Sunday, September 18, 2005

A Place in the Sun


By ERIC J. SAVITZ


SUNSHINE IS FREE. That simple fact is what gives the solar-power business so much allure. You don't have to extract it from the ground, it's not subject to embargos, it's nonpolluting and if the supply ever ran out, we'd have a bigger problem than high gasoline prices. On the surface, at least, it certainly seems like an obvious way to address some of the economy's ongoing energy problems.

It's also well understood: America has been tinkering with solar power for decades. In a symbolic act during the 1979 energy crisis, Jimmy Carter installed solar panels on the roof of the White House. (He also urged us to wear more sweaters.) But as the crisis faded, so did interest in solar. After Ronald Reagan and his brown suits moved into 1600 Pennsylvania Ave., the White House solar panels were removed -- and solar power resumed its previous position as a technology considered more suitable for calculators and pool heaters than powering the grid.

But with talk growing of a new energy crisis, thanks to record prices for crude oil and gasoline, solar companies have been attracting renewed attention. Michael Rogol, an analyst with CLSA Asia-Pacific Markets who tracks the global solar market, says the stocks in the sector are up about 150% over the past 12 months. Wall Street is ramping up to slake the thirst for solar stocks with more supply: SunPower, a subsidiary of chip-maker Cypress Semiconductor, has filed to come public, as has Q-Cells, a large, fast-growing German solar-cell company that Rogol calls "the Netscape of the solar sector." Another large player, Norway's Renewable Energy Corp., or REC, has also said it plans an IPO.

Encouraged by this new enthusiasm for the sector in the public markets, venture capitalists have been funding a steadily increasing number of solar-related start- ups, sinking more than $100 million into new solar companies in the first half of 2005. (See table: The Next Generation.) The recently passed energy bill provides some modest incentives for solar power, and many states have installed solar-friendly tax incentives of their own.

While solar represents a tiny percentage of global power generation, it is growing rapidly. Worldwide, solar power production this year should reach 1.5 gigawatts, double the 2003 level. By 2010, according to CLSA, the total should quadruple to six gigawatts. Industrywide revenue, the firm predicts, will grow from $11 billion this year to $36 billion in 2010.

Now that's some nice, Google-style growth. But investing in the sector isn't easy. Many of the biggest producers of solar cells are actually divisions of much larger companies -- BP, Sharp, Shell, General Electric -- that you'd hardly consider pure plays. And most of the more focused solar companies, with a few exceptions, are still private or trade outside the U.S.

Meanwhile, just as demand seems poised to take off, the solar industry finds itself grappling with a shortage of polysilicon, the raw material used to create both silicon cells and semiconductors. At least for the next few years, the industry's growth rate will be muffled not by any shortage of demand, but rather by insufficient supply. In all, finding good investments will require ingenuity.

The basic idea of solar power is simple. Energy from the sun strikes a silicon panel, releasing electrons and creating electricity. Those panels are connected together in modules, which can provide power standing alone or hooked into the electrical grid. One of the standard, but magical, pitches made by solar equipment providers is the image of your electricity meter running backwards: When the sun is shining and demand for power is high, you can be selling power back to the grid, while others buy it.

[Sun]
The Bottom Line: Though solar stocks have surged over the past year or so, some could rise further. Some analysts think MEMC, the largest-capitalization play on solar, could jump another 50%.


What's not so simple is the economics of solar power. For starters, while the sun's energy is abundant, it isn't available 24/7. (You may be familiar with a fascinating natural phenomenon known as "night," and another frequent but less predictable factor called "clouds.") Ergo, solar power is more practical in some places than others. Also, silicon panels are rather inefficient: Most of the potential energy in sunshine is lost. So to create meaningful amounts of electricity from solar panels, you need lots of them.

The good news is that as the industry has grown, the retail cost of solar energy has dropped an average of 6%-7% a year for the past 15 years, says Rhone Resch, director of the Solar Energy Industries Association, a trade group. Within 10 years, Resch says, solar should reach parity with the average retail electricity price.

"This is not your grandpa's solar," says Ron Pernick, the principal of Clean Edge, a Portland, Ore.-based research firm. He figures the costs of production have been dropping about 18% for every doubling of output -- and output is doubling every two or three years. Still, the industry isn't at parity yet. Resch says solar power, at 22-23 cents per kilowatt, costs about twice as much as the average retail price of electricity in the U.S.

Keep in mind, too, that installing a solar system requires a large upfront capital investment that may require some creative financing. Putting a solar system on your roof with enough cells to run your house could set you back $25,000-$30,000. You do get to lock in costs, though: Resch likens it to buying a car and paying for 25 or 30 years of gasoline upfront.

One small company, Sun Edison, has set up an intriguing scheme where it places solar systems on the flat roof of a supermarket or big-box retailer, then sells the power back to them. The equipment itself is owned by an investor -- in each of the four installations they've completed, it's Goldman Sachs -- which benefits from tax incentive programs. Sun Edison's payoff comes years from now as it gradually buys back the equity and associated income in the equipment.

Fortunately for the solar-power industry, a number of state and national governments have decided that there is a public good in developing alternatives to fossil-fuel based energy production, and have installed lucrative subsidy programs designed to overcome the cost differential.

The most substantial incentives have been offered by Japan and Germany. While neither country is among the world's sunnier climes, both have become the global leaders in solar power. So it should be no surprise that many of the more successful publicly held solar companies are traded in Frankfurt or Tokyo, not New York. (See table: Sunny Prospects)

For domestic solar advocates, that situation is a source of no little frustration. "Our resources are orders of magnitude better," sighs the trade group's Resch. "But Germany has created the best incentives in the world." Germany's policy, designed to reduce the country's reliance on fossil fuels, provides a fixed payout of about 54 cents per kilowatt hour for as much power as you can produce.

Rick Feldt, CEO of Evergreen Solar, a Marlboro, Mass., solar-cell company, complains that the incentives in the recently passed federal energy bill provides little help. He notes that the bill offers only two years of tax credits, with no assurances after that -- not enough to get manufacturers to commit investment capital in the business.

In the U.S., the industry suffered a blow recently from the demise of California Gov. Arnold Schwarzenegger's so-called Million Solar Roofs initiative, which would have provided substantial incentives in the nation's largest state for both residential and commercial buildings. Though the measure passed easily in the state Senate, it fizzled after the governor threatened a veto over amendments to the bill in the state Assembly that would have required solar-installation work to be handled by licensed electricians at the prevailing union wage rate. The governor lately has talked about stepping around the legislature via the adoption of similar incentives through the state's Public Utility Commission.

WHILE THE STATUS OF THE CALIFORNIA MEASURE is important, the talk of the solar industry is the ongoing shortage of polysilicon, the raw stuff used to manufacture photovoltaic cells. For many years, the only real use for that particular material was to make silicon wafers for the semiconductor industry; the solar industry's needs were minimal. But not anymore.

Thanks in no small measure to the incentive programs in Germany and Japan, solar-cell demand has expanded 40% or more for several years running, versus 20%-25% in the past. The result is that by 2006 almost half of the world's polysilicon supply will be soaked up by the solar-cell makers. Richard Winegarner, proprietor of consulting firm Sage Concepts, says the market is about 10% short this year, with the solar-cell industry, and not chip makers, absorbing most of the resultant pain.

"I can't find a data point anywhere that shows anything other than a very real shortage of polysilicon that is going to get worse over the next two or three years," says Paul Leming, an analyst with Princeton Tech Research. "It would take a solar-panel market collapse to bring any slack capacity to the polysilicon business any- time soon."

Not surprisingly, polysilicon prices have soared: Winegarner says contract pricing has moved from about $32 a kilogram to $45 since 2003. Spot pricing, depending on whom you ask, is running $60-$80 a kilogram, though Winegarner notes that there is "essentially no volume" in the spot market. "The industry has already wrung out every nook and cranny of inventory and scrap," he says.

