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Huaneng Power International, Inc.: Raising Capital in Global Markets As management of Huaneng Power International Inc.

(HPI), you must decide how to proceed with the companys planned initial public offering. 1. Was the chosen issue price for HPI a reasonable value? Present your recommendation on whether, where, how and why HPI should have proceeded with the issue. Use WACC for valuation. Allowed rate of return can be interpreted as rate of return to induce foreign investors to invest in Huaneng. That is, it is the required rate of return on equity. Although we do not have a good data for beta, you can back down beta from the required rate of return. Use numbers in Exhibits 8 and 12 to calculate free cash flows. As you will notice, the valuation will heavily depend on growth rate and discount rate. Thus a sensitivity analysis on these would be essential. 2. Is this the right time for HPI to raise capital overseas, and will foreign investors be interested in investing in this company? As an institutional investor, would you have bought stock in this company? 3. Are there alternatives to a stock offering at this time? 4. What criteria are important in determining the market for this firms stock?

InternationalCorporateFinance&Governance Professor Florencio Lopez-de-Silanes HUANENG POWER INTERNATIONAL INC. Raising Capital in Global Markets -A case analysis Submitted by: Group 30 Abhishek Lohia (Msc RAM) 23980 Satendra Yadav (Msc Finance) 23799 Noel Khoury (Msc RAM) 1 Question No. 1 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, and iii) HPI's strengths and weaknesses. China, officially the People's Republic of China is the world's largest country by population and one of the largest by area, measuring about the same size as the United States. The country's varied terrain includes vast deserts, towering mountains, high plateaus, and broad plains. Beijing, located in the north, is China's capital and its cultural, economic, and communications center. Shanghai, located near the Yangtze, is the most populous urban center, the largest industrial and commercial city, and mainland China's leading port. One-fifth of the world's population--1.2 billion people--live in China. China recognizes more than 5O national minorities and many different regional languages. As a result of the reforms of the 1980s and 1990s, the Chinese economy grew almost 10 percent a year from 1980 to 2005, making it one of the largest economies in the world in the early 21st century. China also opened its market to the outside world. To help quicken the pace of modernization, the state encouraged foreign investment and the import of advanced technology. In 1980 China began establishing special zones for foreign investment. The original four were called Special Economic Zones (SEZs) and consisted of Shenzhen, Zhuhai, Shandou, and Xiamen, all in southeastern China. By the late 1990s a variety of similar types of zones had been added, including a fifth SEZ, Hainan Island.

Most zones are located in urban economic centers, particularly coastal cities, cities along the Yangtze River, provincial capitals, and cities and towns along China's borders. In 1992 the government announced the goal of establishing a socialist market economy, meaning a market economy led by the CCP. To accommodate this change and other economic reforms, the government has shifted its role in the economy. Under the planned economic system, the state determined production and pricing. In a market economy, however, consumer demand for goods and services determines production and pricing. The Chinese government's new role involves creating a stable and competitive economic environment through the application of laws and regulations. Deng and Jiang's reforms in the 1990s were particularly successful at stimulating economic growth, but they also created problems for the Communist leadership. China's foreign debt began to increase rapidly, and growing consumer demand led to rising inflation. 2 Since the early 1990s, the government has 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, provided some assurances against nationalization, allowed foreign partners to become chairs of joint venture boards, and authorized the establishment of wholly foreign-owned

enterprises, now the preferred form of FDI. In 1991, China 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. China also 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. During the four years to 1993, GNP (at current market prices Rmb million) had expanded by +96% or +18% CAGR 1989-93 (reviewed from inflation +51% or 11% CAGR 1989-93) to Rmb 3,138.0 billion. Foreign investors often quote China as having 1.3 billion consumers, and with urban incomes growing 14% a year since 1978, often think that great numbers of unserved customers are there for the taking. 1989 1990 1991 1992 Population (m) Growth 1993

1 126 1 139 1 156 1 173 1 185 1,2% 1,5% 1,5% 1,0%

GNP at current market prices (Rmb bn) 1 599 1 770 2 024 2 404 3 138 Growth Real GNP growth 10,7% 14,4% 18,8% 30,5% 4,1% 8,2% 13,0% 13,4%

