MERGERS AND ACQUISITIONS AN INTEGRATION IN ENERGY SYSTEMS: THE CASE OF EDP RENOVÁVEIS AND MARTIFER GROUP AUTHOR: ANA RITA FRAZÃO DE SOUSA HAND-IN DATE: 15-07-2013 SUPERVISOR: PETER TSVETKOV PROGRAMME: MASTER OF SCIENCE IN BUSINESS ADMINISTRATION This thesis is a part of the MSc programme at Universidade Católica Portuguesa. The school takes no responsibility for the methods used, results found and conclusions drawn. ABSTRACT The recent advent of privatization of one of the main actors in the Energy Industry Sector, in Portugal, made the whole segment to be under the spotlight. The liberalization of the energy segment in Portugal, the vicissitudes in the regulation and the increasing importance of the renewable segment conducted to an amplified interest in studying a possible deal with this industry. Furthermore, when assessing the companies and its potential in terms of performing a deal, the criteria were not only the likelihood of becoming real, but also the existence of an added- value analysis. The possibility of creating a trend in the industry, integrating businesses so far separated enhanced the research and demanded a detailed overview of more than one sector. In fact, consolidation, liberalization and regulation are generic concepts that cover a large spectrum of situations. However, all of them are attributable to the Energy Industry nowadays. Hence, such a wide segment facing several challenges brought up the possibility of a vertical integration of EDP Renováveis (EDP R) with a company in the energy systems segment as a key-movement. Consequently, Martifer Group SGPS (Martifer) came as an obvious partner. Tacking fiercer competition (consolidation and liberalization), and uncertainty in the mature markets towards renewable energy production subsidization (regulation) due to the hazy economic environment, with decreasing costs by integrating a downstream company may be a valuable comparative advantage. Both companies are quoted in the Portuguese Stock Market, with a worldwide scope though - increasing the benefit of merging. This dissertation will, then, focuses on analyzing the previously referred companies, being Martifer the target of EDP R in the attempt to integrate the business segments, not only in the wind segment, but also diversify through the solar one. Additionally there is potential of evolving in the best practices developed and improve management. In order to do so a careful industry analysis was developed, covering in total five industries: metallic constructions, wind and solar energy systems production and project development; and electricity production from both renewable sources: wind and solar. EDP R and Martifer are, as of 31st of December 2012, according to the valuation performed, undervalued companies, with considerable upside values. Moreover, the latent synergies were esteemed and represent a 40% premium over Martifer’s average market capitalization of 2012. ii ACKNOWLEDGMENTS The learning opportunity of a Dissertation represented the chance of facing a final demanding challenge, as the very last step in the conclusion of the studies for the Master Degree. The author would like to thank Peter Tsvetkov, the Dissertation Advisor, for the availability and helpful feedback. Additionally, the incessant availability of some friends, like Ana Carolina Caetano, Duarte Alves Ribeiro, Francisco Martins, Joana Quintanilha Nunes, Maria Patrão and Nuno Clara, not only in terms of sharing and discussing ideas about the thesis developed, but also by being present in moments that required a certain strength to keep the hard work resiliently. In general, the Bloomberg room audience shall not be forgotten. The terminal is obviously an essential tool, but it also represents a meeting point of finance students that always have a valuable point of view to give. Last but not least, a special gratitude sign to her family, for the constant support in her education life. iii TABLE OF CONTENTS Introduction .............................................................................................................................................. 1 Literature Review ...................................................................................................................................... 2 A. Valuation Overview ...................................................................................................................... 2 1. Cash Flow based Models ......................................................................................................... 3 1.1. Generic Aspects .............................................................................................................. 3 1.1.1. Discount Rate............................................................................................................. 4 1.1.1.1. Cost of Equity ..................................................................................................... 4 1.1.1.2. Cost of Debt (Rd) ................................................................................................ 9 1.1.2. The cash flows ........................................................................................................... 9 1.1.1.1. Time frame (t) ................................................................................................... 10 1.1.3. Growth Rates ........................................................................................................... 10 1.1.1.2. Operating Assumptions ..................................................................................... 11 1.1.1.3. Terminal Growth Rate ....................................................................................... 11 1.1.4. Taxes and Currencies............................................................................................... 12 1.1.5. Leverage implications ............................................................................................... 12 1.2. Models Philosophy......................................................................................................... 12 1.2.1. APV ......................................................................................................................... 13 1.2.2. WACC-based DCF ................................................................................................... 13 1.2.3. Equity Cash Flow and DDM Model ............................................................................ 14 2. Other Models ......................................................................................................................... 15 2.1. Multiples ........................................................................................................................ 15 2.2. Returns-based Approach ............................................................................................... 16 2.3. Real Options ................................................................................................................. 16 3. Multinational Firms’ Valuation ................................................................................................. 17 B. Perspectives on Mergers & Acquisitions ...................................................................................... 19 1. Types of Transactions ............................................................................................................ 19 2. The post-merger issue ........................................................................................................... 20 3. Value Creation and Synergies ................................................................................................ 20 4. Valuation of Synergies ........................................................................................................... 22 5. Method of Payment ................................................................................................................ 23 6. Control premium .................................................................................................................... 23 Industry and Company Analysis .............................................................................................................. 24 A. Industry Overview ...................................................................................................................... 26 1 Renewable Energy ................................................................................................................. 26 1.1. Introduction ................................................................................................................... 26 1.2. External Context ............................................................................................................ 29 1.2.1. M&A activity in the sector .......................................................................................... 30 iv 1.2.2. Considerations by Geography ................................................................................... 31 1.2.2.1. Europe.............................................................................................................. 31 1.2.2.1.1. Portugal ................................................................................................ 31 1.2.2.1.2. Spain .................................................................................................... 32 1.2.2.1.3. Romania ............................................................................................... 33 1.2.2.2. USA.................................................................................................................