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    The Fuqua School of Business at Duke University

    FUQ-09-2006

    Rev. February 15, 2006

    HUTCHISON WHAMPOA LIMITED AND THE PHASE II

    SHANGHAI DEEP-WATER PORT PROJECT

    Introduction

    On September 30 2004, Hutchison Whampoa Limited (HWL) signed a contract with Shanghai International Port Group (SIPG), the state-owned company focusing on port-related business in the Shanghai region, for the Waigaoqiao Phase V project. HWL, which

    is controlled by Hong Kong tycoon Li Ka-shing, the richest man in Asia, will form a joint venture company with SIPG and hold 50%

    equity. The total cost of the project is expected at $482 million.

     Since 1998, we have co-operated with Shanghai on a much larger scale and in greater depth. I believe there will be a better

    future, particularly through our efforts to develop Shanghai into an international port and trading center.

    - Li Ka-shing, Chairman, Hutchison Whampoa Limited

    The Waigaoqiao Phase V project would be a great improvement for Shanghai to handle the increasing shipping demand, but the solution to transport bottlenecks caused by the lack of a decent deep-water port will be the Yangshan Deep-water Port Project, the

    Phase I of which is under construction. Several overseas port and shipping services operators including HWL have expressed interest

    in investing in the Phase II part of the Project. But the $800MM investment cost, increasing competition in the port industry, and the

    ports long term profitability are causes for concern.

    Hutchison Whampoa Limited (HWL)

    The beginnings of Hutchison Whampoa Limited (HWL) go back to the 1800s. In 1880, John Hutchison, a British expatriate in Hong Kong formed the John D Hutchison and Company Ltd., taking over an existing firm. During an acquisition program in the Prepared by Vidya Vishal, Jerry Wang, Grace Zhao, Gaobo Zhou under the supervision of Campbell R. Harvey. Copyright ? 2006. All Rights Reserved.

     Hutchison Whampoa Limited and The Phase II Shanghai Deep-water Port Project 03-2006

    1960s, this company took control of a diverse set of companies, including the Hongkong and Whampoa Dock, (the first registered company in Hong Kong; owned dry docks in Whampoa in China’s Guangdong province since 1861). Hutchison International saw tumultuous times in the 1970s, and had to be rescued by the Hongkong & Shanghai Bank, which bought the entire company and eventually renamed it the Hutchison Whampoa Limited in 1977.

    In 1979, Cheung Kong Holdings acquired HWL, making its founder, Li Ka-shing the first Chinese to control a British-style hong (trading company). In the 1980s, HWL started its diversification into energy, mining and telecommunications and other businesses.

    By 2004, HWL had holdings in five core businesses: ports & related services, telecommunications, property & hotels, retail & manufacturing, energy & infrastructure. For the year ended Dec 31 2004, the Group’s consolidated turnover was approximately

    HKD179 billion (USD 23,000 million). HWL now has operations in 54 countries and employs over 200,000 people worldwide. Meanwhile, Li Ka-shing came to be known as Superman in Hong Kong circles, and was named Asia’s richest and most influential

    businessman by the Fortune magazine in 2004.

    Hutchison Whampoa Limited (HWL), through its subsidiary Hutchison Port Holdings (HPH), is the world’s leading port

    developer and operator, operating 242 berths in 41 ports spread over 20 countries in Asia, Africa, the Middle East, Europe and the

    American continents.

    HWL was the first foreign capital firm to invest in and operate container terminals in Shanghai in the early 1990s. Twenty years

    ago, private companies were not allowed to invest in key infrastructure projects like ports and bridges. Even for Phase I of the

    Shanghai Yangshan deep-water port, the construction and operation of the port were handled by government-controlled subsidiaries -

    Tongsheng for construction, and Shengdong for operations. Now the government was opening up Phase II for private company involvement. Shanghai’s importance as an import-export gateway to China was rising, and this made a presence in the Yangshan deep-water port all the more desirable. HWL was interested in an equity stake in the Yangshan Phase II project.

    Exhibit 1 shows 2004 and 2004 income statements of Hutchison Whampoa Limited.