Total debt (USD bn) Growth Current Account (USD bn) Growth Consumer price inflation

44,8 52,5 60,8 68,3


17,2% 15,8% 12,3% 12,7% -4,3 12,0 13,3 6,4 -11,9

-379,1% 10,8% -51,9% -285,9% 17,5% 1,6% 3,0% 5,4% 13,0%

Figure 1 MACROECONOMIC DATA 3 1990 Total population Growth Urban Population (m) Growth Rural Population (m) Growth 1991 1135 1,4% 299 2,7% 836 1,0% 1992 1151 1,2% 307 3,3% 844 0,5% 1993 1165 1,1% 317 3,2% 848 0,4% 851 327 1178

Figure 2 DEMOGRAPHIC TREND II) The key success factors can be divided into 3 elements: A) Understand PRC main strategic goals: a. The need of a modern technology to improve the power's productivity b. The need of foreign capital to faster the growth in the economy, this capital will finance positive NPV projects, and investment opportunities for the Chinese company at a low price. c. The need to expand the capacity in the power sector to meet the increase in demand.

B) Choose the right partner to invest: a. He should have the experience in dealing with foreign investors, b. Should have strong relationship with national and local governments c. Should have a market leadership C) Be an investor of a powerful industrialized country a. It gives a strong bargaining power b. It protects from unfair treatment c. It offers important advantages as strong currency and large stock exhanges HPI (Huaneng Power International) created in 1994, develops, constructs, operates and manages large power plants throughout China. It's the larger power firm in the PRC and operates five plants in the fastest-growing provinces of China. The company is a spin-off of HPIDC and its shareholding in 1994 was as follows: 4 HPIDC: 54% Local governments: 46% Today, HPI is seeking for capital to conduct planned projects HuanengPower ShandongPower HPIcompared International International toShandong Assets Sales(1993)inUSDm NetIncome(1993)inUSDm As%ofSales 20,4% 906,0 470,8 96,2 32,2% 449,0 +457,0 146,9 47,3 +323,9 +48,9


Earnings/share(expected'95)inUSD Price-Earningsratio(Expected'95) Figure 3 Competitive analysis iii) HPI Stengths' and weaknesses Strengths:

1,45 14 14


+0,4 +0,0

1- HPI's strong connections with central and local authorities: HPIDC, a Chinese governmentforeign joint venture, is the major shareholder (54%) of HPI, Local government investment companies own the remaining shares, HPI's managers are former top management of HPIDC and Ministry employees 2- Reliable plants: Using modern technology from abroad, more reliable than the average PRC power plant 3- Fast-growing targeted market: 23% of the population, 31% of the national GDP 4- HPI increasing profitability and efficiency: Net profit margin has grown by 1.1 pts, Plant completed on time and within budget 5- Sustainable profitable activity: HPI as the exclusive developer of new planned plants in provinces in which it currently operates, Guaranteed rate of return on electrical generating assets 5 Weaknesses: 1- Geographical dispersion of HPI's power plants: 1,600 kilometers among five coastal

provinces, Far from coalfields regions particularly the Shanxi province coalfields, Primitive transportation infrastructures 2- Insurance issue: No business interruption insurance to protect company from unanticipated events , No third-party liability insurance coverage for accidents on company property 3- Allotments issue: No guarantees that the company would continue to receive transportation, coal and oil allotments, Going prices are much more higher 4- Skilled operational personnel issue: Insufficient trained personnel to operate the planned plants, High cost of foreign engineers Question 2. HPI wants to access financial markets. What are the options available to the firm? Provide pros and cons of available options in particular, deal with: a. Debt markets. b. Equity markets: i. In particular, what type of listing is suitable for Huaneng to pursue? i.e. domestically within China and internationally, listing in Hong Kong, London and the US. (In the US between different ADR levels) ii. What are the benefits for a non-US firm that decides to list on a US exchange? HPI wants to access to financial markets, in fact the internal sources of capital are strained for many reasons: 6

