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IssueAlert for  March 26, 2001 

E.ON May Be Closing in on Purchase of Powergen

by Will McNamara 
Director, Electric Industry Analysis

[News item from Reuters] German utility E.ON AG is near a deal to take a 
stake in Britain's fourth largest power utility Powergen (NYSE: PWG) at a 
price 30 percent above current levels. According to the German paper 
Handelsblatt, E.ON's supervisory board reportedly will make a final decision 
in the next week. Powergen, meanwhile, said it is still in talks on a 
possible offer from another company. "There can be no assurance that these 
discussions will result in an offer being made for the company," Powergen 
said in a statement. The company first announced that it was in talks to be 
purchased on Jan. 16. 

Analysis: The word that E.ON, Europe's second largest power company, would 
buy a stake in Powergen at a fat 30-percent premium of around 6.90 pounds 
increased Powergen's British stock price by as much as 7 percent to reach 739 
pence. A combination of the two companies would create a power firm on par 
with Europe's largest power companies, France's EDF and Italy's Enel. Since 
talks about a potential acquisition by E.ON surfaced in January, Powergen's 
stock price has climbed 21 percent. In addition, according to Reuters, 
Powergen jumped to the top of the gainers list for the United Kingdom's FTSE 
100 blue chip index. On March 22, Powergen stock reached 739 pence, while the 
FTSE 1000 index was down 2.5 percent at 27-month lows. Powergen also trades 
in the United States on the New York Stock Exchange, where Powergen shares 
opened March 26 at $42.00. 

If the rumors about Powergen's price tag are true, E.ON would end up paying 
more than nine pounds a share or six billion pounds (U.S. $8.5 billion) for 
the U.K.-based Powergen, which carries a debt of about 5.2 billion pounds. 
These projections exceed previous reports from financial analysts who 
suggested that E.ON would pay no more than eight pounds a share for Powergen. 
E.ON might be feeling increased pressure to finalize a deal with Powergen 
since other players such as Scottish Power have also expressed interest in 
the company. With significant capital to spend (Reuters reported up to $50 
billion including proposed divestitures), E.ON reportedly believes that 
Britain, where demand is outpacing the rest of Europe, is the best country in 
which to begin a rapid expansion strategy. Despite the fact that Powergen had 
previously acknowledged that it was working on a deal with E.ON, over the 
last week it has maintained that discussions continue with other companies.  

E.ON, formed as a result of last year's merger between Veba and Viag, 
supplies Germany and Europe with electricity, heating, natural gas, water and 
petroleum. Germany, which opened 100 percent of its energy market all at once 
in April 1998, has undergone a period of rapid consolidation. As a result, 
the largest power companies in the country have begun seeking competitive 
opportunities across the Continent (this is a growing trend in Europe as 
companies from other countries are following the same competitive strategy). 
E.ON must expand outside of its home country, where analysts have speculated 
that core profits in its generation business have become unstable. In many 
ways, consolidation is a means of survival for E.ON, as Europe continues to 
liberalize and electricity prices fall as a result.  

Powergen*which generates about 14 percent of the electricity used in England 
and Wales and has electric and gas operations throughout Europe, India, Asia 
and Australia*is a company that became known for its global expansion 
efforts, especially in the United States. Just last December, Powergen 
completed a $3.2 billion acquisition of Louisville, Ky.-based LGOEnergy Corp. 
Powergen had wanted for some time to penetrate the U.S. market, as a result 
of consolidation that had taken place in the United Kingdom. The acquisition 
of LGObecame appealing to Powergen because of the U.K. company's desire to 
establish a strong presence in the Midwest market. Altogether, LG&E's two 
utilities and numerous unregulated businesses total about $5 billion in 
assets, which was thought to support any further expansion that Powergen 
might have had in mind.  

Powergen has a market capitalization of $6.66 billion and P/E ratio of 11.02 
(according to Yahoo Finance). However, the company has struggled over the 
last year. Powergen's primary subsidiary, LGOEnergy, saw its profit for 2000 
decline by 4 percent to $497 million from $518 million. As the parent 
company, Powergen saw its profits decline by 12 percent in 2000, to $518 
million from $590 million, although its revenue increased 11 percent to $6 
billion, up from $5.4 billion in 1999. Keep in mind that Powergen's 
acquisition of LGOwas not completed until December 2000, so LG&E's earnings 
will be reflected fully in its parent's financial report starting this year.  

If E.ON were to acquire Powergen, it would gain several strategic advantages. 
E.ON would no longer be reliant solely on the German market, where falling 
prices and continued consolidation limit competitive opportunities. In 
addition, the purchase would give E.ON a hold on generating assets in the 
United Kingdom, and the comparatively low-cost power production, 3.7 million 
customers and various business operations that LGOoffers in the United 
States.  

As noted, Powergen has acknowledged that it has received approaches from E.ON 
and other companies. Based on available reports, those "other companies" are 
most likely RWE (Germany's largest power supplier and a rival of E.ON), 
Vivendi and Suez Lyonnaise (French mega-utilities) and an unnamed American 
power company (Enron or Southern Energy would be my best guess). However, 
word from its management team is that Powergen is not interested in getting 
tied up (as a purchased entity) in merger or acquisition proceedings at this 
time as it may be planning additional purchases of its own in the United 
States.  

On the other hand, the rationale for Powergen to be sold to a company like 
E.ON is taking shape. British restructuring law has forced large generators 
to sell power stations to reduce any likelihood of market power. As a result, 
Powergen has morphed from a pure U.K. generating company to a broad-based 
company engaged in telecommunications, gas, and distribution services. Ed 
Wallis, Powergen's CEO, has stated that presently it has become very 
difficult for Powergen to compete with larger rivals in an enlarged European 
market. As noted, Powergen's strategy over the last year has been one of 
further expansion in the United States, and the purchase of LGOwas perhaps 
more expensive than Powergen had planned. In order to make further U.S. 
acquisitions, Powergen needs adequate capital or equity in order to finance 
the acquisition, something that has become more difficult since its purchase 
of LG&E.  

Nevertheless, if the deal takes place it will require regulatory approval in 
the United States from FERC, the SEC and the Kentucky Public Service 
Commission (among other possible agencies). The climate for U.S. energy 
industry mergers and acquisitions has become rather turbulent in recent 
weeks. Three high-profile mergers (Entergy / FPL Group, Con Edison / 
Northeast Utilities and Sierra Pacific Resources / Portland General) have all 
encountered difficulties that could derail their pending deals. In addition, 
according to a recent report in the Wall Street Journal, announced worldwide 
mergers and acquisitions this year totaled $390.4 billion (as of March 21), 
which is about one-third of the volume during the same period last year. 
Also, about 164 merger deals have been withdrawn from the market, compared 
with 153 deals that were withdrawn for the same period last year, according 
to the WSJ report.  

Analysts that have been closely watching the potential for an E.ON / Powergen 
deal say that Powergen's U.S. operations in LGOcould prove to be a major 
stumbling block for the two companies, and that E.ON may find U.S. regulatory 
requirements to be much more stringent than those in Europe. Specifically, 
the SEC has strict rules regarding what kinds of companies can own public 
utilities (a category into which LGOfalls) and E.ON's diverse, non-power 
operations may send some red flags to American regulators.  Consequently, 
although E.ON appears rather confident that this deal will be completed 
rather soon, Powergen's reported resistance and U.S. regulatory obstacles may 
thwart this yet-to-be-formally-announced partnership.   

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