Chinese infrastructure and energy investment in Europe – one more

Chinese investors may be about to conclude another big European infrastructure deal, with the potential sale of a 35% stake in CDP Reti. I do not believe that this will drive up the share prices of SNAM and Terna short term. But I see the deal as attractive for the parties involved. I do see active Chinese investment in infrastructure, energy, utilities and cleantech in Europe. That should support private transaction activity, sector valuations and also operating fundamentals.

The Italian government is in advanced talks to sell a 35% stake in CDP Reti to the Chinese State Grid National Development, a wholly owned subsidiary of the Chinese State Grid. CDP Reti holds a 30% stake in SNAM and will also hold a similar stake in Terna.

The deal would be worth about Eur 2bn. I estimate it could exceed Eur 2bn, on the basis of both companies’ current ratings. But because the stake is in unquoted CDP Reti, a discount can be justified. Terna trades at  P/E of 15.3x 2015E, which is at the high end of the European utilities sector. It yields 5.03%. SNAM trades at a P/E of 14.8x 2015E and a 5.8% yield. The yields are attractive, but I do not see much room for multiple expansion at this stage.

The cash flow attractions of first and foremost Terna, but also SNAM and their strong dividends make them prime investments for infrastructure funds. The Chinese investors will see that as one of the core attractions.

The deal follows a string of Chinese investments in infrastructure globally, in energy in Europe, and in Italian energy, utility and infrastructure assets.

But also, the energy context fits with the investors’ broader strategy: Peoples’ Bank of China’s 2% stake in ENI and Enel (deal of March 2014) and Shanghai Electric’s acquisition of a 40% stake in Ansaldo are intriguing.

SNAM has the particular attraction of gas infrastructure which in my view will get increasingly valuable. It will become the backbone of the broader energy system and an enabler of affordability and system reliability. SNAM also operates LNG terminals which will in my view become highly valuable assets in a world of increasing global gas trade connection and LNG arbitrage. The Chinese interest in that element must be very high.

Infrastructure has partnered with a Chinese connection for a while in a symbiotic way. Chinese investors are looking to gain access to strategic resources. Some of that is achieved through infrastructure investment. That in turn in many cases enables asset or resource development. The many deals in Africa are examples o that.

The Italian government and the companies would achieve stable shareholders. There might still be concerns of strategic asset protection. But the Italian government has been looking for Chinese investment as a help to reduce its budget deficit.

Chinese infrastructure and energy investment in Europe will continue to play an active role, see also UK nuclear and UK water. I can see this as a support factor for large scale private deals. That should also support valuations and interest in the sectors on a broader scale.

 

EU energy efficiency on the slow path

The new EU energy efficiency target of 30% goes in the right direction, but won’t deliver a kick start to the energy efficiency market. It is a tool that could address the big challenges in Europe, climate, affordability and energy security. But its implementation is to weak. I expect energy efficiency to be a very big market, but growth will be on a steady path. Investors should look for building efficiency, solar BIPV, lighting and most importantly demand management and smart features. IT energy efficiency will come up as the next big issue, and there will be big opportunity for the tech sector.

The EU will set a 30% energy efficiency target by 2030, up from 20% by 2020, according to the latest proposals. The number is controversial, the range that member states were looking for went from 25% to 40%. And, the target won’t likely be binding. At this stage, it is an EU wide target rather than one that will be broken down at country level and legally implemented by state legislations.

Energy efficiency is seen, and rightly so, as a policy tool that could address the big challenges; climate, affordability and security of supply. But there is too little consensus to make the policy effective. The Eastern European states find the burden of transition too high, others would like to push for more, and yet others want freedom for their own policy implementation. That context cannot deliver a strong enough framework for measures that would make an impact.

As a very important element, the EU energy efficiency target is directed towards improving security of supply and reducing energy import dependency. I see the target in its current form as unlikely to deliver that. The incentive is not strong enough to deliver the required investment.

Energy efficiency should address affordability in some countries, namely the UK. Bills in the UK are amongst the highest in Europe, despite tariffs being amongst the lowest. That is a result of high consumption, which in turn is a function of weak energy savings performance. Energy efficiency will be the key to this debate. But, the UK is resisting a binding target as it looks to implement its own policies that are far from clear on the matter at this moment.

