Long-Term Corporate Value Creation For Japan Power Sector
December, 2007
The Children’s Investment Fund (TCI)
Explain
OPENING REMARK
Changed
The Children’s Investment Fund (TCI) is a long-term shareholder of global companies
•
Substantial permanent capital with long-term horizon
•
Core investments in infrastructure assets
We have invested in utility industry including J-Power, an attractive company with significant potential
•
J-Power privatized in October 2004 with shares sold to Japanese and global investors
•
Has a solid core business and sound operational management
•
Strong and stable cashflows is a characteristic of J-Power’s business model
TCI like to identify strong companies and increase investments in those with good corporate governance
•
Japan is a developed nation and we believe have potential for good long-term investing
•
Like to participate in government’s encouragement for more foreign investments
We thoroughly study our companies and develop thoughts for value creation for them
•
Current management plan for domestic businesses is sound with some improvement potential
•
Overseas expansion can be refined so J-Power is more than just a minority “financier”
To improve corporate value, capital structure and cost of capital needs refining
•
EPCOs are financially healthy, with room to improve its cost of capital and corporate value
•
Addresses stakeholders’ need by reducing the cost of achieving long-term energy goals
•
Increase in corporate value will lead to stability in employment for employees
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
-1-
Explain
THE CHILDREN’S INVESTMENT FUND MANAGEMENT (TCI)
TCI is an investment management partnership headquartered in London with an office in
Hong Kong. It manages over US$10bn (1.2 trillion yen) of client assets.
Our investment universe is global and our time horizon is medium to long term. We identify
strong business franchises with solid fundamentals in the expectation of realising absolute
returns over time. Our capital base has substantial permanent capital together with long-term
rolling lock-ups, allowing us to undertake long-term investment.
The Fund’s investors are mainly institutional investors, including universities and insurers.
The partners of the firm are also key investors in the Fund. This alignment of the long term
investment approach of both manager and investors allows the Fund to better withstand the
volatility associated with equity investing.
Our portfolio thus has lower turnover than many investment funds, in turn allowing us to
build stronger relationships with the management of companies in which we invest.
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
-2-
Explain
THE CHILDREN’S INVESTMENT FUND FOUNDATION (CIFF)
The Fund is named The Children’s Investment Fund because the TCI Fund Management donates a large
proportion of its profit to The Children’s Investment Fund Foundation (CIFF). Hence the Foundation
benefits directly from good investment performance of the Fund. This also ensures sustainable income
for the Foundation, enabling it to make long-term commitments to its grantees
CIFF aims to demonstrably improve the lives of children living in poverty in developing countries by
supporting sustainable strategies that will have an impact on their lives and their communities. CIFF
acts as a catalyst for change by:
•
Filling gaps and breaking bottlenecks to unleash significant potential for change
•
Demonstrating an ability to bring best practices to scale and reach large numbers of children
•
Promoting a comprehensive approach to children, family and community
•
Supporting intervention that will be sustainable beyond CIFF funding
•
Taking risks and supporting innovative approaches where there is potential for high impact
•
Monitoring the impact of its grants on children, encouraging adaptation and sharing lessons
learnt
The Foundation‘s website is www.ciff.org
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
-3-
CIFF FOCUS AREAS AND APPROACH
Current Countries Of Focus
Approach
Four Key Areas
1.
2.
3.
4.
Children Affected by HIV/AIDS
Emergency Humanitarian Assistance
Water, Sanitation and Hygiene
Education
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
-4-
OUR BACKGROUND
Chris Hohn
Mr Hohn is the Managing Partner and Portfolio Manager of The Children’s Investment
Fund Management Limited.
Prior to founding the Fund, he worked at Perry Capital for seven years in New York and
London where he was the Portfolio Manager of the award-winning Perry European Fund,
managing USD$1bn (12 trillion Yen) of assets.
Chris received an MBA from Harvard Business School and a Bachelor of Science in
accounting and economics from Southampton University in England.
John Ho
Mr Ho is a Director of The Children’s Investment Fund Management (Asia) Limited; and
also a Netherlands entity that own shares in J-Power. Mr Ho heads up TCI’s office in Hong
Kong and is responsible for its Asia-Pacific and Japanese investment activities.
Prior to joining TCI, Mr Ho was a senior equities analyst with Citadel Investment Group in
Chicago, US. Before moving to the US, John was with the Boston Consulting Group in
Sydney, Australia, assisting Australian and New Zealand-based top management on
corporate finance, value-based management and business strategy issues.
Mr Ho lectured in finance and option pricing at the University of New South Wales,
Australia, where he also graduated with First Class Honours and University Medal in
finance and mathematics.
Mr Ho currently serves on a number of Boards of TCI’s investee companies, helping them
improve corporate value and corporate governance
Philip Green
Mr Green is an infrastructure and utility expert in TCI’s London office.
Prior to joining TCI, Mr Green was a top ranked utilities analyst at Merrill Lynch and
Goldman Sachs with over ten years experience in European and global utilities.
Mr Green is a graduate in Geotechnical Engineering from the University of Newcastle
Upon Tyne in England.
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
-5-
Explain
TCI HAS STRONG KNOWLEDGE IN GLOBAL INFRASTRUCTURE INVESTING
Example Global Infrastructure and Utility Investments
US: public infrastructure
investments
China: Investments in
government electric and
gas utility, tollroads
Spain: Transmission
company investment
Korea: private
infrastructure company
Italy: large national
infrastructure
company
Japan: Investments in
electric utility
South-East Asia: Utility
investments
Brazil: integrated utility
investments
Australia: extensive
knowledge
TCI possesses deep global knowledge and experience with
infrastructure and utility companies and their corporate value creation
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
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TCI HAS EXPERIENCE AND TRACK-RECORD IN HELPING TO MANAGE
INVESTEE COMPANIES TO INCREASE CORPORATE VALUE
Explain
Example Of Our Activities With Our Largest Investments
1
We view ourselves as business owners, not short-term traders of stocks
2
Formally and informally in strategic discussions with top management (e.g. CEO,
CFO) in shaping company vision, strategy and policy
3
Leveraging our global reach and capability, TCI works with companies to offer
analyses, advice and suggestions on improving company performance
4
Participate in Board as full members, directly helping the Board drive corporate
value creation
5
Pro-active involvement in some of our companies “day-to-day” issues, such as
recruiting senior personnel, working with advisors and improving corporate
governance of companies
Strong track record of our investee companies creating substantial value
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
-7-
TCI STRIVES TO BE RESPONSIBLE INVESTOR TO HELP OUR INVESTEE
COMPANIES INCREASE CORPORATE VALUE
Explain
Changed
We Believe EPCOs Like J-Power Makes
Attractive Investments
For example, we invested in J-Power because it
has strong business fundamentals and
excellent long-term potential
We were also encouraged by the Government’s
aim to internationalize the shareholder base
through privatization
TCI makes relatively large and concentrated
investments to focus on the best companies
We do not trade short-term as this does not
create sustainable value, in our view
Our focus allows us to build strong
relationships with management to help enhance
corporate value over the medium to long-term
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
We Intend To Help Increase
Corporate Value Of Our Investee Companies
TCI would like to be a long-term investor in
Japan
We have long-term capital and substantial
permanent capital
We find Japan an attractive country, with a
stable regulatory regime and government
encouragement
As a business owner with substantial global
utility and infrastructure experience, we believe
we can bring a new perspective to help improve
J-Power’s corporate value
This will benefit all stakeholders, including
existing management and employees
-8-
Explain
AGENDA
INTRODUCTION: CASE FOR CORPORATE VALUE CREATION
DOMESTIC OPPORTUNITIES
INTERNATIONAL OPPORTUNITIES
ENVIRONMENTAL OPPORTUNITIES
CAPITAL STRUCTURE AND CAPITAL MANAGEMENT
CORPORATE GOVERNANCE
