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Huaneng Power International Inc. (HPI) is an electrical power generation company operating in the Peoples

Republic of China (PRC). It was spun off from the Huaneng Power International Development Corporation (HPIDC),

a joint venture with the Chinese government, for the purpose of developing and operating modern, coal-firing

power plants to meet the expected increase in demand. The rapid expansion plans of HPI coupled with the

mandate to use modern technology fueled the need for foreign investment. The primary question was which

international market presented the best opportunity for success?

The United States has some of the largest and most influential equity exchange markets in the world. This offers

several advantages to foreign firms looking to raise substantial capital. The fact that a company is listed on the New

York Stock Exchange (NYSE) or the National Association of Dealers Automated Quotations (NASDAQ) brings prestige

in and of itself, in addition to increased exposure, investor access and company valuation.

Foreign companies listing on a U.S. exchange have several options, with American Depository Receipts (ADRs) being

the most common. Several types of ADR issues are available depending on the level of regulatory reporting

required and the availability to certain types of investors. HPI decided to issue ADRs at Level III, which carried the

highest regulatory and reporting requirements but also allowed ADRs to be listed on any major U.S. exchange.These increased regulations also make a company more desirable to certain classes of investor, as information is

more readily available and internal corporate fraud is less likely.

Essentially, HPI stock, through ADRs, would be available to U.S. retail investors as well as institutional investors.

U.S. investors crave new and emerging market opportunities. Knowing this, both the NYSE and NASDAQ markets

have heavily promoted themselves to attract investors to Chinese investment opportunities. Additionally,

deregulation in the U.S. has devalued domestic utility companies, and investors are looking for utility companies

that can offer a better return. These facts combined lead to higher initial valuations and a better chance of raising

the necessary capital.

The advantages to HPI of listing on a U.S. stock exchange, through the issue of ADRs, are clear and convincing.

American investors are craving a product that HPI can provide. The primary question now shifts to the investors: Is

HPI a good investment? Several factors influence the answer including the political and economic environment in

China, the growth potential of the Chinese power generation market, historical and planned operations of HPI, and

their financial performance and expected returns.

China is a communist state transitioning from a socialist market economy towards a more free market economy.

The government is still actively controlling the economy and many state-owned enterprises (SOEs) still operate.

However, the PRC central government has imposed mandates that SOEs must be profitable and private enterprise

has expanded. HPI is an example of a partially government owned corporation, in conjunction with domestic andforeign investors, that operates in a free market space, although vestiges of government control remain. Even after

an issue of ADRs, the state-run HPIDC will retain a controlling stake in HPI. This, combined with the legal

environment in China limits the legal recourses available to investors seeking to sue the company.

This close relationship with the HPIDC offers several advantages as well. HPI has had a successful history under this

ownership arrangement. Connections with the central and local governments can be leveraged to facilitate the

construction and operation of new plants. Additionally, HPIs primary customers are regional distribution grids

mainly operated by the same local governments.

China offers some unique economic, legal, and political risks and opportunities. By offering their stock on an

American exchange, HPI is indicating that it has the opportunity for growth, and can stand up to the regulatory

rigor that U.S. investors demand.

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The market potential in China for power generation is sizeable and apparent. Installed capacity and electricity

generation have increased at nearly double digit percentages over the last eight years and is not expected to slow.

Additionally, the central government has recognized that an adequate electricity supply is crucial to economic

growth. The demand for electricity is high, especially in the less developed and developing provinces. This demand

sustains higher prices and increased profits for HPI.

On the other hand, this growth is not sustainable indefinitely, and investors are savvy to hype and inflated

expectations. For example, HPI faces the risk of a lack of qualified personnel to manage and operate their new

plants. Similarly, Shandong Huaneng Power (SHP) is a sister company to HPI, but operates solely in the Shandong

province of China. Its recent IPO on the NYSE was completely sold out, but the value of SHP stock has fallen over 5%

since.

In order to take advantage of the market potential evident in China, HPI must also ensure its operational

capabilities are aligned with the opportunity. China has the largest known reserves of coal in the world. This,

combined with the use of modern, high-tech equipment from leading global manufacturers, indicates that HPI has

the physical capacity to meet demand. In fact, currently operational plants have been successful using this sameproduction model.

Other factors may impact HPIs operations however. The costs associated with purchasing and transporting the

necessary coal can become prohibitive. The initial allotment of coal to HPI at discounted prices will not be enough

to meet future demand, necessitating the purchase of coal at market prices. Additionally, transportation accounts

for a large portion of the price: up to 50% for some of the more rural areas of the country where infrastructure is

limited. The limitations imposed by primitive infrastructure also affect plant construction and expansion.

Furthermore, companies are not required to carry business interruption insurance or liability insurance, exposingHPI to business continuity risks in the face of natural disasters or workplace accidents.

Operationally speaking, HPI has been successful up to this point in expanding its power generating capacity.

Whether their current business model is adequate in light of rapid expansion is another matter.

Lastly, investors should carefully consider the financial implications of owning HPI stock. Raising capital in a foreign

currency can introduce significant foreign exchange risk. Given that HPI would still require over $3 billion in capital,

some portion would presumably come from foreign investment, this risk is substantial. This assumes that the

company will be successful in raising the additional money needed to execute its expansion strategy. Additionally,

HPI is not expecting to pay dividends on its stock. While not uncommon for a growing company, it is troubling that

despite offering a $0.50 dividend, Shandong has continued to lose value in the market.

On the positive side, the central government has authorized HPI to offer a guaranteed rate of return on fixed assets

of 15%. This is extremely attractive to investors, especially in the U.S. markets. Add to this the tax treaty between

the U.S. and China limiting capital gains withholding to 10% and the potential is very enticing.

Having decided to take advantage of the opportunities inherent to U.S. markets, HPI is going to issue level III ADRs,

available to all types of investors. The risks inherent with a Chinese company are somewhat mitigated by the

transparency required by U.S. regulations. Additionally, the growth potential of the Chinese electric power market,

combined with the historical performance of HPI and the financial incentives available make this a very appealing

investment.