Heather Johnstone, Senior Editor
Analysis recently issued by the UN Environment Programme, showed that in excess of $148 million in new funding entered the sustainable energy sector, comprising the renewable energy and energy efficiency industries, globally in 2007. This represents an increase of 60 per cent on 2006.
Wind attracted more global investment than any other non-fossil fuel based technology, and is exemplified by the initial public offering (IPO) of Iberenova, the wind power development arm of Spanish power giant Iberdrola at the end of last year, which raised $7.2 billion, and was Spain’s largest ever IPO and the fourth largest public deal of the year.
A similar picture was seen with solar power, which attracted the greatest share of venture capital and private equity investment, totalling $3.7 billion.
Although greater investment in clean and sustainable energy is encouraging when you consider today’s growing concerns over climate change, rising oil prices and energy security, this bullish news does raise the question: could a bubble develop in the global renewable energy sector?
KPMG, in partnership with the Economist Intelligence Unit, asked exactly that question in its recent survey of more than 200 senior executives from across the global energy industry, covering power generators, oil & gas majors, renewable energy suppliers, energy distributors and financial investors from Europe, North America, the Middle East and Africa and Asia-Pacific. And the answer it received was surprising.
Is a bubble developing?
In its ‘Turning Up The Heat’ poll, fifty per cent of respondents, and nearly two-thirds in Europe, agreed that there is a “real risk” of a bubble in the renewable energy sector, with high valuations cited as being the leading cause of the failure of merger and acquisition (M&A) efforts in the last three years (Figure 1).
Source: The Economist Intelligence Unit 2008
The prices currently being paid for renewable energy companies appear to be rising rapidly. To supplement the report, a number of senior executives were interviewed, and their unanimous decision was that high valuations in current deals were taking place. As examples, the report highlights Suzlon Energy’s acquisition of REpower last year, where the price paid for the German wind turbine manufacturer was estimated to be around four times its value a few years earlier. And, according to the Financial Times newspaper, the final sale price was about four times REpower’s annual revenue. Similarly, Suez Group’s acquisition of Compagnie du Vent, valued the French wind generator at more than 50 times its annual revenue.
Some companies are also looking to take advantage of these current high prices. Babcock & Brown Wind Partners, for example, recently launched a “strategic initiative” to identify and potentially sell off a selection of its high value wind assets, particulalry in Europe.
Calculating the average enterprise value (EV) per operating MW of recently completed deals, based on available data, suggests an average of $4.9 million per MW of operating capacity as an approximate measure (Table 1). By comparison, several greenfield developments have been built for approximately half that amount per MW, according to publicly available costs says the report.
Given that EV is a measure of a company’s value typically used to gauge a theoretical takeover price, these data suggest that buyers have been willing to pay a significant premium for renewable energy targets.
The report found that these high valuations are already having an impact on the level of activity. with 52 per cent of respondents believing that high valuations are a factor restricting the growth of the renewable energy sector. Only regulatory constraints and uncertainty scored higher.
Another sign of a potential bubble identified was the growing number of small investors entering the market, while bigger, more experienced companies are being more cautious. Two-thirds (66 per cent) of the largest companies (with annual revenue over $10 billion) agree that a bubble is a possibility. While far fewer (44 per cent) smaller companies (with revenue under $500 million) are concerned.
Although the bigger firms are doing the majority of the buying, smaller ones are much more likely to incur new debt (45 per cent compared with 24 per cent). The smaller companies are also more likely to take on higher gearings, with about one-half (48 per cent) accepting figures of over 50 per cent. Just one-third (32 per cent) of larger companies do the same.
According to the report, the adoption of new technologies is frequently accompanied by a rapid upsurge in the valuations of the companies involved, a large correction, and then more restrained growth as businesses build real value. The most prominent recent example was the dotcom boom and bust.
According to Ed Northam, CEO of Viridis Clean Energy Group, a similar trajectory is likely. “I don’t think it will be as extreme as with dotcoms, but we haven’t seen the end of the frenzy stage yet.” Current valuations will eventually seem conservative, he thinks, but not as quickly as some would expect. “Those with a long-term focus will be proven correct, but people who will have used aggressive assumptions in the medium term will end up under pressure.”
However, not everyone polled agrees with the dotcom comparison. Estanislao Rey-Baltar, CFO of Iberdrola Renovables believes that unlike many dotcom-era internet firms, which were based on unproven ideas, the renewable energy sector makes something measurable.
Moreover, Vivek Kher, head of communications at Suzlon Energy, argues that it is not the price per se that matters. “If a company will add value, it will be acquired,” he says. In the survey, 61 per cent of executives agreed that their company’s last acquisition has added value.
