Mergers and Acquisitions in Utilities 2017

Transcription

1 Mergers and Acquisitions in Utilities 2017 From the breakup of the utilities sector in Europe to its remodeling in other regions, investors have a major hand in M&A activity worldwide. 1

2 The global utilities and energy infrastructure sector, driven in large part by financial investors, is changing dramatically and for markedly different reasons around the world. Global deal activity in the sector reached a record high of 329 billion in 2016, and the trend promises to accelerate. Portfolio optimization and divestitures could drive another record year in 2017 through mergers and acquisitions (M&A) of utility and energy infrastructure companies. Movement is especially pronounced in Europe, where financial investors are taking a rising share of deal activity, in effect breaking up the region s energy value chain. In contrast, rebounding market capitalizations in the United States and the Americas are spurring a wave of mergers and industry consolidations. A potential renewed focus on traditional energy infrastructure inspired by President Donald Trump s energy plan could further strengthen the market values of incumbent utilities. In the Middle East, India, and China, cross-border utility M&A deals are on the rise. A striking combination of seven deal rationales drives the trend for both buyers and sellers. We will take a closer look at those rationales after examining the sector s transformation region by region. We also will examine greenfield opportunities an area of immense investment in new generation, transmission, and distribution that is rising in tandem with M&A. M&A Dynamics Around the World Globally, 2016 was a record year in total deal value in utilities and energy infrastructure (see figure 1). Worldwide deal activity around renewables was a major driver. In the United States and Canada, industry consolidation resulted in several mega-mergers (including the acquisition of Oncor Electric Delivery by NextEra Energy and large pipeline infrastructure deals). Asian companies are increasingly active in cross-border M&A. Figure was a record year in total deal value in utilities and energy infrastructure; Europe continues with stable development Deal value 329 Number of deals 1,420 1,344 1,244 1,136 1,237 1,207 1,261 1,086 1, Europe North and Central America Asia Others Notes: Includes integrated utilities (power, gas, water, heat); power generation companies (including renewables); energy pipeline infrastructure companies. Date of announcement is 2016, including deals with status pending. Disclosed deal values only. Sources: Dealogic database; A.T. Kearney analysis 1

3 In contrast, from 2008 to 2010 global top deals were mainly led by European utility mergers. In 2008 and 2009, utilities accounted for more than 80 percent of European deal activity (see figure 2). But as market capitalization of European utilities fell to its currently record-low level, financial investors increased their deals in the sector, which have risen dramatically in value from 10 percent of all deals in 2008 to 77 percent in The entry of financial investors powered with cheap money such as private equity and infrastructure funds has triggered the splitting up of companies and the breakup of the integrated utility value chain. Investors select the most preferred assets, which have tended to be focused on the regulated business of renewables and grid infrastructure. In the process, investors have effectively supplanted utilities as the leading asset owners. Now financial investors are taking over non-regulated businesses as well. Figure 2 In Europe, financial investors are taking a rising share of total deal value Deal value Number of deals % 7% 8% 3% 12% 10% 19% 11% 21% 19% 27% 24% 26% 23% 23% 20% 27% 33% 30% 28% 12% 33% 31% 35% 49% 56% 77% 22% 18% 21% 34% 29% 33% 32% 35% 36% 84% 82% 55% 47% 42% 43% 43% 31% 20% 54% 57% 51% 43% 41% 39% 45% 44% 45% Utility and energy investors Financial investors Other Notes: Date of announcement is 2016, including deals with status pending. Disclosed deal values only. Numbers may not resolve due to rounding. Sources: Dealogic database; A.T. Kearney analysis While those investors are attracted by low company valuations in Europe, high valuations open the field for intra-sector deals and consolidations (see figure 3 on page 3). Market capitalization of European utilities has decreased from pre-financial-crisis all-time highs to all-time lows, with the basement probably not yet reached. Many U.S. and Asian utilities, on the other hand, have shown strong increases in market capitalization since They prevent opportunities for financial investors short-term optimization strategies. Overall, the divergence in market values is mainly due to political and regulatory pressure on European companies, which has endangered utilities business models there. Other contributing factors include changes in foreign exchange rates and low-risk regulated businesses comprising a greater share of U.S. utilities business portfolios. 2

