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UK Sunday Herald
The style of the two men could not be more different. In front was Ian Russell, the chief executive of ScottishPower whose normal clipped, precise tones were screwed slightly tighter by the tension of the moment as he tried to make his company’s case.
Behind him via a video link was Warren Buffett, the so-called Sage of Omaha who many regard as the world’s savviest investor setting out in joke and jibe why he has bought the business.
The two men were explaining to the world in a surprise deal announced on Tuesday why ScottishPower had decided to sell PacifiCorp to Buffett’s Berkshire Hathaway investment business.
Russell was mainly serious and Buffett smiling but did that mean that it had been a sad day for ScottishPower and a brilliant one for Berkshire?
Certainly the sale price of $9.4 billion (£5.13bn) to Berkshire Hathaway subsidiary MidAmerican which was made up of $5.1bn for the equity plus the assumption of $4.3bn of debt is some way off what the Glasgow-based utility paid for it. Ironically, however, in the same week Russell was awarded £620,000 of Scottish Power shares.
The PacifiCorp sale which one observer described as “a handbrake turn” by ScottishPower surprised the market. But in fact Russell and his team had made the decision to sell after a review of the options. It was after the utility failed to hit a profit target last year that it began to review its strategy and think again.
As Russell put it last week: “This is the right decision for share holders. It is a difficult decision but it is the right one to sell to MidAmerican and return the capital to shareholders.”
Russell and his team have concluded that to truly drive PacifiCorp forward it would need $1bn a year in investment over the next five years. At the same time it planned to invest £4.5bn in its remaining businesses.
But is the unexpected sale of PacifiCorp now an admission of failure?
Russell argues that that is not the case and, last week, attempted to maintain that the acquisition of PacifiCorp had not been a mistake.
“In terms of strategy when we acquired PacifiCorp we wanted to use it as a platform for growth, to improve the efficiency of the business and achieve financial benefits from it,” he said. “We have transformed PacifiCorp since then doubling profits.”
Their styles are so different so it would have been interesting to have been a fly on the wall when the two men met in the early stages of the discussion of the deal.
Russell had looked at the market and carefully selected Berkshire Hathaway as a potential suitor. The two groups met at energy events in the US and Russell knew that Buffett was keen to expand in energy.
While arguably ScottishPower might potentially have attained more money by seeking other bidders and an auction, Russell took the view that it was best to avoid the uncertainty and resulting share price turbulence that would have caused.
Hence the reason he started a process of negotiation which meant the bid teams from the two companies had to work around the clock over the weekend. They finished in New York about 9.30 in the evening, or about 2.30am UK time or just about five hours before the ScottishPower results – and the surprise deal – were to be announced to the City. Russell with his typical precision and fastidiousness had ordered that the deal should be completed in time to be announced at the same time as the utility’s results.
While they are very different one thing that Russell and Buffett have in common is that they are both long-term players. For his part Buffett had suggested that he does not expect ever to sell PacifiCorp but invest and build to deliver value for the longer term.
Unlike Russell and his colleagues, Buffett does not have the disadvantage of shareholders clamouring every few months for a dividend – he is very much about long-term capital growth.
Buffett clearly believes he has got a good deal. Berkshire Hathaway can extract value out of PacifiCorp that ScottishPower simply can’t. Certainly that is suggested by Buffet’s comment: “PacifiCorp is a business that may not fit the profile of ScottishPower but it fits our profile.”
The deal which is actually the second biggest in money terms that Buffett has ever done will use up a slice of the $40bn capital pile that Buffett has been sitting on. He had not invested for some time because he said he did not see businesses that were worth putting Berkshire Hathaway investors’ money into.
The deal will also have the side benefit of taking away public attention from a Berkshire subsidiary’s involvement into the AIG affair. What was the world’s largest insurer is the subject of civil lawsuits over allegedly using reinsurance deals to overstate its earnings.
Those that know Russell say that the PacifiCorp move, while it may have surprised the market, will have been long thought about and its implications for longer term shareholder value carefully considered.
A first look at the numbers suggests that this was a bad if not horrendous result for ScottishPower. As James Sparrow, an analyst at Royal Bank of Scotland put it last week: “PacifiCorp has not been a successful acquisition, both operationally and financially.”
