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JULY 2004
INVESTMENT CLIMATE IN THE LATIN
I N V E S T M E N T C LI MAT E I N T H E LAT I N
A
NO W
P EORWSEE RC T SO ER C T O R
A MMEER R
I CI ACNA P
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Key highlights of the North American power sector
2003 recap
2004 market dynamics
Retreat from unsuccessful growth strategies
Year of “cleanup”
“Back to basics” was credit driven and will not
serve as growth strategy going forward
Focused on core businesses, principally
domestic
Regulators are being cautious to allow utilities
Strengthened balance sheets
Growth utilities will attract a disproportionate
share of new capital
Increasing presence of financial sponsors
Excess capital from institutional investors
Institutional investors consider that
investments in utilities could provide more
stable returns than those in the stock or
bond markets
Strategics and sponsors positioning for
potential regulatory changes
Large European utilities looking for growth
Cost driven consolidation
Private equity sponsors will continue to
challenge corporate buyers
Earnings stabilized and credit rating
downgrades mostly completed
competitive returns
Several sponsors already own assets to
compete on a strategic basis
The utility and merchant generation
sectors enjoyed improved liquidity and
greater access to capital markets
Demonstrated willingness to invest long-term
and wait for developing business
fundamentals and regulatory outcomes
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The power M&A market has become more robust with
financial sponsors continuing to make meaningful
acquisitions
Value of M&A transactions in the North
American power sector (US$ mm)
Selected Investments
Deal size
82,910
87,470
19,120
2000
2001
2002
24,030
2003
Source: Thompson Financial
# of M&A transactions in the North
American power sector
171
Acquirer/target
$mm
03/10/04
Sempra and Carlyle-Riverstone JV/
AEP (Texas Central Co.)
$430
02/24/04
TransCanada/
Gas Transmission Northwest
01/16/04
AIG Highstar/
El Paso Corporation
12/15/03
Enterprise Product Partners LP/
Gulfterra Energy Partners
5,063
11/21/03
KKR/JPMP/Wachovia/
Unisource Energy
2,968
11/18/03
Oregon Electric Utility Co LLC; TPG/
Cortland General Electric
2,350
10/20/03
Goldman Sachs Group/
Cogentrix
2,415
09/02/03
Evercore/
85% ownership interest in Michigan Electric
5/12/03
Southern Union/
Panhandle Eastern Pipe Line
1,797
04/21/03
Consortium (Madison Dearborn, Carlyle/Riverstone)/
1,082
1,703
938
NA
54.6% interest in Williams Energy Partners (Williams)
97
2000
Date
2001
105
2002
136
2003
Source: Thompson Financial
04/16/03
GS Linden Power Holdings LLC; Goldman Sachs/
East Coast Power
1,056
04/11/03
Loews Pipeline Holding Corp/
Texas Gas Transmission
1,045
11/25/03
Constellation Energy Group Inc/
Energy East
423
07/08/03
Private Power LLC/
Primary Energy
335
Source: SDC
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Stock prices for utilities have recovered over the last 18
months; however, increasing interest rates could slow this
trend
Year forward price-to-earnings ratio
Relative stock price performance
(% change)
Integrated companies
300%
UTY
Merchants & traders
Integrated
250%
T&D
Merchant
T&D
200%
1H 99 2H 99 1H 00 2H 00 1H 01 2H 01 1H 02 2H 02 1H 03 2H 03 1Q 04
Source: Tradeline
150%
U.S. 10-year treasury (% change)
150%
100%
130%
110%
50%
90%
70%
0%
Jan-99
50%
Dec-99
Nov-00
Oct-01
Sep-02
Aug-03
Jul-04
Source: Tradeline
Note: Integrated: AEP, Cinergy, CMS Energy, Dominion, Duke, DTE Energy, Entergy, Exelon,
FirstEnergy, FPL, PG&E, PPL, Progress Energy, Public Service Enterprise Group, Southern Co., TXU
Merchant: AES, Calpine, Dynegy, El Paso, Reliant Resources, Williams
T&D: Consolidated Edison, Energy East, Northeast Utilities, NSTAR
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Jan-99
Dec-99
Nov-00
Oct-01
Sep-02
Aug-03
Jul-04
Source: Bloomberg
3
Key highlights of the European power sector
Generation
Transmission and distribution
Limited and volatile demand growth
EU Directive, unbundling and third-
party access for transmission assets
Natural gas replacing coal as fuel
Limited enforceability
source
mechanisms
Declining reserve margins
Implementation of RAB-based
regulation
Prices making generation
uneconomic
Transmission bottlenecks
Ownership consolidation
Introduction of third party
equity/debt
Emissions restrictions and CO2
trading
Equity investors appetite for