1- HPI has a limited internal investors because of a i) tight controls on credit (1988 and 1992) and ii) Low liquid and low capitalized internal stock exchanges 2- The rise in inflation has led to a moderation in the GNP: The reforms and planned prices relaxing put pressure on consumer prices, the controls implemented to struggle inflation caused have been reduced. 3- Competition against other vital sectors for scarce capital The advantages and the drawbacks of 1) equity and 2) debt 1) Debt: a. Advantages: Interest deductibility from profits allows paying fewer taxes or in other words it leads to a tax economy (M&M capital structure theory), bonds are generally a safer investment. b. Drawbacks: Weight of interest payments (bond interest payments are made even if the company is loosing money), issuing bond increase the company's risk of default, Bonds often offer a fixed interest rate unrelated with free-risk rate ( we may loose some opportunity cost). 2) Equity: a. Advantages: Funds received do not have to be repaid, The firm do not have the expense of paying interest (no obligation for the dividends), the equity enlarged the

investor's base, it leads to an opportunity to raise new capital, the equity issuing can overcome barriers to international investment (if the investors are international. b. Drawbacks: The firm should reach a certain rate of return in order to obtain enough cash to pay dividends, the Opex will rise due to additional costs such as reporting requirements, registration costs and listing fees and it dilutes the old investors' share power (control). If the company would raise capital through equity issuance in China, then it may have some difficulties concerning the amount (Rmb 34,3 bn), it's too high to be integrally issued internally. But 7 if HPI issues debt then a huge amount of debt would generate too high interest expenses and the domestic banks can't afford huge capital requirements. But what's the most suitable stock exchange for HPI? LSE (London Stock exchange) ? i) Advantages: One of the world's largest stock exchange, it has always been focused on international trades ii) Drawbacks: Competitive for small issuances, No listing premium for firms asking for large issuance So the HPI equity issuance (between $700m and $860m) may be undersubscribed HONG KONG STOCK EXCHANGE?

i) Advantages: The Stock Exchange is familiar with PRC companies for more than one year, there's an index for PRC firms ii) Drawbacks: It Has never absorbed such Chinese large issue, it has mixed reception for PRC firms Maybe a saturated market which would gather little attention on HPI equity raising NYSE i) NYSE PresidentWilliamDonaldsoninterest inwinningthe listingsforPRCfirms ii) Favorable measures announced by the SEC: Encouragement of American investors to invest in Chinese firms equity, Submission of only two years audited earnings instead of three iii) Limits: recent lackluster performance of U.S. markets, and there's a mixed reception of Shandong issuances BENEFITS OF BEING LISTED IN U.S. 8 1) It's one of the largest and more efficient market in the world for trading stocks, The regulatory environment: securities laws and regulations, regulatory oversight and enforcement by the SEC, and "monitoring by gatekeepers such as analysts and institutional investors" 2) Better Governance: to prevent controlling shareholders to extract private benefits from the corporation

3) Ability to raise more funds internationally in the future and at lower cost 4) Existence of highly liquid secondary market for company shares 5) Attraction of a listing premium: often, benefits of being listed in NYSE offset listing costs THE MOST SUITABLE ADR: LEVEL III 1) ADRs (American Depositary Receipts) are negotiable certificates that indirectly represent ownership of shares the overseas company for American investors. They facilitate the purchase and sale of foreign firms. 2) What choice to make: a. Level I, Level II: not suitable for capital raising b. Level III: it concerns foreign companies that wish to be listed in major U.S. Stock Exchanges. But it is demanding much disclosure and accounting requirements c. Rule 144A: it concerns foreign companies that wish to raise equity through Private U.S. Placement. It is cheaper, simpler and demanding less disclosure and accounting requirements than the ADRs level III 3) Nevertheless, the SEC revised GAAP requirements downward Question No. 3 What is the right cost of capital for the various Equity options? Measure and explain the cost of capital for each equity option. The equity options available with HPI are as follows: Raising equity in Chinese markets

