Europe

Mixed fortunes for power deal players

Issue 3 and Volume 20.

The worldwide total for merger and acquisition deals in the power sector in 2011 was $174.4 billion, up 16 per cent from 2010. But the number of deals dropped from 670 in 2010 to 583 last year.

The trends in merger & acquisitions involving power utilities is changing, with radically divergent trends apparent not just for East and West, but also for the two sides of the Atlantic.

Kelvin Ross, Deputy Editor

The landscape of mergers and acquisitions (M&A) within the global power utilities market is changing like never before. And, for the first time, traditionally dominant regions are being outpaced by the world’s emerging markets.

These are the conclusions of analysts at PricewaterhouseCoopers (PwC) in their annual Power Deals report, which examines M&A trends over the past 12 months in the global power utilities market. The report covers deals involving power generation, transmission and distribution, natural gas transmission, distribution and storage, and energy retail. Renewable energy deals are excluded (they are featured in PwC’s publication Renewables Deals). And, for the first time, the report looks at projections for the coming year.

Firstly, let’s look at the headline figures. The worldwide total for M&A deals in the power sector was $174.4 billion, up 16 per cent year-on-year. Yet the number of deals was down 13 per cent from 670 in 2010 to 583 last year. This broke down as 468 electricity deals and 115 involving gas. Of the 583 total, 436 were domestic and 147 across borders.

A year ago, the value of deals had been heading towards the highs of 2006–07, the last peak of M&A activity before the credit crunch suddenly kicked in. But at the start of 2012 this bounce-back has stalled, with deal values currently near the credit crunch lows of 2009.

What has caused this? One of the major drivers is the crisis in the eurozone, which PwC says will continue to cloud the deal environment this year. The uncertainties over the euro – with Greece’s debt crisis at their heart – caused M&A activity in the region to shudder to a halt as investors reassessed their options in the face of fears of recession and the worst-case scenario of a complete collapse of the currency.

European deals completed over 2011 totalled 142, a drop from the 190 of 2010. The value of these deals was $39.8 billion, a significant fall from the 2010 figure of $70.3 billion.

Yet the outlook for Europe is not so uniformly bleak: while deal value in 2011 was much lower than 2010, the number of deals is still considerable and PwC says that companies remain on the lookout for opportunities.

Europe’s crisis spurs dealmaking

A characteristic of European deals is the need for many utilities to shed assets in a bid to revive balance sheets that are mired in the red. The biggest European deal was E.ON’s sale of Central Networks to US company PPL Corporation for $6.5 billion, which was part of E.ON’s efforts to divest itself of assets worth €15 billion ($20 billion) by the end of next year. One of Europe’s biggest deals this year is likely to be E.ON’s sale of its gas transmission operation in Germany, Open Grid Europe.

Fellow German utility RWE wants to claw back €9 billion and a key stepping stone to this was the September sale of a 74.9 per cent stake in German electricity transmission system operator Amprion. Future deals to hit this target are likely to be the sale of its gas grid operator in the Czech Republic, Net4Gas, a stake in its Berlin water company Berlinwasser and parts – or all – of its Dea upstream gas and oil business.

Meanwhile in Sweden, Vattenfall drew up a consolidation blueprint with the ultimate aim of refocusing its business domestically and in Germany. This strategy got underway with the agreed sale of Nuon in Belgium to Italy’s Eni, and the sale of its Polish heat, electricity distribution and network services to PGNiG and Tauron. Vattenfall ended 2011 with a deal to sell its electricity and heating distribution assets in Finland to a Goldman Sachs/3i consortium for €1.54 billion. A further deal of note was the decision by France’s EDF to increase its stake in Italian company Edison to 78.95 per cent at a cost of $6.3 billion.

Looking to the year ahead, PwC predicts that, unsurprisingly, the eurozone crisis will continue to have an impact on M&A activity, although not inevitably in a negative way.

“It is unlikely to halt the divestment programmes of the major utility companies,” said the report.

