May 7, 2004
The Rationale Behind East Hope Group's Venture Into Lysine Production in China
An eFeedLink Exclusive Report
East Hope Group is building China's largest lysine production plant in Baotou city, Inner Mongolia. The first phase of construction has begun in March 2004, and initial production is expected to commence in October this year. The initial production capacity is 20,000 tons and is projected to reach 200,000 tons when the whole project is completed.
East Hope Group is a privately owned enterprise in China. It was established by Mr. Liu Yongxing, the chairman of Hope Group after the Group went through a restructuring in 1995. While feed production remains it core business, East Hope Group also engages in other businesses, such as wheat flour, biological engineering and chemical products.
Analysts believe the East Hope Group is investing in lysine production due to dwindling earnings from its feed operation business. This report reveals Liu's ambition of building a business empire of a different dimension.
For the past 6 to 7 years, Liu has traveled to various parts of China. His relentless journey of seeing, listening, exploring and searching had a purpose; to find other suitable investment opportunities to diversify the business of East Hope Group. Liu revealed, on hindsight, that he did not have a clear direction and concrete plans on what he wanted to do in the beginning. All he knew was to source for a second business empire outside the feed milling industry, and he envisaged that it would most likely to be an investment in a heavy industry sector.
After witnessing the closure of the production line of a steel company in the United States, it strikes Liu that a shift in the world's production system has been underway. China was gradually evolving into an important global manufacturing center. Thus enterprises' demand for raw materials, energy, and installation capacities was expected to grow significantly. Armed with the vision of China's potential in the heavy industries, Liu chose to venture into the same arena while he was searching for a second core business for his East Hope Group in 1996.
However, before Liu actually put his plans into action, he had to assess the alignment of his existing factors of production namely, capital, technology, concepts and manpower. He had studied in depth the organizational principles of Wang Yongqing, the renowned "management guru" in Taiwanese business circles. Liu learnt that the secret of Wang's success in building Formosa Plastics lay in his ability to unify upstream and downstream production activities through the years. Liu affirmed that this would be the guiding principle for his foray into the heavy industrial sector
From 1996 onwards, Liu Yongxing embarked on extensive field studies of small enterprises. He shied away from large companies in the beginning because they were "unattainable". Through communication with various consultants and technical people, he learnt more about companies' guiding concepts and product monitoring systems. Liu's dream of integrating the new enterprise and existing feed production business into a complete industrial chain was gradually being realized.
"A company's investment should be diversified but it should still have a main core business," Liu said. In examining the nature of the feed production business, they found that lysine was the main upstream product and that it was needed in substantial amount for the production of animal feed. The technology employed in the production of lysine was highly specialized and somewhat monopolized. In order to produce a ton of lysine, 2400 kwh (kilowatt-hour) and 20 tons of steam power were required.
Based on these considerations, was it possible to reduce production cost by producing heat (steam) and electrical power simultaneously? Although the production of heat and steam power seemed to be the essential and logical way to proceed, lysine production was not Liu's main choice for an investment. Meanwhile, he has begun narrowing down the list of potential businesses. By 2001, the original list of a few hundred options had been eliminated to just three or four. In particular, aluminium and power generation ranked high on Liu's list.
Since 1998, Liu had a feasibility plan that sought to combine the production of aluminium with power generation for his second core business. As the manufacture of aluminium required a substantial amount of energy input, it would make business sense to incorporate aluminium manufacturing with power generation. This would give the company a better edge over others. Besides, it was common knowledge that the power supply grid in China was inefficient. Hence if the company was able to generate its own power, not only could it supply the energy needed in aluminium production, the excess power generated could even be sold.
What was even more exciting for Liu was that, the proposed integrated aluminium production and power generation business could be linked up with his mainstay business of feed production to form a complete industrial chain. Power generation was not a "direct" raw ingredient in the production of animal feed but the steam produced in the process could be recycled for use. If it could be used with electrical power, then the combination of the two could well provide the requirements for the production of lysine.
The waste water generated during the production of lysine could be made concentrated by using the excess steam produced during power generation. A feed additive (with trace elements of lysine) would then be formed and it could be added to cattle feed material. This procedure was both environmentally friendly and cost effective. With this comprehensive plan, Liu was quick to take concrete steps to realize them. After ten months of negotiations and research, East Hope Group finally signed an agreement with Liaocheng Xinfa Power and Steam Generation Company to form a joint-venture enterprise with a total investment cost of RMB1.5 billion. East Hope would hold a 51% stake in the new company, which could produce 160000 tons of aluminium electrolytes and generate 310000 kwh of power annually. After the agreement had been signed, the project was held back by the surging prices of raw materials, fuel and other factors.