It is certainly all a far cry from the heady days of 1999 when ScottishPower struck what was regarded as an innovative deal to take over the American utility. It was the first time a foreign company had been allowed to buy a US utility as a wave of energy deregulation gained momentum across the US at the end of the 90s.
The power company has sold the deal throughout as testimony to the innovation that was taking place in the UK sector following the Thatcher government’s wave of privatisation. This put the UK businesses way ahead of their counterparts in the US.
But ScottishPower found its American foray much tougher than it expected. Mind you who could have expected the Californian power crisis of 2000 and other goings on in the market which owe more than a little to the highly questionable activities of a former power company called Enron.
It was also dogged by bad weather, problems with power stations and a dollar which again fell much more than was predicted.
The regulation of utilities is always a complex business that would make many business people tear their hair out but in the US the process is even more fraught. State governors have a big say in such issues and so there is a level of politics in the US that makes regulation more difficult to call and even harder work.
The company also faced bad publicity and resulting dents to its reputation in some quarters as a result of its PacifiCorp operations. A further example of that came last week when the Klamath river native Indian tribes of California and Oregon attacked ScottishPower over the sale.
In a statement sent to the media in the UK and US the Hoops, Karuk, Klamath and Yurok tribes accused the utility of “stringing them along” and “selling them down the river” by engaging in negotiations with the tribes while planning the sale.
You can well imagine that having a situation where Native Americans no longer accuse them of irresponsibility and damage to their traditional way of life and the environment would be a welcome development for ScottishPower chiefs.
But was the PacifiCorp deal the right medicine for ScottishPower to swallow for the long-term value of the business?
On the face of it ScottishPower will make a capital loss of about £927 milliion but those close to the company argue that this damage is not as bad as it first appears.
They suggest that this is largely only a paper figure and that the loss was offset by gains of £485m from a currency hedging arrangement. Further they argue that the book figure for PPM Energy, the American wind power and gas storage business that ScottishPower retains, actually undervalues it and its longer term contribution to the utility going forward.
Analysts believe that the utility’s three remaining businesses are strong with each of the divisions having the potential to improve earnings over the next five years. JP Morgan analysts estimate earnings per share growth to average around 7% as the group will now be constituted, compared to 4% with PacifCorp still part of the group.
But as Ian Mitchell and Caroline Randall of JP Morgan say in their note: “In our view the positive share reaction was a combination of speculation that ScottishPower may now become an acquisition target and the recognition of the improved prospects of the smaller, remaining group.”
You can be sure that even now investment banks and other advisers are tuning up their pitches on why ScottishPower would be a good potential takeover target.
One name that has figured quite largely in the speculation over the last week is E.ON of Germany. E.ON already runs Powergen, the second-largest energy supplier in the UK and the second-largest electricity generator. Centrica has also been named as another potential suitor.
Perhaps the favourite option being mentioned, however, is that of an all-Scotland deal between Scottish & Southern Energy and ScottishPower.
As the JP Morgan analysts say, PacifiCorp had long been seen as a stumbling block to a ScottishPower/ S&SE tie-up. “With this removed, the logic of creating a national champion is compelling in our view.
“The combined business would possibly face regulatory hurdles and would probably have to sell some generation and perhaps regulated assets, but neither would likely be a deal breaker and cost cutting potential from combining the companies’ customers bases and distribution networks could be substantial.”
It is certainly ironic that ScottishPower, which captured all the headlines with its innovative deal across the Pond to buy PacifiCorp, might be considered a target for its other less exciting Scottish competitor which built its business in its UK base.
Of course the extreme ScottishPower “returning with its tail between its legs from over the Pond” view assumes that the PPM business is only a token.
In fact the utility has quite ambitious targets for PPM which is a wind power business and also the third-largest gas storage business in the US. It aims to almost treble its current 800 megawatts of power generated now to about 2300 megawatts by 2010. It also plans to boost its gas storage division from the current 30bn cubic feet to 125bn cubic feet by 2010.
It is certainly not accurate to think of this as a token business. But are the prospects of it and the utility’s two divisions, infrastructure and power generation, enough to convince the market that it should retain its independence.
As Ian Russell put it last week when asked about the possibility of takeover: “The chief executive has the responsibility for these decisions. It will be for others to decide what the future is.”
That future looks very open as of now. While Ian Russell has removed the biggest operational area of difficulty for the group he has also taken away one problem area that deterred would-be bidders.
Page Updated: Thursday May 07, 2009 09:14 AM Pacific
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