The world's polysilicon makers are working frantically to add capacity, but supply is unlikely to catch up for a while. Optimists think the shortage could be cured by 2007. Neil Gayle, coordinator of the Critical Materials Council of Sematech, a chip-industry consortium, thinks there could be shortages though 2009.

The bottom line is that there won't be enough solar cells to meet demand for at least the next several years, potentially triggering a supply crisis for some smaller players that lack contractual supply arrangements with polysilicon producers.

The chip industry has expressed its own concerns about the potential for the shortage to slow the electronics business. But this is a lot bigger problem for solar-cell companies than for the chip industry: While silicon represents less than 1% of the cost of semiconductor products, they account for more than 30% of the raw-material costs for solar cells. A doubling of silicon pricing wouldn't mean much for chip makers, but it would be a big problem for the solar business, which must hold down costs to compete with conventional power.

The obvious play on the polysilicon shortage is MEMC Electronic Materials (ticker: WFR), a St. Peters, Mo., company that is one of the world's largest producers of silicon wafers. Unlike some of its rivals, MEMC produces most of its own silicon feedstock, and in fact sells some excess supply back into the market. The result is that MEMC benefits from soaring wafer pricing without suffering the associated increase in raw-material pricing. MEMC shares have doubled over the past year, to a recent $19.79, boosting the company's market capitalization to about $4 billion. That makes MEMC the largest-cap play on solar growth.

And there may still be some juice left in MEMC shares. Leming of Princeton Tech Research thinks the stock could move up another 50%, and says he can "sketch a scenario where it can double or triple from here," noting that the company trades for only about 12 times expected 2006 earnings of $1.56 a share. Profits at that level would be up 39% from an expected $1.12 a share this year. And this, by the way, is for a company that does not yet do much direct business with the solar industry. Leming thinks MEMC could eventually cut a deal with solar-panel makers to provide dedicated wafer supplies. If so, Lemming says, the growth could lift the stock to $50.

MEMC ranks fourth in the world in polysilicon capacity, behind Hemlock Semiconductor, which is partially owned by Dow Corning. Third on the list is the other potential wafer investment, Japan-based Tokuyama. Also in the top five are Wacker Chemie, a privately held German chemical conglomerate, and Advanced Silicon Materials, which was recently sold by Japan's Komatsu Electronic Metals to Renewable Energy Corp., the Norwegian solar-panel maker. The purchase of Advanced Silicon by REC, which as noted is planning an IPO, assures the company of sufficient silicon supplies.

Then there's SunPower, the Cypress subsidiary now in registration to come public. It is losing gobs of money -- for the first half of this year, it lost $13.6 million on revenues of $27.3 million. But the company is attracting considerable interest for its highly efficient solar cells: The company claims in its SEC filings that it generates up to 50% more power per unit of area than conventional cells. In an industry where driving costs lower is a key to long-term success, SunPower should attract eager buyers.

The only current domestic pure-play solar option is Evergreen Solar (ESLR) of Marlboro, Mass. -- and it has some similar attractions. Evergreen shares have increased sixfold over the past 18 months. The company uses a novel process for generating solar cells that it claims uses 35% less silicon than conventional manufacturing processes. That should give Evergreen an edge in the race to reduce costs. And CEO Rick Feldt says the company has a pilot project that would cut the silicon used per wafer by another 50%.

WHILE CERTAINLY THE STREET IS ENAMORED of Evergreen's technology, analysts are equally enthused about its joint venture with Germany's Q-Cells. The two companies are building a new solar-cell manufacturing plant near Q-Cells' headquarters in Thalheim, in eastern Germany. The plant will dramatically increase Evergreen's capacity, adding 30 megawatts of cell production to the 15 megawatts it can produce at its own factory in Massachusetts. Feldt thinks the German plant will be far more efficient than the company's domestic plant, perhaps generating $100 million a year in revenue with gross margins of 30%-35%. Assuming the plant comes on stream as expected, Feldt says, the company should turn profitable on a run-rate basis sometime in 2006.

Moreover, Feldt says that if the German venture is successful, the partners would increase their production to as much as 120 megawatts. And if that happens, he says, the joint venture could add additional capacity in other locations. If that all plays out, says J. Michael Horwitz, an analyst at Pacific Growth Equities, "it could be one of the better stocks in 2006." And if the German project has problems? Then so will the stock.

CLSA's Michael Rogol, a big Evergreen fan, in a report earlier this year, listed a total of 15 solar stocks to buy. Many are outside the U.S.: Kyocera, Sharp and Sekisui Chemical of Japan; Thailand-based Solartron; Motech of Taiwan; Carmanah and ATS in Canada; and Germany's Conergy and SolarWorld.

The global range is a reflection of the fact that, unlike oil or gas or coal, producing energy from the sun is about creative engineering and -- at least for the moment -- bold government policy, not geographic advantage. No one is going to discover a new source of sunlight, but it's possible to figure out better ways to use it. Anyone can get in the game. Even America.

Tasty Outlook

Barron, By ANDREW BARY


ASSET-RICH NESTLÉ IS STARTING TO ATTRACT greater U.S. investor interest, due to the strength of its global food business, an increasingly shareholder-oriented management and the huge combined value of its stakes in Alcon, the world's top eye-care company, and international cosmetics colossus L'Oréal. Nestlé's U.S.-listed shares (ticker: NSRGY) have risen 9%, to 72, this year, but they still could have significant upside because the Swiss giant is a bargain relative to other major food companies when its Alcon (ACL) and L'Oréal (12032.FR) stakes are stripped out. This makes Nestlé an attractive sum-of-the-parts story. - The shares trade for a moderate 17 times projected 2005 profits of $4.15, but Nestlé's 2005 price-earnings ratio is just 12.7, excluding the market value and earnings contribution of its Alcon and L'Oréal holdings. That's a cheap price for the world's largest and, arguably, best-positioned food company. Nestlé has exposure to fast-growing products like bottled water, pet food and ice cream, as well as the industry's most extensive presence in the developing world, where the growth outlook is better than in the mature Western Europe or U.S. markets. Nestlé gets almost 30% of its sales in Latin America, Asia and Africa. Nestlé's 2005 P/E, adjusted for Alcon and L'Oréal, is much lower than the average multiple of 16 for major U.S. food stocks like Kraft (KFT), General Mills (GIS) and Kellogg (K). The American depositary shares of France's Groupe Danone (DA), meanwhile, at their recent price around 22, have risen 21% this year and fetch a rich 22 times estimated 2005 net income amid continued speculation that PepsiCo is interested in buying the company.

The global food industry clearly faces challenges, including the growth of discount retailers in the U.S. and Europe, the rising popularity of private-label brands, limited pricing power, the trend toward eating away from home, as well as rising commodity and packaging costs. Food tastes differ widely around the world, making it difficult for companies to develop truly global brands. Among the limited number of goods with worldwide appeal are coffee, chocolate, soda, scotch and cigarettes. Food remains one of the most fragmented businesses in the world. Nestlé's No. 1 position and $74 billion in annual sales translates into just a 2% share.

Highlighting the troubles in the food business are the struggles of Kraft, General Mills and Campbell Soup (CPB) to generate growth in both sales volume and profits. Kraft stock, at 31, is back where it stood at its initial public offering in 2001.

Nestlé has performed well since chief executive Peter Brabeck, 61, took over in 1997: The Vevey, Switzerland-based company has delivered 5.7% organic revenue growth -- 7%-plus, if acquisitions are included. That's impressive by the food industry's slow-growth standards. Nestlé shares have doubled since 1997, but haven't risen much in recent years.

Bulls are betting that Nestlé will hit its goal of 5% to 6% annual organic revenue growth, which could translate into yearly profit gains around 10%, based on a widening in Nestlé's profit margin, now at 12%, and share buybacks. During the first half of 2005, organic revenue growth was 5.2% and earnings were $2 a share, up 11% from the level in the same period a year ago. The company also pays out about 40% of profits in dividends, and typically lifts payouts annually. The current yield is 2.2%.