4 Figure 3 Financial investors are attracted by low company valuations in Europe, while high valuations instead trigger corporate M&A, including stock deals Market capitalization vs. financial investors deal activity Europe North and Central America Asia 82% 83% +125% +206% +106% +84% Market capitalization 2008 vs E.ON 50 9 RWE Southern Duke CLP 7 13 Huaneng Share of financial investors in utility deal activity (% of deal value) % 12% 3% 13% 6% 8% 21% 49% 56% 51% 77% 79% 73% 13% 43% 31% 20% 37% % 25% 45% 11% 33% 17% 55% 42% 38% January 2008 June 2016 Other1 Financial investor Utility and energy 1For example oil and gas, industrials, and construction and building. Notes: Includes integrated utilities (power, gas, water, heat); power generation companies (including renewables); energy pipeline infrastructure companies. Date of announcement is 2016, including deals with status pending. Disclosed deal values only. Numbers may not resolve due to rounding. Sources: Dealogic database; A.T. Kearney analysis Seven Deal Rationales Drive the Transformation Shifts in the utilities and financial industries will lead to seven deal rationales in the next few years. 1. Asset stripping due to decreasing portfolio synergies of integrated utilities 2. Divestments triggered by the financial needs of state-owned companies 3. The first exit wave of financial investors (reaching the end of their investment cycle) 4. Portfolio shifts of utilities (prompted by de-carbonization and growth in renewables, for example) 5. Financial investors strong appetite, driven by continued low-cost capital 6. The geostrategic interest of sovereign wealth funds and state-owned companies 7. Venture and growth investments in new energy business models Here are the rationales in greater detail: 1. On the sell side, the integrated portfolio design of Europe s largest utilities is under pressure, leading to asset stripping to offset decreasing synergies and satisfy financial needs. The slump in market capitalization of large utility companies in Europe has markedly affected their valuation (see figure 4 on page 4). Industry leaders are finding that selling off less desirable assets can generate more value than keeping them in the traditional value chain setup. 3

5 Figure 4 Disruptions in energy systems led to a slump in the market capitalization of large utility companies in Europe Market capitalization 85% Europe America Asia 82% % 83% 20% +125% +131% +206% 73% +210% % % +106% % % EDF E.ON Iberdrola RWE Enel CEZ Fortum Southern Dominion Duke AEP Tepco CLP Huaneng Huadian January 2008 June / Change in company value (market capitalization) Sources: Datastream; A.T. Kearney analysis The generally decreasing synergies between value-chain steps leads to strategy realignments and the sale of certain businesses, such as transactions between regulated grid and renewables entities and unregulated businesses, including conventional generation, trading, and sales. E.ON and RWE are examples of how spinoffs are taking place and how leading players are breaking up the integrated utility business model. To address low valuations and decreasing synergies, they broke up their integrated businesses and split off certain assets to newly created companies. In January 2016 E.ON spun off its conventional businesses to form Uniper. The assets included gas, coal, and nuclear generation, energy trading, and parts of its international business. Uniper then went public in the second half of the year. Now, the remaining E.ON SE is based on energy transition-focused businesses, including sales, grids, renewable energy, and customer solutions. RWE bundled its new businesses in a subsidiary called Innogy, which went public in October Innogy oversees sales, grids, and renewable energy, while coal, gas, and nuclear plants, as well as energy trading, remain with holding company RWE. The strong stock price increase of Innogy in the first few months may be an indication that the asset stripping deal rationale is feasible. High leverage ratios create additional financial urgencies for select utilities. The cumulative financial pressures force major utilities to sell off shares of even their most valuable assets, as the Swiss company Alpiq did, to facilitate company restructuring, cost reduction, and efficiency improvement. 4

