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CommentJune 3 2009

Energy sapping

 Left to right: Noah Bulkin and John Lynch Merrill Lynch's orchestration of the EDF purchase of British Energy was one of the most complex and drawn-out deals of its kind ever undertaken. Writer Edward Russell-Walling
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Energy sapping

What was once Merrill Lynch has been through some choppy waters to emerge as part of the new Bank of America Merrill Lynch (BAML). While all this was going on, Merrill's London-based mergers and acquisitions (M&A) and energy teams managed to stay focused to conclude one of the most exhaustingly complex deals on record.

When EDF's drawn-out purchase of British Energy completed in January, the task was not yet over. It was followed by the sale of a stake in the UK nuclear generator to Centrica, owner of British Gas. This was finally announced last month.

BAML's involvement with the deal began shortly before Christmas 2007, when it was asked to assist state-controlled French power utility EDF in the potential acquisition of British Energy.

Familiar territory

BAML knew the target well. It had worked with the company when the UK government saved it from bankruptcy in 2002 and took a two-thirds stake in return. The bank also had a long relationship with EDF. It received a mandate, initially as sole adviser, though it was joined by BNP Paribas later in 2008.

EDF was not the only party interested in British Energy, which, in spite of its flaws, presented a one-off entry ticket to the UK nuclear power market. The UK government was committed to private-sector nuclear expansion, but British Energy couldn't pay for it by itself and had been looking for a partner since early 2007. Recurring problems within its ageing fleet of advanced gas-cooled reactors helped to convince the company it had no future on its own.

"The company represented a unique opportunity to establish a presence in the UK on a large scale," says Noah Bulkin, the nuclear investment banking director who led the UK M&A team. In March 2008, British Energy admitted it was in talks that could lead to a possible takeover. As discussions with suitors went on, EDF, with its know-how and financial muscle, gradually emerged as the preferred option. Centrica simultaneously entered into discussions with EDF over taking a minority stake in British Energy, saying it would also consider a full merger.

The UK government eventually decided Centrica lacked the expertise and financial strength to pilot the nation's nuclear way ahead. But the company hadn't played out its hand yet. It owned a 25.5% stake in SPE, Belgium's second-largest electricity group. EDF had its eye on SPE, regarding it as key to its Benelux strategy, but in July Centrica exercised pre-emption rights to snatch a further 25.5% from under EDF's nose, giving itself majority control - a shrewd move.

The BAML team worked flat out to juggle contradictory demands, of which EDF and British Energy managements were just the start. There was the UK government, wearing a number of different hats: as shareholder (now down to 36%), as architect of national energy policy and, via the Nuclear Liability Fund, as steward of the future of British Energy's ageing nuclear plants.

Then there were other shareholders who, in EDF's case, included the French state. At British Energy, they included a number of increasingly vociferous investors - notably Invesco - who felt high energy prices would go yet higher, and who wanted an appropriate price. To complicate matters further, some were also Centrica shareholders who had disagreed even among themselves over a Centrica-led or EDF-led solution.

"We were trying to run all these different processes in parallel, shuttling between the City and Westminster and Paris, sometimes having to cover for each other," Mr Bulkin recalls. "It was quite a balancing act."

Innovative investment

A volatile oil price didn't help, because British Energy's value depended on perceptions of where it would go. Adding another layer of complexity was the instrument devised by BAML and NM Rothschild, British Energy's advisers, to give the energy bulls some upside exposure to rising nuclear output and energy prices. This was the 'contingent value right' (CVR) or 'nuclear power note', to be offered to investors in lieu of part of a cash offer.

"These were incredibly complicated to structure - to get the economic formula right, to structure the elements correctly so that investors could hold them, and to make them tradeable," says Mr Bulkin.

Apart from anything else, they had to find a market that would list them. Since they weren't really equity and weren't really debt, the London Stock Exchange wouldn't have them. London's Plus Markets eventually agreed to list them on Plus Quoted, its junior arm, but that only raised another problem. Plus wanted BAML to make markets in the CVRs, but the bank wasn't connected to the exchange.

"So we had to build the technology," says Mr Bulkin. "We had to speak to people in the bank that we had never come across and persuade them it was worth building a link with a market BAML had never dealt on."

It was about this time that another name was added to BAML's list of shuttle diplomacy destinations - the Thames Valley town of Henley, home of Invesco. Everyone was getting closer to a deal but, remember, the late summer and autumn of 2008 were turbulent times. EDF announced a recommended offer valuing British Energy at £12.5bn ($19.3bn) on 24 September.

Long-term perspective

John Lynch, BAML's head of EMEA power, makes the point that energy contracts need to envisage possible developments 20 years or more from now. "It's such a long game," he says. "There was a lot of chaos in the market at that time, but we had to step aside and focus on the long-term view."

The offer was accompanied by a memorandum of understanding in which Centrica agreed to buy up to 25% of British Energy at a price more or less equivalent to the EDF bid. But the price of oil, and British Energy's value, was already heading south and had a lot further to go. Once the EDF takeover became a fait accompli in January this year, the horse trading began in earnest.

The UK government had favoured the idea of a UK shareholder for political as well as competition reasons. Centrica had a pressing need to secure future power supplies. What would it pay for a stake? EDF wanted to recoup part of what appeared an increasingly expensive purchase price. It also wanted to gets its hands on SPE.

The bargaining was hard and protracted and, in the end, each side claimed it had what it wanted. Centrica pays £2.3bn for 20% of British Energy - less per share than EDF paid, but only by 6%. That buys it at least 20% of existing output. It will fund 20% of new nuclear capacity but gets no management control. EDF, which will also supply Centrica with additional power over a five-year period, gets its SPE stake for €1.3bn. That reduces Centrica's outlay, leaving it cash to spend elsewhere.

"You can't overstate the complexity of the transaction's asset swap element, from a legal and a commercial perspective," Mr Bulkin maintains. "That took over a year to do." EDF, he adds, has now established a model allowing a strategic investor to come in as a partner without operational control - it has already said it may sell further stakes.

What was the trickiest part? All of it, BAML says. "It's like a chair," Mr Lynch observes. "If one leg is not solid, the whole thing falls over."

Mr Bulkin agrees, but concedes he had doubts. "If you had come to me and said 'this is what we're going to do', I would have said 'good luck - but you will probably be wasting your time'," he says. "But EDF have phenomenal teams themselves and together we have achieved what seemed impossible."

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