In a broader sense, energy savings should ease market balances and with that contribute to improving affordability. But that will be counteracted by other policy costs, such as green levies, system costs and the like.

I do see energy efficiency as a market of growth. But, I doubt that the EU target in its current form will do much to kick off the market. Otherwise, rising energy prices may deliver an incentive. Those will not come through tight markets, but through policy costs. Capacity balances will not justify increasing prices until the end of the decade in Europe, according to my calculation.

The energy efficiency market will with this continue a path of steady but slow expansion. I see continued growth in solar BIPV, building efficiency, lighting, demand management, consumer appliances and smart features. Names that are positively exposed are St Gobain, Siemens, Osram, Aixtron, but not to forget Apple and Samsung as well as Infineon.

I can also see EU directives and regulation coming through on IT. Technology, eg internet, stand by appliances, mobile devices, connectivity and much more has recently been named as one of the major energy demand drivers by the IEA. It is a big growth sector and increasing IT requirement will mean a completely new and yet unaccounted push in electricity demand. Energy efficiency in technology is a great opportunity for investors. I expect the tech sector to lead on this in its own right.

 

EDF and pricing: the big boys

EDF’s price reduction to the Exeltium consortium has a minor impact on earnings, but leaves the door open for more. It also shows the high levels of political risk in France and the fact that EDF’s tariff are a tool of policy. The shares are cheap with a 20% 2015 P/E discount vs the sector, but that is reflective of risk.

EDF has announced it will reduce its tariff for the Exeltium consortium which represents the 50 largest power consuming companies in France. The new price will be Eur 42/Wh, in line with the average annual French wholesale market rice. Exeltium members currently pay Eur 50/MWh.

I can see the commercial rationale of the renegotiation by Exeltium. The level of Eur 50/MWh was out of line with the market. It was derived on the basis that the Arenh price would go out to reach wholesale power prices in excess of Eur 50/MWh. But the market situation has completely changed. At those original levels, energy intensive companies struggle with competitiveness. The adjustment makes sense; still it is negative news. The new price is about covering costs of new build, and that tightly. It is reflective, from EDF’s perspective, of the general market malaise.

The deal also clearly shows the fingerprints of politics. The government is reported to have stepped in with “friendly” intervention. The element of international competitiveness of the largest French companies is highly political. Note the high emphasis in the communication of the deal put on competitiveness with German and North American manufacturing businesses under the angle of energy. It is my view that cost of energy will replace cost of labour as the major factor of distinction in global competitiveness.

The French government did not hesitate to step in in order to safeguard the interest of its wider industrial policy. Energy policy feeds into that. Affordability at the retail level and competitiveness at the industrial level are high priorities of the government. EDF is a tool at hand.

That ads to the recent negative news on end customer tariffs and the formula revision. The news on tariffs continue negative. I estimate a minor impact, less than 0.5% of group EBITDA for 2014, but EDF’s earnings outlook is clearly all but improving.

There is risk for future adjustments, after this deal has set a precedent. The current wholesale power spot price stands at Eur 24/MWh, and futures are a touch below Eur 42/MWh.

The shares look cheap at a P/E 2015 o 12x vs an average of 14x for the European utilities sector, but the discount reflects political risk that has returned with vigour.

 

E.ON’s Spanish sale

A good bidders list for E.ON’s Spanish assets improves the pricing outlook for E.ON. But the assets will likely go below book value. I estimate a total of up to Eur 1.8bn, vs a book value of Eur 2.7bn. Still, the sale should enable E.ON to come very close to achieving its net debt target. The case is slowly improving, even though investors need patience.

The number of bidders for E.ON’s Spanish assets mentioned in the report by Expansion yesterday is a positive for speed and potentially pricing of the assets. Villa Mir of Spain and EDP are amongst the bidders. Beyond that, there are infrastructure funds on the potential list of bidders.

Given the grid assets, the infrastructure interest is clear. But EDP’s position might also be strong. The combination of trade buyers and infrastructure may overall improve the valuation for E.ON.

