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									             Southern Energy’s
           Investment in CEMIG



                                 Matt Michaud
                                 Judd Murphy
                                    Tory Noto
                                  Matt Palasek
11/17/00                                  1
                   Outline
•   Project Description
•   Southern Energy
•   Brazil
•   CEMIG
•   Project Overview
•   Solution
         Project Description
• Partnership to purchase 33% of CEMIG
  voting stock from Minas Gerais
  – AES (65%)
  – Southern Energy (25%)
  – Opportunity Fund (10%)
           Southern Energy
• The unregulated subsidiary of The Southern
  Company
• Southern Energy is a major Independent
  Power Producer (IPP) in Asia, Europe, and
  South America
• Seeking large returns in international
  investments
           Southern Energy
• SEI has assumed both minority and
  majority positions and has gained valuable
  operating experience
• Invests in both developed and emerging
  markets
• Southern takes a long-term view of
  investments in emerging markets
• In emerging markets Southern looks to gain
  first-mover advantage
Brazil
                   Brazil
• 10th largest economy in the world
• Annual inflation reached peak of over
  2500% in 1993, now down at 7.3%
• Foreign direct investment increased from
  $25 billion in 1994 to $52 billion in 1996
                                    Brazil
Brazilian Inflation, 1993 - 1996
(% Change in One Year)

                                    1993          1994           1995        Sept. 1996

General Prices (domestic)           2,708.55       1,093.84          14.78         9.82
Wholesale Prices (domestic)         2,639.27       1,029.36           6.39         7.07
Consumer Prices                     2,489.11         929.32          21.98        12.98

Source: The Economic Intelligence Unit. "Country Profile - Brazil," The
Economic Intelligence Unit Limited , 1997.
                     Brazil
• Brazil is widely regarded as the best nation in
  Latin American for utility investments
• By 2007, Brazil will need an additional 30,000
  MW of generating capacity, requiring an
  investment of $20 billion
• Now on cusp of full sector privatization
• Electricity demand growing at 5% per year
• 10% guaranteed return to utilities ended in 1995
                         Brazil
• Generating capacity: about 62,000 MW.
• Electric generation components:
   –   Hydro: 91.02%
   –   Fossil Fuels: 4.92%
   –   Nuclear: 0.99%
   –   Other: 3.07%
• Total Production 317 billion kWh
• Total Consumption 336 billion kWh
• Total Imports (Paraguay) 42 billion kWh
                                         Brazil
Latin America Installed Capacity - 1997


 (in Megawatts, MW)    Hydroelectric   Thermoelectric    Geothermal        Nuclear           Total

Argentina                      8,687           11,686               1            1,018          21,392
Belize                            23               43               -                               66
Bolivia                          313              497               -                -             810
Brazil                        54,134            7,490               -              657          62,281
Colombia                       8,140            6,474               -                -          14,614
Costa Rica                       981              292              65                -           1,338
Chile                          3,882            3,976               -                -           7,858
Ecuador                        1,500            1,414               -                -           2,914
El Salvador                      404              450             105                -             959
Guatemala                        507              466               -                -             973
Guyana                             -              157               -                -             157
Honduras                         434              305               -                -             739
Mexico                        10,125           30,076             744            1,309          42,254
Nicaragua                        103              238              70                -             411
Panama                           621              434               -                -           1,055
Paraguay                       7,491               38               -                -           7,529
Peru                           2,499            2,499               -                -           4,998
Suriname                         189              200               -                -             389
Uruguay                        1,521              716               -                -           2,237
Venezuela                     14,003            8,525               -                -          22,528

TOTAL                        115,557           75,976             985            2,984         195,502

Source: Evans, Andrew. "Opportunities for Power Generation in Latin America," Reuters Business Insight -
Energy , 1998.
                     CEMIG
• State-owned utility of Minas Gerais
   – Federal government has large minority investnment
• Fully integrated – generation, transmission, and
  distribution
• Has exclusive rights to sell to 96% of Minas
  Gerais
• Generally considered best utility investment in
  Brazil
                    CEMIG
Installed Power Plant Capacity - 1995
(MW)

                     Hydroelectric      Thermal
       Companies       Capacity         Capacity      Total Capacity
Electronorte                 4,718              783            5,501
Chesf                        8,617              290            8,907
Furnas                       7,212           1,297             8,509
Eletrosul                    2,602              620            3,222
Total Electrobras           23,149           2,990            26,139

