RWE’s move into the UK power market through its acquisition of Innogy is a bold move and reflects its aggressive multi-utility expansion strategy. Is there a limit to RWE’s ambitions?

German energy and environmental services company RWE AG has reached agreement for a €8.5bn ($7.5bn) takeover of Innogy, the UK energy utility. Innogy accepted an increased offer of £2.75 (€4.44) per share in an all-cash deal expected to be complete by the end of June 2002.

The offer values Innogy’s issued share capital at €5.0bn, a 31 per cent premium to the company’s closing price in mid-February when RWE first approached Innogy. RWE will take on an estimated €8.4bn of debt as part of the deal.

The activities of Innogy will form a new UK-based RWE unit. Innogy CEO Brian Count will report to Dr. Dietmar Kuhnt, chairman of RWE’s management board.

The deal is RWE’s third major acquisition since September 2001, and reflects its ambitions to be not just a major player in the European power industry, but a true international multi-utility. The company wants to have leading competitive positions in four utility sectors: electricity, natural gas, water and waste disposal. A series of acquisitions and asset disposals has made sure that it is well on its way to achieving this ambition.

Late last year, RWE announced the takeover of American Water Works, a leader in what is the world’s largest water market, for €8.5bn. This acquisition, together with its Thames Water subsidiary in the UK and activities in South America, will make RWE the third largest water company in the world.

RWE’s acquisition of a majority stake in Czech Republic gas company Transgas together with eight regional gas utilities for €4bn will make RWE the second largest gas pipeline operator and the fourth largest gas company in Europe. RWE expects gas consumption in the Czech Republic to grow by four per cent per year, and Transgas’ strategic position as an east-west transit hub presents RWE with good opportunities for growth.

RWE’s acquisition of Innogy will be largely debt-financed. Standard & Poor’s has put RWE’s credit ratings on CreditWatch with negative implications, reflecting the size of the bid against the backdrop of its recent large acquisitions and reduced financial flexibility caused by conditions in its domestic market.

Standard & Poor’s points out, however, that “RWE continues to benefit from a strong business position, a robust balance sheet, and disposable non-core assets”. It also expects the company to enter a period of consolidation and to avoid further large acquisitions in the near-term.

Innogy is a good fit for RWE. It is a leading integrated energy company with a flexible generation portfolio and a strong trading arm. It is the leading supplier of electricity in the UK with 4.7m customers and a 20 per cent market share, and the second largest supplier of gas with 1.9m customers and an eight per cent market share.

Commenting on the deal, Kuhnt said: “Innogy is the UK’s leading integrated electricity business and this transaction significantly enhances our multi-utility strategy. Innogy’s flexible generation portfolio and strong customer skills will be of real value to the RWE Group.”

Innogy generated net sales of €6.2bn and a net profit of €351m in the year to 31 March 2001, and offers stability through its favourable ratio of generation to sales. RWE expects the deal to be earnings-accretive in the first full year following completion.

Moving up in the world: RWE’s acquisition of Innogy places it above E.ON in terms of energy customers
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On completion, RWE will have approximately 20m energy customers. Across Europe, the company will generate some 211 TWh and supply 321 TWh of electricity, making it the number two player in generation and number three in supply.

But RWE is entering a market in which many companies have failed. Datamonitor believes that the UK electricity market must be one of the least attractive in the world. Datamonitor’s research director, Jon Lane, states that intense competition in generation and retail coupled with a tough regulatory regime means that most utilities struggle to sustain their financial performance.

In light of this, Lane believes that RWE has probably paid too much for Innogy, although he admits that it probably had little choice considering the competition in Europe from companies such as EDF.

But RWE should benefit from Innogy’s experience in the tough UK market. “Innogy has successfully negotiated a highly competitive market through strong cost cutting, re-branding, innovative marketing, restructuring, and value creation,” says Lane. “It has been the most successful UK vertically integrated utility at both maximizing the value of its power generation assets and winning high-margin residential customers organically from its competitors. RWE wants to do this in Germany and hopes Innogy can tell it how.”

In addition, RWE will be able to use its presence in the UK water market to its advantage. It will pool the customer service facilities and administrative functions of Thames Water and Innogy, and gain sales synergies by giving Innogy access to Thames Water’s 3m customers.