By Vincent Wess (WHU – Otto Beisheim School of Management) and Steven Skomra (Georgetown University) - Date: 14/12/2019
Overview of the deal
Acquirer: E.ON SE
Target: Innogy SE
Seller: RWE AG
Enterprise value: EUR 36,970.5
Announcement date: 12/03/2018
Date of approval: 19/09/2019
Acquirer advisors: BNP Paribas SA, Perella Weinberg Partners LP
Target advisors: Deutsche Bank AG, Goldman Sachs & Co. LLC, Lazard
Seller advisors: Bank of America Merrill Lynch, Citi, Rothschild & Co
Following the Fukushima disaster in 2011, German energy policy embarked on a radical transition, known as “Energiewende” (“energy transition”) which included that all nuclear power stations were to be removed from the system by 2022 and large subsidies for renewable energy production. As a result, the two largest utilities of Germany, Eon and RWE, saw themselves faced with two challenges. On the one hand, their conventional power was squeezed out of the market by heavily subsidised wind and solar energy which put downward pressure on wholesale energy prices. On the other hand, the country’s four largest utilities were ordered to pay a combined EUR 23.6bn into a state-controlled fund to cover the costs of storing Germany’s nuclear waste which was EUR 6.2bn more than the four had provisioned for.
Being seen as near-hopeless basket cases, the two competitors undertook some of the most radical restructurings Germany had seen in a while. Eon spun off its coal and gas-fired power stations, as well as its energy trading business in a company named Uniper, while Eon retained the cleaner, greener businesses – renewables, energy distribution and customer solutions – which resembles the idea of a bad bank. RWE went the other way and spun of its green generation assets coupled with its grid business in a company called Innogy which became Germany’s largest utility company by market value.
However, uncertainty in the sector remained and only 17 months after Innogy’s IPO, RWE and Eon announced a new deal that would transform Germany’s energy landscape once again and for both companies, the deal ends the era of vertically integrated utilities that generate energy, own the supply grid and control the relationship with the customer.
“What we are presenting to you is one of the most creative design deals in German industrial history and a unique opportunity” - Johannes Teyssen, Eon Chief Executive
Company Details (Eon)
Eon was created in 2000 through the merger of VEBA and VIAG. In 2016, it separated its conventional power generation and energy trading operations into Uniper while retaining retail, distribution and nuclear operations. Eon sold its stake in Uniper through a stock market listing and sold the remaining stock to the Finnish utility Fortum in 2018. Today, the company states that it operates with three main business units: Energy networks and customer solutions, renewables and German nuclear energy.
- Created: 2000, headquartered in Essen, Germany
- CEO: Johannes Teyssen
- Number of employees: 43,302 (2018)
- Market Cap: EUR 19.891bn - EV: EUR 31.078bn
- LTM Revenue: EUR 28,539bn – LTM EBITDA: EUR 3,482bn
- LTM EV/Revenue: 1.08x - LTM EV/EBITDA: 8.84x
Company Details (RWE)
RWE is Germany’s second largest utilities company. It was founded in 1898 and was active in all steps of the value chain in energy markets until it carved out its business units for supply, grids and renewable generation in 2016. Prior to Innogy’s IPO, the company was highly leveraged and challenged by falling wholesale energy prices and high storage costs. Through the IPO, RWE gained €2.6bn in cash and a 76% stake in what became Germany’s largest energy company that it could sell off if it needed cash for investments or to meet its nuclear waste storage liabilities.