Book value of the assets is Eur 2.7bn. But I doubt that that will be achievable. I estimate a realistic fair value in the order of Eur 1.8bn, based on about 6x EV/Ebitda.

At that level, I estimate the company will almost hit its target net debt/Ebitda ratio of 3x. And there will be a reduction in the negative earnings contribution.

The earnings are bottoming very slowly, and investors need patience. But the case is marginally improving.

 

 

 

RWE – a glimpse of sunshine

RWE has entered into a symbiotic marketing partnership with Conergy. It will gain brand equity, whilst Conergy will strengthen its own market position. For RWE, this is a very good deal and a step in the right direction of its strategic reinvention. It will need many more of those.

RWE has entered into a partnership with Conergy for solar roof top system leasing for commercial customers. RWE will market systems of 50-200kw to its customers. Conergy will design and install the systems and components and offer operations and maintenance services.

Solar leasing will see growth in my view, it is a very flexible model. It is already a good part of the US market, and I expect to grow elsewhere.

The deal makes a lot of sense for RWE. It fits with its reshaping strategy towards energy services. The company needs to leverage its customer base to build a portfolio of value added services. Solar is a very important part of that strategy, in my view, utilities will have to have a convincing solar offering within their supply strategy.

With Conergy, RWE has brought on board a very highly recognised brand. That will give it an edge with its German customer base. There has been some taint through the Conergy bankruptcy, but Conergy has recovered. The RWE deal is symbiotic for both parties. It will help strengthening Conergy’s brand again, and RWE will gain brand equity on its own through it.

Conergy is now refinanced and should be able to deliver under the deal with its new structure.

This is a step in the right direction for RWE. In the context of the company’s much larger and long term strategic shift, it is a small step still. Many more need to follow.

Guest comment: Energy Affordability: The Rising Tide on UK Shores

by Dr. Mark Powell, Head of Utilities, AT Kearney

The UK has experienced some of the lowest cost energy in Europe over the past twenty years or so.  Part of the reason for this has been the success of privatization and liberalisation which has driven significant efficiencies in the sector in comparison to the era of state ownership.  This reality has largely been ignored in more recent times as we have increasingly felt the pain of rising costs.  This has placed energy affordability as the centre of the Energy debate.  Everyone us now ganging up to blame everyone else for these rises.  Labour blame the energy companies despite the fact that there is increasing evidence that energy policy and the drive to hit aggressive carbon and renewables targets is also a key reason for costs rising.  Whatever view you hold, one thing is clear, energy affordability is now front and centre as a key issue and is not going to go away and will become a key factor in the future direction the industry takes.

The problem with the debate is that terms like “affordability” and “fuel poverty” are being thrown about without a proper consideration of the facts and figures which surround them.  We thought it was about time we had a proper look at the issue in order to shed some light on this important debate.

From 1978 to 2012, domestic energy prices in the UK have grown by an average of 5% per year for electricity and 6% per year for gas.  These hardly seem excessive although have outstripped the retail price index.  Furthermore, when you compare them to the average gas and electricity prices for Europe as a whole they have been between 20 and 40% lower than the average.  This leads to the first reality of affordability in the UK – we actually pay less for our energy than our European neighbours, the problem is that we consumer more on average than they do so our total bills are, on average, increasingly higher.  The problem, it would seem, is not so much prices as consumption.  We have some of the least efficient housing stock in Europe and, one supposes that our weather does not exactly help either.

We next have to also consider the real income affects as well.  Since the financial crisis households have experienced a decline in real incomes.  This has led to an increase in the proportion of household income spent on energy.  This has risen from an average of 2.8% in 2005/06 to 4.2% in 2011/12. This however hides the more important fact which is that this has affected the lower third of households by a much greater degree with the proportion of their income spent on energy rising from 6.4% to 8.8% in comparison with the top third only experiencing a 1% increase from 1.5% to 2.5%.  The reduction in real incomes has not been experienced evenly across groups such that affordability is much worse at the bottom and this is partly due to real income affects.

