NATIONAL AUDIT OFFICE
REPORTBYTHE COMPTROLLERAND AUDITOR GENERAL
TheSale of ScottishPowerand Hydro-Electric
ORDEREDBY THE HOUSEOF COMMONS TO BE PRINTED IO JULY 1992
LONDON: HMSO 113 f6.55 NET THESALE OF SCOTTISHPOWERAND HYDRO-ELECTRIC
This report has been prepared under Section 6 of the National Audit Act, 1983 for presentation to the House of Commons in accordance with Section 9 of the Act.
John Bourn National Audit Office Comptroller and Auditor General 3 July 1992
The Comptroller and Auditor General is the head of the National Audit Office employing some 900 staff. He, and the NAO, are totally independent of Government. He certifies the accounts of all Government departments and a wide range of other public sector bodies: and he has statutory authority to report to Parliament on the economy, efficiency and effectiveness with which departments and other bodies have used their resources. THESALE OF SCOTTISHPOWERAND HYDRO-ELECTRIC
Contents
Pages
Summary and conclusions 1
Part 1: The companies and the sale 6
Part 2: Achievement of objectives 8
Part 3: Control of costs 20
Glossary of terms 23
Appendices
1. Electricity industry restructuring in Scotland 24
2. Authorised supply areas of ScottishPower and Hydra-Electric 26
3. List of the principal advisers and contractors appointed by the Department 27 THESALE OF SCOTTISHPOWERAND HYDRO-ELECTRIC
Summary and conclusions
1 In June 1991 the Scottish Office Industry Department (the Department), acting on behalf of the Secretary of State for Scotland, sold 100 per cent of the shares in the two Scottish electricity companies Scottish Power plc (ScottishPower) and Scottish Hydro-Electric plc (Hydra-Electric) for just under E3.5 billion, payable in two forms: nearly g2.9 billion from the sale of shares, and some SO.6 billion from the staged repayment of injected debt. In preparing the companies for the sale, the Department wrote off some El billion of National Loans Fund debt.
2 The sale was the last stage in the Government’s programme to privatise the electricity industry in Great Britain. It followed the sale of the twelve regional electricity companies in England and Wales, in December 1990, and the partial sale of the two generating companies, National Power and PowerGen, in March 1991.
3 The Scottish companies generate, transmit, distribute and supply electricity. They face competition from each other, and from other companies, for the generation and supply of electricity to customers in Scotland. Each of the Scottish companies has the monopoly of the transmission and distribution of electricity within its authorised supply area. They may also compete in the electricity generation and supply markets of England and Wales.
4 The companies were floated on the London Stock Exchange. The Department offered for sale some 1.2 billion shares at E2.40 each, payable in three instalments.
5 The Government’s overriding objective was to complete the privatisation of the electricity industry in Great Britain within the lifetime of the Parliament. Within that overriding objective, the Department sought in relation to the Scottish sale: to maximise net proceeds; to achieve a modest premium on the issue price in the period following the start of dealing; to promote individual share ownership, firstly in Scotland, but also in the United Kingdom as a whole; and to encourage share ownership by individual company customers and employees.
6 This report sets out the results of a National Audit Office examination of how far the Department achieved their objectives for the sale, and how they controlled its costs. The National Audit Office examined Departmental papers, held discussions with Departmental officials and advisers, and consulted senior executives of the two companies. The National Audit Office were assisted in their work by Hambros Bank Limited.
Achievement of 7 The National Audit Office’s main findings and conclusions are: objectives On the overriding objective of completing the iale to timetable (a) The Department achieved the privatisation of ScottishPower and Hydro- Electric by June 1991, selling all their shareholding in each of the companies (paragraphs 2.2 to 2.4).
1 THESALE OF SCOT’I’ISHPOWRAND WDRO-ELECTRIC
On maximising net proceeds subject to achieving a healthy aftermarket Method of sale I$) The Department decided to sell the companies by~floating them on the London Stock Exchange as they considered that this method of sale would best meet their objective of promoting increased individual share ownership, while maximising sale proceeds through creating competitive tension between individual, institutional and overseas investors (paragraph 2.6).
Valuation of the companies: assets (cl The Department reviewed the bases on which the companies’ fixed assets were valued, and carried out a revaluation exercise which included identifying properties which might have significant alternative use values (paragraphs 2.10 to 2.16).
(d) The Department introduced clawback provisions on property with the aim of enabling the taxpayer to share in future gains from property disposals or deemed disposals by the companies (paragraphs 2.17 and 2.18).
Debt (e) Both companies inherited high levels of debt from their predecessor boards. The Department sought to maximise proceeds by keeping to a minimum the amount of debt written off, while at the same time ensuring the long term financial viability of both companies. This involved a net write-off of Government debt of E417.7 million (paragraphs 2.19 to 2.25).
Profit and dividend estimates and prospects (fJ Following intensive negotiations with both companies, the Department secured their agreement to estimates of profits and dividends for the year ended 31 March 1991 which they judged satisfactory and to positive statements on prospects for dividend growth in subsequent years (paragraphs 2.26 to 2.29).
Corporation tax losses
(gl The Department wrote off the balance of outstanding corporation tax losses, arising out of unused capital allowances, in each company, amounting in total to s505 million (paragraphs 2.30 and 2.31).
Partial or full sale (h) The Department identified a number of factors which pointed in favour of a full sale in June 1991. The Secretary of State decided to sell all the Government’s shareholding in the companies (paragraphs 2.32 to 2.34).
Carrying out the sale (i) In carrying out the sale, the Department adopted a number of measures first used by the Department of Energy in the sale of National Power and PowerGen.
2 THE SALEOF SCOTTISHPOWERAND HMRO-ELECTRIC
Bookbuilding (j) Institutional and overseas investors were required to indicate, in advance of pricing the offer, how much they would be prepared to invest at a range of yields; this is known as bookbuilding (paragraphs 2.36 and 2.37).
Underwriting (k) The Department dispensed with primary underwriting, bearing the risk themselves of failure to secure adequate sub-underwriting of the offer and of the offer being undersubscribed (paragraphs 2.38 and 2.39).
Back-end tender (1) A proportion of shares was provisionally earmarked for offer to the highest bidders from institutional and overseas investors after the close of the offer period; this is known as a back-end tender (paragraph 2.40). Implementation of the back-end tender raised additional proceeds of ~C42.25million (paragraph 2.51).
Pricing the offer (m) The Department took the view that in pricing the offer at a yield of 5.1 per cent they would maximise proceeds and minimise the risk of exciting excess demand while still attaining their target premium. In deciding not to price the offer at a yield of 5.2 per cent, they accepted a greater risk that the anticipated premium might be eroded over the offer period but judged that risk to be acceptably low. The difference between selling the shares at 5.1 per cent rather than 5.2 per cent represented additional proceeds of ~!Z55million (paragraphs 2.43 to 2.46).
Aftermarket premium (n) The premiums at which the shares opened at the start of trading were within the Department’s target range of 5 to 10 per cent of the full offer price, equivalent to 12 to 24 pence. On the second day’s dealing ScottishPower’s shares fell just below the bottom end of the target premium range, closing at a premium of 10.5 pence. They traded mostly below that premium for some months after the sale. Over the same period, Hydro-Electric shares traded mostly at higher premiums. In the six months following the close of the first day’s trading, the share prices of both companies reduced relative to the electricity sector and to the market as a whole and, whilst mostly remaining above the offer price, moved below the aftermarket target premium range (paragraphs 2.52 and 2.53).
On promoting increased individual share ownership Incentives for individuals (0) In order to avoid adverse media comment and the risk of an unsuccessful sale in Scotland, the Department offered customers of the two companies equivalent payment terms and incentives to those offered to customers of the regional electricity companies (paragraphs 2.60 to 2.62).
Incentives for employees (p) Incentives offered to employees were in line with those offered to employees in the other electricity sales which represented a higher return than incentives offered in certain other past privatisations (paragraphs 2.63 to 2.66).
3 THESALE OF SCOTTISHPOWERAND WDRO-ELECTRIC
Target subscription levels (q) The Department met their target for subscription levels (3 to 4 times the initial public offer) from individual investors (paragraph 2.67).
Share allocation (r) 10.3 per cent of the shares offered to individuals were allocated to company employees and pensioners. Customers investing in their supplying company were allocated 35.6 per cent (paragraph 2.70).
Share retention (s) 67 per cent of individual shareholders in both companies had retained their shares at 31 December 1991. This is higher than in the two previous electricity sales over comparable periods (paragraphs 2.72 and 2.73).
