The European Union’s Third Energy Package – which came into effect in September 2009 – opened the door for outside investors to buy national transmission networks. This coincided with an increase in the proportion of electricity generation coming from renewable sources, often located in places without adequate grid connections and carrying technical challenges for grid operators. Combined with the wider economic pressures on utilities balance sheets and it has created, according to Daniel Wong, head of European infrastructure at Macquarie Capital, the “perfect storm”.

“It’s a perfect storm of a higher cost of capital and more expensive debt, significant capital expenditure requirements and unbundling regulation that has prompted many of the large utilities to sell off some regulated assets,” he explains. “There are also some companies that are retaining their regulated assets and looking for institutional investors to help fund capex for their transmission networks.”

Institutional investors have been bidding for electricity and gas transmission system operators (TSOs) and distribution system operators (DSOs). Tens of billions of euros – whether as equity from sponsors or debt from banks – have been pumped into acquisitions.

One of the early deals was Elia and IFM’s Eu810 million ($1.078 billion) purchase of Eurogrid in October 2010, which paved the way for later deals in 2011 and 2012. The Macquarie-led Open Grid Europe (OGE) acquisition is only the most high-profile, and most popular with lenders, of recent deals. Macquarie has also bought RWE assets in Germany and the Czech Republic, while E.ON and Eni have been active sellers.

The trend continued into 2012 with the Eu790 million disposal of Macquarie European Infrastructure Fund’s stake in UK-based Wales and West Utilities to Cheung Kong Holdings, as well as the sales of Naturgas Energia Transporte in Portugal and SNAM in Italy. More assets are up for sale (see table on following page).

u Transmission possible

Banks explain their eagerness by noting the strength of the sponsors and the assets. Much of the equity for energy infrastructure purchases has come from institutional investors, either directly or through infrastructure funds, which have cash to put to work with long horizons. Some of these buyers already have exposure to similar assets in the UK, Australia and the US, and liberalisation of European markets has brought some attractive assets within their grasp.

Institutions’ historic areas of focus, particularly high-grade equities and high grade corporate and sovereign debt, have recently produced subdued returns. Those sovereign wealth funds that traditionally invested in US treasuries have also seen lower returns, while Asian investors have also experienced lower returns in their domestic markets. This has prompted them to shift their focus to real assets such as infrastructure and real estate. European gas and power infrastructure usually benefits from inflation-linked tariffs and a strong regulatory framework. Crucially, it should be able to provide returns of more than 10%.

Transmission assets do not come cheap, and banks remain wary of providing debt at high levels of gearing. Many of the networks also require significant future investment. Buyers therefore need to make big upfront and ongoing equity commitments. “The buyers of these infrastructure assets tend to have a strong credit profile and investment backing,” says one banker. “As such, there is plenty of appetite and liquidity for banks to participate in the acquisitions.”

In the case of Fluxys’ purchase of Eni’s stake in the German TENP and Swiss Transitgas projects, the debt to equity ratio was 50:50. A consortium of 3i Infrastructure, Goldman Sachs’ GS Infrastructure Partners and Ilmarinen Mutual Pension Insurance Company, meanwhile, put up Eu600 million to close a debt package of Eu940 million for the acquisition of Vattenfall’s power and heat distribution businesses in Finland, equivalent to 60% gearing.

“Sponsors and banks love distribution assets,” says Carloandrea Meacci, a partner at Ashurst in Milan who worked on the Eu2.2 billion refinancing of F2i and AKA’s acquisition of three sets of Italian gas assets from Enel, E.on and GDF. “To a large extent they have no construction risk and, in the case of gas, enjoy a strong regulatory framework, as the revenues are not underpinned by gas consumption to a great extent, relying instead on a regulated asset base (RAB) mechanism.”

The largest deals have required a large cast of arrangers, but lenders want to work with cash-rich, long-term buyers of assets with reliable, inflation-linked revenues. “There is plenty of liquidity in the banks in terms of lending to infrastructure acquisitions,” Macquarie’s Wong says. “In fact, the deals tend to be pretty straightforward, as the capital value of the assets is enshrined in regulations and linked to inflation. Tenors have shortened for project finance lending but regulated utilities are pretty stable. Some of the larger deals require a large number of banks to participate to get them done.”

A Macquarie-led consortium’s acquisition from E.ON of OGE showed how enthusiastic lenders could be. The 12,000km network runs across Germany, carrying up to 62 million cubic metres of natural gas per year, making it one of Europe’s largest natural gas transporters. It is well placed to serve northern, southern, eastern and western Europe and carries around 70% of Germany’s annual shipping volumes. The grouping, comprising Macquarie European Infrastructure Fund 4 (24.11%), British Columbia Investment Management Corporation (32.15%), ADIA (24.99%) and MEAG (32.18%) paid Eu3.2 billion – 20% above OGE’s expected sale price of Eu2.5 billion.

