Just the mention of Elliott Management (henceforth Elliott) strikes fear into the hearts of executives globally; so one could only imagine the worry longstanding SSE CEO Alistair Phillips-Davies felt after hearing Elliott had built a stake in his firm.
Elliott’s infamy originates from its activist investment approach. Led by Paul Singer, Elliott builds stakes in underperforming companies, then pressures management to make changes that will ultimately improve the share price. While Elliott claims most of their investment campaigns proceed without conflict, a significant number have ended in drama. Executives at Athenahealth, Arconic and Citrix Systems have all publicly fallen victim to Elliott’s litigious and aggressive investment approach, now Elliott and Singer have SSE and its executives clearly in their sights.
Elliott’s plan, in this case, is to push for a separation of SSE’s renewable energy portfolio from its regulated electricity transmission and distribution business. Elliott believes SSE’s 4 Giga Watts of wind and hydroelectric power assets are undervalued. Elliott is not alone in this view; RBC Capital Markets’ European Utilities Analyst John Musk described SSE as “undervalued at current levels” and Deepa Venkateswaran, European Utilities Senior Analyst at Bernstein Research, has called for the spin-off SSE’s renewables business since 2019 to “provide a transparent valuation”. In a note from July, Ms Venkateswaran wrote that she believes SSE is “significantly undervalued when we apply transaction multiples”, arguing that SSE’s renewables portfolio is undervalued by as much as half due to the conglomerate discount being applied by investors.
Elliott’s plan to split renewables businesses from traditional utilities has worked numerous times before. Elliott itself pushed the Portuguese utility company EDP to sell a stake in its Iberian electricity distribution unit and offload its Brazilian operations to finance the expansion of EDP’s renewable portfolio. Then Elliott pushed for the renewables arm to list. Now, thanks to a tripling of the share price in three years, this subsidiary is worth more than its parent company. More recently, in July the Spanish infrastructure conglomerate Acciona floated its renewables division to capitalise on the significant long-term valuations in the renewable energy industry. Additionally, Spanish utility giant Iberdrola has said it is studying a spin-off of its own renewables arm “in much detail”.
SSE’s management has opposed the spin-off vehemently, with CEO Alistair Phillips-Davies remarking on the November 17th half-year results investor presentation that “The plan today is absolutely the optimal plan. There is no other plan out there.” Their plan is to run SSE as they have been, with the regulated networks and renewables businesses at the core. Finance Director Gregor Alexander described how this “very deliberate mix of economically regulated and market-based businesses provides resilience against seasonal variability”. The exceptionally still and dry weather conditions across the UK for much of the first half of the year has shown the strength of SSE’s diversification. While the renewables business suffered immensely (with renewable output being 32% below its target, SSE has had to buy-back hedges at higher prices due to higher gas spot prices leading to adjusted EBIT decreasing 82% year-on-year), SSE’s other business like Thermal & Gas Storage have seen strong growth due to the recent market volatility. This has led to the overall adjusted EBIT of SSE increasing 12% and pre-tax profit increasing 30%, showing the benefits of SSE’s business model.
There are also questions surrounding the need to split SSE further. SSE has reorganised its operations in recent years to focus on the core business that stands to benefit from the energy transition; in turn, disposing of non-core assets like its stakes in gas distribution company SGN for £1.2bn and waste-to-energy venture Multifuel for £995m. Therefore, Mr Phillips-Davies argues the logic that had driven others to break themselves up did not apply to SSE. On the half-year results investor presentation Mr Phillips-Davies also argued that the scale SSE will allow it to continue to achieve attractive returns: “Scale is very important, If you’re half the size, you’ll only get half the funding.” He then claims a separate renewables arm would have to sell stakes in projects at a much earlier stage, reducing returns on investments.
Ms Venkateswaran challenges Mr Phillips-Davies rationale. She is “not convinced” by the claim a standalone renewables business could not fund new projects. Danish Ørsted and German RWE have both managed to fund growth despite spinning off regulated electricity businesses. She also objects to SSE’s estimates of £200m up-front separation costs and annual £95m “dis-synergies”. These appear very high, especially in comparison to other companies currently undergoing split. For example, GE estimates the implied annual costs of their three-way split will fall between $150m and $200m annually.
The future of SSE remains to be seen. Despite the clear rejection of Elliott’s plan during the investor presentation, things can still change. Shares traded down 5% after the results were released, signalling a lack of confidence among investors in the direction management want to take the firm. Moreover, Elliott has not commented on SSE at all: the size of their stake and the outcomes of their meetings with SSE’s management and major shareholders are unknown.
Even if the structure of SSE remains the same in the short, there could be an inevitability to a split. Martin Young, Senior Utilities Analyst at Investec wrote in a note that “if SSE is successful in building a global offshore wind business [SSE has more than 15GW of renewable assets in the pipeline], the split question will return to the table”. At that point, the renewable business will be large and mature enough that any of Mr Phillips-Davies concerns around access to funding will be quashed prompting more calls for a split. Ultimately, the potential SSE split demonstrates a key market trend in the utilities sector. The increasing desire to split high growth renewable generation assets from transmission and distribution networks.
By Matthew Brooker
Sector Head: Archit Lal