| http-equiv="Content-Type" content="text/html; | | | | value of their shares. This is possible by preparing |
| charset=utf-8"> | | | | a cost of control account also referred to as a |
| U.K. ELECTRICITY INDUSTRY | | | | capital reserve. |
| A REPORT OF U.K. ELECTRICITY INDUSTRY | | | | Acquisitions require very huge initial cash outlays. |
| EXECUTIVE SUMMARY | | | | When RWE was acquiring the subsidiaries it spent |
| The industry is liberalized with several electricity | | | | billions of dollars for the purchase. Acquisitions |
| firms operating freely in the market. Companies | | | | have led to expansion of customer base in |
| acquire one another without restrictions with the | | | | addition to the production of more energy. This |
| aim of improving their market share. Others | | | | was evident when shanks’ UK landfill was |
| merge with the same objective. Maybe the only | | | | acquired in 2003. Its combination with waste |
| tough government regulation is the EU legislations | | | | recycling group led to the saving of operational |
| on the environment. There are many methods of | | | | costs. It also pushed the group to the top as one |
| generating electricity i.e. power stations, nuclear, | | | | of the highest energy producing company in |
| coal and renewables. Coal is one method that is | | | | Europe. [10] |
| not environmentally friends and the companies | | | | Consequently when an electricity firm is deemed |
| have been warned against emitting harmful | | | | as not well performing, the Par lent Company can |
| emissions to the environment. | | | | decide to dispose it. It can also be as a result of |
| Mergers and acquisitions are associated with many | | | | pursuing waste disposal contracts. This was the |
| financial issues. The financial statements would | | | | case when shanks wanted to dispose UK landfill in |
| have to be prepared on consolidation basis, huge | | | | 2004. However any disposal must get the |
| capital need be set aside and the companies must | | | | approval of the shareholders. The financial issue |
| be ready to successfully grapple with the | | | | related to disposal of subsidiaries is on how to |
| treatment of certain transactions like dividends, | | | | consolidate the disposal in the final accounts. What |
| pre and post acquisition profits. | | | | is more important is the percentage so disposed |
| As much as acquisitions can be beneficial, there | | | | and date of disposal.[11] |
| are also problems associated with it. The investor | | | | Like disposals, it is also important to note the date |
| company and the acquired company may be | | | | a company was acquired and the percentage of |
| incompatible in many aspects. Their policies and | | | | acquisition and whether the acquisition gave rise |
| rules may be a complete contrast as is their | | | | to a subsidiary or associate. It is worth interesting |
| cultural and ethical believes and practices. | | | | that the position of a single entity can change |
| The acquirers then needs to analyze, evaluate the | | | | from that of associates to subsidiary and |
| company to be acquired and only make the | | | | vice-versa. For instance RWE acquired 75% of |
| acquisition plan if only and if the benefits outweigh | | | | tapada in December 2000. This led to an increase |
| the costs.[1] | | | | of the percentage holding from 25%. The financial |
| RESEARCH OBJECTIVES / PROBLEMS POSED | | | | implication here is that W.e.f December 2000; |
| During the research, one of the problems was the | | | | RWE should prepare the accounts of Tapada as |
| reluctance of the firms in being subjected into a | | | | by the regulations governing subsidiaries and not |
| study. Not all the questions were answered some | | | | associates. The consolidation must incorporate the |
| most relevant information could not be obtained | | | | minority interest of 25% (100%-75% in the |
| due to unavoidable circumstances. The cost of | | | | shares of Tapada. It must be noted that minority |
| the research was also underestimated only to be | | | | interest in the profits and other reserves in the |
| found that it is costly affair. | | | | subsidiary is based on the profits as at the end of |
| CONTENTS | | | | the accounting period. But the interest of the |
| 1.0 Background | | | | members of the group is based on the date that |
| The term acquisition refers to a situation where | | | | the company acquired the subsidiary. This is |
| one company purchases the shares in other one | | | | because, this was the date Tapada became a |
| or more companies. This can be through cash or | | | | member of the group. A distinction should also be |
| by issuing its own shares or a loan stock in | | | | made between pre-and post acquisition profits. It |
| exchange of the shares. This method of business | | | | is only the pre-acquisition profits that the holding |