It is however the case that energy prices have outstripped most other general costs faced by households.  From 2001 to 2012 the CAGR for RPI was 3.1% while retail gas prices went up by 9.5% and retail electricity by 6.5%.  Interestingly however, despite the ongoing debate about the link between wholesale gas and retail gas and power prices, on average for this period wholesale gas prices increased by 7.2% and so are not that out of step with retail prices across time as many would like to believe. This does support the view that retail prices do largely follow wholesale movements and challenge the automatic assertion that the power companies do not align retail and wholesale prices over time.

Let’s move away from prices for a moment, as I said earlier, prices are one thing, but affordability is also about consumption.  What becomes clear is that affordability would actually be significantly worse had we not experienced a noticeable decline in average electricity and gas consumption which has declined by 2% per year from 2004 to 2014.  If this trend continues then average consumption in 2024 would be 27% less per household.  This starts to demonstrate that consumption reduction will have a greater impact than prices movements over time.

What do we think the picture will be like over the next ten years? Our analysis shows that when price and consumption patterns are taken into account, an average household duel fuel bill will increase from £1,324 in 2013 to £2,012 by 2024.  This is an increase of £680 per household and a rise of 51% over the next ten years.  At an average CAGR of 3.9% this is almost certain to outstrip RPI and lead to affordability becoming worse.

Modelled average residential dual fuel bill – A.T. Kearney base case, 2010-2024 (£/year, Nominal £)

The question is while gas prices have clearly had a large effect on costs in the past few years, what will be driving these increases in the next ten years?  If you break down the bill, what becomes clear is that the single biggest factor driving these costs will be energy policy both at a UK and European level. EU policy costs will drive a CAGR in bills of 7.9% and UK only policy a staggering 16.2%.  This is against wholesale costs which will remain largely static.  If you include all elements of the bill including retail costs and profits and network costs, only 18% of the bill is actually within the control of the individual energy companies.

The projections on bills have assumed that we continue to enjoy the effect of ongoing consumption reductions. What happens if you are unable to enjoy these reductions?  Many household suffer from much poorer housing standards and have less access to new efficient appliances which are driving these reductions.  Our analysis shows that while a dual fuel bill for most would increase by in real terms by 0.6% per year, it would go up by a 6.7% from 2013 to 2024 for those unable to take advantage of ongoing efficiency measures. When you look at all of this across all households, our analysis suggests that without energy efficiency by 2020 up to 80% of All UK households would be spending more than 5% of their household income on gas and electricity.

So where does all of this leave us – there are a few conclusions to draw:

Energy costs are going to continue going up and become less and less affordable with duel fuel bills 52% higher in 2024 than they are today.

The key driver for cost rises over this period is policy costs, at both UK and European level.  Without these costs bills would actually be 2% lower in 2024 than they are now.

There is little that the energy companies can do to change this as only 18% of costs are in their control and very little of the 18% is actually profit.

The real issue for affordability is not prices, it’s the increasing impact of relative efficiency those who are unable to take full advantage of efficiency reductions will see their bills raise massively and the poorest in society will experience a regressive effect as they pay increasingly higher proportions of their income on energy than anyone else.

What this analysis highlights is that we should not be talking generically about “affordability” without understanding the drivers and the facts and economics that underpin what is actually happening.  The UK has had lower than average prices and higher than average consumption profiles than the rest of Europe.  Affordability is much more about consumption management and the costs of greening our system with more expensive renewables than it is about wholesale gas prices and retail profits.

The time has come to have a proper debate on the best way to handle the issue of energy affordability, not to get into tit-for-tat debates about who is to blame.  Affordability is much more complicated than that but it is clear that this issue is not going away anytime soon.  Maybe when it comes to Energy Policy in the UK we need a new debate and a plan B.

RWE: Lignite and the summer trough

RWE is campaigning for its lignite plant to be considered as back up capacity. I think the likelihood of that successfully resolving the profitability issue of the generation business is low. Meanwhile, the summer trough will provide weak pricing and not much else that could support the share price. The only supportive factor is relative shifts of political risk within Europe. The shares trade I line with the sector and I do not see any premium as justified. There is risk of a short term correction after the recent good performance.

