Gridlock
There were two bits of good news for the UK's power distribution
monopoly, National Grid PLC, at the end of the summer. Firstly, the
industry regulator, Office for Gas and Electricity Markets (OFGEM),
decided to implement price controls for the sector that were far
more favourable to the company than its original proposals (which
were put forward at the end of June). Secondly, its ambitious
takeover of US-based electricity generator Niagara Mohawk was tied
up in mid-September. The deal should close by year-end 2001. But
the company now has its work cut out in integrating its recent
string of acquisitions into the corporate whole.
Niagara Mohawk is by far the largest acquisition that National Grid has made in the US, and it doubles the company's presence there. It is the second gas and electricity distribution company in the State of New York (after ConEdison) and has 1.5 million subscribers. The company posted a profit before tax of $1.3 billion in 1999 from a turnover of $4.1 billion. National Grid is acquiring the company for $3 billion in cash and shares ? valuing Niagara Mohawk shares at $19. It will also assume a total of $5.9 billion Niagara Mohawk debt, giving a total transaction value of $8.9 billion.
This is an ambitious acquisition ? which still has to be passed by the regulators. It follows on from National Grid's recent acquisitions of the New England Electric System (NEES) for £3.2 billion and Eastern Utilities Associates (EUA) for $643 million. The deals were partly financed by a $3 billion debt facility co-arranged by ABN Amro, Barclays, Chase Manhattan, Deutsche Bank, Dresdner Kleinwort Benson and HSBC.
Niagara Mohawk makes the UK-based company the ninth largest electricity utility in the US, and comes hot on the heels of other UK acquisitions in this sector. Powergen has bought Kentucky-based LG&E and Scottish Power bought Utah-based Pacificorp in 1999. Conservative estimates reckon that US electricity companies are 30% less efficient than their UK counterparts, so the opportunities for the UK players to clean up are very tempting. National Grid chairman James Ross has said that the expansion of the company into the US is simply driven by the desire to find good deals. The company has also developed a strong telecoms dark fibre business (which installs fibre along distribution and transmission networks and leases it to telecoms, internet and cable operators) in the US, which signed sales contracts in the year to March worth £70 million.
National Grid's strategy is to have 40% of business in the US, 40% in Europe and 20% in emerging markets. ?The Niagara Mohawk acquisition makes the US business a major part of the National Grid,? says Paul Lund, sector analyst at Standard & Poors in London. ?It is now a bigger generator of business than the UK and will undoubtedly be the focus of the group.?
The question is whether National Grid has bitten off more than it can chew. Niagara Mohawk has problems ? and its acquisition means an estimated increase in National Grid liabilities of a whopping $6.9 billion. It is burdened with substantially higher levels of debt than most other operators in this sector and has only just managed to unwind a large volume of high-cost power supply contracts. But National Grid estimates that the acquisition will deliver efficiencies of $90 million over four years ? half of this figure being achieved in the first year. ?They need to create synergies with the existing US national grid,? says Lund at S&P. The distribution of electricity in New England has been hugely inefficient as supply is determined on a county-by-county basis. This, suppliers have had to run power lines across counties that they do not supply to in order to reach those that they do.
Industry experts are divided as to whether this acquisition means that the company is overstretching itself ? if the deal is approved by regulators National Grid's gearing will be over 100%. All are agreed, however, that National Grid must now concentrate on integrating the acquisitions that it has made rather than continuing to expand.
The operations of NEES and EUA have been integrated and rate plans agreed and implemented. National Grid reckons that this integration is already resulting in savings of around 50% of EUA's controllable costs. This should be around £25 million a year and the company expects to achieve that in the first year of integration. But National Grid itself has played down the likelihood of further expansion in the near future. When contacted by Project Finance, a spokesman for National Grid said, ?To be of any interest to us in the short-term further acquisition would need to offer special opportunities. Either a small transaction to fit with our existing ?footprint? in the US or a major opportunity too important to miss.? Others are more definite. ?They should not buy anything else,? says one analyst at a London-based US bank. ?They should spend the next two years integrating all the acquisitions,? he says. National Grid has predicted that its US acquisitions will be earnings neutral after goodwill amortisation in 2000/01 and will enhance earnings thereafter.
