Special Report

Business Strategy and rules for Globalization in the Energy Business Sector
Considerations on the Re-organization of European Electricity and Gas Industry and Policy Perspectives

白石 重明


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Executive Summary

  • The main reasons for the increasing activities toward the re-organization of the European electricity and gas market through international M&A are;
    1. Regulatory Factors: the establishment of general and foreseeable rules for investments
    2. Business Factors: the trend toward creating a common unified European market for electricity and gas
    3. Macroeconomic Factors: economic growth and the abundant liquidity
    4. Environmental Factors: the involvement of renewable energy suppliers to overcome environmental constraints
  • The recent global financial crisis has had deterrent effects on global M&A transactions due to of the following factors; 1) the sluggish equity financing caused by slumping stock prices; 2) increasing difficulties in stock swaps caused by depressed market values; and 3) worsening conditions for debt financing. On the other hand, there are companies seeing the crisis as an opportunity to expand their businesses, such as Gazprom of Russia and RWE of Germany. It means that, in a sense, the global financial crisis has accelerated global M&A activities, along with the slumping stock prices of acquired companies.
  • It is likely that global M&A activities, as a business strategy, will be accelerated over the course of the stabilization of the macro economy. It has been speculated that there could be only three or four utilities in the European electricity and gas market after the M&A wave runs its course. In that sense, global M&A would continue in the future. It will also be the case for the Japanese market from the utilities' perspective, even though the Japanese market has not been seen as an attractive target for M&A because of the following reasons; 1) the return on investment (ROI) is not high enough for M&A due to the responsibility for supplying electricity and gas under the bundled market model; 2) high business risk exists due to the difficulties in putting costs on top of prices; and 3) Japan heavily relies on significantly costly nuclear power.
  • With regard to the ideal rules for global M&A, it is not enough to take into consideration only existing controversies over restrictions on foreign investors, but it will be necessary to look into 1) whether we should emphasize security on an individual company basis (or primarily, whether being affected by a particular shareholder causes any problems or not) and if it is, what kind of tools should be taken to ensure the "security" (e.g. , holding a majority of shares by stable shareholders such as the government, golden shares, or restricted voting rights, etc.); 2) what the rules based on the reciprocity principle should be.

Ⅰ. Introduction

Recently, global M&A has been accelerating the re-organization of the European electricity and gas industry. For instance, E.ON, German's largest power utility, made a bid for Endesa, a Spanish electricity utility, beginning in February 2009, and the bid received much attention as one of the typical cases of industrial re-organization through M&A transactions.

The recent global financial crisis starting in September 2008, however, has been affecting the trend in the re-organization of the European electricity and gas industry. Indeed, it has been realized that investment activities have been restricted by several factors: share prices have been going down; the market environment for financing has changed; and sales for core businesses have decreased. On the other hand, some companies have used M&A transactions to expand their businesses, taking advantage of the global financial crisis.

Based on the current trends described above, this report aims at taking the following steps;

(1) reviewing the reasons for the intensified M&A activities in Europe;
(2) evaluating the effects of the recent global financial crisis on the re-organization of the European power sector;
(3) examining the future trend in global M&A activities; and
(4) considering the ideal policy measures for global M&A.

This report contains publicly available information as well as that provided by members involved in the EU Commission, governments, and power utilities.

Ⅱ. Reasons for accelerated activities in European electricity and gas market reform

The reasons why the European electricity and gas industry re-organization has been active were described in a policy discussion paper, "Background, Trend, and Structure of the European Electricity and Gas Market Reform - Multiple Games by Companies, Countries, and International Organizations." (RIETI Policy Discussion Paper Series 08-P-005)

The paper categorizes the reasons into the following four factors: 1) regulatory factors (the establishment of general and foreseeable rules for investments); 2) business factors (the trend toward creating a common single European electricity and gas market; 3) macroeconomic factors (economic growth and the abundant liquidity); and 4) environmental factors (the involvement of renewable energy suppliers to overcome environmental constraints).

1. Regulatory Factors (the Establishment of General and Foreseeable Rules for Investments)

First of all, the establishment of rules for investments has certainly accelerated the industrial re-organization in the European power sector through international M&A. According to the people involved directly in global M&A, the important element to be addressed is the fact that the rules are established in a foreseeable manner rather than whether the rules really promote cross-border investments or not.

(1) The Free Movement of Capital as Principle

The free movement of capital is recognized as one of the essentials along with goods, persons, and services in order to build an "internal market" in Europe. In fact, Paragraph 2 of Article 14 under the Treaty establishing the European Community describes as follows: the internal market shall comprise an area without internal frontiers in which the free movement of goods, persons, services and capital is ensured in accordance with the provisions of this Treaty.

