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November 20, 2001



Asset Sale Between TXU and EDF Supports European Strategies of Both Companies



By Will McNamara
Director, Electric Industry Analysis


[News item from PR Newswire] TXU Corp. (NYSE: TXU) has agreed to sell its 2,000 MW coal-fired West Burton power station, near Retford, Nottinghamshire, England, to London Electricity Group for GBP366 million (U.S. $523 million). In another transaction, TXU also announced the sale of Eastern Electricity, its U.K. distribution business, and its 50-percent interest in 24seven, the company that operates and maintains the distribution network, to London Electricity for GBP 1.31 billion (U.S. $1.873 billion). London Electricity, a distribution company that serves three million customers across Britain, is a subsidiary of Electricite de France (EDF), the state-owned and largest energy firm in France. London Electricity already owns the other 50 percent of 24seven. 

Analysis: It's rather rare that an asset sale equally benefits the two energy companies involved in the transaction, but that appears to be the case in this deal between TXU and EDF. Both companies are pursuing different strategies, but they share a common goal of gaining a leading position in their respective niches in the European market. The transfer of both TXU's generating station and the entire distribution business in the United Kingdom to the French conglomerate EDF should help both companies increase market share in their respective markets. The divestiture enables TXU to obtain its goal of accumulating a total of about $2 billion in available capital to grow its energy merchant business across Continental Europe. For EDF, which aims to gain 20 percent of the market in Britain, the sale solidifies the company's position as a leader in the distribution sector and also expands its generation assets (both through its London Electricity subsidiary). Although the deal appears to be a winning transaction for both companies, one stumbling block toward obtaining necessary regulatory approval is the lingering frustration over EDF's expansion in other countries while the French market remains comparatively restricted. 

Before moving on to the individual strategies of TXU and EDF, let's establish what is included in the current transactions. As noted, the sale of the generation assets includes only the coal-fired West Burton plant, for which London Electricity has also agreed to complete the installation of a flue gas desulphurization process. The transaction also includes a long-term contract for TXU to supply the station with coal. TXU Europe's distribution business is actually the largest in the United Kingdom, and includes the assets and wires that deliver electricity through a 56,000-mile network in East Anglia and southeast England. Both transactions must obtain regulatory approval from the European Union, and U.S. regulators may review the sales as well. 

Let's now look at the separate gains that the two companies make in these transactions. 

TXU Corp.
First, it is important to note that the European expansion of Dallas-based TXU Corp. is driven by the company's TXU Europe subsidiary. TXU's divestiture of its U.K. power assets is part of a larger strategy that the company has been pursuing for over a year. In a nutshell, TXU Corp. has sought to gain $2 billion from selling off non-strategic assets owned by TXU Europe to support further growth of the company's core trading and merchant energy businesses across the Continent. In February 2001, TXU Europe announced the sale of its gas-field assets in the North Sea to Consort Resources, which was the first indication that the company was moving away from a hard-asset strategy. TXU believes it only needs to have access to power supply through various contracts to retain its position as a leading power trader in Europe. Toward this end, TXU Europe also recently announced the sale of its 20-percent stake in Spain's Hidroelectrica del Cantabrico. In June, TXU completed the divestiture of its 1,000-MW Rugeley coal-fired power station to International Power. In August, TXU sold two gas-fired power plants in Eastern England, totaling 705 MW, to Centrica, a British gas and home services supplier, for $250 million. 

Under the current sale of its U.K. assets, TXU exits the regulated pipes and wires business in the United Kingdom and gains available capital to support further growth in its trading business across the Continent. Specifically, from both sales TXU reportedly will reach its total of $2 billion in available financial resources and substantially exceed its previously established GBP 1 billion debt-reduction target. In other words, proceeds from the sales reportedly will allow TXU to strengthen its financial position by reducing debt, and TXU says it expects to cut its net debt-to-capital ratio to 55 percent by early 2002. However, the sale of the distribution assets includes a one-time write-off of $150 million that TXU is taking associated with transaction and debt restructuring. The write-off has caused TXU to reduce its 2002 earnings by 39 cents a share. The company now expects to earn between $4.35 to $4.45 a share next year. 