“The underlying fundamentals for such deals remain strong. Companies need to continue to reposition their fuel and value chain mix and to seek out growth markets. They have big investment requirements and need to manage leverage. Debt markets remain constrained and, as RWE’s late 2011 share sale showed, the equity markets are likely to only provide a part answer. Raising capital from disposals remains an important priority and is likely to remain a strong feature of power deals in 2012.”

Indeed, PwC states that the eurozone crisis will “act as a spur for dealmaking”, pointing to potential sales of state-owned assets in Ireland and Italy, including the part-privatisation of Irish gas company Bord Gais.

PwC also spotlights European power grid operator TenneT as being a prime candidate for sell off. TenneT is struggling to cope with demands being placed on it by the state to link Germany’s many wind farms to the grid, a move which is critical since the Merkel government’s decision to withdraw from nuclear power.

For those companies looking to ease balance sheet woes, joint venture project and investment relationships are likely to figure strongly in 2012. Last year RWE held talks with Gazprom about the possibility of the two firms covering gas and coal fired plant in Germany, the Netherlands and the UK. This deal failed to come to fruition in 2011 but PwC states that it “remains a distinct possibility” for this year.

A further trend peculiar to Europe relates to energy prices, which PwC says have become “a hot issue as the cost of decarbonisation bites and the economic situation puts pressure on customer budgets”. PwC states that concerns about energy prices have created “a trilemma in the triangle that has to be balanced between affordability, sustainability and security of supply”. This is adding to the uncertainty faced by dealmakers and investors.

China looks abroad

But the European trend of companies and governments seeking to shed assets means opportunities for other acquisition-hungry regions of the world – and, in particular, China.

PwC believes that the crisis in the eurozone will “act as a spur for dealmaking”.

The most notable deal was China Three Gorges’ $3.5 billion bid for a 21.35 per cent stake in Energias de Portugal (EDP) – a move PwC sees as “symptomatic of increased interest in expansion into overseas power markets by Chinese generating companies”.The EDP deal will give China Three Gorges a foothold in the boom market of Brazil, a tactic mirrored by China’s State Grid Corporation’s bid for a 25 per cent stake in Portuguese power grid company REN. But expansion in the fast growing Brazilian market was an important focus for European companies as well. E.ON lost out to China Three Gorges for the EDP deal. But this disappointment was tempered when at the start of 2012 it entered into an agreement to take a 10 per cent stake in Brazil’s MPX Energia. This deal is expected to lead to major investment by both parties into new power generation capacity. Meanwhile, Spain’s Iberdrola bought Brazilian distribution company Elektro for $2.9 billion.

This year, Chinese companies’ appetite for western markets is expected not only to continue but to intensify at some considerable pace. And it is not just the Chinese who are pursuing this ‘go abroad’ strategy. Japan’s power sector may still be reeling from the Fukushima disaster a year ago, but the country’s dealmakers are working apace.

The top ten global M&A deals in the power utilities sector are dominated by activity in the US. The Duke/Progress merger – number two on the list – will create the largest utility group in the US.

The second-largest Asia-Pacific deal of 2011 was the $1.2 billion distress sale by Griffin Energy of two coal fired power plants in Australia to Kansai Electric Power and Sumitomo Corporation. Marubeni Corporation clinched a 40 per cent stake in Queensland gas distribution network Allgas, and Itochu Corporation bought a 33 per cent share of Belgian electricity firm T-Power.

Of course, the Japanese company most affected by last year’s earthquake and tsunami is Fukushima operator Tokyo Electric Power Company (Tepco), and on the M&A front its future is suitably cloudy. The company has already started asset sales and these are likely to accelerate this year.

The total number of deals transacted in the Asia-Pacific region in 2011 was 156, just a 3 per cent drop on the 160 done a year earlier. The 2011 deal value was $14.1 billion, compared with $19.7 billion.

North America Stays Buoyant

If there is a constant between the 2011 M&A activity and that of previous years, it is that the North American market remains buoyant. American deals dominated the top ten as US companies moved to gain scale. In the US, 117 M&A deals done last year, a 6 per cent increase of the 110 carried out in 2010. However, the value of these deals has rocketed 119 per cent, from $49 billion in 2010 to $107.5 billion.