Furthermore, Paragraph 1 of Article 56 applies the principle of the free movement of capital to any transactions not only within an internal market but also with third countries as it describes, "within the framework of the provisions set out in this chapter, all restrictions on the movement of capital between Member States and between Member States and third countries shall be prohibited." In general, this paragraph is recognized as an enforceable provision by itself.

(2) Exceptional Measures

On the other hand, the Treaty Establishing the European Community allows the following restrictions on capital movement as exceptional cases;

  1. Measures under the Treaty as of 31 December 1993 are effective. Also, even after 1994, the Council may, acting by a qualified majority on a proposal from the Commission, adopt new measures on the movement of capital. (Article 57)
  2. Member States have the right to take measures which are justified on grounds of public policy and public security. (Article 58) This article, however, is seen as a narrowly-defined and stricter than the "public welfare" principle. A judicial precedent established by the European Court of Justice demonstrates this point, which requires new measures to satisfy the following requirements:
    - to be without prejudice;
    - to be transparent and legally treatable;
    - to be appropriate (to make a balance between purposes and means)
  3. Where movements of capital cause serious difficulties for the operation of the EU, the Council, acting by a qualified majority on a proposal from the Commission and after consulting the ECB, may take safeguard measures for a period not exceeding six months. (Article 59)
  4. If an action to interrupt or to reduce economic relations with other countries is taken by the EU, the Council may take the necessary urgent measures on the movement of capital. (Article 60)
  5. Member States shall not be obliged to disclose the information which is the essential interests of national security, and they shall be allowed to take the necessary measures to protect the production of or trade in arms, munitions and war material. (Article 296)

Among the above exceptional circumstances, regarding measures associated with public policy, public security, and national security as described in b. and e., each country, indeed, has dealt with the reality by taking some exceptional measures.

For instance, in France, the Monetary and Financial Code states that financial dealings between France and foreign countries are unrestricted (Article L151-1), while the Government may enact a decree subject to declaration, prior authorization, or inspection of financial dealings for maintaining the national interest. (Article L151-2) Moreover, the Minister for the Economy may order a foreign investor to halt the transaction, if it threatens public order, public safety or national defense interests. (Article L151-3) Furthermore, in 2005, foreign exchange restrictions subject to 11 relevant sectors (targeted at those more than 33.3% of shares) were introduced in response to the risks such as money laundering.

In Germany, the Aussenwirtschaftsgesets declares free movements of capital (Article 1) as well as restrictions on foreign entities holding more than 25% of shares of arms manufacturing companies. (Paragraph 7 of Article 7) Currently, approximately 20 companies are relevant to the paragraph and in addition to them, dual use (for both arms and commercial) manufacturing companies are under dispute.

In the United Kingdom, there is no comprehensive measure with regard to foreign investment restrictions, even though individual restrictions exist; for example, requiring British to hold more than 25% of shares of fishing boats as a condition for their registrations. However, regarding some companies in the military industry such as Rolles Royce, the Government holds their golden shares and implements several measures.

As described above, there are exceptional measures for global M&A and many countries have paid attention to it, particularly in the electricity and gas sector due to energy security. According to the author's interviews with global M&A professionals, however, it is realized that investment activities have become more feasible thanks to the clarification of the rules, even though they impose some restrictions. Therefore, the establishment of the clear and stable rules has enhanced the predictability of acquisitions and accelerated the re-organization of European electricity and gas industry through global M&A.

(3) The TOB Directive of the EU Commission

In addition to the above measures ordered by sovereign nations, the improvement of the rules as to how defenses against acquisitions should be dealt with has accelerated global M&A.

The EU Commission, which declares the free movement of capital, has discussed rules for M&A. In 2004, it enacted "Takeover Bids Directive - Directive 2004/25/EC of the European Parliament and of the Council of 21 April on takeover bids" and required Member States to conform national laws to the Directive.

Over the course of its policy-making process, each member state discussed the roles of corporate defense against acquisitions rather than government regulations, and it took twenty years to reach a final consensus.

The reasons for taking such a long time to adjust conflicts would be 1) the essential deference between the common law emphasizing shareholders and the continental law interpreting a company as a social value from the legal perspective, and 2) the conflict between parties favorable to a certain degree of order and parties desiring more M&A activities from the economic perspective. Furthermore, during discussions, there was a rumor about a plan of the Ford Company to acquire Volkswagen, and also, there was an announcement of the plan of EDF, a French company, to acquire the ENEL, an Italian company; in some senses, these individual cases affected the controversies regarding the Directive. After many years of discussions, the TOB Directive was enacted in a politically compromised form.

