What premium might ENW command?

The regulatory and political pressure on network companies is rising, but Electricity North West should still fetch a handsome price if its owners put it up for sale as expected.

A report late last year that the owners of Electricity North West (ENW) may be planning to auction off the company in a sale that could fetch over £2 billion has piqued significant investor interest, say energy sector experts.

Although the distribution network operator, part-owned by infrastructure investment funds managed by JP Morgan Asset Management, is still declining to comment on the story from Sky News in October, market watchers believe the availability of this type of low-risk, cash generative business could prove highly attractive to some investors.

According to market sources, the prospect of a sale has generated interest from a raft of energy industry players and foreign infrastructure investors, undeterred by fears that a Labour government could take regional energy networks back into public ownership and amid rising political concern over foreign ownership of Britain’s critical national infrastructure.

A sale within the coming months of the electricity distribution giant, which supplies five million people from Manchester to rural Cumbria, could bring in well over £2 billion, based on a typical 30 per cent premium on the regulatory asset value of £1.7 billion reported in the company’s most recent financial results for 2017/18.

Andrew Perry, energy principal at management consultancy firm Oliver Wyman, says he expects Chinese investors to get involved. “They have shown a preference before for UK network assets and could be prepared to pay a premium for this that would put other competitors off.” Names in the running are said to include the Hong Kong-based billionaire Li Ka-shing’s Cheung Kong Infrastructure (CKI), the name behind UK Power Networks, which covers much of the South East.

Utilities with deep pockets and a network preference would also seem obvious acquirers – but in truth the value is likely to be too steep for them, Perry warns.

Regardless of the outcome of any auction, a potential investor is likely to look at the opportunity to develop distribution system operator (DSO) capabilities to add value, says Perry. So, a sale could add impetus to the development of capabilities like, for example, active network management and the use of flexibility, which ENW has worked hard on in recent innovation schemes.

Tom Palmer, principal consultant at analyst Cornwall Insight, agrees that ENW is a great prospect for any potential buyer in a networks landscape facing disruption. In particular, Palmer points to ENW’s involvement with the Energy Networks Association’s Open Networks project, which is driving forward active network management and defining the shape of future DSOs.

“This will see it become more active in day-to-day interaction with operators to manage planned and unplanned outages, in addition to network reinforcement ­planning,” he says. “This will see changes in how they are regulated, alongside the upcoming RIIO2 price control changes being proposed.”

Low-risk premiums

Key among the changes and challenges Ofgem has posed to the industry in its RIIO2 framework is a crunch on the price of equity enjoyed by DNOs.

In July 2018 Ofgem announced that RIIO2 will lower the cost of equity range – the amount network companies pay their shareholders and the baseline rate of return that it considers necessary and sufficient to attract investment – from its current rate of between 6 and 7 per cent to between 3 and 5 per cent. The regulator estimates that the reduction will save consumers more than £5 billion over the five-year price controls.

Some market commentators suggest the investor interest generated by deals like the mooted ENW sale do little to assuage public concerns about inflated profits in the sector, or consequently the regulator’s focus on the issue.

But Mark Fitch, an energy expert at PA Consulting, takes a more positive view. While he acknowledges that there are some inflated premiums from utility deals, he suggests persistent investor appetite for regulated businesses shows Ofgem has pitched the balance of risk and return well in its price control plans. The sector remains attractive compared with alternatives such as UK gilts – where real returns remain firmly in negative territory, he explains.

“Recent transactions for Cadent, Affinity and Firmus in Northern Ireland have seen eye-watering premiums over the regulatory value – over one-and-a-half times in some cases – and the interest in the growing independent network providers market remains hot,” Fitch tells Utility Week.

“The persistence of premiums over regulatory value means it is no surprise that regulators are slashing headline returns. As they raise the bar for rewards, they are also carefully managing the overall risk to keep it balanced with a ‘fair bet’, where companies believe they have a reasonable chance of attractive rewards.” He adds: “With the right leadership and organisational agility, they can continue to be confident of delivering attractive returns.”

But while networks may remain attractive to many investors on the look out for low-risk premiums, a potential network sale would not be a free for all. Ofgem is likely to limit the geographic reach of any one owner.

PPL Corporation, the US owner of Western Power Distribution, already dominates much of the South West and South Wales, while Cheung Kong Infrastructure Holdings controls much of the South East. Scottish Power and SSE each control just two regions although SSE’s failed attempt to spin-off its energy supply business in a merger with Npower late last year makes it an unlikely contender.

A shake out of any committed runners and riders vying to take ENW on from JP Morgan Asset Management should follow completion of a strategic review of the business. According to anonymous sources quoted by Sky News, bankers at Citi were appointed to conduct such an exercise in late 2018 in preparation for a sale.