E.ON’s “bad power” spinoff promises little upside

December 1, 2014

By Olaf Storbeck

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

E.ON is coming clean on dirty energy. In a historic move, Germany’s largest utility is exiting conventional generation and bundling unwanted risky assets into a new company to be spun off. The remaining E.ON will concentrate on distribution and green electricity. While both management teams will benefit from focus, this “bad power” spinoff will struggle to offer a tempting investment case.

Chief Executive Johannes Teyssen is facing up to the reality of German energy policy. Berlin’s decision to phase out nuclear power and grow renewable energy, paired with falling demand for electricity, has blasted utilities’ business models. The supply of subsidised electricity from wind turbines and solar panels fed into the grid on a preferred basis has more than tripled since 2003. That has crowded out gas, coal and nuclear and dragged down wholesale electricity prices.

Operating profit from E.ON’s conventional power generation fell by two-thirds between 2010 and 2013. Many of the group’s conventional plants no longer earn their cost of capital. It’s akin to a financial crisis for the power sector. But E.ON’s balance sheet is now more trustworthy than that of a bank loaded with sub-prime securities in 2008: the group took a 4.5 billion euros write-down on Nov. 30.

Demergers usually spell dissynergies as costs are duplicated. Here, the value of dedicated managements is almost certainly worth more given the strategic challenges in power. Both companies operate in entirely different segments of the market. The snag is that there is only so much E.ON can do to make the spin-off attractive to new shareholders. The unit, with an estimated one-third of group EBITDA, could be worth around 10 billion euros. It will take E.ON assets in Brazil and Russia, although these will add currency risk as much as emerging-market sparkle. As a business in run-off, the new company will need a generous dividend to lure income investors. Hence E.ON is keeping debt with the parent. Capex will be low, so cash generation should be healthy in the short term.

It is unclear just how long the cash will continue. Germany wants to drive the share of renewable energy from 25 percent to 45 percent in 2025. Potential new subsidies for conventional power plants for providing back-up capacity could alleviate the pain, although the government has yet to be persuaded. E.ON’s share price reaction – up 4 percent at 14.84 euros – looks overdone.

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