The same analyst reckons that Niagara Mohawk can be successfully integrated. ?They definitely have the management to cope with these acquisitions,? he says. ?They haven't overstretched themselves at all.? Lund at S&P isn't so sure. ?They really have to tie these [new acquisitions] down,? he says. ?There is a huge risk in terms of management time and they could get distracted from their other business. They may have overplayed it ? only time will tell.?
OFGEM softens
It is certainly vital that National Grid does not take its eye off the ball at home. The company itself was formed by the break-up of the UK's Central Electricity Generating Board (CEGB) in 1990 and was listed in 1995. It is the monopoly electricity transmission provider in the country, and as such is closely watched by the government regulator. The OFGEM decision on transmission controls at the end of September was far more favourable to the company than some had expected.
In June, the regulator had said that it would assume a cost of capital in the range of 5.5% to 6.25%. It had also proposed that there should be price cuts of between one and six percent in 2001 with subsequent price rises being limited to inflation minus 3 percentage points. But in September the proposal had been adjusted to a cost of capital of 6.25% and price rise limitation of inflation minus 1.5 percentage points ? and no price cuts in 2001. The decision was extremely good news for the company and prompted widespread upgrading of the stock. But there is no pleasing some people. ?The 6.25% cost of capital figure is disappointing,? says the National Grid spokesman. ?However, the final proposals as a whole represent an increase of £100 million in allowed revenue over five years compared to the proposals in June.? He believes that OFGEM changed its mind as a result of the ?strong case that the company put during consultation after the draft proposals.?
?This decision has a very positive impact as we now have regulatory certainty,? says one analyst. ?The June assumptions were quite tough.? He reckons that the initial review was harsh as a result of National Grid's privileged position as a single monopoly. Some observers also believe that OFGEM was keen to be seen as listening to the market after criticisms that have been made of OFWAT, the water regulator, in the handling of that sector. OFGEM is certainly in need of some good PR, following the recent announcement that the New Electricity Trading Arrangements (NETA) for the UK, due to be implemented on November 21, will now be delayed due to technical problems. This delay has had a knock-on effect in the industry, with the likelihood that the moratorium on the building of new gas-fired power stations (which was due to be lifted in October) will now also be delayed until NETA is implemented.
The NETA delay has serious ramifications for energy market operator EnMo, which is part-owned by National Grid. EnMo, together with three partners (one of which is another National Grid subsidiary, ESIS), plans to launch an energy exchange, trading electricity and gas, six to 10 weeks prior to the implementation of NETA. Other partners in the project are the Scandinavian power exchange NordPool and US-based software company Altra Energy Technologies. The delay will mean an increase in costs for EnMo.
More interconnectors
In addition to linking up with NordPool, National Grid is also planning to construct an interconnector link between Norway and the UK ? opening up access to both markets for all players. The company has joined forces with Statnett, Norway's transmission company and Hydro Energy (a division of Norsk Hydro) to carry out studies on the project. The cable would be 350 miles long and carry 800MW. This project is just one of several interconnector feasibility studies that National Grid has undertaken following the successful financing of its interconnector link between the UK and the Isle of Man. Others involve links with Ireland and the Netherlands.
The £45 million Isle of Man deal closed in April 1999 and was the first interconnector to be funded on a project finance basis. It is 105km long and will carry 40MW of power. Financing for the deal was arranged by Midland bank, which has since been incorporated into HSBC. Gary Lindsey, part of the project lending team at HSBC in London, worked on the deal. ?It was actually a hybrid between a corporate and a project finance loan,? he says, explaining that the deal will be renegotiated after five years. ?The intention was always to look at a capital market refinancing.? The Isle of Man cable was jointly sponsored by National Grid and the Manx Electricity Authority and was contracted to Pirelli General and BICC Cables. Cable-laying began in May this year and the link is due to go live this month (October).
