From Karachi Electric to Shanghai Electric

Iqbal Hashmi
Experienced business leader

Karachi Electric Supply Company - KESC was sold to Saudi Al-Jomaih Group in 2005 at a price of 260
million dollar or 15.86 billion rupees in 2005. The opposition leader in Sindh Assembly Nisar Ahmed
Khuhro raised the voice against then Federal Minister for Privatization and Investment Dr. Abdul Hafeez
Sheikh, military led management of KESC and Prime Minister Shaukat Aziz for selling KESC at a throw
away price. He also criticized criminal silence of MQM on the issue. Mr. Khuhro raised five major concerns
at that time:

1. Selling of KESC at a very low price. According to his statement in Sindh Assembly KESC assets were of
80 Billion rupees worth and account receivables alone of KESC at the time of sale was 22 billion Rupees.

2. Government under the pressure of World Bank and other donor agencies privatized KESC without proper
homework and this will only increase the size of begging bowl in future against the false claims of the
government.

3. 19,000 employees of KESC will suffer and unemployment will increase as deal didnt protect employee
rights.

4. Power tariff will increase causing undue pressure on consumers.

5. Small and medium sized industries will close down as a result of loss of competitiveness because of rise
in electricity prices for commercial users.

Time proved the legitimacy of the concerns raised by Mr. Khuhro back in 2005. A consortium led by
Kanooz Al Watan with Siemens as technical partner offered the highest bid of Rupees 1.63 per share for 9.7
billion ordinary shares of KESC and were declared successful for being above the minimum acceptable
price or reference price of 1.3 Rupees. KESC was thus sold at a total price of 15.85974 billion rupees to Al-
Jomaih Group who was the actual bidder in the consortium. The second seven-member consortium led by
local investors Hassan Associates offered Rs1.01 per share or Rs9.7081 billion for 73 per cent ordinary
shares of KESC.

Few points are worth mentioning here on the sale KESC by Privatization Commission of Pakistan:

1. Why Hassan Associates submitted a bid below minimum acceptable price? Technically KESC was sold to
single bidder as Hassan Associates didnt qualify as a bidder for quoting below reference price.

2. Why reference price was set at such a low value? KESC in 2005 was having mostly thermal based 1800
MW installed capacity with 1200 MW generation capacity. Just for comparison purpose, the HUBCO Board
approved the 225 MW capacity Narowal Power Plant in 2007 at an estimated cost of Rupees 24.276 Billion.

3. Aljomaih Holding Company is an industrial conglomerate with a diversified portfolio of manufacturing,

beverages, real estate, investment, automotive services, and heavy plant equipment industries primarily in
Saudi Arabia. Aljomaih Holding Company was not having expertise in power generation at the time of
acquisition despite being 150 years old company. Prequalification criteria set for KESC is thus a big
question mark.

4. Why a lucrative monopoly was sold on the basis of asset valuation and share price in the market? Why
future earning potential was not used as a basis?
Inexperience of the company became evident in the first year of operation when company failed to manage
generation and distribution problems. The company was facing a disastrous situation as it failed in its efforts
to improve the financial and operational position. In couple of years they started to look for a buyer and in
2009 The Abraaj Group purchased the equity of KESC at a price of 361 million dollar or 30 billion rupees
with full management rights. In 2009, it was Pakistan Peoples Party Government. In Musharraf era they
were critical on the sale of KESC then it is interesting that in the era of PPP, KESC was sold to another
group who was having no expertise in power generation and distribution. The Abraj Group is a private
equity firm operating mostly in high growth markets. Private equity firms have expertise in acquiring an
under- valued company, improving managerial and operational efficiency to an optimum level and selling it
when a reasonable profit level is achieved. This is what the Abraj Group exactly did. They changed the
senior and middle management, right sized the organization, brought efficiency in distribution and
operations mainly through outsourcing and cost cutting, divested non-productive assets and as a result of
turnaround efforts converted KESC into Karachi Electric a profitable organization.

