Centrica, Endesa, Enel, Europe, Middle East & Africa

What now for cross-border deals?

Issue 4 and Volume 15.

E.ON has abandoned its bid for Spanish utility Endesa. Heather Johnstone takes a look at the tortuous takeover battle and asks: what does this outcome mean for future cross-border power deals?

After more than 14 months the E.ON-Endesa saga finally reached its climax, but not necessarily the one many envisaged. On Monday, 2 April 2007, E.ON announced that it was withdrawing its €42.2bn ($56.6bn) bid for Spain’s biggest electricity provider. However, E.ON does not walk away empty-handed.

In what is seen as a ‘backroom’ deal to share out the assets of Endesa, E.ON will receive an extensive portfolio of equity holdings, including operations in Spain, Italy and France, worth in the region of €10bn if Enel and Acciona succeed in acquiring the utility. In Spain, E.ON will acquire the power utility Viesgo from Enel, as well as additional generation capacity from Endesa. Together this makes it the fourth largest player in the Spanish market. E.ON will also acquire E.ON Endesa Italia in Italy and Endesa France/SNET in France, as well as some activities in Poland and Turkey.

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The battle for Endesa began back to September 2005, when Gas Natural made a cash/share €22bn offer. The following February, however, E.ON made an all-cash bid of €29.1bn. Independent competition authorities reviewed the rival bids and recommended that the bid by Gas Natural be blocked, because the company already generates electricity in Spain, so raising competition concerns. The E.ON bid, on the other hand, was recommended to proceed because “it would not significantly impede competition in the European Union or in any substantial part of it”.

The Spanish authorities, however, had a different idea. They wanted the acquisition of Endesa to produce a strong ‘national champion’ rather than the utility becoming a German subsidiary. Thus, in response the Spanish government overruled the Competition Tribunal’s recommendation to block the Gas Natural bid and conditionally approved it.

Furthermore, Spain’s Council of Ministers adopted new legislative measures that increased the supervisory powers of the national energy regulator over takeover bids, enabling the energy regulator to impose a number of conditions on the proposed E.ON takeover, including obligations to use Spanish-produced coal, maintain the Endesa brand and retain Endesa’s assets outside mainland Spain for five years. The effect of these conditions was to essentially block the E.ON bid, by making it commercially unviable for the company to proceed.

The European Commission (EC) hit back by declaring the Spanish energy regulator’s measures were “unlawful” and gave the Spanish authorities until the middle of January 2007 to withdraw them. The authorities failed to comply and at the end of January the EC initiated legal proceedings against Spain at the European Court of Justice.

In February of this year, more than 18 months after its initial offer, Gas Natural finally withdrew its bid for Endesa. On the surface this meant that E.ON’s bid would be able to proceed without any further hitches. Alas, this was not to be.

Enel SpA, an Italian utility already operates in the Spanish market, emerged as a rival bidder in partnership with Acciona, the Spanish construction company in March. In the period that E.ON had been embroiled with Gas Natural the two companies had built their stake in Endesa to 46 per cent, plus the partnership had the support of the Spanish government. Enel-Acciona indicated that they would offer €41 a share if E.ON failed to secure more than half of Endesa’s shares within a six-month period. E.ON tried to salvage the deal by increasing its offer further, but in the end the company felt that Acciona’s and Enel’s involvement in Endesa made its orginal goal of acquiring the company impossible.

The E.ON-Endesa saga is not the first example of a cross-border deal in Europe coming up against national protectionism. But, according to Michael Grenfell, partner at Norton Rose, it certainly is one that has most dramatically pitted the forces of globalized capitalism, pushing for cross-border mergers and acquisitions, against the forces of economic nationalism, which are seeking to protect key national assets against foreign takeover.

It is interesting times in the European power market. According to the recently published Power Deals Annual Review from PricewaterhouseCooper, 2006 was a bumper year for merger and acquisition activity in Europe, with the E.ON-Endesa deal given the so-called ‘mega-mega deal’ label. Furthermore, with the market continuing to be liberalized, further consolidation is likely, resulting in only a handful of market.

The major lesson of E.ON’s 14-month battle for Endesa is that cross-border mergers in the European energy market are extremely difficult. One executive of a large European utility summed it up when he said that E.ON withdrawl of its bid marked “a sad day for the industry”, underlining how difficult cross-border deals are. He also expressed concern that cross-border deals in the future may experience similar difficulties.

However, E.ON does not appear battle-weary. According to Wolf Bernotat, E.ON’s CEO, there will be more consolidation to come in the European energy industry, and the German group would play an active role. Speculation on future tagets for E.ON include Centrica, Scottish and Southern Energy and International Power. Interestingly, all are based in the UK, which has a well liberalized utility market, so national protectionism would be extremely unlikely to raise its ugly head.