SSE more focussed, Innogy now semi-detached

“Since it drives the top-line, the impact of the proposed price cap – a factor cited by Innogy as a clear negative – will be a key valuation parameter.”

Two big six energy companies, SSE and Innogy – the owner of the Npower brand – have announced plans to merge their British retail energy operations, thereby creating a new independent energy supply business with up to 12 million customers; its shares will be publicly quoted. Some other related assets are included in the proposed deal although SSE’s Irish operations are excluded.

This initiative has some parallels with the 2010 T-Mobile/Orange merger – owned at the time by Deutsche Telekom and France Telecom respectively – in the ultra-competitive mobile telecoms market.

In financial terms, the deal is actually quite modest compared with the overall market value of both SSE and Innogy’s parent, RWE. In fact, SSE’s household retail business for the first-half of 2017/18 was loss-making, due principally to seasonal factors.

By contrast, its networks operations produced a half-year operating profit of £355 million, with the lightly-regulated electricity distribution business contributing £176 million. These regulated returns enable SSE to deliver impressive dividend growth – the 2017/18 interim dividend payment will be 28.4p compared with just 7.7p back in the 1998/99 half-year.

Innogy, whose npower brand has been badly tarnished by IT problems, reported a thumping £90 million loss in 2016 for its UK energy supply business. No wonder, it wants out.

The split, on an equity basis, for the new company is 65.6 per cent v 34.4 per cent in favour of SSE. Completion is not expected until Q4 2018 at the earliest: various regulatory approvals need to be secured in the interim. Post flotation, SSE plans to pass on the sale proceeds to its shareholders.

Last year, Innogy was partially demerged from RWE, but the latter still holds a pivotal circa 75 per cent stake.

Over the last decade, RWE’s share price performance has been dreadful. The combination of depressed generation prices, low power demand, Germany’s forthcoming nuclear power close-down and excessive debt has been immensely challenging.

Interestingly, Innogy has confirmed that this planned deal will be treated as a “financial investment” – City shorthand for exit shortly after the six months lock-in period has expired. Little detailed financial data is currently available on the new business, so valuing it is complex.

Since it drives the top-line, the impact of the proposed price cap – a factor cited by Innogy as a clear negative – will be a key valuation parameter. Details of how it will be implemented, and its timing, remain vague.

Furthermore, discerning investors will expect substantial cost synergies to be delivered by the new entity: material IT savings should be achievable. And major branding changes are likely – as was the case in the DT/FT mobile telecoms merger – when the new company launches.

More generally, other members of the big six will assuredly review their energy supply operations – and how to improve their lacklustre returns. And all, of course, will be very interested in how the market values the new business.

The proposed deal will undoubtedly impact other energy market players, such as the quoted Good Energy, and unquoted suppliers including First Utility and Ovo Energy.

Interesting times for sure.