With the divestiture proceeds in hand, TXU Europe's primary business model will remain focused on energy trading, a market in which the company holds a top-three position throughout the Continent. Further, the asset sales extricates TXU from the distribution sector, which it acknowledges is a business that provides lower returns and declining profitability. The bottom line for TXU in this and related sales is to "recycle capital into the faster growing merchant energy business," in the words of TXU Europe's CEO, enabling the company to derive more than three-fourths of its subsequent proceeds from this business. It is important to note that TXU Europe includes generating, trading and retail operations under the larger umbrella of its energy merchant operations. TXU Europe will probably remain involved in Britain's retail market, where the company retains the power-supply contract to serve 5.5 million customers, but the company is no longer interested in the distribution sector of this market. 

Moreover, it is clear that energy trading is now the core of TXU's European operations. TXU Europe holds a trading volume of approximately 600 GWh, and earlier in 2001 the parent company TXU Corp. reported a 75-percent jump in its revenue that was attributed in large part to its energy trading business, both in Europe and the United States. TXU Europe still hopes to control physical assets in Europe, as represented by its purchase this year of a 51-percent state in Germany's Kiel utility, which in terms of volumes and customer base is the ninth largest of hundreds of municipalities in Germany. However, it is clear that TXU is moving out of the U.K. power distribution market and its sights are more clearly focused on Continental Europe. 

Upon the word that the sales would drag down its earnings growth for the next three years, TXU shares fell about 8.5 percent on Nov. 19 to close at $45.59. In early morning trading on Nov. 20, TXU shares were priced at $45.15. However, Wall Street analysts indicate that the sales should increase TXU's long-term attractions because it will presumably be pursuing other acquisitions enabled by these sales. 

Electricite de France
As noted, London Electricity is buying the generation and distribution assets from TXU, but it must be understood that these moves are being driven by the French-government owned Electricite de France, London's Electricity's parent company. EDF, which still maintains a practical monopoly status in France, purchased London Electricity in 1998 for 1.9 million British pounds ($2.72 billion) from Entergy Corp. Based on comments from EDF over the last year, the company plans on expanding its products and services and investing in further strategic alliances to become a multi-energy company. 

In fact, London Electricity acknowledges that the purchases are part of the company's strategy to consolidate its position within the United Kingdom. Thus, while the U.K. market no longer appears to be a core focus of TXU, it obviously holds appeal for other companies that are attempting to gain a market share in Europe. Upon completion of the transactions, EDF / London Electricity will increase its share of the U.K. generation market to 7.5 percent from 4.5 percent, and reduce the gap that currently exists between its market share of generation versus distribution in the United Kingdom. London Electricity already owns the Cottam power station, a 2,000-MW coal-fired generating plant located near the West Burton plant. However, London Electricity will still own far less generation capacity in the United Kingdom when compared to the market leaders Powergen (which controls 10,000 MW) and Innogy (which controls about 8,000 MW). 

Thus, the true focus of these purchases by London Electricity may be on the distribution sector. Upon completion of the transactions, London Electricity will own Britain's largest power distribution network and control about 18 percent of the country's distribution business. Analysts have suggested that EDF overpaid for TXU's West Burton plant (the buying price represented a 26-percent premium over the plant's book value), but got a fair price for the distribution assets. The point here may be that EDF was arguably willing to pay more for the generation assets as it already holds a solid lock on distribution in the United Kingdom and is attempting to expand further by gaining control over generation assets. Representatives from London Electricity have said that the company and its parent want to be one of the top five players in the United Kingdom, and have a goal of gaining 20 percent of market share in the region. London Electricity has been named as a contender for the U.K. supply company Seaboard, which current owner AEP plans to put for sale next year. Seaboard serves around two million customers in England (in the towns of Kent, Sussex and Surrey). 

The involvement in EDF in this U.K. expansion has added a renewed spark to an old debate, namely the growth of EDF into other European countries while competition in France remains comparatively restricted. In other words, EDF has been the target of intense criticism across Europe for the last several years as the governments of other countries and other power firms have argued that EDF has taken advantage of investments abroad while fiercely protecting its own turf. For instance, while Germany has opened 100 percent of its power market to competition, France has opted for a phased-in approach, opening a third each of its power and gas markets by February 2003 and August 2008, respectively. While France remains rather blocked, EDF has freely admitted that it plans to acquire other companies in England, Spain, Italy, and possibly the United States. This dichotomy may become a factor as the current transactions with TXU fall under review of the European Union. 


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