Power and utilities M&A outlook down and appetite for divestment up

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  • 33% of companies are planning to divest assets in the next year
  • Appetite for acquisition down as focus on core assets and cost reductions

London, 30 May 2012 – Persistent market volatility, austerity measures, Eurozone uncertainty and potential for slowing growth in emerging markets have continued to dampen the acquisition appetite for power and utility companies, according to EY’s latest Capital Confidence Barometer, based on interviews with 189 power and utilities senior executives in 33 countries.

Only 14% of power and utility respondents anticipate pursuing an acquisition in the next 12 months and with all the divestment and limited enthusiasm for acquisitions, it is expected that many buyers will come from outside the core power and utility sector. Buyers are likely to include infrastructure funds, sovereign funds, private equity firms and other financial buyers.

However, there is positive news in certain markets with the number of domestic respondents who believe the US economy is improving more than tripling; with 58% of US power and utilities executives viewing an improving local economy compared with just 17% six months ago. The increase in US local economic confidence reflects improving credit markets, stronger consumer confidence and a falling unemployment rate.

Joseph Fontana, EY Global Power & Utilities Transaction Leader comments, “The recovery in global equity prices, liquidity injections by central banks and corporate earnings have all supported this increase in optimism, and power and utility companies are generally optimistic about their local markets.”

By contrast, positive sentiment is declining for China, with 10% viewing the local market as improving, compared with 27% in October 2011. Yet, despite the fall in confidence, 90% of power and utility respondents still view China as stable, up from 73% six months ago.

Divestment now a core strategy
However, accessing capital is proving to be restrictive and, as a result, appetite for divestment is up. Transaction activity is likely to be prevalent, with markets such as Brazil reporting that nearly 70% of power and utility executives are planning to make an asset divestment in the next year. This is more than double the global power and utility response rate, and reflects the massive generation build-out required to support the growing domestic economy.

As Brazil grapples with the extraordinary investment required, this demand is likely to result in increased M&A activity in the region as small and mid-tier power and utility companies dispose of assets to free up capital. With excess cash or access to global capital markets it is predicted that foreign sovereign funds, particularly from Asia, along with European utilities looking to deleverage from slow domestic markets, are likely to be the buyers of these assets.

Globally, the main driver of power and utility companies’ divestment plans is a focus on core assets, with 61% citing this as their key objective. Reflective of low domestic growth in continental Europe, companies listed raising cash to compensate for underperforming businesses as a key driver of planned divestment. Within the US it is anticipated that there will be divesting of noncore assets to focus on emission reduction and energy savings, driven by stricter emission rules. In Q1 2012, close to 40% of the total US deals were either related to renewable power generation or energy management services.

Appetite for acquisitions declines; however, buyers may be outside the sector
The global M&A market for power and utilities companies continues to be restrained, despite increasing confidence in local and global markets. While fiscal tightening by European banks might restrict future M&A activity, the growing number of asset disposal programs by European utilities and the European governments’ privatization programs are expected to drive deal flow in the short term with foreign sovereign buyers especially active in this space.

Higher growth markets in Asia-Pacific and Latin America continue to be the most preferred investment destinations for power and utility companies globally. Despite the improved deal making environment, power and utility executives remain cautious about M&A, with a heavy preference on organic growth. The Q1 and Q2 2012 earnings season is presenting itself to be a key determinate of how aggressive companies may be in the growth targets and pent-up demand for growth will likely see a rush for quality assets fuelling M&A activity in the second half of 2012.

Fontana summarizes, “Despite a slow start to the year from a transaction perspective, we anticipate robust deal activity in Europe and Latin America, as well as continued opportunistic generation acquisitions in the US to drive an increase in M&A activity in the remainder of 2012.”

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