(t) 81.2 per cent of customer, employee and pensioner shareholders still retained shares at the end of December 1991. It seems likely that this relatively high overall level of retention was influenced by low premiums, and that low premiums generally made it profitable only for those with large allocations to sell. Disposals have been highest among those allocated most shares. By the end of March 1992, the number of individuals continuing to hold more than 2,000 shares (employees and pensioners only) in ScottishPower had reduced by 78 per cent. The corresponding figure for Hydro-Electric was 50 per cent (paragraphs 2.72 to 2.78).
(4 The Department have not conducted any research into individual investors’ reasons for retaining or selling their shares. In the view of the National Audit Office, such research in the period immediately following the sale might have provided useful information on key factors influencing individuals’ buying, selling and retaining decisions which might also be of assistance to departments planning future sales. The Department argue, however, that it would be a matter for departments planning future sales to carry out any such research if this were thought to represent good value for money (paragraphs 2.73 and 2.79).
Controlling the 8 The National Audit Office’s main findings and conclusions are: costs of the sale Financialcontrol and project management (a) The Department prepared a detailed project plan and followed appropriate procedures in their appointment of advisers (paragraphs 3.2 to 3.4).
Marketing (b) The Department focussed their marketing campaign on potential investors who would best meet their sale objectives. They were aware of the danger of encouraging too much demand during the offer campaign and cut back on advertising when the target level of registrations had been achieved. As a result of this and other economies they achieved savings of around El.2 million by comparison with their original marketing budget (paragraphs 3.5 to 3.14).
4 THE SALEOF SCOTTISHPOWERAND HYDRO-ELECTRIC
General conclusion 9 The Department carried out the sale of the companies on favourable terms for the taxpayer, securing proceeds which were as high as could have been expected. The decision to proceed with a 100 per cent sale took account of the fact that the sale was taking place in a sector already established in the market, using pricing techniques that had been successfully applied in the previous electricity sale, and in favourable market conditions. For the first few months after the sale, one of the two companies traded for the most part within the Department’s target premium range; the other fell just below the bottom end of that range on the second day’s trading and mostly traded at lower premiums thereafter.
10 The Department met their target for subscription levels from individual investors and were able to allocate a large proportion of the issue to individual investors, particularly to customers, employees and pensioners of the two companies. Overall, share retention levels have been higher than in the two previous electricity sales but there have been significant disposals by those individuals who were allocated the most shares.
Recommendations 11 In the National Audit Office’s view departments should, when pursuing objectives set by the Government in relation to future sales: . continue to build on the innovations successfully introduced in this and in the previous electricity sale; . continue to set appropriate targets by which they can monitor, appraise and influence progress towards achieving their objectives for the sale; l continue to evaluate the contribution incentives might be expected to make towards achieving sale objectives including their possible impact on share retention; and . carry out market research to establish why individual investors bought, sold or retained shares.
5 THE SALEOF SCOTTISHPOWERAND HYDRO-ELECTRIC
Part 1: The companies and the sale
1.1 In June 1991 the Scottish Office Industry public sector, the nuclear and nuclear related Department (the Department), acting on behalf assets and liabilities of the old boards were of the Secretary of State, sold 100 per cent of transferred to a new company, Scottish the shares in the two Scottish electricity Nuclear Ltd. companies Scottish Power plc (ScottishPower) and Scottish Hydra-Electric plc (Hydro- 1.4 ScottishPower and Hydra-Electric face Electric). In preparation for the sale the competition from each other, and from other Department wrote off some fl billion of companies, including the clcctricity cornpanics outstanding National Loans Fund debt. Gross in England and Wales, for the generation and proceeds from the sale will eventually amount supply of electricity to consumers in Scotland. to just under s3.5 billion: nearly fX?.Sbillion Each company has the monopoly of the from the sale of the shares and seme fo.6 transmission and distribution of electricity billion from the staged repayment of injected within a specified geographical area known as debt. Figure 1 sets out the gross proceeds and the authorised supply ama. They may compete the overall timetable for payment. in the electricity generation and supply markets of England and Wales. Both ScottishPower and Hydro-Electric are obliged, under the Figure 1: Gross proceeds Nuclear Energy Agreement, to take electiicity Emillion from Scottish Nuclear until April 2005. The Sale of equity by instalments main features of the restructuring of the June 1991 1,211 Scottish electricity industry are summarised at May 1992 822 Appendix 1. Appendix 2 shows the Apri 1993 822 - approximate locations of the authorised supply Equity proceeds (Figure 8) 2,855 areas of ScottishPower and Hydra-Electric. Debt repayment varying instalments until 2005 : 626 3 c I.il ScottishPower and Hydro-Electric were offered Gross proceeds 3,481 for sale, by means of a flotation on the London Source: Scottish Office Industry Department Stock Exchange, to individual and institutional his Figure shows the estimated gross proceeds from the sale and investors in the United Kingdom and Overseas the timetable for payment. investors. The offer was at a fixed price except for 16 per cent of the shares which were sold 1.2 This sale was the last stage in the by tender to institutional and overseas Government’s programme to privatise the investors. electricity industry in Great Britain. It followed the sale of the twelve regional electricity 1.6 The Department offered for sale some 1.2 companies in England and Wales, in December billion shares. The fixed price offer was at a 1990, and the sale of the majority of the price of f2.40 for each share, payable in three Government’s shareholding in the two instalments: fl on application, 70 pence in generating companies, National Power and May 1992 and 70 pence in April 1993. Bids in PowerGen, in March 1991. the tender secured on average a premium of 23 pence. 1.3 The sale was preceded by the restructuring of the Scottish electricity industry. Under the new structure, which came into effect on 31 March 1990, ScottishPower and Hydro-Electric were created primarily out of the South of Scotland Electricity Board and North of Scotland Hydro- Electric Board respectively. Following the Government’s decision in November 1989 to retain the Scottish nuclear industry in the THE SALEOF SCOTTISHPOWERAND HYDRO-ELECTRIC
Objectives for the sale Scope of the National Audit Office examination 1.7 Within the Government’s overriding objective to complete the privatisation of the electricity 1.8 The National Audit Office examined: industry during the lifetime of the Parliament, the objectives for the sale of the Scottish (a) how far the Department had achieved the companies were: sale objectives (Pact 2 of Report); and (b) how the Department controlled the costs subject to market conditions, to transfer of the sale (Part 3 of Report). them to the private sector through a simultaneous public offer for sale no later 1.9 The National Audit Office reviewed how the than June 1991; Department planned and carried out the sale, to maximise the net proceeds of sale and the outcome. This work included an subject to: examination of Departmental papers and discussions with Departmental officials and (il the achievement of a healthy their principal external advisers. The National aftermarket; Audit Office also consulted the Chairman and [ii) the promotion of increased individual senior executives of Scott&Power and the share ownership, firstly in Scotland but Chief Executive and Finance Director of also in the United Kingdom as a Hydra-Electric. The National Audit Office have whole, consistent with the sales of the obtained advice from Hambros Bank Limited. electricity supply industry in England The National Audit Office are grateful for the and Wales: and help they have received in carrying out this study and producing their report. (iii)& encouragement of share ownership by individual company customers and employees.
7 THESALE OF SCOTTISHPOWERAND HYDRO-ELECTRIC
Part 2: Achievement of objectives
2.1 This part of the report examines how far the identified the most appropriate method of Department were successful in achieving their sale, consistent with their other objectives; sale objectives: valued the companies by reference to the [a) to complete the sale to timetable: most appropriate criteria; (bl to maximise net proceeds subject to considered ways in which a proportion of (i) achieving a healthy aftermarket any value not identified at the time of the (ii) and [iii) promoting increased individual sale might subsequently be recovered share ownership. through suitable clawback provisions; negotiated with the companies appropriate debt arrangements, together with profit Objective (a): completing the and dividend estimates and prospects: sale to timetable and 2.2 The Government’s overriding objective was to carried out the sale on the best possible complete the privatisation of the electricity terms for the taxpayer, including supply industry in Great Britain within the identifying an appropriate target range of lifetime of the Parliament. The sale of premiums, consistent with their objectives, ScottishPower and Hydra-Electric was drawing where appropriate on the preceded, in December 1990, by the sale of experience gained from previous the twelve regional electricity companies who privatisations, notably the sales of the distribute and supply electricity in England and electricity companies in England and Wales and, in March 1991, by the partial sale Wales. of National Power and PowerGen, who generate electricity in England and Wales. I Method of sale have separately reported on the sale of the twelve regional electricity companies in 2.6 The Department decided that, having regard to England and Wales (HC 10 of Session their objective of promoting increased 1992-93) and of National Power and individual share ownership, the most PowerGen (HC 46 of Session 1992-93). appropriate method of sale would be the flotation of both companies by a public offer 2.3 The Department aimed to carry out the sale of of fixed price shares open to individual, ScottishPower and Hydro-Electric by June institutional and overseas investors. Offering 1991, this being the earliest feasible date the shares to these three groups was also following the sale of National Power and intended to give rise to competitive tension PowerGen in March 1991. between them, thereby maximising sale proceeds. outcome 2.4 The Department completed the sale of the Valuation of the companies: dividend yield Scottish companies, which were sold in their 2.7 When a utility is floated on the stock entirety, by their June 1991 target. exchange, the basis on which it is normally valued is the expected stream of future Objective (b)(i): maximising nei dividends to shareholders. This is known as proceeds subject to achieving a the yield. This was chosen by the Department healthy aftermarket as an appropriate basis on which to value the two companies. This basis had been adopted 2.5 The National Audit Office examined whether by the Department of Energy for the previous the Department had: electricity sales.
