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Fragile Foundation

The capital markets have recovered … or have they?

Fortnightly Magazine - October 2009

the environment stabilizing, and with a growing sense that there will be an economic recovery over the next few years, we are starting to see increased interest in M&A activity.

As companies think about how vulnerable they were in the midst of the crisis—and, for example, as they consider the large amounts of money that must be spent to build large nuclear plants and renewable projects—there will be growing acceptance of the idea that a transaction driven by scale benefits is independently justifiable.

Nastro: M&A deal velocity across all sectors is down versus 2008, a decline of approximately 35 percent in dollar terms and 50 percent by volume. Also, the composition of transactions is changing, with all-cash transactions representing approximately one-third of the deals, which is significantly below historic averages in the range of 60 to 70 percent. Companies are hoarding cash as they continue focusing on balance sheet strength. And premiums for acquisitions have increased significantly, to 53 percent from the historic average of 40 percent, as premiums are being paid against depressed share price levels.

M&A activity is largely correlated to equity markets. During the downturn, companies had to finance acquisitions using their stock, and now that equity markets are open again for new issues, companies are able to finance acquisitions using cash.

Also a number of private infrastructure funds continue looking at opportunities in the utility space. They’ve raised significant amounts of capital they can put to work, and we expect to see more activity from them going forward.

Looking to 2010, M&A activity in the utility industry will be driven by regulated companies continuing to seek scale to finance their cap-ex programs. Size matters, and we’ll likely see mergers of equals to build scale. Of course the regulatory backdrop is important. Given the fact we’re in a rising price environment, regulators may become more receptive to consolidation as a way to reduce potential rate shock for customers. If the synergies in a transaction can offset price increases, regulators might be more likely to approve that transaction without putting on onerous restrictions.

Also companies will continue to shed non-core assets as a way to finance their significant cap-ex programs.

In the merchant power sector, liquidity and funding pressures could be a potential catalyst for consolidation. But credit-rating pressures are limiting the buyer universe. If rating agencies are going to be punitive in how they assess the business risk profile of a merchant generator, you’re less likely to see integrated or hybrid players step in and acquire merchant generators.

Generating assets will continue changing hands, driven in part by liquidity concerns, but many will wait for the perceived bottom to pass before they look to monetize those assets.


Greener Pastures

Fortnightly: What’s the outlook for financing renewable energy projects, given the financial market turmoil and the regulatory changes that have happened in the past year or so? How have these changes affected financing structures?

Redinger, Keybanc : Two things happened in the renewable space. First, a lot of the tax equity players that were in the market don’t have