by Joseph Fontana, Ernst & Young LLP
Mergers and acquisitions (M&A) have been on a downward trend, in particular after the banking crisis and credit freeze of September 2008. Table 1 shows a severe decline in M&A activity for the power and utilities sector toward the end of 2008 and into first quarter 2009 (Q109). Quarter by quarter between early 2008 and the beginning of 2009, transactions dropped nearly 60 percent.
This falloff is more dramatic for financial investors such as private equity (PE) and infrastructure funds (see Table 2), where completed deals fell from 31 in first quarter 2008 to five in first quarter 2009: more than an 80 percent drop. Except for first quarter 2009, when the average deal value was lifted by one large transaction, the declining average deal value reflects the scarcity of debt typically used to fund these transactions.
Deals are still being done, however, where strategically sensible and financially viable (although many large deals were announced before the financial market turmoil). Recent multibillion-dollar transactions include the $23 billion acquisition of British Energy by EDF in the U.K. (closed in early 2009), and the $8.3 billion acquisition of Energy East by Iberdrola in the U.S.
Globally, fewer cross-border transactions have occurred. In the second half of 2008, 131 domestic transactions were completed compared with 70 cross-border deals; a trend that continued into first quarter 2009.
The U.S. is a quiet market now, largely a result of the collapse of the banking sector, the financial buyer community and the lack of any available noninvestment-grade debt. The only deal of note was the Puget Energy acquisition by a consortium of financial investors.
Across Europe, some countries stand out for their strong M&A activity: the Netherlands, Italy, Germany, France, the U.K., Russia and Turkey. Across the region, however, deal activity decreased 50 percent, with a virtual standstill of outbound transactions (for example, investments in other geographical areas such as Asia or the Americas) in fourth quarter 2008 and first quarter 2009. Significant activity includes the long-awaited close of the merger between Gaz de France and Suez and the acquisition of British Energy by EDF. We have also seen numerous renewable energy assets change hands, especially in the U.K.
Asia, Australia and India
Though these markets operate independently from one other, they are all experiencing high intraregional M&A activity. Previously, substantial outbound activities were the norm, as Australian infrastructure funds, Southeast Asian sovereign wealth funds and Japanese trading houses demonstrated an appetite for U.S. and European assets. Now, only the latter continue to invest at significant levels. Overall, M&A transactions declined 70 percent from third quarter 2008 to first quarter 2009.
Right now, the opinion of credit agencies is more important than the long-term benefits of any transactions. In this economic climate, access to capital markets is key. Executives have put liquidity in the spotlight and are doing everything they can to protect their companies’ credit ratings. No one is going to jeopardize that with a transaction credit agencies might frown on, as a downgrade from AA to BBB could add as much as 661 basis points to the cost of borrowing. For example, EDF was downgraded after it acquired British Energy and is considering asset disposals to raise cash.
For debt markets, there are two worlds at the moment: one for investment-graded businesses and the other for noninvestment-graded businesses. Our research shows that investment-graded businesses are still raising debt at significant volumes.
For example, in the U.S. where debt markets are arguably tightest, investment-graded utilities raised $31.7 billion in debt in first quarter 2009 (compared with $22 billion in first quarter 2008). So the markets are open to the right kind of credit. These funds are earmarked for future capital expenditure programs, however, rather than transactions.
Noninvestment-graded players are being shut out of the market because they can’t raise debt at the terms they want or with covenants they deem fair. For PE houses, this means they don’t have the debt available to earn leveraged returns on their investments.
As an example of fundraising on a grand scale, Sweden-based utility Vattenfall has raised a new $6.8 billion credit facility at a decent interest rate to fund the acquisition of the first tranche (49 percent) of Dutch utility Nuon (total deal value of $10.8 billion). Evidently lenders were convinced of the buyer’s financial health and strategic rationale behind the deal.
We are seeing a stalemate between buyers waiting for bargains and sellers holding out for prices they want. This likely will turn into a buyer’s market as the trend toward disposals of assets gains traction. In first quarter 2009, European utilities announced asset sales totaling about $40 billion. The question remains: Who will be willing to buy them?
It’s also likely that the recession will cause stricken owners to sell assets to raise cash to pay off debt. So we expect prices to fall and buyers—primarily market participants with cash or equity to swap—to pick up some bargains. Once the credit market stabilizes, the balance of power may shift, so timing will be key.
There may be important developments on the renewables front. With a new U.S. government that takes a strong position on green investments and other stimulus measures around the world, there is renewed vigor in this sector. Consolidation is likely, but as yet it’s unclear who will lead at the start of 2010.
Joseph Fontana is Ernst & Young LLP’s global utilities and power industry leader, transaction advisory services. He has more than 25 years of corporate finance and transaction experience primarily focused on the power generation and utility industry. He’s led more than 70 power and utility due diligence transactions in the past five years with a combined deal value in excess of $100 billion. Reach him at email@example.com.