| combination is also referred to as purchase | | | | company is entitled to. |
| method. In an industry, there can be scarce | | | | The treatments of dividends pose a great |
| resources that a firm may exploit but which it | | | | problem when dealing with acquisitions. Dividends |
| cannot singe handedly. Acquisition then becomes | | | | may be received by a holding company from its |
| of essence for the company to capture a wide | | | | subsidiary company out of the pre-acquisitions |
| market and make use of available resources. In | | | | profits or post acquisitions profits. This does not |
| the UK electricity industry, there are a lot of | | | | pose any financial problem. A financial problem |
| government regulations especially the EU | | | | arises of the dividends came from pre-acquisition |
| environmental legislation. This stipulates that | | | | profits. If this is the case, they are credited to |
| companies should be wary of carbon emissions to | | | | investment in shares of the subsidiariary Account |
| the environment. This is likely to lock many of | | | | thereby reducing the cost of control or increasing |
| them that may not have complied with this | | | | capital reserve. If the dividends declared are partly |
| legislation by 2015. A company in the industry can | | | | of pre-acquisition and post acquisition profits then |
| acquire more companies and widen its market | | | | the dividend received is divided into two parts in |
| share as a result of the exit of those companies | | | | proportion to its declaration out of pre-acquisition |
| that would not have complied with regulations.[2] | | | | and post- acquisition profits. The dividends relating |
| In acquisition, companies do not combine. The | | | | to pre-acquisition profits is credited to |
| companies remain independent separate legal | | | | investments account but the dividends relating to |
| entities. However, there may be changes in | | | | the post acquisition profits is credited to profit and |
| control. A company can acquire effective control | | | | loss Account. [12] |
| of another company by owing not less than 25% | | | | 1.3 THE ETHICAL AND CULTURAL ISSUES |
| of the voting power in that company. In the UK | | | | ASSOCIATED WITH ACQUISITIONS. |
| electricity industry, acquisitions fall into three | | | | A company may acquire another company in |
| categories. These are the horizontal structures, | | | | either the same country or from another foreign |
| vertical structures and mixed structures. | | | | country. As much as there can be a difference in |
| The horizontal structure is where one electricity | | | | ethics and culture in another country the same |
| firm owns directly controlling interest in more that | | | | exists within a given country. These ethical and |
| one subsidiary. This may be illustrated as follows | | | | cultural issues if not combated, may negatively |
| for illustrative purposes only. | | | | affect the performance of the group of |
| Interpreted, it would mean that power Gen has | | | | companies. |
| acquired 80% of the controlling interest in EDF, | | | | Companies coming from two different regions |
| 70%in innogy (RWE) and 60% in Scottish power. | | | | would obviously the faced with language problems. |
| The vertical structure is where a parent company | | | | Take for instance the acquisition of transgas by |
| owns directly controlling interest in a subsidiary, | | | | RWE. Transgas is based in the republic of Czech. |
| which in turn owns directly controlling in another | | | | These are two different nations with different |
| company. Assume that power gene acquired | | | | languages. |
| 80% of the shares in EDF. EDF also acquired 60% | | | | Another cultural issue associated with acquisitions |
| of the shares in innogy. This scenario can well be | | | | is the attitudes of the members of both the |
| illustrated as follows: Powergen would have a | | | | investor company and the acquired company. This |
| direct controlling interest in EDF of 80% and has | | | | can either be positive i.e. where the members |
| an indirect arithmetic interest of 48% in innogy | | | | value each other’s positions and roles or |
| (i.e. 80% of 60%). Even though the arithmetic | | | | negative where members undermine each |
| interest of powergen in innogy is less that 50%, | | | | other’s significance in the group. |
| innogy is a sub- subsidiary of powergen. This is | | | | There is also differences in the way processing of |
| because powergen control EDF and EDF control | | | | information is done. Whereas one electricity |
| innogy and therefore by extension, powergen | | | | company has been practicing a centralized |
| controls Innogy.[3] | | | | information processing system, the other may be |
