With a steady stream of transactions in the retail electric sector, consolidation is continuing, even as new participants continue to enter the market. Acquisitions in this sector raise considerations unique to this business requiring particular attention.
Key considerations relating to the review of the target’s customer contract portfolio and addressing changes in the value of the target’s “book” between the date that an acquisition agreement is signed and the date the acquisition is completed — the “interim period” — are highlighted below.
Customer Contract Portfolio
A retail electric provider’s portfolio of customer contracts is typically its primary asset. Issues that often arise during the purchaser’s due diligence process include:
“- Contractual Prohibitions on Assignment — Contracts should be reviewed to determine whether assignment is prohibited, or a customer’s consent is required for assignment, including a deemed assignment through a change of control. Internal restructuring undertaken in connection with a spin-off of a subsidiary should be carefully reviewed, because anti-assignment provisions can apply to such transactions under the law of certain states.
“- Uniformity of Contracts — Contract portfolios are often large, and even if permitted it may be impractical to review each contract during due diligence. A typical approach is for the diligence team to review the target’s contract forms, or a sampling of contracts, supplemented by a targeted review of significant contracts. Where a contract portfolio has been built through acquisitions, the diligence team should confirm that older contracts have been renewed on the target’s current forms.
“- Retail Sales Channels — Retail electric providers frequently use multiple sales channels to build their customer contract portfolios, which sometimes include a non-employee sales force. The diligence team should review the target’s compliance policies and complaint history, and ensure that the compensation and incentive structure for each sales channel is understood and is replicable by the purchaser.
Changes in Value prior to Closing
An important component in determining the purchase price is the market value of the target’s customer contract and supply portfolios (its “book”). Once the purchase price is agreed, the parties will need to determine how to address, if at all, changes in the value of the “book” that occur during the interim period, which may last several months due to required consents and regulatory approvals.
One approach is to adjust the purchase price for market value changes during the interim period. This approach preserves the economics of the deal through the closing, but places the pre-closing risk of the business on the seller, which is often looking to minimize its ongoing exposure in connection with its exit from the business. A more popular approach is to adjust the purchase price at closing only for working capital changes, without addressing changes in the underlying market value of the “book.”
Because the purchaser assumes additional risk under this approach, interim period covenants are used to limit changes that affect the risk profile of the “book,” including prohibitions on new transactions that exceed certain dollar amount or time period criteria, or that would require exceptions under risk management policies. Also, purchasers frequently seek the right to monitor changes in the “book” during the interim period, although access to competitively sensitive information must be limited to comply with antitrust laws.
This article highlights just a few unique considerations that arise in the acquisition of retail electric providers. It is important to have a deal team with sector experience to ensure that these issues are appropriately addressed.