Utilities companies find themselves operating in a contradictory environment of regional activities and global developments. This environment is further enhanced by the future dynamics of international utility markets and the geopolitical and regulatory effects. The risk profile of the entire industry is changing and the capital markets have had significant changes as well. A large number of players in the capital market, like pension funds and insurance companies, try to find their place in financing the utilities business through specialized infrastructure, private equity or even hedge funds.
The IEA expects an average annual growth rate in primary energy demand by 1.6% with a doubling in the global electricity demand by 2030. The investment pressure on electricity and gas companies is immense. Meeting projected demand will entail cumulative gas and electricity investment of some US$12.7 trillion in this period. With just nearly 60% for electricity (including the required gas infrastructure even 70%) will be needed. Therefore the energy market will remain furthermore very attractive for investors.
Financing will essentially come from the finance market, but the rules of the game have changed through liberalisation and regulation processes. More or less every country has gone through unbundling when supporting market opening and this presents a significant increase of risks. Furthermore enhancing those risks are fuel mix issues, security of supply and different approaches to climate change. All these issues increase the complexity of financing in the utilities business, the significant growth in demand is only going to be met through external financing and through cross-border transactions. Some companies will be able to finance themselves from their own cash flows or by means of focussing on their core business strategy. Others will look for financing coming from the capital markets. Equity and debt financing based on strong balance sheets and improved credit ratings are much more important now than it was before, and Basel II plaid its important role in the process. US utilities have worked their way out of ‘junk’ status, while utilities in Western Europe and some parts of central Europe have excellent credit ratings.
Infrastructure funds tend to go for a long-term commitment with stable cash flows in the regulated business, while private equity and hedge funds take on risks with a short exit and appetite for high profits. For example, in 2003, the 4,000MW Drax coal power station in the UK went through an insolvency process. However, with coal prices on the rise, equity and private investors showed in 2005 strong interest in buying it for £475/kW, or nearly seven times as much as the last coal-fired station was sold in UK.
PwC identified1 PricewaterhouseCoopers: Under Pressure* Utilities global survey 2005, Page 42 five top criteria that investors when considering investing into utilities business:
1. Greater regulatory certainty,
2. Regulatory incentives for investments,
3. Corporate transparency,
4. Improved price environment,
5. Focused core business strategy.
Opportunities and risks in financing German utilities
Hybrid forms, Mezzanine:
Effects – growing significance of hybrid financing tools in particularly for medium-and mid-sized utilities
Opportunities – improvement in equity-debt ratio; better rating; decrease in capital costs; liquidity and credit improvement
Risks – to find appropriate tools; the right optimisation of debt-equity-mix, adherence to debt covenants
Infrastructure funds:
Effects: International player on the German market (Australians are leading with Macquarie); focussed on infrastructure projects in monopoly areas, e.g. networks
Opportunities – access to capital; sustainable engagement
Risks – till now hardly best-practice in Germany; higher pressure to give dividends; expects stable cash flow and long-term value growth potential
Private equity funds:
Effects - The utilities have becoming increasingly a target for private equity companies that work on an international basis; increased participation in tenders; a high political resistance
Opportunities – access to capital in the regulated and non-regulated market; acquisition of the entire companies; often puts in place radical restructuring
Risks - temporary engagement; significant influence on corporate activities; pressure to provide dividends, leverage
Hedge funds:
Effects – exploitations of price swings; enormous political resistance
Opportunities – access to large capital pool; investment in struggling companies
Risks – short-term engagement; pressure to provide dividends; influence on corporate activities, already in the case of minority stake holdings
Conclusions:
At international level, special investment funds recognise the attractiveness of the utility sector. These funds already have enormous investment capital at their disposal, which will rise further in future through the diversification of the investment strategy of e.g. pension funds. German market is seen by these funds as 'a paradise' because of its blue-chip companies, excellently educated workforce and its central European location attractiveness. The German utility sector still remains relatively unexplored by investment community, but first attempts will be definitely coming due to the growing investment pressure for the utilities business.
1 PricewaterhouseCoopers: Under pressure: Utilities global survey 2005, page 42
