Power transactions and trends
Global power and utilities mergers and acquisitions:
2013 review and 2014 outlook
Deals change the face of Africa’s power
Market reform and new generation capacity development are changing the face of the African power sector.
There is now a sense of urgency about investing in Africa, created by a confluence of social, economic and political factors. The most significant is acknowledgement that the lack of reliable electricity is putting a brake on economic growth. Combined with demographic trends, sector reform (particularly the introduction of private sector participation in the electricity sectors in South Africa and Nigeria), individual countries’ responses to climate change commitments and new resource discoveries, this is a recipe for change.
There’s also increased awareness that the private sector has a key role to play in introducing private capital, innovation, new technology and in supporting skills development and new industries.
Large-scale transactions for Nigeria and South Africa
One of the biggest deals in 2013 was the privatization of Nigeria’s electricity companies. The sale of 5 generation and 10 distribution companies attracted strong interest from several international players.
South Africa’s Renewable Energy Independent Power Producer Procurement Program was another massive undertaking, falling outside the traditional deal structure.
Past not a predictor of the future
One of the advantages of an emerging market is its ability to leapfrog technologies, which creates completely different development curves and timescales. Investors need to understand that the past is not a predictor of the future and not simply assume that emerging countries will follow the path of more established markets.
Outlook for 2014
According to our Africa Attractiveness report, nearly 40% of all infrastructure project activity and one-quarter of the more than US$700b in estimated project value was directed into the power sector. We expect to see sustained activity in this area.
Initiatives that could drive transactions in the next three to five years include:
Navigating through a complex market
- Identify geographies where the groundwork has been done and governments have commenced programs.
- Timing is everything. Source local knowledge, insight and expertise to avoid going in too early.
- Follow the new discoveries: where are the finds? In Africa, gas is the next new frontier.
Strategy rethink impacts M&A in Brazil
2013 saw utilities adjusting to the new market environment. Brazil continues to attract inbound capital as one of the leading destinations of emerging market investments. The previous year’s regulatory changes cut into some generation and transmission revenues with a consequent impact on EBITDA and share prices. This drove portfolio rebalancing and consolidation in the regulated market.
Wind power continues to rise
Brazil is taking significant steps to develop its power infrastructure with a 10-year energy plan. The plan calls for more than US$85b of investment in electricity generation through 2022 to support national growth targets and meet increased energy demand.
Government-run auctions of rights to run generation assets were based on renewable generation. Wind power continued to be a competitive source of energy in the wholesale market, and 2013 witnessed a significant number of transactions.
On the transmission front, the Government is also using the auction mechanism to increase grid coverage and connect ongoing and planned generation projects.
Brazil attracts investments from top European utilities
Germany’s E.ON SE was among the year’s big inbound European investors, expanding its market position in Brazil by increasing its stake in MPX, the Brazilian EBX group’s energy arm. Enel Green Power’s business unit, Endesa, is seeking to develop 700 MW of renewable capacity in Brazil (and 500 MW in Chile) by 2017.
Distressed asset sale boosts Energisa
The top five Americas-based deals of 2013 included the sale of distressed assets belonging to Grupo Rede Energia, a major Brazilian distribution company. Energisa emerged as the victorious buyer and, as a result, will increase its presence in Brazil.
Eletrobras rethinks strategy for distribution
Eletrobras — Brazil’s state-run electricity utility — reported losses in its quarterly and annual results in 2013 and has embarked on a restructuring program. It is seeking Government approval to sell its six distribution units, which lost a combined 1.33 billion reais (US$0.56b) in 2012.
Outlook for 2014
Our global research has identified evidence of improved access to capital, which will fuel deal activity in 2014. In Brazil, capital was actually available for projects last year, but companies held back because they were concerned to understand the market and the new regulation before progressing to investments.
Now that the market has settled, utilities can come forward to take opportunities. 2014 will be a year to consolidate plans made in 2013.
