Aboitiz Power Corporation (AP) Date: March 04, 2016 To: Gavin Lee Submitted by: Jeff Ayo, Daniel Camagay, Ronald Tan, Martin Whalley (8:00-9:20pm class) Table of Contents:

1. Executive Summary

2. Philippine Power Industry (Introduction)

3. Aboitiz Power (Overview)

a. History

b. Deliberate Partnerships

c. Acquisitions

d. New Plant Developments

e. Industry Positioning

f. Diversified Generation and Distribution Assets

4. Value Creation

5. Capital Structure

6. Parent Support and Solid Management

7. Conclusion

8. Appendix (Refer to labels at the lower right corner)

a. Asian Financial Crisis

b. EPIRA

c. EPIRA Timeline

d. Power Assets

i. Table of Power Assets

ii. Graphs of Development Timeline

1. Acquisition and New Plant Developments

2. Renewable and Nonrenewable development

iii. Sources of Renewable and Nonrenewable Capacity

e. Generating Capacity Ownership

f. Generation Assets

g. Distribution Assets

h. Table of Distribution and Retail Service

i. Sample Generation Profile (Luzon 2013)

j. Current Structure of Philippine Power Sector

k. Value Creation Table

l. Common Sized Balance Sheet

m. Benchmark Interest Rate

n. Debt Timeline

o. Awards and Recognitions

Executive Summary

Aboitiz Power (AP), the power business arm of the Aboitiz Group, is the second largest power producer

and one of the largest power distributor in the Philippines. It effectively owns and supplies 16% of the

power capacity in the country. Through the strategic partnerships it has formed with other power

producers, it collectively controls 28% throughout Luzon, Visayas and Mindanao.

The Aboitiz Group started investing in the electricity distribution business in Visayas and Mindanao in

the early 1900’s. They eventually ventured into power generation by developing some of the country’s

earliest hydroelectric plants. However, it was only in the mid-2000’s, when state owned power assets

were privatized by the government, that AP was able to grow and position itself as one of the biggest

power players in the Philippine Industry.

The value creation story of AP stems from the recognition of an opportunity and capitalizing on it as a

first mover. It was through strategic partnering and acquisitions, prudent financial management, and

stern corporate governance that the company had produced phenomenal value for shareholders since

its IPO in 2007.

Philippine Power Industry (Introduction)

During the 1980s stretching to the 1990s, shortage in power supply was rampant in the Philippines. The

state-owned National Power Corporation (NPC), which owns majority of the country’s power generation

assets, was considered weak and unable to raise capital to increase capacity. Due to a looming power

shortage, NPC dealt with Independent Power Producers and signed power purchase agreements (PPA)

for a total capacity of 2,648MW from 1991 to 1993. By 1997, 37 PPAs had been concluded, however at

that time, the Asian Financial Crisis had hit the country which slowed investor interest.

During the crisis, the Philippine peso fell sharply, increasing the foreign currency exchange components

of the IPP contracts, which were mostly in US currency. Demand growth did not meet expectations due

to a drop in economic growth. Since many of the PPAs were based on fixed price terms and take-or-pay

clauses, the average cost of power rose significantly. These costs were not fully passed to the retail

tariffs, therefore NPC accumulated high losses (see appendix: Asian Financial Crisis)

Thus, in 2001, the Philippine Government enacted the EPIRA law which aimed to bring private sector

capital into the power industry. The goal was to meet the growing need for new power project

investments in a timely manner, and to manage consumer prices (see appendix: EPIRA). This law

enabled AP, as well as other local companies, to enter and invest in the Philippine power sector.

Aboitiz Power Overview

History

In 1998, while the government was deliberating for the passage of the EPIRA Law, the Aboitiz Group

started organizing its management to pursue potential power projects. The group consolidated its

existing power generation assets, totalling to just 73 MW at that time, under a newly formed investment

vehicle named Aboitiz Power Corporation (AP). When EPIRA was enacted (see appendix: EPIRA

timeline), AP was prepared to roll-out its strategies to fully maximize the business opportunities

presented by the government’s change in policy.

AP eventually went public in 2007 and raised Php10.1 billion. The cash raised would fund the ongoing

projects it had at the time and would be the building block for its partnerships and acquisitions in the

years to come. This would be the only time the company has raised equity funds to date.

Deliberate Partnerships, Acquisitions, and New Plant Developments

Partnering and acquisition were the strategies used by AP to build its power generation capacity almost

overnight. To date, majority of the power capacity of AP are generated from existing plants that were

acquired and rehabilitated (see appendix: Table of Power Assets; Graph of Development Timeline). The

following are details of their capacity build up.