Several analysts covering the 139-year-old Nestlé see modest upside potential of 10% to 15% in the next 12 months. The appreciation could be much greater over the next few years if Nestlé's financial performance stays strong and its story becomes more widely known.

Andrew Wood, a Sanford Bernstein analyst, has come up with a sum-of-the-parts value on Nestlé of around 480 Swiss francs per share, or $95 for the U.S.-listed shares. The Swiss shares traded Friday at 367 Swiss francs. Each U.S. share equals a quarter of a Swiss share.

Nestlé's fans like what they see in its food business and its not-so-hidden other assets. "We used to see Nestlé as a slow-moving animal that was less concerned with driving profitability than in getting bigger," says David Herro, manager of the Oakmark International Fund, a Nestlé holder. "Quietly, and somewhat masked by currency swings, there has been a change in emphasis to running top-notch businesses focused on returns, not on size," says Herro. He maintains that the shares could rise at least 50% over the next few years.

Nestlé offers a hedge against a weakening dollar, because its underlying shares are denominated in Swiss francs, historically one of the world's strongest currencies. The downside: A stronger franc crimps reported revenue and profit growth. This happened last year when the dollar weakened.

MEANWHILE, "NESTLÉ'S MANAGEMENT ACTS as if it were a family company. They look out generationally," says Thomas Russo, a partner at Gardner, Russo and Gardner, a Lancaster, Pa., investment firm that has a position in Nestlé. Russo happily notes that Brabeck talks about an investment time horizon of 35 years.

Russo also points to Nestlé's success in China, where it has $1 billion in annual sales and is the largest foreign food company. Overall, Nestlé's sales dwarf those of its rivals. Kraft, the No. 1 U.S. food maker, probably will have 2005 sales of $33 billion, less than half Nestlé's.

The Swiss company's scale is enormous. It operates in more than 100 countries, runs 500 factories and employs 247,000 people. Its products include Stouffer's frozen foods, Nescafé coffee, Dreyer's and Häagen Dazs ice cream, plus Poland Spring, Perrier and San Pellegrino water. Nestlé is the leading global maker of infant formula, the No. 1 pet-food maker, and a major chocolate producer. Nestlé generates about 60% of its sales from six key brands: Nestlé, Nestea, Nescafé, Purina, Maggi and Buitoni.

Table: Hidden Value

The Nestlé story still isn't well-known in the U.S. investment community. One of the major reasons: The shares are traded on the Pink Sheets, limiting institutional ownership and research coverage. As an over-the-counter stock, Nestlé is less liquid and carries a lower profile than the shares of such other major European companies as BP, Royal Dutch Shell, Vodafone and Unilever, which are New York Stock Exchange-listed. Average daily volume in Nestlé's American depository receipts is modest, at about 150,000 shares. The Swiss shares are more liquid.

A Pink-Sheet listing means investors can't find Nestlé's share price in newspapers, although quotes are easily available online through Yahoo!, Dow Jones' MarketWatch and other sources. It reports results semi-annually, and they conform to Swiss accounting standards.

Nestlé could easily meet NYSE listing requirements by reporting its results based on U.S. accounting standards in addition to Swiss standards, but has opted not to. "We don't perceive any benefit," says a Nestlé spokesman, noting that there are an ample 100 million U.S. ADRs outstanding; Brabeck wasn't available to speak to Barron's.

The listing issue doesn't bother Russo. "Nestlé's accounting is perfectly sufficient for me. U.S. GAAP isn't the only pure standard of accounting."

While there may be a strong asset story here, there isn't yet a break-up story. Nestlé management has shown no willingness to part with its 75% interest in Alcon, now valued at $28 billion, or its 27% interest in L'Oréal, now worth $14 billion. Those stakes account for almost 40% of Nestlé's $111 billion market value. Our calculation doesn't reduce the value of the Alcon and L'Oréal interests to account for any capital-gains taxes. Both Alcon and L'Oréal have been phenomenal investments for Nestlé since they were made in the 1970s. The big Swiss food outfit acquired Alcon for $276 million, and it paid a similar amount for its one-quarter stake in L'Oréal. While it's unclear whether Nestlé would pay any tax on the sale of either holding, it's notable that the Swiss didn't require any tax to be paid when Nestlé sold 25% of Alcon in a 2002 U.S. initial public offering.

Under an agreement with the Bettencourt family, a key L'Oréal shareholder, Nestlé can't buy additional L'Oréal shares before 2007 at the earliest, or sell or transfer L'Oréal stock through 2009.

No such restrictions exist with the Alcon stake. Alcon is a low-profile but phenomenal success story. It sells a range of eye-care products, including treatments for glaucoma, cataracts and infections; intraocular lenses; contact-lens solution; and artificial tears. Its shares have surged to 121 from 33 at the 2002 IPO. Alcon, however, isn't cheap, selling for 35 times estimated 2005 profits. Its $38 billion market value is equal to a stiff eight times annual sales.

Many U.S. investors are biased against European companies because they consider them weakly managed, relative to their American counterparts, and less oriented toward shareholders' interests. Just compare top-notch Procter & Gamble (PG) to its European rival, Unilever (UN) -- which only recently seems to have righted itself after years of restructurings.

Among the knocks against Nestlé is that it's too European, too long-term-oriented, too bureaucratic and too difficult to understand. And Brabeck, a 37-year Nestlé veteran, may not have the charisma of Gillette CEO Jim Kilts, or Hershey's Rick Lenny. That's on purpose. Brabeck has contrasted Nestlé's more deliberate management approach with the CEO-fixated "Anglo-Saxon" style, in which new chief executives often feel the need to shake up their organizations. "I get the feeling that in the Anglo-Saxon environment, the company is at the service of the CEO. At Nestlé, the CEO is at the service of the company," Brabeck said at a June investor conference.

By food-industry standards, Nestlé invests heavily in research and development, as it seeks to transform itself into more of a "health and nutrition company." One of its innovations is Dreyer's Slow-Churned ice cream that has half the fat and 25% fewer calories than regular Dreyer's (also sold as Edy's), yet has a premium-quality taste. Nestlé has shown that being environmentally friendly can pay off. It cut its water use by 37% in factories and energy consumption by 24% per unit since 2000. This plays well in eco-friendly Western Europe.

[foods]
Nestlé has focused on water, ice cream and pet food. It's also a big producer of frozen foods.


Brabeck has countenanced one American innovation: a share buyback: Nestlé began its first repurchase program in July. It's admittedly modest, at 1 billion Swiss francs ($800 million), and is due to end at the close of 2005. But Nestlé has vowed to step up the buybacks in 2006. Analysts estimate that the buyback could total 2 billion Swiss francs in 2006 and perhaps 4 billion francs in 2007. A Swiss franc is worth about 80 U.S. cents.

Another rap against Nestlé is that it's always on the verge of a major, dilutive acquisition. The reality is that Nestlé has shown restraint in recent years. Its last major purchase came in 2002, when it paid $2.6 billion for Chef America, the maker of Hot Pockets frozen foods. Wolfgang Reichenberger, Nestlé's chief financial officer, has said that Nestlé "doesn't see a major acquisition in front of us." Brabeck says that in several critical areas, like pet food, water and U.S. ice cream, Nestlé has all the scale it needs.

The lack of a major deal has allowed Nestlé to begin its repurchase program because the company has been able to pay down debt related to prior acquisitions with its ample cash flow. Nestlé has an old-fashioned attachment to its prized triple-A credit rating. Net debt, now a very manageable $10 billion, had to come down before Nestlé would consider a buyback program.