National Grid already owns and operates interconnectors with France and Scotland. This part of its business saw profits rise by 7% from 1998 to 1999 to £36.2 million. It is, therefore, a lucrative option for National Grid and it is not surprising that the company is so keen to get involved in further links. In addition to the Norway, Ireland and Netherlands proposals, National Grid has also been shortlisted for a BOO project to construct a 2000MW interconnector between Tasmania and mainland Australia. ?There should be a lot of interconnector deals coming up,? predicts Lindsey at HSBC. ?National Grid is a prime mover in this.? He explains that interconnector deals do have a high-risk element for project financiers due to the difficulty in testing prior to construction. The key thing is to get the jointing right as you cannot really test the cable until it is already underground. ?Burying a cable under several metres of water is not the easiest thing in the world,? he says. ?By the time you are testing it, it is already underground. You must, therefore, be very comfortable with the contractors going in.?
Away from the US and Europe, National Grid has concentrated most of its efforts so far in the emerging economies in Latin America. But it does have transmission interests in Zambia (through its ownership of 80% of the Power Division of Zambia Consolidated Copper Mines) and is working in joint venture with Karnataka State Electricity Board in India to build a transmission line. It has also made a small joint venture in Poland, NG Koleje Telekomunikacja, with subsidiary Energis. The consortium is due to launch services at the end of this year. Other partners include Polish National Railways (PKP) and local telecoms operator Centrala. The company will run a network leasing existing fibre running along PKP's network. National Grid plans to invest £60 million in Poland over the next 18 months.
It has not all been plain sailing, though. National Grid's plans to install a 500KV transmission line with three substations in Pakistan had to be scrapped in 1997 when the political situation in the country made the project impossible. The government terminated the project after National Grid refused to execute a performance guarantee. The World Bank, The ADB and NatWest had been lined up to fund the deal.
But Latin America remains the focus for National Grid. The company has a 50% stake in Brazilian long-distance telecoms company Intelig. National Grid plans to invest $281.2 million in Intelig ? which announced losses of R$105.5 million for the first half of 2000 in September ? over the next four years. The investment in this start-up has so far cost the company £75 million and finance director Stephen Box has refused to put a figure on how much the venture could cost the company for the full year. Intelig started operations in January 2000 as a joint venture between National Grid (50%), Sprint (25%) and France Telecom (25%). Sprint was to sell its stake following its acquisition by MCI WorldCom but this has been put on hold.
The project was set up with the aid of a $1.5 billion loan provided by EPC contractors to the scheme, Nortel Networks and Alcatel. The deal was signed in September 1999.
The push into Latin America has also been increased over the last year with the acquisition of a 30% stake in Telefonica Manquehue in Chile for £55 million and 50% of new venture Southern Cone Communications, which plans to develop a network linking Argentina's principal cities and cross the Andes to link to Santiago in Chile.
All shopping sprees have to be paid for, and National Grid's is no different. It has so far managed to pay the bills partly thanks to its extremely successful spin-off, Energis. The company was set up in 1993 for £400 million and now has a market capitalisation of around £18 billion ? far greater than that of National Grid itself. Energis provides voice, data and video services by piggybacking fibre-optic lines on National Grid's existing network ? an extremely successful plan that the company plans to replicate with the Southern Cone project. National Grid cashed in Energis's value in March this year when its sold a 10% stake, realising about £1 billion (leaving it with a 36.3% stake). These funds were put towards the costs of the US acquisitions. It has had plans to sell Energis since 1998, when the company made up roughly 80% of the entire market capitalisation of National Grid, and the latter's ambitious run of acquisitions now makes that desire even more pressing. At the beginning of 2000, chief executive officer David Jones announced that the company planned to sell Energis ?within the next three years?, but in April warned that ?we think it will probably happen in the first half of that period?. Likely buyers include Deutsche Telecom and France Telecom. A slight spanner was, however, thrown into the works with Energis's announcement at the end of September that it plans a £400 million share placement to fund internet capability and European expansion. The deal is being run by Cazenove and Dresdner Kleinwort Benson. As part of the deal, National Grid has had to undertake not to sell any of its shares before January 2001 except in connection with an offer for Energis, a sale of its entire holding or a transfer of shares to a bond holder.
