British power utility SSE PLC (LON:SSE) said it has agreed to demerge its household energy and services business and combine with Innogy’s UK sUBSidiary Npower as it posted a drop in first half profits.
SSE, which announced on Tuesday that it was in advanced talks with the German company, confirmed a deal to create an independent UK energy supply business
Shares rose initially before falling back 1.21% to 1,393p in late morning trading as anlaysts raised doubts over whether the companies would get the green light from competition authorities.
Possible regulatory hurdles for SSE-Npower deal
UBS analysts said: "Restructuring creates potential for large synergies in retail and for a re-valuation of the non-retail businesses. But regulatory approval could be a hurdle."
Neil Wilson, senior market analyst at ETX Capital, echoed the comments from UBS by saying "it’s hard to see it overcoming competition concerns"
However, Deutsche Bank argued that it would be difficult for competition authorities to object to the combination since the government is planning a price cap on standard tariffs, limiting any customer detriment.
"While SSE could benefit from increased retail scale in the near term we believe that technological disruption is accelerating in the industry and that this willundermine the long term profitability of retailing in the UK," it added.
"The combination of a standard tariff price cap, the threat of reverse customer default tariff auctions by Ofgem and the increasing ease of entering the market with ‘pre-packed’ new retail businesses is undermining the valuation of incumbent retailers in our view.
Big six under pressure
SSE said shares of the combined group will be admitted to the premium listing segment of the official list on the London Stock Exchange and Hargreaves Lansdown said the new energy supplier faces a challenging market.
The so-called big six energy suppliers in the UK have been losing customers at a growing pace to smaller suppliers. They are also facing an impact to profits from the government's planned price caps.
"The new listing will be born into a difficult environment to say the least, but the prospect of cost savings, greater scale and a greater focus on retail activities should all count in its favour," said George Salmon, equity analyst at Hargreaves Lansdown.
SSE's chief executive Alistair Phillips-Davies said the decision to demerge its household energy and services business follows a "scale of change" in the sector.
He believes the separation of the business and proposed merger with npower will "enable both entities to focus more acutely on pursuing their own dedicated strategies, and will ultimately better serve customers, employees and other stakeholders".
"SSE will remain a balanced group of related businesses, specialising in the energy, infrastructure and services needed to support the transition to a lower carbon future, but continuing to serve business and Irish customers; whilst the demerged retail business will build on a history of operational excellence and first-class customer service to pursue its own dynamic strategy for GB customersm," he said.
The deal is expected to be completed by the “last quarter of 2018 or the first quarter of 2019”, the group said.
SSE's first half profits plunge
Separately, the company revealed a 40.4% drop in profit before tax to £402.2mln and a 43.9% fall in earnings per share to 29.8p on a reported basis for the six months to 30 September.
SSE said the earnings decline was expected and was mainly due to capital expenditure on electricity transmission projects and the disposal of a 16.7% stake in Scotia Gas Networks Limited October 2016.
Still, the company raised its dividend by 3.6% to 28.4p and plans to increase the full-year dividend at least in line with the retail price index. SSE said it is working to keep dividend cover within the expected range of around 1.2- 1.4 times earnings for the year but it is likely to be at the bottom of this range.
The group expects to report full year earnings at least in line with consensus forecasts of 116p.
Challenging operating environment
Chairman, Richard Gillingwater, said: "The operating environment continues to present a number of complex challenges to manage, with significant political and regulatory intervention an ongoing feature of the energy sector.
"Our priorities for the rest of this financial year are clear. For customers, it's energy provision that meets their current and future needs; for investors, its annual growth in the dividend that keeps pace with inflation."