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2016 review and 2017 outlook

Power transactions and trends

Value driven by networks, with renewables emerging as a key investment strategy

 

2016 is now over – a year where, more than ever before, the market was split between those who have electricity and those who do not. In developed markets, continued overcapacity remains a blockage to new greenfield deals, whereas in developing markets, the scale of the opportunities is becoming more and more obvious over time, with around 100 GW of new capacity scheduled to be required in Africa and the Asia-Pacific region alone. The year saw strong P&U deal activity across regions, with investment in regulated networks and renewables leading the way:

US$89.3b value in regulated networks – 46% of total deal value

EY - US$28.4b value in renewable energy assets – 15% of total deal value

The appeal of both asset classes, mainly in developed markets, is demonstrative of the current imbalance between the limited supply of projects in developed countries with excess capacity and low wholesale prices, and the amount of capital available and ready to be deployed in these regions. Sellers in developed markets are benefiting from unprecedented competition for good assets, and emerging markets are beginning to take advantage of the capital available.

2016 also heralded the entry of material new energy deals in the market, with renewable energy technologies once considered risky or experimental beginning to emerge. These technologies have now earned a firm place in the investment landscape as a main strategy for many investors looking to diversify early and become part of the future value chain. See our interviews with senior members of China Three Gorges and Bank of America Merrill Lynch in this edition of Power transactions and trends (PTT).

2016 trends

Networks continue to command high premiums

As the sector's most sought-after assets, networks continue to command high premiums in all regions. Some of the year’s most noteworthy M&A examples include:

  • US$18.4b acquisition of Energy Future Holdings Corporation, an energy services provider in Texas, by Next Era Energy
  • US$14.4b acquisition of a 61% stake in National Grid Gas Distribution by a consortium led by Macquarie Infrastructure and Real Assets
  • US$12.6b acquisition of a 50.4% stake in Ausgrid, an Australian transmission and distribution (T&D) company, by Industry Funds Management Pty Ltd and AustralianSuper

Renewable energy M&A rose to a new high

EY - US$28.4b total deal value in renewables, including 10 multibillion-dollar deals

Deals across all segments of renewable energy remained high in 2016. In the Americas alone, 46 transactions totaled US$8.3b.

While Latin America is sparking interest – as discussed by China Three Gorges’ Wu Shengliang in our interview in the Asia-Pacific region report – it was the US that saw most deals. The country is attracting significant investment by foreign players, including those from Canada, Europe, Australia and New Zealand, who are targeting higher returns than possible at home. Most in demand are assets backed by quality counterparty power purchase agreements (PPAs) that offer stable returns and allow the widest possible range of capital to participate.

Value of generation assets declines further

The market remains tough for independent power producers (IPPs) due to continued market oversupply, trading at discounts in all regions

  • Americas: discount of 2% to long-term historic averages
  • Asia-Pacific: discount of 17% to long-term historic averages
  • Europe: discount of 13% to long-term historic averages

IPPs are expected to remain flat in 2017.

New energy businesses hit mainstream investment agenda

As we predicted some 18 months ago, we saw a shift in investors’ appetite toward new energy businesses in 2016 and a subsequent increase in deal activity in this space. 2016 saw some of the world’s biggest utilities make moves into new energy technologies:

  • Enel announced it would acquire a 100% stake in US-based Demand Energy, a developer and operator of energy storage systems and software.
  • E.ON invested in Kite Power Solutions, a UK-based start-up working in high-altitude wind power generation technology.
  • Innogy expanded its energy storage focus by acquiring photovoltaic (PV) and storage company BELECTRIC Solar & Battery.
  • National Grid procured 201 MW of energy storage capacity for US$86.4m.

2017 outlook

Europe will continue to be a tough market, sending investors overseas

Most of Europe's P&U deal activity in 2016 was driven by regulated network sales. We saw M&A in both generation and renewable energy decline as investors and utilities had to tackle more complex deals. For example, Engie SA, the French utility, acquired OpTerra Energy Services, a US-based company that provides a comprehensive set of energy and sustainability management services, for an undisclosed consideration in Q1 2016. Centrica, a UK-based utility, acquired Neas Energy A/S, a Denmark-based energy asset management company, for US$244m in a bid to bring synergies to its current energy marketing and trading activities. In 2017, we expect investors to continue to look abroad, most likely to the Asia-Pacific region, to deploy capital, and for opportunistic investments and divestments to be competitive.

The US will require careful attention

As the most dominant country in the Americas P&U sector, the US will be the subject of much investor scrutiny in 2017. Rising interest rates and President Trump's energy policy changes (pdf) are likely to affect the investment climate – though to which degree will remain to be seen. It’s worth noting though that, ultimately, the US market is oversupplied and does not require additional generation capacity, with opportunistic renewable investments, gas peaking plays and new energy investments the most likely deals.

Capital will flow into Asia-Pacific

With the investment conditions in Europe and the US likely to send investors in these markets scouting for overseas opportunities, the Asia-Pacific market is emerging as one of the top targets for investment houses, utilities and funds with a global focus.

