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Utility Week 27th Sept 2019

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18 | 27TH SEPTEMBER - 3RD OCTOBER 2019 | UTILITY WEEK Finance & Investment Analysis I t is not oen that City analysts and corpo- rate financiers praise the Competition and Markets Authority (CMA) – whose recom- mendations sometimes eliminate expected bonuses – for its far-reaching insight. But, in its in-depth analysis of the UK electricity supply market in 2016, the CMA addressed the contentious issue of "detriment" – in essence, the extra amount paid by household consumers as a result of the market's inherent defects. Much to the undisguised fury of British Gas parent company Centrica and the other members of the big six, the CMA concluded that the "detriment" figure between 2012 and 2015 averaged £1.4 billion per year – a seriously chunky number. In undertaking this provocative analysis, the CMA used key data from two new mar- ket entrants, First Utility and Ovo Energy. Both companies have become disrupters in a market which, for a generation, had been dominated by the big six integrated energy suppliers. The UK supply market share of the big six has fallen from 97 per cent in 2014 to around 73 per cent currently. Disruption is clearly to the fore. Fast-moving market Nonetheless, most of the approximately 70 new entrants have really struggled in a fast- moving market that can suddenly be over- taken by events such as cold weather snaps. Indeed, some 15 small energy suppliers have collapsed since January 2018. And many others are struggling financially. Among the most well-known casualties was the previously quoted Flow Energy, whose apparent obsession with boilers and their technology overwhelmed its supply business – the latter was eventually folded into Co-Op Energy. For the two leading market disrupters, major deals have been announced. In the case of First Utility, it has been bought out by the mighty Shell, whose com- bined – A shares and B shares – market capi- talisation currently exceeds £185 billion. In theory, given its towering financial strength, it could buy the whole of the UK electricity industry. Subsequently, First Utility has been rebranded as Shell Energy. For Ovo, its recent deal with SSE repre- sents a "great leap forward" and will provide it with an energy supply customer base of approximately five million, more than three times its current number of customers. The total cost of the deal, which replaces the failed SSE initiative to merge its house- hold supply business with the then RWE- controlled Innogy, amounts to £500 million. Once the deal is completed, £400 million of this amount will be paid over to SSE, while the outstanding £100 million is covered by a bond, due to be redeemed in 2029: various other financial reconciliations will also take place. The interest rate on the latter is a formi- dable 13.25 per cent, almost identical to the ill-fated Sirius Minerals bond – to fund a massive potash scheme in Yorkshire – that was pulled in mid-September. For SSE, aer the embarrassing Innogy setback, the deal will be seen positively, although the sale price may seem relatively low. However, SSE has been unequivocal in stating that its priorities are its renewable generation assets, whose underlying valu- ation will have risen in recent years, and its regulated networks businesses that effec- tively fund the dividend. Avoiding a dividend cut – a la Centrica – remains key. As part of its announce- ment covering the Ovo deal, SSE reaffirmed its dividend targets, linked to the RPI, until 2022/23. The deal will also reduce its burgeoning net debt of £9.4 billion at March 2019. Challenges of integration For Ovo, this deal is a veritable game- changer, although integrating such a comparative large increase in customer num- bers will be challenging. Not to be under- estimated either are the additional risks to its business model that the deal entails. However, despite being barely profitable, Ovo's valuation, as implied by the 20 per cent stake taken by Mitsubishi, indicates a figure of about £1 billion – a commend- able effort for a start-up business founded as recently as 2009. Assessing whether Ovo has overpaid is not easy, given the various adjustments to SSE Energy Services' business such as the Northern Ireland customer base that is excluded and certain balancing items. On an asset basis, SSE is selling the busi- ness at 34 per cent below book value – a pronounced discount. The equivalent exit price/earnings ratio exceeds 14, although Entrants knock the big six The market share of the big six has fallen by 24 percentage points since 2014. The disruptors are here – and Ovo's purchase of SSE will see the big six become the big five, says Nigel Hawkins. Chief executive Iain Conn will step down next year following a huge cut to Centrica dividends The latest cost estimate is now £10 billion at EDF's third-generation Flamanville plant Iberdrola's market valuation is driven by its laser-like focus on renewable generation

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