SSE defends £3bn Transco asset deal

By Ian Fraser

Sunday Herald

September 5th, 2004

IAN Marchant, the 43-year-old former accountant who runs Perth-based Scottish and Southern Energy, is proud to boast of following in the footsteps of his predecessor Jim Forbes and avoiding overpaying for energy assets.

But even Marchant’s fans in the City of London believe that the former Coopers & Lybrand accountant may have broken the mantra with last week’s highly leveraged acquisition of two gas distribution networks from National Grid Transco (NGT).

In the biggest deal of SSE’s short life (the company was formed from the merger of Southern Energy and Scottish Hydro-Electric in September 1998 and celebrated its sixth anniversary last week) it agreed to buy two of NGT’s local gas distribution zones (LDZs) for £3.16 billion.

When the deal completes on April 1 2005, SSE will become the UK’s second largest energy distribution company after Centrica.

A legacy of British Gas, which was privatised by Margaret Thatcher in 1986, Transco’s LDZs own and operate the network of buried pipes – gas mains – that crisscross the UK’s towns and cities.

Infamously, a leaky and poorly maintained pipe caused the explosion in Larkhall, Lanarkshire, which in December 1999 killed a family of four and tore apart several homes. That incident led to the first indictment in Scotland of a corporate body for the crime of culpable homicide.

The two LDZ’s being acquired by the SSE-led consortium distribute gas to an estimated 5.6 million customers, with 1.7 million of these in Scotland. “These are very modern networks that have been continually added to,” insists an SSE spokesman. “They are not a Victorian infrastructure.”

Several other of Transco’s regional distribution networks were bought last week by a consortium led by other buyers including China’s Cheung Kong Infrastructure Holdings, United Utilities and Australia’s Macquarie Bank, prompting union fears of jobs losses, loss of pension rights, safety fears and concern that the deal would mean consumer prices would rise.

Energywatch expressed astonishment at the scale of the windfall for NGT shareholders. Allan Asher, the consumer watchdog’s chief executive, said: “Not only are shareholders set for a bonanza, the buyers of the networks will expect to generate even more value from their new purchases.

“Before this deal goes through, we want to know why the value has shot up and what the consequences for consumers are likely to be.”

However the series of transactions was welcomed by the gas and electricity regulator, Ofgem, which believes new competition in the gas distribution sector could spell lower prices.

Peter Atherton, an energy analyst at the US brokerage Merrill Lynch warned that SSE was paying a hefty premium for the assets, which it may take years to recover.

Atherton said: “Although the SSE joint venture has paid the lowest premium to regulated asset value, its 10.1% premium still adds up to £289 million. This is a very sizeable amount to recover when one considers that the combined total operating controllable cost base for the two LDZs is no more than £190m in the current year.

“Even with SSE’s management experience, it will be impossible to recover that premium within the current regulatory period to 2008. This is a full price and recovery of the premium will prove extremely challenging. In our view the acquisition is value neutral at best.”

SSE dismisses such fears. It believes it can cut costs at the newly acquired LDZs using its well tried cost-conscious management style. It also believes costs can be cut because of the geographic overlap between its existing electricity supply businesses in Scotland and the south of England and the gas distribution networks. The company believes its purchase of the LDZs will be earnings- enhancing from the first full year of ownership, meaning 2006.

It is important to note that SSE did not put up all the cash itself. In fact, in a first for the Perth-based group, it bid together with two giant Canadian public sector pension schemes. These were the CAD$34 billion (£14.5bn) Omers local authority pension fund and the CAD$79bn (£34bn) Ontario Teachers’ Pension Plan.

SSE has effectively taken a 50% stake in a new joint venture company, formed together with these two financial partners. Overall, Marchant’s group is putting up just £519.4m in cash to control over £3.16bn of assets, with a consortium of international banks putting up £2bn of debt to help fund the deal.

A spokesman for SSE said: “The price we paid was not excessive to the point where National Grid Transco made a killing. There is potential for cost savings of 35% and NGT said in its analysts’ presentation that the distribution networks are worth materially more than their regulated asset values. Our whole rationale is about the delivery of synergy savings.

“We’ve done a lot of deals in the past few months – the focus now is on delivery.

“We are not intending to lay people off although there may be some natural wastage. There is also a lot of scope for in-sourcing.” By that the spokesman meant bringing the contracts for activities such as pipe laying and maintenance in-house.

He added: “There may be areas where we now find we have two depots. In such cases we will bring the depots together. It has more to do with consolidation of property than job losses.

“In SSE’s six-year life there have been no compulsory redundancies and we have grown staff numbers from 9500 at the time of the merger to 12,500 today.”

The two gas distribution networks SSE is acquiring employ 2000 people with 800 of these in Scotland. Under Tupe rules, contracts of employment for these personnel will transfer to the new joint venture company on April 1. SSE says that pension rights will be unaffected by the deal.

Unusually for SSE it used two investment banks to assist with the takeover. These were Dresdner Kleinwort Wasserstein and Lexicon Partners.

The SSE spokesman said: “We’ve done some extremely good deals without external advisers, but this was felt to be necessary because of the sheer size of the deal. You don’t want to do a deal that is in excess of £3bn without some external advice.”

Morgan Stanley was the lead adviser to NGT and at one stage claimed to have drummed up interest from 50 potential buyers.

Once the deal completes SSE is poised to receive half the earnings from the two networks. It will provide corporate and management services to the networks, under an agreement with the consortium. In exchange, the Perth-based firm will receive an annual management fee.

Marchant said: “We have been working very closely with our partners for almost a year now, and I am very pleased that this has culminated in this agreement with NGT. I believe this is a good outcome for all concerned, including gas customers in Scotland and the south of England.

Copyright 2004 SMG Sunday Newspapers Ltd.

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