Fortunately for Liu, a previous experience with Shandong Aluminium Company had taught him a valuable lesson. Liu realized the importance of raw material sources and costs for a metal production company. He thought that the ideal plan was to locate the new plant in close proximity to a coal mining area. The land should also be vast (which would better absorb the impact of possible environmental degradation) and well supplied with natural water sources. After surveying many areas, he felt that the most suitable site would be Baotou in Inner Mongolia. The other factor favoring Baotou over other locations was the fact that the city was located in a corn-producing belt, and the crop was one of the main ingredients in the production of lysine.
With the support of technical personnel from the relevant government departments, the first ton of aluminium was produced in East Hope Aluminium Company.
"During phase I, four sets of thermo-electricity generators with a capacity of 155,000 kwh will be built. Every hour, 320 m3 of steam can be produced. In turn, the steam can be used to manufacture 200,000 to 250,000 tons of lysine per year," said Liu. "Besides enabling us to reduce costs by 15-20%, this setup would propel us to be the largest lysine manufacturer in the world," Liu said.
The production of this specific amount of lysine per year would also require the input of 0.8-1.0 million tons of corn as raw materials. The residual corn meal generated during the lysine manufacturing process could be used to produce 1 million ton of high quality feed materials for beef and dairy cows. Incidentally, this amount of feed could support the feed requirements of the animal husbandry industry of Inner Mongolia.
It seemed that the industrial chain that Liu had in mind would materialize with the completion of the lysine plant in Inner Mongolia. However, he felt that East Hope Group should not continue to focus only on the feed producing business. Instead, the aluminium and power generation plant should take the lead in the diversification process. More aluminium oxides and related upstream products should be produced.
The demand for aluminium oxide in China had been increasing steadily. In June 2003, Liu took a decisive step in the direction of the industry. East Hope Group, together with Henan Huanghe Aluminium, Power Generation Group, Jiede Metal Company of the USA, and Pioneer Global Investment Company, signed an agreement to invest RMB4.5 billion in the construction of an aluminium oxide production line. The proposed plant, to be built in Sanmenxia of Henan, would have an annual production capacity of 1.05 million tons per year. In addition, East Hope Group would hold a 51% stake in the joint-venture company. However, the project was put on hold when the management of China Aluminium Company began voicing their dissatisfaction over various issues. Meanwhile, Liu continued to persuade the Chinese authorities to encourage private enterprises to participate in the restructuring of heavy industries.
According to sources, the situation had taken a turn for the better. East Hope Group has reportedly said that China Aluminium would take up stakes in the Sanmenxia project.
East Hope Group did not borrow from banks or financial establishments for the purpose of funding the first phase of the project. The RMB2 billion-investment fund was raised through private equity issue. Some analysts felt that East Hope Group could no longer give the capital markets or banks a miss. They believe East Hope Group would no longer be able to "do-it-alone" if it wants to embark on major business ventures.
Regardless of the avenues in which funds were raised, analysts felt that Liu Yongxing's conservative stance towards managing the company's finances had to be changed. For a company with a 50% debt ratio as compared with one that had not incurred any debt, the requirements for cash flow were rather different.
At this stage, however, funding was secondary for Liu. The pressing problem was one related to the procurement of raw materials for aluminium oxide production. Liu mentioned that in terms of production scale and technology, the Baotou plant could be ranked amongst the top metal companies in the world. Where costs and efficiency were concerned, the plant certainly has an edge over her competitors. However, the availability of aluminium oxide, which was an upstream raw material, was the deciding factor for the success of any electrolytic aluminium enterprise.
The global distribution of aluminium oxide mineral ores affects the supply situation and China does not have positional advantage in this aspect. This would affect the global competitiveness of East Hope Group's aluminium business. Being a meticulous planner, the 55-year-old Liu would have calculated the risk involved in this venture and know the implications of his decision. "If this venture fails, the effort that I have put in for the past few decades would be negated. Therefore, it is important that we achieve instant success," Liu has said.
"We don't have to wait till 2008, the year in which the funds would be fully invested. By 2005, we would have to think about the next investment strategy. Planning is the only sure way to avert risk," he added.
