Business Week - 18 Dec 06

Prof. Robert B. Laughlin
Department of Physics
Stanford University, Stanford, CA 94305
(Copied 24 Aug 09)

Toshiba-Westinghouse Takes China Nuclear

Critics bashed the Japanese company for buying the Pittsburgh electricity player, but power station sales are hot

By Kenji Hall
December 18, 2006, 7:58AM EST

Toshiba CEO Atsutoshi Nishida had little time to savor his victory in nabbing Westinghouse Electric. Within hours of the handover from British Nuclear Fuels in October, analysts were grilling Nishida about his plans for Westinghouse. Most of the comments criticized him for agreeing to a whopping $5.4 billion price for the 77% stake in Westinghouse and for his optimistic 17-year plan to recoup the investment.

But the Nishida-bashing may ease up a bit after Westinghouse's multibillion dollar deal in China. On Dec. 16, Westinghouse said it won a contract to build four 1,000 MW nuclear plants for China, edging out France's Areva, the world's biggest nuclear engineering outfit. The facilities are part of China's plan to supply energy to an industrializing beltway that runs along the coast of Shandong province in the northeast to Guangdong province in the south.

Nuclear power accounted for less than 2% of the country's power supply last year, according to Zhao Jianping, senior energy specialist at the World Bank. By 2020, China expects to spend $50 billion on more than 30 new reactors, adding to nine 1970s-era ones operating now and quadrupling power generation from nukes.

Buying the Technology

Terms weren't disclosed, but analysts estimated that China would spend upwards of $8 billion. That's a huge coup for Toshiba, and not only because of the gargantuan size of the sale. The Japanese company's expertise lies in boiling-water reactors, which have been largely limited to its home market.

It's the dominant player, with a third of the market, but lately, public opposition to nuclear power has darkened the near-term outlook. One reason Toshiba went after Westinghouse was to get at the Pittsburgh-based company's pressurized-water-reactor technology as a way of expanding business overseas.

The two combined for 24% of all the world's nuclear reactors built through last year. By 2020, Toshiba expects 130 orders for new power stations worldwide, and estimates that the Westinghouse unit alone can win at least 20. In addition to the four in China, they're counting on 16 coming from the U.S., where companies are considering replacing more than a few of the 103 reactors in operation.

Diversify for Safety

Toshiba is also hoping to ride a nuke buildup that's likely to gain speed in fast-growth economies such as India, Brazil, and Romania. Adding Westinghouse to its books could allow Toshiba to rake in nearly $6 billion in sales in the power-generation business by 2015, from around $3.4 billion, or about 6% of total sales, today.

Having both technologies has another benefit: It gives Toshiba more flexibility in bidding for jobs. As prices of natural gas, coal, and oil rise and calls for green energy sources grow louder, more countries are expected to view nuclear energy as an attractive option. Those countries won't likely want to depend too heavily on any one type since that could leave them at risk of a blackout if problems or defects surface.

High-Margin Maintenance

Investors applauded news of the deal in China, nudging shares of Toshiba Plant, the nuclear unit that trades separately from the chipmaking and consumer-electronics giant, 3% higher in Tokyo trading on Dec. 18. But analysts are a tougher crowd to please. Many were irked that Toshiba initially had announced plans to buy a 50% stake in Westinghouse, only to spend more on a far bigger share later.

They also have been critical of Toshiba for relying on loans instead of equity to finance the acquisition and for giving overly favorable terms to its investment partner, The Shaw Group. The Baton Rouge, La.-based engineering firm, which bought 20% of Westinghouse, stands to benefit the most by doing the high-margin maintenance work on reactors. The third partner in the consortium, the Japanese engineering firm Ishikawajima-Harima Heavy Industries, got 3%.

Perhaps the biggest gripe has been that Toshiba wasn't more up front about Westinghouse's assets. Without that information, analysts - whose estimates of the assets range from $2 billion to $2.5 billion - can't accurately tally the goodwill costs that Toshiba can amortize over time or assess Westinghouse's real value, which many suspect is lower than what Toshiba paid.

Forecasting the Synergies

Though Toshiba is touting the benefits for both companies, don't think it will be easy bringing Westinghouse into the fold. One major reason: Westinghouse has close ties to Toshiba rival Mitsubishi Heavy Industries of Japan. For its new AP1000 reactor, Westinghouse worked with The Shaw Group on design, but outsourced the technology for reactor equipment such as steam generators, cooling pumps, and turbines to Mitsubishi Heavy.

Toshiba wants Westinghouse to sever ties with Mitsubishi Heavy so its own engineers, collaborating with Ishikawajima-Harima Heavy, can step in. But by doing so, Toshiba could face questions about plant safety and reliability, says Goldman Sachs analyst Ikuo Matsuhashi. "It is difficult to forecast what type of synergies Toshiba can achieve," he wrote in a recent report.

That messy arrangement is made all the more complicated by Mitsubishi Heavy's recent moves to shore-up its own power business. On Oct. 19, it forged a partnership with Areva in medium-sized pressurized-water reactors, and has reportedly entered negotiations with General Electric about marketing a new still-uncertified reactor in the U.S.

Redrawing Industry Alliances

The truth is, Toshiba's earnings will likely benefit almost immediately from Westinghouse's business. Initially, the contribution won't be very large. In the fiscal year through March, 2007, Toshiba forecasts a 12.2% rise in operating profit to around $2.3 billion on a 6.4% gain in sales to $57 billion. Credit Suisse Securities Japan estimates that within a year, the business from Westinghouse could add another $34 million to profits, and by March, 2011, could be generating an extra $85 million.

Toshiba will be up against more formidable rivals following a redrawing of industry alliances in recent months. The company will also have to figure out how to bring its engineers up to speed on Westinghouse reactor designs even as it shares nuclear expertise with a Chinese business partner, one of the conditions for landing contracts on the mainland. While Toshiba won the first big gig in China, there's plenty to do in order to ensure it keeps the winning streak going.

With Frederik Balfour in Hong Kong