China $50 Billion Power Goal Leads to Australia: Real M&A

State Grid Corp. of China’s search for as much as $50 billion of international power assets may reveal that Duet Group and Spark Infrastructure Group are among Australia’s most attractive takeover targets.

China’s biggest power distributor last month won regulatory approval to buy Australian assets including almost 20 percent of electricity and gas company SP AusNet. Duet, with a market value of $2.2 billion, and the $1.9 billion Spark may be the next targets because of their regulated, long-term cash flows from gas and electricity assets across Victoria, South Australia and Western Australia, said Morgans Financial Ltd. and Royal Bank of Canada.

Crimped by price caps in China, State Grid is turning overseas, where it says returns from investments can be five times higher than at home. The state-owned company’s 2012 return on invested capital of 3.8 percent trails all but one major listed utility in Asia, according to data compiled by Bloomberg. To boost its returns, State Grid could look for acquisitions in Australia because it’s a relatively safe place to invest, said PricewaterhouseCoopers LLP.

“China has a well-stated ambition to globalize its large enterprises,” said Andrew Parker, a Sydney-based partner at PwC specializing in Asian deals. “There’s a lot of positive attraction about Australia, with a stable economic and political environment and a regulatory regime which is generally understandable and reliable.”

Spark rose 0.9 percent to A$1.63, the highest level in almost six weeks, at the close in Sydney. Duet climbed 1.3 percent to A$2.01, the steepest gain since Dec. 12. The benchmark S&P/ASX 200 Index fell 0.2 percent.

Overseas Push

Beijing-based State Grid says it’s the world’s largest utility and that it has a workforce exceeding 1.5 million. At the end of 2012, it had $16.4 billion of cash and cash equivalents and that year generated $40.4 billion in cash from operations, according to the most recently available data compiled by Bloomberg.

State Grid President Liu Zhenya is seeking as much as $50 billion in international assets by 2020, a goal that’s in line with Premier Li Keqiang’s “going out” policy of acquiring overseas resources. Liu said in November 2012 that overseas assets totaled only $5 billion and that returns on State Grid’s overseas investments have been three times to five times more than from domestic holdings.

“There’s encouragement from the government to go out of China and invest,” Joseph Jacobelli, senior Asia utilities analyst with Bloomberg Industries in Hong Kong, said in a phone interview. “Australia is perceived as a low-risk, attractive environment.”

Regulatory Approval

State Grid, which paid Singapore Power Ltd. A$824 million ($739 million) for 19.9 percent of SP AusNet, will probably seek a larger slice of the Melbourne-based operator of electricity networks, Nathan Lead, a Brisbane-based analyst at Morgans, said by phone. State Grid agreed to buy a stake in Australia’s ElectraNet Pty in 2012.

The Australian government last month approved the SP AusNet investment, as well as the purchase of 60 percent of a closely held business that manages more than A$5 billion of Australian energy assets.

“Australia is open for business, and we welcome foreign investment when it is not contrary to the national interest,” Treasurer Joe Hockey said in a statement at the time.

That approval will give Chinese buyers confidence, said Paul Johnston, a Melbourne-based analyst at RBC.

More deals in Australia are “highly likely,” Johnston said by phone. “It’s the stability of the regulatory regime we have in Australia.”

Duet, Spark

After SP AusNet, Duet and Spark are the next most likely targets, Lead said. Sydney-based Duet’s assets include 80 percent of a natural gas pipeline in Western Australia, and electricity and gas distribution businesses in the southeast, its website shows.

While Johnston agreed that both are potential targets, he said that a takeover of Spark would be more complicated.

Spark, based in Sydney, only owns 49 percent of its three regulated electricity distributors with more than 1.8 million customers. Companies controlled by Asia’s richest man, Li Ka-shing, own the rest, according to Spark’s website.

“It would be attractive to a passive investor,” Johnston said. “It would have to be very much aligned” with how Li’s Cheung Kong Group operates the assets, he said.

State Grid said in an e-mail that it’s drawn to Australia’s “stable regulatory environment, high quality assets and attractive commercial environment.” It declined to comment on other potential acquisitions. Representatives for Spark, Duet and SP AusNet declined to comment.

GrainCorp Blocked

The approval of the SP AusNet investment came after Australian Treasurer Hockey in November blocked a $2 billion takeover of GrainCorp Ltd. by U.S.-based Archer-Daniels-Midland Co. He said that foreign control of the local grain handler wasn’t in the national interest.

There’s little threat to Australia from a Chinese owner of SP AusNet, Duet or Spark, said Adrian Atkins, an analyst at Morningstar Inc. in Sydney.

“The regulator is so heavily involved, setting the tariffs and also ensuring they perform well,” he said by phone. “There’s not much a foreign investor could do to hurt the country.”

In China, State Grid’s revenue is largely capped as the government uses power prices as a tool to keep inflation in check. The government makes every decision from on-grid power tariffs to retail prices, and State Grid is only left with a fixed margin in transmission.

Utility Returns

Compared to publicly-traded utility companies in Asia with market values higher than $5 billion and for which data is available for return on invested capital, closely held State Grid has a lower return than every company aside from Korea Gas Corp. Among the listed companies, the average return is 8.8 percent, according to the most recent data compiled by Bloomberg.

“If you don’t determine how much you get paid and you have to pay for the cost of the goods, there’s not a lot you can do to maximize profits,” said Jacobelli.

Australian power companies are regulated by the Australian Energy Regulator, which determines how much a network operator can charge, usually over a five-year period. That process, where the regulator stipulates a fair return and a fair cost of debt, makes such assets appealing to a large buyer such as State Grid, according to Atkins at Morningstar.

State Assets

“It makes more sense for these assets to go to big, strong players that can access debt and equity cheaply,” he said.

It’s not just publicly-traded utilities that may appeal to State Grid. Electricity assets owned by Australian state governments also are expected to attract Chinese buyers if they are put up for sale, said Parker at PwC.

New South Wales state may opt to sell networks that carry electricity to homes and businesses -- assets known as poles and wires, David Leitch, a Sydney-based analyst at UBS AG, said in a phone interview. A full sale could bring in as much as A$34.5 billion, Infrastructure Partnerships Australia estimated in 2011.

State Grid is also targeting other nations. It has spent more than $7 billion in overseas acquisitions since 2007, including investments in Brazil and the Philippines, according to estimates by UBS last year.

That doesn’t mean State Grid won’t continue to look for more regulated power investments in Australia, said Atkins at Morningstar.

“It makes sense for big companies like that to buy these kinds of assets,” he said. “They’ve dipped their toe in the water here with SP AusNet.”

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