The important aspects of the Directive are described as below.

a. Board neutrality rule

The board of the offered company acquiring information about takeover bids shall obtain the prior authorization of the general meeting of shareholders before deploying any post-bid defensive measures. (Article 9) This imposes a neutral responsibility and respects the principle of democracy of shareholders.

b. Breakthrough rule

Any pre-bid defenses such as any restrictions on the transfer of securities or on voting rights in the articles of association of the offeree company shall not apply vis-à-vis the offeror during the time allowed for acceptance of the bid. (Article 11) This rule, however, reclaims the one share-one vote principle and shall not apply to preferred shares which do not have voting rights and should be restricted on in exchange of economic benefits. This rule is also recognized as a radical tool of TOB within the EU Commission.

c. Opt-out/out-in

Since the above two rules were difficult to arrange, their implementation are options as products of political compromises (Article 12). First of all, Member States have the authority on choice with regard to legislation of the two rules (opt-out). Second, the company may be allowed to follow the EU Directive based on the resolution of amendment of the articles of association in case the member state where the company is located violates the Directive (opt-in).

d. Reciprocity rule

Member States may exempt companies which apply the Board neutrality rule and/or the Breakthrough rule from applying the two rules, if they become the subject of an offer launched by a company which does not apply the two rules (Paragraph 3 of Article 12). This paragraph requires the votes at the general meeting of shareholders, regardless of whether the rules apply is due to national law or opt-in by an individual company. Moreover, this rule is the important starting point to consider how the rules for global M&A should be in the future as analyzed later in this paper.

Member States developed national laws in response to the TOB Directive as described above. The Board neutrality rule applies to eighteen countries, within which seventeen countries had already had the rules similar to the Directive before the TOB Directive was enacted. (Malta is the only country not having had any similar rules before.)

With regard to the Breakthrough rule, only the Baltic States have signed it, and the only way is to be voluntarily adopted by an individual company. However, there will be few cases where the Breakthrough rule causes problems, because Baltic States hold less than 1% of the total capital of the EU.

Finally, although rules for TOB do not necessarily foster M&A, the establishment of well-defined rules by EU Member States would help M&A activities become more predictable and, in part, enhance the re-organization of European electricity and gas industry.

2. Business Factors (the Trend Toward Creating A Common European Electricity and Gas Market)

Activities toward the creation of a common unified European electricity and gas market have been dramatically changing its business environment, which have accelerated the re-organization of utility industry through global M&A in Europe. This is a typical dynamism recognized as the "2R-2R Model," which explains that corporate strategy evolves cyclically between "2R as a base of company's strategy = corporate resource and risk" and "2R as a strategic action of a company = redefinition and relocation of business" (2R-2R Model: see "Structure of Economic Globalization: Multiple games among firms, sovereign states, and international organizations" RIETI Discussion Paper Series 08-J-037). This paper will particularly focus its discussions on the electricity sector.

(1) Activities of the EU Commission toward a European internal market

The EU Commission has fostered activities toward a European internal unified market since the EU Electricity Directive was enacted in 1996.

More specifically, the Directive 1996 forced Member States to deregulate at least 32% of the nation's electricity market by 2030 and to impose on vertically-integrated utilities an obligation of unbundling accounting between each sector of generation, transmission, and distribution. Furthermore, the 2003 amendment of the Directive required them to liberalize the electricity retail market of each country (approximately 60%) other than the residential sector by July 2004, to completely liberalize the retail market by July 2007, and to unbundle the transmission and distribution network owners from the legal, organizational, and decision-making points of view.

With regard to the amended Directive, however, Member States were obliged, but could not meet the deadline, July 1st 2004, to legislate it internally. In this respect, the EU Commission showed its strict stance on its electricity policy, issuing warnings and filing suit with the European Court of Justice (Court of Justice of the European Committee) against Estonia, Greece, Ireland, Luxemburg, and Spain. The full liberalization of the electricity sector ordered by the amended Directive was, in fact, achieved by July 2007.

Furthermore, in addition to the Directive, more detailed measures are implemented; the Trans-European Energy Networks project was conducted with an aim to help improve international interconnection network capacity and enact preferential subsidies for building international interconnection networks.

These activities are partly involved in the European energy strategy aiming at a "sustainable, competitive, and stable supply of electricity."

While the EU Commission was doing so, specific projects to integrate different markets were also increasingly implemented. In particular, one of the key projects was "the Electricity Regional Initiative" led by the European Regulator Group of Electricity and Gas (ERGEG). This initiative aims to develop regional electricity markets as the first step toward the creation of a common European electricity market within the EU; the Baltic, Central Eastern Europe, Central Western Europe, Northern Europe, Southern Europe, and the England/Ireland regions. (Some areas are covered by more than one defined region.) Currently, issues such as interconnection networks and the adjustment of supply and demand are discussed respectively in each region.

