What's driving the utilities merger boom?
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The utilities market has been the focus of much merger activity in recent months. But this is as much about politics as economics.
Is there a utilities merger boom?
Yes. In the last few months, European utilities have seen two of the largest-ever deals in Europe: Eon’s €55bn bid for Spain’s Endesa and the €70bn merger of Suez and Gaz de France (GdF).
Meanwhile, Italy’s Enel, France’s EdF and Germany’s RWE have signalled that they do not intend to be left out. And UK utilities such as Centrica, Scottish Power and Scottish & Southern are all potential takeover candidates.
What’s driving all this activity?
European utilities are awash with cash (about €140bn of it) and can’t think how else to spend it. Companies such as Eon, Enel, Gas de France and EDF have been able to slash their debt because of high energy prices. Until recently, shareholders had preferred that the windfalls were paid back to them through share buybacks or dividends. Now they are increasingly happy to back deals.
Haven’t we been here before?
Yes. European utilities went on a similar shopping spree six years ago. Some of those deals were domestic mergers, such as Eon, designed to consolidate market positions. Others looked suspiciously like empire-building, as reckless European groups pursued scale for scale’s sake.
That often meant snapping up British utilities because these were the most easily available, given the UK’s relaxed attitudes to foreign investment. So Eon bought Powergen and RWE bought Thames Water. Many of these deals proved hugely value destructive, which is why investors have been wary of deals until now.
So what’s changed?
This time, the utilities argue, they’ve got a very good reason to do deals. The EU is insisting that every member state fully opens its domestic market to competition by 1 July 2007. This means that many European utilities, which currently enjoy near monopolies in their domestic market, are soon likely to be losing market share. Many of them, therefore, need to find new sources of revenue to make up.
Meanwhile, the opening up of domestic markets creates opportunities for them to do business overseas. But taking advantage of those opportunities requires them to be big.
Why do they need to be so big?
Because utility groups need scale to finance the huge costs of building generating capacity. Eon estimates that Europe needs to build 250-300GW of new capacity over the next 15 years, as well as new storage capacity, interconnectors and transmission networks. That will cost billions of dollars.
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So are all these mergers a good thing?
Not necessarily. Some of them are clearly driven by politics. For example, before Eon made its hostile bid for Endesa, the Spanish government had over-ruled its own competition commission to try to help rival Spanish utilities Gas Natural and Iberdrola carve up the company. Its plan was to create two powerful Spanish national champions ahead of full liberalisation. The government is now doing all it can to frustrate Eon’s bid.
Similarly, the French government moved swiftly to pre-empt a bid by Italy’s Enel for French utility group Suez by giving its blessing to a merger between Suez and GdF.
Will governments get away with this?
Time will tell. The French government can make a reasonable defence of its actions. Its decision to change the law to let its stake in GdF fall below 70% means that the merger with Suez amounts to a privatisation of the company, thus reducing state control of the sector.
At the same time, the deal creates a strong new competitor to EdF in the electricity market. Also, Enel has not yet made a bid for Suez, so the French government can hardly be accused of blocking a deal. The test will come if Enel does make a bid. But the Spanish government has no such excuses. Its actions smack of protectionism.
Is this just about electricity and gas?
No. Politicians talk about energy as a “strategic sector” that requires special treatment, and there are legitimate concerns about security of supply in a world where there is greater competition for access to scarce resources.
But there are much wider issues at stake, including the future of European integration and the role of national governments. Attempts to create domestic champions and block foreign bids are best seen as a desperate attempt for relevance by national governments that have lost power to both the markets and the EU. The outcome of these energy sector deals could determine whether Europe becomes an open, free-trading, liberalised single market – or economically marginalises itself.
The long war to liberalise the energy market
The European Energy Regulators Group for Electricity and Gas (ERGEG) recently set up seven “regional energy market projects” to hasten liberalisation. This follows complaints from Neelie Kroes, EU competition commissioner, that the EU energy market is concentrated among just a few national companies. He said there was no significant cross-border competition and that interconnections were lacking between different national markets.
ERGEG was set up in 2003, and seems to have been given a wake-up call by the commissioner. Meanwhile, individual countries are creating national champions and mega-mergers are being planned in company boardrooms. It could be a long war.
Simon Nixon is executive editor of Breakingviews.com
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