German response to competition creates new electricity powerhouse

The merger of Veba and Viag will create Germany`s largest and Europe`s third largest electric utility. Siân Green looks at the market forces surrounding this deal and the aspirations of the new company in the rapidly developing European electricity market.

Siân Green

Rumours of talks between the German industrial giants Veba and Viag were finally confirmed in September when the two groups announced details of a merger that will create the second largest industrial group in Germany with core business activities in energy and chemicals.

The deal has been made in response to the liberalization of the German and European electricity markets, and is indicative of the cost-cutting pressures that utilities are under. The merger puts Veba and Viag in a leading position in a market where competition is becoming fierce.

The new company – which will be named in the coming months and will be headquartered in Düsseldorf – will have sales of over $81bn (euro76bn) based on last year`s figures. It will divest non-core activities and focus on growth in Europe`s liberalizing energy sector. The boards of both companies have approved the deal, which will now be examined by the Federal Cartel Office (BKA) and the European Commission.

The merger creates Germany`s largest energy company through the consolidation of Veba subsidiary PreussenElektra and Viag`s Bayernwerk. The energy holding company, to be headquartered in Munich, will be Europe`s third largest electricity group after Enel of Italy and France`s EDF. The new company will control Viag`s electricity supply business in south Germany and Veba`s in the north, each consisting of generation, transmission and distribution elements, giving a strong basis for further expansion in Europe.

The driving force behind the merger deal was liberalization of the German and European electricity markets which is forcing utilities to cut costs in response to falling prices. Through the merger, Veba and Viag will be able to make savings in generation, transmission and distribution that will help them to compete on a national level.

Most savings from the merger will be made in the energy business. Savings in this sector will reach around euro700m ($744m) per year by 2002, while further savings of euro100m per year will come from the chemicals business and operational cuts from Veba and Viag. According to Veba spokesman Josef Nelles, one third of the savings in the energy business will come from personnel cuts, while the remaining two thirds will be derived from operational cuts. Overall, around 2500 job cuts will be made.

The reason for the large synergy savings is the close fit of the two group`s core businesses. “Both companies focus on energy, [in particular] electricity, and chemicals,” said Nelles. “This means that we have a very good fit.” Non-core businesses, including interests in telecommunications, packaging, logistics and aluminium will be sold over the next two or three years, generating revenues of euro28bn that will be used to finance acquisitions.

But Veba and Viag`s latest move has other strategic advantages – not least making them less vulnerable to takeover. A leaner and more focused Veba-Viag company will also be able to revive flagging electricity sales in the German market. With a one-third share in the electricity market, the new German powerhouse is in a strong position to compete with its domestic rivals as competition heats up.

But perhaps the biggest driver for the merger was fear of losing out to competitors in a rapidly developing competitive European electricity market. Other German utilities, notably RWE, have recently become aggressive at home and abroad.

RWE, until the merger Germany`s largest electricity utility, launched in August 1999 its “Challenge 2010” programme under which it aims to attain a market share of 10 to 15 per cent of the total volume of Europe`s energy market by 2010. It will not achieve this through internal growth alone, and has therefore pledged to spend euro30bn on international acquisitions in the next ten years. It has already made a bid for a stake in german utility EnBW, which has also taken aggressive steps in the market, and is said to be in talks with several companies in the UK. It also recently announced that it is to cut the board of its holding group from 11 to five members.

But RWE is also eager to maintain its lead at home in Germany. After the merger announcement, it developed plans to cut its electricity charges to households by 7.3 per cent to pfennigs23.99/kWh as of November 1 while keeping its standing charge the same. Another utility, VEW, also announced plans for an energy alliance to counter both the merger and RWE`s aggressive pricing.

But the merged Veba-Viag company has plans of its own. It believes that both its size and its geographical location will give it strength in Europe – and also possibly further afield. While it aims to capitalize on its top position in the German electricity market, it will also be seeking opportunities elsewhere. “We are looking to expand [our domestic market share],” said Nelles. He added: “Our main focus is Europe, but acquisitions or partnerships overseas are not excluded. In the IPP business it could be possible to do something overseas.”

Overall, the new company`s aim is to become a leading global multi-utility. “This merger is the first step, and more steps will follow,” said Nelles, who did not rule out the possibility of the company`s business being expanded to “an international, maybe global level”. He added: “[The merger] gives us a good basis for further steps … to expand in electricity, energy and other utility businesses”.

Veba and Viag`s plans must first overcome two main regulatory hurdles – the BKA and the EC. The former has already said that it would not oppose the merger, but is likely to require the new company to implement third party access rules to its grid network, a move that would further heighten competition among the utilities in what is fast becoming the most competitive market in Europe.

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