Sales of the century
The European Commission says it intends to clamp down on the large-scale mergers that are threatening to kill off competition. But few expect the wave of M&A taking place among Europe's gas and power firms to end just yet. NJ Watson reports
THERE is no doubt that Europe's gas and power utilities are in a phase of consolidation. So far this year, there have been 77 deals, worth a total of $104bn – some 30% of the total value of global transactions – according to Dealogic, a financial data and software vendor.
This follows 2005, itself a record year for mergers and acquisitions (M&A) in terms of the number of deals, the total value of deals, the value of a single deal and the number of large deals valued at over $10bn. Dealogic says 527 deals were announced by the world's utilities in 2005, valued at a total of $196bn – a 15% increase from the previous year and nearly five times greater than 2003's total. Of those deals, five were valued at greater than $10bn. In 2004, just one that exceeded that amount.
Europe accounted for the bulk of the deal volume. The pace of business was such that there were on average four deals announced each week. In Europe's electricity sector, the number of deals rose by 17% from 2004 and the total value of these deals was some 200% higher, at over $100bn.
The auditor PricewaterhouseCoopers (PwC), in a report on the power sector in 2005, notes 2005's statistics were boosted by three big privatisations – Electricité de France (EdF), Gaz de France (GdF) and Enel – but even when these are stripped out, the value of European power assets in play rose by 144% to $95.5bn.
So what is the main driving force behind this consolidation in Europe? In a word: liberalisation. By 2007, all consumers, retail and business within the 25 states of the European Union (EU) should be able to choose their electricity and gas suppliers and already many of these countries are well on their way to allowing this – although sadly just many are as far behind. This new competitive environment is, therefore, limiting companies' ability to grow organically, forcing many to look at M&A for growth.
Paradoxically, the lack of liberalisation in some countries is also fuelling M&A. France, Germany and Spain have done little to liberalise their gas and electricity markets and the governments there have been beefing up their former incumbents through mergers in order to head off any attempt by foreign utilities to enter these markets once they are forced to open. This blatant attempt to create national champions and keep out foreign competitors can be seen in the state-backed take over of the Franco-Belgium utility Suez by GdF, as well as the all-Spanish merger of Endesa and its smaller rival Gas Natural.
The process of consolidation is also itself creating more deals. The privatisation of Enel was part of an agreement between the firm and the Slovakian government, which insisted on the Italian state relinquishing its majority holding in the Rome-based company before it would allow it to buy 66% stake of the Slovenske Elektrarne power monopoly. Likewise, if the Suez deal is to have any chance of getting through, France may have to sell down its stake in GdF to satisfy EU rules on state-owned shareholdings.
High energy prices are also fuelling consolidation by boosting the rationale for such large and expensive transactions. Together with heightened worries about security of supply, since Russia cut gas supplies to Ukraine over a dispute about money, high prices have also forced companies to merge vertically up the power supply chain, prompting what PwC calls a "a blurring of traditional boundaries between upstream fuel supplies and utility company operations".
"Security of supply concerns are reinforcing the drive to diversify and acquire assets, particularly in Europe, and competition authorities appear not to be standing in the way," says Manfred Wiegand, global utilities leader at PwC. "The attitude of the competition authorities will be critical to future deals." By all accounts that attitude is expected to harden.
A change of heart
Looking ahead, analysts argue there will almost certainly be a move away from domestic M&A, which dominated the power and gas sector in 2005, towards more cross-border deals. Dealogic says the number of domestic deals globally in 2005 rose by 23% from the previous year, to 363, which represented 71% of the total value of deals in the sector. The five deals over $10bn reflected this trend towards domestic consolidation, as companies expanded their businesses both horizontally and vertically.
This development has gone down badly with the European authorities. In its February report into how the deregulation of the continent's energy markets is progressing, the European Commission singles out market concentration as one of the main hindrances to competition and the creation of a single market by the deadline of 2007. Naming no names, the Commission points out that in one country (France, of course) the main power producer (EdF, of course) enjoys an intolerable 86.7% share of domestic installed capacity. And this wave of domestic consolidation is only making matters worse, especially if those companies begin to integrate vertically as well as horizontally, because it means they will have little or no interest in trading with new entrants.
The Commission is promising to get serious. Since the report emerged, a series of officials have gone on record as saying the organisation intends to revise the rules that allow national governments to wave through many deals so that mergers will be considered in a wider context to see whether they hurt competition across the bloc as a whole.
Such a move could scupper the GdF-Suez merger, which is being valiantly defended by French politicians, but roundly condemned by almost everyone else. Especially vocal against the deal have been the Italians – unsurprising given that GdF's sudden bid for Suez was designed to thwart an expected Euro50bn (42bn) offer from Enel. The Italian electricity group is preparing a counter-bid for Suez, but is reportedly seeking assurances from EU Competition Commissioner Neelie Kroes that her office will lean on France not to block any bid. The hoopla surrounding all this is being billed as a test of the Commission's credibility in forcing member states to honour their commitment to opening up their energy markets.
