Utility Week

34 | JULY 2022 | UTILITY WEEK Finance Sector is ripe for M&A activity – but will regulators play ball? The UK utilities sector remains an attractive market for potential investors. But the bar for regulatory approval of deals has grown ever higher. Comment I t doesn't take a soothsayer to see that more bids for regulated UK infrastructure assets are on the cards, in particular for pipes and wires networks. Investors are looking for safe havens from the economic fallout of Covid and the Russia-Ukraine war. With their predictable returns, and clear in• ation hedge, infrastructure busi- nesses o• er just that. Add in the UK's track record of a stable regulatory framework as well as the government's drive to decarbonise the energy and water sectors, and UK infrastructure o• ers an attractive investment story. Even a- er the government's recent windfall tax, which focuses on the pro‚ ts of oil and gas companies, the net- work businesses retain their sparkle. Private equity giants including Blackstone and KKR have said they will invest billions in the UK infrastruc- ture, with KKR recently raising $17 billion for its biggest ever infrastructure fund. Their timing could hardly beŠbetter. Five-year regulated price reviews give investors invaluable insight into what they can expect in the com- ing years. In fact, the Pennon bid for Bristol Water came three months a- er the appeal to the Competition and Markets Authority (CMA) on water price controls was concluded, while Macquarie sealed its bid for National Grid's gas transmission unit in March, three months a- er the relevant Ofgem price review. But successful bids don't automatically translate into deals. Should the CMA get involved, any investigation will be invasive and costly, not just in ‚ nancial terms but also management time. Companies may have to pass thousands of internal documents to the CMA as part of the process and even a "Phase 1" investigation can take up to 12 months including the initial information gather- ing stage. An in-depth "Phase 2" investigation can add a further eight months. The Pennon/Bristol Water deal is a good example. It took nine months for the Phase 1 investigation to conclude, and Pennon only got the deal over the line a- er o• ering signi‚ cant concessions to the CMA. These included separate reporting so Ofwat can maintain its benchmarking regime. So, what's on the regulatory horizon for investors in infrastructure? While the UK's regulatory framework is stable, the markets themselves are changing. And the prevailing market landscape is all-important when it comes to determining the level of regulatory intervention. Looking to the energy market as an example, with the collapse of 28 UK suppliers last autumn, Ofgem predominantly stepped in to select a "supplier of last resort" – with- out any competition investigation. Speed was of the essence. But the e• ect on competition has potentially been signi‚ cant. Today, the UK has fewer energy suppli- ers, particularly smaller, innovative ones, and of those remaining the big boys are bigger. Seen through this lens, the CMA may not waive through a deal in the same way as it did with SSE and Npower in 2018 – although the deal itself was ultimately abandoned. Even before this the CMA had stepped up its will- ingness to block deals or impose conditions in recent years, notching up the risk for investors. Between 2019 and 2021, our analysis of CMA merger decisions reveals that 19 deals were blocked or abandoned at Phase 2 compared with just three between 2015 and 2017. The changes in the market make-up and the emerging cost- of-living crisis are likely to further fuel the regulator's appetite for intervention. For funds with positions in multiple assets within the same sector, it's also important to note that the CMA doesn't just look at deals where full, or even majority, ownership is involved. It has the power to intervene in deals where an investor acquires "material in• uence" across more than one business. For example, the CMA carried out an investigation of Amazon's purchase of a roughly 15% stake in Deliveroo where Amazon also gained the right to a seat on Deliveroo's board. What can acquirers do to up their chances of success? Too o- en, there is a perilous gap between their mindset and that of the regulators. But by expanding their deal preparation, investors can mitigate the risk of regula- tory scrutiny or CMA investigation. They need to be able to see their deal in the context of the market, through the eyes of both the sector regulator and the CMA, at the pre-bid stage. This should be buttressed with an informed view of sector regulators' reform agendas and policy priorities set within the broader govern- ment policy context. They also need to understand how various deal scenarios might in• uence the regulators. Forewarned is forearmed. And when questions come in from regulators, interpreting these and determining how best to respond is a ‚ ne art that demands expertise and experience. A deep understanding of the way the system works and how best to in• uence the development of the regulators' thinking – through providing the right evidence at the right time – can be the di• erence between keeping a deal on the track or it being derailed. Joel Bamford and Simon Oates are both directors at Fingleton Joel Bamford was senior director of mergers at the CMA until February 2022, while Simon Oates has held executive director positions at businesses including Southern Water. Simon Oates Joel Bamford

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