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
-9-
Explain
DISCIPLINED AND SYSTEMATIC WAY FOR CORPORATE VALUE CREATION
Corporate And Enterprise Value Creation Measurement Framework
Profitability
Corporate and Enterprise
Value Creation
•
Maximise cost and asset
efficiency
•
Providing best service to
customer, with optimal
efficiency
•
Attractive best human talent
Return on
Assets (RoA)
Examples of form of growth:
Return on
Equity (RoE)
•
Growth
Capital
Structure
Efficiency
Sufficient RoE to ensure longterm viability of enterprise
•
Capital has an economic cost
•
Improving efficiency will
reduce overall cost
•
Should seek continuous
improvements
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
•
Sales growth;
•
Higher asset utilisation;
•
Better use of capital deployed;
•
Better utilisation of talent and
human resources
Growth has a cost in the form of
capital costs and must be taken into
account
- 10 -
Explain
EXAMPLE: J-POWER’S RETURN ON EQUITY (ROE) SUFFERED SINCE 3/2001
Title slightly changed
J-POWER Consolidated Return on Equity (RoE): 3/98 – 3/08E
(%)
15
14
13
J-Power became
publicly listed company
12
11
10
9
3/2008 RoE is
estimated based on
forecast 3/2008 Net
Income
8
7
6
1998/3
1999/3
2000/3
2001/3
2002/3
2003/3
2004/3
2005/3
2006/3
2007/3
2008/3
RoE = (Net Income ÷ Average Shareholder Equity)
Source: J-Power Financials and Factbook
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
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Explain
J-POWER’S RETURN ON EQUITY IS FALLING AND IS BELOW 10%
J-Power Return on Equity (RoE), Consolidated
([Net Income] ÷ [Shareholder Equity], 3/01 – 3/07, %)
J-Power Return on Equity (RoE), Parent
([Net Income] ÷ [Shareholder Equity], 3/99 – 3/07, %)
13%
13%
12%
12%
11%
11%
10%
10%
9%
9%
8%
8%
7%
7%
6%
6%
5%
5%
2001
2002
2003
2004
2005
2006
2007
1999
2000
2001
2002
2003
2004
2005
2006
2007
Management needs to understand and explain why RoE is falling precipitously
Source: J-Power Annual Reports and Fact book
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 12 -
Explain
RETURN ON ASSET HAS ALSO FALLEN TO LOW LEVELS
J-Power Return on Assets (RoA), Consolidated
([Net Income + Interest Exp] ÷ Total Assets, 3/01 – 3/07, %)
J-Power Return on Assets (RoA), Parent
([Net Income + Interest Exp] ÷ Total Assets, 3/99 – 3/07, %)
6.0%
6.0%
5.5%
5.5%
5.0%
5.0%
4.5%
4.5%
4.0%
4.0%
3.5%
3.5%
3.0%
3.0%
Falling to low levels
2.5%
2.5%
Falling to low levels
2.0%
2.0%
2001
2002
2003
2004
2005
2006
2007
1999
2000
2001
2002
2003
2004
2005
2006
2007
Falling and record low RoA is a very negative signal.
Management needs to examine its strategies properly.
Source: J-Power Annual Reports and Fact book
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 13 -
Explain
J-POWER’S PARENT OPERATING PROFIT SINCE MAR-2001
(Billion of Yen)
130
120
Halving of
Operating Profit
since IPO
110
100
90
80
70
60
50
40
2001/3
2002/3
2003/3
2004/3
2005/3
2006/3
2007/3
2008/3
Note: Mar-2008 Operating Profit shown is guidance provided by Management
Source: J-Power Financials
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 14 -
Explain
NEGATIVE RoE AND RoA TREND NEED TO BE CAREFULLY UNDERSTOOD
Continuously falling and low RoE and RoA hurts corporate value creation
Some potential explanatory factors, e.g.
•
Reduction in interest rate and hence lower tariffs to customers
•
Reduction in efficiency and higher costs
•
Capital invested with low returns
•
Growth that is not value-enhancing
Some factors are outside of management control (e.g. lower interest rates), but
others (e.g. efficiency) must be vigorously managed by top management
Management’s strategic and mid-term plans must address these trends, and
appropriate targets and managerial control put in place to measure and rescue
such trends
We wish to help management study and reverse negative RoE and RoA trends, so
corporate value creation can be attained and J-Power can continue to provide
services to customers at reasonable prices
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 15 -
Explain
COMPREHENSIVE CORPORATE VALUE CREATION PROCESS NEEDED
Target Setting
• Set RoE and RoA targets, in
the context of the industry
• Dis-aggregate these targets
into operational metrics and
measures
Compensation
Evaluate and reward
performance
• Ensure incentives align with
corporate value creation
objectives
Strategic and Mid-Term Planning
Corporate Value
Creation
Process
Reporting
Select strategies and quantify
expected outcomes
• Corporate/Business process
• Efficiency improvement
programs
Investment Planning
Systematically report on
outcomes against target set
• Tie back to strategic and
investment plans
• Should get better RoE, RoA
Develop/assess business cases
• Capital expenditure
• Major operating expenditure
program
• Human capital plan
Execution
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 16 -
Explain
COPORATE VALUE CREATION PROCESS INCLUDES ALL STAKEHOLDERS
Government/Regulator
Citizens / Green Groups
Adhere to legal and
regulatory requirements;
active part of meeting
national energy goal
Correct treatment
of the environment
Lenders / Banks
Interest rate,
ability to repay
Partners/Suppliers
Management
Good remuneration/Image/satisfaction
Fair value for
services and products
Competitors
Shareholders
Employees
Appropriate returns,
Dividends
Fair remuneration and treatment
Correct treatment
Customers / EPCOs
Fair price/quality/availability for service
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 17 -
Explain
TCI RECOGNISES THE IMPORTANCE OF JAPAN’S NATIONAL ENERGY POLICY
Japan’s national energy policy goals are key sources of input to J-Power’s
corporate value creation process and its plans
Therefore, the Japanese government and METI is a key stakeholder in the
whole process
METI also welcomes foreign investments, especially those that pro-actively
invest in the country for long-term value creation
TCI believes understanding, incorporating and participating in the national
energy goal is vital for all stakeholder success
Given J-Power’s position, there are significant opportunities for corporate
value creation
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 18 -
Explain
KEY GOALS OF THE “FUNDAMENTAL LAW ON ENERGY POLICY MEASURES”
1 Maintenance of Stable Energy
Supply and Security
2
Environmental
Considerations
“Energy security measures
“Energy demand and supply policy
“Economic restructuring related
established on the basis that energy
supply sources will be diversified,
energy self-sufficiency will be
improved, and energy security will
be maintained in recognition of the
state of the world’s instabilities
surrounding energy …”
measures shall be established to
the effect that energy demand and
supply will be realised with a view
to global warming prevention and
creation of sustainable societies by
promoting conversion to non-fossil
fuel energy use, such as solar and
wind power, and rational use of
fossil fuels …”
policy measures on energy demand
and supply such as liberalisation of
the energy market shall be
established to the effect that
manufacturers fully exercise their
independence and creativity while
demand-side benefits are fully
assured in complete recognition of
policy objectives defined in the
previous two articles …”
3
Utilisation of
Market Mechanisms
The Law called for the development of a “Fundamental Energy Plan”
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
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Explain
“NEW” NATIONAL ENERGY STRATEGY: CHALLENGES
Japan’s Energy security and environmental issues
• 4% energy self-sufficiency, lowest of large industrialised nations
• Declining global oil reserves
• China and Asia rapid consumption growth – increasing import
pressure
• Increasing global CO2 emissions
• Need for improved international cooperation
Issues need to be tackled on a global scale
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 20 -
Explain
NATIONAL ENERGY STRATEGY: JAPAN’S KEY TARGETS
Promote energy saving: 30% improvement in energy consumption by 2030
•
Advanced energy saving technology
•
Industrial sector-specific benchmarks
•
Mechanisms to evaluate energy-saving investments
Maintain at least 30-40% nuclear market share even after 2030
•
Maximise the potential of existing plants – safe efficient operations,
life extension
•
Advancement of nuclear fuel cycle – strategy to secure uranium,
waste disposal
•
Address siting issues for new plants
•
Develop technological, personnel excellence
•
2050+ commercialisation of fast breeder reactors?
Strengthen strategic cooperation with international partners
•
Technology development, nuclear, CO2 abatement, fuel supply
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 21 -
CHANGING INDUSTRY ENVIRONMENT
Energy security the highest priority…
Securing oil and gas supplies
• 90-96% import dependency
• Middle East focused
• Retain high level of domestic stockpiles
• Increase investment in drilling rights
• Participate in field development/LNG
• Build technical and political relationships
• Seek to diversify sources of supply - GTL
Reliance on nuclear power
• Need to restore confidence in safety
• Integrity of infrastructure – quake proof?