Listing and raising equity in USA markets (NYSE) Listing and raising equity on the Hong Kong stock exchange (HKSE) Listing and raising equity in UK (LSE) 9 The right cost of capital for the above equity options shall be the Weighted Average Cost of Capital (WACC) in each of these markets: The cost of debt shall be same in all the above markets, since debt component is fixed for the company. The cost of equity shall depend on the market where the shares are issued and listed, since the company's stock price will fluctuate in that particular market and will bear a systematic risk with respect to that market. The company's asset will have different betas (a measure of systematic risk) for different markets. Thus, the stock will behave in a different manner on NYSE than on HKSE and so both will have different measures of their beta. The WACC is calculated as per the following formula: WACC = [Ke x (E/V)] +[ Kd x (D/V) x (1 tax rate)] Where, Ke = cost of equity Kd= cost of debt E = Equity Value ; D = Debt Value

V=E+D E/V = proportion of equity in the capital D/V = proportion of debt in the capital Thus, we need to calculate the Cost of Equity Ke for HPI in each market, by using the CAPM formula: Ke = Rf + L (Rm Rf), where Rf = risk free rate Rm-Rf = market risk premium L= Levered Beta for HPI The information available with regards to HPI is as follows: 10 Cost of Debt (interest) Effective Corporate Tax Rate Equity Finance Debt Finance E/V D/V D/E Ratio 8% 9% $ 612995 $ 533433 0.5347 0.4653 0.87

The WACC in each market is calculated as below: 1) Chinese market In the Chinese market, the allowed rate was 15% on equity financed net fixed assets, and so the cost of equity is taken as 15%. Ke 15%


8% (15%*.53)+(8%*.47)(1-.09) 11.37%

2) The American market The beta given of the electric power generating industry in the US is first unlevered using the formula : U = L/ [1 + (1-tax rate)(D/E)] and then the levered beta for HPI is re-calculated using its debt-equity ratio of 0.87. Doing so, we get the levered beta for HPI in the U.S. market as 0.49. U.S. Govt. LT Bond Yield - Risk Free rate S&P 500 LT Market Premium Beta of Electrical Power Generating Industry in U.S D/E ratio of Electrical Power Generating Industry in U.S Unlevered Beta of above 0.3218 11 D/E ratio of HPI Levered Beta (L) of HPI Ke = Rf + (Rm - Rf) WACC 3) Hong Kong For the Hong Kong market, the risk free rate used is the 1 year Exchange Funds Bills and Notes as of 3rd October, 1994, published by the Hong Kong Monetary Authority. 0.87 0.49 10.41% 8.94% 8.09% 4.73% 0.52 1.01

The beta average of 1994 for two major electricity players in Hong Kong, namely, China Light and Power Company, and Hong Kong Electric Holdings Limited is used as a proxy of the levered beta for HPI in the Hong Kong market. Hong Kong Hang Seng Index Market Premium 1969-1993 ( Rm - Rf) Exchange Funds Bills and Notes Hong Kong 1 year 1994 (Rf) Beta of Electrical Power Hong Kong Ke =Rf + ( Rm - Rf) WACC 4) London Stock Exchange The risk free rate used is the UK I year government liability bonds, as of 3rd October, 1994. The market risk premium is the historic returns on the LSE, as per the report by Bank of England. The beta for HPI on LSE is assumed to be same as that in the US markets. UK Govt. 1 year liability 1994 LSE Market Risk Premium Beta of HPI on LSE 8.40% 5.28% 0.49 12 Ke = Rf + ( Rm - Rf) WACC 10.99% 9.25% 0.87 17.24% 12.61% 13.05% 5.89%

Thus, the cost of capital for each equity option is as follows: China Ke 15% US 10.41% Hong Kong 17.24% UK 10.99%