For all the criticism of Nestlé's acquisitive ways, its three big deals this decade, Ralston-Purina, Chef America and Dreyer's, have turned out pretty well. The $10 billion Ralston deal, completed in 2001, nearly doubled Nestlé's sales in the high-growth pet food market. The company was shrewd enough to put the management of its entire global pet-food business in the hands of Ralston's talented team, based in St. Louis.

Nestlé's profile on Wall Street has risen somewhat in the past year, for an unfavorable reason. The company got into a well-publicized spat with some big institutional investors over whether Brabeck should also assume the role of chairman, following the retirement of Rainer Gut from that post earlier this year. Nestlé prevailed, in what really amounted a tempest in a teapot, or perhaps a coffee pot. (Nestlé is one of the world's largest coffee makers with its Nescafé brand.)

It's true that Nestlé historically has separated the roles of chairman and CEO, and many companies are deciding that one person shouldn't wear both hats. Yet Brabeck's wish to hold both jobs for a limited time hardly seems an affront to good corporate governance. Nestlé is expected to name a new CEO in several years, while keeping Brabeck as chairman.

OPERATING IN EUROPE, Nestlé doesn't have the same flexibility that American companies do to shut factories and lay off workers, if conditions deteriorate. Nestlé, however, is unwilling to cave in to what it views as unreasonable labor demands. Last year, it threatened to sell Perrier because of a disagreement with a union at its Perrier factory in southern France, which was only about a quarter as productive as its San Pellegrino plants. Nestlé decided to keep Perrier after the union agreed to job cuts and to boost productivity.

The Swiss food conglomerate was founded in 1866 by Henri Nestlé, who had developed a cereal-based infant formula for babies whose mothers had died or couldn't breast-feed. This was a breakthrough, because the children of such mothers sometimes died, since the other breast-milk alternatives used until then weren't sufficiently nutritious. Nestlé grew by acquisitions into the early 20th century, focusing on milk. Milk-related products remain the company's largest revenue source, followed by beverages (mostly water and coffee), frozen and other prepared foods, candy and pet food.

Nestlé entered the chocolate market in the 1920s and developed the first instant coffee, Nescafé, in the 1930s. Nescafé got a big boost during World War II when the U.S. army provided it to the troops.

After the war, Nestlé began expanding into Latin America and the rest of the developing world. Nestlé is now the dominant maker of infant formula outside the U.S. But in the American market, it badly trails Bristol-Myers Squibb (BMY), the maker of Enfamil, and Abbott Laboratories (ABT), the producer of Similac.

[Brabeck]
Brabeck: "In the Anglo-Saxon environment, the company is at the service of the CEO. At Nestlé, the CEO is at the service of the company."


Nestlé's overseas formula business ignited controversy in the 1980s after critics attacked Nestlé for urging poorly educated mothers in the developing world to forsake superior breast milk for formula -- leading to isolated boycotts of the company's products. Worse, Nestlé's powdered formula required water, which often was unclean. Nestlé has largely defused the formula issue with strict marketing rules. For example, the company acknowledges the superiority of breast milk, and won't advertise or give out free samples in the developing world.

Size can breed arrogance. In infant formula, Nestlé took a long time to reach an agreement with Martek Biosciences (MATK), which produces DHA, a fatty acid critical to brain and eye development that is present in breast milk but not cow's milk, the basis for formula. While Nestlé's rivals, notably Bristol-Myers Squibb and American Home Products, embraced DHA a decade ago, Nestlé didn't seal its deal with Martek until 2003. Nestlé's view, apparently, was that it was so big, it didn't need DHA. DHA-boosted formula now dominates the U.S. market and is growing abroad.

Nestlé is battling throughout the world to maintain its market-leading positions. In the U.S., Nestlé is the No. 1 seller of bottled water, with an estimated 40% share, thanks to a portfolio of solid regional brands, including Poland Spring in the Northeast and Arrowhead in the West. But Coca-Cola (KO) and PepsiCo (PEP), faced with an eroding soda market, have been seeking to expand into the growing water market, using their powerful bottling networks. Coke has Dasani; Pepsi, Aquafina.

"Nestlé's goal is to maintain and defend its share, and it has done a good job," says Bill Pecoriello, the beverage analyst at Morgan Stanley. "Nestlé is the low-cost product because it owns its own springs and produces its own packaging." Nestlé, for instance, dominates the important warehouse-club market, which has a rising share of the U.S. water market.

Looking ahead, analysts and investors see several potential merger opportunities for Nestlé. One scenario floated by Sanford Bernstein's Wood is that the company could ultimately buy the rest of L'Oréal. That likely would cost $40 billion or more. Yet Nestlé could finance nearly all the cost with the sale of its Alcon stake and L'Oréal's 10% interest in the European drug maker Sanofi-Aventis. Such a deal would create a "mammoth" consumer-goods company, with 50% more sales than Procter & Gamble, Wood wrote in a research note. Any action on L'Oréal would have to wait until at least 2007.

A final, mega-deal could involve Coca-Cola. This would be the ultimate merger of equals, since Coke and Nestlé have similar market values. Combining the two would give Nestlé's water and beverage units access to Coke's global bottling network, while providing diversification for Coke at a time when its core soda franchise is eroding. But insular Coke is unlikely to make such a move any time soon.

Then again, Nestlé could keep prospering without making any deals. While many of its rivals are in the doldrums, Nestlé's strong brands and developing-world exposure probably give it the food industry's best outlook.

Making the story even better: Nestlé's Alcon and L'Oréal interests effectively give its stock one of the sector's lowest P/E multiples. It's unusual to find an industry leader with a cheap valuation. Nestlé holders should be dining well in the coming years.

U.S. Focuses on a Macau Bank In Probe Into North Korea Ties

By GLENN R. SIMPSON and GORDON FAIRCLOUGH
Staff Reporters of THE WALL STREET JOURNAL
September 16, 2005; Page A4

The U.S. government's accusation that a small bank in the Chinese enclave of Macau was laundering money for North Korea triggered a run by depositors and appeals for calm by the government there.

The developments came after Secretary of State Condoleezza Rice linked such U.S. enforcement efforts to ongoing talks in Beijing over dismantling North Korea's nuclear program. The talks deadlocked soon after they started earlier this week, with North Korea insisting that the U.S. and others provide a nuclear reactor to generate electricity before it will give up its atomic-weapons programs, a demand Washington has flatly rejected.

The U.S. move this week against the Macau bank, Banco Delta Asia Ltd. is part of a broader investigation disclosed last week in The Wall Street Journal into banks Washington suspects of aiding North Korea. The U.S. suspects the banks of aiding North Korean ventures that include counterfeiting and narcotics and allegedly helping to finance North Korea's nuclear program. "We're not sitting still," Ms. Rice said during an interview with the New York Post. "We're working on anti-proliferation measures that help to protect us," she said, citing the possibility of freezing assets.

The Macau government said it was setting up a special team to investigate the U.S. allegations, which could put Banco Delta Asia on a blacklist as an entity of "primary money laundering concern." The U.S. Treasury Department called the bank a "willing pawn" of North Korea and is proposing to bar U.S. financial institutions from doing business with it.

On Friday, more than $5 million was withdrawn by depositors of the bank, which has about $420 million in assets, Reuters reported. The Special Administrative Region of Macau called on its citizens "to keep calm, do not easily listen to ungrounded rumours, [and] have faith and confidence in the financial system of Macao." It said its banks were well-regulated.

In the nuclear talks, China tried to break the impasse by floating a new draft of a joint statement meant to serve as a blueprint for a final settlement. To placate Pyongyang, Beijing added a paragraph that noted North Korea's assertion of its right to peaceful use of atomic energy and said the parties would further discuss the country's desire for a so-called light water reactor, according to a U.S. official. (See related article.)

The U.S. official said that initial feedback from North Korean delegates, in a "very brief, informal" exchange yesterday, indicated that they weren't satisfied with the changes. The Americans aren't completely happy with the new language either.