regulated assets
Asset values declining
Restructuring and unbundling
High number of assets for sale
Privatizations
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The Latin American investment environment has
significantly improved over the last 18 months
GDP growth (%, annual change)
EMBI+ SOT Indices per country
Bps
8,000
6,000
4,000
2,000
0
Dec-99
Argentina
Colombia
Brazil
Ecuador
Chile
Peru
10%
Brazil
Ecuador
Chile
Peru
5%
0%
(5)%
(10)%
(15)%
Feb-01
Apr-02
May-03
Jul-04
Exchange rate
Argentina
Colombia
2002
2003E
2004F
2005F
Stock exchange indices
Brazil
Ecuador
Chile
Peru
Argentina
Chile
450%
325%
200%
Feb-01
1997—2001
Source: JPMorgan research
Source: Global Economic Data as of July 13, 2004
75%
Dec-99
Argentina
Colombia
Apr-02
May-03
Jul-04
Source: Global Economic Data as of July 13, 2004
500
400
300
200
100
0
Jan-01
Nov-01
Peru
Colombia
Oct-02
Brazil
Ecuador
Aug-03
Jul-04
Source: Global Economic Data as of July 13, 2004
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However, investment conditions in the Latin American
power sector differ significantly across countries
Investment environment
Less favorable
More favorable
Credit rating
Brazil
Mexico
Argentina
Venezuela
Chile
Peru
Ecuador
Bolivia
B2/B+
Baa2/BBB-
Caa1/SD
Caa1/B-
Baa1/A
Ba3/BB
Caa1/CCC+
B3/B-
Regulatory Outlook
Local ECM
Local DCM
Valuation level
Buyers' appetite
The power sector is particularly affected by political uncertainty, social
problems and economic volatility
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Finding the “right” risk/reward balance will continue
to be the challenge for power sector players
Country risk versus electricity consumption growth
10.0%
Peru
22,000 GWh
Electricity consumption
1995—20025 CAGR (%)
9.0%
8.0%
DR¹
5,400 GWh
7.0%
Venezuela
95,700 Gwh
6.0%
5.0%
4.0%
Brazil
342,300 GWh
2.0%
1.0%
0.0%
6000
1200
Panama²
3,800 GWh
Argentina
84,800 GWh
3.0%
1000
800
600
Chile
43,700 GWh
Colombia
45,200 GWh
400
Mexico
160,200 GWh
200
0
EMBI + SOT (bp)
Source: CIER, SENER, OLADE, ARIAE; electricity consumption data as of 2002; EMBI+ data as of July 14, 2004
1 DR growth from 1999 to 2002
2 Panama growth from 1995 to 2001
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Country/ regulatory risk is the main factor affecting
implied multiples across countries
Illustrative comparison based on theoretical company with different domicile
Theoretical company
Country 1
Country 2
Country 3
Country 4
100.0
100.0
100.0
100.0
EBITDA
45.0
45.0
45.0
45.0
Depreciation
12.0
12.0
12.0
12.0
= EBIT
33.0
33.0
33.0
33.0
Tax rate
40.0%
17.0%
33.5%
35.0%
Capex
12.0
12.0
12.0
12.0
= FCF
Fundamental valuation
19.8
27.4
21.9
21.5
2.0%
3.0%
3.0%
4.0%
0.0%
1.0%
4.9%
7.1%
7.1%
9.1%
11.5%
13.4%
397
466
265
238
45
45
45
45
8.8x
10.3x
5.9x
5.3x
Sales
1
FCF expected growth (g)
2
Country risk
3
Discount rate (WACC)
Firm value: FCFt+1/(WACC - g)
Implied FV/EBITDA multiple
EBITDA
FV/EBITDA
1
2
3
JPMorgan estimates for perpetuity growth rates
SOT over UST10
Calculated based using a 0.8 unlvered beta, 40% debt/total capital. Pre-tax costs of debt calculated using a 100bp spread over each
adjusted risk free rate
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Valuations have gradually recovered driven by the
improved external perception of the region and
increasing local investor’s appetite
Valuation drivers during 2002 - 2003
Valuation drivers for 2004
Reduced country risk/
FX appreciation
Increased country risk/
FX volatility
Increasing
asset
prices
Depressed
asset
prices
Strategic players
facing liquidity
crisis
Limited number
of buyers
Strategic players’
improved financial
condition
Strategic players response
More balanced
supply/demand
of assets
Strategic players response
New strategies focused on domestic markets
Renewed focus on portfolio optimization strategies
Market signaling of plans to reduce emerging market’s exposure
“Wait and See” approach in general
Restructuring of portfolios
Increasing willingness to take advantage of highly liquid local markets
Balance sheet impairment through FX and goodwill adjustments
Optionality approach towards non-core investments with tough exit
alternatives
Limited number of M&A transactions due to
significant bid/offer price gap
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Highly liquid local markets become an important
alternative to reduce exposure to the region
9
Local groups, financial sponsors and the public market