Enel probably fancies its chances in a straight fight for Suez, given that GdF's bid is floundering over the price – GdF is proposing a one-for-one share exchange, despite having a share price more than Euro4 lower that that of Suez on 16 March – and a lack of synergies from any merger that would help cut costs. Enel, however, may decide first to find a partner that would buy Suez's water assets before launching a bid and will be mindful starting an expensive bidding war with GdF at a time when assets are already considered pricey.
"There are many twists and turns still to come," reckons Simon Wardell, an analyst at the consultancy Global Insights.
Somewhat overshadowed by the GdF-Suez mess, is another domestic merger that is being backed by the government in question, but is troubling the Commission. Since September 2005, Spain's Gas Natural has been locked in a take-over battle for its compatriot Endesa, a deal that has been heavily backed by the Socialist government of prime minister Jose Luis Rodriguez Zapatero. The issue became more of a hot potato when Germany's E.On unveiled on 21 February an audacious €29bn counter-offer for Endesa.
The Commission has set a deadline of 25 April to decide on whether to approve E.On's offer, but this can be extended if it finds antitrust problems. In the meantime, the Commission has warned the Spanish government not to take any steps to block E.On's bid for Endesa that might be construed as unfair discrimination against foreign companies – a warning perhaps for Paris. Already, Spain has passed a law to expand the scope of its energy regulator's veto power to include deals where a foreign bidder targets a Spanish energy firm.
Clearly, therefore, the Commission's attitude to cross-border merger shows it is not against mergers per se, regarding consolidation as a natural process in any deregulated market. So long as there are sufficient competitors in EU markets, M&A should not hinder the development of competition. It is likely, therefore, that 2006 will see an increase in cross-border mergers, a segment of the market that was dominated in 2005 by financial institutions.
Games without frontiers
According to PwC, much of the momentum for cross-border M&A has come from the continued emergence of so-called infrastructure funds – investment funds that are attracted by the potential for predictable income and capital growth. Those rewards are amply illustrated by last year's sale of Texas Genco to NRG Energy. Texas Genco had been bought in 2004 by a consortium of four private-equity firms – The Blackstone Group, Hellman & Friedman, Kohlberg Kravis Roberts and Texas Pacific Group. The investors used about $0.9bn of their own cash to buy Texas Genco and in about a year sold it on to NRG for a reported $4bn in cash and $1.8bn in stock.
In Europe, apart from the GdF privatisation, the largest cross-border gas deal last year was the $1.8bn purchase of E.On's Ruhrgas metering business by the UK private equity investors CVC Capital Partners. Elsewhere in Europe, Australia's Challenger Infrastructure Fund paid $0.838bn for UK gas-transportation business Inexus.
Australian investment bank Macquarie Bank advised Challenger on that deal and is becoming an influential player in the rise of infrastructure funds. In 2005, its Macquarie European Infrastructure Fund bought a 49% stake in NRE Holding, a Netherlands-based operator of gas and electricity distribution networks, while Macquarie Bank bought renewable generation assets in the UK and Germany.
Until now, it is these financial players rather than the traditional utilities that have been heavy investors in the renewable energy sector. However, with competition and high energy prices improving the economics for a whole raft of alternative suppliers – from wind to photovoltaic – traditional players will inevitably start to invest in these new areas. While many utilities have created their own renewable energy divisions, analysts say many will choose to buy in the technology. There has been speculation recently that Royal Dutch Shell is looking to acquire the world's leading wind turbine manufacturer, Vestas.
The opening-up of southeastern Europe's energy markets will also feature increasingly in the plans of large utilities as, according to PwC, they "march towards 'super regional' status". Southeastern Europe is estimated to need some Euro25bn to be able to integrate into the energy market of the EU by 2012 and governments in the region are busy privatising swathes of their energy sectors.
M&A opportunities include the privatisation of a 90% stake in Macedonia's Elektrostopanstvo na Makedonija power distribution company, for which Austria's EVN and the Czech Republic's CEZ submitted binding bids on 15 March. The stake is expected to fetch between $120m and $215m. In Bulgaria, the privatisation agency has announced that the government plans to launch tenders for six district heating companies by the end of April, including plants in the cities of Plovdiv, Varna, Rousse, Pleven and Pernik.
CEZ, which has put together a war-chest of at least Euro3bn for acquisitions in the region, is also competing against GdF, Enel, Spain's Iberdrola, and Germany's RWE Energy in the tender for Romanian power distributor Electrica Muntenia Sud (EMS). The government is offering a 51% stake in EMS, with the option of increasing the stake to 67.5% through a capital increase. According to a source close to the company, CEZ is close to making an acquisition in Serbia and Montenegro.