8 THESALEOFSCOTTISHI'OWERANDHYDRO-ELECTRIC
2.6 Yield is usually expressed as a percentage, 2.14 The valuations arising out of this review were representing the proportion of the gross subject to a further review in December 1990. dividend to the share price. Companies This further review, which focussed on non- commanding low yields are typically those specialised property, resulted in a net which ape seen by investors as offering good downward adjustment which reflected the growth potential and/or low risk. These general fall in the property market since the judgements also take account of how first revaluation exercise. investors view the prospects of other companies, since they are in competition for 2.15 The Department made special arrangements investors’ funds with the company being sold. for land previously identified for possible future The yield demanded by investors is also power stations at Torness, Portencross, influenced by factors extraneous to the Chapeldonan and Stakeness. Each of these company, in particular interest rates and, more properties was judged to be surplus to the generally, prevailing levels of confidence in the requirements of the companies. As at 31 market. December 1989 the four properties had an 2.9 For a given dividend, the lower the yield estimated combined open market value of acceptable to investors, the greater will be the some f1.4 million. The Department decided to value of the shares and hence the proceeds transfer the ownership of these properties to from the sale of the company. Conversely, the Scottish Nuclear so that gains from any future higher the yield required by investors, the disposal would accrue entirely to the public lower will be the proceeds. sector. 2.16 The Department’s revaluation exercises Valuation of the companies: assets resulted in an increase in the fixed asset values 2.10 To confirm the value of the companies’ assets, of ScottishPower and Hydro-Electric of f38 million andf6.4 million respectively, as against the Department, jointly with both companies, appointed valuers in December 1989 to carry pre-revaluation historic book values. The sale out a revaluation exercise. The Department prospectus set out the value of each were particularly concerned to identify any company’s fixed assets on the historic cost surplus assets or any with a potentially higher basis (original cost less depreciation) and on an abridged current cost basis (replacement value for some alternative use. cost less depreciation). On the historic cost 2.11 The bulk of the companies’ fixed assets basis this amounted to some ~51.8billion, and consisted of land, buildings and equipment of on the abridged current cost basis some f4.8 a specialised character, relating to the billion. The historic cost basis is the one on generation, transmission and distribution of which the accounts of the companies had electricity. Such assets included power been prepared in the past and the one on stations. Most of the remaining assets which the directors of both companies intend consisted of non-specialised property, assets to prepare annual accounts in the future. under construction and miscellaneous machinery. Clawback provisions 2.17 The Department considered the case for 2.12 The valuers reviewed all specialist sites in introducing clawback provisions on property order to identify property with significant sales to enable the taxpayer to share in any alternative use values and any surplus gains arising from future property disposals by property. Eleven sites were identified with the companies which it had not been possible potential alternative use values in excess of fl to identify at the time of the sale. Following the million each. transfer of some surplus property to Scottish 2.13 Non-specialised property, including offices, Nuclear, and having identified only limited shops, depots, land reserved for new power alternative use values for property owned by stations, surplus property and property held for the Scottish companies, the Department investment purposes was valued on the basis considered that the benefits that might accrue of the price it might command on the open to the taxpayer as a result of such a provision market. The Department also instructed the were likely to be small. By the same token, valuers to identify any such property which however, they concluded that the inclusion of they considered would have a significant property clawback provisions was unlikely to alternative use value, and to quantify that have a detrimental effect on the dividend yield additional value. at which the companies would be sold.
9 THESALE OF SCOTTISHPOWERAND HYDRO-ELECTRIC
2.18 The clawback provisions apply to any disposal interest, which, if not fixed, will nmve only in or deemed disposal by the companies of accordance with general interest rates. At individual properties owned or leased at higher levels of debt, however, sale proceeds vesting, in the period to 31 March 2001. Under are likely to decline. This is because the costs these provisions, gains in excess of f325,OOO of servicing debt beyond certain levels are will trigger clawback and the provisions will likely to be perceived by investors as apply to the whole of the gain, which will be unacceptably high in relation to earnings and a shared equally between the taxpayer and the risk to the ability to pay dividends. company concerned after deductions for corporation tax and costs. The gains subject to 2.22 In floating the companies, the Department, clawback will consist of any additional value therefore, had to have regard to the maximum realised above the existing use valuation at 31 amount of debt that the companies could bear March 1991 or, in the case of non-operational without endangering their ability: to meet property, the historic cmt. So far there have interest payments: tn repay the debt when it been no receipts from clawback. No clawback became due; to pay dividends; and to provide will apply to disposals or deemed disposals of for future investment. specialised property to a purchaser who 2.23 The proportion of a company’s debt to its continues de existing operational use of the equity is normally referred to as its gearing. property until 31 March 2000. The Department were advised that, having Negotiating the sale: debt regard to the relative nature and size of each company’s operational assets and competitive 2.19 At vesting both companies inherited position, the gearing of Hydra-Electric should substantial levels of National Loans Fund debt be smne 5 to 10 percentage points lower than from their respective predecessor boards. Prior that of ScottishPower. The Department’s to flotation, the outstanding loans totalled advisers concluded that gearing in the range f1,043.6million,amountingtof508.7millionin of 40 to 50 per cent for ScottishPower and 36 ScottishPower and f534.9 million in Hydro- to 45 per cent for Hydra-Electric would Electric. As the National Loans Fund cannot maximise proceeds, subject to interest lend to private sector companies the payments being covered at least four times by Department wrote off all these debts. profits. Following intensive negotiations with the companies, agreement was reached on 2.20 To maximise proceeds from the sale, the levels of debt which implied gearing of 48 per Department then sought to have an cent for ScottishPower and 43 per cent for appropriate pact of their investment in the Hydro-Electric, assuming inclusion of the companies represented by new debt at revised fixed asset values noted in paragraph flotation. This required the injection of new 2.16. The f38 million revaluation was not debt into the companies for which the included in ScottishPower’s balance sheet at companies received no cash. The debt attracts 31 March 1991, although it was disclosed by market rates of interest. Whether or not the way of a note to that balance sheet. On this injection of new debt maximises total basis the gearing was 51.4 per cent. proceeds depends on a judgement as to which is the higher: 2.24 To float the companieswith theselevels of (a) the proceeds from repayment of the gearing, the Department injected long-term principal sum of the debt; or debt of f284 million into ScottishPower and f228.2 million into Hydra-Electric in the form @I the additional equity proceeds that might of debentures for which the companies be realised from the sale if that amount of received no proceeds. In addition, short-term debt was not introduced. debt of flog.9 million and other long-term debt of f3.8 million was imposed on 2.21 Proceeds tend to be maximised by the ScottishPower and Hydro-Electric respectively injection of a sustainable level of debt. to extract outstanding cash balances in each Servicing debt capital out of any given level of company. profits is normally cheaper to a company than servicing equity capital. There are two reasons 2.25 The combination of National Loans Fund debt for this. First, interest on debt is tax written off and long-term and short-term debt deductible, while dividend payments are not. injected into the companies resulted in net Second, dividends usually increase with time, debt written off of f417.7 million (see which is not normally so in the case of Figure 2).