    China Economy

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     03-2006 Hutchison Whampoa Limited and The Phase II Shanghai Deep-water Port Project Title

    Although China is still a developing country with a relatively low per capita income, it has experienced tremendous economic growth since the late 1970s. In large part as a result of economic liberalization policies, the GDP has doubled every 7 year since year 11987. In 2004, the GDP reached $1.65 trillion, with growth rate of 9.5%.

    The strong economic performance attracted foreign investment inflow, which started to soar during the 1990s and continued to rise during 2000s. In 2004, China surpassed U.S. and became the most attractive destination for Foreign Direct Investment (FDI).

    During 2004, FDI inflow totaled $60.6 billion, 13.3% higher than the year before.

     2Exports in 2004 rose 35.4% to $593.4 billion, while imports surged 36.0% to $561.4 billion FDI is estimated to increase another

    30% by the 2008 Olympics, soaring to $80 billion. China's challenge in the 21st century is to balance its highly centralized political

    system with an increasingly decentralized economic system. The overall business and trade environment in China and abroad for the

    development of the national economy is positive. However, the economic growth is under the pressure of both further adjustment and

    over-supply brought by excessive production capacity.

    China Port Industry

    With the acceleration of the world economic integration and the continuous rapid development of the Chinese economy and foreign trade, the port industry in China was growing fast and broke record in 2004. The cargo handling capacity of major coastal

    ports reached 1.8 billion tons with a growth rate of 13.5% year on year. The container handling capacity was more than more than 60

    million TEU (Twenty-Foot Equivalent Unit).

    There are 3300 productive berths in the coastal ports of China. Of these, 745 berths are deep water berths with capacity of over

    ten-thousand tons each. More than 130 ports are open to foreign vessels and accommodate more than 60,000 ships from over 100 countries each year. The eight key mega ports are divided into three economic regions: Bohai Bay region, Changjiang Delta region,

    and Zhujiang Delta region. Exhibit 2 shows operating data of these key ports.

    The development of China's port industry is closely related to foreign trade import and export. Handling capacity and foreign trade cargo throughput of major ports increased by 11.29% and 14.70% per year on average respectively during the period of 1991-

     1 China Statistical Yearbook 2004 2 WMRC Country Report: China

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     Hutchison Whampoa Limited and The Phase II Shanghai Deep-water Port Project 03-2006

    2004. Moreover, the average increase of container throughput reached 30.05%, which is higher than the 18.38% rise in foreign trade 3import and export and the 9.69% increase in GDP. Because the foreign trade import and export, the main driver of port industry, increased at lower growth rate than container throughput, the high growth rate (more than 30%) of container throughput is hard to

    sustain. It is estimated that annual increase of container throughput will be 10% - 20% for the next ten year.

    The overall trend for the port industry is that nationwide container throughput will increase at a declining rate, while the handling

    capacity of most coastal ports still increase at significantly high level, around 20% per year. The competition among ports will

    intensify following the low utilization rate and excess capacity. Some ports may have to lower their charging for container loading and

    unloading services.

    Shanghai Ports

    The Shanghai Ports, an aggregated term for all the shipping ports in Shanghai, boasts a cargo handling capacity of 8.14 million

    TEU. The importance of the port is increasing at a rapid pace, particularly as a gateway for container transport. As a result of the

    accelerated export demand, the growth rate at the ports averaged 29% per year in the past three years, and is expected to continue once

    China is accepted into the World Trade Organization (WTO). (Exhibit 3)

    However, the port faces three major constraints:

    o Water depth at the Yangtze River estuary and Huangpu River is only 7-8 meters. Because of this, third and fourth generation

    container ships can only enter and leave the port at high tide. Fifth and sixth generation ships need 15 meters to move freely.

    o The Huangpu River is not wide enough for large ships. Container ships cannot turn freely within the port. Large ships need to

    unload cargo to smaller ships prior to entering the port, resulting in increased shipping costs.

    o The port lacks modern logistics to provide comprehensive services

    To overcome these constraints and evolve into a key navigation hub in Asia, the construction of a deep-water port with wide berths

    became critical for Shanghai. Having no suitable place for such a harbor in its own area, the Shanghai Municipal Government (SMG)