The U.S. delegation huddled inside the American embassy late into the evening Friday. "We got some proposals today. We've been discussing them," said Christopher Hill, the chief U.S. negotiator said, returning to his hotel after midnight. "We'll see where we are tomorrow." China asked all of the countries at the talks, which also include Japan, Russia and South Korea, to respond to its proposed draft by Saturday afternoon.


It's Fourth and Long for Stocks


WSJ, By CRAIG KARMIN
September 18, 2005

The stock market is heading into the final stretch of 2005 in what could be the first down year for U.S. stocks since 2002. While there's plenty of cause for concern in the fourth quarter, there's starting to be some reason for hope, too.

First the bad news. Economists are still scrambling to assess the economic damage wrought by Katrina. Bank of America says that the hurricane destroyed national wealth of at least $50 billion, and perhaps as much as $100 billion. Crude-oil prices have been hovering in the mid-60s, stoking inflation fears and worries that consumers are going to spend less if they're paying more at the pump.

Yet the fourth quarter historically has been the best one for stocks, and some investors are counting on history repeating. They say that the economic impact of Katrina could be painful but most likely is temporary. After topping $70 a barrel, oil prices have retreated to $63, and the economy still looks to be in decent shape.

Indeed, most analysts now think the Federal Reserve will feel comfortable enough with economic growth prospects to raise interest rates again when the policy committee meets Tuesday. Moreover, with European and Asian markets chalking up good gains this year, some market pros suggest U.S. stocks are poised to play catch-up over the next three months.

"If you look at the stock market without emotion, you have to wonder why it isn't moving higher like the other major markets in the world," says Jim Paulsen, chief investment strategist for Wells Capital Management. For the year, the Dow Jones Industrial Average is down 1.3%, compared with gains of 12% or more in Tokyo, London and Germany.

Not everyone shares this optimism. Russ Koesterich, senior fund manager at Barclays Global Investors, sees a few dark clouds. For one, the sharp rise in oil prices has come as the U.S. savings rate is close to zero. During previous oil-price surges in the 1970s, he notes, the savings rate was between 7% and 10%. That means consumers have less of a cushion if oil prices start moving up again.

Reading the Signals

Mr. Koesterich also dismisses recent consumer-confidence numbers that showed continued strength -- though the latest confidence numbers, released Friday, were notably weaker in reaction to the aftermath of Katrina. He argues that there's not a strong correlation between those numbers and actual spending habits. Instead, he focuses on same-store sales numbers. "Those are telling us that spending is decelerating," he says.

Just last month, retail giant Wal-Mart shook up the market when it posted its smallest profit gain in about four years and lowered its profit forecast for the remainder of the year, saying customers were spending less because of high gasoline prices.

Even the bond market has been signaling that the economy is due for a slowdown. The Treasury yield curve, which plots the relationship between Treasury debt of different maturities, has been flattening out in recent weeks.

That means the difference has been narrowing between the yield offered by short-term Treasury debt and the yield on the 10-year note. If the two-year note's yield rises above that of the 10-year note, then the yield curve will be said to be inverted -- a phenomenon many economists say signals the economy is decelerating.

Still, Mr. Koesterich thinks the Fed could bail out the stock market. Even if, as expected, the Fed raises rates a quarter percentage point to 3.75% this week, any sign that it may be nearing the end of this tightening cycle would be well received by stocks, he says. "Then we could squeeze out some gains," Mr. Koesterich suggests, "but I'm not expecting fireworks."

The case for bigger gains, others say, is stronger if investors take a closer look at the economy: Economic growth for 2005 should come in between 3% and 4%, long-term interest rates remain low, inflation appears to be largely under control, job creation is rising and the housing market -- despite numerous warnings of a bubble about to burst -- remains firm.

Healthy Profits

Moreover, analysts have been underestimating profit growth for most of the past two years, turning more conservative after being too bullish in the late 1990s. Mr. Paulsen points out that overall corporate profits rose nearly 18% in the second quarter compared with the year-ago period. "That was far better than people expected even 90 days ago," he says.

Lehman Brothers in a report this month also recommends an overweight position in stocks, citing the strong balance sheets at most companies and the relatively attractive valuations of stocks compared with bonds.

At the same time, some analysts argue that the recent headline concerns may be overstated. Ajay Kapur, director of global-strategy research for Citigroup, argues the inflation threat in particular has been overblown. He says high oil prices won't necessarily slow down the economy significantly unless they lead to broader inflation. "No signs yet," he wrote in a report earlier this month.

And as order slowly returns to New Orleans, some economists suggest that the disruption from Katrina may be more contained than once thought.

"Typically, in the immediate aftermath of natural disasters such as hurricanes, the economic impacts -- both their magnitudes and durations -- tend to be overstated," Bank of America chief economist Mickey Levy wrote in a recent report. He is now forecasting a moderate deceleration in economic growth and declines in profits, but "these impacts are likely to remain temporary."

Joseph Battipaglia, chief investment officer for Ryan Beck & Co., agrees, noting in a September report that Louisiana and Alabama account for around 2% of total U.S. economic output. More worrying to the economy, 90% of the Gulf Coast's oil production has been shut. But, he adds, "timely restoration of both output and processing has been established by authorities as a high-priority item."

So what stocks might lead a fourth-quarter rally? Mr. Paulsen thinks energy stocks have had their run this year and instead favors technology shares.

Mr. Koesterich likes companies in sectors such as health care that can raise prices even when inflation is low. Worried that the consumer may be flagging, he would avoid auto makers, mainstream retailers and department stores. Instead, he likes companies in sectors that cater to business spending to take advantage of strong balance sheets, including industrials and technology.

Incremental Decision Making and Corporate Restructuring

Barry Naughton
Economic and business stories have dominated Western press attention to China in 2005, perhaps more so than in any previous year. Perceptions of a dynamic "rising China" have burst into American consciousness in an unprecedented fashion. Ironically, however, leadership decision making on economic policy in China seems to be sliding back toward a more bureaucratically dominated and less imaginative pattern. From a policymaking standpoint, there has been little significant innovation during 2005. This article reviews developments in four areas: currency revaluation, share conversion, consolidation of firms, and the new industrial policy for the steel industry. Taken together, the trends in these areas suggest a move toward cautious, incremental, and bureaucrat-dominated policymaking as well as an effort to step up the pace of corporate restructuring.

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Friday, September 16, 2005

Not the New Deal

September 16, 2005

Now it begins: America's biggest relief and recovery program since the New Deal. And the omens aren't good.

It's a given that the Bush administration, which tried to turn Iraq into a laboratory for conservative economic policies, will try the same thing on the Gulf Coast. The Heritage Foundation, which has surely been helping Karl Rove develop the administration's recovery plan, has already published a manifesto on post-Katrina policy. It calls for waivers on environmental rules, the elimination of capital gains taxes and the private ownership of public school buildings in the disaster areas. And if any of the people killed by Katrina, most of them poor, had a net worth of more than $1.5 million, Heritage wants to exempt their heirs from the estate tax.

Still, even conservatives admit that deregulation, tax cuts and privatization won't be enough. Recovery will require a lot of federal spending. And aside from the effect on the deficit - we're about to see the spectacle of tax cuts in the face of both a war and a huge reconstruction effort - this raises another question: how can discretionary government spending take place on that scale without creating equally large-scale corruption?

It's possible to spend large sums honestly, as Franklin D. Roosevelt demonstrated in the 1930's. F.D.R. presided over a huge expansion of federal spending, including a lot of discretionary spending by the Works Progress Administration. Yet the image of public relief, widely regarded as corrupt before the New Deal, actually improved markedly.

How did that happen? The answer is that the New Deal made almost a fetish out of policing its own programs against potential corruption. In particular, F.D.R. created a powerful "division of progress investigation" to look into complaints of malfeasance in the W.P.A. That division proved so effective that a later Congressional investigation couldn't find a single serious irregularity it had missed.