Pace of consolidation to increase
Although half of the executives polled expressed a concern over the renewable energy sector potentially overheating, 56 per cent of respondents believe that company valuations will continue to rise and M&A activity will accelerate in the near future. Furthermore, almost three-quarters (72 per cent) of executives believe that the size of deals will increase, while over two-thirds (68 per cent) expect the competition for targets to grow, with 59 per cent believing that infrastructure funds and financial investors will bring more money into the sector.
Rhys Stanwix, head of energy strategy at Scottish & Southern Energy (SSE), thinks this consolidation “will likely continue for the foreseeable future”. Suppliers, he explains, are required to deliver on increasing targets, but there are a large number of developers, many of which are small. “That will drive you to do either a lot of contracting or, what has happened, consolidation where suppliers buy them up,” he argues. “There are a lot of portfolio benefits and economies of scale in owning the facility” he concludes.
This interest, however, is concentrated in particular areas of the renewable energy market, according to the report. Roughly 60 per cent of those surveyed expect consolidation to accelerate in solar, wind and biofuels, with only a minority expecting the same for hydroelectric firms (27 per cent) and tidal energy (14 per cent), with the majority expecting no change.
Growth predictions follow a similar pattern, with over three-quarters foreseeing high or moderate growth from wind, solar and biofuels, but only 46 per cent from hydropower and just 27 per cent from tidal. Over the next three years, the number expecting to purchase a hydro company will drop by about 9 per cent, while those planning to buy a wind or solar business will go up between 45-60 per cent.
Stanwix describes the varying appeal of these power sources as purely a question of economics, saying wind is a benchmark technology, it’s at market and it’s economic. Equally important, are the European support mechanisms and feed-in tariffs, which favour to both wind and solar, even though the latter is remains more expensive to produce.
Who is doing the buying?
The survey also found that M&A activity varies according to the specific interests of the buyers. One common factor, however, is that the big are swallowing up the small, with most executives polled for this report believing that big, international energy companies will be among the most active in seeking acquisitions (68 per cent), followed by specialist renewable companies (56 per cent). However, other types of investor have become more prominent in recent times, particularly infrastructure and other specialized funds.
Source: The Economist Intelligence Unit 2008
When considering M&A in the renewable energy industry, says the report, it is best to see it as several overlapping markets, rather than one large one.
Within traditional energy companies, power generators are buying far more companies than oil & gas majors. Nearly nine out of ten (89 per cent) power generators had acquired a renewable energy company in the last three years and 78 per cent are either in the process of completing an acquisition or actively seeking one.
Power generators are looking at their end product, namely electricity, and accordingly, they are buying a lot of wind companies says the report. About 39 per cent of those polled have done so in the last three years and 54 per cent expect to do so in the next three. SSE, for example, recently announced a target to grow its renewable energy capacity in the UK and Ireland to 4000 MW by 2013, by investing à‚£2.5 billion ($5 billion).
With these purchases, power generators are focused on growth: increased market share is a top priority (selected by 68 per cent), as is the penetration of new markets (54 per cent). Far behind are energy security (7 per cent) and technology acquisition (4 per cent).
Ultimately, however, regulatory targets are behind much of this activity. With governments, especially in the European Union where M&A activity is particularly strong, mandating significant renewable sourcing for energy, power companies have little choice but to look at such options says the report.
Renewable energy providers have a different profile. They are on average much smaller à‚— two-thirds of the renewable energy firms polled had annual revenue of less than $500 million.
To date, their interest has focused on wind and to a lesser extent solar, but in future far more expect to buy into solar (48 per cent) than wind (32 per cent). This is partly owing to increased competition from larger energy players in wind, as well as the greater need for innovation to make solar viable, which is highly attractive to specialist outfits.
Renewable energy companies, like traditional power generators, are engaging in M&A to boost market share (56 per cent cited this among their top three responses) and geographic growth (40 per cent). Given their size and mission, they are also pursuing better economies of scale (40 per cent) and new technologies (32 per cent).
Infrastructure funds, private equity firms and other financial investors are also likely to be major M&A participants, according to the survey. Financial investors look set to add liquidity and potentially higher valuations to all sectors of the renewables market: 39 per cent of those who took part in the survey expect to purchase a wind business in the next three years, and one-half intend to do the same for solar.
Different kinds of investors, however, will focus on different technologies. Private equity firms, and especially venture capital players, are more interested in biofuels and solar, which remain more speculative investments. Infrastructure funds, on the other hand, are turning to wind assets, because of its stable long-term cash flow.
Although 50 per cent of survey respondents expressed concern that there was a “real risk” of a bubble developing, few appear to believe that such a bubble is ready to burst, with the pace of consolidation expected to continue to increase.
Whatever lies ahead for the renewable energy sector, there is little doubt these are exciting times for all parties involved.