UK Merger Will Lead To US Expansion For More Efficient Utility

Owners of thousands of miles of electricity wires and gas pipelines in the north-east of the US have been warned that the British companies coming. The merger announced yesterday between National Grid and Lattice, the owners of the energy transmission networks, will create a company with an annual operating cash flow of GBP 3.5bn ($5bn) and a combined market value of almost GBP 15bn. This will provide plenty of fire power for the merged group to satisfy its appetite to buy energy infrastructure companies in the liberalised power markets of the US north east. Roger Urwin, the National Grid's chief executive, will become chief executive of the merged group. He is in no doubt that growth opportunities remain greater on the other side of the Atlantic than in continental Europe where governments have been reluctant to weaken the market power of existing dominant suppliers. Analysts believe that potential acquisition targets include Energy East of Albany, Northeast Utilities of Hartford, and Nstar of Boston, though National Grid stressed that it would not look at large acquisitions until it had completed the merger. National Grid has already invested $13bn (GBP 9bn) in the region buying distribution businesses. But its spending power had been diminished by write downs of its residual UK and South American telecommunications interests following the sector fall out. The merger will address this by giving it a stronger financial base on which to raise further debt. Analysts say it will now be able to fund a series of billion dollar US acquisitions over the next few years, if it wishes. The combined group will also deliver annual cost savings of about GBP 100m by axing one of two London head offices and merging the operating headquarters ithat are based in the West Midlands. National Grid is currently based in Coventry and Lattice in Solihull, Birmingham. Redundancies, however, are likely to be restricted to no more than a "few hundred" head office staff out of a total combined workforce of 30,000. The companies will find it very difficult to reduce operational staff further, as Transco is already cutting 2,400 jobs, without jeopardising output and safety. As monopoly transmission operators, both companies' charges will continue to be strictly controlled by Ofgem, the industry regulator. Ofgem yesterday signalled that it had "no reservations in principle" to a merger. The regulator's benign comments are perhaps not surprising. A significant portion, if not all, of the UK savings expected from this merger would normally be passed on to customers when prices are next reviewed by the regulator. So why do the deal? The answer lies in the "safe but boring" investment reputation of regulated UK utilities. Traditionally, they produce predictable revenue streams to fund dividends, but offer little prospect for capital growth unless they invest in other businesses. For a while, it looked as though telecommunication services would generate the investment excitement required by shareholders. National Grid raised GBP 2bn from its GBP 500m investment in Energis, its telecom arm, but has now written down the value of its remaining 32.5 per cent stake. National Grid and Lattice both say that they will continue to provide sites for mobile phone masts, but will eventually withdraw from their other telecom interests. The alternative, pioneered by National Grid, is to invest abroad in the products and services that the groups know best: electricity and gas networks. The US north-east has provided fertile ground for this venture. Continental European countries, although enthusiastically supporting energy market liberalisation, have failed to follow the British lead in forcing companies to relinquish ownership of transmission networks to independent operators like National Grid and Lattice. A merger of the two companies, nonetheless, will create Europe's fourth largest utility producing a national champion to compete with EDF of France and RWE and Eon of Germany which have invested heavily in the UK electricity and gas supply services. French and German markets by comparison have proved very difficult to penetrate. “We would like to expand on the continent as markets open up but progress is slow,” says Mr Urwin. The UK experiences of National Grid and Lattice in cutting costs to beat regulatory efficiency targets should stand it in good stead in more inefficient US energy markets, he says. US transmission operators often own both electricity and gas networks. The addition of Lattice will bring important experience to National Grid's existing US team. The combined group hopes eventually to benefit from the federal authorities's drive to create broader, independently operated regional electricity transmission networks. They believe that this will encourage greater energy flows between states and also boost competition in the region. So far the logic has been well received by institutions. One analyst said: “Lattice shareholders will be giving up some of the short term value in the company if they accept this deal but the longer term looks a whole lot more exciting as part of an enlarged group.”