This commitment to honest government wasn't a sign of Roosevelt's personal virtue; it reflected a political imperative. F.D.R.'s mission in office was to show that government activism works. To maintain that mission's credibility, he needed to keep his administration's record clean.

But George W. Bush isn't F.D.R. Indeed, in crucial respects he's the anti-F.D.R.

President Bush subscribes to a political philosophy that opposes government activism - that's why he has tried to downsize and privatize programs wherever he can. (He still hopes to privatize Social Security, F.D.R.'s biggest legacy.) So even his policy failures don't bother his strongest supporters: many conservatives view the inept response to Katrina as a vindication of their lack of faith in government, rather than as a reason to reconsider their faith in Mr. Bush.

And to date the Bush administration, which has no stake in showing that good government is possible, has been averse to investigating itself. On the contrary, it has consistently stonewalled corruption investigations and punished its own investigators if they try to do their jobs.

That's why Mr. Bush's promise last night that he will have "a team of inspectors general reviewing all expenditures" rings hollow. Whoever these inspectors general are, they'll be mindful of the fate of Bunnatine Greenhouse, a highly regarded auditor at the Army Corps of Engineers who suddenly got poor performance reviews after she raised questions about Halliburton's contracts in Iraq. She was demoted late last month.

Turning the funds over to state and local governments isn't the answer, either. F.D.R. actually made a point of taking control away from local politicians; then as now, patronage played a big role in local politics.

And our sympathy for the people of Mississippi and Louisiana shouldn't blind us to the realities of their states' political cultures. Last year the newsletter Corporate Crime Reporter ranked the states according to the number of federal public-corruption convictions per capita. Mississippi came in first, and Louisiana came in third.

Is there any way Mr. Bush could ensure an honest recovery program? Yes - he could insulate decisions about reconstruction spending from politics by placing them in the hands of an autonomous agency headed by a political independent, or, if no such person can be found, a Democrat (as a sign of good faith).

He didn't do that last night, and probably won't. There's every reason to believe the reconstruction of the Gulf Coast, like the failed reconstruction of Iraq, will be deeply marred by cronyism and corruption.

E-mail: krugman@nytimes.com

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Bush Plan Spans Political Spectrum

By JOHN HARWOOD and JOHN D. MCKINNON
Staff Reporters of THE WALL STREET JOURNAL
September 17, 2005; Page A6

WASHINGTON -- In his bid to repair the Gulf Coast and his own standing, President Bush has set out to blend liberal-sounding, big-government ambitions with conservative-sounding, small-government solutions.

The president's call, in his speech to the nation Thursday night, for heavy investments in infrastructure, health, housing and worker training evoked memories of Democratic predecessors Bill Clinton, Lyndon Johnson and even Franklin Roosevelt. His plans to use tax breaks, vouchers, and incentives for entrepreneurship reflected longstanding dreams by conservative icons Ronald Reagan and Jack Kemp. Mr. Bush insisted yesterday in a news conference he won't support tax increases to finance his proposals.

Yet welding both models in a bitterly divided Congress poses one of the most difficult challenges of Mr. Bush's five years in office. The Republican right is balking at costs that have already topped $60 billion, while the Democratic left welcomes ideological policy fights on which they often prevailed before Hurricane Katrina. Saddled with his lowest-ever approval ratings, Mr. Bush will have little time for trade-offs when his proposals hit resistance on Capitol Hill.

"There's not the time for the normal partisan games," says Republican Rep. Bobby Jindal of Louisiana, who represents part of New Orleans.

Mr. Bush can't escape huge costs for rebuilding Gulf Coast infrastructure. But details that emerged yesterday indicate that Mr. Bush is trying to achieve a balance by designing some of his policy proposals -- at least initially -- to be of more modest cost. Economic adviser Allan Hubbard said the Gulf Opportunity Zone program -- likely the most expensive of the economic-revival initiatives -- will cost only about $2 billion.

Aid to school systems that are accepting evacuee children will cost another $2 billion, but officials said some of that money might simply be shifted from federal aid that previously was earmarked for the schools children were attending before Katrina struck.

[Bush in New Orleans]
President Bush concludes his remarks after a televised address from New Orleans on Thursday.


Mr. Bush's Katrina relief plan also includes $227 million for higher education, including student-loan assistance for displaced adults and money for colleges accepting an infusion of displaced students. The health-care measures -- largely reimbursing states for costs of treating evacuees -- will cost about $350 million.

The Gulf Opportunity Zone would revive the concept of bonus depreciation for business investment that many economists say boosted a shaky economy in 2002. As a further incentive for rebuilding businesses, the new bonus-depreciation measure will apply to structures, and not just equipment. "You're going to see a very, very quick response," Mr. Hubbard said.

Mr. Bush's proposed Worker Recovery Accounts revive another idea the administration sought to pass during his first term to encourage unemployed people to locate new jobs. The accounts would give hard-to-place job seekers as much as $5,000 for training and education, and allow them to keep part of the money if they find work quickly. The increased aid for education also would allow local school districts to be reimbursed for vouchers for private schools.

Some Republican leaders are signaling limits to the federal effort amid projections, like one from the conservative Heritage Foundation yesterday, that Katrina could help push the budget deficit past $500 billon in 2008 to $873 billion in 2015. "We don't want to create the idea that somehow the federal government is going to recreate everything destroyed by Katrina," says House Majority Leader Roy Blunt of Missouri. "People who didn't have insurance shouldn't come out as well as those who did."

For their part, Democrats aim to exploit what President Clinton's former domestic policy chief Bill Galston calls the "mismatch between the policy details and the tone poem" of Mr. Bush's speech. With his plan to implement school vouchers while bypassing some union wage rules in the Gulf, they say, Mr. Bush is vulnerable to continued defections from independents and centrist Republicans.

Mr. Bush said in his news conference that some of Katrina's costs may be financed with unspecified spending cuts in other programs. Some of those cuts might not have to be too large initially, because other aspects of the package also carry relatively modest price tags. The administration's new homesteading initiative would give low-income people federally owned property through a lottery, in return for their pledges to build homes on it. But officials yesterday suggested that the most readily available source will be about 4,000 homes in the affected areas that were financed by federal programs but have since been foreclosed upon.


China's Benchmark Measure Of Capital Expenditure Rises


By AIPING CUI
DOW JONES NEWSWIRES
September 16, 2005

BEIJING -- China's urban fixed-asset investment grew faster than expected in August, partly because of the low base a year earlier.

But fixed-asset-investment growth continues to ease when compared with recent years, suggesting that authorities won't see a need to rein in economic growth by tightening monetary policy, economists said.

The National Bureau of Statistics said Thursday that urban fixed-asset investment, China's benchmark measure of capital expenditure, grew 28.5% in August from a year earlier, beating expectations of a 24.3% gain, and up from 27.7% in July.

For the first eight months of the year, urban fixed-asset investment totaled 4.12 trillion yuan ($509 billion), up 27.4% from a year earlier.

Fixed-asset-investment growth has been declining from around 40%-50% in 2003 and part of 2004. Economists said that even if fixed-asset-investment growth remains at current levels for the rest of the year, policy makers won't issue fresh measures to curb lending.

"There's no sign of loosening credit right now...looking at the figures for yuan-lending growth or the mid- and long-term lending growth," said Lu Wenlei, an analyst from SYWG Research and Consulting in Shanghai. He noted that yuan-denominated lending at the end of August was up 13.4% from a year earlier, and mid- and long-term loans were up 17.8% from a year earlier.

This shows that the domestic economy is still on track to cool down somewhat, he said.

"Fixed-asset-investment growth will keep declining for the rest of the year," said Zhang Le, an analyst from China Merchants Securities in Shenzhen, though he estimates that fixed-asset-investment growth will stay above 25% for the rest of 2005.