10 THE SALEOF SCOTTISHPOWERAND HYDRO-ELECTRIC
estimates were referred to in the sale Figure 2: ScottishPower and Hydro-Electric prospectus as pro forma estimates. debt before and after Government write-off
SconishPower Hydra-Electric Tootal 2.28 In March 1991, following protracted Debt Debt Debt fmillion Emillion fmillian negotiations, agreement was reached between the Department and ScottishPower on an Outstanding National (508.7) (534.9) (lsM3.6) Loans Fund debt estimate for the prospectus of a pro forma written off dividend of f75 million and a statement that dividends were expected to increase in real Debt injected 393.9 232.0 625.9 terms. Negotiations with Hydro-Electric were Net debi write-off (114.8) (417.7) (302.9) concluded in April 1991 and resulted in Source: sale prospect”s agreement on an estimate for the prospectus This Figure shows that the amount of debt written ofI in net terms by of a pro forma dividend of f35 million and a the Department amounted to f417.7million. statement that dividends were expected to increase in real terms. Negotiating the sale: profit and dividend estimates and prospects 2.29 The difficult negotiations leading up to agreement on these pro forma dividends As the two companies were to be valued by reflected the fact that they were covered only reference to their dividend yield, it was just over two times by the companies’ pro important in order to maximise proceeds for forma profits. This cover was recognised to be the Department to agree with the directors of at the lower end of the range likely to be the companies estimates of first year acceptable to institutional investors for these dividends, and also to agree with them companies, but the Department were advised statements about dividend policies and future that it would be sufficient, given the prospects which were as positive as possible. companies’ prospects. By way of illustration, fl million of dividend is worth +Z26million in proceeds at the offer yield Negotiating the sale: corporation tax losses of 5.1 per cent. These statements are the arising out of unused capital allowances responsibility of the directors of the companies and are included in the prospectus 2.30 Both ScottishPower and Hydro-Electric advertising the companies for sale. Failure to inherited substantial corporation tax losses meet these expectations and to adhere to from their respective predecessor boards. The stated policies would be seen by the market as losses consisted of capital allowances in a serious indictment of the directors, unless respect of capital investment programmes unforeseen circumstances arose. The directors which had been unused because the capital therefore negotiated these estimates and allowances concerned had exceeded net prospect statements with the Department with trading profits for the years in question. These the above circumstances in mind. It remained unused allowances were available for carry- open to the Department to postpone the sale if forward to later years and would have they were unable to reach a satisfactory sheltered the companies’ taxable profits arising conclusion to these negotiations. In addition, in those years, thus reducing the tax from the the Department inaintained the sanction of privatised companies. selling only a proportion of their shareholding, whereas the directors wanted the Department 2.31 Under the Electricity Act 1989, the Department to dispose of it all. had the power to write off all or part of these outstanding tax losses. The Department were The companies were to be floated in June advised that sale proceeds would not be 1991, three months following the end of the reduced by removing these losses prior to 1990-91 financial year. The Department’s flotation because the market would be unlikely negotiations with the companies focussed on to take account of possible tax losses in estimated profits and dividends for 1990-91, assessing dividends and yield. As is generally and on prospects for profitability and dividend the case in flotations, the market would expect growth over the subsequent five years. This the dividend policies of the companies to be required estimates to be made of what profits formulated on a cautious, long-term basis. This and dividends might have been for 1990-91 would reflect an expected ongoing rate of had the companies’ new capital structures corporation’ tax, excluding the benefit of any been in place for the whole of that year. These tax losses. The Department wrote off the
11 THE SALEOF SCOTTISHPOWERAND HYDRO-ELECTRIC
companies’ tax losses as at 31 March 1991, market rise or unsatisfied demand for after allowing for offset of taxable profits for shares between setting the price and the 1990-91. This balance of tax losses totalled start of dealing; and E505 million, amounting to f280 million for . some 3.1 million individuals had registered ScottishPower and E225 million for Hydro- an interest in applying for shares and so a Electric. The Department did not make any partial sale would have limited the extent projection at the time of the sale of the likely to which the Department might achieve ultimate benefit to the Government from this their objective of promoting increased write-off. ScottishPowertold theNational Audit individual share ownership. Office that they currently estimate that the additional amount of tax they are likely to have 2.34 On 2 May 1991 the Secretary of State decided to pay is approximately 675 million. to proceed on the basis of a full sale.
Carrying out the sale: packaged shares Full or partial sale 2.35 The Department decided that the shares 2.32 The Department had to decide before the should be offered at a fixed price, the price to publication of the pathfinder prospectus on 8 be the same for each company. To secure an May 1991 (17 days prior to the announcement even demand in both companies from of the offer price) whether the sale objectives institutional and overseas investors, shares would be best met by a partial or full sale. On were to be offered to these two groups of the basis of the progressive dividend policy investors in the form of package units, with the they had negotiated with the companies, and ratio of shares in the package reflecting the assuming favourable market conditions, the number of shares on offer in each company. Department’s advisers estimated that a partial sale of 60 per cent in June 1991 followed by a Carrying out the sale: bookbuilding further sale in, say, 1994-96 might provide 2.36 In a fixed price offer, a crucial stage is to marginally higher gross proceeds than a 100 gauge as accurately as possible the likely level per cent sale in June 1991. On the other hand, of institutional and overseas demand for the the Department and their advisers had regard shares. to the difficulty of predicting future market conditions, and recognised that the companies 2.37 As part of that process, the Department would also be facing uncertainties in the future employed a technique known as bookbuilding. which might influence proceeds from This had been implemented for the first time in subsequent disposals. These uncertainties the sale of National Power and PowerGen. included the effect of competitive pressures in Institutional and overseas investors were asked the developing electricity market, future price to specify, through the Department’s brokers, regulation and environmental developments, in two stages in advance of the offer, how such as emission level reviews in the mid- much they might be prepared to invest at a 1990s. range of yields specified by the Department. These indications are not contractually binding 2.33 The Department and their advisers also but, on the basis of this information, shares identifiedthefollowingadditionalfactorswhich are allocated, some provisionally, to the pointed in favour of a full sale in June 1991: highest bidders.
l the existence of an electricity sector on Carrying out the sale: underwriting the stockmarket, offering clear markers to 2.38 Underwriting traditionally takes place in two help set a reliable yield for the Scottish stages. First, before the offer is announced, a companies; syndicate of primary underwriters commit . a full sale would enable sufficient stock to themselves to purchase the shares, if be made available to individual, necessary, from the time the offer is institutional and overseas investors, so announced until the sale has been completed. that price tension could be maximised; Second, as soon as the offer is announced, sub-underwriting is offered to institutional 0 United Kingdom and overseas markets investors, who, upon acceptance, carry the risk were buoyant, and receptive to the sale, until the sale is completed. In this sale, and the use of a back-end tender would however, the Department followed the enable the Department to benefit from any Department of Energy’s example in the sale of
12 THESALE OF SCOTTISHPOWERAND HMRO-ELECTRIC
National Power and PowerGen in dispensing the back-end tender which it triggers, is also with primary underwriting, since the use of designed to put pressure on institutions to bookbuilding was expected to provide a accept a higher price than they might reliable guide to the pricing of the offer at a otherwise offer, as it squeezes supply. level that would ensure a satisfactory sale. The Department also decided, again following the Carrying out the sale: pricing the offer Department of Energy’s example, that the offer should be sub-underwritten. 2.43 In pricing the offer, the Department aimed to ensure that when the shares came to be 2.39 Dispensing with primary underwriting meant traded on the stock exchange, they would , that the Department would bear the risk of not command a modest premium of 5 per cent to securing adequate sub-underwriting and of the 10 per cent on the fully paid share price offer being under-subscribed. As the final [equivalent to between 12 and 24 pence a + stage of bookbuilding was to take place two share). This was in order to secure a healthy days before the offer price was announced, the aftermarket while at the same time not offering risk of not securing adequate sub-underwriting a premium so large as to provoke substantial was felt to be minimal as long as the results of oversubscription and subsequently to the bookbuilding were carefully interpreted. encourage investors to dispose of their shares The Department recognised, however, that in order to reap immediate gains. bookbuilding provided no guarantee that the issue would be successfully sub-underwritten 2.44 The bookbuilding exercise was held in two in the event, for example, of a sudden fall in stages (24 and 28 May), the latter stage being the market in the period between the two days before the Department announced announcement of the offer price and securing the offer yield and share price (30 May). At the sub-underwriting. Generally this period is no first stage, the Department asked institutions more than one day. and overseas markets to indicate their Carrying out the sale: back-end tender potential demand at yields ranging from 4.5 per cent to 5.8 per cent. At the second stage, 2.40 The Department decided that, if demand was the range was narrowed to 4.6 per cent to 5.4 sufficient, a proportion of the shares per cent. provisionally reserved for allocation to institutional and overseas investors would be withdrawn. They would then be re-offered to 2.45 The second bookbuilding exercise indicated these investors by way of tender after the that the offer would be once covered at 4.7 close of the fixed price offer to individual per cent. The Department’s principal financial investors, and would be allocated to the and braking advisers considered that in highest bidders. This arrangement, which is practice the companies would actually trade at known as a back-end tender, had been a yield of 4.8 per cent to 4.9 per cent. They implemented for the first time by the therefore advised that, in order to obtain the Department of Energy in the sale of National target premium of 12 pence to 24 pence a Power and PowerGen. share, the offer should proceed on the basis of either a 5.1 per cent or 5.2 per cent yield. The Carrying out the sale: individual investors Department’s advisers considered that the likelihood of the anticipated premium being 2.41 In line with previous flotations, the Department eroded over the offer period was relatively low. announced that the proportion of shares I provisionally reserved for allocation to individual investors as a group would be 2.46 The Department chose 5.1 per cent, at which increased if subscriptions from individual level bookbuilding showed the offer to be investors exceeded, in this case two times, the twice covered, in order to maximise proceeds provisional allocation. In that event the and to reduce the risk of substantial proportion would be raised from 32.8 per cent oversubscription. In deciding not to price the of the issue to 56.2 per cent, and the offer at 5.2 per cent, they accepted a greater provisional allocation to institutional and risk that the anticipated premium might be overseas investors would be correspondingly eroded over the offer period, but judged that reduced. risk to be acceptably low. The difference between selling the shares at 5.1 per cent 2.42 This feature not only helps promote increased rather than 5.2 per cent represented additional individual share ownership but, together with proceeds of g55 million.
