscure transaction  Weak investors' protection law. .  Even if China is a fast growing and developing economy the total control of PRC over the economy could lead to arbitrary decision over ownership of Chinese companies.

we would advise our clients to invest in this kind of security.   Fast Growing Economy Diversification Opportunity Negative Correlation with US market Lack of Transparency Possibility of arbitrary decisions from the governement   Generally. . However . we still need to compute at which price they should buy it.

$18.4 .5 widely above the theoritical price.1 ◦ EPS or ADR for Huaneng : $1. the appropriate issuing price should be approximately 10% to15% lower : $17. Moreover.1*1.45 ◦ Price per ADR : 14. he would like to have a risk premium for the chinese specificities. An American Investor would compare the price of ADR with the stock prices of similar industries in US. According to our analysis .44   HPI indicated a share price between $22.45 = $20.3 . Additionally. ◦ US Independent Power Product PER : 14. we do not take into account any risk premiun in the theoritical price.5 and $27.

Given the current international investor environment (and not in 1994). what steps could HPI and the Chinese government take to make it easier for firms from China to raise capital internationally? .

 The biggest liberation economic expansion . China widely opened its market since 1978 and passed from an organized economy to a liberal economy with a high state control.

European Central Bank (2012) . All the financial system needs to be improved: ◦ Need for a more efficient transfer of funds from the savers/lenders to the borrowers ◦ In order to appeal international investments.

Aruna Kumar 2007 . Develop direct and indirect finance: D.

 . But China still needs to reinforce its liberalisation to allow its national firms to have a proper access to national and international funds. The aim of China's macro-economic policy is to maintain a steady economic growth to avoid big economic fluctuations and to enhance the people's living standards.

 First step: more intermediaries to develop and rationalize the financial intermediation ◦ Initiate a bank reform program cleaning up nonperforming loans and opening the sector to foreign participation and competition. ◦ Develop national private major financial indutries and not only sovereign funds such as China Investment Corporation . Those funds should be invested in the economy. ◦ Making more efficient the large Private and public savings and currency reserves.

. Every assets would be more liquid and more interesting for foreign investors. ◦ Appealing chinese banks and firms to be more active in the financial markets.  Step 3: Develop financial markets: ◦ International funds need liquidity and a strong secondary market to trade efficiently. Stimulate IPO. Step 2: Strengthen the financial sector by: ◦ Recapitalizing the banks. Government should provide more liquidity within the banks to allow more easing from the financial sector. SEO etc.

◦ It will be easier for companies and individuals to buy foreign currency and invest in overseas capital markets. . Foreign investors are feared by such practices. ◦ Allow companies to diversify their risks and get better returns.  Step 5 : Being more flexible on the exchange market and monetary policy: ◦ The opacity of Chinese policy in terms of currency limits the capital inflows from abroad. Step 4 : Release some control: ◦ The state should be less present in every deals such as IPO.

. Nowadays. Step 6: ◦ Ask chinese companies to comply with US GAAP or IFRS principles. chinese accounting standards are unsuitable for the firms who whish to appeal international capital. ◦ Modernize and standardize the accounting standards and practices.

   . Implement International accounting standards Acting more like a modern company and avoiding too closed relations with PCC and HPDIC Invest abroad to be more recognized in some key countries Reassure foreign investors by being more transparent in the firm’s management.

    P. Financial stability. Lokamanya Tilak P G College of Management. Aruna Kum (2007). . An Overview of Indian Financial System. historical and expected. University of Navarra Depositary Receipts. E. Fernandez (2004). Market risk premium: required.C. Reference guide.B. JP Morgan D. (2012).

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