Centrica and EDF strike win-win deal, but one wins more than the other

May 13, 2009 (Datamonitor via COMTEX) -- BGYNY | Quote | Chart | News | PowerRating -- EDF and Centrica have finally struck a deal concluding the long running sale of British Energy. After months of negotiations it will come as a relief to both parties, but while EDF walks away with GBP2.3 billion and a 51% stake in SPE, the terms that Centrica secured will reap more immediate gains for the former UK incumbent.

On May 11, EDF announced the revised terms of an agreement to sell a stake in British Energy (BE) to Centrica. Centrica will pay GBP2.3 billion for 20% of BE, valuing the nuclear generator at GBP11.6 billion, 10% less than the sum EDF paid for it eight months ago. The reduced valuation of BE is a direct result of the changed environment in which utilities are now operating. Collapsing demand from manufacturers and a glut in European gas supply have pushed down electricity prices, bringing Centrica shareholders to argue that the original MOU inked with EDF in 2008 was a poor deal.

The situation placed Centrica chief executive Sam Laidlaw in a quandary. On the one hand, shareholders (legitimately) argued that in the midst of a recession, GBP3.1 billion (the price that Centrica was originally going to pay for a 25% stake in BE) could buy far more than it could at the peak of a boom in energy prices and that Centrica should either renegotiate or walk away. Conversely, strategic considerations which envisage increased future baseload demand alongside higher long-term carbon prices mean that the utility must position itself to exploit the nuclear renaissance.

That Mr Laidlaw managed to reconcile these two disparate positions is a credit to his negotiating skills and strategic vision. In the final outcome announced on May 11, Centrica will pay for a smaller stake at a reduced share price. Around half of this will be paid for in cash but, in a side deal that made the BE agreement possible, Centrica will offload its 51% stake in Belgian utility SPE to EDF. This was an astute move for three reasons.

To begin with, EDF is paying GBP1.2 billion for 51% of SPE (14 times the Belgian utility's EBITDA) which values the company at 2008 prices (unlike the new BE valuation). Securing such a high price was a coup. Secondly, SPE was of decreasing strategic value to Centrica. Slow liberalization on the continent and dominant incumbents have essentially thwarted the utility's mainland ambitions - the foothold SPE represented is of little importance as Centrica looks instead to expand in the US.

Finally, in tying the SPE sale into the BE agreement, Centrica retains sufficient cash to purchase other upstream assets, given that its own are in fast decline. Centrica is specifically interested in Venture Production, the North Sea oil and gas producer in which it already has a 23.6% stake and could acquire in full for around GBP1.3 billion. However, Centrica will be especially keen to preserve its primary existing upstream asset in the UK, Morecambe Bay; because it is a swing field, it is relatively easy to turn the tap on and off, technically speaking. This means that the gas stored here can be used to meet short-term demand spikes at relatively low cost, presenting opportunities for arbitrage - an ever more valuable feature as prices become increasingly volatile.

This final point overlaps with Mr Laidlaw's overriding objective: reducing Centrica's exposure to wholesale gas and electricity markets. The BE agreement reduces Centrica's power exposure to around 55%. Should it acquire Venture as well, this figure would fall for gas too.

EDF can also claim to have reaped a positive outcome from the negotiations, although perhaps not to the same extent. The French utility has long-standing ambitions to acquire SPE (after a failed attempt early last year) and parting with GBP82 million more than Centrica paid is inconsequential to a firm with a market capitalization of nearly GBP60 billion, especially when its main shareholder is the French government. Furthermore, EDF is buying a controlling stake that Centrica pieced together through smaller acquisitions, so it could be argued that a higher price tag is appropriate.

A similar argument can be applied to the reduced price that EDF secured from selling 20% of BE to Centrica - it simply isn't that big a deal to a firm the size of EDF. CEO Pierre Gadonneix labeled the markdown as merely "symbolic". Yet that did not stop the markets from punishing EDF with a 2.4% share price drop, while Centrica rose 3%. The reaction reflects concern among investors that EDF may have bitten off more than it can chew in recent months. The acquisition of BE, coupled with an expensive bidding war against Warren Buffet for control of US group Constellation Energy ($4.5 billion), has left EDF with an alarming debt to equity ratio.

However, EDF will seek to reduce its GBP22.3 billion debts this year through the disposal of non-core assets - most likely distribution and transmission networks in the UK or France. This makes both financial and political sense, since the EC may well seek to improve competition through effectively forcing large utilities into unbundling on antitrust grounds in the near future.

Although Vincent de Rivaz, EDF's chief executive in the UK, was correct in describing the deal as "good for both sides", Centrica has secured a better deal than many thought likely through skilful brinkmanship and diplomacy. It has acquired a stake in the UK's most important energy industry - new nuclear build - and could hardly ask for a better partner in terms of technical expertise. What is more, it has achieved this at a price which keeps shareholders happy. Judged according to these somewhat Anglo-Saxon terms, EDF may be seen to have faired somewhat worse, but then EDF's main shareholder - the French government - does not operate along such lines.

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