Niagara Mohawk is by far the largest acquisition that National Grid has made in the US, and it doubles the company's presence there. It is the second gas and electricity distribution company in the State of New York (after ConEdison) and has 1.5 million subscribers. The company posted a profit before tax of $1.3 billion in 1999 from a turnover of $4.1 billion. National Grid is acquiring the company for $3 billion in cash and shares ? valuing Niagara Mohawk shares at $19. It will also assume a total of $5.9 billion Niagara Mohawk debt, giving a total transaction value of $8.9 billion.
This is an ambitious acquisition ? which still has to be passed by the regulators. It follows on from National Grid's recent acquisitions of the New England Electric System (NEES) for £3.2 billion and Eastern Utilities Associates (EUA) for $643 million. The deals were partly financed by a $3 billion debt facility co-arranged by ABN Amro, Barclays, Chase Manhattan, Deutsche Bank, Dresdner Kleinwort Benson and HSBC.
Niagara Mohawk makes the UK-based company the ninth largest electricity utility in the US, and comes hot on the heels of other UK acquisitions in this sector. Powergen has bought Kentucky-based LG&E and Scottish Power bought Utah-based Pacificorp in 1999. Conservative estimates reckon that US electricity companies are 30% less efficient than their UK counterparts, so the opportunities for the UK players to clean up are very tempting. National Grid chairman James Ross has said that the expansion of the company into the US is simply driven by the desire to find good deals. The company has also developed a strong telecoms dark fibre business (which installs fibre along distribution and transmission networks and leases it to telecoms, internet and cable operators) in the US, which signed sales contracts in the year to March worth £70 million.
National Grid's strategy is to have 40% of business in the US, 40% in Europe and 20% in emerging markets. ?The Niagara Mohawk acquisition makes the US business a major part of the National Grid,? says Paul Lund, sector analyst at Standard & Poors in London. ?It is now a bigger generator of business than the UK and will undoubtedly be the focus of the group.?
The question is whether National Grid has bitten off more than it can chew. Niagara Mohawk has problems ? and its acquisition means an estimated increase in National Grid liabilities of a whopping $6.9 billion. It is burdened with substantially higher levels of debt than most other operators in this sector and has only just managed to unwind a large volume of high-cost power supply contracts. But National Grid estimates that the acquisition will deliver efficiencies of $90 million over four years ? half of this figure being achieved in the first year. ?They need to create synergies with the existing US national grid,? says Lund at S&P. The distribution of electricity in New England has been hugely inefficient as supply is determined on a county-by-county basis. This, suppliers have had to run power lines across counties that they do not supply to in order to reach those that they do.
Industry experts are divided as to whether this acquisition means that the company is overstretching itself ? if the deal is approved by regulators National Grid's gearing will be over 100%. All are agreed, however, that National Grid must now concentrate on integrating the acquisitions that it has made rather than continuing to expand.
The operations of NEES and EUA have been integrated and rate plans agreed and implemented. National Grid reckons that this integration is already resulting in savings of around 50% of EUA's controllable costs. This should be around £25 million a year and the company expects to achieve that in the first year of integration. But National Grid itself has played down the likelihood of further expansion in the near future. When contacted by Project Finance, a spokesman for National Grid said, ?To be of any interest to us in the short-term further acquisition would need to offer special opportunities. Either a small transaction to fit with our existing ?footprint? in the US or a major opportunity too important to miss.? Others are more definite. ?They should not buy anything else,? says one analyst at a London-based US bank. ?They should spend the next two years integrating all the acquisitions,? he says. National Grid has predicted that its US acquisitions will be earnings neutral after goodwill amortisation in 2000/01 and will enhance earnings thereafter.
