Details announced: National Energy Investment Group and a JV formulatedAfter market close on August 28, Shenhua and GD Power announced thedetails of its merger plan, which has got approved by State Council accordingto SASAC. Other than merging Shenhua and GD Power at the parent grouplevel and formulate new entity called National Energy Investment Group, twolisted entities also formulated a thermal power joint venture with ashareholding split of 56% (GD) vs. 44% (Shenhua). Both Shenhua and GD willhave part of their thermal power assets respectively injected into the new JVas capital investments and GD will be the controlling entity. Shenhua will have18 thermal power assets with estimated book value (as of end of 1H17) ofRMB25.3bn injected into the new JV. In this transaction, Shenhua’s 18 assetsare valued at RMB29.3bn, c.1.16x book value. Relatively, GD contribute 22thermal power assets with book value of RMB29.1bn. In the transaction, GD’sassets are valued at RMB37.4bn, c. 1.28x book value.
Not ideal to Shenhua’s shareholders but dilution containedAccording to previous years’ profits disclosed by Shenhua and GD, Shenhua’saverage annualized ROA (based on 1H17 profits) of contributed assets shouldbe about 1.5% and ROE at c.2.1% while GD’s average ROA at c.1.4% and ROEat c.2.6%. However, GD’s assets will be able to be valued at 1.28x book value,high than 1.16x book value of Shenhua’s assets. We believe the transactionseems not that favorable to Shenhua. Nevertheless, Shenhua’s contributedassets only account for c.8% of Shenhua listed co.’s book value (ex-minority)and 1H17 net profit (at c.RMB300m) of these contributed assets accountedonly c.1% of Shenhua’s total 1H17 NPAT at RMB26.2bn. Thus, we believe thistransaction’s dilutive effect to Shenhua’s overall return and asset quality isvery much contained.
Constructive on Shenhua’s intention to protect shareholder
We observe the details of the merger quite creative. We believe the transactionallowed Shenhua to achieve China government’s will for thermal IPPconsolidation and vertical integration of thermal power industry while creatingleast impact to Shenhua listed co.’ minority shareholders. As such, werecognize Shenhua’s efforts to protect minority shareholders. Putting theparent group consolidation into longer term perspective, IPP consolidationswill allow Shenhua to operate in a more concentrated industry. Meanwhile, thegroup parent will have more alternatives for future asset injection or capitalmarket operations to unlock asset values for minority shareholders. As such,we think current outcome should be constructive to investors.
Buy re-iterated for Shenhua
As we explained above, we think the deal will barely impact Shenhua listedco.’ 2017DBe NPAT. Shenhua’s 1H17 result announcement demonstrated thatthe company is doing very well for its coal and transportation segments. Webelieve Shenhua will still be able to achieve c.15-16% ROAE in 2017. Currently,the stock is trading at only 1.1x 2017DBe BVPS. We believe the stock’svaluation is very attractive to investors, especially when concerns aboutpotential asset quality dilution are relieved.