| When a company acquires part of the | | | | decentralizing this function. Companies from |
| shareholding of another, the other part is taken | | | | different nations may be observing different |
| by the minority group and is referred to as | | | | national holidays and how this will be reconciled |
| minority interest. It is called minority interest | | | | after an acquisition is another cultural issue. It may |
| because their holding is usually less than 50% | | | | also be the culture of one company that |
| shares of the company that has been acquired. | | | | shareholders have to get high returns on their |
| As the net assets of a company are financed by | | | | investment with or without profits. The other |
| share capital and reserves so the proportion of | | | | company’s focus would be on divestments |
| the ordinary shares, preference shares and | | | | retaining as much profits as possible. |
| reserves attributable to outsiders is calculated, and | | | | Ethical issues associated with acquisitions are |
| is shown as minority interest on the liabilities | | | | issues like competition. The two firms may be |
| side of the balance sheet of the holding | | | | former competitors now joining forces and |
| company.[4] | | | | forgetting their rivalry. It would be quite interesting |
| One of the challenges of accounting for | | | | to see how the two former rivals would now be |
| acquisitions is on the calculation of minority | | | | working together for a common objective. |
| interest. To obtain the minority interest in EDF and | | | | There is also the issue of down sizing after an |
| innogy the proportion of ordinary shares and that | | | | acquisition. The group may reduce its workforce |
| those of preference shares held by the minority | | | | for operational efficiency. They have to do this |
| will first be established. The amounts are then | | | | professionally to avoid confronting the legal issues |
| added. Then the minority’s share of each | | | | and labour laws the wrong way. |
| reserve (i.e. capital and revenue reserves) in the | | | | After an acquisition has taken place, many |
| subsidiary company is calculated. As the reserves | | | | changes follow and the group starts doing things |
| belong to equity shareholders so the | | | | in a different way. This may be in processing of |
| minority’s share of each reserve depends | | | | electricity, marketing, recruitment and selection, to |
| on the percentage of ordinary shares held by the | | | | name just but a few. In adapting the above |
| outsiders. The minority interest is calculated by | | | | changes, the group must consider doing them |
| adding up the amounts of share capital and | | | | ethically and professionally in a manner not likely |
| reserves attributable to the outsiders.[5] | | | | to injure /harm other companies in the sector. |
| But in the simple illustration above the holdings of | | | | They have to have a fair play as this would also |
| both the parent energy company (powergen) on | | | | safeguard them from unnecessary legal tussles. |
| the subsidiaries, EDF and innogy would be: - | | | | Differences in both ethics are and the culture of |
| Holding in EDF in Innogy Ltd | | | | two different companies can affect their |
| Powergen 80% powergen = 80% X 60% = 48 | | | | performance after a merger. Reconciling these |
| % | | | | differences then by both management is |
| Minority 20% Minority | | | | inevitable. [13] |
| 100% Direct 40% | | | | 1.4 THE OPPORTUNITIES AND BENEFITS OF |
| Indirect (20% X 60%) 12% | | | | ACQUISTION |
| 52% | | | | The acquisitions arising in the electricity industry in |
| 100% | | | | the UK have given the acquirers a competitive |
| The effective interest of powergen in innogy is | | | | edge over the other power producing companies. |
| 60%. The last form of structure of a group is | | | | When Louisville Gas and Electric (LG&E) |
| mixed structures. This is where a parent | | | | acquired the UK energy in 1998, the demand for |
| company owns a controlling interest in atleast one | | | | its electricity rose suddenly to more than 350,000 |
| subsidiary. In addition the parent company and the | | | | customers. The electricity market in the UK is a |
| subsidiary together own controlling interest in | | | | very liberalized market. The price elasticity in the |
| another company. | | | | electricity industry triggers a more than |
| This structure can be illustrated as follows: | | | | proportionate demand, Because acquisitions lead |
| The holdings in the above structure may be | | | | to a reduction in operating costs, costs of |
| computed as follows: - | | | | equipments, reduced labour costs, etc, LG& |
| In EDF | | | | E was able to reduce the price of electricity and |
| Powergen 80% | | | | be able to operate profitably. The end result was |
| Minority 20% | | | | an increase in demand hence high sales turnover |