The same analyst reckons that Niagara Mohawk can be successfully integrated. ?They definitely have the management to cope with these acquisitions,? he says. ?They haven't overstretched themselves at all.? Lund at S&P isn't so sure. ?They really have to tie these [new acquisitions] down,? he says. ?There is a huge risk in terms of management time and they could get distracted from their other business. They may have overplayed it ? only time will tell.?
OFGEM softens
It is certainly vital that National Grid does not take its eye off the ball at home. The company itself was formed by the break-up of the UK's Central Electricity Generating Board (CEGB) in 1990 and was listed in 1995. It is the monopoly electricity transmission provider in the country, and as such is closely watched by the government regulator. The OFGEM decision on transmission controls at the end of September was far more favourable to the company than some had expected.
In June, the regulator had said that it would assume a cost of capital in the range of 5.5% to 6.25%. It had also proposed that there should be price cuts of between one and six percent in 2001 with subsequent price rises being limited to inflation minus 3 percentage points. But in September the proposal had been adjusted to a cost of capital of 6.25% and price rise limitation of inflation minus 1.5 percentage points ? and no price cuts in 2001. The decision was extremely good news for the company and prompted widespread upgrading of the stock. But there is no pleasing some people. ?The 6.25% cost of capital figure is disappointing,? says the National Grid spokesman. ?However, the final proposals as a whole represent an increase of £100 million in allowed revenue over five years compared to the proposals in June.? He believes that OFGEM changed its mind as a result of the ?strong case that the company put during consultation after the draft proposals.?
?This decision has a very positive impact as we now have regulatory certainty,? says one analyst. ?The June assumptions were quite tough.? He reckons that the initial review was harsh as a result of National Grid's privileged position as a single monopoly. Some observers also believe that OFGEM was keen to be seen as listening to the market after criticisms that have been made of OFWAT, the water regulator, in the handling of that sector. OFGEM is certainly in need of some good PR, following the recent announcement that the New Electricity Trading Arrangements (NETA) for the UK, due to be implemented on November 21, will now be delayed due to technical problems. This delay has had a knock-on effect in the industry, with the likelihood that the moratorium on the building of new gas-fired power stations (which was due to be lifted in October) will now also be delayed until NETA is implemented.
The NETA delay has serious ramifications for energy market operator EnMo, which is part-owned by National Grid. EnMo, together with three partners (one of which is another National Grid subsidiary, ESIS), plans to launch an energy exchange, trading electricity and gas, six to 10 weeks prior to the implementation of NETA. Other partners in the project are the Scandinavian power exchange NordPool and US-based software company Altra Energy Technologies. The delay will mean an increase in costs for EnMo.
More interconnectors
In addition to linking up with NordPool, National Grid is also planning to construct an interconnector link between Norway and the UK ? opening up access to both markets for all players. The company has joined forces with Statnett, Norway's transmission company and Hydro Energy (a division of Norsk Hydro) to carry out studies on the project. The cable would be 350 miles long and carry 800MW. This project is just one of several interconnector feasibility studies that National Grid has undertaken following the successful financing of its interconnector link between the UK and the Isle of Man. Others involve links with Ireland and the Netherlands.
The £45 million Isle of Man deal closed in April 1999 and was the first interconnector to be funded on a project finance basis. It is 105km long and will carry 40MW of power. Financing for the deal was arranged by Midland bank, which has since been incorporated into HSBC. Gary Lindsey, part of the project lending team at HSBC in London, worked on the deal. ?It was actually a hybrid between a corporate and a project finance loan,? he says, explaining that the deal will be renegotiated after five years. ?The intention was always to look at a capital market refinancing.? The Isle of Man cable was jointly sponsored by National Grid and the Manx Electricity Authority and was contracted to Pirelli General and BICC Cables. Cable-laying began in May this year and the link is due to go live this month (October).