Historically, investment interest has been solely in large, non-complex deals, with more difficult transactions left on the table. But, as international investors rush in, simple deals are drying up, and we may see more complex deals done in 2017, requiring sharper skills within deal teams to capture full value. The stage is set for the Asia-Pacific region, along with the Middle East, to host the world’s most interesting deals in 2017.

Reforms make emerging nations investment hot spots

In 2017, we expect continued investor interest in the energy sectors of India, Mexico, and several countries in Africa and the Middle East. Diverse international players are attracted to these emerging hot spots as governments move to enact reforms to improve the competitiveness of their energy sectors and provide an avenue for excess global capital to be deployed. Some of the more notable deals in emerging markets in 2016 included the following:

  • Tata Power Renewable Energy, an Indian power company, acquired Welspun Renewables Energy, a solar power developer, for US$1.4b.
  • Infraestructura Energetica Nova, a Mexican energy infrastructure developer, acquired Ventika Wind Power Project, a wind farm with a cumulative capacity of 252 MW, for US$852m.
  • I Squared Capital, a US-based energy fund, acquired the Latin American business of Duke Energy Corporation, consisting of power generation and T&D facilities, for U$1.2b.
  • Guangdong Yudean Group, a Chinese business engaged in wind generation, and YTL Power International Berhad, a Malaysian investment holding company, acquired 45% and 15% stakes respectively in Attarat Power Company, a Jordan-based company engaged in the management of a 554 MW power plant, for U$1.3b.

Energy market reforms will continue to create new and interesting opportunities for investors in 2017.

Competition sees capital shift

Investors take stakes in Australia’s traditional and new energy assets

EY - Tom Butcher

Tom Butcher is a managing director in BofAML’s Investment Banking Division and is Co-Head of Transport, Infrastructure, and Power & Utilities for Australia. Tom has 15 years of experience and has advised on more than AU$100b of transactions in the transport, infrastructure, power and utilities sectors. His experience includes strategic advice, trade sales, privatizations, public and private market M&A, principal investment, financing, and debt and equity capital market issuances.

A shortage of global power and utilities investment opportunities has shifted investor focus to Australia. The country’s energy market stands to benefit, with keen interest in both traditionally attractive regulated assets and relatively new energy technologies. Matthew Rennie spoke to Tom Butcher from Bank of America Merrill Lynch (BofAML) for his view.

Safe, stable and sizeable assets

As a managing director who co-heads BofAML’s Transport, Infrastructure, and Power & Utilities team in Australia, Tom Butcher has played a role in many of the deals in Australia’s power and utilities sector over the past two years. He says that, as one of the few stable OECD economies with multiple, large assets on offer, Australia is a very attractive investment destination.

“Strategic and financial investors with billions in equity to invest are challenged to find suitably large and executable opportunities in North America and are pursuing only selective opportunities in South America,” Butcher explains.

“Europe has regular deal flow, but these transactions can be complex and often you need a local partner, which can limit the opportunity. Asia is still an emerging focus. This leaves the UK and Australia as the two key markets that offer up the kind of big, multibillion-dollar transactions these investors seek.”

Long gone are the days when Australia was considered too remote and inconsequential to attract investors seeking power and utilities assets. This has changed, says Butcher, with many international utilities and investment funds having an active local presence, to better pursue the high-quality and large opportunities on offer. Investors are further encouraged by a falling Australian dollar, continuing regional growth and a stable regulatory environment.

Investment appetite broadens in a competitive market

Butcher says that many investors continue to favor the market’s largest, multibillion-dollar deals that are sold through government or private sector sale processes. Competitive market dynamics and the search for value means players are also pursuing alternative opportunities, such as unregulated assets, smaller-sized investments or those with complex execution aspects, which limit the number of bidders.

“Investors are still seeking large, straightforward deals, but demand far exceeds supply,” he says.

“We are seeing an increase in transactions that are more complex to execute. They might need a different approach that breaks up businesses or involves partnerships.

“There are some deals that seem too hard and haven’t been able to close for various reasons. Our view is that there is greater interest in these harder deals, and they may well get done in the next 12 to 24 months.”

Butcher also senses a broadening of interest. “Safe bet” regulated assets remain favored – Butcher expects significant interest in the lease of New South Wales energy distributor Endeavor in 2017.

But he says there is also ample interest in investment in new energy technologies. “Relatively new technologies such as energy storage, solar farms and other renewable power generation assets are no longer too challenging for many investors,” says Butcher.

“The most experienced overseas investors, in particular, see these as a huge opportunity, not a risk. They feel very confident in the investment thesis over the long term and are confident of superior risk-adjusted returns being generated. These assets have a place in investment portfolios and sit comfortably alongside lower risk assets, such as regulated networks.”

These shifting priorities have created interesting investment conditions says Butcher.

“There’s a lot of moving parts and, with the right knowledge, you can make sound investment decisions and do extremely well. For an industry known historically as being a bit boring, all of a sudden it’s quite dynamic and exciting and is set to continue to evolve for many years to come.”

EY - Power transactions and trends: Q4 2016