The four-tranche Eu2.75 billion ($3.4 billion) financing for OGE has probably set a benchmark, and comprised a 3-year Eu1.1 billion tranche, complemented by a Eu1.1 billion five-year term loan, a Eu100 million five-year revolver and a Eu450 million five-year capital expenditure facility. Despite competitive margins, syndication was oversubscribed and pushed each lender’s ticket down to around Eu200 million. The deal brought in Siemens Bank, Emirates NBD, Nord/LB, BTMU, Prudential Capital, SMB, BNP Paribas, Commerzbank, Crédit Agricole, EDC, ING, RBC, Scotiabank, Societe Generale, UniCredit, CIBC, HSH Nordbank and SEB.

It is a similar story with other contemporary deals. The debt component for Fluxys’s TENP and Transitgas acquisitions took the form of a 10-year amortising loan from Banca IMI, BayernLB, BNP Paribas Fortis, Crédit Agricole, ING, UBS and UniCredit, while Macquarie’s acquisition of Thyssengas from RWE was backed with a Eu415 million ($573 million) 5-year debt package from BNP Paribas, UniCredit, Crédit Agricole and WestLB.

Such has been the competition from the banks that pricing has been competitive with the wider corporate market. Pricing on the German OGE deal ran from 125bp to 175bp, while the Italian F2i/AXA deal ran between 240bp and 375bp, still very competitive for its home market. Pricing may be low, but banks insist they benefit from an asset with stable returns.

“The profile of OGE and the high interest meant pricing was aggressive, which could have put a few banks off, but OGE is a trophy asset, as it is the biggest stand-alone network in Europe,” the banker comments. “As such there were no real challenges in terms of the financing or syndication. In fact, lots of banks wanted to get involved and it was heavily fought over.”

Bound to bond

The acquisition financings feature main tranches that are corporate in structure – and tenor. The financings have been relatively short – usually no more than 10 years – rather than the 20 years that an availability-based social infrastructure asset might command. These short tenors prefigure a later refinancing, as has been the case in Canada or Australia, where domestic lenders have never been comfortable with longer tenors. The debt financings backing acquisitions are not pure bridge loans but mini-perms, structured to give sponsors time and flexibility in carrying out a bond refinancing.

“The financing mechanism for regulated infrastructure utility acquisitions has not changed materially over the last few years,” Macquarie’s Wong says. “They tend to be backed with a mini-perm 3-, 5- or 7-year debt facility as a bridge to a refinancing or more likely a bond issue.” Given their risk profiles, sponsors hope that the assets will have access to a similar universe of investors to utilities, which regularly visit the bond market.

Indeed, some of the first crop of buyers used the capital markets from the start. When Belgian transmission operator Elia and IFM acquired German transmission operator Eurogrid from Vattenfall in May 2010, they part-funded the deal with Eu500 million in 10-year bonds priced at 127bp over mid-swaps at a reoffer price of 99.552% for a coupon of 3.875%. UBS International Infrastructure Fund (92%) and CDC Infrastructure (8%) used a RBS- and UBS-led NKr3.8 billion ($680 million) equivalent Norwegian Krona and US dollar bond issue to support their acquisition of an 8% stake in the Gassled offshore transmission network from ExxonMobil.

However, bonds should provide a steady source of business as sponsors look to pay down acquisition bank loans, particularly as those loans inch closer to maturity. “The OGE financing was set-up on an acquisition basis to allow bonds to be issued to repay some of the debt,” one banker familiar with the structuresays. “The bonds do not have to fully refinance the debt but can be utilised alongside the banking debt. There is a strong sense that OGE will go to the bond markets to lock in the longer maturity debt that the banking market is unable to provide.”

A number of the recent acquisitions included a bank refinancing of existing debt on the target assets. Fluxys’ purchase of Transitgas had a Sfr1.068 billion ($1.17 billion) 10-year senior term loan, some of which would refinance Eu650 million of existing debt for the company. “The F2i/AXA deal involved the financing for the purchase of GDF’s G6 assets as well as the refinancing of Enel Rete and E.ON Rete,” adds Ashurst’s Meacci. “The terms were very good, considering the economic climate in Italy, mainly because of the quality of the sponsors and the quality of the assets.”

One example of the likely bank-to-bond refinancing model comes from Solveig Gas Norway, a consortium of Canada Pension Plan Investment Board, Allianz and Abu Dhabi Investment Authority, which bought a 24.1% stake in Gassled from Statoil in 2011. The group is refinancing the acquisition with a medium-term note programme, which includes senior secured bonds with a fixed interest rate of 5.32% and private placement debt with a 4% coupon.

