Deregulation presents the best of times and the worst of times. As it sweeps the world, it offers great expectations for some. And great disaster for others. From airlines to electricity, telephones to television, industries and companies that used to operate as monopolies or cartels are being shaken up, and in some cases shaken down. The early example of airline deregulation in the US shows that not every company will make it.
‘Deregulation’ is actually a misnomer, since regulators are exercising considerable regulatory ingenuity to enforce competition on former ‘natural’ monopolies. And it’s not just complacent managements that are at risk. Investors in countries like the US see formerly rock solid investments bob up and down on the waves of the market. In a sector where IR used to consist of making sure the right names were on the dividend checks, investments can now become explosive growth stocks, paying out little or no income as companies invest heavily in infrastructure, or carry out frenetic M&A activity at home and abroad.
On the other hand, saddled with ‘stranded costs,’ white elephant nuclear power stations, antique equipment or inherited obligations amounting to $150 bn in the US alone, it may be simply that they have no profits pay out.
Real Disparity
While Wall Street is cautious about domestic utilities, some of its favorite overseas holdings are deregulated and privatized companies across Europe, Latin America and Asia. However, according to Lehman Brothers analyst Paul Parshley, ‘Investor relations makes a big difference on how well companies are received as they come to market,’ he says. ‘And there ‘s a real disparity in IR efforts.’
While many companies use specialist PR or IR firms to handle their investor relations needs rather than setting up their own operations, Spanish electric utility Endesa is singled out by Parshley as ‘a real leader, comparable to some of the best – and so their stock and debt issues are widely held.’ He identifies the reason for their success in their active IRO in New York, Fernando Lario (see box, page 32).
What about Endesa’s rivals? ‘Being inept means they’re not heard from!’ Parshley dismisses. In addition to individual corporate IR efforts, he points out that many countries run a sort of collective IR effort. He gives the example of Venezuela, which had a track record of interfering too much and too often in prices and conditions. ‘In setting the stage for selling off television companies, the government made a concerted effort to create the impression they were playing for the same sort of aims as management and shareholders.’
Governments like Brazil and China have taken similar pains to reassure investors of their business-friendly attitudes – and apparently with some success considering the considerable utilities investments pouring in from the US and elsewhere despite high risk. ‘Some do it better than others,’ comments Parshley laconically.
However, it’s not just developing countries that can fan investor frissons. Global power player AES Corp wryly points out that the only plant they ever lost to government action was in Florida. British Railtrack’s IRO Peter Durman had the task of averting fears of the incoming Labour government’s windfall tax on privatized companies. ‘There was a lot of speculation about who would be in, and how it would be calculated, whether on dividends, or return in the first year.’ Even so, on Railtrack’s IR tour through the US and Canada earlier this year, ‘North Americans were no more concerned than domestic investors. In terms of regulation, our US investors are only too well versed over Britain. They have concerns about information flow, but that’s obviously our job.’
Luis Fernando Lopes, chief economist at Brazil’s Banco Patrimonio, explains his country’s success with the economy’s deregulation along with utilities: ‘Before, prices and profits were fixed. Now, the reason why Brazilian utilities have become so attractive is the country’s [three-year old, inflation-fighting] Real Plan and its effects on disposable income. It represented a huge reversal of income distribution from society’s rich to the less-well- off. We had a consumer boom, the early growth rate was 100 percent. The government also moved on to deregulation with lots of incentives for foreign direct investment.’
However, reassuring investors about potential political problems is only part of deregulated companies’ problem, particularly in the US. Many in this situation are classified as utilities, which analysts and investors in the US have regarded as very conservative, almost fixed income investments. ‘Look at AES,’ says Parshley, ‘They had to work hard to convince investors that they were a growth stock. They have slightly more risk than most utilities but much more opportunity.’
So a much higher share price is in the offing if investors and analysts can be convinced that these are growth rather than fixed income stocks. Jeanne Hanley and Michael Matty, principals in North Granby, Connecticut-based research firm Capital Reflections, suggest that the whole power sector ‘has been off people’s radar screen for a long time. It used to be that when you went to see utility managers, all you wanted to do was to check that they were breathing. Now you really need to differentiate between a growth utility and those who are not going to survive. So you need good IR to identify managements that can cope with changes, that can say here’s the road map.’
