SSE has announced that the merger of its GB retail supply business with npower has been called off. It was clear that the deal was in trouble back in early November when SSE told the stock market that the terms of the merger were being re-negotiated.
This was always a complex transaction with a high degree of risk. Whilst most commentators focused on the regulatory risk – would Ofgem and the CMA allow the merger and on what terms – the biggest threat to the deal completing was always going to come from the volatility in the supply market.
The deal was particularly complex because it involved SSE and npower merging their supply business to form a new company that would be listed on the stock market. This required three things. First, each company had to agree on the value of the respective supply businesses on the day the terms were agreed. Second, they needed to agree on what the value of the new combined business would be when it was formed. And third, they had to agree on what support each parent company would provide during the creation of the new business, especially in terms of the balance sheet and IT systems.
These are difficult things to agree on even in stable markets, but alas the GB energy retail market is anything but stable. The market is seeing fierce competition and the introduction of the price cap on standard variable tariffs has changed the profit outlook for supply businesses materially. Evidently SSE and npower could no longer agree on the valuation of each other’s supply businesses given the volatility of the market.
So what now for SSE and npower? SSE had intended to fully de-merge its stake in the new merged company and thereby exit the GB supply market. According to the SSE’s stock exchange statement they still intend to exit the market and are reviewing options for their supply business.
SSE’s options essentially boil down to one of three. First, they could de-merge their supply business into a separate entity and list it on the stock market. However, this would not be easy. The business has been losing customers and faces great regulatory and market pressures. Its hard to see investors giving such a business a warm welcome (and decent valuation) unless SSE was willing to bequeath the new company a very strong balance sheet that would tide it over until the market stabilised.
The second option for SSE is a trade sale. Would SSE’s supply business be attractive to either a new entrant – such as an upstream energy company – or perhaps to one of the mid-sized suppliers? For a such a company a deal would be transformative, increasing the size of their business by many times. But would they be willing to take on a legacy business with all the regulatory, IT, and political problems that come along with it? As for a new entrant, Shell acquired First Utility and its possible that they or another upstream energy company could be interested. But what is clear is that, in these circumstances, any potential trade buyer might view SSE’s supply business as a risky proposition and set the price they are willing to pay accordingly.
The third option for SSE would be to recreate the npower merger with another partner. But with the time and expense already expended on the npower deal being wasted its hard to imagine SSE having the patience to follow this route.
As for npower its future is now tied up in the huge and enormously complex asset swap between its parent Innogy and E.ON. It might be that E.ON decides to take npower and merge it with its own supply operations, but will only do so if it believes that npower has enough value to make the cost of doing so worthwhile.
What we are seeing though is the start of a major restructuring of the supply business at both ends of the market. Recently we have seen a number of the smaller new entrants exit the market as their business models got caught out by rising wholesale prices and non-commodity costs. At the top end we are seeing one of the major players in SSE trying to exit and a big question mark over the future of npower. Overall the profit pool available to suppliers is being slashed by the price cap and competition. One thing is certain – more change is coming.