TURNING THE TIDE
A heavy drain on taxpayers' money and local banks, the Three Gorges project needs private funding, fast.
By Yang Jian

In Yichang, a city built on the banks of a murky section of the great Yangtze River, a team of investment bankers from China International Trust and Investment Corporation (CITIC) is working round the clock to help Yangtze Electric Power obtain an A-share listing on the Shanghai Stock Exchange. Hardly a rare phenomenon in capital-hungry China, but this is no ordinary example of privatizing state assets. The controlling shareholder of this company in Hubei Province is the China Yangtze River Three Gorges Project Development Corporation, or Three Gorges Company, the state-owned enterprise behind the largest and the most complex hydroelectric-power project in history.

The money raised by Yangtze Electric Power's IPO will be spent on the last phase of the Three Gorges project, to begin in 2004. The size of the issue is small, however, and no foreign investor has shown interest in buying a stake in the project which is expected to cost a total of US$22 billion by the time construction draws to a close in 2009. Most of it will continue to be borne by loans from state-owned banks.

Yangtze Electric Power was created last September as the listing vehicle for the Three Gorges Company. News about the company's intention to float some of its shares was rife as early as last spring. In March 2002, Li Yongan, vice president of the Three Gorges Company told the Financial Times that the company was planning a domestic listing which would involve private placements offered to foreign investors, as well as further listings in Hong Kong and London.

Li is now general manager of Yangtze Electric Power as well. Today, his team is only willing to confirm plans to offer shares to domestic investors, with CITIC as lead underwriter. Kou Reming, vice president and CFO - who blames ignorance about the project's potential for the absence of a foreign listing - says the domestic IPO will launch after the first batch of Three Gorges generators begin operation in August.

The office of the board secretary, which functions as the corporate communications department, admits to planning for a September or October IPO though it confirms that no formal application has been made to the China Securities Regulatory Committee, a necessary step for a domestic listing. A CITIC manager in Shanghai, who declines to be named, believes that Yangtze Electric Power's IPO will encounter no opposition from regulators because it is part of the government's strategic planning.

Kou hopes that 15-20 percent of the subsidiary will be offered to the market. Currently, the company has 5.53 billion shares, so according to Kou's calculation, one billion A-shares are likely to be offered. According to CITIC's estimation, Yangtze Electric Power is expected to pull in about US$0.5 billion based on current market conditions. Kou says the money will be used to buy 26 sets of electricity generators which the parent company is offloading over the next few years in exchange for capital to fund the final stage of construction.

Staying Focused

Before those transfers happen, the Gezhouba Hydro Power Plant in Yichang remains Yangtze Electric Power's sole asset. It was built as an experiment in the 1970s to find out whether it was possible to build a larger Three Gorges dam and has been operating successfully since 1981. It was given to the Three Gorges Company in 1993 by the central government as a ready-made, operating component to raise money for the grand project. Ten years on, the Three Gorges Company gave the Gezhouba plant to Yangtze Electric Power in exchange for the majority stake.

Kou says of Yangtze Electric Power: "We will bring generous cash dividends to our shareholders, not like some listed companies which give investors nothing but a pile of paper by issuing new shares recklessly." He estimates that when all 26 sets of generators are in operation by 2009, 84.7 billion kilowatts, or 100 billion kilowatts when combined with the output of the old Gezhouba plant, of electricity will be generated in a year, or approximately 5 percent of forecasted national consumption.

At US$0.03 /kWh, the electricity price recommended by the State Development Planning Commission, Yangtze Electric Power will generate over US$3 billion each year. However, Kou will not speculate on how long shareholders will have to wait to see any profit. He expects one set of generators to cost about US$0.54 billion. In other words, even if the IPO does raise the expected US$0.5 billion, it will only cover the cost of one of the 26 sets.

But there is some good news. While the State Development Planning Commission issues a recommended tariff, it's for guidance only. The Three Gorges Company press center confirms that Yangtze Electric Power can set its own electricity price since, like all power companies, it is encouraged to follow free market principles. As of January 1 this year, the Gezhouba plant set its tariff at RMB0.151 per kilowatt. Kou believes it to be the lowest in China - and proof that the other Three Gorges hydropower generators will be offering a similarly competitive tariff compared to coal power stations.

No Deal

With the source of revenue identified and an A-share listing on its way, Yangtze Electric Power appears to be making the right moves as the financing platform for the entire Three Gorges Project. Yet its failure to generate any interest abroad is a cause for concern among its managers.

