The sale of British Energy, once part-nationalised as it was considered too important to fail, should pay dividends for the British government. NM Rothschild, the team which advised on the deal, explains how it pulled off such a coup. Writer Edward Russell-Walling.
When UK Prime Minister Gordon Brown’s government took the plunge and decided to prop up UK banks with taxpayers’ money, it might have comforted itself with the thought of British Energy. That was also a part-nationalised business in crisis, but one that should now yield the taxpayer a tidy profit.
The sale of nuclear generator British Energy to Électricité de France (EDF) served the government’s purposes, but the original transaction did not thrill all of its other shareholders. NM Rothschild & Sons, lead financial adviser to the acquired company, had a job on its hands to design a deal that suited everyone, as both energy and financial markets lurched about.
Left to right: Andrew Whiting, Stephen Vaughan, Philip Smelt and Richard Murley
Chequered history
British Energy has not always brought joy to its backers – quite the reverse, in fact. Consisting of various advanced gas-cooled reactor (AGR) plants and a single pressurised water reactor plant, the company was privatised in 1996. By 2002 it was in serious difficulty, from a combination of low energy prices and technical problems with the uniquely British AGR reactors.
The company generates 20% of the UK’s electricity, however, so if the capital cost is ignored, it has significant value. Moreover, like British banks in more recent times, it was regarded by government as too important to fail. So the government took over its reprocessing and decommissioning liabilities in return for what was effectively a two-thirds stake.
It emerged from a quarrelsome restructuring in 2005 with a new management team. The original shareholders were left owning only 7.5% of the company and the bondholders, who had capitalised their debt, owned about 27%.
Linked to prices
British Energy’s fortunes are directly plugged in to power prices – the higher, the better. Though it has no captive customer base, the company’s great virtue is the fact that it is nuclear – independent of the predations of oil and gas prices, and carbon emission-free. As such, it was always likely to play a pivotal role in the government’s unfolding energy policy. The government was deeply concerned about a looming shortage of generating capacity as old power plants closed from 2015 onwards, and was leaning increasingly towards the nuclear principle.
This was not lost on the new board of directors, who hired Rothschild as a strategic adviser in 2006. “The company was wondering whether it had an independent future,” explains Rothschild managing director and mergers and acquisitions specialist Richard Murley. “Should it take a partner? It realised there was likely to be a strategic transaction at some time. So we attended board meetings and gave old-fashioned corporate finance advice.”
The fact was that, with its portfolio of ageing power stations, British Energy badly needed to build new ones. But nuclear plants cost large sums of money, perhaps £4bn ($6.93bn) apiece. “It quickly became apparent to us that the company couldn’t afford new nuclear on its own,” says Mr Murley. “It needed a partner.”
In summer 2006, government gave its official thumbs-up to a new nuclear programme, saying it would have to be funded by the private sector. British Energy’s share price – about £2 when it came out of restructuring – had risen along with power prices to about £7. But then came more technical problems. Cracks in boiler tubes at two older plants led to extended shutdowns in 2006 and 2007 and the shares tumbled once again.
British Energy might have been faltering, but the government’s appetite for new nuclear power remained firm. In early 2007 it was announced that the company would seek a partner, and Rothschild’s work began in earnest.
As Mr Murley points out, the company was a jewel for the right buyer, not least because it owned the most suitable sites for any new plants – right next door to the old ones. “It had the sites, the know-how and the relationships with the local community to get planning permission,” he says. Nuclear’s stock was generally on the rise, because of rising oil prices and carbon concerns, and the UK was Europe’s second-largest nuclear generator and a highly attractive market.
European interest
More than half a dozen large utilities, mostly European, expressed an interest. At this stage, only partnership was on offer, and discussions ranged around what British Energy might contribute and how it would be rewarded. In summer 2007, the government sold down its stake in the company to 36%. “By last winter, it was apparent that the government wanted a very significant nuclear investment and that it wanted it quickly,” recalls Mr Murley. “And it became clear to British Energy that there was a real opportunity to include the existing business in any partnership.” The search for a partner had become a full-blown auction.
It was obvious from Rothschild’s conversations with the European utilities that they would take on the AGR portfolio if it meant an entry ticket to the UK nuclear programme. And the government could see the benefit of entrusting a key part of it to one of these powerful, well-resourced players.
But the government was not the only shareholder. And the other shareholders all had their eyes on what, at the time, was the rising price of energy. “The kind of people who chose to be British Energy shareholders were bulls on medium-term commodity prices,” notes Stephen Vaughan, Rothschild managing director and head of utilities. “And British Energy was one of the purest plays on the energy price. You couldn’t expect them to sell out at a consensus view of where that price was going.”
It was clear that price was going to be an issue. But first a buyer had to be found. EDF was always a strong contender. Germany’s RWE was interested and proposed a bidding partnership with Sweden’s Vattenfall, though the Swedes later pulled out. Centrica, owner of British Gas, was also keen, though the government regarded it as too small to be the lead purchaser (EDF may now sell it a 25% stake). The likes of E.ON and Iberdrola were in the chase for a while.
At the end of 2007, the shares had been trading at about £5. As Rothschild explored the subject of price with candidates, “the air got a bit thin”, in Mr Murley’s words – about £7. “In fact, it was only when the price went much above £7 that EDF moved ahead of the other bidders,” he says.
The government accepted that £7 to £7.50 was a fair price, but other shareholders, more optimistic about power prices, felt it should be higher. By the summer of this year, the board had agreed in principle to accept EDF but instructed Rothschild to do a bit more for the optimists. “We had two classes of shareholder, and it was incumbent upon us to come up with an offer that appealed to both,” says Mr Murley. Enter the contingent value right (CVR), better known as the nuclear power note.
In the offer that was finally presented to shareholders in July, they could take £7.65 in cash, or £7 and one CVR. The CVR entitled its owner to annual payments for a certain number of years based on revenues, and offered some participation in any upside.
Optimists prevail
Well, the optimists blew a raspberry at that, led by Invesco, which owned 12% of the shares. “EDF bid for British Energy in tatters” shrieked the Financial Times. “It looked like it had been called off,” says Mr Murley. “But internally everyone knew it hadn’t been called off. We just had to do more work on the CVR and get a bit more cash.”
The revised offer added a mere 9p to the cash-only bid, raising it to £7.74, but substantially improved the possible upside from the CVR. If power prices crash, it is worth nothing. If they go completely wild, it could now be worth up to £5. Realists think it is probably worth 50p to £2.
The government and Invesco have undertaken to accept the offer and EDF has bought 26% in the market, so it already has 62% of British Energy. Completion of the offer depends on clearance by the European Commission, which the parties are hoping to get by the end of the year.
If so, the government will come out well ahead. Its intervention in British Energy cost about £6bn. It will get back assets worth about £9bn.
“About 90% of that will have been in cash, if the offer completes,” says Mr Vaughan. “So the government comes out with cash well ahead of the liabilities it took on. That sets an interesting precedent for wading in to save an industry you can’t allow to fail.”