• Improve incident reporting/reduce cover ups
• Increase capacity utilisation
• Aim for best in international class operations
• Increasing capex – existing and new plants
…Closely followed by environmental commitments
Reduce emissions and diversify energy sources
• Kyoto+ commitments – CO2 reduction targets
• Environmental protection – reduce other emissions
• Energy conservation – reduce per capita consumption
• New energy sources – heavily promoted. Small % of energy mix
• Expensive technology – requires subsidy and back-up power
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
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CHANGING INDUSTRY ENVIRONMENT
Reduced emphasis on further deregulation?
Competition unlikely to be excessive in any event
• High barriers to entry – sector dominated by regional EPCOS
• Cost plus tariff regime – reduces incentive to compete
• Sector-wide tariff cuts in deregulated segments to date
• Future tariff cuts to align with cost reductions?
• No excess generating capacity
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 23 -
J POWER WELL POSITIONED TO CREATE VALUE BY PARTICIPATING IN THE
NATIONAL ENERGY GOALS
Strengths
Explain
Challenges
• Unique wholesale focus
• Low risk, stable tariff structures
• Efficient, low-cost coal plants
• Large scale, low-CO2 hydro power
• Engineering expertise
• Generation technology innovation
• Strong financial position
• Scaleable domestic capex pipeline
• Continue to improve core efficiency
• Manage risk from further de-regulation
• Deliver major domestic investments
• Focus diversification efforts
• Deliver value from overseas expansion
• Adapt to market mechanisms
• Build skill base in energy trading
• Consolidate environmental strategy
• Achieve an efficient capital structure
• Enhance corporate governance
• Continued training in new technology
and maintenance of skilled workforce
Flexibility key to long term prosperity
We believe J-Power can capitalize on these strengths and challenges to
create long-term corporate value
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 24 -
Explain
WIN-WIN STAKEHOLDERS RELATIONSHIP – ALL GOALS CAN BE ACHIEVED
Basic Framework Of Role Between Government, Regulator and EPCOs
Government and regulator provides regulatory framework and energy policy
EPCOs, including J-Power, have a national responsibility to deliver the plan
EPCOs and J-Power are also listed companies, and delivers the plan using
capital provided by private sector (i.e. debt-holders and share-holders)
EPCOs must attract private sector financing, by providing appropriate returns
to the capital providers
Government and regulator plays a key role to smooth the whole process and
encourages market mechanism to work
Financing and planning with an eye to long-term
is crucial for executing the energy plan
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 25 -
Explain
BUSINESS PLAN FOR CORPORATE VALUE CREATION
Domestic
Overseas
Revenue Opportunities
• New Investments, plants and IPPs
• Add Flexibility to Core Business
• e.g. Risk management, trading and others
Cost Opportunities
Environmental
Initiatives
• Carbon & emission
opportunities
• Improve Operational Efficiency
• Maintenance Improvements
• Procurement Improvements
Capital Management and Capital Structure
• Minimize cost of capital
• Appropriate dividends
Capital
Management
• Seek profitable
growth, not just
growth per se
• Improve capex
management
and recognize
cost of capital
Corporate Governance
• Investor Communication and Commitment to Performance Targets
• Executive Compensation Alignment
• Substantial outside Director presence
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 26 -
Explain
AGENDA
INTRODUCTION: CASE FOR CORPORATE VALUE CREATION
DOMESTIC OPPORTUNITIES
INTERNATIONAL OPPORTUNITIES
ENVIRONMENTAL OPPORTUNITIES
CAPITAL STRUCTURE AND CAPITAL MANAGEMENT
CORPORATE GOVERNANCE
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 27 -
Explain
CRYSTALIZING POTENTIAL DOMESTIC OPPORTUNITIES
Framework for Assessing
Potential Opportunities
Drivers of Value Creation
Hypothesis
1. New investments:
High
New
Plants
Domestic
IPP / PPS
and
acquisitions
• New plants
• Domestic IPP / PPS and
acquisitions
Existing Capability
2. Improve operational efficiency:
Maintenance
Improvements
Carbon
Trading
Spotmarket
strategy
Trading
and risk
management
• Maintenance improvements
• Procurement improvements
3. Add flexibility to the core business:
• Trading and risk management
• Spot-market strategy
Procurement
Improvements
• Carbon trading
4. Set stretching targets to maintain
high discipline
Low
Low
Strategic competitive advantage
High
Size of circle
denotes potential
size of opportunity
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 28 -
EXAMPLE: J-POWER NEW INVESTMENTS: 2GW NEW PLANT UNDER
CONSTRUCTION
Explain
Changed
Thermal generation - Isogo New #2
•
600MW coal-fired, on-line 2009
•
Replaces obsolete plant with latest coal-firing technology
•
Net 335MW capacity increase
•
Highest thermal efficiency of any domestic pulverised coal plant
•
Uses new technology of dry de-sulphurising equipment
•
Contracted to Tohoku
Nuclear generation - Ohma
•
1,400MW MOX ABWR
•
J Power’s first nuclear plant. Scheduled on-line 2012
•
Slight delay to start (now 2007/08) due to seismic design evaluation
•
Will consume 25% of domestically processed MOX fuel
•
Fully contracted with EPCOs
•
Additional transmission under construction
These are good projects and serve national interest, with reasonable returns. But they must
be monitored so as to ensure all outcomes and tracked and corporate value enhanced
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 29 -
DEVELOPING CO2-FRIENDLY THERMAL PLANT
Thermal generation – IGCC and IGFC with CO2 capture
•
Develop coal gasification and zero emission technologies
•
Large scale proof of project with Chugoku
•
Draw on international expertise to capture value potential in cost effective way
•
Combine with mid/long term aim of capturing CO2
Nuclear generation
•
Leverage knowledge from Ohma project
•
Further potential build?
Renewables
•
Wind, biomass, micro-hydropower
•
Kyoto mechanisms - CDM/JI projects, emissions trading
PHEV
•
Work with METI, NEDO, Keidan-ren to encourage switch from oil-based transport
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 30 -
Explain
J-POWER SHOULD CONTINUE TO FOCUS ON OPERATIONAL EFFICIENCY
For J-Power to offer competitive pricing to customers, it must have strong
operational efficiency
Such efficiency refers to operating costs as well as capital costs for new
investments. Programs should be devoted to:
•
Procurement improvements – e.g. Is J-Power getting best value for
its procurement, including fuel, raw material, capex for new plants?
•
Maintenance improvements – e.g. Is maintenance service providing
best value for money?
Overall, J-Power has highly competitive costs compared to other EPCOs.
However, a detailed study should be performed to help drive the business to
world-class efficiency levels
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 31 -
J-POWER HAS LOWEST COST THERMAL GENERATION
Average Total Cost Per kWh of Thermal Power Production: 3/2005, 3/2006, 3/2007
(Yen / kWh)
11.8
11.1
9.6
9
7.2
7.5
7.5
8.4
8.1 8.2
8.1
7.7
7.6
5.6 5.8 5.5
J-Power
Hokuriku
4.9
5.2
7.6
7.1
6.7
5.5
8.4
9
8.6
8.4
7.3
7.5
6.6
6
Hokkaido
Chugoku
Kyushu
Tohoku
Chubu
Tokyo
Shikoku
Kansai
Source: Yuho of EPCOs
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 32 -
J-POWER IS THE THIRD LARGEST HYDRO POWER GENERATOR IN JAPAN
Hydro Power Generated By EPCO: 2004-2007
(b kWh, % of Total)
85.3
84.8
71.2
79.3
Kyushu
5.5%
5.6%
4.3%
5.0%
Hokuriku
7.7%
7.2%
8.3%
7.8%
Tohoku
11.4%
11.0%
13.2%
12.2%
Chubu
12.2%
12.3%
10.6%
10.9%
J-Power
14.2%
15.4%
14.7%
15.8%
Tokyo
15.7%
16.0%
17.4%
17.2%
Kansai
21.7%
20.5%
19.8%
18.9%
2004
2005
2006
2007
Shikoku
Hokkaido
Chugoku
Source: Yuho of EPCOs
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 33 -
J-POWER HAS VERY COMPETITIVE HYDRO POWER GENERATION COST
Average Total Cost Per kWh of Hydro Power Production: 3/2004, 3/2005, 3/2006, 3/2007
(Yen / kWh)
9.5
8.8
8.6
8.4
7.9
7.4
7
6.7
6.7
6.6
6.4
7
6.8 6.8
6.9
6.3
6
5.3 5.3
4.8
4
3.3 3.3
Hokuriku
5.2 5.2
5.3
5.1
5.3
4.7
4.6
3.9 4
3.7 3.8 3.6
3.6
5.4 5.4
5.1
3.3
Tohoku
Kansai
J-Power
Hokkaido
Chubu
Shikoku
Chugoku
TEPCO
Kyushu
Source: Yuho of EPCOs
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 34 -
Explain
ADD FLEXIBILTY TO CORE BUSINESS: POTENTIAL OPPORTUNITIES
Potential Opportunities To Examine
Trading and risk management: to maximize revenue potential from current operations
•
Scaleable IT platform, analytic applications
•
Business processes - deal capture to settlement
•
Personnel skills – hire, develop and nurture staff
•
Build strong risk management and control systems
Spot-Market Strategy: to open up new revenue stream
•
Japan has low spot-market trading now, but increasing and could be good long-term opportunity
•
Utilise J-Power’s resources and know-how to create new revenue stream
Carbon Trading: how to take advantage of imminent Kyoto Protocol adoption
•
In addition to complying with environment standards, J-power should leverage its developing skills and
knowledge to generate income
•
Focus on core flexibility, link electricity, oil, gas, coal, emissions trading & optimise cost and revenue
benefits to capture value
Examine and restructure non-core activities and question better standards than status quo
•
Ensure correctly sized and resourced
•
Maximize returns – hold and grow/divest?