Just before the launch of Yangtze Electric Power, Li Yongan led a team to Hong Kong in the hope that companies such as Hong Kong-based CITIC Pacific, CLP Power and US-based Mirant would agree to invest in the Three Gorges project. The trip was unsuccessful. In hindsight, it seems surprising that CITIC Pacific, a CITIC subsidiary that invests in infrastructure and power projects, declined a slice of a project its parent company is now underwriting. All three companies have confirmed that they were in talks with Li but declined to give details why they rejected the deal.

Kou admits that no progress has been made to lure private foreign investors since that trip and a listing in Hong Kong, New York or London is not likely in the near future. He blames foreigners for not understanding. "In my opinion, if one really has to identify potential risks for investors, there are two possibilities. The first is that the Three Gorges project can't generate electricity at all. The other concerns the balance and coordination of different parts of the project." He thinks that the likelihood of the former is small because construction has so far been smooth. As for the latter, he maintains that strong support from the state will make sure that the jigsaw pieces fall into place.

"The Three Gorges project has been following a strict timetable for the last nine years. It will bring enormous benefits to shipping and flood prevention. No quality problem has occurred in the construction and the budget is well under control. Judging from the current progress, the total investment for the project will not surpass RMB180 billion, 20-plus billion less than the original budget," he says.

Provincial Power

So he says, but, as a power industry analyst at Deutsche Bank's Hong Kong office points out: "Investors are realistic. They focus on nothing but the figures in financial reports. The Three Gorges project may truly help flood prevention and navigation, but they are not accountable revenue for the company." The analyst, who prefers not to be named, points to other issues that concern international investors. Return on investment from hydropower projects tends to take longer than coal power stations. Also, listing Yangtze Electric Power is aimed at supporting further exploitation of resources in the upper reaches of the Yangtze River. This is just the kind of grandiose project that many investors see as a bottomless pit for their money.

While Kou shows enormous confidence in the fact that the Three Gorges project will deliver economically, others are not convinced that the expensive dam will hold. In addition to the countless reports by international experts denouncing the technology behind building the dam, the Chinese government admits that the project is plagued by widespread corruption. In 2000, 97 officials were punished and one sentenced to death for embezzling funds put aside for the relocation of over a million people whose homes were to be flooded by the dam. Unfortunately for Kou, many observers have indicated that they doubt the safety of a complex construction project which is associated in any way with bribery - bribes, after all, can lead to substandard material and workmanship. The project's negative impact on the environment, which could result in enormous expenses for the company in the future, as well as the sheer cost of relocating local residents are other areas for concern.

Analysts are also worried that the development of power facilities on the Yangtze River will be held up by local protectionism. Michael Komesaroff, president of Urandaline Investments, a consulting firm that specializes in capital intensive industries, cites the Ertan Power Station in Sichuan province as an example. Financed by the World Bank and the Chinese government, output only reached 30 percent of its potential capacity during the early stages of operation. The provincial government told local companies to buy electricity, at a higher price, from smaller, local power stations run by local power companies. China's power industry is just beginning its re-organization, which will reduce the influence of provincial power companies, but this will take time.

In an attempt to reject these accusations, Kou Reming goes as far as to say that Yangtze Electric Power is not selling its shares merely for the sake of money. "Raising funds, whether domestically or internationally, is not our priority. Instead, the company wants most to improve corporate governance and management performance by bringing external shareholders," he claims. That may be true - the company will be seen to be clean through the extra vigilance of outsiders - but it's a statement that smacks of an executive toeing the new party line rather than one representing a company with debts running into billions.

He also thinks that the company has done well in terms of transparency. "Go and take a look at the official website of the Three Gorges parent company. You will find all the answers to questions about migration and the environment," he says. The website is not as packed with information as he claims. It is mostly about the economic benefits of the project but it makes little mention of potential harm to the environment. And there is nothing about the cost of migration and relocation. The irrepressible Kou, however, stresses that attracting foreign investors is still on the company's agenda and adds that, in the meantime, Yangtze Electric Power will raise more money through issuing bonds and applying for bank loans.

The board secretary office states that many domestic commercial banks have shown interest in providing loans. Bank of China and Agriculture Bank of China have already signed agreements with the Three Gorges Company on more loans. Kou may promise investors a share of the US$3 billion annual revenue, but from the way the project is being funded, years of earnings will be used to repay loans. The whole project, while still in the construction stage, is kept going by rolling credits. Given that the government is keen to stop indiscriminate loans to SOEs, the banks' generosity may run out quite soon .

Yang Jian is a journalist based in Shanghai.