China coal and nuclear:Merger between CGN and Shenhua?

Event

According to Bloomberg news, Shenhua Group (unlisted parent of ShenhuaEnergy) may seek a merger with another SOE, China General Nuclear PowerCorp (CGN Power). This potential merger could create a utility enterprise withUS$204bn of assets. According to the news reports, the Chinese authoritiesare still considering the proposal. The reports also suggest that an alternativeproposal would be for Shenhua Group to merge with China National CoalGroup, the parent company of China Coal Energy (1898 HK, HK$4.04,Outperform, TP: HK$4.86, Coria Chow).

Impact

We would question the potential synergies if Shenhua Group is merged withCGN Power. We note Shenhua Group’s major assets are coal-fired, solarfired,and wind power.

CGN Power is only focused on nuclear power plant operations in China andhas no coal-related assets. In China, the nuclear sector has high entrybarriers: only 3 groups (CGN, China National Nuclear Power, and StatePower Investment) own nuclear power operation licenses.

We believe it’s more likely that China Shenhua would like to leverage onCGN’s licence to develop nuclear power, rather than CGN leveraging onChina Shenhua in terms of its coal-related business. We note Shenhua Grouphas been looking to expand into nuclear power by considering a stakeacquisition at project level. We think this would be a more reasonableapproach than a complete merger, as Shenhua Group could leverage on theproject owner’s expertise and it would be easier to execute than a completemerger.

If a merger happens, we think it would be at the group level. China ShenhuaEnergy (1088 HK, HK$14.74, Underperform, TP: HK$10.57, Coria Chow) onlyhad Rmb42bn of cash at end-2015, compared to CGN Power’s Rmb218bn.

Given the long construction cycle of nuclear power plants (usually at least 5years), we believe even if a merger happens at listco level, it would be a longtermstory and would not impact the earnings of CGN Power and ChinaShenhua in the short to medium term.

Outlook

If the merger happens between CGN and Shenhua Group, we would notexpect the parent company to immediately inject the nuclear assets into ChinaShenhua (the listco) due to the long construction cycle of nuclear plants

If the merger is between Shenhua Group and China Coal Group, we believethere could be some synergy as the two coal companies have a combinedmarket share of 18% in China. However, we believe a major challenge wouldbe the restructuring and optimization of resources between the groups aftermerger. If the merger occured at listed company level, we believe ChinaShenhua could be worse off. With more than Rmb42bn of cash at ChinaShenhua but Rmb97bn outstanding borrowings at China Coal, we believe alikely scenario would be the merged entity using the cash from ChinaShenhua to de-gear.