At press time, French energy group EDF’s planned sale of its UK electricity network seemed to be on track to become one of 2010’s major infrastructure deals.
EDF's network: in
EDF’s UK network distributes power to almost eight million homes in the south-east and east of England and was put up for sale in October 2008 to help cut the group’s debt. Barclays Capital, BNP Paribas and Deutsche Bank are running the sale for EDF and are said to be preparing a staple package to offer to the future winner.
The company’s UK assets have a regulated asset base (RAB) of close to £4 billion (€4.4 billion; $6.4 billion), which means that a sale at a 20 percent premium could net EDF close to £5 billion. But tough new rules unveiled by regulator Ofgem in December 2009 are capping shareholder returns more than was initially expected, dampening EDF’s prospects of a good price.
The deal has been steadily gaining momentum with several key infrastructure investors lining-up to bid for the assets.
As it stands, there appear to be two consortia already formed, with three other bidders going it alone. The first consortium to emerge comprised rival utility Scottish and Southern Energy (SSE) together with Canadian pension fund Borealis. Then, in January, the Canada Pension Plan Investment Board (CPPIB) was said to have been joined by the Abu Dhabi Investment Authority (ADIA) and Macquarie to form another consortium.
Global Infrastructure Partners, high-voltage operator National Grid and Cheung Kong Infrastructure Holdings, a fund owned by Asia’s wealthiest man, Li Ka-shing, are the other bidders thought to be looking at the deal. But by the time indicative offers are submitted, it will not be surprising if some of these bidders have coalesced or recruited other parties to join them.
Part of the reason for this lies in the sheer size of the deal, with the source saying bidders will have to write an equity cheque of between £1 billion and £1.5 billion.
Equally compelling, the source explains, is that only the right combination of bidders – merging financial firepower with strong operational expertise – can hope to get a good return from the deal in light of the tough new rules imposed by the UK regulator.
Ofgem’s final regulation for the five years starting on April 1, 2010 angered the industry by cutting sharply into shareholder returns.
Ofgem said the weighted average cost of capital (WACC) for electricity operators should be set at 4 percent post-tax – half a percentage point below returns allowed by recent regulation in the water sector. The WACC is the average of the cost of equity and debt and effectively regulates what sort of returns shareholders can expect from their investments in the sector.
In the midst of a sales process, a lowering of allowed returns can directly translate into a lower purchase price. Citigroup analysts estimated that Ofgem’s proposals will shave close to €200 million from EDF’s RAB, lowering it to £3.87 billion from the start of April.
On a more positive note, operators will be able to increase prices over the next five years, with law firm Freshfields estimating in a report that EDF’s network will see price increases of between 5.5 percent and 8.8 percent. Ofgem has, however, also implemented stringent performance criteria regulating everything from price increases to the baseline return on equity a company can earn – which can fluctuate between 3 percent and 13 percent depending on performance.
For would-be buyers, financial muscle will not be enough – operational expertise will be essential to make EDF a worthwhile investment. If January’s teaming up of CPPIB, ADIA and Macquarie serves as an indication, bidders have already started to get the message. Expect others to follow between now and the initial bid deadline.