The number and value of M&A deals in the North American rose last year, with US transactions dominating the global top ten mergers for 2011

The year started with the $25.8 billion merger between Duke Energy and Progress Energy and was followed by a strong flow of other deals, including a proposed merger between Exelon and Constellation and two mega mergers in the gas pipeline sector. Indeed, it is the first time that all-US deals accounted for six out of the ten largest deals in the PwC report.

The Duke/Progress deal will create the largest utility group in the US, with around 7.1 million electricity customers and 57 GW of generating capacity from coal, oil, natural gas, nuclear and renewables. But the biggest deal in the US – or anywhere else in the world – was Kinder Morgan’s $37.9 billion purchase of the gas pipeline assets of El Paso. PwC notes that the gas supply glut in the US, caused by the expansion of shale and other forms of unconventional gas, “has changed the economics of power generation and gas transportation”.

“Low gas prices combined with lower power demand have put strains on power generation,” it states. “Many generation plants are under-utilised in a changed supply-demand and price environment. Sales of gas fired plant have added to smaller deal flow. The changed gas environment has created opportunities for, but has also put strains on, gas pipeline operators. Pipeline businesses deliver stable cash flows, often high yield, but the inter-regional differences that are the basis of pipelines flows have been altered in a different supply and price environment.

The crisis in the eurozone was a key factor in European M&A deals falling significantly both in value and in number

“At the same time, more sources of supply have required more pipeline investment. As a result, greater spread and size is being sought by companies.” The Kinder Morgan/El Paso deal highlighted this trend, says PwC.

Over the next nine months, ‘buy versus build’ will be the mantra for US generation, according to PwC, as current market conditions make this the more economical option.

The quest for ‘scale and balance’ will also continue among US power firms. Last year saw a rush of major deals as US companies sought to strengthen balance sheets and rebalance regulated versus non-regulated returns. These deal imperatives, predicts PwC, will continue into 2012. Scope remains for a continued flow of deals in the US, but its strength will depend on state regulators. The big 2011 US deals are still to get over the finish line in terms of regulatory clearance. “Companies will be looking closely at the reaction of regulators before weighing up their next moves,” states PwC.

Given that merger activity is now at the same level as it was in 2008–09, it might be tempting to draw some parallels between the financial climates of the two times, but PwC cautions against this. The credit crunch, it states, had a “definite focus, centred around the Lehman crash”. The current crisis, however, lacks an equivalent “big event focus – a rear view mirror event that can be seen as a turning point. Instead there is ongoing material uncertainty.”

While the value of deals in the Asia-Pacific fell dramatically, their number dipped only slightly from 2010’s figures

‘Rolling Uncertainty’ For 2012

It is this ‘rolling uncertainty’ that PwC says will characterise deals throughout the next nine months. Dealmakers are facing a perfect storm of a fragmented liquidity landscape, uncertain bank finance and no end in sight for an easing of debt issuance. And yet PwC considers the credit-crunch advice of ‘if you don’t have to be in the market, stay out of the market’ does not apply in 2012.

While no one knows if things will be better or worse in six months’ time, “in this environment, perhaps paradoxically, a complete brake on dealmaking makes less sense”. “If a deal is highly strategic and mission critical, then parties may feel it is worth doing if it can get done. With the uncertainty over how long the constraints will persist, it’s a brave bet to stay out of the markets just in the hope that things will improve.”

South and Central America saw a significant rise in both the value and number of deals

PwC concludes that 2011 saw the global M&A deal landscape significantly change. “In the past, Europe and the US were the dominant influence on deal activity,” it states. “Now two other important influences are coming right to the fore – the involvement of very active Asia-Pacific investors and the pace of growth markets such as Brazil. We’re also seeing markets move at different speeds and in different directions. Growth in emerging markets is contrasting with recession in Europe. These different speeds will provide opportunities for buyers able to exploit cross-continental value opportunities.”

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