Are network valuations at peak levels?

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A bidding war for an ever-shrinking number of network assets is pushing valuations to record levels. As highlighted in our latest edition of Power transactions and trends, these assets are trading at an average premium of more than 65.3 per cent to Independent Power Producers across the Americas (61 per cent), Asia-Pacific (65 per cent) and Europe (70 per cent).

Of course, the attraction of investors to these assets is not new with their ability to generate long-term stable cash flows, much sought after in volatile times. But are these “safe bets” really as solid as they appear? As our sector continues to transform, and distributed energy goes from fringe to front and centre, are the world’s utilities making investment decisions based on a view of the “utility of the future”?

Seeking stable returns in a volatile market

Regulated network and grid assets have historically been favored by investors eyeing long-term stable cash flows, as well for those keen to beat short-term market uncertainty caused by volatile commodity prices and depressed electricity demand. As seen in the chart below, the appeal of these assets around the world is only growing.

Some of the biggest utilities deals of the past year have involved regulated assets, including Duke Energy’s acquisition of Piedmont Natural Gas for $6.7bn, a price which represents a near 40 per cent premium, and a $7bn acquisition of Fortum Distribution AB by Borealis Infrastructure Management, reflecting a premium of 17 times Fortum’s FY1 EBITDA. Similarly, in February 2016, Fortis Inc acquired ITC Holdings for $11.3bn, representing a premium of 14 per cent.

Transmission and distribution valuations 2007-2016

Average P/E trading multiples for select regulated utilities (on FY2 consensus EPS estimates, 2011-Q2 2016)

Focus shifting towards disruptive energy technologies

But behind the big ticket deals that dominate transactional reports such as Power transactions and trends, some smaller deals are worth attention too. While the numbers may not be high, these transactions indicate how our sector’s continuing transformation is beginning to shape investment decisions.

Some of the deals show how more major utilities are bucking the trend to bet safe and instead investing in disruptive energy resources (DER), including battery storage and microgrids. With global DER capacity projected to reach 335 GW by 2024 (from 110 GW in 2015), it is likely to have significant repercussions for networks and system operators. 

This quarter we saw French utility giant Engie acquire an 80% stake in the California-based firm Green Charge Networks, that consists of 48 MWh of energy storage projects deployed or under construction in the US. Also in the US, the merger of Southern Company with microgrid developer, PowerSecure, for $415m shows how many of the world’s biggest power companies are starting to shift their investment focus.

We’re also seeing increasing investment by utilities in off-grid technology. Engie and Enel SpA have announced investments in mini-grid projects in Kenya and other African countries during the quarter. In May, Enerdeal signed a deal with Forrest Group to develop one of the largest fully off-grid solar power plants in Africa – a 1 MW solar power plant with 3 MWh battery storage in Congo.

At the same time, more non-utilities are aggressively pursuing stakes in this space. In Europe, we’re seeing upstream oil and gas companies diversifying into new technologies and battery storage. In June 2016, GE Ventures bought a stake in German battery manufacturer Sonnen to expand its presence in this market. Tesla’s bid to acquire SolarCity is part of Elon Musk’s grand vision for the energy company of the future offering end-to-end clean energy products to customers. If successful, this deal could completely change the energy company business model, and have long-term repercussions on the energy services segment of the value chain.

What is the long-term impact of distributed generation?

The juxtaposition of these two investment trends poses some interesting questions.

Will a risk-averse M&A strategy focused on regulated assets yield long-term, sustainable results? Or are disruptions such as energy storage and distributed energy set to bring these soaring network valuations down to earth?

It’s too early to give a definitive answer to these questions. But it is time for utilities to consider the long term nature of the industry. Are strategies based on a clear understanding of the medium to long-term impact of distributed generation on utilities? Will investment decisions made now prepare utilities for the future – or see them lose out to more innovative and visionary competitors? Perhaps the most insightful question is what role these network businesses can play in this brave new world.

Matt Rennie is EY’s Global Power & Utilities Transactions Leader. He is based in Brisbane. For more information, visit ey.com/ptt

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