Tied with such an initiative, parts of the markets have been already integrated. For instance, the electricity markets in France, Belgium, and the Netherlands are called TLC, of which operation has already started on January 1st, 2006. The market integration at Iberia peninsula led by Portugal and Spain is called MIBEL, of which operation started on July 1st, 2007.

(2) The Third Directive (Plan)

While the market liberalization was expected to help create a common European market, its creation through competition, in fact, faced many barriers. The fundamental problems are described as follows in the order of the EU Commission's perspectives.

a. Market Control Power by Large Utilities

Although the liberalization of regional markets has been partly achieved, the market is, in reality, concentrated in many regions due to the market power of large utilities.

b. Lack of Capacity at the International Interconnection Networks

The capacity of the international interconnection lines is not enough, which is a technical barrier and would prevent the market from accelerating its integration. This is because the strategy for promoting investments in interconnection lines is not appropriate.

c. Barriers to Full Competition due to Incomplete Unbundling

While the transmission and distribution sectors are unbundled at the legal level, they are not unbundled at the ownership level; the unbundling is not complete and this causes ineffective competition in the market.

In order to solve these problems and help enforce competition in the market, the EU Commission enacted the Third Directive in September 2007, which is currently under adjustment at the European Parliament and the European Council.

The Third Directive contains several elements; in particular, the application of ownership unbundling is one of the largest points to be proposed. (However, it is permitted to fully entrust the ISO (Independent System Operator) to manage the properties when owned by the ISO itself.) Ownership unbundling forces electricity generators operating within the EU not to own their networks, because ownership unbundling applies to all networks within the EU. Moreover, this requirement applies to non-Member States. Therefore, business strategies of utilities are largely affected in this respect as well as the overall trend in the creation of a common European electricity market.

(3) The Impacts of the EU Commission's Competition Policies

While competition policies not only focus on the electricity and gas market, the EU's competition policies would have affected the recent market reform in the European electricity and gas market.

EU competition policies have their fundamental legal basis in Article 81 (Restrictions on cartels) and Article 82 (Restrictions on market power) of the Treaty Establishing the European Community.

The EU enforces its stance toward cartels by implementing the Leniency program (a policy to dissolve cartels, providing for the exemption or the reduction of duties for a party if it cooperates with the Directorate-General for Competition, confessing an involvement with cartels and submitting evidence) or by significantly increasing duties.

Under the circumstances, it is pointed that M&A transactions would be conducted as a means of reducing competitors in order to reduce the risk of cartels being detected. Indeed, there may be a risk of violating Article 82, when an M&A transaction succeeds and as a result, an acquiring company obtains a dominant market power. M&A, however, attracts companies as one of the corporate strategies due to the prior authorization of mergers and the gradual change in the way of implementing Article 82 from the existing way, looking at types of violations, to a new way, looking at the actual effect of M&A on the market.

Toward the creation of a common European market, the EU Commission has shown its stance favorable to global M&A in the electricity and gas market. For example, the EU Commission welcomed the plan of E.ON, a German utility, to acquire Endesa, a Spanish utility, or the plan of Iberdrola, a Spanish utility, to buy Scottish Power, a British utility. These events also foster the re-organization of the electricity and gas industry in Europe through M&A.

3. Macroeconomic Factors (Economic Growth and the Abundant Liquidity)

Macroeconomics is also one of the factors to accelerate the re-organization of the European electricity and gas industry. The two important elements from the macroeconomic perspective would be that (1) the increasing demand in electricity and gas seems to be a new business opportunity under the steady economic growth in Europe and (2) the abundant liquidity necessary for financing M&A exists.

(1) Steady Economic Growth in Europe

The European economy has been successfully growing over the years by expanding the number of Member States of the EU and by introducing the Euro currency. When it comes to the growth rates of GDP over the five years in 27 Member States of the EU, many of the industrialized countries experienced negative growth rates between 1995 and 2000 as shown in Table below. (On the contrary, all of the developing countries except Bulgaria and Slovenia recorded positive growth rates during the same period of time.)

The world's growth rate, however, reached 6.44% between 2000 and 2005, whereas all of the Member States experienced the higher growth rates. In particular, not only the developing countries but also the industrialized countries showed higher average growth rates.

During the same period of time, the US's average growth rate recorded 4.88% and the Japan's rate was - 0.51%, which implies that the European economy at that time was very strong.

Table: GDP Average Growth Rates of the EU 27 countries, 1995-2000, 2000-2005
France-3.299.98Czech Republic0.5216.93
Luxembourg-0.412.52Slovak Republic0.7318.33

It is no doubt that the strong economy affected the re-organization of the European electricity and gas industry. The ways of affecting the market are categorized below. The strong economy:

  1. expanded business due to the increase in electricity demand in accordance with the economic growth;
  2. provided new business opportunities in Eastern Europe due to the increase in demand in developing energy infrastructure in the East as the EU expands its territory from west to east (It is realized that investment in Eastern regions is necessary to foster the economic growth in the East and to restrict migration to Western regions.); and
  3. increased revenues, on the other hand, as the electricity demand increases, and raised investment funds for expanding businesses.