13 THE SALEOF SCOTTISHPOWERAN!, HYDRO-ELECTRIC
2.47 This yield placed a value of nearly f2.9 billion reference to the partly paid price of the shares on the companies. The share price, announced (El each). The bids ranged between 101 pence on 30 May, was set at E2.40, and some 1,198 and 150 pence, with an average of 123 pence. million shares were made available. The ratio All those bidding for shares at or above 120 of shares in the package of shares in both pence received shares at the price they bid. companies was set at 68 ScottishPower: 32 Japaneseand European investors were the Hydra-Electric. most successful bidders in the back-end tender and obtained 88.8 per cent of the 2.48 United Kingdom institutions bid more strongly shares available in the tender. The tender on the full range of yields than overseas secured additional proceeds of fZ42.25million. investors and the Department decided to have 82 per cent of the offer underwritten by these The aftermarket institutions and 18 per cent by overseas investors. Figure 3 summarises United 2.52 At the close of the first day’s dealing in the Kingdom institutional and overseas demand in shares (18 June) the market valued the bookbuilding at these allocations. Within ScottishPower at f2,082 million and Hydro- the overseas underwriting allocation of 18 per Electric at fl,005 million, an increase ofs126.3 cent, the individual markets received: Japan 40 million and f84.4 million respectively over the per cent; Europe 30 per cent; United States of offer yield valuation of the companies. The America 20 per cent; and Canada 10 per cent. closing share premiums were 15.5 pence (or 6.5 per cent of the fully paid share price) for ScottishPower and 22 pence (9.2 per cent) for Figure 3: United Kingdom institutional and Hydra-Electric, both within the Department’s ! overseas demand at different yields target range of 12 to 24 pence. The upward Demand expressed in terms of the number of movement in the market of about 1.2 per cent Possible times each market’s allocation was covered during the offer period accounted for about 3 offer yields UnRed Kingdom overseas Total pence of the premiums available on the first her cent, ma&t market underwritten day of trading.
4.7 1.11 0.64 1.02 2.53 On the second day’s dealing Scott&Power’s 4.8 1.35 1.12 1.31 4.9 1.54 1.60 1.55 shares fell just below the bottom end of the 5.0 1.94 2.03 1.95 target premium range, closing.at a premium of 5.1 2.05 2.28 2.09 10.5 pence. They traded mostly below that 5.2 2.16 2.58 2.24 5.3 2.29 2.75 2.37 premium for some months after the sale. Over the same period, Hydro-Electric shares traded Source: Sconish Office Industry Department mostly at higher premiums. Figure 4 shows This Figure shows, at difkrent yields. how many times the offer was covered by bids imm United Kingdom institutions and overseas that in the six months following the close of investors. the first day’s trading the share prices of both companies reduced relative both to the O”tcome electricity sector and to the market as a whole 2.49 Between the fixing of the offer price on 30 May and, whilst mostly remaining above the offer 1991 and the close of the offer to individual price, moved below the aftermarket target investors on 12 June there was a modest premium range. increase of about 1.2 per cent in the value of the Financial Times All Share Index. Objective (b) (ii] and (iii): 2.50 At the offer price, demand from individual promoting increased individual investors exceeded two times the number of share ownership shares initially allocated to this group. This level of demand triggered reallocation of 23.4 I 2.54 In addition to achieving a healthy aftermarket, per cent of the shares to individual investors the Department’s objective of maximising net bringing their total allocation up to the proceeds was subject to: envisaged 56.2 per cent. It also activated the back-end tender for a further 16 per cent of [ii) the promotion of increased individual the shares. share ownership, firstly in Scotland but also in the United Kingdom as a whole, 2.51 Under the terms of the back-end tender, consistent with the sales of the electricity institutional and overseas investors were supply industry in England and Wales: and invited to submit bids by 14 June 1991 by
14 THESALE OF SCOTTISHPOWERAND KYDRO-ELECTRIC
Figure 4: Movements in share prices (fully paid basis) from date issue was priced to 31 December 1991
Percentaoe chanoe in share orices
1, , , /+----- , , , ,Start , of ,trading ( , , , , , , , , , , , , , , , , , , , , , May 28 June 18 Aug 6 Sept 3 Ott 1 NW5 lkc 3 DE 31
Scottish Power Hydro-Electric Fl Al Share Electricity Sector
source: P”t#Shed stock Market pr,ces fe?ll at close Of trade at me end Of em week romwing the stall Of trading. This Figure compares movements in the share prices of ScottishPower and Hydra-Electric with those of the FinancialTimes All Share Index and the Financial Times Index for the ekctricib sector as a whale.
(iii) the encouragement of share ownership by . set appropriate targets at relevant stages individual company customers and along the road to the sale; employees. . adopted an appropriate allocation policy: 2.55 The promotion of increased individual share and ownership was a key feature in the sale, largely accounting for the method of sale chosen and . monitored the outturn. particularly features such as the allocation of a majority of the shares to individual applicants, and the incentives provided to encourage Definitions individual investors. The National Audit Office examined whether, in pursuit of these 2.56 TheDepartmentconfirmedtotheNationalAudit objectives, the Department had: Office that they wished to persuade individuals 0 defined what they meant by promoting who had not previously owned shares, or if they increased individual share ownership; had but no longer did so, to purchase and retain shares; and to persuade those who . considered the need for incentives for each already owned shares to add to their portfolios of the groups of individual investors they by purchasing and retaining further shares. wished to ateact: They were particularly concerned to.promote individualshareownershipinScotland:thiswas the first privatisation since the sale of British Gas which involved Scottish customers.