Ensure processes understood by staff and communicated with stakeholders
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 35 -
Explain
SPOT MARKET IS OPEN PROVIDING A SOURCE OF PRICING AND TRADING
Japanese Power Exchange Price
(Yen per kWh)
30
Power
exchange
price (DA-DT,
DA-PT)
25
20
15
11/1/2007
10/1/2007
9/1/2007
8/1/2007
7/1/2007
6/1/2007
5/1/2007
4/1/2007
3/1/2007
2/1/2007
1/1/2007
12/1/2006
11/1/2006
10/1/2006
9/1/2006
8/1/2006
7/1/2006
6/1/2006
5/1/2006
5
4/1/2006
10
Source: www.jepx.org;
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 36 -
Explain
ADD FLEXIBILTY TO CORE BUSINESS: ILLUSTRATED
Need to develop expertise to maximize the value of the asset base
Coal Business
• Diversify channels
• Coal trading
• Coal resource
Environmental
• Renewable energy
• Utilize CO2 credits
• CDM mechanism
Power
Generation
Spot-Market /
Energy Trading
• Create platform
• Diversify channels
• Technology driven
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
Non Energy
• PFI/PPP business
• Engineering
• Technology/storage
- 37 -
Explain
ADDITIONAL SCOPE FOR VALUE ENHANCEMENTS
Use of excess generation capacity
• Maximize plant availability and flexibility
• Capture option value through energy trading
Improve transmission asset utilisation
• Fault detection and maintenance
Networking and benchmarking
• Benefit from international relationships
• Third-party involvement in divisional benchmarking
Technology/systems
• Asset management
• Systems control
• Maintenance scheduling
• Procurement
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 38 -
Explain
AGENDA
INTRODUCTION: CASE FOR CORPORATE VALUE CREATION
DOMESTIC OPPORTUNITIES
INTERNATIONAL OPPORTUNITIES
ENVIRONMENTAL OPPORTUNITIES
CAPITAL STRUCTURE AND CAPITAL MANAGEMENT
CORPORATE GOVERNANCE
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 39 -
Explain
INTERNATIONAL STRATEGY: OVERVIEW
Overseas power generation markets can be attractive as they allow J-Power to:
•
Expand in growing markets
•
Build competitive advantage with environmental and other technologies
•
Capture relatively higher but stable returns than in the domestic market
Shareholder value needs to be maximised over time through:
•
A portfolio approach
•
Maximising the value of existing assets
•
Growing the portfolio in a value-creative manner
•
Supporting the J-Power group dividend policy
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 40 -
CREATING A SECOND CORE BUSINESS
1
Approach
2
Maximise Asset Value
Portfolio management adds value
and reduces risk:
All acquisitions are quickly and
efficiently integrated to:
• Geographical spread
• Long term contracts
• Visible cash flows
• Fuel diversity
• Environmentally friendly
• Drive project returns
• Optimise plant operations
• Leverage existing assets
• Benefit from partnerships
• Seek effective routes to market
3
Portfolio Growth
New investment opportunities are
subject to rigorous evaluation
criteria, focusing on:
• Financial return/risk
• Market suitability
• Degree of control
• Technology experience
Key notion: Leverage domestic market skills to develop a “second core business”
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 41 -
Explain
J-POWER ALREADY HAS AN INTERNATIONAL GENERATION PORTFOLIO
18 IPPs in 7 countries/regions. Gross operational capacity 7.3GW (net 3.3GW)
Geographic Spread: Operational/UC Assets
Capacity Growth: Operational/UC Assets
8,000
3500
7,000
3000
6,000
2500
5,000
2000
4,000
1500
3,000
2,000
1000
1,000
500
0
0
2003
2004
•
2005
2006
Net MW
Gross MW
2007E
2008E
China
Europe
Taiw an
Phillipines
Net MW
Gross MW
Thailand
USA
How has management added corporate value as a result of these investments?
For example:
• Has these produce return and IRR above cost of capital?
• Has it enhanced human resource talent of J-Power?
• Has the delivery of these assets match with original plan and expectations?
• How has these reduce overall risk of J-Power as a corporation?
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 42 -
Explain
INTERNATIONAL GROWTH TARGETS (AT APRIL 2007) NEEDS JUSTIFICATION
Key target markets are Thailand, Southeast Asia, US and China. CAGR in net income is
forecast to be 28% over the next 6 to 8 years on 120+ billion Yen of future investment
Equity Income Years to March mmYen
Equity
Income: 3/07, billion Yen
15
10
5.4
1.5
1.7
2005
2006
2007
2009-10 Target
2013-15 Target
Equity Income can be easily brought about by expending a lot of valuable capital, but:
• Higher Corporate Value ≠ Higher Equity Income
• Higher Return ≠ More contribution from Equity Income
Management needs to demonstrate these higher Equity Income leads to corporate value
enhancement
In particular, what RoE, RoA and IRR are earned on these investments?
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 43 -
Explain
MANAGEMENT MUST CONVINCE INVESTORS CAPITAL IS NOT BEING WASTED
Long term growth needs to be balanced with shareholder return requirements
Investors need visibility and confidence over:
•
120b Yen capex forecast – market/asset type/leverage
•
Rate of Return hurdle rates by region, asset risk profile
•
Ownership size and structure of investments
•
Cash flow – ownership control or affiliate
Little details to-date, and investors unclear these ultimately benefit J-Power
•
For example, there are many minority stake investments – why are these
good for J-Power? What is the value proposition for the company?
Investors can then evaluate the risk/return potential of the capital allocation
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 44 -
INTERNATIONAL PROJECTS SHOULD BE DETERMINED ON A RETURN-ONCAPITAL BASIS
Explain
Scenarios For International Project Capex
Return on
Capital or
IRR
(%)
Positive
Spread
Business
Cost of Capital
Neutral
Spread
Business
• Growth capex
• Increase
here is value
return on
creating –
equity first
investors would
support this
• Then grow
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
Negative
Spread
Business
While these
investments will
still yield equity
income, over the
time, investing at
below cost of
capital will destroy
corporate value
• ‘Avoid’ growth
• Reduce
Re-investment
• Divest or Liquidate if
already in the
business
- 45 -
Explain
ILLUSTRATION: HOW INCREASING EQUITY INCOME CAN DESTROY VALUE
Added in footnote
A
Year
1
2
3
4
5
6
……….
50
Net Present Value
(Using 10%
discount rate)
Cash Income Before
International Expansion
100
100
100
100
100
100
……….
100
992(1)
2a
Generates
positive
“Equity Income”
1 Large capex
investment
B
International
Expansion Project
-200
10
10
10
10
10
……….
10
A+B
Cash Income After
International Expansion
-100
110
110
110
110
110
……….