- Founded: 1898
- CEO: Rolf Martin Schmitz
- Number of employees: 17,748 (2018)
- Market Cap: EUR 17.366bn - EV: 20,979
- LTM Revenue: EUR 13.595bn – LTM EBITDA: EUR 1.075bn
- LTM EV/Revenue: 1.54x - LTM EV/EBITDA: 19.52x
Deal Structure and Mechanics
The transaction will see Eon acquire Innogy, followed by a series of asset swaps that will radically transform both groups’ business. First, Eon will get RWE’s 76.8% stake in Innogy and will then make an all-cash offer of €40.00 per share to innogy’s minority shareholders. In return, Eon will then hand back innogy’s renewable energy assets as well as its own to RWE. Furthermore, RWE will gain a share of 16.67% in the combined entity and the minority stakes held by Eon’s subsidiary PreussenElektra in the RWE-operated nuclear power plants Emsland and Gundremmingen. RWE will also make a cash payment of €1.5bn to Eon. Although the transaction has a value of about €43bn, only little cash will therefore change hands. Eon’s buyout offer for Innogy’s minority investors will cost about €5bn and RWE will pay €1.5bn in cash to Eon.
The total offer value of €40.00 per share will consist of an offer price of EUR 36.76 per share, plus the payment of assumed dividends from Innogy of a total of €3.24 per share for the fiscal years 2017 and 2018. This price represents a 15.8% premium over Innogy’s share price as of 09/03/2018, one day prior to announcement and a premium of 29.4% over Innogy’s share price of a month before the announcement.
On July 30th 2018, Eon owned 86.2% of the Innogy shares and in March 2019, the European commission opened an in-depth investigation into Eon’s proposed acquisition as it may reduce competition in retail markets for electricity and gas in several European member countries. However, on the 19th of September, the commission approved the transaction subject to remedies wherefore the last closing condition had been fulfilled.
Projections and Assumptions
For RWE and Eon, this deal ends the era of integrated utilities that generate electricity, own the supply grid and control the relationship with the customer. Essentially, it ends vertical integration and indicates that the industry has given up on the value of vertical integration as one Analyst puts it. Initial market reactions have seen RWE’s shares rise over 50% since the deal’s initial announcement 18 months ago, while Eon has only risen about 5%. Investor enthusiasm around renewables has driven this growth as European governments seek to reduce their future usage of coal and oil and RWE will acquire a significant amount of renewable assets through the transaction.
Eon plans to squeeze out the remaining shareholders over the next weeks to become the sole owner of Innogy before it will start with the integration of Innogy’s assets into its own business. Upon completion, Eon will have 50 million European customers which is an increase of over 60% compared to today’s number of Eon’s customers. The transaction will combine the geographically diversified and complementary energy networks and customer solutions business areas of Eon and Innogy which will make Eon’s future structure more focused and efficient. This will create a new company that is highly focused on operating its energy grids and developing modern customer solutions which ideally positions Eons as an innovative driver to support the transition in Europe’s energy markets, for example through a faster development of E-mobility or the expansion of intelligent energy networks in Europe. Furthermore, it will also increasingly benefit from other trends in the industry such as the rising number of renewable generations that are connected to the grid and the digitalisation. Also, Eon might benefit from higher valuations as it will operate largely regulated assets such as networks which investors like due to the predictable returns that regulated businesses generate. The transaction will improve the efficiency of Eon’s operations by means of the combination of energy networks and customer solutions business segments and the administrative and management functions of Eon and Innogy. Eon sees potential for synergies from the reduction of duplicative functions at group level, the planned integration for the IT systems, as well as synergies in the customer solutions and energy networks areas and expects them to account to approximately EUR 600 to 800 million annually as of 2022 which includes the results from cutting 5000 jobs positions.
For RWE, this deal marks a strong strategic shift as it reverses its move to pull out of the renewables business. It is basically buying back the assets they carved out less than 2 years ago. Once the transaction is completed, RWE will be the second-largest offshore operator in the world and the third-largest producer of renewable energy in Europe. Accordingly, RWE becomes a leading energy producer in Europe with renewable generation assets that have a high growth potential, combined with the reliable supply of conventional generation which enables it to generate sustainable earnings in the long run.