15 THE SALEOF SCOTTlSHPOWERAND WDRO-ELECTRIC
Customers every ten shares held for a period of three years subject to a maximum of 300 bonus 2.57 Market research, commissioned by the shares. For the present sale, the Department Department in 1989, indicated that potential adopted this approach for preregistered customer investors would be unlikely to wish customers buying shares in their own to take up all the shares and that up to 80 per supplying company. In addition, they brought cent of individual investor demand would cane forward the issue of bill vouchers by three from elsewhere. months at au estimated cost of f300,000 - f400,OOO.This was in order to compensate 2.58 The Department allowed customers to customer investors, in part, for the fact that purchase shares in their own supplying their first year return was lower than the company or a package of shares, but not both. corresponding return for customer investors in They set the minimum level of shares the sale of the regional electricity companies customers could purchase in their supplying because shareholders in the Scottish company at 100 to encourage applications companies had to wait longer for their first from those who had not previously been dividend. shareholders. 2.62 Customers who had registered an interest and Non-customers who decided to apply for the package of shares could receive, in addition to the 2.59 In order to prevent over or undersubscription incentives available for shares in their by non-customers, in one or other of the supplying company, bonus shares of one for companies, the Department required individual every twenty purchased and held for three investors who were not customers to apply for years in the other company. All preregistered a package of shares. The minimum size fixed non-customers were eligible to receive bonus for the package was 300 shares because with shares, up to a maximum 150, of one for every ScottishPower approximately twice the value twenty purchased and held for three years. of Hydro-Electric, the Department considered that a holding of many fewer than 100 shares Incentives for employees in Hydra-Electric would have been uneconomically small both for the shareholder 2.63 As in previous sales, special terms were and the company. offered to employees of the companies to purchase shares to encourage them to take a Incentives for individuals stake in the future of their companies. Employees of Scottish Nuclear were able to 2.60 The Department decided to offer incentives to benefit from those terms to purchase shares in individual investors for three reasons: to ScottishPower. The employee incentives encourage individuals to register au interest in package was drawn up in consultation with the the sale; to encourage those who had management of the companies and the registered to apply for shares; and to employees’ trade union representatives. encourage long term shareholding. To this end, Employees could benefit from free and incentives were only available to applicants matching offers, and from discount and priority who had registered au interest in buying offers. shares. To avoid adverse media comment, which might affect registration and application 2.64 Under the free and matching offers, each 1 levels and prejudice the success of the sale in employee could apply for free, fully paid Scotland, the Department concluded that they shares to a value of f140, and a further fz I had to offer equivalent payment terms and worth for every completed year of continuous I incentives to those offered to customers in the service. In addition, matching shares were sale of the regional electricity companies. offered whereby employees could obtain two free shares for every share purchased up to a 2.61 In the sale of the regional electricity companies fully paid value of f230. the share price of f2.40 is payable in three instalments. Customers could opt for a bill 2.65 Under the discount offer, each employee could voucher of fl8 for every 100 shares purchase shares up to a fully paid value of purchased, subject to a maximum off 270 over El,250 and receive a discount of 20 per cent two and a half years for a holding of 1,500 on that price on payment of the third shares or more, or for one bonus share for instalment. Under the priority offer employees
! I 16 , THE SALEOF SCOTTISHPOWERAND HYDRO-ELECTRIC
(and pensioners) could apply for shares in their be likely to meet this target if some 3 million employing or formerly employing company up individualsregistered aninterest inapplyingfor to the value of fl5,350 at the fully paid share shares. In the event, they secured 3.6 million price, and receive them in priority to any other registrations and the offer was 3.2 times applicants for shares. In sum, au employee or subscribed. pensioner could, under the discount and priority offers, apply for a maximum of 6,917 2.68 Before setting the offer yield, the Department and 6,396 shares respectively. Investors in the used market research to help assesslikely discount and priority offers could opt for bill demand from those who had registered au vouchers or bonus shares. interest in buying shares. They estimated that, exclusive of company employees and 2.66 Under the free, matching and discount offers pensioners, individual investors were likely to the incentives had a maximum value of f880 account for scune f3 billion of demand, of for an outlay of f1,230 for au employee with which nearly f800 million would come from 16 years service (the average for the industry). Scottish investors. In the event, after the These amounts are in line with those for the Department had tightened the offer yield to 5.1 regional electricity companies’s& updated by per cent, individual investors actually applied inflation, and represent a greater return to the for nearly f 2.5 billion worth of shares of which employee than in privatisations prior to the f722 million was from investors resident in regional electricity companies’ sale. The Scotland. In addition, employee and pensioner Department took the view that the only demand totalled f171 million and non- appropriate ccarse was to give employees in registered demand f237 million. In total, some Scotland the same as their counterparts in 2.2 million individual and employee and England and Wales. Figure 5 compares the pensioner applications were received. value of incentives offered to employees in the Scottish sale to those offered in certain past Share allocation privatisations. 2.69 The Department allocated shares to individuals in the following priority order: employees and Figure 5: Employee incentives pensioners; registered customers applying for shares in their supplying company either as Company YMJ Value Of Personal Incentives Investment part of the package or on an individual Required company basis: registered non-customers C’ r applying for shares in both companies; and oSritish Telecom 1984 683 2,817 non-registered applicants. The Department aBritish Gas 1966 782 2,542 wished to make allocations to all customer registrants (except perhaps in response to very 0Water Companies 1989 806 2.538 large applications); to make no allocation Hegional Electricity and 1990 860 1,220 Electricity Generating significantlysmallerthantheminimumpackage Companies size to as many non-customers as possible: to Scottish Electricity Companies 1991 880 1.230 treat equally customers in the two companies Source: National Audit Office who applied for shares in their supplying Notes: * Maximum value of incentives based on 15 wars service. company; to allocate numbers of shares o Value at December 1990 prices. amounting to no less than 5 per cent of the This Figure compares the value of the incentives on of&r to number applied for; and to scale back if employees, and the personal investments required, ior the sales of necessary, applications from registered non- British Telecom. British Gas, the Water Companies, the Regional c”stomers. Eleclricity and Electricity Generating Companies and the Scottish Eleclricity Companies. 2.70 In the public offer the Department allocated Targets: subscription and registration 10.3 per cent of the shares on offer to company employees and pensioners, who 2.67 In order to trigger reallocation from institutional received all the shares they asked for. and overseas investors to individual investors, Customers investing in their supplying the Department required subscription of at company received 35.6 per cent of the shares. least two times the original level of the public Within this group, allocation was made in full offer. To allow a margin for uncertainty, the to registered customers who applied for up to Department aimed to achieve 3 to 4 times 2,000 shares in their supplying company (97 subscription of the shares initially reserved for per cent of registered customer applicants). the public offer. They considered they would
17 THESALE OF SCclTnSHPowERAND HYORO-ELECTRIC
Non-customers received 54.1 per cent of the 2.74 In the first six months following flotation, share shares on offer (see Figure 6). Within the premiums as well as disposal rates were low. registered non-customer group, two thirds Premiums in this period for ScottishPower applied for the minimum number of package ranged between 19% pence and a discount of shares (300). They received 250 shares. Those 5 pence: Hydro-Electric premiums ranged applying for more than 300 shares had their between 24 % pence and a discount of %p. allocations scaled down progressively; those The range in the equivalent period for the who applied for 1,000 shares or more, and regional electricity companies was 34 % pence applicants who had not registered, received to 170 pence. For the electricity generating nothing. companies the equivalent range was 10 pence to 71 ‘/z pence. In the absence of research Figure 6: Share allocation lo individuals following the sale, it is a matter of speculation I Shares As a percentage As a percentage how far there is a link between the level of allocated of sharesapplied of sharesallocated share premiums and disposal rates or whether (millions) for to individuals % % other factors, for example, allocations closely matching demand, and customer loyalty, may CompanyEmployees 67 100 10.3 and Pensioners also be relevant. Customers 231 93 35.6 2.75 In the period following flotation to the end of Non-Customers 351 45 54.1 December 1991, individual customers, 649 100 employees and pensioners Who sold shares, so”,cs: sc0nk.h CJfke ,“dl&-fly Depamw”r. had sold. on average. 1.203 shares each. Figure 7 shows that, overall, 9.8 per cent of Tfis Figureshows the pdoQ givenfirst to companyemployees and pensioners.and secondto customersapplying for sharesin their supplying customers, employees and pensioners were company. allocated over 1,000 shares each. These allocations accounted for smne 42 per cent of Share retention the total allocations to customers, employees 2.71 The Department sought, as noted earlier, to and pensioners. manage the level of demand for shares throughbringingthe dividend yield down to 5.1 2.76 Data provided by the registrars suggest that per cent. As a result, the Department were most disposals were probably made by those able to match allocation closely to demand: 97 employees and pensioners who were allocated per cent of those applying with customer more than 2,000 shares. Allocations to these preference received all the shares they asked groups accounted for scame21.5 per cent of for. In allocating shares largely in accordance the total allocations to customers, employees with what had been applied for, the and pensioners. By the end of March 1992, Department hoped that this would encourage the number of employee and pensioner customers, employees and pensioners to retain shareholders of ScottishPower continuing to their shares. hold more than 2,000 shares had reduced by 78 per cent. The corresponding figure for 2.72 Data held by the companies’ registrars at the Hydro-Electric was 50 per cent. By contrast, end of December 1991 (six months after the the number of customer and other employee sale) indicate that 81.2 per cent of customer, and pensioner shareholders continuing to hold employee and pensioner shareholders still fewer than 2,000 shares by that date had retained shares. This compares with a non- reduced by a lower percentage: 28 per cent for customer retention rate of 64.2 per cent. ScottishPower and 21 per cent for Hydro- Overall, 67 per cent of all individual Electric. ’j shareholders had retained shares at that date. i 2.73 The Department have not conducted any 2.77 It seems likely that the relatively high overall market research into the reasons why smne level of retention (81.2 per cent) by customers, individuals have sold their shares in the two employees and pensioners, at the end of the Scottish electricity companies while others six months following the sale, was influenced have retained them. The National Audit Office by low premiums, and that low premiums note that in the first six months following the generally made it profitable only for those with sales of the regional electricity companies and large allocations to sell. Individuals selling theelectricitygeneratingcompanies, individual shares will generally be liable to pay shareholder retention rates were respectively commission to selling agents. Commissions 40 per cent and 54 per cent. vary but a flat rate charge of about f15 was I I
18 THESALE OF SCOTTISHPOWERAND KYDRO-ELECTRIC
Figure 7: Share allocations to customers, employees and pensioners by size of holding Numberof Shares Numberof Employees Allocated Customers & Pensioners To& % 96-500 327,405 2,006 329,413 69.9
501-1000 93,798 1,743 95,541 20.3
1001-2000 35,915 567 36,482 7.7 9.6 2001-6917 9,953 9,953 2.1 > Total 457,118 14.271 471,389 100.0
Source:Scottish Office IndusbyDepartment Note: This Figureexcludes free and matchingshares allocated to employees,which are initially held in tnM and cannot be sold for a limited period,and sharesheld by customer of one comoanvin their non-suoolvinocomoanv. This Figureshows the numberof customers,employees and pensionersallocated shares in their supplyingor employingcompany. by size of holding.