(2) Abundant Liquidity

Coupled with the booming European economy, liquidity is so generously supplied to the region that financing for M&A becomes easier and, therefore, global M&A is accelerated.

4. Environmental Factors (the Involvement of Renewable Energy Suppliers to Overcome Environmental Constraints)

In Europe, environmental issues have received much attention and therefore, they are recognized as a corporate social responsibility as well as an issue affecting business performance. In particular, electricity generation produces a significant amount of CO2 emissions, which would be almost the same level of CO2 emissions as the steel and the chemical industries. Therefore, emissions reduction should be seriously addressed.

Electric utilities in Europe have attempted to acquire utilities owning a lot of renewable energy generation such as wind power to reduce CO2 emissions per unit of electric output.

The acquisition of Scottish Power (United Kingdom) by Iberdrola (Spain) for 11.6 billion pounds is one example; the fact that Scottish Power owned wind power generation in the United Kingdom and the United States was one of the determining factors for the acquisition. The other example is that E.ON (Germany) acquired wind power generators in Spain and Portugal owned by DONG Energy (Denmark) for EUR 722 million in August 2007.

In the future, the environmental issues will be addressed more seriously in such a way that could affect companies' business performance. As a result, they will accelerate acquisitions of renewable energy generators through M&A transactions or asset purchases. Indeed, renewable energy generation is expected to be one of the solutions for meeting the increasing energy demand in Eastern Europe, and for that purpose, new investment plans are already under discussion.

Ⅲ. The Impact of the Global Financial Crisis

Needless to say, the global financial crisis impacts businesses in the electricity and gas market in various forms, and this chapter will focus on the issues relevant to M&A.

1. The Impact of Falling Stock Prices

Since the so-called Lehman-shock happened on September 15th 2008, the stock prices of large European electricity and gas utilities have continued declining in 2009, after crashing on October 10th 2008 and October 28th 2008. For instance, the stock price of E.ON, a large German utility, has remained 25% below its level before the Lehman-shock.

Such a decline in stock prices raises the cost of equity, and in fact, many utilities are inclined to rely on debt financing. For instance, the trend in debt financing by E.ON and EDF after the Lehman-shock is described in the Table below.

Company Issue Date of Debt Issue Price of Debt Duration Interest Rate
E.ON2008.11.17EUR 1 billion2 years4.75
2008.11.17CHF 0.25 billion4 years3.875
2009.1.8EUR 1.5 billion7 years5.5
2009.1.15CHF 0.4 billion5 years3.375
2009.1.15GBP 0.35 billion5 years5.125
2009.1.15GBP 0.7 billion30 years6.75
2009.1.21EUR 1.75billion5 years4.875
EDF2008.11.19EUR 2 billion4 years and 2 months5.625
2008.11.28CHF 1 billion5 years3.375
2009.1.16EUR 2 billion6 years5.125
2009.1.16EUR 2 billion12 years6.25
2009.1.22USD 1.25 billion5 years5.5
2009.1.22USD 2 billion10 years6.5
2009.1.22USD 1.75 billion30 years6.95

Since it is believed that debt financing is not the best way of raising capital for M&A, declined stock prices which result in equity financing being difficult (in turn, forcing a reliance on debt financing) restrict M&A activities.

Furthermore, the declined stock prices obviously wreak havoc on corporate market values. Indeed, the following graph represents the market values of selected companies in February 2009, compared to those in August 2008 (before the Lehman-shock).

Graph: The Market Values of the Selected Companies, EUR (Billion)Graph: The Market Values of the Selected Companies, EUR (Billion)

The declined stock prices which the market has experienced during the crisis also result in the application of non-cash methods of M&A, such as stock exchanges, being difficult. In other words, M&A activities may be restricted in the following manner: the stock prices decline → the market values fall → stock exchanges become difficult.

2. The Changes in the Debt Financing Environment

When it comes to M&A by debt financing, M&A is restricted, because the cost of debt is increasing.

For instance, long-term corporate credit ratings on Europe's large electricity and gas utilities have been downgraded; as of January 2009, the ratings are A2(Moodys) and A(S&P) for E.ON, Aa3(Moodys) and A+(S&P) for EDF, A2(Moodys) and A-(S&P) for ENEL, and A1(Moodys) and A(S&P) for RWE.

Indeed, the transition from equity financing to debt financing, which is observed in the market, is not necessarily in favor of the latter in terms of interest rates for financing. In this respect, M&A activity should decrease.