110
900(2)
- 92
2b Gives higher total
cash income than
before (110 now vs 100
before)
(1)
(2)
3 However, despite higher
equity income, the
expansion
destroyed value
992 = 100 / (1.1) + 100 / (1.1)^2 + 100 / (1.1)^3 + … + 100 / (1.1)^50 = Present Value of the Cash Income for next 50 years, BEFORE INTERNATIONAL EXPANSION
900 = -100/(1.1) + 110 / (1.1)^2 + 110 / (1.1)^3 + … + 100 / (1.1^50 = Present Value of the Cash Income for next 50 years, AFTER INTERNATIONAL EXPANSION
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 46 -
Explain
INTERNATIONAL EXPANSION ENTAILS RISK AND NEEDS MONITORING
International expansion done properly will enable J-Power to become stronger
However, in the past, many companies embarked on grand international expansion
plans that end up putting company at risk (e.g. Japan during bubble economy days)
International portfolio needs to deliver growth, cash flow and dividends
Clarity needed on scale of investment and value proposition, and management
must demonstrate clearly how international investments actually add value
Expansion and spending money overseas can destroy massive value
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 47 -
AGENDA
INTRODUCTION: CASE FOR CORPORATE VALUE CREATION
DOMESTIC OPPORTUNITIES
INTERNATIONAL OPPORTUNITIES
ENVIRONMENTAL OPPORTUNITIES
CAPITAL STRUCTURE AND CAPITAL MANAGEMENT
CORPORATE GOVERNANCE
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 48 -
Explain
ENVIRONMENTAL STRATEGY
Aim: reduce unit CO2 emissions to 10% below 2002 levels by 2010, through:
Improving energy efficiency in plant operations
• Reduce power plant own use ratio
• Use energy efficient equipment on renewals
• Use latest technology in new plants
Low CO2 investment
• Nuclear power - Ohma
• Clean coal (IGCC, IGFC) and gas CCGT/cogen
• Renewables - wind, biomass, micro-hydropower
• Kyoto mechanisms - CDM/JI projects, emissions trading
Reducing CO2 footprint
• Environmental management system being introduced
• Achieve a re-cycling rate of 97% by March 2010, ultimately zero waste emissions
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 49 -
OPPORTUNITIES: IMPROVING ENERGY/C02 EFFICIENCY OF THERMAL PLANT
Strong environmental credentials due to modern fleet
• Best plants supercritical, >40% net efficiency, low SOx/NOx
• Transfer technology benefits to older plants on re-fit
Opportunities
• High pressure steam path
• Blade technology
• Co-firing – biomass, carbon neutral waste products
• Low NOx burners
• Biomass feeder systems
• Coal drying and feeder systems
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 50 -
OPPORTUNITIES: CO2 TRADING
Integrated trading strategy
Dedicated emissions trading expertise
• Best use of CO2 credits
• Exploit Kyoto mechanisms – CDM/JI
• Increase international exposure
- Asia
- US regional
- EU ETS
• Build trading relationships with exchanges
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 51 -
OPPORTUNITIES: KYOTO MECHANISMS
Clean Development Mechanism (CDM)
Emission reductions through investment by an
industrialized country in a country without reduction
commitments are credited to the emission account of
the investor country
UN approvals to date
• >720 CDM projects
• Will supply >960 million certificates by 2012
• Chinese projects most certificate volumes
• India is leading in the number of projects
Joint Implementation (JI)
Emission reductions through investment by one
industrialized country in a second industrialized country
are credited to the emission account of the investor
country
Opportunities
• Renewables
• CH4 reduction
• Biofuels
CDM projects by host country, July 2007
• Energy efficiency
Carbon sinks
• Afforestation
18%
4%
• Re-forestation
43%
9%
11%
15%
China
India
Brazil
Korea
Mexico
Others
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 52 -
Explain
AGENDA
INTRODUCTION: CASE FOR CORPORATE VALUE CREATION
DOMESTIC OPPORTUNITIES
INTERNATIONAL OPPORTUNITIES
ENVIRONMENTAL OPPORTUNITIES
CAPITAL MANAGEMENT AND CAPITAL STRUCTURE
CORPORATE GOVERNANCE
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 53 -
Explain
CAPITAL MANAGEMENT AND CAPITAL STRUCTURE FRAMEWORK
Financing
Cashflow
Operating
Cashflow
Economic
Capital
Dividends &
Buy-backs
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
Capital
Expenditure
- 54 -
Explain
EXPLAINING OPERATING CASHFLOW: RESIDUAL CASHFLOW
Operating cashflow is
the residual cashflow
AFTER all stakeholders
are satisfied
Financing
Cashflow
Operating
Cashflow
Economic
Capital
Dividends &
Buy-backs
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
Capital
Expenditure
- 55 -
Explain
SHAREHOLDERS AND STAKEHOLDERS ARE ALIGNED TO MAXIMIZE VALUE
Illustrative Claims on Company Corporate Value
Customer benefits in
return for providing
revenue
Stakeholders’
claims
Operating cashflow is
the residual cashflow
AFTER all stakeholders
are satisfied
Revenue from
customers
Employee
Salary & Bonus
Suppliers and
distributors
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
Cash Profit
Interest to
debtholders
Tax to
government
Operating Cash
Flow
- 56 -
J-POWER HAS STABLE CASHFLOW GENERATION
Operating Cashflow of J-Power: 3/2003 – 3/2007
(millions of Yen)
179.9
172.6
167.4
174
157.2
2003/3
2004/3
2005/3
2006/3
(1)
2007/3
(1) Thermal utilization was low due to maintenance outage, causing operating cashflow to be lower
Source: J-Power Annual Reports
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 57 -
OPERATING CASHFLOW IS RETURN ON CAPITAL AND NEEDS STRINGENT
MANAGEMENT ON ITS USE
Explain
Operating Cashflow is a form of return and reward, due to investors putting in
“risky” capital to allow the Company to realize its vision
This return and reward is AFTER all stakeholders have already benefited from the
Company’s activities
It becomes capital that management is entrusted to use appropriately
•
Management has fiduciary responsibility to allocate the capital wisely
•
Must only be used for corporate value creation
•
Has numerous uses that needs to be carefully analyzed
•
Not to be used for “growth” just for its sake to make company bigger
This capital has a cost and must be allocated to its various potential uses for
corporate value maximization
Management needs to be transparent with use of operating cashflow, and its use
must be stringently monitored
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 58 -
OPERATING CASHFLOW IS A SCARCE SOURCE OF CAPITAL AND ITS USE AS
CAPEX MUST BE PROPELY ALLOCATED
Financing
Cashflow
Operating
Cashflow
Explain
Capital Management Key Points
• All capex must generate
appropriate return
• Management and Board
held accountable
Economic
Capital
• Must be carefully studied,
measured and analyzed
Dividends &
Buy-backs
Capital
Expenditure
1. Maintenance Capex
2. Domestic and generation Capex
3. International and other Capex
“International and other Capex” needs to be rigorously understood and defended
Such spending should not be a result of “left over” operating cashflow leading to
automatic capital deployment - it is very easy to spend money overseas, but very
difficult to truly create corporate value
Instead, such spending must be based on sound opportunities for corporate value
creation. Management and Board must thoroughly demonstrate this to investors
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 59 -
Explain
CAPITAL MANAGEMENT: KEY TAKE-AWAYS
A healthy long-term orientated enterprise always seek “profitable growth”
Growth as a stand-alone goal is not correct
•
Growth must accompany increase in corporate value
•
Managment must demonstrate “profitable growth”, not just
“growth”
Spending capex is not the only way to grow
•
Capex requires use of economic capital, and its costs must be
carefully evaluaed before using it to grow
•
In fact, growth utilising capex can easily destroy value
Increasing efficiency and productivity are valid and better ways to grow
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 60 -
Explain
CASHFLOW MUST APPROPRIATELY RE-CYCLE TO ALL STAKEHOLDERS
Role, Purpose and Issues With Appropriate Dividends
• Dividends is a form of promise to investors, where
their risky capital were used
• Investor return in the form of an appropriate
dividend must be paid if/when a profit is made
• If management becomes short-term and neglect to
provide appropriate dividends, it encourages
investor to become reluctant to invest in the
future
• Management who fails to provide appropriate
returns reduce flow of funds into the economy,
negatively impacting the Japanese economy
• e.g. pension funds and aging population will
require appropriate dividends for their
retirements
Shareholder
Other Stakeholders
Debtholder
Financing
Cashflow
Economic
Capital
• Paying low and inappropriate dividends can be a
sign that management is not committed to
generating good return, lowering corporate value
• Paying low dividends means “more money is
available to spend elsewhere”, creating potential
moral hazard problem that management waste the
capital and destroy corporate value
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
Operating
Cashflow
Dividends &
Buy-backs
Capital
Expenditure
- 61 -
J-POWER MANAGEMENT ONLY PROVIDE INVESTORS 6.4% OF OPERATING
CASHFLOW AS DIVIDENDS, WELL BELOW JAPANESE EPCO AVERAGE
Explain
Operating Cash Flow Payout, FY 3/2007
(Dividend + Buy-Back / Operating Cash Flow, %)
42
28
13.5
6.4
J-Power
Management
EPCO Avg
US Utilities Avg
UK Utilities Avg
It is an important management duty to pay appropriate dividends
We believe it is more appropriate for J-Power to pay dividend around the Japanese EPCO average
Healthy sense of tension between management, shareholders and stakeholders can improve J-power
and its long-term value creation
Source: Bloomberg, Broker Analyst Research
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 62 -
Explain
DILIGENT CAPITAL MANAGEMENT REQUIRES MINIMIZING COST OF CAPITAL
Capital Management Framework
• A key management task is perform
“capital management”
• This involves procuring overall funds that
would minimize overall cost of capital
• This means minimizing the cost of
“financing cashflow”, so the economic
capital procured has low cost that is
ultimately used for capital expenditure
Financing
Cashflow
Operating
Cashflow
Economic
Capital
Dividends &
Buy-backs
Capital
Expenditure
• For a corporation to grow, one key way is re-invest
• The goal of investing is not to just spend money,
but to strategically create corporate value
• Investing well with reasonable return will improve
corporate value
• All stakeholders benefit from the whole process
Capital Management is a holistic process where:
1.
