ENERGY E.ON Becomes a Bargain

Mergers and acquisitions in the worldwide energy market reached a record level in 2016. In Europe, financial investors are on the hunt, and German industry giant E.ON could soon be fending off takeover attempts.
How long can E.ON CEO Johannes Teyssen keep the sharks at bay? Photo: Krisztian Bocsi/Bloomberg

E.ON has long been a bargain. The German energy company is currently valued at less than €14 billion ($15.11 billion) on the stock exchange, which is eons away from the €105 billion that had made it the most valuable company on the German Stock Index, or DAX, in early 2008.

So far, Chief Executive Officer Johannes Teyssen has been relatively relaxed about the threat of a hostile takeover in light of the company's loss of value. Mr. Teyssen had the ultimate poison pill on E.ON's balance sheet: obligations resulting from Germany's phase-out of nuclear energy. The costs of disposing nuclear waste are virtually incalculable, but will certainly be in the billions – a fact that has deterred any potential buyers. No one was about to voluntarily assume this task or the risks associated with it, which will last for generations.

But E.ON will soon lose this poison pill. The company, like other operators of nuclear power plants in Germany, will transfer its responsibility for nuclear waste to the planned public nuclear fund. In other words, E.ON will soon be rid of its baggage at a time when the operating business is booming. This makes the company a bargain on paper – and a takeover candidate.

Mr. Teyssen is keeping his composure. "Theoretically, the world can do without E.ON," the CEO said at the Handelsblatt energy conference last week, "but that goes for every company."

Nevertheless, E.ON has prepared for a worst-case scenario. The company only recently extended contracts with banks and law firms, which would help it fend off a hostile takeover attempt. E.ON is portraying these precautions as routine; a spokeswoman recently described the precautions as mere "defense mandates," which need to be extended from time to time.

But the truth is that, for a large utility like E.ON, the risk of becoming the target of a hostile takeover is now greater than ever. According to a current study by the A.T. Kearney consulting firm obtained by Handelsblatt, the volume of M&A activities in the global electricity and gas market reached a record €329 billion last year – almost €140 billion more than in the previous year.

Theoretically, the world can do without E.ON, but that goes for every company. Johannes Teyssen, Chief Executive Officer E.ON

The volume climbed from €31 billion to €57 billion in Europe alone. This figure includes the takeover of Vattenfall's brown coal activities by Czech investors EPH and PPF, as well as the sale of German gas network operator Thyssengas.

According to Andreas Stender, an energy expert at A.T. Kearney and one of the authors of the study, the trend will persist: "There will continue to be many mergers and acquisitions in the energy market."

There are many reasons for the wave of takeovers. Companies in the United States are valued so highly that they are using their stock for takeovers. In Europe, however, energy suppliers, grid operators, power plants and wind farms have become cheap due to both strict regulations and tough competition. For this reason, they are now attracting financial investors. The former monopoly returns have declined, but returns in the high single digits can still be achieved with networks or renewable energy – returns that are many times higher than the interest financial investors can achieve in the capital market at the moment. Financial investors already accounted for 77 percent of transaction volume in the European energy market last year. "Financial investors are desperately seeking lucrative investment opportunities," said Mr. Stender.

So far, investors have largely limited themselves to acquisitions of individual projects, such as wind farms, or specialized companies, like electricity or gas network operators. But that will change. "It's only a matter of time before financial investors also venture to take over large, integrated utilities – and then break them up," said Mr. Stender. "Many utilities are undervalued in Europe. The individual parts are often worth far more than the entire company."

This is also true of E.ON. Analysts at Bernstein Research recently completed a so-called sum-of-the-parts analysis, in which individual units are appraised based on their respective results. The analysis produced a corporate value of €44.6 billion for E.ON. After subtracting reserves, pension commitments and financial liabilities, the company should actually be worth €21 billion on the market, or almost €7 billion more than it is today. According to the Bernstein Research analysis, the regional distribution networks in Germany alone are worth more than €15 billion – and with minimal obligations to the company at large.

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Investment management firm Knight Vinke recognized this some two-and-a-half years ago. At the time, the company invested in E.ON with the goal of spinning off the networks, and since then it has called for the dismantling of E.ON – without success. Although management has politely listened to the proposals, it has not entertained any of them yet. E.ON's CEO Mr. Teyssen has also showed no sign of changing this stance. Instead, he is firmly rejecting calls to break up the company again in order to sell off individual parts. "As far as I'm concerned, this is just financial acrobatics and has nothing to do with strategy," he stressed in an interview with Handelsblatt a few weeks ago. "I see no added benefit to a large-scale breakup."

After spinning off its coal and gas-fired power plants into a new company, Uniper, Mr. Teyssen insists E.ON has now achieved an optimal structure with distribution, networks and renewable energy divisions. Mr. Teyssen affirmed this at last week's energy conference and cited the example of smart cities as a future trend. "You cannot plan an intelligent neighborhood unless you have a deep understanding of infrastructure, are familiar with the possibilities and limits of renewable energy and get customers involved." It is not a matter of "blunt synergies," he explained, but of finding the best solutions for customers.

As Handelsblatt has learned, the management and the supervisory board are currently unaware of any concrete advances to take over the company. But E.ON also hasn't rid itself of its poison pill, nuclear waste, yet.

I see no added benefit to a large-scale breakup. Johannes Teyssen, Chief Executive Officer E.ON

Competitor RWE demonstrated how to unleash value by completely focusing on business involving the "Energiewende," Germany's shift away from nuclear power and toward green energy. The company also split apart. But while E.ON listed its old business on the stock market under the burden of large write-offs and without nuclear energy, RWE listed its new business. The initial public offering of Innogy SE, which focuses completely on renewable energy, networks and distribution, was a complete success in October. The new company is worth €16 billion – more than parent company RWE, which is valued at €7.5 billion. Innogy has also displaced E.ON as the most valuable German energy company.

Also, unlike E.ON, Innogy is largely protected from a takeover. RWE AG, with its brown coal power plants and municipal shareholders, still owns 77 percent of the company. This makes it unappealing for corporate raiders.

Although RWE plans to sell off additional pieces of Innogy, it also intends to keep its majority stake in the long term. This could give the new company and its CEO, Peter Terium, the peace and quiet they need to develop their new business.

Not so for the competition. "There is a fundamental logic for financial investors to buy an integrated utility and break it apart," said A.T. Kearney expert Mr. Stender. Networks, in particular, are appealing because of their "attractive and secure returns." According to Mr. Stender, "it's a dangerous situation for the large utilities."