The auction of a majority stake of National Grid’s four UK gas distribution networks presented a rare opportunity for largest asset managers, sovereign wealth and pension funds to deploy bulky equity cheques. In a show of confidence for UK regulated markets in the aftermath of EU referendum, one consortium eventually bid a 50% premium to the regulated asset value (RAV).

The transaction saw two UK infrastructure funds that were originally PPP-focused, successfully bidding their relatively new strategies to diversify into the regulated utility space. Amber Infrastructure-managed INPP and Dalmore Capital both made their regulated asset entrance with the Thames Tideway Tunnel construction project in 2015, and repeated the feat by buying stakes in these gas assets. The two funds were part of a larger consortium which was named the winner after a competitive bidding process.

The auction

National Grid first announced plans to sell at least 51% of its UK distribution assets in November 2015.

A stakeholder consultation ran from February to April 2016, then in July the regulator Ofgem granted consent for National Grid to spin off its four UK gas distribution networks in to a newly created standalone operator National Grid Gas Distribution (NGGD). The new entity would have its own licence, extricated from the gas transmission assets also in subsidiary National Grid Gas.

The assets are four out of the eight distribution networks in the UK and serve 10.9 million customers through 130,000km of pipeline.

Global appetite

There was a surprising elimination in the first round of bidding, after the auction had been launched in July 2016 and indicative offers submitted in September. A consortium consisting of investor heavyweights Hermes, USS, Canada Pension Plan Investment Board, Abu Dhabi Investment Authority (ADIA) and Kuwait Investment Authority, had been tipped to win but failed to qualify for the second round.

At the final stages several bidders from Asia were in the fray. Hastings, Singapore Power and China Resources Gas had teamed up and were against a bid led by Chinese conglomerate Fosun. The other two competitors included a rumoured bid from Warren Buffet’s Berkshire Hathaway and the eventual winner Quad Gas Group.

Quad Gas Group comprises:

• Macquarie Infrastructure and Real Assets – 14.5%
• China Investment Corporation's subsidiary CIC Capital Corporation - 10.5%
• Allianz Capital Partners – 10.2%
• Hermes Investment Management - 8.5%
• Qatar Investment Authority – 8.5%
• Amber Infrastructure-managed fund INPP – 4.4%
• Dalmore Capital – 4.4%

Dalmore's contribution to the consortium included £185 million of capital from two Korean institutions Hanwha Life and Scientists and Engineers Mutual-aid Association.

Valuation

The group placed an enterprise value on NGGD of £13.8 billion ($17.3 billion). The price represents a premium of approximately 50% to RAV, which was £8.7 billion at 31 March 2016.

Charles Currier, partner and head of corporate at CMS UK which advised Quad Gas Group, says: “When National Grid sold the other four distribution grids back in 2004, the RAV premiums were reported to be in the 17-18% range. It shows how in 12 short years the market has changed significantly, as bond and fixed income yields have reduced so investors are prepared to accept lower yields out of very core stable businesses, with stable cash flows.”

Just over a month before final bids for National Grid’s deal, SSE agreed to sell 16.7% of gas distribution network SGN to ADIA for £621 million at a roughly 45% premium to RAV, in that case for a minority stake.

In a 3 April 2017, a report from Standard & Poor's entitled “Premiums for UK regulated utility assets are riding high, but what are the means for payback?”, argued that given the gas distribution sector’s regulatory asset base is set to remain flat or even decline slightly in real terms, “the premiums paid could imply that investors anticipate alternative methods of payback to the regulatory-approved tariffs such as financing or operating out-performance.”

S&P suggests utilities are “excellent candidates” for more complex financing, and that [the regulator’s] allowance for the cost of new debt is still higher compared to what we have observed in the marketplace.”

The eight-year regulatory period for NGGD will run until March 2021.

Equity

To finance the acquisition of 61% of NGGD, Quad Gas Group committed £3.6 billion in equity, paid on 31 March 2017. National Grid retains a 39% stake in the assets.

There is an agreement in place that the Quad Gas Group could acquire a further 14% ownership from National Grid, if either party chooses to exercise the option between 1 March 2019 and 31 October 2019. Quad Gas Group would pay £800 million for that 14%. In addition Quad Gas Group has pre-emption rights over the residual 25%.

Debt financing

Throughout the bid process, the group had a bank debt shorter term acquisition package, however once in preferred bidder position the consortium raised a long-term debt piece from Macquarie Infrastructure Debt Investment Solutions (MIDIS). In all, the debt financing came to £2.3 billion to support the 61% acquisition, though there is existing debt in the gas distribution company’s structure. Based on all debt, the debt to RAV leverage is 81%, S&P says.

The £502 million long-term debt package originated by MIDIS comes from MIDIS clients, MIDIS’s UK Inflation Linked Infrastructure Debt Fund, as well as Barings and its clients provided a smaller amount. The debt has tenors that vary between 20-25 years with interest rates that are fixed, floating, and inflation-linked.

In addition 13 banks provided broadly even tickets, IJGlobal understands.

They provided a £650 million three-year senior term loan, a £650 million five-year senior term loan, a £380 million revolving credit facility and a £120 million debt service reserve facility. On the three-year senior debt, pricing starts at 110bp over Libor, with step-ups over time.  There is a premium to that margin on the five-year piece.

The banks are:

• Bank of China
• BNP Paribas
• China Construction Bank
• Credit Agricole
• ING
• JP Morgan
• MUFG
• RBC
• RBS
• Santander
• SEB
• SMBC
• Societe Generale

S&P rated NGGD at BBB+ on 3 April 2017.