China eyes merging seven power generation firms into three

Shenhua, Datang Power and CGN will become one.

Bloomberg reported yesterday that China was planning on merging seven power-generation companies into three. Jefferies believes excess capacity, President Xi's supply-side reform initiatives and political considerations are behind this plan.

According to Bloomberg's report, China was planning on consolidating the current seven power-generation companies into three.

Shenhua, Datang Power and CGN will become one; Huadian, China Power and CNNC will become another; with the final one to be created by merging Huaneng and SPIC. We believe such government-engineered M&As are highly likely owing to President Xi's supply-side reform initiatives (rationalize capex and reduce excess capacity), and the current mixed ownership reform efforts (which also involve industry restructuring).

Here's more from Jefferies:

According to the State Grid Corp. of China, China's power supply and demand balance is in an "easy" state, which means excess supply. In 2016, power generation capacity rose by 8.2% while power demand grew only by 5%. In 2017, capacity is forecast to grow by 6.3% while demand to increase by a mere 3%.

While the government wants to continue reducing its reliance on fossil-fuel power capacity (especially coal) by discouraging investments, previous high subsidies on renewable energy have resulted in excessive investments in hydro, wind and solar power. If the speculated M&A takes place, the three new power generation companies will cover all fuel types: fossil fuel, nuclear and renewables. That could also be one of the objectives of this exercise.

They have done it in telecoms, and power is similar. There used to be four telecom operators in China. In 2008, the NDRC engineered the sale of China Unicom's CDMA network to China Telecom (a pure fixed line operator then), and the merger between Unicom's remaining GSM operation with China Netcom (another pure fixed line operator then), to create two integrated operators.

At the same time, China Mobile bought China Railcom's fixed line network to become another integrated operator. The concept of "integrated" operator in telecom is somewhat similar to covering all fuel types in power generation. More importantly, China Telecom and China Netcom at that time were vying for 3G licenses to get into mobile communications, which was the growth area, and the NDRC did not want to do that to avoid excess capacity.

Now a similar situation is emerging in power generation: nuclear and renewables are likely the growth area while fossil fuels are declining, Power companies without much capacity in the growth areas will try to expand into them, causing potential oversupply. Note that in the 17 months before the announcement of telecom consolidation in 2008, China Telecom's stock price had risen by 33%, Unicom by 62% and Netcom by 30%.

Unicom's current mixed ownership reform could be a similar exercise. Furthermore, our view that Unicom will eventually gain access to SAPPRFT's 700MHz spectrum in the current mixed ownership reform is also based on our belief that President Xi's supply side reform will not support giving SAPPRFT a mobile license, which will create excess capacity. We view Unicom's mixed ownership reform as another industry restructuring for telecom, although it does not involve China Mobile or China Telecom.

Consolidation happened in steel, and partially, in building materials. We would also like to highlight that the government has recently engineered the merger of Baosteel and Wuhan Steel (both listed in A share market), and CNBM and Sinoma (but only parent cos). Power is not as strategically important as telecom now (China wants to be a leading digital country by 2020), and thus will be under even more pressure to consolidate.