Apart from frenetic M&A activity running at some $50 bn last year, and equally frantic cost cutting, many utilities are looking for new profit sources, like using their power lines for video and other communications. US power companies have some 600,000 miles of fiber optic to control their own systems, which they now realize is a potential revenue source.
Gas companies in particular are facing takeovers by hungry power companies seeing synergy in energy. And in the UK, TV cable systems, many of them bought by US Baby Bells restricted in their domestic competition, are now offering telephone access in competition with British Telecom. From next January, EU-mandated deregulation will make that kind of scenario general across the Union.
However, risk is the faithful spouse of opportunity. No less than 45 US states are considering allowing retail power customers to choose their supplier. ‘Early entrants like Enova and Southern are trying to sell their power as brand name. They are going to have to push their power as reliable. They are also trying to switch over from mom & pop stocks to growth and are actively lowering their pay-out ratio,’ says Hanley.
Out of the Box
It is not easy shaking off analysts’ preconceptions. They prefer neat categories, and mostly have utilities in the ‘don’t buy’ box, so individual holders still own 70 percent of the utility stock. Railtrack’s Peter Durman, for example, says the company is covered in the US by both transport and utility analysts. ‘We’re quite unique, and that creates some interest because people are intrigued by the unusual. But like other utilities, we tend to have fixed returns, although there are opportunities in cost cutting.’ Unlike many other utilities however, ‘There is no overseas growth in the short term; we’ll stick to our knitting.’
Mark Fisher, IRO for San Diego-based Enova, reports the massive California utility is beginning to change its profile with investors, albeit slowly. ‘I think growth is a little extreme. The message is more a combination of growth and income, and mostly the latter.’ Nonetheless, he adds, ‘We’re expanding internationally, initially in Mexico, and deregulation is opening up new markets in the western region of the US.’ He has had to explain to shareholders that, ‘We changed our dividend policy since we can no longer provide regular dividend increases. Our earnings will be more volatile in the future so we want to grow our way into a lower dividend payout ratio.’
Enova also had to change its outlook. In the past, growth came out of investment in infrastructure. ‘We had to change it to the less you spend, the more you make. We changed to performance-based rates and competitive benchmarks that align the interests of shareholders and customers since earnings increase as the rates go down.’ As a result, the high individual ownership is reduced, and top-flight institutions are getting interested: ‘Capital Research & Management is now our second biggest shareholder, up from zero.’
Kilowatts & Megahertz
Over at Boston Edison company, they have succeeded in growing their institutional holdings to about 40 percent, reports Philip Lembo, who started as IRO ‘one month before Massachusetts opened its deregulation docket.’ He confesses he hasn’t ‘heard a company yet that didn’t claim it wanted to be in the top quartile of growth. But the challenge is to do it. We’re still a very concentrated industry, and for time being we will have not so much growth as a growth and income combination.’
Lembo’s IR constituency is broadening all the time, he finds. ‘We’re getting different analysts coming, since we are in retail marketing, telecom, and videos. It’s not enough to trot out the numbers of kilowatts and megahertz anymore. There’s a lot more interpretation and analysis needed.’
On the other hand, he points out that deregulation is ‘as challenging to the analysts as it is for the people in the industry. They have to look at the quality of management, and things like the regulatory environment instead of just checking five year spending plans and earnings.’
In terms of IR, Lembo has to get his all senior officers on the road, not just the CEO. As an IRO, he says, ‘the challenge is getting in the loop, since so much information is needed, and to have an input into investment decisions. Now, for example, I get analysts who want to compare Massachusetts’ regulatory plans with Illinois or Pennsylvania, so I have to know them all.’
John Bilacek of Ohio-based American Electric Power speaks candidly: ‘Power, as an investment, is no longer plain vanilla since deregulation. Now it’s low cost companies versus high cost companies that have stranded costs, and analysts are starting to look at the potential for the recovery of those costs. So far, we only have competition at the wholesale level. But as each and every state across the union looks at this competition, we will get down to the retail level.’