6 2. State-owned holding companies are forced to sell off assets due to financial pressure to reduce debt levels. Numerous states and government agencies find they need to reduce debt levels, which are often exacerbated by political or social developments. Authorities can thus be forced to either drive the portfolio cleanups of publicly held holding companies or privatize shares of utility companies (or companies as a whole) as a way to reduce public debt levels. Portugal recently sold the public power grid operator REN as part of the Portuguese Stability and Growth Program, while Greece is currently launching a tender for the public power grid operator ADMIE, and the United Kingdom s Network Rail is considering the sale of its power lines. And in Asia, some state-owned utilities have begun reassessing their portfolios and considering asset sales. 3. First-wave financial investors in utility companies are reaching the end of their investment cycle. Several factors are at work here, starting with the nature of private equity funds, which tend to be medium-term holders of assets. They typically invest their clients money for up to five years, perhaps extending that time to 10 or 15 years, for example for investments in regulated businesses. Their early investments in energy infrastructure are reaching the end of their time horizon, prompting the first wave of exits. U.S.-based private equity firm Energy Capital Partners LLC recently sold AES Red Oak LLC, an American gas-based power producer, for example, while First Reserve Corp. sold 101 megawatts of its solar photovoltaic assets in Italy in Meanwhile in Europe, investors selling activity reached an all-time high in 2016 (see figure 5). We expect first-wave sell-offs to increase during the next few years. It is important to note that there are long-term investors in infrastructure as well with extended holding periods, such as formal infrastructure funds and pension funds. 4. Utilities are realigning their strategies and shifting their portfolios to focus on certain regions or businesses. Driven by generally decreasing synergies between value-chain steps, utilities are shifting their portfolios to focus on certain businesses (typically carbon-free businesses and assets) or regions (typically the companies core or home region). Figure 5 In Europe, financial investors selling activity reached an all-time high in 2016 Deal value 11.7 Number of deals Notes: Includes integrated utilities (power, gas, water, heat); power generation companies (including renewables); energy pipeline infrastructure companies. Date of announcement is 2016, including deals with status pending. Disclosed deal values only. Sources: Dealogic database; A.T. Kearney analysis 5

7 This is particularly true for utilities that now concentrate on areas with stronger future growth potential, such as retail or renewables, which are being acquired at a greater rate. Italian firm Enel, for example, integrated recently with Enel Green Power, while London-based EDF has acquired a wind farm from E.ON in the United Kingdom. Investors are also looking to increase their renewable assets value through mergers and acquisitions that bring greater economies of scale and operational excellence. M&A transactions in renewables increased 60 percent from 2010 to 2015, according to the United Nations Environmental Program. In mature markets, such as Europe, these transactions are starting to outpace even new investments in this field. Regarding international investments, some buyers have had limited success, which has led them to sell or swap assets to focus on their regions instead. Austrian firm Verbund transferred energy business it had in Turkey to E.ON. In return, E.ON transferred hydro plants in Austria and Southern Germany to Verbund in an asset swap. 5. The record low cost of capital is sharpening financial investors appetite for energy assets. Infrastructure funds have raised markedly more money in recent years, thanks to low interest rates and the resulting availability of cheap money (see figure 6). At the same time, there have been limited opportunities to invest in traditional infrastructure asset classes such as toll roads and harbors. Consequently, large amounts of money have flowed into utility investments, especially in the areas of renewables and grid. Financial investors often have a better credit rating than traditional utilities do, so they can obtain debt at better terms. Utilities themselves bring the needed energy-related expertise to the table. So aside from restructuring and efficiency improvements, financial optimization with a partner from the financial industry has become a main source for utility companies yield Figure 6 Europe-focused infrastructure funds are raising more money for future deal activity Infrastructure assets under management Invested volume 80 Dry powder/to be invested 40% Infrastructure funds focus industries 5% 11% 29% 15% Renewables Energy and utilities infrastructure Transport Social Other Brownfield vs. greenfield % % Brownfield Greenfield Sources: Preqin; A.T. Kearney analysis 6