National Grid already owns and operates interconnectors with France and Scotland. This part of its business saw profits rise by 7% from 1998 to 1999 to £36.2 million. It is, therefore, a lucrative option for National Grid and it is not surprising that the company is so keen to get involved in further links. In addition to the Norway, Ireland and Netherlands proposals, National Grid has also been shortlisted for a BOO project to construct a 2000MW interconnector between Tasmania and mainland Australia. ?There should be a lot of interconnector deals coming up,? predicts Lindsey at HSBC. ?National Grid is a prime mover in this.? He explains that interconnector deals do have a high-risk element for project financiers due to the difficulty in testing prior to construction. The key thing is to get the jointing right as you cannot really test the cable until it is already underground. ?Burying a cable under several metres of water is not the easiest thing in the world,? he says. ?By the time you are testing it, it is already underground. You must, therefore, be very comfortable with the contractors going in.?
Away from the US and Europe, National Grid has concentrated most of its efforts so far in the emerging economies in Latin America. But it does have transmission interests in Zambia (through its ownership of 80% of the Power Division of Zambia Consolidated Copper Mines) and is working in joint venture with Karnataka State Electricity Board in India to build a transmission line. It has also made a small joint venture in Poland, NG Koleje Telekomunikacja, with subsidiary Energis. The consortium is due to launch services at the end of this year. Other partners include Polish National Railways (PKP) and local telecoms operator Centrala. The company will run a network leasing existing fibre running along PKP's network. National Grid plans to invest £60 million in Poland over the next 18 months.
It has not all been plain sailing, though. National Grid's plans to install a 500KV transmission line with three substations in Pakistan had to be scrapped in 1997 when the political situation in the country made the project impossible. The government terminated the project after National Grid refused to execute a performance guarantee. The World Bank, The ADB and NatWest had been lined up to fund the deal.
But Latin America remains the focus for National Grid. The company has a 50% stake in Brazilian long-distance telecoms company Intelig. National Grid plans to invest $281.2 million in Intelig ? which announced losses of R$105.5 million for the first half of 2000 in September ? over the next four years. The investment in this start-up has so far cost the company £75 million and finance director Stephen Box has refused to put a figure on how much the venture could cost the company for the full year. Intelig started operations in January 2000 as a joint venture between National Grid (50%), Sprint (25%) and France Telecom (25%). Sprint was to sell its stake following its acquisition by MCI WorldCom but this has been put on hold.
The project was set up with the aid of a $1.5 billion loan provided by EPC contractors to the scheme, Nortel Networks and Alcatel. The deal was signed in September 1999.
The push into Latin America has also been increased over the last year with the acquisition of a 30% stake in Telefonica Manquehue in Chile for £55 million and 50% of new venture Southern Cone Communications, which plans to develop a network linking Argentina's principal cities and cross the Andes to link to Santiago in Chile.
All shopping sprees have to be paid for, and National Grid's is no different. It has so far managed to pay the bills partly thanks to its extremely successful spin-off, Energis. The company was set up in 1993 for £400 million and now has a market capitalisation of around £18 billion ? far greater than that of National Grid itself. Energis provides voice, data and video services by piggybacking fibre-optic lines on National Grid's existing network ? an extremely successful plan that the company plans to replicate with the Southern Cone project. National Grid cashed in Energis's value in March this year when its sold a 10% stake, realising about £1 billion (leaving it with a 36.3% stake). These funds were put towards the costs of the US acquisitions. It has had plans to sell Energis since 1998, when the company made up roughly 80% of the entire market capitalisation of National Grid, and the latter's ambitious run of acquisitions now makes that desire even more pressing. At the beginning of 2000, chief executive officer David Jones announced that the company planned to sell Energis ?within the next three years?, but in April warned that ?we think it will probably happen in the first half of that period?. Likely buyers include Deutsche Telecom and France Telecom. A slight spanner was, however, thrown into the works with Energis's announcement at the end of September that it plans a £400 million share placement to fund internet capability and European expansion. The deal is being run by Cazenove and Dresdner Kleinwort Benson. As part of the deal, National Grid has had to undertake not to sell any of its shares before January 2001 except in connection with an offer for Energis, a sale of its entire holding or a transfer of shares to a bond holder.
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