are becoming important players in the utility sector
Selected transactions
%
Purchase price
EBITDA
acquired
(US$mm)
multiple
99%
N/A
N/A
9%
122
10.9x
Argentina
28%
14
N/A
Generation
Argentina
7%
10
N/A
29%
N/A
N/A
53
N/A
Date
Acquiror
Target
Seller
Sector
Country
Apr-04
CDC
Cobee
NRG
Generation
Bolivia
Mar-04
Market
CGE
PPL Global
Distribution
Chile
Mar-04
Dolphin
Transener
National Grid
Transmission
Costanera
Southern
Management
Mar-04
Sebastian Pinera
& other
Cone
Feb-04
Darby Overseas
Termobarranquilla
First Energy
Generation
Colombia
Feb-04
Enersur
Yuncan (under
Peruvian
Generation
Peru
100%
(Tractebel)
construction)
government
Dec-03
Pacific Hydro
Coya/Pangal
Codelco
Generation
Chile
100%
76
N/A
Nov-03
Quiñenco
ESSAN
Government
Water
Chile
100%
188
7.6x
Water
Chile
100%
86
8.1x
Water
Chile
100%
26
5.9x
(CORFO)
Dec-03
Hurtado
ESSCO
Government
(CORFO)
Dec-03
Hidrosan
EMSSAT
Government
(CORFO)
Nov-03
SNPower
Cahua/Pacasmayo
NRG
Generation
Peru
100%
N/A
N/A
Oct-03
Grupo Hurtado
ESVAL
Anglian Water
Water
Chile
45%
82
8.6x
May-03
JPMPartners /
Emdersa
First Energy
Distribution
Argentina
100%
N/A
N/A
HSBC Power fund
Mar-03
Grupo Matte
Canutillar
Endesa
Generation
Chile
100%
174
7.8x
Mar-03
CGE
Rio Maipo
Enersis
Distribution
Chile
100%
170
12.0x
Mar-03
Hydro Quebec
SING Transmission lines
Endesa
Transmission
Chile
100%
110
N/A
Source: Publicly available information
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Key considerations when assessing the attractiveness
of the Latin American power sector
Political stability
Macroeconomic stability
Treatment of foreign investment
Contract enforceability and creditors’ rights
Financing availability
Regulatory stability
Growth prospects
Availability of investment opportunities
Opportunity cost
Growth potential is not necessarily the only key driver of
investment decisions
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Current trends in the Latin American power sector
Strong outlook for power consumption
Strong performance of companies under tough operating and financial conditions
World class assets and strong management
Companies with financial difficulties addressed them in a manner satisfactory to investors
Certain international companies implementing exit strategies
Capital allocated to non-core markets
Companies with no hurry to exit could pursue optimization strategies in the interim
Unwillingness to take significant write-offs
Waiting for a better time to sell given depressed assets’ valuation
Players with uncertain strategies following a “wait and see” approach
Not sure of pursuing an exit strategy
Believe that “the worst” has already happened in the region
Pursue optimization of portfolio
Still attracted by the growth potential of the market
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Current trends in the Latin American power sector
(cont’d)
Companies with a long-term strategy
Potential to become sector “consolidators”
Restructure and refinance their portfolios
Divest non-controlling positions
Partner with local companies
IPO/Secondary offerings
Increasing participation of local players
Different risk-reward profile vis-a-vis that of international players
Increasing interest of financial sponsors
High return expectations
To-date, mainly focus on distressed assets requiring low upfront investments
Increasing role of the local capital markets
Significant liquidity in some markets
Attractive conditions for raising both equity and debt
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Key challenges for the Peruvian power sector
Maintain a positive political and macroeconomic outlook
Attract private capital to fund significant infrastructure requirements
Continue privatization/concession processes
Develop and maintain a reliable regulatory framework
Independent regulatory entities
Political and social agendas should not interfere with the development of the sector
Importance of a transparent and fair setting of tariffs, attractive enough to promote
further investment
Address challenging social concerns through well structured measures
Importance of attracting foreign investment
Company’s cost of opportunity
Why Peru vis-à-vis other countries?
Leverage on companies already present in the country
Continue supporting the development of the local capital markets
Become a reliable player in energy integration with other countries
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