| 100% | | | | of electricity. For instance after acquiring the UK |
| | | | energy was able to serve more than 300,000 |
| In Innogy | | | | customers with natural gas. It can therefore be |
| Powergen | | | | summarized that an acquisition offers the |
| § Directly 40% | | | | enterprises an opportunity to capitalize on the |
| § Indirectly 24% | | | | responsiveness of their customers to prices |
| (80% X 30%) | | | | changes which are direct consequence of |
| 64% | | | | acquisitions (and mergers). |
| | | | Acquisitions offer the companies a good |
| Minority | | | | opportunity to make use of technology in the |
| § Directly 30% 100% - (40% + 30%) | | | | market. The electricity industry is one that |
| § Indirectly 6% | | | | requires a lot of technological techniques in its |
| (20% X 30%) | | | | manufacture. 3.7% of the UK energy is produced |
| 36% | | | | from nuclear and about 5% is as a result of |
| 100% | | | | renewable energy. An electricity firm can acquire |
| | | | another in order to take advantage of its |
| Even though the arithmetic interest of powergen | | | | diversified technology in the production of |
| in innogy is 64%, the effective interest is actually | | | | electricity. |
| 70%. An arithmetic interest that is more than | | | | Another benefit arising from acquisitions is that |
| 50% does not necessarily imply control. | | | | the combined entities would have a stronger |
| A merger is simple a combination of two or more | | | | market power/ share. The result? — More |
| firms to form a single firm. Like in the UK | | | | investors in the company which shall be the |
| electricity industry, many are companies that | | | | Linchpin for the growth of the company. |
| have merged in the recent past. An example is | | | | Internal growth is a slow process of growth. |
| the merger between RWE and VEW in April 2000. | | | | Internal growth may deplete a company’s |
| The merger resulted in the two companies almost | | | | resources and even affect its liquidity position; |
| dominating the market with duopolistic effects. | | | | owing to the massive resources that would be |
| Now the two companies have a market share of | | | | required. If an electricity company intends to place |
| 70% of the electricity industry in Germany. It is a | | | | reliance on internal growth as opposed to external |
| business combination in which the shareholders of | | | | like acquisitions, chances are that it might be |
| the combining enterprise combine control over, | | | | overtaken by those companies which have |
| the whole, or effectively the whole of their net | | | | embraced acquisitions as a form of growth. |
| assets and operations to achieve a continuing | | | | Internal growth is also barred from becoming a |
| mutual sharing in the risks and benefits attached | | | | success due to an agency of conflict inherent in |
| to the combined entity such that neither party | | | | the management. Management may undertake |
| can be identified as the acquirer.[6] | | | | projects which are only profitable in the short |
| The UK electricity industry is an industry that is | | | | — run to benefit from them only during |
| faced by the threat of new entrants to the | | | | their period in office. A single firm may also not |
| industry. The number of electricity generating | | | | be having a well competent staff to push through |
| firms stand at around 15. In 1990, there were | | | | the growth process. But acquisitions. |
| about three of them. This has the risk of the | | | | Inject new management into the team that would |
| price of electricity declining due to competition. To | | | | steer growth of the group company. Together |
| combat this, two or more companies may unite | | | | with other related benefits such as reduced |
| their interest (merge) with the sole aim of | | | | operating costs and other economies of scale |
| increasing their market power (share). By doing | | | | associated with acquisitions, the process of |
| this, more efforts can then be directed towards | | | | growth is enhanced compared to internal |
| the customer rather than fighting the competitor. | | | | growth.[14] |
| An example was RWE and VEW that merged | | | | 1.5 POST- ACQUISITION PROBLEMS THAT TEND |
| and improved their market share to 70%.[7] | | | | TO PREVENT EXPECTED BENEFITS BEING |
| The shareholders of the combining enterprises join | | | | ACHIEVED. |
| a substantially equal arrangement to share control | | | | One of the problems encountered by most UK |
| over the whole or effectively the whole of their | | | | firms after an acquisition is incompatibility of the |
| net assets and operations. In addition the | | | | investor company and the investee (acquiree). |
| management of the combining enterprises | | | | And this incompatibility is from many areas of |