Itaipu                       6,300                            6,300
Cesp (SP)                    9,461                            9,461
Cemig (MG)                   4,928             125            5,053
Copel (PR)                   3,324              20            3,344
CEEE (RS)                      896             511            1,407
Light (Private)                768                              768
Celg                           675                3             678
Eletropaulo                    820              470           1,290
Sub-Total                   27,172            1,129          28,301
Other                          514              558           1,072
TOTAL CAPACITY              50,835            4,677          55,512
            Project Overview
• Southern’s share would cost $276 million
  – $126M in cash
  – $150M in dollar-denominated debt
     • Thus exposing SEI to currency risk
                           Project Overview
                                     Pre-Transaction Ownership
                             Voting Shares          Preferred Shares              Total
Owners                    Number     Percentage    Number     Percentage   Number     Percentage
Minas Gerias government     47,658      83.99%        6,957       9.52%      54,615      42.07%
Electrobras                    831       1.46%        1,270       1.74%       2,101       1.62%
Others                       8,253      14.54%       64,852      88.74%      73,105      56.31%
Total                       56,742     100.00%       73,079     100.00%     129,821     100.00%


                                    Post-Transaction Ownership
                             Voting Shares          Non-Voting Shares       Non-Voting Shares
Owners                    Number     Percentage    Number     Percentage   Number     Percentage
Minas Gerias government     28,933      50.99%        6,957       9.52%      35,890      27.65%
Others                         831       1.46%        1,270       1.74%       2,101       1.62%
Electrobras                  8,253      14.54%       64,852      88.74%      73,105      56.31%
AES                         12,171      21.45%            0       0.00%      12,171       9.38%
Southern Energy              4,681       8.25%            0       0.00%       4,681       3.61%
Opportunity Fund             1,872       3.30%            0       0.00%       1,872       1.44%
Total                       56,742     100.00%       73,079     100.00%     129,821     100.00%
             Project Overview
• Consortium would be given
  –   Veto power on expenditures > 1 million real
  –   4 of 11 seats on the board
  –   3 ‘key’ executive positions
  –   Ability to pass through costs
• Southern brought in partnership for industry
  expertise
                  Real options
• Delayed investment: wait to see how regulatory
  situation develops, then expand capacity
  accordingly
• Invest in gas-fired-plants: hedge against hydro
  power, Bolivian pipeline makes this possible
• Delayed bid: given that they are the only bidder,
  they could delay their initial bid until the
  regulatory situation is clear
   – But, the ship may sail without them
        Solution – Discount Rate
• Base case cost of equity was 24.8%
• Adjustments
   – Assumed beta of .4 for average utility investment
   – Adjusted up/down for idiosyncratic risks
       •   Extreme reliance on hydro (Up)
       •   Uncertain regulatory framework (Up)
       •   Weak judicial system and unsettled political climate (Up)
       •   Cemig is fully integrated (Down)
       •   Privatization trend (Down)
       •   Improved operating margins after investment (Down)

• Adjusted cost of equity is 18.9%
        Solution – NPV Analysis
Free cash flows to common equity:
• Used consensus analyst cash flow estimates and adjusted
  to reflect operating efficiencies
• Assumed minimum purchase price as initial investment
• Accounted for optionality of delayed investment
       NPV without option: ($14.7M)
       NPV with option:    $44.7M
Assumptions for delayed investment option:
• 50% chance of deregulation (at least of wholesale market)
• 1,500 MW capacity investment
• Return (cash flow) per MW in-line with projections
         Solution - Comparables
Comparable Acquisition:
• Implied price of $34.72
   – Light SA purchase by AES in 1996, Light is a distributor
   – Bovespa index has improved 40% since that time

P/E Multiples:
• Average Brazil utility implies $43.79
• Weighted average implies $51.92
   – Weighted more heavily on fully integrated peer
              What Happened?
• Acquisition went through at $56.15/share (minimum)
• Economic crisis hits Brazil in 1998
   – Abandoned peg to USD
   – Caused by Asian currency crisis, Russian default
   – Since beginning of 2001 the real has depreciated by
     more than 20%
• Random
   – 1998 – New governor of Minas Gerais sued to remove
     partnership’s control through local courts
   – 2000 – Partnership wins in court
   – 2001 – CEMIG upgraded to ADRs on NYSE
              What Happened?
• 2001-02 – Energy crisis in Brazil
   – Drought led to lack of hydro-generation
   – Consumers asked to cut consumption by 20%
   – Inadequate transmission system means electricity
     cannot get to underserved markets
   – Government ordered 50 thermoelectric plants to be
     built, but lack of guarantee led to dearth of investors
   – Thus far 36 plants are in process of being built (14,200
     MW) and Brazil entered into a power contract of 2,800
     MW from Paraguay and Argentina.

								
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