Thus, we see that lowest cost of capital is possible only at the equity markets in the USA, whereas Hong Kong has the highest cost of equity and capital. So, US markets should be the destination for making the new issue of equity. Question 4: Now imagine you are HPI's investment banker and you are proposing an ADR on the NYSE. You have to convince HPI's bearer of the price at which they should issue the shares? What is a reasonable share price? Why? The price at which the issue should of shares should be made must be devised carefully after analysing all possible means of arriving at the fair price for the company's shares. The three possible ways of estimating the fair value are: Discounted Cash Flows of the free cash flows of the firm. P/E Comparable with PRC based companies going for recent IPOs in international markets Trading Multiples, viz. P/E ratio and Price/Book Value of International Power Generating Groups. 1) Discounted Cash Flows The EBIT and depreciation figures for half-year 1994 have been doubled to reflect the figures for the entire year. 13

The discount rate is the cost of capital (WACC) arrived at in Q3 for the US markets, i.e. 9%. The forecasts provided in Exhibit 12 have been used. Taxes have been taken at the forecast level. However, post 1999, it is assumed that longterm effective tax rate of 17.37% will be in force when temporary tax holidays now received will expire. The perpetual growth rate is taken at a conservative level of 4%, much below the GDP growth rate of China. It is assumed that after 1999, the capital expenditure incurred would be just enough to offset the depreciation and maintain the existing capacity. all figures in

thousands 1994 Perpetuation (doubled for full year) EBIT 481163.28 Depreciation 2,82,295 Capital Expenditures 3,44,000 Operating Cash 1,07,042 76,428 2,25,000 1,62,599 1,86,751 76,429 2,48,589 3,34,753 4,62,657 2,62,495 5,35,000 1995 1996 1997 1998 1999

1,12,562 1,91,829

6,28,000 9,05,000 -


Flows 481163.28 Less: Taxes 83578.06

-41,530 2,918 -

3,88,972 6,05,687 14,305 20,835 -

4,71,582 29,175

62,248 20,120

4,00,952 25,316

Free Cash Flows -44,448 3,75,636 397585.22 Year of Discount Discount rate (9%) 0.596267 Discounted Flows 223979.5 Cash -40778 1 0.917431 2

4,03,277 6,26,522 3 0.84168 4

5,00,757 5 6


0.772183 0.708425 0.649931



-354749 14


PV of Free Cash Flows Discounted Perpetuity Total Enterprise Value Less: Net Debt Equity Value Price/ADR

-967387 4930995 3963608

533433 3430175 27.4414

2) P/E Comparable with recent PRC based company IPOs Another method adopted is to estimate the mean and median P/E Ratio of recent IPOs by PRC companies in foreign markets, and taking that multiple as the proxy for estimating the fair value of shares of HPI. For this purpose, we have eliminated IPOs where offer size was too low compared to

that of HPI's. Company Shandong Huanheng Power Dongfang Electrical Tianjin Bohai Chemical Yizheng Chemical Fibre Beiren Printing Shanghai Petrochemical Tsingtao Brewery Median Mean Value of HPI shares: EPS/ADR Median Mean $ 1.45 19.575 19.367857 15 3) P/E and P/BV multiples compared to International Power Generating Groups Comparable with International PE Ratio Price to Book Ratio Power Generating Groups Asian Power Products South American Utilities U.S. Independent Power Products U.S. Utilities 10.2 15.6 23 14.1 1.2 2.24 2.27 2.47 Exchange NYSE Hong Kong Hong Kong Hong Kong Hong Kong 15.2 11.3 16.3 12 11.2 13.5 P/E ratio 14

Hong Kong Hong Kong 13.5 13.35714

European Utilities Median Mean HPI Valuation EPS/ADR Book value/ADR Median Mean 1.45 9.67

11.4 14.1 14.86 As per P/E

1.64 2.24 1.964 As per P/BV

20.445 21.547

21.6608 18.99188

We have also already discussed the key strengths of HPI arising from its being the largest power firm in PRC, its ambitious growth plans, the attractive Chinese economy, the Government support and various other privileges it enjoys, that put it in a position so as to command a premium over what Shandong Huaneng Power is trading at. The lowest price estimate we get from the above is $ 19.4 per ADR and the highest we get is $ 27.44 per ADR (as per the DCF model). Thus, we can safely fix the price to be at $ 24 per ADR so as to attract the foreign investors into value buying. The company is in a position to command better prices than other comparable firms because of its market power and unique position, while the said price of $ 24 is also below the real intrinsic value of the shares at $ 27.44. 16 This price would ensure that the potential investors take note of the company and are happily willing