In terms of business turnaround and financial performance, Abraj Group proved its inherent expertise by
improving net profit from -14.1% to sales in the first year of acquisition to 14.9% in 2015. Similarly, return
on equity of KE improved from -46.8% to 22.1% in 2015, revenue increased by 83% and profit after tax
increased from a loss of 15 billion rupees in 2010 to a profit of 28 billion rupees in 2015. Compared to 83%
increase in revenue in 5 years, increase in units generated is only 17%. Financial objectives from the
perspective of a private equity firm were achieved and with the improvement in financial indicators, KE was
sold to Shanghai Electric at a price of 200 billion rupees at seven times profit of 2015. For a private equity
company besides earning cumulative profit of 26 billion rupees (profit for the financial year 2015-16 not
included) from operations and getting a final price of 200 billion rupees on 30 billion rupees investment six
years ago is a big fortune.

Acquisition of KE by Shanghai Electric is being perceived negatively because of the fact that business of
local manufacturers and suppliers of KE will suffer badly but in broader perspective there are several key
advantages for local consumers of electricity:

1. KE has been acquired first time by a multinational company known for its expertise in efficient power
generation and distribution.

2. Shanghai Electric is also manufacturers of capital equipment related to power generation.

3. Electricity will be available at a lower cost to local consumers.

4. Shanghai Electric has announced investment of 1000 billion rupees in power sector which means in future
consumers in Karachi will get rid of load shedding.

5. Unlike private equity firms, Shanghai Electric will focus on long term stay in the market and will invest
accordingly.

6. Competitiveness of commercial users will enhance with the passage of time due to availability of
electricity at a lower cost which will increase employment.

7. Difference in the perspectives of predecessor and successor is clear. Predecessors purchased KESC as an
undervalued company and made fortune through turnaround of the company, whereas the successor
purchased the company at fair market value considering the strategic importance of the long term investment
opportunity in an underutilized company having tremendous growth prospects.

Some analysts are also of the view that Chinese investment in KE will not create jobs for the locals as they
prefer to bring employees from home country. It is practice of European and Japanese companies as well
that generally they prefer to fill in top management positions with home country employees. This is
necessary for smooth running of operations in coordination with parent company at least in the initial years.
Middle management and staff positions can't be filled with foreign employees because of the cost escalation
hence these opportunities will be available to competent locals. Gradually when confidence level of parent
company will enhance because of the performance of mid career managers then in due course of time they
will make their way to top management positions. Locals will also get ample exposure to technology and
professional training which will create positive spill over effect in the economy.

A new breed of China based manufacturers, distributors and suppliers will also develop to provide supply
chain support for the 10 billion dollar planned investment. One may argue that our economy will become
dependent on China but we need to look at this argument with a realistic approach. First, competence of our
government is evident from the fact that they are willing to outsource even daily garbage pick up to foreign
companies and people of Pakistan are also are in favor because of the expected efficiency of operations.
Second, our businessmen themselves are not willing to invest in the economy with the long term vision
because of variety of reasons. Third and most important is the fact that it will not be wise if we do not take
advantage of the economic growth happening in China. Economy of peripheral countries like Indonesia,
Malaysia, Thailand and Vietnam grew because of the positive fall out of the economy of Japan. As
competitive advantage is a dynamic concept and it changes with time therefore, in due course of time China
will not remain competitive in certain sectors and will try to shift it to other low cost countries and we as
good neighbors should be able and competent to take advantage of that. After all why China is investing in
Energy sector in Pakistan? It is just because of saturation and diminishing returns in their own market.

With the passage of time, Shanghai Electric will add reliability in operations and thus businesses will not be
required to put additional capital investment and operational expense in diesel/gas generators. Business of
diesel/gas generators importers and UPS suppliers will continue to shrink but if because of structural
changes in the economy those suppliers will weed out who are promoting inefficiency in the system then in
the long run this will serve the interest of consumers in general and economy in particular. There is also a
possibility that some other local suppliers and manufacturers will not be able to survive in this situation but
the question is for how long consumers and tax payers should pay for their incompetence? In strict economic
terms and from consumer perspective it makes no sense at all.