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China's Billion Dollar New Energy IPO
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China's biggest IPO of 2021 so far is not some super-sexy semiconductor play or mobile app, but rather a renewable energy company with a very familiar name.
That company is called Three Gorges New Energy (三峡能源) and it is a subsidiary of China's Three Gorges Corporation, builder of the world's biggest dam.
In June 2021, the company sold 8.57 billion shares on the Shanghai Stock Exchange to raise 22.5 billion RMB or $3.5 billion USD.
As of this writing in Aug 2021, the unit is worth about 160 billion RMB or $24.5 billion USD. It trades under the stock ticker SH:600905, which means Americans can't buy this.
And Americans shouldn't buy this. Because this is a company profile, not an investment brief.
Since I have written before about the Three Gorges Dam and China’s solar industry, this IPO caught my eye. In this video, we will talk about the company, an interesting glimpse into China’s plans for its renewables industry.
Intro to Three Gorges New Energy
The name is a little deceiving. The business unit does not actually own or operate the Three Gorges dam. More like branding, I think.
The operations associated with the company's eponymous dam belong to a sibling company - China Yangtze Power.
Rather, Three Gorges New Energy builds and operates wind and solar farms. It had once been a state-owned corporation within the Ministry of Water Resources working on water conservation methods.
Three Gorges Corporation then bought it and for whatever reason turned it into their renewable energy resources vehicle. The company still has some very small hydropower projects left.
Wind provides about 55% of revenue. Onshore about 47%, and offshore about 8%. Solar provides most of the rest - about 44%.
About Three Gorges Corporation, the Majority Owner
Three Gorges New Energy is 74.9% directly and indirectly owned by China Three Gorges Corporation. I am going to call it CTG for the sake of brevity.
CTG is a power industry development company. When the Party decided that it was going to build a dam across the Three Gorges, they established CTG to do the construction.
After the dam was completed, CTG then founded another subsidiary, China Yangtze Power, to operate and receive the cash flows from the Three Gorges dam.
Yangtze also operates other dams on the Yangtze River, including the Xiluodu and Xiangjiaba dam.
Yangtze Power now publicly trades on the Shanghai stock market, under the ticker symbol 600900. As of this writing, the company's market cap is 449 billion RMB or $69 billion USD. It yields an annual dividend of 3.57%.
When I first read about this structure, I had thought it a little weird. Why two subsidiaries? Why didn't CTG simply roll its solar and wind energy plays into Yangtze Energy? Yangtze is already a large, well-established public company, after all.
I cannot pretend to know what they are thinking, but I reckon that it has to do with policy and growth. The Chinese government is pushing the development of "new energy" sources. It classifies "new energy" as wind, solar, tidal, and "water power without regulation capability", whatever that means.
Hydropower is not included, and so does not receive the same feed-in tariffs. So it's not a growth stock. It makes sense. China is the most dammed country in the world. They have been damming since the days of Mao. Not that many more dams to build.
The two companies' PE ratios as of this writing reflect this. Three Gorges New Energy has a 38.8 ratio, while Yangtze has 16.
Anyway, back to Three Gorges New Energy. The utility has been expanding its portfolio quite rapidly.
In 2008, the company had about 143 megawatts of installed capacity. At the end of Sept 2020, that number has grown 12x over to 11,900 megawatts. An annual growth rate of 45.7%.
This trend is expected to continue as China's 14th Five-Year Plan dictates the quadrupling of total installed renewable energy capacity from 2021 to 2025.
Currently, the company has projects in 30 provinces, autonomous areas, and municipalities across the country.
The majority of its revenue derives from China's north, northwest, and east.
Offshore Wind and Solar
The Party has set a path for China to be a leader in offshore wind energy. Thus, this is a special focus for the company. Three Gorges New Energy is in the midst of "unswervingly implementing the strategy" as they so often like to say in Chinese media.
The company estimates that by the end of 2020, total installed and in-production capacity of offshore wind power will reach 4,270 megawatts.
Which, assuming they hit that number, would be as much as what Japan has in total overall installed wind capacity.
Offshore wind projects are more complicated than their onshore counterparts. They require engineers to deal with confounding factors like sudden severe weather, icing issues, deep waters, and complex sea floor topography.
This is the company's chosen core competency, so they are doing the end-to-end installation all by themselves. It has required them to build, amongst other things, China's first indigenous submarine cables and sea booster stations, a kind of dredging machine.