Procuring funds at overall lowest cost of capital
2.
Turning them into economic capital and recognizing it costs
3.
Using such economic capital wisely to create corporate value
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 63 -
MINIMIZING COST OF CAPITAL IS EQUIVALENT TO EFFICIENTLY USING
FINANCIAL RESOURCES
1
Type of resource
Desired Outcome
Result
2
Physical
Resources
Financial
Resources
• Fixed asset resources
• Fuel mix resources
• Knowledge resources
• Financial capital resources
• Debt providers
• Equity providers
• Usually recorded on balance
sheet and can be observed
• Cost is the cost of capital of
each capital source
• Efficient operating cost per
kWh power produced
• Fair price per kWh for
customers
• Minimise fuel cost and high
availability
• Efficient utilisation of
financial resources and
optimal financial structures
• Attractive overall financial
cost and restrictions
• Flexible and readily available
• Fair return to capital
providers
3
Explain
Human
Resources
• Managerial human resource
• Engineering human resource
• Most human resource are
within the company, but
some can be ‘outsourced’ to
improve efficiency
• Develop skillset and bring
out the best of staff
• Fair pay and provision for
staff to be motivated
All 3 types of resources need to be efficiently managed
and utilised to achieve optimal outcomes long-term
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 64 -
COST OF CAPITAL AND CAPITAL STRUCTURE
Key Question:
How do we utilize financing to best effect?
How do we minimise cost of financing?
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 65 -
COMMON THINKING ON FINANCING REQUIRES DEEPER ANALYSES
Common Thinking
Initial Interpretation
Deeper Analyses Required
“… in order to continue to ensure
its profitability in business, the
company needs to maintain and
further improve its competitive
position with respect to funding
terms”
Refers mainly to debt financing.
Makes sense to seek good terms
and lower cost of debt
“Funding term” should
incorporate more than just debt
financing. Cost of equity not ‘free’
Makes sense to ensure business
is profitable and competitive
Business profitability should be
analyzed from an operating
perspective, and not mixed in
with financing
“… the Company believes that
further strengthening of its equity
base is essential”
If equity base is “too small”,
makes sense to strengthen it
There are both cost and benefit of
strengthening equity base.
Need to analyze what is ‘optimal’
mix of equity and debt
What is “too small”?
“… the Company needs to
maintain a high grade bond rating
to enable it to procure such funds
on competitive terms”
Makes sense that the higher
grade bond rating a Company has,
the lower the cost of debt
“…it is imperative for the
Company to continue to
accumulate retained earnings at
the same time as it undertakes
large scale capital expenditures”
Retained earnings are equity
return owing due to past
investments. Capex refers to
future investments.
Need to define what is “high”
grade bond rating
Goal of EPCO is to ensure low
cost overall financing, not only
“high” grade bond rating
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
Retained earnings of EPCOs grow
anyway. Key is to ensure funds
for capex can be procured
Equity financing not only source
- 66 -
Explain
SHIFTING MINDSET WILL MAXIMIZE CORPORATE VALUE OF J-POWER
Common Mindset
1
Financing using debt is bad, and it is risky
‘Best-Practice’ Mindset
Debt is neither good nor bad. It is a resource to be optimised
Business risk of an asset is independent of level of debt
Using less debt can improve profitability
2
Using less debt may increases cost of capital
Management should focus on business operating profitability
and efficiency separate to efficiency of financing
Using less debt may reduce discipline on management
3
Level of debt is governed by maintaining high
credit rating
Level of debt should be governed by thorough analyses of level
of business risk, and service-ability of debt load
4
High credit rating is a successful trait
High credit rating can be very costly in the form of higher cost
of capital by under-utilising low cost financing options
5
Equity ratios is the key measure of capital
structure
Equity ratio is a poor measure of capital structure
Economic coverage ratios are better indication of financial
health of company
6
All new capex project should be financed by
operating cashflow of a company
Operating cash flow is effectively equity financing. Its cost
should be incorporated as part of overall cost of capital
7
Building equity base and retaining earnings is a
cheap way of financing
Equity financing is not free
Cost of equity is much higher than cost of debt
High equity base builds cushion for management errors
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 67 -
LONG-TERM CAPITAL EFFCIENCY MEANS MINIMISING OVERALL COST OF
CAPITAL THROUGH AN APPROPRIATE FINANCING MIX
Quantitatively, the goal is to create a financing mix that minimises the “weighted average cost
of capital” or the “WACC”
WACC = a1 x k1 + a2 x k2 + a3 x k3 + a4 x k4 + … + an x kn
a1 , a2 … etc represents the % of the financing that uses financing instrument 1, 2, … etc
k1 , k2 … etc represents the cost of the financing that uses financing instrument 1, 2, … etc
Put another way, achieving capital efficiency involves splitting the future cashflow generation
by its assets into different streams (i.e. different financing instruments – i.e. instrument 1, 2,
… etc) that will appeal to investors with different tastes, wealth and tax rates
Minimising WACC means not only minimising costs of each one (i.e the k1 , k2 … etc ), but
also the mix of the financing (i.e. the a1 , a2 … etc )
The most common source of financing is debt and equity
Achieving capital efficiency is a critical ingredient to
sustainably achieving Japan’s energy policy goals because of
the substantial value creation capital efficiency delivers
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 68 -
J-POWER RANKS WELL ON MARKET EQUITY RATIO, AN IMPORTANT
ECONOMIC MEASURE OF CAPITAL STRUCTURE
Market And Book Equity Ratio of Japanese EPCOs, As At March-2007
(Shareholder Equity ÷ Total Assets; Market Capitalisation ÷ Total Assets; %)
49.2
48.7
45.8
43.4
39.3
Market
Equity Ratio
34.9
37.5
41.7
39
34.9
30.5
30.3
26
27.1
26.5
24.4
26.8
24.2
23.1
22.4
Book
Equity Ratio
Tokyo
Chubu
Kansai
Chugoku
Hokuriku
Tohoku
Shikoku
Kyushu
Hokkaido J-POWER
Market Equity Ratio Is Relevant As Stock Price Can Be Used To Raise Equity Financing
Market Equity Ratio A Better “Economic” Measure, But Fluctuates With Stock Price
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 69 -
Explain
J-POWER HAS HIGH ‘CASHFLOW COVERAGE’ AND MANAGEABLE DEBT
PROFILE
EBITDA Coverage, FY March-07
(EBITDA ÷ Interest Expense, times coverage)
Operating Cash Flow Coverage, FY March-07
(Operating Cashflow ÷ Interest Expense, times coverage)
11.9
10.3
8.8
8.9
8.8
8.3
8.1
8.9
8.6
7.9
7.5
7.9
Japan
Average
7x
Developed
Country
Average
4-5x
6.9
6.6
6.2
5.9
5.4
7
6.5
J-POWER
Hokkaido
Kyushu
Shikoku
Tohoku
Hokuriku
Chugoku
Kansai
Chubu
J-POWER
Hokkaido
Kyushu
Shikoku
Tohoku
Hokuriku
Chugoku
Kansai
Chubu
Tokyo
Developed
Country
Average
3-4x
Tokyo
Japan
Average
9x
10.7
Ability To Service Debt Is Very High For J-Power
On Average, Cash Flow Needs To Drop 70-80% Before Financial Risk Are Threatened
J-Power’s debt load is manageable and conservative