    3 Investment Study in China's Port Industry, Beijing Okokok Information Consulting Co 4

     03-2006 Hutchison Whampoa Limited and The Phase II Shanghai Deep-water Port Project Title

    found that the Big Yangshan and Little Yangshan islands in the Hangzhou Bay, 27.5 kilometers from Shanghai’s southern coast, with

    water depths of 15 meters and a stable geological structure, made a good site for Shanghais deep-water port. (Exhibit 4)

    The Yangshan Deep-water port project

    The Shanghai Municipal Government conducted massive feasibility research on the Yangshan Deep-water Port project since the mid 1990’s. In August 1999, when the Shanghai Government submitted the Yangshan Deep Water Port Phase I Project Proposal to the State Economic Planning Commission, the Shanghai government had to use a container to store the proposal, which weighed two tons,

    and shipped it with a Boeing 747.

    In Feb. 2001, the China State Council officially approved Shanghai Government to initiate the project planning for the Yangshan

    Deep Water Port Phase I. In March 2002, the Yangshan Project Proposal was approved by the State Council and the State Economic Planning Commission, and the project began construction on June 26, 2002.

    In 2002, the Shanghai Government founded Yangshan Port Construction and Command Office to take full control of the Yangshan Port Phase I construction. At the same time, Shanghai Tongsheng Investment Group (SHTS) was founded. SHTS was invested by three state-owned entities: Shanghai International Investment Group, Shanghai Port Authority, and Shanghai State-owned

    Asset Management Company. (Exhibit 5 shows the complete deal structure for the Phase I Project.). Shanghai Tongsheng was announced to be the entity that was in charge of the construction and operation of the Yangshan Phase I project. However it is widely

    considered that Shanghai Tongsheng and the Yangshan Port Construction and Command Office are one entity that has two official titles. The name of Tongsheng Investment is used to handle the financing of the project, and the name of the Command Office is used

    to coordinate relationship with other political entities, such as the Zhejiang Provincial Government.

    After the completion of the Phase I Yangshan Deep-water port, the port will be managed and operated by the Shanghai Port Container Co. Ltd. (Exhibit 6)

    The phase I project is expected to cost $1.7 billion and will be financed via $907 million in debt and the remaining in equity. The

    debt will be provided by a consortium of five domestic banks: China Construction Bank, the State Development Bank, the Bank of China, the Industrial and Commercial Bank of China, and the Shanghai Pudong Development Bank. A larger $2.06 billion line of credit was offered by these banks and five others until the year 2020 to be used on the entire Yangshan Deep-water Port project.

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     Hutchison Whampoa Limited and The Phase II Shanghai Deep-water Port Project 03-2006

    Yangshan Deep Water Port project has four separate components: Yangshan Deep Water Port Zone, Donghai Bridge, Lu-Hu Freeway, and Luchao District.

    (1) Yangshan Deep Water Port Zone: the Phase I port area with the first five container berths. The total handling capacity of the five berths would be 2.2 million TEUs. It is projected to be completed by end of year 2005. The channels would be 15.5 meters deep,

    allowing fifth and sixth generation ships and 8000-TEU ultra-large ships may be accepted. (Exhibit 7)

    (2) Donghai Bridge: A bridge connecting Big Yangshan & Little Yangshan to Luchaogang, the closest on-shore point in Shanghai. The bridge is 32 kilometers in length, with 6 lanes and annual throughput capacity of 5 million TEUs. (Exhibit 8)

    (3) Luchao District: the district provides a land area of 1.5 sq. km, with storage area of 720,000 sq. m. and 15 container cranes. It is also designed to become a new port city in Luchaogang, to provide comprehensive logistics support, storage, processing, and other

    auxiliary services. The district is connected to the Yangshan Deep-water Port via the Donghai Bridge.

    (4) Lu-Hu Freeway: A freeway connecting Luchao and Shanghai, designed to be 43 kilometers in length.

    The Phase I Yangshan Deep-water Port will price container process fees competitively at RMB 350 per TEU, while the price at the 4Waigaoqiao Port will be increased from RMB 460 to RMB 506 to divert container throughput to the new port. This price is

    significantly lower than the Singapore Port and Pusan port in Korea. Future competition from neighboring ports will further exert

    downward pricing pressure on the port.

