Power industry companies’ growth strategies are increasingly targeted on cross border mergers and acquisitions, according to a new survey, with regulatory obstacles and lack of availability of finance the greatest challenges to completing deals.
“It is key that companies embarking on mergers and acquisitions (M&A) in another jurisdiction understand the local regulatory environment from the outset” says Nicholas Hughes, Senior Associate at Clifford Chance, who published the report in association with the Economist Intelligence Unit.
“For example there are many jurisdictions where transmission and distribution have a heavily regulated pricing regime. It is fundamental to understand the current regulatory regime but also to obtain insights from people who have advised on deals in that country as to what it is likely to happen to the regulatory regime in the future.”
“We all know that the power sector is by its nature more of a long term investment than some other sectors. Understanding how the pricing regime operates in the current regulatory period is one thing, but actually it's just as important understanding how the actions you take during this period are likely to impact the pricing regime in the next period.”
The report, entitled Cross-border M&A: Perspectives on a changing world saw only 35 per cent of power sector respondents consider their organisation to be effective at managing regulatory risk on cross-border deals despite regulatory issues being cited as the biggest single risk to organisations' M&A activity in the next two years.
The report also found that while the majority of M&A in 2010/11 was domestic, driven particularly by some significant deals in the US, 53 per cent of companies were focusing on cross-border deals in high growth markets, in terms of their future growth strategy.
Asia-Pacific based respondents (75 per cent) were significantly more focused on M&A than their peers in Europe (25 per cent) and North America (47 per cent).
Nicholas Hughes, who has experience in advising International Power, Actis and other energy investors, points to the recently announced subsidy cuts for renewable generation in Spain and the UK as evidence of the types of changing regulatory environments which power companies must adapt to, and have awareness.
“It’s important to understand and take account of the difference in regulatory regimes depending on the part of the power sector you are focused on and the jurisdiction in which you are looking to invest.
If you look at Europe and the unbundling legislation, clients have to be careful what assets they buy to avoid tripping themselves up for a future deal. Where you have legislation restricting ownership at multiple levels in the value chain, it is essential that your company understands the rules and is clear about its future plans. Clients don’t want to acquire some small generation assets in one jurisdiction and suddenly find out that it impacts their ability to execute a larger transmission deal in another jurisdiction."
In addition to regulatory complexity, a lack of availability of finance is being felt in Europe. Some companies are looking to overcome this by becoming involved in strategic partnerships particularly with Asian companies – in 2011 a Qatari sovereign wealth fund took a stake in Iberdrola while CIC and GDF SUEZ also announced a cooperation.
“I can see future opportunities for Asian bidders and Middle Eastern sovereign wealth funds investing in Europe where they have got capital and European utilities are looking to improve their capital position. These utilities want to make the most of available opportunities, often in overseas growth markets, but they need the capital to fully exploit these.”
The evidence for development of M&A in high growth economies is obvious in Latin America, which has growing populations and significant development rates that can only be sustained by access to power. It makes for a positive outlook for power industry investment, with genuine competition for assets in Brazil in particular.
Meanwhile the regulatory acceptance of Constellation and Exelon’s merger has provided an injection of confidence in terms of future deal activity in the US.
Hughes points out that there are challenges unique to the power sector: “The lifeblood nature of the power industry means that Government actions will always have a disproportionately greater impact on the power sector as compared to many other industries.”
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