3. The Impacts on the Acceleration of M&A

On the other hand, the global financial crisis has, in part, fostered M&A activities. Challenges which competitors' managements are facing are opportunities for a company to expand its market share. Even though it is difficult to raise funds, it is possible for a company holding abundant short-term liquidity to expand its market share. In addition, depressed market values of acquired companies attract M&A activities, because such companies could be purchased for less a costly price.

Taking into consideration the trend described before, Gazprom, a Russian utility will expand its business, looking at global M&A. In February 2009, Kruglow, Deputy Chairman of Gazprom's Management Committee (Head of Gazprom's Finance and Economics Department), implied that the company would seek large assets and M&A as a means to expand its business during this economic downturn. In that respect, participants' perspectives are not in line, but the European Commission suspects that Gazprom would possibly seek opportunities for M&A, to which the Commission should pay attention. In particular, one of the reasons why the company is paid attention may be the fact that it has a strong presence as well as its role as an important player in the Russian government's policies not only inside but also outside of Russia. This aspect should also be addressed for the future, not only by European countries but also by the Japanese government as well as Japanese companies.

Furthermore, in December 2008, RWE, a German utility, announced the expansion of its market share by investing EUR 80 billion over the next ten years. After that, the RWE actually acquired Essent, a large electric utility of the Netherlands, for EUR 9.3 billion in total in January 2009. As a result, RWE became the fourth largest utility in Europe on a sales basis. This case shows global M&A is recognized as a means of corporate strategy and utilized effectively to leverage the financial crisis. Global M&A as a means of corporate strategy will be attempted in the future as well.

Ⅳ. The Future Prospects of Global M&A

In the previous chapters, we have seen that the global financial crisis overall restricts global M&A even though it continues to be utilized effectively as a means of corporate business strategy. What will the future hold? In this chapter, we will focus on issues relevant to electricity and gas utilities.

1. Macroeconomic Environment and Business Strategy

(1) Macroeconomic Environment

Needless to say, the future trend in global M&A will be affected by the macro economy. Here the key question is how long the current financial crisis will continue. Although there is still uncertainty, the overall economy has become stable and therefore, it is expected to recover in 2010.

Indeed, the stock price behavior in each country/region as an indicator implies the economy will recover by the summer of 2009, possibly enough to buoy stock prices again.

However, since the trend above is supported by government policies including emergent measures, its sustainability should be doubted. Therefore, the future must be carefully observed.

(2) Business Strategy

According to unofficial interviews with people involved in or close to the EU Commission, the electricity and gas suppliers in Europe will be or should be amalgamated into three or four companies.

Such a perspective is widely realized among the suppliers. Also, based on this perception, some officials are expecting a national supplier to become one of the winners.

Under this general understanding, coupled with the recent global financial crisis, market reform through global M&A remains stagnant, because the several factors described in the previous chapters restrict M&A and those involved spend too much time on the responses to the crisis to leverage the crisis for market reform. However, as stated before, some parties are attempting market reform anyway, seeing the crisis as an opportunity as the situation stabilizes.

Global M&A as a means of business strategy will be more popular over the course of the recovery from the recent global financial crisis.

2. M&A Associated With Japan's Electricity and Gas Utilities

(1) The Reasons For The Perspective That Japan's Electricity and Gas Utilities Would Not Easily Attract M&A

It is widely seen that it will be difficult for foreign companies to acquire Japan's electricity and gas utilities.

The first reason is that the market is not attractive because high returns on investment will not be expected under the present regulatory system, where all of the three sectors, generation, transmission, and distribution, are unbundled and, therefore, utilities have to be responsible for electricity supply completely. In fact, the best possible way of investment in the electricity sector would be that an acquiring company divides regulated sectors (transmission and distribution sectors) and liberalized sectors (generation, wholesale, and retailing sectors), consolidates all debts in the regulated sectors, and sells the business in liberalized sectors at a higher price. Under the present regulatory system in Japan, such a strategy is unrealistic, because it is believed that since the profitability of the power sector is subtle, a few percentage points, the benefits of utility acquisition would be quite small.

The second reason is business risk. With regard to electricity prices, while the changes in fuel prices can be passed on to consumers, it is practically difficult to pass on other costs such as those resulting from accidents at nuclear power plants to them. Indeed, there was no increase in electricity prices due to the huge losses caused by stopping the Kashiwazaki-Kariwa nuclear power plants operated by Tokyo Electric Company after the Mid Niigata Prefecture Earthquake.

The third reason is that Japan's electricity utilities heavily rely on nuclear power. Nuclear power plants require significant investments from the economic perspective, imposing disaster risks. Also, once plants are built, significant investments for the plants become sunk costs.

