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Spain: Third time lucky for Gas Natural

GAS NATURAL should complete its acquisition of Unión Fenosa this month – its third attempt in five years to buy a power company. Analysts say the industrial logic of the deal is robust. Gas Natural's gas assets and Unión Fenosa's electricity assets are a natural fit; combining them should enable the gas supplier to lower its dependence on gas sales and to add value to its gas-supply operations through power generation.

As things stand, Gas Natural's presence in the power market is small even by Spanish standards – let alone in European or global terms. Acquiring the country's third-biggest power group, says Gas Natural, will, at a stroke, achieve the targets set out in its 2008-12 strategic plan and start to fulfil its ambitious vision of international growth, obviating years of organic growth. Greater industrial scale should also give the combined group more clout in commercial negotiations.

Following the deal, Gas Natural says it will double in size – becoming one of the three largest utilities in the Iberian peninsula, the "largest liquefied natural gas operator in the Atlantic basin and one of the largest operators of combined-cycle [gas-turbine (CCGT)] power generation in the world". It will have more than 20 million customers – 9 million of them in Spain – and worldwide power-generating capacity amounting to 17 gigawatts.

But there are drawbacks, the biggest of which are financial. The company is taking on large amounts of bank debt to fund the acquisition – €18.26bn ($23.19bn), according to Gas Natural. With its shares already under pressure, the firm last month launched a €3.5bn rights issue – of one new share for every existing share, at an issue price of €7.82 a share – to start to pay down that debt. Asset disposals should help too it hopes, possibly generating €3bn. But even then it would be highly geared. With domestic gas and electricity prices in sharp decline and the general economic outlook both grim and uncertain, that will put the new company under significant financial strain in the months to come.

In addition, the price being paid – €18.33 a share, valuing Unión Fenosa at around €16.75bn – is regarded as too high, particularly given weaker prices in both companies' primary markets. There are doubts over whether the synergy benefits that should be generated by merging the two companies – estimated by Gas Natural at about €300m a year – are strong enough to justify what is seen as a significant premium.

Another problem could be the combined group's over-exposure to gas-fired electricity generation. Gas Natural – controlled by oil firm Repsol and savings bank La Caixa – says the merged entity's combined electricity businesses will result in a "balanced and competitive generation mix, in which CCGT will continue to play an important role". The new company, claims Gas Natural, will be "one of the main CCGT operators worldwide".

But some analysts see this strength in CCGT as a potential weakness: when electricity demand falls, gas-fired generation is the first to be affected. Rival companies have a greater presence in other market segments – including hydropower, other renewables and nuclear – and that diversity could prove beneficial. With Spanish electricity sales falling by around 9% on the year, according to grid operator Red Electrica, and gas sales down by up to 20%, according to companies operating in the sector, over-exposure to gas-fired power generation could prove particularly risky.

Analysts say there are other threats to success. But by the time the transaction is completed – with regulatory and government approval secured in February, that should occur in April, Gas Natural chairman Salvador Gabarro said last month – nine months will have elapsed since the deal was announced and market fundamentals have shifted significantly since then. As a result, equity analysts would like to see more information on the integrated company's financial targets. And while Gas Natural has articulated targets for merger synergies and a plan for managing its hefty debt burden, they would like greater clarity on what the company would do if adverse market circumstances – a prolonged recession, for example – throw its forecasts and plan into jeopardy. "What if things don't go well?" asks one. "What are the plan Bs and the plan Cs?"

That uncertainty is exacerbated by the lack of experience in both companies of handling a deal of this size. Senior management executives must show the market that they are up to the task, delivering the promised benefits, coping with imploding demand, handling public-relations problems such as potential job losses and proving to a doubting marketplace that the long-term strategic gain is worth the short-term pain.

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