RWE is on the path of campaign for its lignite operations. The head of lignite generation has said that the company’s lignite plant will be as flexible as gas in its ability to serve as back up capacity for renewables.

I agree that lignite plant has become much more flexible, and RWE has particularly focused on improving technology with the goal of flexibility over many years now. That has yielded results, by and large thanks to the BoA technology. On operational grounds, lignite may now come close to gas as far as backup ability is concerned. Management claims it can now ramp up and down capacity by 50% within 30 mins, which is in line with gas. There is still another question though, because RWE’s lignite plant I larger in scale than what would be envisaged average plant size for gas.

If the company is looking to position its lignite operations for the capacity scheme under discussion, I see the chances as weak. Politically, lignite is badly perceived. The high emission profile is one reason. The connected open cast mining is another. There is a lot of resistance against that, and the state government of North Rhine Westphalia is looking to reduce lignite mining. It has recently said it is looking for open cast mining to reduce by 300mt by 2030, from currently 1.3bn.

Back to the emissions issue, for the time being, the company benefits from extremely low CO2 costs. But, that may change at any time a follow on regime from the current EUETS comes in. It is hard to predict if and when that will occur, but the downside risk is big. And, any increase in emissions allowance costs will not get reflected in the wholesale power price as that will driven by the soft capacity balance for the foreseeable future. That makes for operational risk of lignite on the cost basis.

Politically, the emissions profile of lignite will make it unacceptable as back up capacity under the capacity scheme, most likely. The company may achieve a temporary inclusion through skilful negotiation. That could be the case if the back up capacity scheme will be designed very broadly and fuel agnostic. At this stage, there is no clear path of that, and indications are that the scheme will be directed towards gas.

I sense that the company is also looking to improve acceptability of its lignite mining operations in order to counter the threat of output reduction. RWE is diligently highlighting employment and the number of local contracts for business it has handed out. The connection to backup capacity is well brought up from a communication stand point and as said above has value. But the stance of the State government which includes the Green party will likely be tough.

RWE has also said that it cannot cope with any further negative impact from the EEG. I agree with that view in the light of the 25% y/y decline of operating earnings in the generation business and the company’s well over 4x net debt/EBITDA ratio.

The lignite campaign may yield limited results at best in my view on either of the target topics, acceptability as back-up fuel, EEG impact reductions, and lignite mining protection. What RWE needs is a complete reshaping, or a material change in the power price outlook. The latter not in sight with futures standing at Eur 35/MWh, the generation business does not set for any improvement. A complete reshaping will take time.

The shares have performed in line with the European utilities sector, and marginal positive news flow has supported performance. RWE trades on a 14x P/E 2015E, in line with the sector. I cannot see any premium for the business vs the sector. The only potential for relative upside is a shift in relative political risk within Europe away from Germany and towards France and the UK (see my recent post – Political risk, published June 2014). The “summer trough” on pricing will not bring any positive news flow, and a short term correction could occur in my view.

EDF – Report from the French and the British front

In the UK, EDF’s negotiations with Chinese nuclear developers may lead to a fully Chinese developed and operated new reactor. That may speed up the new build programme and lead to cost efficiencies. EDF will see comparatively lower profitability with its early reactors compared to the follow-on ones, even though returns are protected by Cfd’s. In France, there are indications of the size of the retroactive tariff adjustment. That may contribute to helping the company getting closer to achieving its guidance in the absence of meaningful tariff increases for 2014, but it won’t completely compensate. I see political risk remaining as an overhang.

EDF is in negotiations with China over the potential sale of one of its sites for nuclear new build in the UK. If negotiations conclude successfully, that could mean a first new nuclear reactor in the UK could get built and operated by Chinese developers.

By the time, the Lancashire reactors come to build stage, Chinese developers that are currently in partnership with EDF will have gone up the experience curve through Hinkley Point. They would transpose their expertise and likely streamline the process further, eventually with the result of a lower cost point.

Competition within the nuclear new build sector will intensify with that. GDF Suez has already proposed a lower cost point for its reactor build than Hinkley Point. Any Chinese new build will lie below that still.