available. On this basis an individual selling 2.79 The Department question whether they would 500 shares will break even at a premium of 3 have obtained value for money by pence; selling 1,000 shares, he breaks even at commissioning market research into share a premium of 1% pence; and selling holdings retention patterns after this privatisation. In the of 1,500 shares and above, he breaks even at view of the National Audit Office, however, a premium of lp. such research in the period immediately following the sale might have provided useful 2.78 It also seems likely that low premiums information on key factors influencing combined with small shareholdings played a investors’ buying, selling and retaining part in the fact that, six months after the sale, decisions in the particular circumstances of 64.2 per cent of non-customers still retained this sale. These factors include the impact of shares. For example, by the middle of March advertising, incentives, media comment and 1992 Hydco-Electric still had some 780,000 the expected and actual level of the non-customer shareholders in England and aftermarket premium. The results of this Wales with less than 100 shares each, in research might also be of assistance to accordance with the terms of the share departments in planning future sales. The package for which they applied. The company Department argue, however, that it would be a told the National Audit Office that this matter for departments planning future sales to represented a significant administrative cost to carry out any such research if this were them and that they were actively encouraging thought to represent good value for money. such shareholders either to increase their holdings or to sell them.
19 THESALE OF SCOTTISHPOWERAND HYDRO-ELECTRIC
Part 3: Control of costs
Overall costs 3.3 The Department’s financial advisers (Barclays de Zoete Wedd and British Linen Bank) 3.1 The Department estimate that the net costs of prepared a detailed plan of the tasks the sale, excluding their own staffing costs, necessary to complete the sale. Monitored by value added tax and stamp duty, will amount the Department, they set up a number of to E98.0 million [Figure 8). This represents working groups for particular areas of the plan. some 2.8 per cent of gross proceeds. It These groups comprised representatives from includes an estimate of the costs of incentives the relevant advisers, the Department and, as for individual shareholders. appropriate, the Treasury and the companies themselves. The Department’s representation Financial control and project on the various working groups allowed them to ensure that satisfactory progress was being management made in all areas of the sale. 3.2 The National Audit Office examined whether the Department had: 3.4 The Department employed 33 principal l prepared a project plan by reference to advisers and contractors for the sale (Appendix which they allocated resources and 3). The Department’s appointments were monitored progress towards targets; and based primarily on their assessment of the . identified their external advice quality of service offered, but regard was also requirements and followed appropriate had to price. Five advisers were not appointed procedures in their appointment of on a competitive basis: these advisers were external advisers. already working for either the Government or the companies in an advisory capacity (for Figure 8: Estimated proceeds and costs of example, as valuers or auditors) and were the sale judged to have given satisfactory service. f E Treasury approval was given for the million million appointment by single tender of these five Valueof sharesoffered for sak 2.975.9 advisers. Add: prmeds from h.sC!w”d tender 42.2 Less: proceedsforgone by way of incentives Employees’free and matchingshares and discount lg.7 Individualinvestors’ bonus shares 52.9 63.5 Marketing Equityproceeds 2.854.5
Less:other costs as follows: 3.5 The National Audit Office examined whetha Undenwiting 21.5 the Department had: Sellingand brakingcommi%ion 4.1 ReceivingBanks, printing and other logisticalcosts 29.4 . Markettngcosts 5.8 adopted a strategy that was appropriate to UK Advisersfees 19.6 the particular requirements of the Scottish .’ oveneas costs 9.1 sale; and Less interest on applicationmoney .pl j 98.2 . appraised the effectiveness of this Incentivesfor individualshareholders 9.8 strategy in meeting its targets.
Net costs of the sale 98.0 - Target audience Net proceedsfrom sale 01shares 2,756.5 Proceedsfrom repaymentof debt 625.9 3.6 In May 1989 the Department commissioned Estimatedtotal net proceeds w2.4- market research to determine the level of likely Source:Scottish Office bdosfry Departmentestimaied 00num as at demand for the offer from residents in 31 March 1992 Scotland, England and Wales. This research This Figureshows estimatedproceeds, costs and total net proceedsfrom indicated that sane 80 per cent of total the gale of ScoibshPowerand Hydra-Electric. demand from individuals was likely to come
20 , THESALE OF SCOTTBWOWERAND HYDRO-ELECTRIC
from investors who had bought shares 3.10 The Department launched their offer campaign previously, with almost half of this demand in March 1991. This campaign had two main from residents in London and the South East objectives: first, by creating and developing of England. Given, however, the Department’s awareness of the offer and its timing to objective of promoting increased individual encourage individual investors to register an share ownership, particularly in Scotland, the interest in the offer; second, to convert the Department sought to maximise Scottish maximum number of registrants into demand by targeting its campaign on all adults applicants. The Department set themselves the there. The Department were advised that to target of obtaining three million registrations. campaign as extensively in England and Wales They estimated that, based on experience from would be prohibitively expensive and previous privatisations, this number of unnecessary. Instead, the Department targeted registrations would be sufficient to ensure that its campaign in England and Wales on those the offer was fully subscribed by individual residents most likely to invest in the sale. The investors. Department were advised that these potential investors tended to be mainly resident in 3.11 The Department used a combination of southern England. advertising [television, press and posters) and media information campaigns in order to communicate their marketing message.In Coordination with the sales of the regional addition, at the Department’s request, the electxicity companies and the generators Chairmen of the companies sent a mailshot to each of the companies’ customers to inform 3.7 The primary task for the Government, the them of the forthcoming sale and to invite industry and their advisers was to ensure the them to pm-register. A mailshot was also sent successful flotation of tbe whole of the non- to individuals resident elsewhere in the United nuclear electricity supply industry. To achieve Kingdom who had applied for shares in the this it was important to ensure that the regional electricity companies. individual marketing initiatives for each of the three sales were complementary and in the outcome best interests of the industry as a whole. To this end the Treasury produced guidelines for 3.12 The Department achieved their target level of the management of a coordinated marketing registrations within five weeks of the beginning timetable in order to prevent any conflict of the eleven week offer campaign. To between the campaigns. In addition, the discourage further registrations and thereby respective advisers of the Department and of prevent possibly substantial oversubscription the Department of Energy coordinated their of the offer, the Department cut back on their advertising campaigns. level of television advertising. 3.13 By the end of the offer campaign, the Marketing strategy Department had received some 3.6 million pre- sale registrations. Market research 3.8 The Department’s marketing strategy commissioned by the Department in May 1991 comprised three separate campaigns: an initial indicated that some 54 per cent of these corporate awareness campaign, a further registrants were likely to apply for shares. In corporate awareness campaign nearer to the the event, the market research proved time of the sale, and an offer campaign. accurate since nearly 2 million registrants (54 per cent) applied for shares. 3.9 The objective of the two corporate awareness Marketing costs campaigns was to raise the target audiences’ awareness of the identity and functions of the 3.14 The Department estimate their marketing costs two companies and of the forthcoming sale, to be 25.9 million (excluding value added tax). and to foster positive attitudes to the Scottish This represented savings of around fl.2 electricity industry. To avoid overlap with the million compared with budget. Most of this sales of the regional electricity companies and saving arose in the areas of television the generators the campaigns ran intermittently advertising and television production. from late April 1990 until March 1991.
