Energy Editorials

Mega utility M&A in prospect

A new wave of ultra-large cross border utility deals is in prospect, according to new research from KPMG. Despite a 'frenzied' year, the sector has some way to go before the current cycle of dealmaking reaches its peak, as a clutch of major global states and regions continue to deregulate their energy markets.

On 1 July 2007 the EU's energy market achieved full deregulation, helping producers and distributors to compete freely across national borders and putting the 'national champions' in several domestic markets on notice that they may face increased competition and potential acquisition.

KPMG surveyed 40 senior executives from the largest global power and utility companies, finding that more than three-quarters expect further international consolidation in the coming three years, while 60 percent confirmed that their companies are already seeking acquisitions. "Cross border consolidation will continue as deregulation takes hold in Europe," states the report, "leading to the first mega-utilities."

China, India, Australia and Russia offer the best prospects for growth, according to KPMG, with Australian companies playing an increasing role as investors in other countries.

When asked to select the main drivers for M&A activity, the respondents cited increasing market share, acquiring new products and services, entering new geographical areas and improving economies of scale. Concerns over energy security and climate change were also noted, along with incentives from governments to increase investment in renewable resources. Utilities are paying more attention to the potential of wind power and other renewable energy assets.

"Intense interest in the renewables sector has prompted speculation that bidders are paying too much," says KPMG transaction services partner Andy Cox. "Utilities need to be quick out of the blocks to gain a foothold in the market before their competitors. Reaching an agreed deal without fierce competition is very rare."

One exception to the global picture of mega deals is the United States, where regulation remains largely in the hands of individual states, leading to complex bureaucratic issues when deals are proposed. Although in 2005 the repeal of the Public Utility Holding Company Act helped to dismantle some of the entrenched barriers to M&A, there have nevertheless been several high profile failures, including the Constellation-FPL Group deal and the Exelon-PSEG deal, which became ensnared in the state regulatory process.

A recent paper on utility M&A in the US from Boston Consulting argues that the economic benefits of deals in the sector are so persuasive that there will be a "significant consolidation" in the next five years. "The utility market in the United States has the potential to resemble that of Europe, in which utilities are already consolidated and a wave of megamergers is under way," states the report.

For the moment, the top five US utilities represent less than one quarter of the share of all customers, according to Boston Consulting, whereas in Europe the respective share is one half. Other comparable sectors such as US telecoms are even further consolidated, with the top five taking a 73 percent share of all customers.

"Boston Consulting Group estimates that a typical utility merger offers 18 to 33 percent in savings from economies of scale and the adoption of best practice," says the report. There are major savings to be made in marketing, trading, customer service operations, sales and administration.

Where utility mergers have been well received in the US, such as the $45bn leveraged buyout of TXU Corp by KKR and Texas Pacific Group (TPG), the acquirers have paid close attention to the concerns of the state regulators and those of investors. "KKR and TPG believed that TXU's vision for increasing its coal-fired plants was a strategy that was backfiring with Wall Street and that value could be restored by reversing course," says Patrick Donoghue, senior managing director at FTI Consulting in New York.

Donoghue believes that the role of financial players in the US utility sector is likely to increase, particularly where they can detect value in large groups where specific assets can be sold off. This could be the case with TXU, he argues. Fellow utility Aquila has sold four major assets in the past two years, following the election of a hedge fund senior partner to the company board, realising more than $1bn, he notes.

At least another two or three large US utility companies are expected to merge in the coming years, according to respondents to the KPMG survey.

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