For the sector and UK energy, a decreasing cost point through efficient execution in the project planning and construction phases will be a major benefit. The new build programme may get somewhat closer to ambitious plans than it currently is.

From EDF’s stand point, a sale has a positive cash flow contribution and ease the capex load of the UK nuclear new build programme. By the same token, it however also reduces the benefit of standardisation and scale across the fleet to be built. Profitability will be correspondingly lower. A suite of follow on reactors with lower costs will not be helpful. But the marginal price in the wholesale market will be set by different factors. And the CFD scheme ensures adequate profitability for EDF. Only, other developers will be able to generate higher returns on investment from the programme.

In the meantime, back to France, the retroactive tariff increase ordered by the French Supreme court, may amount to Eur 30/customer. The government is in negotiations with EDF on the matter. Should that amount get confirmed, I estimate a c Eur 900m total EBITDA impact, which could partially make up for the negative impact from the cancellation of the tariff increase due for August this year. But, the full impact will come in this year as the government is looking to spread the adjustment over 18 months. I still see the company’s guidance in danger in the absence of any further meaningful tariff increase in the autumn.

Even if the company hits its guidance, I sense political risk over the new tariff regime and broader intervention in the sector beyond that will prevail as an overhang at least until well into Q3. That will also prevail over UK new build news flow.

 

Fracking in Germany: hard rock

The draft agreement by the German Economy and Environment Ministers propose a moratorium for unconventional gas fracking until 2021, which is on the headline a negative for the industry. But, with continued conventional fracking, the possibility of field trials for unconventional fracking, a possibility for fracking with clean chemicals and mineral rights legislation that in its current form leave some room for development. It is not clear whether this will be the final bill either, it has not been approved by the cabinet yet, and there won’t be a debate before the summer recess.

The German Economy and Environment Ministers have agreed on fracking in a way that is negative for the gas sector.

Fracking will be prohibited for depth of less than 3000m. That rules out by and large all shale resources in Germany. The formations are at depths around 1800-2500m. There will also be prohibition of fracking in any area that is sensitive for drinking water of other health use of mineral and spring water. Fracking will only be allowed if there is no danger for ground water. The ruling will be re-examined in 2021.

Conventional fracking will continue to be allowed. That means no change to current legislation which allows fracking at depths below 5000m. The technology has been in use in Germany for tight gas since the 1950′s.

Initially, the ruling is negative for the unconventional and gas sector in the broader sense. It means there will not be meaningful development of shale resources on a systematic scale in the near future.

But, there are several points to consider in this: Firstly, there will be exceptions that will very likely be issued. The provision for the possibility to allow fracking if there is no danger to ground water leaves room for manoeuvre in terms of exceptions and permitting. The bulk of the resources is in Mecklenburg Pomerania and Lower Saxony where there are large stretches on a relative basis with lower density of population when compared to other areas. There are also formations in North Rhine Westphalia where population density is a greater issue.

The state governments of the States where the majority of the total 2.3tcm of German potential resources are, are pushing for state level legislation, and the relevant states have tried to introduce a legal framework which provides clarity through the means of environmental impact assements. Those states are SPD governed and thus at odds with the SPD Economy Minister, Mr Gabriel. They were looking to pave the way for project development in a publicly palatable way in the this fashion. They will in my view continue to press for development as they are looking to develop the resource and the economic activity that comes with it. They need to counter the decline of conventional gas activity.

Furthermore, there is the possibility in the agreement to allow for fracking if the fracking chemicals are not harmful as far as water safety is concerned. If have recently discussed the development of clean fracking chemicals, specifically destined for the German market under this consideration (see my post ”Germany – cracking for fracking“, published April 2014). The technology is available, and that does open the possibility for deployment under the government agreement.

In addition, legislation, precisely mountain and mineral rights, provides hat licences have to be granted if certain criteria are fulfilled, and there is little room for interpretation. A wider prohibition would mean need for amendment of mineral rights legislation. I consider that unlikely given the CDU’s general position in favour of resource development. Meanwhile, the state level moratoriums of fracking that are in place are illegal on the grounds of existing mineral rights legislation, according to legal experts.