to pocket in the benefit to the tune of $ 3.44 per ADR. Thus, such a pricing should create a win-win situation for both the company as well as the investors. Question 5 What implementation strategy would you suggest? Present your recommendation on whether, how and why HUANENG should have proceeded with the issue. Huaneng needs $ 4.5 billion to finance its development plans, from which $700 - $860 million is being raised in form of equity offerings, which is 15.5%-19% of the total amount. In order to achieve the figure of $4.5 billion the best option for Huaneng would be to raise debt instead of equity. Debt is available at low rates and a n optimum level of debt will maximize the company's value by the way of tax shield. Huaneng is exploring international markets to raise funds primarily because of two reasons. Internal sources were unable to fulfil the debt requirements. Domestic stock exchanges were still in the nascent stage and hence were incapable of raising adequate amount of liquidity. Missing out on expansion plans because of lack of capital would mean lose of great opportunity which can hamper the future growth of Huaneng power limited. So Huaneng should definitely foray into international markets to raise funds required for its expansion plans. The cost of capital for each equity option available to Huaneng is as follows. China US Hong Kong UK





10.99% 17






Thus, we see that lowest cost of capital is possible only at the equity markets in the USA, whereas Hong Kong has the highest cost of equity and capital. So, US markets should be the destination for making the new issue of equity. Huaneng can raise adequate funds from Issuing ADRs in US market which will also provide international exposure and wider access to more institutional investors. Huaneng should look at a level 2 listing which will allow it to get registered on major US stock exchanges like NYSE & NASDAQ. Level 1 won't be able to fulfill the requirements as Huaneng is not a known name worldwide. Private placements to only institutional investors wont be able to fulfill the entire capital requirements and level 2 again requires only partial reconciliation of financial; statements as per GAAP. A level 2 ADR listing will augment Huaneng's image in USA market and will broaden the investor's outlook, increasing the demand for the stock. Level 2 listing will also pave the way for future US listing and capital formation. This seems like a decent strategy and will serve the purpose of Huaneng. The procedure for ADR Level 2 issuing is as follows: 1) Hire an Underwriter (an investment bank) and negotiate the terms and capital raising

details and get the depository agreement signed.. 2) Hire other advisors who are specialists in the field of American Chinese corporate law and security law and consulting companies specialized in ADR listing and issuing procedures and 18 requirements. Huaneng needs also to hire auditors and certified accountants to help with Huaneng financial statements partial reconciliation with GAAP (required for ADR Level 2). 3) Assisted by underwriter, Huaneng has to complete and file with US Securities and Exchange Commission (SEC) the registration statement form F-6. 4) Apply to list on exchange after waiting about 20 days named "cooling off period", time in which Huaneng will have to distribute "Preliminary Prospectus" or " red herrings" to potential clients. This will outline all the material facts about the company. In the same time the underwriter will travel with company management to give presentations to people in the brokerage industry; in this way they will get indication on the interest of potential investors. 5) After the "cooling off period, comply with SEC deficiency memorandum requirements. 6) Price meeting during which price and the volume of offering is established as well as underwriter's commission and commitment, and the over-allotment options. Huaneng

should try to achieve a Firm-commitment agreement with its underwriter through which the underwriter agrees to purchase the whole issue from the firm at a given price and than resale it to the public. This will safeguard Huaneng' from under subscription risks. 7) Finally file the final prospectus with SEC. Question 6. As the investment banker of the institutional investor, would you have recommended to buy stock in this company at all? At what price? Why? 19 I would definitely recommend investing in Huaneng stocks to the institutional investors. The rationale for the same can be summed as under: Poised to grow: HPI is all set to grow as a leading supplier of power to mainland china. This company was a spinoff of HPIDC, which is a well known name in the power industry. Risk Management: From a risk management perspective, ADR provide a mean to invest overseas in order to diversify the portfolio without the inconveniences of foreign currency and lack of information published. HPI shares are recommended to American investors in order to diversify portfolios. There is low correlation between U.S. market and Chinese market at that time. According to the Kutan and Zhou's paper (2006), using data from 16