| participates in the management of the combined | | | | perspective. The policies, rules and procedures |
| entity. A mutual sharing of risks and benefits is | | | | governing the new enterprise are different and |
| usually not possible without substantially equal | | | | reconciling them often meets resistance especially |
| exchange of voting common share between the | | | | from the members of staff. As one company |
| combining enterprises. Such an exchange ensures | | | | can view a given area of social responsibility as |
| that the relative ownership interests of the | | | | beneficial to the organization, another would see it |
| combing enterprises are preserved. | | | | as a cost to the group. For instance, when |
| 1.1 TECHNO — INDUSTRIAL DRIVERS | | | | Powergen purchased Midlands Electricity in |
| FOR ACQUISITIONS AND MERGERS IN THE UK | | | | October 2003, one of the aims of the group was |
| ELECTRICITY INDUSTRY | | | | to satisfy the demand of the customers. It even |
| One of the main drivers that have pushed the UK | | | | provided customers with social services like |
| electricity companies into merging is because of | | | | telecommunication. This decision was met with |
| its associated synergestic effects. Synergy refers | | | | rage and dissatisfaction from the staff of Midlands |
| to the economic (benefits) realized whereby the | | | | who viewed the plan as an unnecessary cost to |
| benefits of the combined firms are higher than | | | | the organization. The acquired company also |
| that of its previously separate firms. Synergy | | | | suffers as a result of policies that are imposed on |
| brings about operating economies. This results | | | | it by the acquirer. These range from — |
| from the benefits due to large scale operations. | | | | adapting of certain specific processing methods |
| This may result from better efficiency in | | | | and production techniques, being forced to acquire |
| management in marketing, production and | | | | additional electricity firms, etc. For instance, when |
| distribution. As a result of merging, the cost of | | | | RWE acquired Innogy in 2002, it also acquired |
| transmitting electricity would likely reduce, as each | | | | Transgas in the same period. They did this |
| company in the merger will only be responsible in | | | | without a full consent of the management allied to |
| supplying electricity in its location and environs | | | | innogy p/c. |
| only. Synergy also leads to financial economies. | | | | Another post — acquisition problem is that |
| These include a lower cost of capital (especially | | | | of little or no co-operation at all between the |
| debt), a greater debt carrying capacity and a | | | | acquirer and the acquired company. Mostly, the |
| higher price-earning ratio. When RWE merged with | | | | management of the investor company tends to |
| VEW in 2000, certain synergestic effects were | | | | intimidate those of the acquired company in |
| evident. These were in Waste Management and | | | | among other areas, the decision — making |
| also in the cross retailing of gas as well as energy. | | | | process. The two firms also suffer from the |
| The other synergestic effect of merging is that | | | | changes that are usually accompanied with |
| of differential management efficiency? This results | | | | acquisitions: These are organizational structure |
| when one firm is relatively inefficient and the | | | | adjustments, changes to rules, policies, regulations |
| merger improves managerial efficiency as well as | | | | and procedures. After an acquisition, the top |
| profitability. For instance, the British Energy | | | | management teams has to change with people |
| (nuclear) may be having an efficient management | | | | losing their previous top positions, employees need |
| thus making it the number one electricity | | | | to be retrained on new production methods and |
| company in the UK.[8] | | | | the marketers have to change to other new |
| In the year 2005 its production capacity was | | | | marketing methods. All these changes normally |
| approximately 9.6 Giggawatts compared to | | | | take a considerable time to be embraced and |
| Scottish and Southern which produced a paltry 5.3 | | | | performance during such a transition period is |
| G.W. This can compel Scottish and Southern to | | | | likely to decline. |
| initiate a merger with the British energy to benefit | | | | With an acquisition, there is also the danger that |
| form its efficient management. | | | | the acquired company may be having certain |
| Another driver related to acquisition is Tax | | | | pending legal suits. The presence of these suits |
| consideration. Highly profitable electricity firms, | | | | would neutralize the benefits that could be derived |