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 70 -
EFFICIENT CAPITAL STRUCTURE BENEFITS ALL STAKEHOLDERS, AND
MAXIMIZES CORPORATE VALUE
Explain
Achieves Japan’s
energy goals
Improves desirability
to invest
Increases
stability of
energy system
Stakeholders
satisfied
Appropriate
returns &
prudent
capital
management
Users can pay
lower prices
Minimizes
cost of capital
Strong capital
management
discipline
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
Appropriate &
efficient
capital
structure
- 71 -
AGENDA
INTRODUCTION: CASE FOR CORPORATE VALUE CREATION
DOMESTIC OPPORTUNITIES
INTERNATIONAL OPPORTUNITIES
ENVIRONMENTAL OPPORTUNITIES
CAPITAL STRUCTURE AND CAPITAL MANAGEMENT
CORPORATE GOVERNANCE
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 72 -
Explain
IMPORTANCE OF CORPORATE GOVERNANCE
Corporate governance involves a set of practice and systems of effective
monitoring of company management, where management are held
accountable to those who have a stake in the Company
•
Involves rights and responsibilities of groups such as Board,
management, employees, shareholders, creditors and others
Poor corporate governance is harmful to society:
•
Reduces company value creation potential
•
Hinders sustained prosperity of a company’s operation
Management must thoroughly review any poor governance practices, or it
will lead corporate value destruction
“Effective corporate governance plays an essential role. This is because
publicly listed companies, in particular, seek broad access to capital
markets for fund-raising purposes, and the authority of directors to perform
their management tasks is ultimately awarded by shareholders”
Source: Japanese Listed Company
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 73 -
Explain
JAPANESE WHITE PAPER COMMENT ON INEFFICIENT MANAGEMEMT
“There is a need to caution against the possibility that the introduction of
defence measures by inefficient management aimed at protecting their own
interests could have a negative effect on productivity and in the long run fail
to raise corporate efficiency.”
“Annual Report on the Japanese Economy and Public Finance 2007 –
Toward Higher Productivity Growth”, Japanese Government White Paper
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 74 -
Explain
POOR GOVERNANCE PRACTICES
Type
Explanation and Effect
Comment
Issuing significant amount of new shares to a new ‘friendly’ party
• New party often not concerned with Company’s corporate value
• New party benefits in the expense of existing shareholder, e.g.
through side-business deals with Company
If new capital needs to be
raised, can be done through
“rights offering” where all
shareholders treated equally
Practice is unfair and leads to poor corporate governance
• Entrenches inefficient managers and consolidate their control
• Harms and dilutes rights of existing long-term shareholders
Investors see TPA is an
extremely negative move for
economy, capital markets and
corporate value creation
Neglect of RoE and RoA
Basic benchmark of company performance and value creation
• Leads to long-term corporate value destruction
• Bad for all stakeholders
J-Power RoE and RoA low
and falling. Management has
not addressed this in its Plan
Introduction of ‘poison
pills’ and similar
defensive measures
Measures and tactics by management to prevent Company from being
owned by specific shareholders
• While in the name of protecting Company, can also entrenches
inefficient management and protects management’s interest only
• Such practice needs to be thoroughly scrutinized
Company have said publicly it
has no plan to do so
Use scarce capital buy shares of other listed entities, and in turn
asking these entities to buy shares of the Company
• Mostly generate no synergies, hence no value creation
• Allows management to ignore non cross-ownership shareholders
• Entrenches inefficient management and its control on Company
Practice often disguised as
“strategic investments” but in
reality gives no real benefit
Third Party Allotment
(TPA)
Promote and increase
cross-ownership
Company welcome investors
who can add value to it
In fact, this practice destroys
corporate value
Investors will strongly oppose management who undertakes these poor governance practices
In extreme cases, management who undertakes these activities will be rejected by investors
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 75 -
FALLING AND WEAK RETURN ON EQUITY (ROE), NOW WELL BELOW 10%
J-Power Return on Equity (RoE), Consolidated
([Net Income] ÷ [Shareholder Equity], 3/01 – 3/07, %)
J-Power Return on Equity (RoE), Parent
([Net Income] ÷ [Shareholder Equity], 3/99 – 3/07, %)
13%
13%
12%
12%
11%
11%
10%
10%
9%
9%
8%
8%
7%
7%
6%
6%
5%
5%
2001
2002
2003
2004
2005
2006
2007
1999
2000
2001
2002
2003
2004
2005
2006
2007
To improve corporate governance, proper targets need to be set to reverse this
extremely worrying trend
Source: J-Power Annual Reports and Fact book
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 76 -
J-POWER’S PARENT OPERATING PROFIT SINCE MAR-2001: THIS IS BAD FOR
CORPORATE VALUE
Changed
(Billion of Yen)
130
120
Halving of
Operating Profit
since IPO
110
100
90
80
70
60
50
40
2001/3
2002/3
2003/3
2004/3
2005/3
2006/3
2007/3
2008/3
Note: Mar-2008 Operating Profit shown is guidance provided by Management
Source: J-Power Financials
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 77 -
Explain
INCREASING SHARE AND CROSS-OWNERSHIP: WHY?
Ticker
Company
J-Power
Ownership:
3/06
(# of shares)
J-Power
Ownership:
3/07
(# of shares)
Ownership in
J-Power:
3/06
(# of shares)
Ownership in
J-Power:
3/07
(# of shares)
2,876,525
2,876,525
N/A
N/A
10,000
10,000
N/A
N/A
8795
T&D Holdings
8411
Mizuho Financial Group
5401
Nippon Steel Corporation
N/A
5,778,000
N/A
827,900
7011
Mitsubishi Heavy Industries
N/A
4,082,000
N/A
627,000
1812
Kajima Corporation
N/A
5,053,000
1,158,600
1,674,500
1803
Shimizu Corporation
N/A
2,809,000
594,000
972,000
9119
Iino Lines
948,000
1,331,900
408,480
589,780
9022
Central Japan Railway Company
1,193
1,193
421,920
421,920
5711
Mitsubishi Materials Corporation
N/A
2,676,000
467,880
717,280
J-Power management has increased share holding in other listed companies
Are These Proper Use Of Economic Capital? What is The True Motivation?
Judging from conspicuous increase in cross-ownership, there appears other management
motivations that may NOT be aligned with corporate value creation
Source: Yuho of J-Power and the listed companies
Note: “N/A” shown means no information found on the share ownership from the Yuho
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 78 -
Explain
GOOD GOVERNANCE PRACTICES
Changed BOTTOM BOX
Investor communication and disclosure of information
Transparency in assessing investments and recognizing the cost of capital
Setting appropriate corporate value creation goals and providing strong
public commitments (e.g. RoE > 10%) in its mid-term Plan
Alignment of interest of Management with corporate value creation (e.g.
through executive and staff compensation program)
Substantial presence of independent and outside Directors
TCI aims to help our investee companies implement
these good corporate governance practices
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 79 -
INVESTOR COMMUNICATION IS A KEY MANGEMENT TASK AND FORMS PART
OF GOOD CORPORATE GOVERNANCE
Wider support for a company’s stock will facilitate new opportunities for
financing and expansion, e.g.
