It’s a familiar tale – a successful Aussie-owned business gets snapped up by a deep-pocketed foreign predator. When the business is in the business of providing essential electricity services to Australian homes and businesses, the deal comes under even more scrutiny.
While the deal in this case hasn’t happened yet, the thinking is now that the private equity bid for listed electricity network owner Spark Infrastructure has a good chance of succeeding, as it offers a sufficient premium to the current share price to both tempt existing shareholders and to deter other potentially interested parties from getting drawn into a bidding war.
The bidding consortium of KKR (the infamous “barbarians at the gates” from back in the day when takeovers were more of a novelty) and the more sedate Ontario Teachers’ Pension Plan Board (OTPPB) have upped their offer to $2.95/share. The stock closed at $2.63/share on July 15, the date of their initial bid. The bid represents a premium to the underlying regulatory asset bases (RABs) of Spark’s network businesses of 57 per cent, i.e., a RAB multiple of 1.57. Finance theory suggests that if a regulated business is allowed to earn exactly its cost of capital by the regulator, its value should be equal to its RAB. So RAB multiples > 1 can be a sign that the business is earning more profit than it needs to, although there may be other explanations for the higher valuation.
KKR and OTPPB’s enthusiasm for Spark, which owns half of three electricity distributors in Victoria and South Australia a well as a 15 per cent share of TransGrid the NSW transmission operator, suggests these regulated network assets are still seen as an attractive investment option. This is hard to square with the doom and gloom expressed by a group of existing shareholders in a recent submission to the AER.
The Network Shareholders Group (of which Spark itself is a member) claim the AER’s 2018 Rate of Return Instrument decision did not allow network businesses to earn enough of a return on their capital to both pay back their debt and provide enough profit to shareholders to support future investments. Their arguments include:
- AER set a lower return on equity than a range of regulators internationally, according to the AER’s own consultants, making Australia less attractive than other destinations for mobile global capital to put its money
- Investment in regulated energy networks has fallen over the last decade
- CEFC involvement in TransGrid’s recent funding round to pay for its share of Project Energy Connect indicates that government intervention is needed to finance approved projects
Consumer representatives are sceptical of these arguments. When returns were much higher in the AER’s early years, networks and their owners didn’t seem to be worried that they might be higher than international benchmarks. After the apparent gold-plating of networks in the first half of last decade, they are relieved to see capex falling. Even if Energy Connect was difficult to finance, given it’s the biggest single network project since NEM start, it may not be much of a guide to financing conditions for much smaller, regular projects.
Perhaps the bidders for Spark haven’t quite understood what they are getting themselves into? It seems unlikely give they are both large, sophisticated global investors, and KKR are advised by Malcolm Turnbull who knows a thing or two about Australian energy.
Maybe the premium is for the unregulated side of the business? Spark owns the Bomen solar farm and has indicated interest in growing its renewable portfolio, while TransGrid has a telco business on the side. But large-scale renewables don’t appear to be such a big money-spinner these days, with the industry’s peak body arguing a plethora of risks is weighing on the sector. In any case the regulated networks are still the majority of the overall business, so the valuation can only make sense if the bidders are confident, they will do well out of that side of the business too.
So, whose investment thesis is right? It could take a while to find out for sure. The AER’s 2018 decision takes a while to roll out – some networks will only be moved onto the 2018 rate of return for their regulatory periods starting 1 July 2022. And underinvestment in networks – if that is indeed the case – could take several years to show up in poorer reliability for customers. But Spark shareholders may not have to worry about all that for much longer.
Note: the author is a member of the Consumer Reference Group, which is advising the AER on its 2022 Rate of Return instrument. Any views expressed are his own.