The stronger fixed-asset-investment growth last month comes after China said its key money-supply indicator in August expanded at its fastest year-to-year rate for 2005 so far. The August M2 money supply rose 17.3% from a year earlier, exceeding the central bank's target of 15% for 2005 for the third straight month.

China's national fixed-asset investment grew 25.8% last year, while urban fixed-asset investment -- which includes a large portion of national data -- grew 27.6%. National fixed-asset investment is issued only on a quarterly basis.

Hong Kong Debates Volatility


Critics Fret About Plans
For 'Bull-Bear' Contracts;
'Domino Impact' on Stocks?

By JON OGDEN and NISHA GOPALAN
DOW JONES NEWSWIRES
September 16, 2005

HONG KONG -- Hong Kong's stock exchange regulator plans to introduce an equities derivative that its detractors believe could undermine the city's thriving warrants market, and bring unwanted volatility to leading blue-chip stocks.

The move to introduce callable bull-bear contracts as an alternative to warrants came as regulators ruled out this week calls from some market quarters for stricter regulations governing the issuance of warrants.

The contracts may be introduced within months of getting the green light from the Securities and Futures Commission, said Paul Chow, chief executive of Hong Kong Exchanges & Clearing Ltd., which operates the stock and derivatives markets. That may be as soon as January, according to local newspaper reports.

Warrants, which give the holder the right to buy or sell an underlying equity at a set price, have become popular among investors in Hong Kong. But they have recently drawn criticism on concerns over market manipulation, with calls to regulators for stronger regulations governing their issuance and trading.

While callable bull-bear contracts share some characteristics of warrants, they are structured to have lower volatility than a warrant and greater pricing transparency, removing the possibility for issuers to generate the sort of profit margins that warrants can chalk up. But some are concerned a so-called knockout feature of these contracts designed to limit investors' losses by a stop-loss mechanism could add to volatility in the market when issues are forced to sell their corresponding hedging position of the underlying stock.

SG Securities' senior vice president of equity derivatives, Edmond Lee, said a stock's downward movement could trigger a series of knockout levels of CBBCs and accelerate the fall of the underlying stock as issuing banks are forced to liquidate hedging positions.

"It could have a domino impact on the market," Mr. Lee said.

A trader with an investment bank said CBBCs could certainly drain liquidity from the warrants market as investors perceive them to be a slightly safer bet.

This would be bad news for a number of banks in Hong Kong, including HSBC Holdings PLC and UBS AG, which last week formally made their forays into the warrants market, which typically accounts for at least 20% of the daily volume on the stock exchange.

The Hong Kong exchange has been mulling the introduction of CBBCs for more than a year. Some in the market believe the exchange has dragged its feet over opposition from warrant-issuing banks, which oppose the introduction of a rival instrument. And some believe the exchange is now keen to introduce CBBCs as a way of defusing some of the criticism leveled at the warrants market.

Last week it was disclosed that the Securities and Futures Commission was investigating instances of alleged market manipulation and may review warrant regulations. But at a meeting Wednesday the exchange's board decided not to impose stricter regulations on the trading of warrants.

The exchange concluded that "supply and demand should determine the volume of warrant issues," said Mr. Chow, the exchange's CEO.

Thursday, September 15, 2005

China's Uranium Search Attracts Interested Sellers


By DENIS MCMAHON
DOW JONES NEWSWIRES
September 15, 2005

SHANGHAI -- As China moves to line up uranium supplies to feed its planned nuclear-power expansion, it is facing little resistance, sparking interest from countries with deposits of the mineral.

In the next 15 years, China plans to build as many as 40 nuclear plants to supplement the nine it has now. That is part of a plan to become less dependent on crude oil and to develop a wider range of energy sources, a plan that could have China bumping up against the strategic interests of the U.S. and its neighbors.

China's search for oil and gas in nearby waters and as far afield as North and South America has already provoked jostling and political tension.

China isn't alone in adopting a long-term nuclear-energy strategy, though for now its ambitions haven't provoked the hostility from the U.S. that similar ambitions in countries like Iran and North Korea have.

Japan already has 55 reactors, supplying 30% of the country's total energy demand. This should rise to as much as 40% within 25 years, under current government planning.

The U.S. aims to generate an extra 50 gigawatts of nuclear power by 2020, increasing its current capacity by more than 50%. China's 40 new plants will provide 40 gigawatts.

Russia and India also have ambitious nuclear-expansion plans, and other countries may follow suit, given soaring oil prices, concerns about the long-term security of oil and gas supplies and worries about greenhouse-gas emissions.

This renewed interest in nuclear power comes as uranium production from mines satisfies just 60% of global demand. The rest comes from secondary sources, such as reprocessed uranium from nuclear weapons.

For now there isn't any serious competition for uranium that might pit China against existing and would-be nuclear powers, but the situation could change.

Australia, Canada, and Kazakhstan, the holders of much of the world's readily extracted low cost uranium, have been making positive noise about selling uranium to China. This is despite the politically sensitive nature of the ore and, in the case of Australia, historical barriers against exporting it to China.

"China will be the main source of rising demand for the next 10 to 15 years," said Steve Kidd, director of strategy and research at the World Nuclear Association, a not-for-profit advocacy group. "U.S demand is less certain. China is already happening."

And while the administration of U.S. President George W. Bush has been strongly supportive of the use of nuclear energy in America, it still needs to persuade private-utility companies to make the big investments needed to expand the sector.

By contrast, China's central government is able to execute its long-term plans with little resistance, Mr. Kidd said.

China's known uranium reserves stand at 70,000 metric tons. It now consumes 1,500 metric tons a year, and by 2020 this could soar fivefold. Domestic uranium production provides about half of China's annual needs, according to the World Nuclear Association.

China National Nuclear Corp., a state-owned firm responsible for all aspects of China's civilian and military nuclear programs, has been shoring up the country's future uranium supplies.

KazAtomProm, Kazakhstan's national atomic company which already had been supplying China with uranium, signed a long-term agreement last November with China National Nuclear to produce and process uranium.

In addition, KazAtomProm President Mukhtar Dzhakishev said in an email to Dow Jones Newswires that China National Nuclear would take a 30% stake in Kyzylkum, a KazAtomProm unit that has the rights to develop the Kharasan field in the south of Kazakhstan. The field has an estimated 55,000 metric tons of uranium.

Kazakhstan, which shares China's northwest border, sits on 17% of the world's uranium reserves.

China National Nuclear declined to comment for this article.

Wynn Resorts Raises Financing For Gambling Resort in Macau


By KERI GEIGER
DOW JONES NEWSWIRES
September 15, 2005

HONG KONG -- Wynn Resorts Ltd., controlled by U.S. casino operator Steve Wynn, has raised a US$744 million loan to finance the construction and expansion of its gambling resort in Asia's gambling capital of Macau.

Wynn Resorts (Macau) SA, a unit of the U.S. parent, tapped a US$729 million equivalent term loan due 2011 and a HK$117 million, or about US$15 million, revolving credit facility due 2007, the company said. It is also taking out a separate HK$156 million equivalent senior secured loan with Banco Nacional Ultramarino SA, a Macau-based bank.

"This is the largest international bank financing of its type completed to date in Macau," said the loan's joint global coordinators, Deutsche Bank AG, Société Générale SA and Bank of America Corp. The loan will be used to help finance the US$1.1 billion Wynn Macau casino resort, which started construction last year.

U.S. casino operators are spending heavily to grab a share of Macau's gaming industry after authorities offered casino licenses to new players three years ago, ending a decades-long monopoly held by local casino tycoon Stanley Ho.

No pricing details were given, but a person familiar with the deal said both loans were priced at three percentage points above the London interbank offered rate. Once the resort opens, loan costs will decline as the credit quality of Wynn Resorts (Macau) improves on revenue inflows from the resort. Wynn Macau is expected to open in September 2006, with additional facilities opening in the first half of 2007.