Finally, field trials will be allowed. That is an important provision, because it allows initial exploratory projects.

The real energy crunch in Germany will, according to my calculation, occur from 2021 when I estimate reserve margins will fall to 2%.  I believe gas build will need to be considered by then. It is intriguing to see that that is the timing of the revision of the proposed regulation.

The energy dependency issue has risen up the agenda again with the Ukraine crisis, and the government is looking to develop resources as part of its energy security strategy. The EU Energy commissioner as said Germany should develop its unconventional gas resources which ads some weight to the public debate.

The SPD ministers proposing the rules framework still need to secure cabinet agreement. The CDU is more favourable to fracking, but wary of public opposition. There won’t be any debate before the summer recess. But there may be room for marginal improvement.

All in all, in its current state this is not a very favourable legislation for the industry, but it is one that leaves loopholes and possibilities for a certain amount of initial activity and exploration to occur, with a view to wider development at later stages. It opens room for more than what is currently possible. And the last word is not yet spoken on it.

 

 

Siemens smells gas

Siemens’s statement that it might look for acquisitions in the US to take advantage of growth in the unconventional energy sector should get well received. The company targets the strongest growth sector within energy. It opens the prospect to build up a track record in a synergistic way with its existing energy offering. It enters the quest for service revenues. With that, it not only swiftly addresses potential concerns on it losing out on Alstom; it proactively opens new potentially high margin business and gets on a path to transpose any expertise globally and last not least to Europe. I expect any acquisition to be in mid size territory, in the order of Eur 3-6bn. With that, the focus on the efficiency programme will be undisturbed.
The CEO of Siemens has said he is open to acquisitions in the US gas sector as he sees attractive growth from shale gas.  I agree that the US unconventional sector is a very attractive end market where growth opportunities for equipment manufacturers are plentiful. Beyond that, Siemens is clearly looking for follow-on service contracts that will provide high margin business and long term stable cash flows. Siemens is not alone in the quest for service revenues. It is a feature throughout the sector and driving equipment market share competition.
The GE/Alstom deal may have sharpened Siemens’s focus on gas equipment. Management may now more than ever see the need to add to its global market share, with a very powerful competitor that has gained scale in a significant way. Siemens has also put significant work into the Alstom deal and may have well assessed its strength and weaknesses in the sector Gain, and its ability and willingness for acquisitions.
Management has made it clear before that it can engage in small to mod sized acquisitions. That should not distract from the efficiency programme. The recent acquisition of Rolls Royce’s energy assets is an example.
Siemens has the balance sheet for good sized acquisitions, with cash of Eur 8.5bn, and debt capacity in the order of Eur 8bn, according to my estimate. I would expect the company to use no more than a fraction of that. The Alstom offer would indicate a willingness to look at targets in the order of Eur 3-6bn in size. I gather that fits with the company’s prime focus on reshaping and its ability to integrate a potential acquisition.
Market share gain in the US will be a struggle, with very strong domestic competitors, large and small. The acquisition route of an established name with strong reputational equity will in my view be the only way to make meaningful in roads.
Siemens may also be looking to grow a track record in the US in order to develop expertise and a reputation that it can transpose to Europe and even other regions with unconventional energy development. At the moment, unconventional energy, chiefly gas in Europe is in its very early stages of development. Uncertainty as to how much, with what success and where will be developed is very high. But the many strategig energy challenges Europe faces, to name just security of supply, gas dependence and affordability in this discussion, in my view make for a backdrop where chances are resources will be developed. In my view, it is a correct stratey for Siemens to develop a positioning to build on its energy engineering leadership in the sector. Unconventional energy is a an end market that will see the strongest rate of growth within the energy sector as a whole. Unconventional gas supply will grow by 55% to 2035, according to the IEA. It is a market that the company should seek a global presence in, and US expertise will be the springboard. The company will find itself in competition and cooperation with the energy services sector as it will likely grow its component and service offering towards integrated solutions. That will also mean commodities as an earnings driver will become more important than they already are. Commodity prices drive energy equipment order flow.
I see Siemens’s statement as consistent and likely to be well received.