Already, AEP has moved into the fiber optic business, hiring an executive from Sprint to build on their internal communications network. Eventually they could have a network across seven midwestern states. With investments in China, bids in for Australia, this April they bought Yorkshire Electricity in the UK – ‘Wall Street recognized the buy as appreciative to our bottom line.’ AEP is also looking at potential gas company acquisitions. Even so, the imbalance of institutional versus individual is still quite stark. ‘We’re about 35 percent institutional. Ten years ago it was 25 percent: IR must have helped in this, but obviously it is an uphill fight.’
US companies have now snapped up many of the British power companies like Yorkshire Electricity. But it is not just to persuade Wall Street that they are a growth stock. Capital Reflections’ Hanley reports that ‘they’re buying because they’re now undergoing the same changes, so they’re buying an educational experience.’
Nanette Young, a Swindon, UK-based management consultant, characterizes that experience as ‘change management’: ‘The preparation for privatization and ensuing deregulation means that British power companies have already had ten years of downsizing staff and reducing the cost of plants. They’ve had to move an industry that’s been engineering-oriented into a more financially-geared operation and that involves changing the mind set of engineers and managers.’
Changing the mind set of investors may be more difficult. ‘These utilities never made much money in the past, so portfolio managers never bothered with them. But at least they were simple. Now they’re getting complicated, so why shouldn’t the institutions just go for technology growth stocks instead? Even in major institutions, lots of analysts have only been following the industry for six months or so, so it really needs good IR to explain the significance of events,’ concludes Michael Matty. It is a conclusion that Investor Relations magazine, of course, would find hard to rebut.
Breaking Barriers
Fernando Lario handles IR for the Spanish power company Endesa. Evidently he is doing something right since US investors have come to hold one third of the current public float of the utility.
The Spanish government sold a 25 percent stake in Endesa in June 1988 and followed it up with 8 percent six years later. This October, a further tranche of 20-35 percent will see the government’s holding go into a minority, and as Lario says, ‘The idea is that the final tranche will be sold by 1999.’ So far Wall Street can’t complain, he points out. The shares bought in 1988 at $12.29 are now trading at three times that price.
‘IR is more important than it looks,’ he cautions, ‘and Endesa has benefited from its application. Some investors know the company and the regulatory environment and macroeconomics of the country, but you have a lot who don’t and they’re who this office is for.’
One big asset that Endesa used to ply on monolingual Wall Street was a fluently English speaking chairman and CEO. The position has now been divided between a non-English speaking chairman, and a CEO who does. However, Lario still brought over the new chairman for an investors’ meeting this May, ‘because it was the decent thing to do. He addressed the meeting through an interpretation service. Then the CEO took over in English.’ However, even more significant than speaking English is the phenomenon of Endesa’s senior officers bothering with investors at all.
Lario explains frankly that one of the reasons for the delay in privatization is that Madrid is less happy with the prospect of a private monopoly than it has been with its own for all these years, and so, ‘the government wanted to clear the playing field for competition.’ A major part of his IR work is preparing investors for that transition. ‘Obviously,’ he points out, ‘competition is going to bring revenue down. The transition from the protected, regulated environment to a free-for-all means a drop in revenue every time.’
Just as in several states in the US, Spain and Endesa are working on a transitional scheme to amortize the stranded costs, which Lario defines as the difference between asset value before and after deregulation. ‘In our case the company will be receiving those transition costs as they are built into the rates for the next ten years.’
As for growth, ‘In an industrialized country, the electric utility is basically a mature industry, so growth has to come from other sources. In our case we’ll be going for diversification in the home market – into gas for example.’
Lario suggests that, in the US, ‘the feeling is that by and large the electric companies will be acquiring the gas companies, and may themselves be acquired by the oil companies, forming big full service energy companies. Energy in the next century is going to be much bigger.’
He tells investors anxious about what happens after Endesa’s ten-year transition that any electric utility will have to undergo a tremendous amount of cost saving, streamlining and head count reductions – ‘Doing the things that every company has to do at the end of regulation to cut costs – just like the airlines,’ he warns.