About 28 banks, including Chinese banks, participated in the loan deal.

Separately, Australian construction group Leighton Holdings Ltd. said yesterday it had won a 200-million-Australian-dollar, or about US$154 million, contract to expand a new hotel and casino complex it is building in Macau for Wynn Resorts Ltd.

In a joint venture with China State Construction Engineering, Leighton Asia (Northern) will design and construct a second building to house two restaurants, an entertainment facility and additional gaming and meeting space, which will integrate with the original phase of the five-star resort.

Rio Tinto Says Oil Prices to Affect China's Demand for Commodities


By JAMES T. AREDDY
Staff Reporter of THE WALL STREET JOURNAL
September 15, 2005 4:59 a.m.

SHANGHAI – China shows no sign of letup in its appetite for commodities such as iron ore, but high energy prices are among the threats to global growth that could yet impact demand, according to resources giant Rio Tinto PLC.

Paul Skinner, chairman of the London-based company, said Thursday that his customers in China are particularly eager to secure long-term supply of inputs like iron ore and suggest less concern about possible short-term economic hiccups.

Yet, he added, Chinese demand for inputs to run its factories will be dictated mostly by the trends in the world economy. "Unquestionably the level of oil and energy prices currently is something that does pose a threat to global growth," he said.

Rio Tinto's board of directors has spent this week in China, fitting in visits to four large steel producers spread around the country. "The customers were talking about their expansion plans and their demand for high quality iron ore," said Chief Executive Officer Leigh Clifford.

China has emerged as a bellwether for global commodity prices due to a voracious appetite for materials like the iron ore used in steel making that Rio Tinto mines in Australia. China's fixed asset investment in areas like energy and transportation projects has lost some momentum this year but remains at super-strong levels, up nearly 29% in August from the year earlier, the government said Thursday.

In a sign of their confidence about the growth, Chinese companies are increasingly eager to lock up supply by taking equity in foreign mines -- in the same way state companies have moved to buy oil production sources in the U.S., Canada and South America.

But Rio Tinto officials said that aside from their two existing joint ventures with Chinese steelmakers they are resisting equity participation in iron-ore projects. "Our message is mining is our business," Mr. Clifford said. "We're not seeking to invest in the steel industry."

China's own surging metals production has weighed on global steel prices this year. Rio Tinto management said demand for their products from China remains extremely robust in the short term.

The company last month exported its 400th ton of iron ore to China after 30 years of business in the country – though 60 million tons of that was in the past year alone. China accounts for a 15% and growing share of Rio Tinto's global revenue, which amounted to over $9 billion in the first half.

Energy is pinching the company, however. Of the $180 million in cost increases it reported for the first half, Mr. Skinner said, some $60 million was in the form of higher charges for running the trucks and trains used to move its resources. Officials declined to forecast prices for iron ore in the coming year after a 71.5% rise in the benchmark selling price applied to China earlier this year.

Wednesday, September 14, 2005

China Construction Bank IPO Contends With Leery Investors


By KATE LINEBAUGH
Staff Reporter of THE WALL STREET JOURNAL
September 14, 2005

HONG KONG -- The big guns have had their shot at investing in China's banking story. Now it's everyone else's turn.

Next month brings the initial public offering of China Construction Bank, expected to be one of the biggest IPOs in the world this year. As the first stock offering in one of China's "Big Four" banks, it will serve as a sort of investor referendum on Beijing's vaunted changes in the industry.

The Chinese government has put US$22.5 billion into a bad-loan bailout of CCB, the nation's third-largest bank by assets, as part of an overhaul leading to the IPO expected to raise about $5 billion. Bank of America has made a $3 billion investment commitment, and the Singapore government's investment company, Temasek Holdings, has offered as much as $2.4 billion. All told, strategic investors such as these have committed some $15 billion to gain access to one of the world's fastest-growing financial-services markets.

In October, institutional and individual investors will at last get to vote with their own wallets. They must assess China's drive to transform its major banks from rubber stamps for state-endorsed lending to profit-minded institutions with professional management. With their shorter-term return horizons, they will want to take an especially hard look at the numbers and listen to some of the pros.

"We will not necessarily follow the strategic investors into the banks, since their objectives are different, in the sense that they need to get access to the market early," says Mark Mobius, manager of the $3.3 billion Templeton Developing Markets Trust. "If we look at the valuations of the Chinese banks, they are not necessarily cheaper than what we can find elsewhere."

According to a recent report by Fitch Ratings, Chinese banks' return on assets and return on equity are among the lowest in Asia, with China's banks clocking an average 0.43% return on net assets and 10.89% return on equity, vying with Taiwan for the worst marks in the region.

CCB says its return on net assets last year was 25.4%, a number Fitch says is "somewhat overstated" in light of an income-tax exemption. Most of the bank's profit was earmarked for dealing with nonperforming loans, the Fitch report says. Last year, CCB more than doubled its profit to 48.4 billion yuan, or $6 billion, and says without the tax break the return would have been 17.3%.

To lure investors leery of the risks -- notably, corruption, bad loans and poor accounting -- the banks have been sold at attractive prices. Bank of America paid about 1.2 times book value for its 9% stake in CCB. That compares with the 3.18 times book that a Standard Chartered-led consortium paid for Indonesia's Bank Permata last year. China's Bank of Communications, which sold shares in June at 1.6 times book, has seen its shares rally 40% from the IPO price.

But appearing to be cheaply priced isn't enough, Templeton's Mr. Mobius contends. CCB will also have to show that recent loan growth is strong enough to withstand a possible slowdown in the domestic economy, which has been growing at world-beating rates above 9%. Inflation slowed in August, and there are concerns that domestic demand is weakening. A slowdown would spell trouble for company profits and could lead to a resurgence in bad loans at the nation's banks. CCB says its nonperforming loan ratio is 3.9%, down from 19.2% in 2002.

Separately, another factor to consider is there is "an inherent contradiction in motivations for all these banks," says Andrew Rothman, China macroeconomic strategist for CLSA Asia-Pacific Markets in Shanghai. "On the one hand, they want to become more like real banks. On the other hand, every bank in China is still controlled by the Communist Party, and the party's interests are not always going to be in line with the shareholders' interest."

For its part, CCB is betting that changes it has made in recent years -- such as cutting branches by 30% in three years, reorganizing management and spending more than $1 billion in technology upgrades -- will be enough to make investors set aside concerns over the risks and wager that management can improve profitability.

For a start, the bank, with nearly 14,500 branches and about 310,000 employees, had its 2004 accounts signed by an international accounting firm, KPMG's Chinese affiliate -- a first for CCB. More important, the bank has reorganized its management, separating audit, lending and risk management into different reporting lines. In the past, auditors reported to branch managers; loan officers were also responsible for risk assessment; and loans could be approved by banking outlets in the hinterland.

"One of the big problems was that they were too decentralized, with the branches having too much authority. The same people who were marketing the loans were also approving the loans," says Peter Tebbutt, a ratings analyst at Fitch.

The bank has set up five board-level committees, including three that are headed by independent directors: a related-party-transactions committee, a risk-management panel and an audit group. The committees might help erode the influence the party has over the bank -- influence that the bank's chairman, Guo Shuqing, publicly criticized this year.

Mr. Guo came in from the nation's central bank after CCB's former chairman, Zhang Enzhao, resigned in March amid allegations of corruption. Since then, the bank has tried to show it is cracking down on corruption within its ranks. "The problem of Zhang Enzhao forces the senior management throughout the bank to pay greater attention to being honest and clean," the bank said in a June statement after implementing a new accountability system.

Investors can take heart from such changes but should remain clear-eyed when approaching China's biggest banks.

"Realistically, if you think about the sheer number of people that are involved here, it is going to take a while to change," says Matt Bekier, a partner at McKinsey & Co. "But once they make up their minds to do something, the execution of those projects is pretty good."