SN Aboitiz Power Group (SNAP)

In the mid-2000’s, AP entered into a 50/50 partnership with SN Power Netherlands, an expert in

hydroelectric plants in Norway, for the acquisition of the 360 MW Magat and 215 MW Ambuklao-Binga

hydroelectric plants from PSALM. Both plants were acquired in 2007. The Magat plant was set to work in

the same year, while the Ambuklao-Binga plants were rehabilitated and began commercial operations in

2011 and 2013. The partnership was mutually beneficial for both parties. SN Power was able to invest in

the local power industry while AP was able to benefit from the technological transfer and funding

support.

STEAG State Power, Inc., East Asia Utilities, Cebu Private Power Corp, Cebu Energy Development Corp.

In the late-2000’s, AP purchased minority equity stakes, or sometimes up to 60% in existing privately

held coal and oil fired plants in Cebu and Mindanao. Collectively, these existing plants added 803 MW to

AP’s controlled capacity in these regions. Through these partnerships, AP was able to carve a market in

these geographical regions, provide steady power supply to its existing distribution units in Visayas and

Mindanao, and gain access to market information.

Acquisitions from PSALM

The biggest contributors to AP’s existing generation capacities were from the privatization of state

owned power assets. Close to 1,142 MW of non-renewable assets and 733 MW of geothermal assets

were acquired by AP from PSALM in the years 2009 to 2011. This excludes the hydroelectric plants

acquired jointly by SN Aboitiz as previously mentioned. Furthermore, one of the acquisitions from

PSALM was an Independent Power Producer Agreement (IPPA) for the 700MW Pagbilao Coal Fired

Power Plant. This acquisition created a business relationship between AP and TeaMEnergy, which is a

joint venture between Marubeni and Tokyo Electric Power Company. Both are considered as two of the

most reputable Japanese companies in terms of expertise in power. The partnership gave birth to a new

venture to expand to an additional 420MW Pagbilao Coal Fired power plant.

New Plant Developments

Apart from acquisitions, AP also develops its own run-of-river hydroelectric plants. The Aboitiz Group

started developing these plants since the late 1900’s and is considered one of its expertise. To date they

have a total capacity of 161.5 MW of run-of-river plants and an additional 94 MW is underway.

In the span of 7 years after its IPO, AP had increased its effective interest in power generation from 73

MW to 2,591 MW; making it the second largest power generation in terms of capacity held. Of the total

capacity, 2,134 MW was acquired through state owned assets under PSALM. The remaining effective

interest was acquired from equity stakes in existing privately owned companies, joint ventures and

through commissioning of new power assets. (See appendix: Graph of Development Timeline) Through

deliberate partnering and effective acquisitions, AP was able to build its business overnight and deliver

the cash flows it needed for future developments.

Industry Positioning

AP’s power generation and distribution assets are located strategically throughout the country. As of

end-2014, the company has 3,740 MW of aggregated power generation capacity, of which it effectively

owns 3,107 MW. While other players have yet to roll-out to other islands, AP holds 18%, 5%, and 15% of

the power generation capacity of Luzon, Visayas, and Mindanao respectively (see appendix: Generating

Capacity Ownership; Generation Assets; Distribution Assets). In total, it has 16% of the country’s

17,585MW National Installed Generating Capacity and is the 2nd biggest power generation company. An

advantage of geographically diversified assets is the minimization of risks resulting from natural

disasters. In the distribution segment, AP has 8 distribution units which serve 840,000 customers located

in Central Luzon, Cebu, Davao, and Cotabato. (see appendix: Distribution and Retail Service)

Diversified Generation and Distribution Assets

AP’s power generating fuel sources are well diversified. More environmental friendly energy sources

such as run-of-river, hydroelectric, geothermal and solar make up 45% of AP’s generating capacity, while

cheaper to run non-renewable sources such as coal and oil make up 55% (see appendix: Sources of

Renewable and Nonrenewable Capacity). The Fuel Mix Policy1 and the Renewable Portfolio Standards

2,

which the government has been looking to strengthen and implement in the near future, will provide

better positioning and flexibility for AP as it can readily address the renewable energy requirements of

its customers. In addition, given the existing daily generation profile (see appendix: Sample power

generation profile Luzon 2013) in the market, AP’s capability to provide baseload, mid-merit, and

peaking energy sources also provides better coverage to its customer requirements.

AP also has its own Retail Electricity Supplier (RES) business that trades electricity from power producers

to retail end-users (or contestable market) that consume more than 1 MW.

1 The fuel mix policy issued by Dept of Energy(DOE) in 2015 is non-firm, but recently, DOE would like to review and

determine if there is a need to strengthen this policy. http://www.businessmirror.com.ph/doe-sets-fuel-mix-

policy-review-in-power-generation/ 2 Sec 4, IRR of RA 9513 (Renewable Energy Act) - Renewable Portfolio Standards is a policy which places an

obligation on power industry players such as generators, distribution utilities, or suppliers to source a fraction of

their electricity from eligible RE resources.