| which pay high corporate taxes, acquire other | | | | from an acquisition. For instance, the electricity |
| companies with large accumulated tax losses that | | | | industry in the UK is an industry surrounded with |
| can be turned into immediate tax savings. A | | | | strict European rules especially regarding |
| merger can also provide an outlet for excess | | | | environmental issues. Many companies find |
| cash without immediate tax considerations. | | | | themselves in difficult legal tussles after an |
| Thirdly, mergers can be driven by the fact that a | | | | acquisition has taken place. Instead of the planned |
| company may be incurring higher costs in | | | | acquisition becoming progressive, it infact |
| replacing its assets compared to the market | | | | becomes a retrogressive exercise.[15] |
| value. To reduce such costs, a merge is | | | | CONCLUSION |
| necessitated. | | | | Mergers and acquisitions have resulted in |
| Apart from the threat of many other firms | | | | economies of scale and synergestic effects for |
| joining the energy industry, individual companies | | | | the UK electricity companies. Increased market |
| are also faced with the threat of hostile takeover | | | | share, greater performance in the stock market |
| by other companies. This has necessitated some | | | | and customer satisfaction are just but some of |
| firms to merge with others to lessen the dangers | | | | the benefits of such combinations. However |
| of being forcefully taken over. These merges are | | | | challenges are also associated with mergers and |
| referred to as defensive mergers and are aimed | | | | acquisitions in the UK electricity industry. For |
| at making the company less vulnerable to a | | | | instance when RWE merged with VEW in April |
| takeover. Managers involved normally argue that | | | | 2000 the benefit was domination of the market |
| synergy rather than their own personal interests | | | | and other synergestic effects like in waste |
| motivated the merger. However many of such | | | | management. However the merger led to more |
| mergers are being designed to benefit the | | | | than 3000 jobs being lost. The firms should also |
| managers rather than the shareholders. [9] | | | | focus on the importance of ethical and cultural fits |
| Some mergers are also driven by the | | | | between them as this may either make the |
| managers’ personal reasons. Many mergers | | | | acquisition/ merger successful or a complete |
| in the sector have been motivated by the | | | | failure. |
| manager’s own reasons for example to | | | | REFERENCES: |
| increase their remunerations power. They are also | | | | Department of Trade and Industry, Government |
| interested in increasing their retirement packages. | | | | of UK ( |
| This is called golden parachute merges. | | | | De Oliveira, Ricardo Gorini and Mauricio Timono |
| Manager’s personal reasons constitute an | | | | Tolmasquim (2004): Regulatory Performance |
| agency conflict if the merger benefits the | | | | Analysis Case Study: Britain’s Electricity |
| managers rather than the shareholders. | | | | Industry’, Energy Policy, Vol 32, No 11, pp |
| 1.2 THE FININCIAL ISSUES ASSOCIATED WITH | | | | 1261-76 |
| ACQUISITIONS | | | | Dubash Navroz and Singh Daljit (2005) Of |
| The first financial effect associated with | | | | Rocks and Hard Places: A Critical Overview of |
| acquisitions is the change in the preparation of | | | | Recent Global Experience with Electricity |
| financial statements. The group would now | | | | Restructuring’, Economic and Political |
| prepare its accounts on a consolidation basis i.e. a | | | | Weekly, Vol XL No 50, December 10-16, |
| consolidated profit and loss account and a | | | | Ernst & Young Report on Electricity Market |
| consolidated balance sheet. For example (RWE) | | | | to the Department of Trade and Industry, UK ( |
| acquired Innogys in 2002.During the same year, | | | | Newbery, David M and Michael G Pollitt (1997): |
| the company acquired Transgas. As from that | | | | The Restructuring and Privatization of the UK |
| year (2002) the group will be preparing | | | | Electricity Supply-Was it Worth It?’ Public |
| consolidated financial statements. Another issue is | | | | Policy for the Private Sector, No 124, World Bank |
| whether the company acquired is a subsidiary or | | | | Porter, Michael: Competitive Strategy, retrieved |
| an associate. Innogy and transgas are subsidiaries | | | | on 29th April, available at |
| of RWE because RWE acquired more than 50% | | | | Thomas Stephen (2005) British Experience of |
| of their shares. Goodwill arising from an acquisition | | | | Electricity Liberalization: A Model for India? |
| must be calculated. Comparing the price at which | | | | Economic and Political Weekly, Vol XL No 50, |
| RWE purchased the subsidiaries and the nominal | | | | December 10-16, 2005. |