At present, Brazil constitutes the majority of opportunities in South America. But investors are increasingly using their established positions in Brazil as a platform to grow in the region – including looking for wind and hydro projects in other countries.
Meanwhile, companies from, for example, Chile and Peru are also continuing to prosper in the Brazilian market. This could lead to a much more integrated South American market in the next few years, with a potential knock-on effect on the number of deals done.
Domestic focus for Gulf deals
To date, the Gulf States of Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and UAE (collectively known as the GCC states) haven’t strictly been an M&A market. Because the power and utilities sector is dominated by a small number of state-owned or public sector-owned monopolies largely operating in an administered rather than competitive environment, there is not a lot of private sector to private sector M&A. Transaction activity is largely based on participation of the private sector in capital projects and commercial undertakings.
As markets become more established and competition in generation becomes more established, we expect growth rather than consolidation to be a dominant driver of activity and for more deals to be done between state-owned businesses and the private sector.
Desire for efficiency drives utility reform
Gulf countries subsidize utility end users heavily, but the rate of population growth is creating concern about possible future budgetary constraints. This has created a preoccupation with efficiencies and a desire for a greater degree of commerciality in the way utility enterprises operate.
In turn, this is likely to open up opportunities for private sector participation in independent power plants (IPPs), general infrastructure build-out and provision of utility services.
Some appetite for outbound investment; main focus is domestic
A number of Middle East funds are planning to diversify their investments and acquire utility assets across the globe.
At present, utilities in the Gulf are focusing chiefly on domestic investment. There is a massive need for new power and water capacity, driven by population growth and the increased industrialization of the region’s economies.
Outlook for 2014
There’s definite interest in switching fuel sources and raising capital from the private sector around the IPP model.
We can expect substantial (and largely inbound) transaction activity in renewables – mainly solar and some wind. As this market takes off, we will see extensive use of IPPs, with foreign private sector capital coming in to fund, build and operate renewable energy plants.
We particularly expect significant transaction activity based on joint ventures between international and domestic companies, with the international companies contributing their renewables expertise and local partners drawing on their local knowledge of land, regulation, environmental issues and power off-take permitting.
Institutional investors might consider ways to play in this developing renewable energy market, which will attract companies of all sizes and have significant funding requirements and long-term off-take profiles.
Outside of the Gulf, an influential factor in the medium to long term will be the major reconstruction challenges and opportunities in countries impacted by unrest and conflict, such as Libya, Syria and Iraq. Their infrastructure repair and rebuilding will need multilateral backing and support.
We expect very substantial capital requirements — involving export credit agencies and multilateral funding bodies — to rebuild essential power and utility infrastructure in these troubled areas. The big international contractors and independent US power companies are likely to take active interest.
Trading houses drive activity as reform looms in Japan
M&A activity in Japan’s power and utilities sector slowed slightly in 2013 amid ongoing uncertainty about the decision to restart the country’s stalled nuclear plants.
Of the deals that occurred during 2013, outbound M&A dominated with trading houses and financial buyers leading the way, driven by the need to rebalance and consolidate.
For Japan’s 10 major utilities, the focus was cutting costs in the face of the nuclear freeze, a weakened yen and the slowing demand of an aging population.
The sector is also preparing for Japan’s proposed reforms of the electricity market, expected to kick off in 2015.
Utilities cut costs, discretely divest
In 2013, Japan’s 10 major utilities kept their focus primarily at a domestic level. The lack of nuclear energy is driving deals aimed at rebalancing portfolios with many utilities moving to divest a relatively large number of non-core assets.
While deregulation of the electricity market looms large, we see this having little real impact on M&A activity in the sector. The big 10 are still trying to grasp the implications of unbundling and are in the early stages of addressing its challenges.
Trading houses target renewables
Japan’s six biggest general trading companies dominated utilities M&A activity in 2013 and drove the year’s big trend in outbound transactions.
Many of these deals focused on overseas renewable assets, particularly European solar.