Overall, it is worth highlighting that AP’s business operations cover the 3 important segments of the

Philippine Power Sector value chain and is well-entrenched in the Philippine Power Sector (see

appendix: Current structure of Philippine Power Sector)

Value Creation

AP’s investments in power assets usually take two to three years before operating commercially and less

if done through acquisitions. For AP, the fruits of its investments came in 2010, when multiple plants

began operations. As a result, net operating profits less applicable tax (NOPLAT) in 2010 leapt almost

four times the previous year. From then on, NOPLAT has been steady from 2010-2012. In 2013 and

2014, despite several small plants starting operations, NOPLAT decreased by quarter of a percent due to

the El Nino phenomenon which affected the production of its two major hydroelectric plants. At the

same time, several income tax holidays of subsidiaries had expired, increasing AP’s effective tax rate

from 4-6% to 15%. (see appendix: Value Creation Table).

In the last five years, AP continued to invest heavily in increasing its power generations assets; adding an

average of Php 20B in fixed assets per year. These were large capacity coal, hydro, and solar projects set

to operate between 2016 to 2018.

Taken together, return on invested capital (ROIC) was derived and showed a 25%, 20% and 21% return

in 2010 to 2012 respectively. Compared to the weighted average cost of capital of 8%, they were

creating sizable economic profit. The ROIC would steeply decline to 13.9% and 11.5% in 2013 and 2014

respectively due to the factors mentioned but were still value creating (See appendix: Value Creation

Table).

Moving forward, the ROIC should resurge back to 20% when water levels normalize, new plant

investments come online between 2016 to 2018, and corresponding fiscal incentives are granted for the

new plants.

Capital Structure

Nearly 90% of AP’s generated capacity is covered by Power Purchase Agreements (PPA), giving the

company a steady and predictable income and cash flow. The remaining portion is sold through the

merchant or spot market.

The company appropriately matches the acquisition of long-term assets with long-term funding (see

appendix: Common Sized Balance Sheet). The current capital structure, composed of approximately 50

percent debt and 50 percent equity, is value accretive to existing shareholders. It can be observed that

there were little to no changes to invested equity capital since AP’s IPO. The company primarily finances

its investments and acquisitions through debt and internal funding, i.e. retained earnings. As the

company undertakes its strategy of building new power plants in 2013, long-term borrowing also

followed suit to finance these green field projects, i.e. increase in Property, Plant, and Equipment

coincides with the increase in long-term debt.

A closer look at the composition of long-term borrowing reveals that there is deliberate management of

debt. The 5-year period from 2009 to 2014 was a period of decreasing interest rates. (see appendix:

Benchmark Interest Rate). Within this period, it can be seen that the company actively managed its

finances to take advantage of an accommodative debt market to lock-in lower interest rates for longer

tenors. In 2012, the company retired 5 to 7 year corporate notes with coupons of 8 to 9 percent and

refinanced it in 2014 by issuing 7 and 12 year bonds at 5.21 and 6.10 percent, respectively (see

appendix: Debt Timeline). In 2014, total long-term borrowings amounting to P41 billion matched the

cash available amounting to P40 billion. Given the rising interest rates moving forward, AP had chosen

to raise the long-term capital needed for its planned future projects while interest rates were still low.

At the same time, issuing the corporate bonds in 2014 was timely as this gives AP a boost in terms of tax

shield benefits. AP’s effective tax rate had increased to 15% due to the expiration of several subsidiary

income tax holidays.

Parent Support and Solid Management

The Aboitiz Group controls 76.88% of the company through holding company Aboitiz Equity Ventures,

Inc. (AEV). AEV’s portfolio of businesses includes power, banking, food and property development. The

current structure is beneficial for AP as the parent is able to provide capital raising support and

management oversight.

The interest of AP is aligned with that of the Aboitiz Group’s, as majority of the board members are

represented by the Aboitiz family and the CEO and the CFO positions are held by the same group. The

board is also composed of ⅓ independent directors, and together with the AboiFzes, they oversee the

following board committees: Audit, Risk and Reputation, and Corporate Governance. In addition, the

company is guided by its manual for corporate governance which was approved by the SEC and is

annually reviewed, revised, and updated in keeping with evolving best practices.

The management of AP has been recognized consecutively for its excellence in corporate governance

and transparency by several independent financial groups. The management have also received

recognitions, specifically awards for best CEO and CFO. (see appendix: Awards and Recognitions)

CONCLUSION

In conclusion, AP was able to capitalize on the opportunity of privatizing state-owned power generating

assets and have continued to grow their business through partnerships, acquisitions, and developing

new plants. Management was able to lead the company into a favorable position by investing in the key

business segments in the power industry early on, and by diversifying its assets in strategic locations and

developing both renewable and nonrenewable capacities. The company has the proven track record of

developing and adopting large scale projects by partnering with both local and foreign experts in the

industry and is financially ready to complete its planned projects. With its current position in the

industry and continued developments, AP is poised to continue to create value for its shareholders and

do its part in responsible investing for the future of this country.