<B>Gas Natural's takeover bid against Endesa: A political or a Strategic move?</B>

Manuel Romera. Technical Director Financial Sector. Instituto de Empresa

26 September 2005

Attention has been focused on the political aspects of Gas Natural’s hostile takeover bid for Endesa. But the deal also makes strategic sense, and the synergies from a linkup would likely benefit the shareholders of both companies. The question is will consumers be forced to pay more for electricity? That is the pressing issue the regulators will be required to analyse in depth.

The energy sector in Spain is in turmoil as another leading player takes a 'leap in the dark'. In this case, Gas Natural, a company that already tried unsuccessfully to take over Iberdrola in 2003, is back on the prowl, this time with a hostile takeover bid for Endesa. Most analysts say political factors are behind the launch of the takeover bid—an argument supported by the sudden outbreak of a nasty political-economic war. The conflict pits the Catalan block—a three-party coalition formed by the Socialists, the United Left and the Republican Left, in alliance with the business triumvirate formed by La Caixa, Gas Natural and Repsol—against the Madrid block—the centre-right Popular Party and its allies, the Caja Madrid and Endesa.

In my opinion, there are also important strategic reasons behind this transaction, which are closely related to the buyer's need to diversify its business. Today, Gas Natural is a company devoted to the marketing of gas (a single product) and although it is the unquestionable leader in Spain, its market share has fallen in recent years. Furthermore, the company is anticipating that a world energy crisis will boost the price of oil and its by-products to record highs. Faced with this situation, the takeover bid has a two-pronged objective: On the one hand, to diversify into energy-related businesses and products in an effort to reduce its dependence on gas; and, on the other hand, to achieve a vertical integration that enables Endesa's gas-fired combined-cycle power stations to continue in operation. In other words, Gas Natural is seeking to link up with a large client.

Who's on the worst end of what should be called a 'situation' rather than a 'transaction'? As usual, consumers, who, one way or another, will be forced to pay more for the energy they consume. Although this seems logical from a market point of view, it is no less true from a political one. Indeed, the powerful front formed by Gas Natural-Endesa and Iberdrola will exert far greater pressure on the government to raise prices. After all, together they will control more than 80% of the Spanish electricity market.

From a stock point of view, the equity premium Gas Natural is offering for Endesa is low, meaning the gas company will probably be forced to improve its bid, since the recent jump in Endesa's share price—accompanied by a drop in Gas Natural's share price--has eroded the bid's initial premium of 14% and weakened the incentives for participating in the takeover offer. In Gas Natural´s attempt to take over Iberdrola, a premium of 20% was offered, while TXU´s bid for Hidrocantábrico implied a premium of 72%. In both cases, the premiums were over and above what Gas Natural is offering today.

If the latest hostile bid is successful, it is likely to yield large benefits for the buyer's shareholders, regardless of the premium finally offered. The gas company is to pay out around 7.5 billion euros in cash, a figure that will be recovered through disinvestments—between 7 billon and 9 billion euros through the sale of Endesa assets to Iberdrola, under a contract to be signed on the day of the launch. The buyer believes these disposals are required by both the CNE and the competition authorities if the the merger is to proceed. However, if the bid goes ahead, I fail to see how the asset sales will achieve greater competition in the sector.

As icing on the cake, the new combination would save a few billion euros on the investments the two companies had planned to make separately. From the point of view of Endesa shareholders, these developments would boost the value of their investment: If the new combination hives off assets, it will be able to streamline overhead and, consequently, cut costs and take full advantage of the synergies generated from the linkup. Company earnings should increase as a result.

I would like to conclude by saying that consumers should be taken as much into account as shareholders, executives, politicians and any participants in a bid of this kind. We must remember that energy is a public service and, as such, it must be appropriately regulated and controlled. Furthermore, competition in the sector must be encouraged in order to benefit consumers. To achieve this, regulators must do their homework, in a thorough and timely fashion.

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