SSE/Npower merger is on the back burner

Could the news of a delay to the tie-up between SSE and Npower, for the two companies to negotiate terms in response to ‘adverse developments’, be the beginning of the end? Rachel Willcox reports.

A year ago it was hailed as a deal set to shake up energy retail by creating the second-largest supplier in the UK market after British Gas. It was to reduce the big six to five and promised a business that was more efficient, agile and innovative for customers.

But the proposed merger between the retail businesses of Npower and SSE has been on a bumpy road since it was first announced in November 2017. And the latest twist in the tale has led even SSE to admit there is some uncertainty over its union with rival Npower.

Over the past 12 months the two organisations have been working on the deal to create a new provider listed on the London Stock Exchange, with SSE shareholders owning 65.6 per cent and Npower owner Innogy holding a 34.4 per cent stake.

Given its scale, few eyebrows were raised when a full inquiry into the proposed deal was launched by the Competition and Markets Authority; final clearance was given in October. However, developments were to take another twist when Ofgem’s official, long-anticipated price cap figure finally emerged on 6 November, at an initial £1,137.

Increased pressure

Despite being in line with predictions, the level of the cap on a typical standard ­variable tariff (SVT) has increased the pressure on an already marginal business. Coming alongside significant customer attrition and other market challenges, it has led some industry experts to suggest it could be the straw to break the merger’s back. In a statement on 8 November, SSE said it was in discussions with Innogy on potential changes to the commercial terms of the proposed merger, prompting a 3 per cent drop in SSE’s share price.

Although SSE has warned completion of the move could be delayed beyond the first quarter of 2019, it has maintained that creating a new independent energy supplier is still its objective. “There is now some uncertainty as to whether this transaction can be completed as originally contemplated; nevertheless, the Board believes that the best future for SSE Energy Services, including its customers and employees, will continue to lie outside the SSE group,” the company said. An update is expected by mid-December.

In many respects, the cap is a convenient distraction and something of a red herring to the risk factors affecting the merger. The combination of dwindling market share in an increasingly competitive market, mounting losses at Npower, and SSE’s own weakened financial position as a result of its recent profit warning, are all conspiring to put the deal under pressure.

“The government’s new price cap is set to limit profits, while customers are now leaving at a run rate of around a million a year between the two businesses. A combination of those two factors have thrown a spanner into the works, although SSE still seems ­committed to getting the deal done,” says George Salmon, an equity analyst at ­Hargreaves Lansdown.

Customer losses

Today, 70 energy suppliers compete for UK customers and 4.3 million switched provider in the first ten months of 2018, according to Energy UK statistics. SSE retail customer numbers fell by 460,000 to 6.48 million in the year to September, while Innogy, Npower’s German owner, saw customer attrition of 530,000 to 4.3 million in the same period.

“Such significant loss of custom inevitably leads to loss of finance, and the proof is in the numbers,” says David Gilchrist, head of utilities at law firm DWF. “Npower is preparing to announce a fourth straight year of losses, while SSE has already announced half-year losses of £265 million. With both companies under a huge amount of pressure to stem the flow of customers and to mitigate financial losses, the capital expenditure required to grow and consolidate the new business is hard to rationalise.” He adds: “Cost-cutting, innovative marketing and a prudent approach to funding new projects are no longer desirable but a necessity.”

Benjamin Lind, strategy lead – utilities and energy at digital consultancy Hedgehog Lab, argues the cap would have been a factor in early discussions relating to the merger. “I think what is clear is that all the big six have been blindsided by the rapid rise of some of the smaller challengers in the ­marketplace, such as Ovo Energy and Bulb, who have been snatching customers from the big ­suppliers at an ever-greater rate.

“The big six still dominate with 78 per cent of the consumer market, but the rate of desertion in the past 12 months alone clearly has some of the incumbent suppliers spooked. Effectively, you’ve got more players fighting over the same turf, and it’s this that has had a bigger impact on the sustainability of SSE and Npower’s merger than just the price cap.”

Cap exposure

SSE’s disproportionate exposure to the price cap was undoubtedly a factor, believes Andrew Perry, energy principal at management consultancy firm Oliver Wyman. “Most of the big six have between 60 per cent and 90 per cent of customers on the SVT, and SSE is at the higher end. When you make a merger announcement like that, there’s always a risk that the business took its eye off the ball at an incredibly competitive time in what is effectively a no-margin business. Npower has been the poorest performing of the big six for some time. The question for me is, what are they looking to achieve?”

Much of the rationale for the deal remains unchanged; it would allow Npower to exit the domestic retail energy market, while SSE would be free to focus on the renewables market following the creation of SSE Renewables, on its vision of being a leading energy company in a low-carbon world, and on building up its networks business. In addition, SSE’s legacy IT system is desperately due an upgrade and moving it onto Npower’s SAP system would tick that box.

But the challenges of integration are immense. “The strategic direction is set and I think it will get delayed,” an industry insider tells Utility Week. “But I wonder if SSE got under the skin of the deal and realised they had bitten off more than they could chew.”

Rachel Willcox is a freelance journalist