    The Phase II Yangshan Deep-water Port Expansion Project

    Construction

    The Yangshan Deep-water Ports phase II expansion project will add 4 berths on the north-west side of the island next to the 5 constructed during phase I. The expanded portion is designed for container shipping only and is expected to be completed in late 2006.

     4 China Business Post, No.648

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     03-2006 Hutchison Whampoa Limited and The Phase II Shanghai Deep-water Port Project Title

    It will add 1,400 meters to the length of the quay and increase annual operation capacity by 2.1 million TEU. With average waterway

    depth of 15m, it will also be able to accommodate up to 8,000 TEU container ships. (Exhibit 9)

    The project is expected to take up 0.64 square kilometers of land; more than what is available on the Yangshan Island. To make

    accommodations, the north-west section of the islands coastline will be expanded into the sea via a sea-fill method, by dumping

    rocks and sand into the sea. Using estimations published by Shimin Qu, former senior engineer at the Shanghai Institute of Port 5Design, it is estimated that applying this method to obtain the 0.64 square kilometers of land would cost $76.8 million.

    At the same time, geographical surveys found that the Phase II expansion site contained a thick mud layer, which is more difficult

    to prepare for construction than the sandy foundation found on the phase I site. Construction workers will apply 5 different techniques

    to dry and strengthen the foundation before it could be readied for construction. The phase II expansion project, including land

    creation, port construction, and supporting infrastructure, is estimated to cost $805 million.

    Operations

    Operations of the phase II port would see similar challenges to those in phase I. Mud needs to be removed from the waterway to

    prevent fresh silt carried down from the Qiantang River from blocking the water passage. Pollutants released when stirring up the sea

    floor can present an environmental hazard that threatens marine life. Also, because the port will be exposed in the open sea, Shimin

    Qu estimated that inclement weather could close the port as many as 50 days per year, affecting the efficiency of the ports non-stop

    operation.

    A potential operation bottleneck is presented on the 32.5 km Eastsea Bridge. The six-lane bridge has a capacity to handle 5

    million TEU a year and is expected to reach 50% capacity in its first year of operation. The port is projected to reach 5.5 million TEU

    shipping amount and exceed the bridges capacity in as early as 2010. Shipping companies are concerned that there would be significant delays on the bridge if accidents occur. The bridge was also designed without railway, so the only way to expand capacity

    is by constructing a new cross-sea bridge, which is not currently being planned.

    Competition

     5 China Mari-Time, No. 68, P.56

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     Hutchison Whampoa Limited and The Phase II Shanghai Deep-water Port Project 03-2006

    Beilun Port in the Zhejiang Province

     The Shanghai Yangshan Deep-water port faces regional competition from the Beilun Port in Zhejiang province, which is about 50 km away. Beilun port is conveniently accessible from Zhejiang province, and when construction of the new cross-bay bridge connecting north and south sides of the Hangzhou Bay is completed in 2009, it will cut the time from Shanghai to the port significantly. Future competition between the two ports is likely to be fierce as shipping companies choose which port to use.

    The provincial government of Zhejiang has announced plans to merge the management and operations of the Ningbo (including Beilun Port) and Zhoushan ports, to create the Ningbo-Zhoushan port. Ningbo port is estimated to have handled 270 million tons of

    cargo during 2005, while Zhoushan will probably have processed 80 million tons by the end of the year. Governor Lu Zushan has been quoted as saying that once the 100 billion Yuan (US$ 12.6 billion) integration and expansion has been completed, the Ningbo-

    Zhoushan port will be an integral part of the Shanghai International Shipping Center, although many have speculated that Zhejiang

    does not want to be left behind by the completion of the Yangshan Deep-water Port complex currently under construction 40 km from

    downtown Shanghai, which is projected to have a final handling capacity of 22 million TEU per year. Officials in Zhejiang estimate

    that the Ningbo-Zhoushan facility will be able to handle 22 million TEU by 2020.