There is a trend seen in power companies in aiming to provide services to customers that help them reduce their energy costs and carbon footprints which is unusual as helping customers reduce their energy bills does not sound like an especially appealing business model for an electricity company. An example for this trend is the GBP 330m acquisition of a business that specialises in making buildings more energy efficient by the UK arm of Engie and other examples include Centrica’s smart-home service called Hive that allows people to control heating and lighting via their smartphone. This shows that there is more value in helping reduce consumption than in selling energy itself which is also affirmed by several experts in this field such as says Wilfrid Petrie, the head of Engie in the UK. The shift describes also recalls to the one undergone by the telecoms industry, which today finds its growth in services and content rather than the line rental and phone calls that used to be its core business. The transaction will shift Eon’s focus away from energy generation and concentrates it towards the operation of its grids and towards customer solutions. This should allow the company to strengthen its skills, its innovative drive and its offer where they are closest to their customers to take full advantage of the arising opportunities. In strategic terms, the structure of the overall Group will make it possible to take part in the shaping of future market developments and the energy transition in Europe by working with partners, cities and municipalities to create superior products and services for customers. This role will become considerably more important in the future as intelligent grids and new solutions will grow closer together, due to increasing decentralisation and the growing digitalisation of the future energy world.
As more and more fossil fuel assets are retired, smaller players in the conventional energy world will become smaller and less competitive and less able to deliver value. The case for consolidation is therefore very strong among conventional generators as they seek strength through scale. According to Julian Critchlow, the former head of the Global Utilities & Alternative Energy Practice at Bain & Company and a director at the BEIS, growth in renewables has created excess capacity of about 25-30% in the European power sector, depressing profit margins for generators. To compete in this industry as a conventional power generator, scale has therefore become even more important. RWE’s decision to take back its renewable energy assets from energy and to solely focus on generation is the biggest sign of this trend we have seen so far. The growth of CO2-free energy generation will increasingly develop from the regulated space to a normal competitive market. Critical mass is the key to success in this field as well. “Before this transaction, neither Innogy nor Eon were in such a position. We join the business units of these two companies under one roof at RWE, thereby achieving the necessary critical mass,” said Mr Schmitz, the CEO of RWE. By tapping into the future growth market of renewables, RWE sets a new stage and creates sustainable prospects and over time RWE should be able to replace its cash flows from conventional generation with renewables.
Risks and Uncertainties
The first risk concerns Eon’s balance sheet. The company will have perhaps €15bn of net debt once it receives the proceeds from selling its stake in Uniper. Add on Innogy’s €15bn and assume that Eon borrows the net €3.5bn needed to buy out the minority shareholders in Innogy. Analysts at Jefferies estimate that the new Eon would have about €7bn in earnings before standard deductions. Even if there are some cost savings, and the performance of Innogy’s troubled UK supply business improves, €33bn is a sizeable pile of debt to service. Given that Eon raised equity a while ago and would surely be testing investors’ patience to do so again, the transaction could lead to a large strain on Eon’s financing abilities.
In another potential blow to RWE, the German government said this year that it wanted to phase out the use of coal power, a key element in the group’s generation portfolio. Details of the plan have yet to be worked out, including the crucial issue of compensation for operators such as RWE, but the target date for the end of coal power has been fixed for 2038. Depending on how dependent RWE will still be on conventional power generation in the future, this could impact earnings and performance of the company in the next years.
Germany is shifting from a situation where electricity is supplied by few dominant utilities led by EON and RWE to a more splintered market in which many smaller players also generate power. Increasingly, these smaller players can also be consumers that generate energy for their own usage and feed the surplus back into the grid. For example, by the end of 2014 in Germany more than 1.54 million PV systems and over 25,000 wind turbines were producing power for the grid. This is summarised in the decentralisation mega trend of the industry. Eon is well positioned for this change as it operates the energy network and develops customer solutions for retail clients. RWE, however, might face a large problem in this in the future as end-consumers and smaller generators could provide a more efficient and cheaper substitutes to RWE’s electricity which would pose a challenge to its business model.