The fourth reason is that there is an actual case that an attempt by a British investment fund to acquire J-Power turned out to fail finally, because of foreign investment restrictions ordered based upon the Foreign Exchange and Foreign Trade Act. In this case, the Government did not permit the investment fund to own electric power substations for transmission networks and interconnection lines or to increase investments in J-Power because of the construction plans for nuclear power plants. As a result, this case raises concerns about corporate management being in line with a nation's policies pursuing national security in a broad sense.

The four reasons organized above are subject to the electricity market. However, they will be more or less relevant to the gas market. Overall, it will be less likely that the Japanese power sector is targeted for M&A due to the present regulatory system of the electricity and gas sectors as well as the uniqueness of their businesses.

(2) Interests of M&A Toward Japan's Electricity and Gas Utilities

According to the interviews, however, there seemed to be a European company attempting to acquire Japan's electricity and gas utilities at least before the current global financial crisis. The possible reasons for the attempt are categorized below.

First of all, while investment funds are concerned about benefits for M&A, Japan's utilities may be attractive to a utility that also operates in the same business sectors, because business in these sectors in Japan is highly expected to be stably profitable and it is possible for the acquiring utility to improve the profitability by introducing its own know-how.

Second, while the business risk certainly exists, it may be a relative value to a utility which has already operated a similar business in Europe.

Third, the sunk costs at the existing nuclear power plants will certainly be remunerated unless new investments are done, which will be relevant to the first reason.

Fourth, regarding the case of J-Power, the M&A transaction attempted by the British investment fund was not allowed by the Japanese government due to concerns about national security in a broad sense. However, it will be possible to purchase Japan's electricity and gas utilities, if an acquiring company is a qualified utility.

In addition to those, there are other reasons for the interest in the acquisition of Japan's power businesses: economy of scale exists from the viewpoint of fuel procurement; Japanese stock prices could become cheaper than expected, depending on trends in stock prices and foreign exchange rates.

Furthermore, the recent global financial crisis has accelerated internal reformation of each company through global M&A as a means of corporate strategy. Therefore, it will not be less likely than discussed in general that global M&A activities targeting Japan's electricity and gas businesses are attempted in the future.

Ⅴ. The Nature of Rules for Global M&A

1. Global M&A and Restrictions on Foreign Investment

The nature of rules for global M&A has been discussed, mainly in terms of restrictions on foreign investment in response to national security. For example, in the case of J-Power or in restrictions on foreign investment in airports, the key issue is what restrictions on foreign investment should be. Indeed, the Japanese government included the statement, "the government shall widely examine the issues on restrictions on foreign investment," in the Basic Reform Program (2008).

National security issues are recognized as problems between nations pursuing national interests based on the principle of realism, whereas cross-border capital movements are based on the idea of pursuing economic efficiency through efficient resource allocation at the international level (equal allocation of marginal productivity = maximization of profits from a corporate perspective). It implies that the issue of restrictions on foreign investment is a product from the conflict between two phenomena, each of which is based on a completely different principle.

To ensure national security, however, restrictions on foreign investment are not enough. Indeed, there is a case where the capital structure of a particular company is important from a viewpoint of national security in a broad sense which cannot be secured by behavior regulations or use of force by government power. For example, with a particular political intention, an authority or management lowers the position of a particular internal airport in the global market by incompletely investing in the airport. In this case, it is difficult to oblige the authority to take more aggressive actions such as investing in the airport significantly, and as a result, a national policy aimed at making Japan's airport an international hub is prevented by a particular political intention.

The order of TCI halting investment in J-Power resulted from the prohibition of the ownership of substations for transmission networks and interconnection lines and the construction plans for nuclear power plants. Although the order did not result from TCI's political intention, it actually represented concerns about whether corporate management is really able to be in line with national policies for national security in a broad sense.

Whether the important thing regarding this issue is that the shareholder having a particular political intention (or an intention opposite to national policies) is foreign or not is unclear.

In the case of J-Power, if the acquiring party was not a foreign company but a domestic investment fund on a legal basis, the government would have not been able to restrict its attempt based on the Foreign Exchange and Foreign Trade Act. However, as far as looking at the evidence which the government showed based on the Foreign Exchange and Foreign Trade Act, the Act would apply to a domestic investment fund.

The reason why foreign companies are wary is that national security is traditionally recognized as an issue between sovereign nations and there are companies (including so-called investment funds), which seem to follow a particular political intention.

2. Measures for a National Security Alternative to Restrictions on Foreign Investment

Based on the above aspects, solutions to the national security issue would be (1) to identify companies important to the country in terms of national security in a broad sense and (2) to adapt a regulatory system which ensures national security on an individual company basis.

