Utility Week

UTILITY WEEK | 17TH - 23RD NOVEMBER 2017 | 15 Finance & Investment led to a £26 million fine by energy regulator Ofgem. "With that history, it's not surprising that Npower has looked at selling up and leaving the retail market," says Elmes. Massara suggests SSE's strategic logic for the merger is twofold. Earnings from domes- tic energy retail are continually subjected to regulatory and government interference. SSE has the largest SVT-base in the country – roughly 90 per cent of its customers – which means the incoming cap will hit hard. The other reason is that the company may feel it will get a re-rating on the rest of the business if it separates out retail. Massara says that, for SSE, the merger creates a new entity which can be floated off, reducing its political risk and leaving a business made up primarily of regulated assets. Others have speculated that, for SSE, the move could be to protect dividend growth. In its 2017 annual report, SSE says it believes its first responsibility is to give shareholders a return on their investment through the pay- ment of dividends that are at least equal to RPI inflation. The company has an impres- sive track record, having delivered a divi- dend increase every year since 1999. Indeed, the company's share price spiked dramati- cally off the back of the merger news. "This is all about placating shareholder demands as the dividend is linked to the retail price index," says Unite's Coyne. Details of what will happen to the merged company – "SENpower", if you will – are unclear. The statement issued by the compa- nies says Innogy will hold a minority stake of 34.4 per cent, while SSE plans to demerge its 65.6 per cent stake to its shareholders upon completion. Stewart suggests that putting the com- pany on the stock exchange will allow Innogy and SSE to get rid of their invest- ment by selling their shares over time. "They might change its name, they might carry on holding it, who knows?" he says. "[The new company] could just not renew any of the contracts for its 12 million cus- tomers," he speculates. "I don't think the 50 small suppliers would be able to cope with that. I think they'd say they could, but would all run out of cash very quickly." Hold all bets for now, though. The listing of Innogy and SSE's new retail energy com- pany is expected to occur in the last quarter of 2018 or the first quarter of 2019, but before that it needs shareholder and regulatory approval. While this merger alone is unlikely to compromise the competitive dynamic of the entire energy market, it does show that cracks caused by political upheaval are beginning to show. "Since it drives the top line, the impact of the proposed price cap will be a key valuation parameter." T wo big six energy companies, SSE and Innogy, have announced plans to merge their British retail energy opera- tions, thereby creating a new independent energy supply business with up to 12 million customers. Its shares will be publicly quoted. Some other related assets are included in the proposed deal, although SSE's Irish operations are excluded. This initiative has some parallels with the 2010 T-Mobile/Orange merger – owned at the time by Deutsche Telekom (DT) and France Telecom (FT) respectively – in the ultra-competitive mobile telecoms market. In financial terms, the deal is actually quite modest compared with the overall market value of both SSE and Innogy's parent, RWE. In fact, SSE's household retail business for the first-half of 2017/18 was loss-making, due principally to seasonal factors. By contrast, its networks operations produced a half-year oper- ating profit of £355 million, with the lightly regulated electricity distribution business contributing £176 million. These regulated returns enable SSE to deliver impressive dividend growth – the 2017/18 interim dividend payment will be 28.4p compared with just 7.7p back in the 1998/99 half-year. Innogy, whose Npower brand has been badly tarnished by IT problems, reported a thumping £90 million loss in 2016 for its UK energy supply business. No wonder it wants out. The split, on an equity basis, for the new company is 65.6 per cent versus 34.4 per cent in favour of SSE. Completion is not expected until Q4 2018 at the earliest: various regulatory approvals need to be secured in the interim. Post flotation, SSE plans to pass on the sale proceeds to its shareholders. Last year, Innogy was partially demerged from RWE, but the lat- ter still holds a pivotal circa 75 per cent stake. Over the past decade, RWE's share price performance has been dreadful. The combination of depressed generation prices, low power demand, Germany's forthcoming nuclear power close-down and excessive debt has been immensely challenging. Interestingly, Innogy has confirmed that this deal will be treated as a "financial investment" – City shorthand for exit shortly aer the six months lock-in period has expired. Little detailed financial data is currently available on the new business, so valuing it is complex. Since it drives the top line, the impact of the proposed price cap – a factor cited by Innogy as a clear negative – will be a key valuation parameter. Details of how it will be implemented, and its timing, remain vague. Furthermore, discerning investors will expect substantial cost synergies to be delivered by the new entity: material IT savings should be achievable. And major branding changes are likely – as was the case in the DT/FT mobile telecoms merger – when the new company launches. More generally, other members of the big six will assuredly review their energy supply operations – and how to improve their lacklustre returns. And all, of course, will be very interested in how the market values the new business. The proposed deal will undoubtedly impact other energy market players, such as the quoted Good Energy, and unquoted First Utility and Ovo Energy. Interesting times for sure. Opinion Nigel Hawkins Director, Nigel Hawkins Associates Market shares, domestic gas 'SENpower' EDF All independents British Gas Eon Scottish Power Market shares, domestic electricity 'SENpower' EDF All independents British Gas Eon Scottish Power Source: Ofgem Source: Ofgem Innogy share price, five days (euros) SSE share price, five days (pence) 42.5 42.0 41.5 41.0 40.5 1,500 1,450 1,400 1,350 7 Nov 10 Nov 7 Nov 10 Nov

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