Banking sources indicate that the heavy interest from the banks in the initial deals will be a forerunner to a bigger battle for the bonds. “Lots of those banks that got involved in the financings will also be looking at offering their services for the long-term bond issue,” one notes.

After two years of frenetic activity, sponsors and banks still appear to be enthusiastic about power and gas transmission assets. Pension funds in Australia and Canada can put around 10% of their assets into infrastructure, while the equivalent percentage is very small in the UK, Europe and the US. In the short term, transmission assets look like an obvious and stress-free way to bring those percentages closer. Banks, meanwhile, are under pressure to produce returns from shorter-dated commitments to straightforward borrowers. “I cannot see many challenges for the proposed deals,” the banker claims. “After all, there is not that much M&A going on elsewhere.”

The list of potential targets is impressive. Iberdrola’s ScottishPower Energy Networks, for example, could have surpassed OGE in size, with a Eu6 billion price tag, although Iberdrola put the deal on ice in January. Total is anticipating proceeds of Eu2.5 billion from the sale of its gas pipeline network TIGF. Other sales on the horizon include a mooted sale by the Dutch government of TenneT and RWE’s proposed sale of Czech operator Net4Gas.

“There are a few potential transactions being spoken about in the market,” Ashurst’s Meacci comments. “The regulatory framework in Italy has been streamlined and this is encouraging international and institutional investors. I expect to see more deals come through, although probably not of the same size as the F2i/AXA project.” Germany has earmarked smaller, municipal power grids for another wave of sales, and financial sponsors could roll these up into portfolios.

Regulatory regimes

But the assets may not be as stable as banks hope. Political risk is an emerging theme on both new deals and refinancings.

“The supply and demand will continue, but the main threat to financing is the regulators,” one source claims. “If they start to introduce new regulations that reduce returns then investors may take a more cautious approach.”

This anxiety is starting to become a reality. Norway has recently proposed slashing Gassled’s tariffs, while the German Federal Network Agency had floated the idea of lowering operators’ revenue cap to 8%. This risk is heightened in troubled peripheral European countries, where banks are mindful of falling foul of tough or retroactive changes, as was the case when the Spanish government retroactively changed solar feed-in tariffs.

“The perception of political risk remains high in some parts of Europe,” Wong confirms. “Investors are trying to interpret the austerity decisions that various governments need to take and the impact of these on investment returns on regulated assets. Currency risk is also a concern, notably in places such as Greece.”

Buyers would, of course, lobby heavily to avoid radical reductions in tariffs or other reforms. Some may challenge the changes in court, as several sponsors of Spanish photovoltaic projects attempted, without success. So far most countries have opted to water down reforms. Germany decided against a cut to 8% and instead cut it from 9.29% to 9.05% before tax.

Any cut in tariffs, combined with a change in the economic situation, could have an impact on the prospects for refinancings, too. Many of the initial deals were closed at such slim margins that any decline in the regulatory framework or host economy would pose a severe challenge to replacing mini-perms with cost-effective new bank or bond debt.

The F2i/AXA financing, for example, closed in summer 2011, just before economic anxiety sharpened in Italy and sent margins rocketing. Had the deal closed a few months later it could have been priced at 100bp higher. Lenders say that getting Italian banks to provide acquisition finance at sub-400bp in the current climate is a tough ask, let alone at the 240bp to 375bp rate that F2i/AXA won.

“The option of a bond buyout is technically possible,” remarks Meacci of the potential refinancing of the deal. “However, the terms of the initial financing were better than what the market is likely to offer nowadays so a bond refinancing, as well as any other refinancing, is probably not very efficient in the current market.”

Mini-perm financings should provide enough leeway for sponsors to close refinancings when conditions improve. “This [financing] model is flexible, as it means a bond can be taken out after one-year should market conditions be suitable or wait a few years down the line,” Macquarie’s Wong adds. “I believe a steady flow of bond issuance from regulated assets should continue during the next few years.”

Bankers also point to the future politics of supply and demand of gas and electricity in a consolidating Europe as another possible financing risk issue. With new pipelines coming into service from Russia and North Africa, the nature of how gas enters the European grid will change. Banks could be indirectly assuming volume risk. “The gas supply could go through alternative pipelines into alternative grids so if the volume in one transmission network drops off, it could be tricky,” the banker adds.

Even so, with roughly 80 TSOs spread across Europe and a glut of new assets set to come to market, there is plenty of positivity in the short-term.

Pending and closed power and gas transmission sales