UK electricity sector switches to takeovers
In recent months, there has been a rush of bids for the UK regional electricity companies (RECs), set up when the market was deregulated five years ago. They became attractive to bidders as their profits soared in a favorable regulatory environment and the first bid came from construction and shipping group Trafalgar House, which offered (US)$1.9 billion for Northern Electric in December last year.
In March this year, the Regulator, Professor Stephen Littlechild, tightened the controls. Stock prices fell, and three days later Trafalgar House withdrew its bid. However, prices soon started to recover as other bidders began to show an interest in the RECs. They still felt there was big profit potential in the UK market, even with the tighter controls.
Between July and September, Southern Electric International (SEI) of the United States launched a (US)$1.5 billion bid for Southwestern Electricity (SWEB), Scottish Power offered (US)$1.6 billion for Manweb, Hanson bid (US)$3.9 billion for Eastern Electricity, North West Water offered (US)$2.5 billion for Norweb, and PowerGen offered (US)$3 billion for Midlands Electricity. The most recent bid was National Power`s (US)$4.3 billion offer for Southern Electric, announced on October 2.
The first deals to be closed were the Hanson offer for Eastern and the SEI bid for SWEB. The North West Water, PowerGen and National Power offers are subject to government approval, with decisions expected on the most recent ones–PowerGen and National Power–around early December.
All the new bidders see particular advantages in buying RECs. It has been reported that both Hanson and North West Water will now be able to relieve tax burdens built up in other areas of their businesses.
For SEI, the UK system of regulation is attractive, because it is based on price control and allows management to gain full benefit from cost-cutting and efficiency improvements. This contrasts with the US system, which is based on restricting the rate of return, and thus limits the benefits that can be achieved by better management.
Another attraction for the new owners is vertical integration. Following the Hanson takeover, Eastern Electricity agreed to buy two coal-fired power stations from PowerGen for (US)$600 million, and is currently reported to be negotiating to buy another from National Power.
PowerGen and National Power are also both going for vertical integration, prompted by the further deregulation of the UK market that will allow all the UK`s 22 million consumers to buy electricity from whichever company they choose after 1998. Currently the smaller users–around half the market–buy only from their local RECs.
Ed Wallis, PowerGen chief executive, has forecast that around six vertically integrated groups will emerge in the UK market. He has been reported in the UK press as saying that he wanted to buy a REC to consolidate PowerGen`s business and that although supplying power may not be as profitable as other parts of the operation, it is part of a “profit chain” that comes from being able to access the entire supply market.
National Power also feels that access to consumers is important. Regulation means that the company has been compelled to sell off some of its generating capacity, reducing its share of the generation market from 46 percent to around 20 percent to 25 percent. The purchase of SEI will give it around 15 percent of the UK`s supply market, and a foundation from which to grow its supply capability into other supply regions.
It remains to be seen whether the takeovers will be good news for consumers. National Power points out that with 20 percent to 25 percent of generation and 15 percent of supply, it can hardly been seen as a monopoly player; but fears remain that vertical integration will lead to higher prices for consumers in the longer term.
Their only hope in that case might be the survival of some independent RECs, so that the regulator would have a benchmark against which to judge the bigger groups when setting price controls. Although the recent level of takeover activity makes survival look difficult for the independents, there is still some hope.
Yorkshire Electricity, faced with speculation that it will be the next takeover target for Houston Industries and Central and South West, two US utilities that recently pulled out of the bidding for Norweb, announced that it is to pay shareholders a (US)$460 million “special dividend,” saying that its strategy was to remain independent and return value to shareholders. A similar payout strategy was adopted by Northern Electric, indicating this may be one way to discourage bidders.