    Singapore Port

    Singapore is favored by its location at the outlet of the strategic Strait of Malacca, which makes it a point of convergence of

    Southeast Asian transportation, attracting 140,000 vessel calls every year. The Port of Singapore has claimed the status of the world's

    busiest port in terms of shipping tonnage since 1986, reaching a container throughput reached 21.33 million TEUs in 2004. The booming world trade, general trend of bigger ships being used, and improvements in services offered at the port combined to keep the

    top status in terms of tonnage.

    Until 2002, the Singapore port charged rates upto 50% higher than neighboring ports, by providing greater efficiency and value-added services to its customers. However, switching customers and stiff competition from ports in Southeast Asia forced the port to

    update its business model and discount its port dues in May 2002. The port signed a 10-year contract with Hanjin, a South Korean

    shipping company, and gained competitive advantage over rival ports by becoming the first foreign port to sign the Container Security Initiative (CSI) with the US, allowing on-site US personnel to screen US-bound cargo containers for weapons of mass destruction.

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     03-2006 Hutchison Whampoa Limited and The Phase II Shanghai Deep-water Port Project Title

    Busan Port

    Busan Port is located in the southeast of the Korean peninsula, and is the gateway connecting the Pacific Ocean and the Asian

    continent. Within the Port, ships enjoy a still water surface and only a small difference between high and low tides. The port also

    enjoys proximity to an international arterial route, and attracts 50,000 vessels annually, and handles 40% of the total overseas cargo

    (imports and exports) and 80% of container cargo. The Busan Port consists of the North Port, South Port, Gamcheon Port and

    Dadaepo Port. Together, the ports can facilitate 169 vessels simultaneously, and can process 91 million tons of cargo annually. The

    Busan New Port, which is under construction and scheduled to be operational by 2011, can berth 30 vessels simultaneously and has an

    annual processing capacity of 8 million TEU per year.

    Other potential investors

     The Phase II expansion project of the Yangshan Deep-water port is the first time the government has agreed to open the

    Yangshan Deep-water port project to foreign and domestic private investment. It is also estimated that the government will allow a

    higher percentage of foreign investment than domestic investment.

    Due to the rapid rise of Shanghai to becoming the third largest container shipping port in the world, many foreign and domestic

    companies have expressed interest in investing in the project.

    COSCO Group

     The China Ocean Shipping (Group) Company (COSCO) is a diversified service company focusing mainly on shipping and logistic business.

    China Shipping (Group) Company

    China Shipping Group (China Shipping) is a shipping conglomerate that operates across different regions and sectors. It is a state-

    owned enterprise under the direct administration of Chinas Central Government and has assets to totaling $5 billion.

    OOCL

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     Hutchison Whampoa Limited and The Phase II Shanghai Deep-water Port Project 03-2006

    The Orient Overseas Container Line Limited (OOCL) is a wholly owned subsidiary of the Orient Overseas (International) Limited (OOIL), a public company listed on the Hong Kong Stock Exchange. OOCL is one of the world's largest integrated international container transportation, logistics and terminal companies

    AP Moeller-Maersk

    The A.P. Moller - Maersk Group is an international enterprise with activities covering diverse areas such as shipping, oil drilling,

    shipbuilding, industry and retail. It is headquartered in Esplanaden, Copenhagen and has total assets exceeding $32 billion.

    Port of Singapore Authority

     The Port of Singapore Authority (PSA) is the world's largest container terminal operator. It operates 19 ports in 11 countries

    around the world, the largest of which is the worlds number 1 container shipping port, the Singapore port, which has a designed

    capacity of 22.6 million TEU a year.

    Future expansion

     In total, the Yangshan Deep-water project will consist of 7 phases and is expected to be completed in 2020. By then, it will include 30 berths with an annual container handling capacity of 20MM TEU. The first 4 phases of the Yangshan project will be constructed on the same island, while future phases will involve other neighboring islands. Future expansion projects are likely to still

    be open to foreign and domestic investment. (Exhibit 10)

    The following table shows container handling volume and growth projections for the Yangshan Deep-water port.

    YearContainer handling volumeCAGR

    20052.2 million TEU

    20105.5 million TEU20.1% (2005 to 2010)

    202013.4 million TEU9.3% (2010 to 2020) Source: Shanghai Port Container Co., Ltd.

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