8 enhancement. GE Energy Financial Services partnering with Enel Green Power North America in 2016 could be a good example of this approach. Continued low interest rates have put heavy pressure on pension and hedge funds and insurance companies to generate earnings, prompting them to invest in utility infrastructure for its higher returns. In 2016, for example, Cerberus Capital Management L.P. and a Madrid-based utility company acquired the Spanish renewable energy company Renovalia Energy S.A. 6. Sovereign wealth funds and state-owned companies are taking a growing geostrategic interest. International sovereign wealth funds and state-owned companies (especially those based in Asian countries such as China, Korea, and Singapore, as well as those in the Middle East) are keen to transfer funds to international infrastructure assets. Apart from stable returns, we see several reasons for these funds to do this, including diversification of money reserves, the transfer of best practices to their own infrastructure companies, and extension of their geopolitical power. State Grid Corporation of China shows a particularly strong track record in foreign grid investments in, for example, Malaysia, Australia, and the Philippines. Among recent examples for foreign investments in Europe is the Chinese holding company Beijing Enterprises acquisition of the German company EEW Energy from Waste and the Singapore Wealth Fund s acquisition of Greenko s renewable assets in India. In the Middle East, the Kuwait Investment Authority recently formed a partnership with Spain s Gas Natural Fenosa, and the Abu Dhabi Investment Authority, together with Goldman Sachs Capital Partners, acquired ReNew Power Ventures in India. Chinese foreign direct investment in the European Union has increased threefold since 2013 (see figure 7). Europe has emerged as the main destination for Chinese investments, with China becoming more successful at gaining services contracts coupled with utility infrastructure investments, such as the Hinkley Point C nuclear power station in England, power plants in Figure 7 Chinese foreign direct investment in the European Union has tripled since 2013 Chinese foreign direct investment in EU % Sources: Merics, Rhodium Group; A.T. Kearney analysis 7

9 Romania, and investments involving State Grid Corporation of China. Seventy percent of Chinese foreign direct investments in 2015 were accounted for by state-owned entities. 7. New business models arise. To develop their customer solutions business, utilities are finding they have to rely strongly on partnerships, joint ventures, and growth investments. Historically, major utilities have failed to innovate new business models internally, so they are buying stakes in a variety of innovative start-ups instead. Along those lines, GDF Suez acquired a company focused on design and operation of digital data centers, and E.ON took a stake in several utility-related start-ups recently. In turn, innovative companies are attracted to utilities for their established client bases and assets. The resulting convergence of different customer solutions (such as energy services and building management services) leads to significant synergies between energy solutions and other businesses. This makes a strong case for various pursuits, including a joint market approach and the bundling of operational capabilities. Major utilities are buying stakes in a variety of innovative start-ups instead. Greenfield Investments: The Next Deal Frontier In addition to M&A activity, greenfield investment in both renewables and traditional energy infrastructure is rising across all regions. During the coming decade, we estimate that greenfield investments in energy infrastructure could reach $8 trillion. This is for several reasons. Countries policy initiatives have heightened the sector s imperative to reduce its carbon output and dependence on imported fuels by encouraging more efficient use of electricity and generating more power from renewable sources, such as the large offshore wind farms that companies are building in the Baltic and North seas. Renewable electricity generation is furthermore one of the global growth sectors to watch for years to come. Cumulative global greenfield investments will include approximately $250 billion annually for renewable power generation during the next 10 years. A functioning CO2-trading mechanism is expected to bring a further boost to de-carbonization initiatives and investments in renewables as well. Transmission and distribution infrastructure is another growth area to watch in greenfield investments. Globally, we expect there to be approximately $350 billion invested annually in transmission and distribution infrastructure during the next decade. The refurbishing of existing transmission lines and construction of additional lines and new smart grids will be critical for transporting electricity from new renewable plants (such as offshore wind) to the places of consumption. Finally, traditional generation, including nuclear power (such as new nuclear plant Hinkley Point C in the UK) and gas-based (which is an important bridging technology to a green-energy world), still offers significant growth opportunities. It will require approximately $200 billion in greenfield investments annually to accommodate future electricity demand growth. 8

10 A New Energy Planet Takes Shape Several factors will continue to influence the utilities and energy sector. Worldwide, the number of players in the utilities sector will grow and become more heterogeneous within investor categories for generation, grid infrastructure, and downstream services, including sales. But territorial outlines will not stop there. In the downstream segment in particular, investors from the telecommunications, Internet, and other high-tech industries will push for convergence of business models. In Europe, deal activity will further push the breakup of the value chain that financial investors have driven so far. As these investors have different planning horizons with most looking to exit in five to 10 years this activity will ultimately change the ways that companies are governed. As financial, governmental, and cross-industry forces exert their influence, opportunities will continue to arise for creating immediate-term value and long-term advantage for investors and companies alike in the energy sector. Authors Hanjo Arms, partner, Berlin Andreas Stender, prinicipal, Berlin Florian Haslauer, partner, Vienna Volker Lang, partner, Munich Patrick Haischer, partner, New York Thomas Luedi, partner, Shanghai 9

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