•
New equity issues to fund growth
•
Acquisitions that boost EPS
•
Strong credit ratings raise debt more cheaply
A company whose share price fully reflects the value of its business is less likely
to become the target of an unsolicited takeover bid
Good investor communication and management can mean the difference
between creating corporate value and realising it
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 80 -
Explain
SINCE IPO, TOTAL DIRECTOR PAY ROSE BUT OPERATING PROFIT DECLINED
New Slide
Bar Chart:
Total Director Pay
(mm Yen)
700
Consolidated
Operating Profit
112b
650
101b
600
Director Bonuses
(Consolidated)
550
500
450
Director Salary
(Parent)
400
77b
350
300
2005/3
2006/3
2007/3
Source: J-Power Yuho
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 81 -
Explain
DIRECTOR PAY AND SALARY DISCONNECTED TO COMPANY PERFORMANCE
New Slide
Consolidated OP (mm Yen)
Mar-05
Mar-06
Mar-07
Mar-08
111,886
101,466
77,141
62,000
-9.3%
-24.0%
-19.6%
339
490
-0.29%
44.5%
162
161
22.7%
-0.6%
-0.1%
-0.3%
YoY Change
Director Salary (Parent, mm Yen)
340
YoY Change
Director Bonuses (Consolidated, mm Yen)
132
YoY Change
Inflation Rate
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
-0.3%
- 82 -
Explain
FRAMEWORK FOR ALIGNING INTEREST OF MANAGEMENT:
USING APPROPRIATE EXECUTIVE COMPENSATION TOOLS
Base Case Situation
1
Base pay +
Benefits
Fixed
Component
Already competitive level of
base salary and benefits
provided to employees, such as
a good retirement plan
Potential Improvement
Proposal
Likely very minor or no change
Top staff use a percentage of
their pay to purchase shares
2
Short-Term
Incentive
(STI)
Some form of motivation shortterm incentive, but not
necessarily aligned to
corporate value creation
STI to incorporate restricted
stock plan
Variable
Component
3
Long-Term
Incentive
(LTI)
Likely immaterial
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
Significantly increase LTI so
employees are motivated to
create corporate value, in the
form of granting restricted
stocks
- 83 -
Explain
RESTRICTED STOCK GRANTS HAVE FEATURES THAT MEET KEY PRINCIPLES
Restricted Stock is an award of stocks with current ownership rights (dividends
and voting), but subject to time or performance vesting, with forfeiture if the
participant terminates before vesting
Subject to TSR and other corporate value
performance hurdle, employees are granted J-Power
stock of specified value
Shares granted are ‘restricted’ shares because they
cannot be sold until more time passes
Transparent and easy to understand, as TSR is an
objective measure and stock awards is a simple
Consistent with value creation, as it ties
compensation of employees with owners’s wealfare
Aligns employees and shareholders as employees
develop a ‘real’ sense of ownership
Consistent with a company’s vision, values and
strategies, as it installs a longer term mindset
A package of grants is a multi-year process (generally
every 3-5 years), and vests 3 years after
Difficult to manipulate, as the long-term nature of
these multi-year grants makes ‘gaming’ the goals and
stock prices ineffective
Motivates and retains the best staff by economically
tying time with the company long-term
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 84 -
ALL EMPLOYEES SHOULD RECEIVE RESTRICTED STOCKS, BUT SKEWED TO
SENIOR MANAGEMENT AND DIRECTORS
Proportion of Compensation by Type
Base Pay
+ Benefits
ShortTerm
Incentive (STI)
LongTerm
Incentive (LTI)
LTI a substantial part of senior management pay
Senior
Management
Middle
Management
Substantial restricted
stocks package
Some restricted
stocks package
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
LTI an important part of middle management pay
Restricted stocks should form the bulk of LTI
Restricted stocks should form a part of STI
Limited restricted
stock package
Other
Employees
Restricted stocks should form the bulk of LTI and STI
LTI a minor part of other employees pay
Most variable pay is STI
Restricted stocks should form a small part of STI
- 85 -
BEATING TSR HURDLES ALLOWS MANAGEMENT TO SHARE IN VALUE
CREATION IN THE FORM OF RESTRICTED STOCKS
Payout of Restricted Stocks vs Total Shareholder Return For Senior Management
(% of base salary p.a., % TSR p.a.)
High TSR means J-power achieves
high value creation. Management
can earn much higher bonus if TSR
or corporate value creation is
“high”
Value of bonus
(% Base Salary p.a.)
High Additional
Salary
J-power achieving a TSR of
10%+ allows management
to earn bonus equivalent to
at least 50% of base salary
Small Additional
Salary
Low
Medium
TSR below Medium is not
‘exceptional’, hence no
award of restricted shares
that year
Note:
High
Total Shareholder Return
or TSR (% p.a.)
Or other corporate
value creation measure
Higher the TSR, higher the bonus
awarded to management. To encourage
long-term behavior, these are granted in
restricted shares
TSR is defined as the return to shareholders in the form of stock price appreciation and dividend payments within a defined period
TSR p.a. = (Stock Price At Year End – Stock Price At Year Beginning + Dividends Paid During The Year) / Stock Price At Year Beginning
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 86 -
KEY PLAN FEATURES PROMOTES MANY POSITIVE CHARACTERISTICS THAT
ALIGN MANGEMENT WITH OWNERS, ESPECIALLY LONG TERM BEHAVIOR
Explain
Key Plan Features
Positive Characteristics
Restricted stock plan is not
‘free’ - management must meet
stock price TSR targets to earn
incentives
• Value of grants are designed to be a material financial
incentive for exceptional performance, so everyone do their
best to achieve increased corporate value
Stocks granted to J-power
management and employees
cannot be sold for 3 years
• Promotes long-term behavior of all management and
employees because any subsequent underperformance would
cause those shares granted to lose value
Management and employees
who leave J-power before the
3-year vesting lose stock grant
entitlements
Plan designed for all
employees, where grants are
made every year for each of
next 3 years with annual TSR
targets
• Plan used to attract best talent to work for J-power
• Acts as a powerful management and employee retention tool
• Increases loyalty of employees to J-power
• Gives J-power employees a shared sense of purpose which in
turn promotes teamwork
• Management and employee has incentive to work hard every
year and can look forward to meeting performance targets
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 87 -
Explain
SUMMARY THOUGHTS ON J-POWER CORPORATE VALUE CREATION
• Return on Equity (RoE), Return on Assets (RoA) and Operating Profit have dramatically
declined. Company management should commit to a minimum target RoE of 10% and
target RoA of 4%, and should be held accountable for failing to meet these targets
• Management must adopt a specific plan that realistically and credibly addresses decline
in corporate value
• Capital expenditures especially overseas expansions must be carefully justified by their
specific contribution to long term profitability and value creation
• We strongly support incentive compensation for management designed to reward
management for increasing corporate value.
-
However, the Company’s current compensation practices have in fact been
rewarding poor performance. Total director compensation has increased
considerably against a background of declining corporate value.
• It is highly dubious that the recent increase in corporate cross-shareholdings between
the Company and “friendly” shareholders can be justified in the best interests of general
shareholders. Company should sell all its equity investments in non-related listed
companies to increase transparency and to align the interests of management with the
interests of general shareholders.
• We believe that the Company would substantially benefit from the appointment of outside
directors. At least two seats on the board be reserved for outside directors.
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 88 -
Explain
FINAL COMMENT
TCI is a responsible global investor
•
Possess substantial experience to assist company create
corporate value
•
Has a strong track-record internationally
This business plan serves as a starting point for discussion and
implementation to significantly improve J-Power’s long-term performance
We are genuinely interested in success of J-Power and Japan on the whole
Let’s start NOW
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 89 -
DISCLAIMER
This presentation is for informational and discussion purposes only. While TCI has
exercised reasonable care as to the information in this presentation, none of TCI and
its related parties (collectively, "TCI") makes any representation or warranty as to the
accuracy or completeness of such information and as such, TCI accepts no liability in
damages or otherwise for the accuracy or completeness thereof.
This presentation is not an offer to purchase or sell shares in any company mentioned
in this presentation (or any other company) and is not intended to solicit any
shareholder of any such company to appoint TCI or any other third party as its/his
proxy in exercising its/his voting rights at any general meeting of shareholders of any
such company, nor to provide any advice in connection with the exercising of the
voting rights by any shareholder of any such company.
This presentation is not intended to have an effect on the share price of any such
company. TCI assumes no responsibility as to any reaction from the market in relation
to this presentation.
These slides have been prepared in English and Japanese. The English version
should act as the reference should a question arise regarding meaning of the content
in the Japanese version.
Long-Term Corporate Value Creation For Japan Power Sector; Please read disclaimer at end of presentation
- 90 -