21 THF.SALE OF SCOTTISHPOWERAND HY!XRO-ELECTRIC
Underwriting costs Cost of incentives
3.15 The National Audit Office estimate that the 3.16 The Department allocated free and matching Department saved around f3.8 million in shares and estimated discounts to employees commission through dispensing with primary to a value of f10.7 million, and initially underwriting. Having regard to their decision expected a maximum bill voucher liability of not to seek primary underwriting, the f14.9 million and a maximum issue of bonus Department decided not to seek sub- shares to a value of f84.7 million. At 31 March underwriting fees lower than had been paid in 1992 the Department’s liability for bill voucher connection with the sales of the regional expenditure stood at f9.8 million and for the electricity companies and of the electricity provision of bonus shares at f52.8 million. generating companies. They paid United Kingdom institutions sub-underwriting commission of 1.25 per cent of the offer price, and overseas institutions 1.2448 per cent. THE SALE OF SCOTTISHPOWER AND HYDRO-ELECTRIC
Glossary of terms
Aftermarket The period following the start of dealing in shares newly issued on the London Stock Exchange.
Capital allowances Allowances designed to give tax relief for capital depreciation of business assets.
Debt injection Debentures issued to HM Treasury, repayable over various periods, for which the cornpanics rcccivcd no Proceeds.
Distribution The local iansport and delivery of electricity at less than 132 kilovolts. Most customers receive their electricity at 240 volts.
Dividend cover A measure of the safety of the dividend, normally obtained by dividing the profit available for distribution by the net dividend to be paid.
Financial Times An index of the share values of some 850 companies quoted on the London Stock All Share Index Exchange, accounting for more than 90 per cent of the value of all listed shares.
Flotation The sale to individuals or institutional investors of shares which can then be traded on a market.
G-3l~ldiO* The production of electricity.
Interest CoYer Profit before interest and tax divided by interest payments.
Offer price The price at which shares about to be issued are offered for sale.
Premium (discount) The amount by which newly-issued shares are traded on the London Stock Exchange above (below) the issue price.
Privatisation The sale to the private sector of assetsowned by the state.
Pro forma estimates In this case, estimates of 1990-91 profits and dividends on the basis that the companies’ new capital structures had been in place since 1 April 1990.
Public offer Sharesprovisionallyallocatedtoindividualinvestors,whichmaybeincreasedinnumberif demand from individuals exceeds a specified level of subscription.
Receiving banks Banks commissioned by the Department to receive and process applications made by or on behalf of individual investors.
Selling agents Financial advisers who acted on behalf of individual applicants and were enabled to claim commission from the Department.
Subscription The total number of shares applied for in relation to the total number on offer.
SUPPlY The acquisition of electricity and its sale to customers.
Transmission The bulk transfer of electricity across the country at high voltages.
Underwriting An agreement under which, in return for commission, financial institutions agree in advance to buy unsold shares. There is primary underwriting and sub-underwriting.
Yield The expected annual income return to shareholders from dividend payments, expressed as a percentage of the full share price represented by the gross dividend.
23 THE SALE OF SCOTTLWFOWER AND HYDRO-ELECTRIC
Appendix 1 Electricity Industry restructuring in Scotland
1 This Appendix outlines the main changes to the electricity industry in Scotland provided for in the Electricity Act 1989.
Electricity 2 Before 31 March 1990, the supply of electricity in Scotland was the responsibility of two industry before regional boards, the South of Scotland Electricity Board (the South Board) and the North restructuring of Scotland Hydro-Electric Board (the North Board). Each board was vertically integrated, that is to say they generated, transmitted, distributed and supplied electricity, between them serving the whole of Scotland and part of Northumberland.
3 The two boards had a different mix of generating plant and served was with different demographic and geographic characteristics. The South Board’s area was characterised by large densely populated urban areas, whereas the area served by the North Board was more widespread and sparsely populated. The vast majority of the South Board’s generation capacity was derived from fossil fuels and nuclear energy, whereas most of the North Board’s capacity came from hydra and pumped storage generation. Scotland has a substantial surplus of generating capacity, with some 11.6 gigawatts of output capacity against a combined peak demand of some 5.5 gigawatts [a gigawatt = one thousand million watts). white Paper 4 In March 1988, the Government published a White Paper (Cm 327) setting out the “Privatisation of proposals for the privatisation of the electricitjr industry in Scotland. The White Paper the Scottish proposed that the South and North Boards be privatised as two separate companies, Electricity each having a mix of generating capacity and accessto the capacity of the nuclear Industry” generating stations, then owned by the South Board, which were to be transferred to a company jointly owned by these companies. In November 1989, however, the Secretary of State announced that this jointly owned company (Scottish Nuclear) would remain in publicownershipandwouldsupplyelectricitytoScottishPowerandHydro-Electric.Under the subsequent Nuclear Energy Agreement, which expires in April 2005, ScottishPower and Hydra-Electric are obliged to take 74.9 per cent and 25.1 per cent respectively of the electricity which Scottish Nuclear declares it can generate from its nuclear stations at Hunterston and Torness.
5 Each company would have the monopoly of tmnsmission and distribution of electricity within its own area.It would also have the monopoly of the supply of electricity within this area, except that the two companies would be able to compete with each other, and with new entrants to the electricity generation market, for the supply of electricity to large commercial customers in Scotland (ie those with peak demands of 1 megawatt (1 million watts) or above until 31 March 1994, falling thereafter to 100,000 watts until 31 March 1998). The two companies would be able to export electricity to England and Wales where they would be in competition with other generators and suppliers. Customers’ interests were to be protected by regulation.
6 The Electricity Act 1989 made provision for these proposals to be given effect.
24 THE SALE OF SCOTTISHPOWER AND HYDRO-ELECTRIC
Regulation 7 Regulatory control of the two Scottish companies is provided by the Office of Electricity Regulation (OFFER), which was established in September 1989. OFFER is headed by the Director General of Electricity Supply and in Scotland by the Deputy Director General of Electricity Supply. The Deputy Director General’s primary tasks are to ensure that power supplies are secure, to promote competition, to protect the interests of consumers, and to ensure adherence to the terms and conditions under which electricity is generated, distributed and sold to consumers. The transmission, distribution and supply of electricity by the two companies are subject to price controls, based on the retail prices index, prescribed by the Director General of Electricity Supply.
25 THE SALE OF SCOTTISHPOWER AND HYDRO-ELECTRIC
Appendix 2
The map below shows the approximate locations of the authorised supply areas of ScottishPower and Hydro-Electric:-
Shetland
ScottishPower THE SALE OF SCOTTISHPOWER AND HYDRO-ELECTRIC
Appendix 3 Principal Advisers and Contractors appointed by the Department
Adviser/Contractor Area of work
Coopers & Lybrand Accountancy and Regulation
Faulds Advertising Agency
De Zoete and Bevan Brokers
Bell Laurie White Brokers
BMO Nesbitt Thomson Canadian Financial
Osler Renault Ladner Canadian Legal
Royal Trust Company Canadian Registrar
Tayburn Design Design Agency
Credit Suisse First Boston European Financial
Barclays de Zoete Wedd Financial
British Linen Bank Financial
Price Waterhouse Fraud/Systems Auditors, share allocation modelling
Daiwa JapaneseFinancial
Hamada and Matsumoto JapaneseLegal
Willis Wrightson Insurance
McGrigor Donald Legal
Citigate Communications Marketing and public relations
PR Consultants Scotland Marketing and public relations
British Market Research Bureau Market Research
BPCC Oyez Waterlow Ltd Printers
National Westminster Bank Receiving Bank
Royal Bank of~scotland Receiving Bank/Registrar
Bank of Scotland Receiving Bank/Registrar
27 THE SALE OF SCOTTKHPOWER AND HYDRO-ELECTRIC
Adviser/Contractor Area of work
Deloitte Haskins & Sells Reporting Accountants
KPMG Peat Marwick McLintock Reporting Accountants
HP: ICM Roadshow Contractor
British Telecommunications (BT) Share Information Office
Mail Marketing Share Information Office
Merz and McLellan Technical
Bank of New York US Depository Bank
Salomon Brothers US Financial
Sullivan and Cromwell us Legal
Jones Lang Wootton Valuation
28