While we have seen trading houses buy stakes in renewable energy projects before, the bigger size of these latest deals signifies a growing motivation of these buyers to target these projects. They see them as solid investments but are also keen to gather much-needed expertise in the renewables sector. We expect similar deals in 2014.
Consolidation in gas
Of the few inbound deals of the year, Kanto Natural Gas Development’s acquisition of a 38.13% stake in Otaki Gas Company Limited is worth noting. The deal between the two natural gas suppliers reflects a long-anticipated trend towards consolidation in the natural gas sector, which aims to increase the efficiency of resource allocation and maximize value for shareholders.
Outlook for 2014
Beyond the big question around whether nuclear will restart, the focus for the Japanese utility sector in the next few years will be the ongoing deregulation process. We expect this to emerge as a strong catalyst for M&A activity throughout the Asia-Pacific region in the near to medium term.
The reforms will also spur on inbound activity, which will increase significantly in the next few years as US, Asian and European investors begin to assess the potential for returns in the newly deregulated market.
Reforms are already beginning to attract new players to the utilities sector, as illustrated by the recent deal by Japanese cable TV company Jupiter Telecommunications to acquire IP Power Systems.
We expect similar interest from other non-traditional players in what promises to be a more robust M&A environment in Japan in 2014.
Energy shift boosts US deal levels in an active year
Across the Americas, deal activity rose by over one third on 2012 levels, driven by continued low wholesale prices, weak demand growth and portfolio optimization by hybrid utilities in search of stable earnings.
The US hosted three of the year’s top 10 global deals, including the world’s largest as MidAmerican Energy Holdings announced its US$10.4b acquisition of Nevada-based public utility NV Energy, Inc.
Canadian utility investors continued to show interest in the US regulated utilities market. Watch out for more cross-border deals in coming months as Canadian financial and strategic buyers seek regulated businesses and contracted generation opportunities.
Shale gas strongly influences US transactions
The continued flood of shale gas on the wholesale market squeezed generation margins. This drove US utilities to divest market-exposed generation assets. Hybrid utilities will continue the multi-year strategy of deleveraging exposure to competitive generation, acquiring rate-regulated businesses, or both. Finding buyers or merger partners will be the biggest challenge.
With the short- to medium-term outlook for power prices weak in most parts of the US, we expect portfolio rebalancing to continue to drive deals as utilities reshape their mix of businesses, switch away from coal or simply move out of generation.
Oversupply on wholesale markets, coupled with slow demand growth, will create prime conditions for further consolidation in coming months, just as they did in 2013.
Diversification will drive M&A
One route to deliver earnings to shareholders could be diversification into new downstream businesses that fit the utility skill set. With expectations of US energy independence and an abundance of cheap natural gas, US utilities with midstream pipeline experience are well placed to take advantage of opportunities ranging from developing interstate pipeline businesses to exporting natural gas from new LNG facilities.
Outlook for 2014
2014 is set to be another active year, with the same basic market dynamics remaining in operation and driving deals.
Hybrid utilities will continue to sharpen their strategies to alleviate pressure on generation assets. We will see further sales of generation portfolios and further acquisition of rate-regulated businesses.
We see continued regulatory support for the establishment of new solar and wind projects. On the distributed solar side, the marketplace of multiple small players is ripe for consolidation, creating transaction opportunities.
We assume capital will continue to be readily available to the big utilities for transactions. But raising capital hasn’t been so easy for smaller players recently, particularly those in renewables. Some of the new business structures could make it easier to attract investors and funding.
An interesting development to watch for is major utility and renewable energy players creating spin-offs structured as yield companies (YieldCos). New YieldCos are likely to become active buyers, but rising interest rates could dampen the excitement about these vehicles.
Finally, a number of financially distressed cities in the US that own electric and gas businesses are keen to exit. We expect more activity of this kind resulting in transactions in the coming months, but this is not a long-term trend.