U.S. sale highlights risks of E.ON's M+A strategy

FRANKFURT Fri Apr 30, 2010 11:32am EDT

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FRANKFURT (Reuters) - On the face of it, E.ON's $6.7-billion resale of its U.S. unit may appear to be a coup, but the German utility lost money on the deal and has to avoid pricey takeovers in the first place if it wants its shares to shine.

The sale of the Kentucky-based business this week ends one chapter in E.ON's messy acquisition history: several billion-euro takeovers in Britain, Spain and Russia are not paying off and suggest that the group's incoming chief executive has to curb the group's risk appetite.

The two predecessors of Johannes Teyssen, who will head the company from Saturday, spent more than 65 billion euros ($87 billion) on takeovers and made E.ON the world's largest utility by sales, but not by any means an investor favorite.

"It's important for the sector to realize that it's not a growth industry....it seems to be the case that the environment is becoming more difficult and he (Teyssen) has to react to that by making the company simpler," said Raimund Saxinger, a fund manager for Frankfurt Trust who holds E.ON shares.

Some analysts were more direct.

"The record of their takeovers has been disastrous, they have a history of paying too much for assets they are keen to get," said an analyst who asked not to be identified.

"If E.ON was to engage in takeovers again that would be a big reason for me to recommend selling its shares."

The U.S. unit epitomizes E.ON's failures: In 2002 E.ON praised it as "an attractive platform for further growth" -- but two impairment charges within 14 months, amounting to about 2.4 billion euros, reveal it has really been the platform of a shrinking business.

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An impairment charge is an accounting measure that means that the market value of a business has fallen below the value of the asset in the company's books. It does not influence earnings from the business.

SOUR DEALS HIT VALUATION

All but one of E.ON's six takeovers worth several billion euros have turned sour. The U.S. unit just sold was part of its British business which it bought in two steps for a total of 18 billion euros.

The unit has posted falling profits since at least 2007.

E.ON's failure to generate profit growth through its takeovers is reflected in its valuation. The Duesseldorf-based company trades at a 22-percent discount to peers such as GDF Suez and Fortum.

E.ON started its expansion shortly after it was founded in 2000, completing the 15-billion-euro takeover of Powergen in Britain and LG&E in the United States in July 2002.

Since the second half of 2002 it has been valued as much as 40 percent less than its peers, according to research from Redburn Partners.

"This company has been a catastrophe (in terms of takeovers) because of the value destruction," said a London-based analyst.

"Just look at new markets and what contribution they bring in," he said.

E.ON bought into what it calls "new markets" -- France, Spain, Italy and Russia -- for some 16 billion euros. In 2009, they together returned 713 million euros in adjusted earnings before interest and taxes.

ONE LARGE SELL-OFF LEFT

Investors may be glad to see that Teyssen has little leeway left for takeovers.

Rating agencies are putting a greater emphasis on utilities' indebtedness, prompting European utilities to limit their liabilities to below previous levels.

E.ON is in the midst of 24-billion-euro investment programme and had aimed to sell assets to have no more debt than three times earnings before interest, taxes, depreciation and amortization, down from 3.3 times at the end of 2009.

With the sale of LG&E in the United States it has just reached that level, analysts such as Christian Kleindienst from UniCredit estimate, leaving no financing capabilities for new ventures.

And there is a trend to lower debt further. Peer RWE has reduced its target for indebtedness to a ratio of below 3 times EBITDA.

Teyssen might therefore be inclined to sell assets rather than acquire new ones and might have one large deal looming.

One person close to the management of the power provider told Reuters that E.ON was considering selling its 3.5-percent stake in Russian gas monopoly Gazprom.

According to data from Thomson Reuters, the stake is worth 141.3 billion roubles ($4.84 billion).

The company is also in talks with GDF Suez and German local utility holding Thuega to sell its 37-percent stake in Gasag..

(Editing by Sitaraman Shankar)

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