The company has also been doing some interesting things to best make use of old coal mine infrastructure.
In the city of Huainan in the Anhui Province, the company has set up a 150 megawatt floating solar installation in the Panyi Coal Mine.
China's policy goals for offshore wind - a clear cutting edge renewable technology - and how they are achieving them are worth reviewing in a future video. Remind me to do that one later.
Industry Dynamics: Costs and Margins
We can boil down the renewable energy industry into three large sections: the upstream components makers, the mid-stream manufacturers, and the downstream end users.
As I wrote about in my video about China's solar efforts, the renewable energy industry's value chain between these three sectors kind of looks like a horseshoe.
Upstream component makers often hold very specialized knowledge and thus can charge high margins for their work. Downstream providers hold the critical customer relationship.
Mid-stream makers are worst off between the three - they are first in line to eat price cuts when things go bad.
Three Gorges New Energy used to manufacture and sell their own wind turbines, but in 2017 they withdrew from this business and fully committed to developing power generation plants. A great decision.
The company has gross margins approaching 60%. Furthermore, these margins are rising year after year, a trend that roughly begins after the 2017 decision to withdraw from turbine manufacturing.
We can also tie these rising gross margins to cheaper wind turbines. The company procures them from two major suppliers - Xinjiang Goldwind and Mingyang Smart Energy - and Three Gorges appears to be holding their feet to the fire.
This trend can't last forever. At some point, we are going to hit some red line where turbine and solar costs cannot decline any further. Until then, it looks like the utility gets to reap the benefits of the improving economies.
Industry Dynamics: Revenue
On the revenue side, electricity prices are regulated by their local government. The exact dynamics are quite complicated and differ from province to province.
For instance, in Sichuan from November to May, there is a regulated government price. From June to October, electricity is sold at market.
In Yunnan, electricity is always sold at market price, unregulated it appears. I guess Yunnan is like the Texas of China.
I reckon that the utility is losing money when the government sets the price.
Probably the best way Three Gorges New Energy can deal with this uncertainty is to diversify into as many provinces as possible. And this seems to be the case thus far.
However, the number of areas with ideal solar and wind properties is limited. As more of these get built out, the marginal benefit of the next site declines, hurting their overall profitability.
Furthermore, the Chinese government has started to work in additional competition into the market. Policy-makers are starting to reduce feed-in tariffs for wind and solar, which shrinks the whole pie for everyone in the industry. Three Gorges is well positioned here, being a state-owned enterprise, to develop on the best sites, but being an SOE is no golden ticket in China.
Other companies in this space include Jingke Technology, Jiaze New Energy, and Jiangsu New Energy. Their gross margins are in the same neighborhood or better, but none have the same size or scale. Nor are they backed by a state-owned entity.
Out in the United States, it is tough to pin down a close comparison for Three Gorges New Energy. People invest in utilities all the time. But these massive companies - Southern California Edison, Pacific Gas & Electric, and such - are quite old school and are not pure New Energy plays anyway.
Renewable energy sources might be a significant part of their power generation portfolio, but they still rely on non-renewable or hydroelectric power for a big chunk of their revenue.
The closest analogue that I can find is NextEra Energy Partners, which is a publicly traded limited partnership subsidiary of NextEra Energy. NextEra is one of the largest electric utilities in the United States and was formerly known as Florida Power & Light.
But you cannot compare this one with Three Gorges because 1) NextEra is a limited partnership and there are investor tax implications associated with that clouding the stock’s true value, and 2) NextEra derives a significant portion of revenue from natural gas pipelines. It's not a pure play renewables stock.
IPO'ing this subsidiary was an interesting play by Three Gorges Corporation.
Fundamentally, Three Gorges New Energy is a utility company operating in a favorable macro-space. It has a few key advantages in this space. These are capital-intensive projects, and this company is suited for deploying lots of safe capital thanks to its state ties.
The company is focusing on a core competency of developing and operating renewable power plants. They are trying to build up a special competitive edge in offshore wind - and possibly offshore solar? But let's see about that. So from an operations standpoint, they have their differentiation.
CTG, the parent company, now has two publicly-traded subsidiaries with strong value for their investor audiences. Yangtze for those wanting income, and now New Energy for those looking for growth. Pretty savvy, I have to say. Now the hard part is for New Energy to deliver on its investors' hopes and dreams.