April 1998 through 30 September 2004, no negative correlation between host U.S. market returns and those of the ADR was found. However, U.S. market volatility has no significant impact on the conditional volatility of Chinese ADRs. These results suggest that the Chinese ADRs offer significant diversification benefits to US investors. Diversification: Another advantage of adding HPI ADRs to the investor's portfolio is holding stocks from an emerging market with high potential and opportunity of growth will diversify the portfolio. Economy: China is fast growing and developed economy and investing in china will not only diversify the risk buy also yield positive results. At What Price - An American Investor would compare the price of ADR with the stock prices of similar industries in US. Additionally he would like to make an risk premium on the ADR for the currency devaluation exposure, the unfamiliar business practices in china, the lack of transparency and the weak investors' protection law and possible corporate governance problem. We are assuming that he would like to purchase the ADR at 10 % discount rate. Comparable with International PE Ratio Price to Book Ratio Power Generating Groups 20 U.S. Independent Power Products 14.1 2.47

EPS/ADR Price = 14.1* 1.45 = 20.44


Additional discount = 20.44* 10% = 18.4 I as a Banker would recommend the Institutional investor to buy the ADR at 18.4. Question 7 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? PRC was a completely state run economy and centrally planned economy before it decided to open up its gate for free market reforms .China's communist party (CCP) did surrender to demands of opening up to the global economy. The CCP had great pressure both from Internal and external business houses to bring about the change in its reforms and make it more liberal. China began its economic reforms and open-door policy in December 1978. The aim of China's macroeconomic policy is to maintain a steady economic growth, to avoid big economic fluctuation and to enhance the people's living standards. The economic growth rate reached 10.2% in 1995 and 9.7% in 1996. The Chinese economic system was on its way from a centrally planning system to a market oriented one.

Steps the Government should take to make it easier for Chinese firms to raise capital: 21 As China continues its economic transition, perhaps the biggest challenge for the government will be to move away from direct interventions in product and financial markets towards providing the institutional and policy frameworks which help markets work efficiently. Within this shift of governance "philosophy", structural reform will be the key to further economic progress. The key areas for structural reform are as below: 1. Streamlining the SOEs & recuperating corporate governance SOEs accumulated large savings because of poor self governance by the government, private enterprises, especially the SMEs, have done the same because poor financial intermediation has limited their access to bank credit. In the early 2000s, China needs to initiate a bank reform program cleaning up nonperforming loans, recapitalizing banks, and opening the sector to foreign participation and competition. 2. Recapitalizing the financial sector Government needs to recapitalize the financial sector by providing them adequate capital at cheap costs. Government should provide additional tax benefits to corporates and other incentives for companies who pull in funds from international markets. 3. Liberalising the capital markets.

Government should work towards better financial intermediation. Authorities should push for further improvements in the banks' commercial operations, internal controls, and governance. They should also lift the cap on deposit rates, which would not only help push up the cost of capital but also allow smaller and more aggressive banks to compete better against large state-owned banks and provide an incentive for big banks to expand credit to small and medium-scale enterprises. Continued government control over bond and equity issuance is a again a serious impediment to these markets. 4. Relaxed rules for currency exchange and investment abroad for increased capital flows. 22 The government should liberalize China's tightly controlled and much criticized foreign exchange regime, which will make it easier for companies and individuals to buy foreign currency and invest in overseas capital markets. Also allowing the companies to diversify their risks and get better returns. 5. Accounting Standards to allow for simpler and faster transactions The Chinese system of accounting is widely considered to be unsuitable for managing corporations in a market economy. As a result, Chinese corporations are gradually moving toward International Financial Reporting Standards. This has proven to be a massive undertaking. One consequence of this system is that Chinese companies who offer shares

for sale in the United States must prepare three sets of statements, one using Chinese accounting standards, one using international standards, and one using North American GAAP standards. So china Should work towards modernize and standardized their accounting standards.