In Europe, for instance, the French government owns 85% of the shares of EDF, although EDF is a public open company. Also, the British government holds golden shares of several companies which conduct businesses relating to defense such as Rolles Royce. Furthermore, there are several companies which have articles of association setting the upper limits on the voting right subject to the total number of issued shares or there are some cases where voting rights are restricted by laws.

Measures on an individual company basis are transparent and predictable, from an investors' perspective, and they are effective in terms of national security in a broad sense.

In Japan, INPEX-TEIKOKU CORPORATION is the only one major company which issues golden shares. This is one of the ways to secure national security, which should be adopted widely by other companies. Indeed, since this is an exceptional case of the fundamental principle - one share-one vote principle, it is necessary to clarify what role a company hoping to issue golden shares will play in national security and to verify that an adopted method, such as holding shares, issuing golden shares, or restrictions on voting rights, will be reasonable.

With regard to the electricity and gas business, the critical issues that should be discussed more would be 1) whether it is necessary to establish policy measures for national security for a company respectively and 2) if it's necessary, what they should be.

However, even if policy measures set respectively on an individual company basis are adequately adopted, it should be separately examined whether restrictions on foreign investment should be eliminated or not. With regard to the point, it is possible that issues on security cannot be dealt with by any prior standardization of criteria, whereas it is also possible that there would be many cases that should be treated respectively based on underlying situations. Therefore, regarding policy measures set respectively on an individual company basis, it will be valuable to have a preliminary review type of a regulatory system for restricting foreign investment as a backup system aiming at dealing with unpredicted cases. For this reason, restrictions on foreign investment have received a consensus among nations.

Obviously, restricting foreign investment should be done under careful control. When the restrictions are actually exercised, it will be important to clarify the reasons for the restrictions in order to improve the predictability of similar cases which may happen in the future. In addition, it will also be essential to share the understanding of restrictions on foreign investment among nations and try to keep policy measures and their operation in each country in line.

3. The Possible Expansion of the Reciprocity Principle

The nature of rules for global M&A should be considered policy measures for national security or a higher-level issue than that solely associated with restrictions on foreign investment. However, there is another issue that should be also examined in a completely different context.

That is the issue of reciprocity, which is an idea that any mergers should be treated in a special manner from a viewpoint of fairness, if an acquiring company and an acquired one have followed different disciplines before an attempted M&A.

For instance, under the EU's TOB Directive, if a company subject to the Board neutrality rule (This is a neutral obligation. The board of the offeree company acquiring the information about takeover bids shall obtain the prior authorization of the general meeting of shareholders before deploying any post-bid defensive measures) or the Breakthrough rule (Any pre-bid defenses such as any restrictions on the transfer of securities or on voting rights in the articles of association of the offeree company shall not apply vis-à-vis the offeror during the time allowed for acceptance of the bid.) is acquired by a company which is not subject to either rule, the former acquired company is not to follow the rules by the Directive.

Furthermore, under the EU's Third Directive, the ownership of generation and transmission/distribution networks should be primarily unbundled. Since this principle applies to non-EU Member States from a viewpoint of fairness, foreign generators operating their business within the EU cannot own any electricity networks within the EU. This is actually intended to prevent Gazprom from acquiring any utilities holding electricity networks within the EU, and therefore, this is sometimes called "the Gazprom Article," which indeed was significantly criticized by Russia. However, the EU Commission insists that the Directive is for fairness in general and not specifically aiming at Gazprom.

As seen before, an idea that policy measures should be set to prevent foreign companies from enjoying advantages will possibly become important in the future.

First of all, in a sense such that a domestic company should be prevented from being disadvantaged needlessly, the reciprocity rule is reasonable and will be developed as a widely acceptable rule in the world.

Second, such a rule will play a role in harmonizing general disciplines for companies as the world is becoming increasingly globalized.

Third, the reciprocity rule will apply more to other areas in various manners. For example, the reciprocity rule will indicate an idea that when an investment fund is acquiring a company, each case should be treated individually, depending on the differences between disciplines (such as the obligation of the disclosure regarding description of business) followed by the investment fund and the acquired company.

Finally, Japan will be recommended to examine carefully what the rules for global M&A based on the reciprocity rule should be.

Ⅵ. Future Considerations

Indeed, the recent global financial crisis has turned down global M&A in part. However, its impact on global M&A will be temporary and in the future, strategic M&A will be definitely accelerated. While Japan's electricity and gas utilities are generally believed to be unattractive targets for M&A, it is not necessarily in line with the reality.

As examined in the previous chapters, with regard to the nature of disciplines for global M&A, it will not be enough simply to examine restrictions on foreign investment as have been discussed before. Instead, the necessity and the nature of policy measures for national security on an individual company basis and the adequate disciplines based on the reciprocity rule should be highlighted to examine details of policy measures.