Imagine the following pitch. “I want about €100 million to buy a soon-to-be regulated utility company. The regulation will be ready in a year, by which time we will know for sure if the price we paid gives us a good or bad deal in relation to the company’s regulated asset base. In the meantime, I should also tell you that 50 percent of their pipeline is unused.”
Swedegas operates Sweden’s largest gas network covering 390 kilometres in the south and west of the country, including the only inter-connection between Sweden and Denmark and the extended European gas network. It was sold by E.ON Ruhrgas, Statoil, DONG Energy and Fortum for an enterprise value of between €200 million and €250 million. For that price tag, buyers could own a national monopoly that comprises a not insignificant part of the European gas transmission network.
But there were disadvantages. The deal would have to be done in Swedish crowns, not the most popular currency. Many of the local banks had committed themselves to working with bidders on an exclusive basis. The regulation would only be ready in October 2010 and, as such, there were only estimates of the future regulated asset base and the weighted average cost of capital (WACC) that effectively caps shareholder returns. Additionally, only 50 percent of the pipeline was in use, raising questions about how to increase capacity and how that increase in capacity would interact with the future cap on shareholder returns.
By the final offer stage, these obstacles had driven the likes of Antin Infrastructure Partners, Colonial, Industry Funds Management and RREEF out of the race. Two bidders were left standing: Infracapital Partners, the infrastructure fund managed by M&G Investment Management, the European investment management arm of the Prudential Group; and EQT’s infrastructure fund.
EQT won after paying somewhere in the region of €200 million, sources close to the deal say. A bank loan from Nordea Bank and Skandinaviska Enskilda Banken will fund half that sum with EQT forking out for the remainder.
Given the complexities surrounding Swedegas, it seems pertinent to ask: did EQT go out of its way just to buy a trophy asset in its home market? Or did the Swedish firm see something in Swedegas that other would-be investors had perhaps failed to get to grips with?
Lennart Blecher, a senior partner and head of EQT’s infrastructure business, is confident about his purchase: “Swedegas is a national monopoly, regulated, and with potential for upside. We view it as a defensive asset and with less risk than some of our other acquisitions”.
Blecher acknowledges the lack of a completed framework, but expects the Swedish Energy Market’s final regulation to be in line with rules in other European countries. He also highlights that EQT is “very well rooted” in Sweden and is in a position to understand the potential risks of new regulation. A look at Swedegas’ board of directors underlines his point. Of the three newly-appointed board members, one is a former Swedish Minister of Finance and another is an ex-chief executive of E.ON Sweden.
Clearly, Blecher’s confidence is grounded. It is, after all, not unreasonable to expect that some of these sources are especially well equipped to negotiate with the regulator. But when pressed for specifics – such as what EQT expects Swedegas’ regulated asset base to be, or what scope he thinks there will be to raise prices – Blecher declines to elaborate.
Martin Lennon, the head of Infracapital Partners, the runner-up on Swedegas, says he was also comfortable with the regulatory risk in respect of their offer, the size of which he declines to disclose.
“Within Infracapital and through being a part of M&G Investments, we obviously have a tremendous wealth of knowledge and experience in the utilities sector at our disposal, which helped us to get comfortable with the regulatory aspect,” says Lennon. “We also had airtime with the regulator and were comfortable with where the regulation was heading in relation to the offer we were prepared to make.”
Another source close to the deal suggests the final regulatory framework could cap shareholders’ returns at 8.5 percent, not adjusted for inflation. This could create a scenario where, even with growth in the pipeline, it would be hard for returns to bump-up against the cap, the source says.
It is understood that Swedegas’ tariff revenues are not entirely volume dependent, deriving in part from a booking fee. This creates opportunity since capacity is booked for the entire year and cannot be revised downwards.
Plugging the gap
Both Blecher and Lennon recognise that the unused capacity is an issue, but believe significant opportunities exist to help plug the gap.
Blecher sees potential for upside in that Sweden uses much less natural gas when compared with other European countries. Only two percent of Sweden’s total energy supply comes from gas compared with 24 percent on an EU level. But the southern and western parts of Sweden where Swedegas’ network is located are much closer to the EU average, deriving 20 percent of their energy supply from gas.
At the time the deal was announced, Stefan Glevén, a director in EQT’s infrastructure fund, outlined some of EQT’s plans for Swedegas: “We see interesting potential in supporting industries to replace oil with gas as fuel and also in meeting the increasing demand for vehicle gas. Transporting biogas is another promising opportunity,” Glevén said.
One bidder which did not go beyond the initial offer stage told InfrastructureInvestor it found Swedegas’ existing client pool too small and the effort of turning the company around too big in relation to its price tag.
Another source that followed Swedegas exemplified how the type of business opportunities Glevén refers to can sometimes fail to materialise. He spoke of two projects which could have potentially boosted Swedegas’ business. One was a natural gas offshore pipeline connecting Norway to Sweden and Denmark; the other was a new gas-fired energy plant in Malmö, in the south of Sweden. Both could arguably have helped plug the gap in Swedegas’ pipeline. Both failed to get off the ground.
In the end, it is probable that EQT’s strong roots in Sweden will serve it well in navigating these pitfalls. Certainly, the risks are there – from currency, to unfinished regulation and an underused pipeline. But EQT is playing on home turf and seems well equipped to turn some of these risks into competitive advantages.