Still Feeling Burned About Foreign Markets
US power companies made a push overseas starting in the early to mid-1990s as the opportunities to grow abroad looked more promising than what was by then a crowded US market. However, by the time Enron collapsed, the companies were tumbling over one another in their haste to shore up their sagging balance sheets by shedding foreign assets. A panel at the Chadbourne conference in June discussed whether US companies made a mistake to beat such a rapid retreat from Europe, Latin America and other overseas markets, whether there are early signs of a revival of interest in foreign markets, and what complications the shrinking dollar and US war on terrorism create abroad.
The speakers are Matthew J. McGrath, vice president and general counsel of PSEG Global, Robert Cushman, vice president - mergers, acquisitions and structured finance for Entergy Corporation, Robert Burke, chief counsel of PPL Global, Juan Fernando Paez, vice president of Conduit Capital Partners, Jacob J. Worenklein, president and CEO of US Power Generating Co., and Merrick Kerr, chief financial officer of PPM Energy. Keith Martin acted as moderator.
MR. MARTIN: Matthew McGrath, has there been a renewed interest by US power companies in investing in other countries?
MR. MCGRATH: I would say not much from our company. US companies are cautious about what their next moves will be. Many companies are still dealing with fallout from the entry into the merchant power market at home. For our own part, even if there were some boy genius developer who wanted to go abroad and make a new investment and had a good opportunity that was in fact real, Wall Street is simply not ready to listen to it.
MR. MARTIN: Bob Burke, do you see any interest in doing new things abroad at PPL Global?
MR. BURKE: Perhaps to the extent that any acquisitions or developments complement the assets that we already hold abroad. However, I agree with Matthew McGrath about the reaction from Wall Street. There is a feeling that revenues generated abroad are not worth as much as domestic revenues. Perhaps it is because foreign revenues are viewed as inherently more risky.
MR. MARTIN: Bob Cushman, any interest by Entergy in going back overseas?
MR. CUSHMAN: I look at it in the long run like my golf game. After nine holes yesterday, I knew where the day was headed, but I didn’t quit and I will be back at it again today even though I know what the end result will be. However, in the short term, the story is different. Entergy was rewarded for shedding its overseas operations and returning to basics in the US. If anyone said today, “Gee, I think we should go around the world and start spending money again,” he would have a short career — very short.
MR. MARTIN: You have a new CEO as a result of the last money spending spree.
MR. CUSHMAN: That’s right.
MR. MARTIN: We heard from the last panel made up of European companies that they see opportunities in the US market. US companies are also focused on the market at home, notwithstanding how weak it is. Isn’t the US market starting to sound like a small sandbox with too few toys in it for everyone who wants to play, and isn’t there something wrong with this picture?
MR. CUSHMAN: It is a tough picture, but one marked by caution on both sides. US companies are cautious about returning abroad. European companies are cautious about the investments they make in the US.
One of the problems the last time is that US companies underestimated how badly their offshore investments could do. We had worst-case scenarios, but they misjudged the bottom of the market. Entergy tried in the 1990’s to do business in 15 countries and, out of those 15, we built or acquired electric distribution companies or power plants in seven and, out of those seven, we made money in four. When you look at such a hit rate and how much effort was required, it is easy to understand the reluctance to try it again.
MR. MARTIN: Bob Burke, do you agree the bottom of the market is a lot farther down than anybody realized? Was that your experience at PPL?
MR. BURKE: Basically. We have had some successes overseas and some misadventures, and I think the successes can be attributed to basic business fundamentals like understanding the market, understanding the regulatory system, and having a capable local management team.
MR. MARTIN: Is there anyone here from a private equity fund that is looking to make investments in the power sector overseas?
MR. PAEZ: Yes, my name is Juan Fernando Paez. I work with Conduit Capital. We are a company that was recently spun off from Deutsche Bank, and we run Latin American investment funds.
MR. MARTIN: Do you sense any growing interest among US private equity funds in putting money into the power sector overseas?
MR. PAEZ: We obviously have an interest, but the conditions are not ideal. We tried raising more money for such investments, and it is a very difficult market. The mere mention of Latin America turns off some investors.
MR. BURKE: People frequently talk about overseas as one homogenous market. There are a thousand different markets overseas. People talk about Latin American risks. There is a big difference between doing business in Guatemala and doing business in Chile. One of the problems with the current attitude on Wall Street is that offshore investments are viewed as inherently more risky than investments in the US without stopping to evaluate them market by market. I have heard countless times during visits to Wall Street about Latin American risk, and yet I cannot tell you what Latin American risk is. I can talk to you about Chilean risk, or Brazilian risk, or Guatemalan risk. They are distinct markets.
MR. WORENKLEIN: The comments so far reflect the current reality in the market, but there is something happening now that is very interesting to me. I have this perspective from being a board member of CDC Globaleq, which is a company owned by the Commonwealth Development Corporation in the United Kingdom that is, in turn, owned by the British government. It was set up to serve as kind of a private sector money entity, and it has new money coming in from private sector entities.
CDC Globaleq bid in the auction for the Edison Mission Energy Asian assets and lost with a bid that we thought was highly credible. There was significant interest in the assets by bidders most of whom were outside the US. Some of them were Asian entities. Some were other companies based in the UK.
What the auction showed is that rates are being bid down below the mid-teens.
The point is there is something happening in the market, and it may be that with the large flow of money into hedge funds and perhaps insufficient opportunity elsewhere, we are starting to see a significant flow of capital into emerging markets. It is not what was expected even a year ago.
Misjudging the Worst Case
MR. MARTIN: Entergy had a mixed experience with its overseas investments. Matthew McGrath, what has been the experience at PSEG Global?
MR. MCGRATH: What we got wrong in the main were the macro-economic assumptions. We have done a very careful self-evaluation over the past couple years of what we got wrong and what we got right, and where we underestimated was in the macro-economic stuff. A case in point is Argentina. The entire economy collapsed. When we got down to the operating stuff, we did okay. When you look at the regulatory stuff, we did okay, and we are still doing okay.
Basic business fundamentals are important. A US utility should ask itself: what does it mean to be local? We are in New Jersey. We have been there for a hundred years. Why is it working? Is it possible to replicate those things once you unpack in a target market, and if the answer is no, then you should not go. If you think there might be a chance, then maybe you should go.
MR. CUSHMAN: Operating plants or electric distribution systems in foreign countries has never been a problem. The problem has been the macro-economic issues. It is understanding the market. It is understanding the regulatory environment in which you are playing and what can go wrong. Tax law changes are a problem. Within months after Entergy acquired London Electricity, the UK government enacted a windfall profits tax that cost us a hundred million dollars.
Too Hasty a Retreat?
MR. MARTIN: Let me switch gears. Many US power companies were so eager at the end of the 1990’s to retreat to the US that they practically dumped their assets abroad and ran home. This was particularly true in the UK market. Was it a mistake to have acted with such haste?
MR. CUSHMAN: No. Entergy was fortunate to have been ahead of the curve. We got out before the true exodus. Look, once a company concludes that it cannot earn its hurdle rate of return, it should get out. Internal debates take up a tremendous amount of management time, and Wall Street does not reward anyone for indecision.
MR. MARTIN: But it seemed like everybody decided at once “we can’t make it” and everybody left, leaving the assets behind.
MR. CUSHMAN: There is a herd mentality. Once some companies exit, it raises questions at board meetings. No one wants to be the last to exit.
MR. MARTIN: Matthew McGrath, did US companies make a mistake? They were practically tumbling over each other in their haste to exit.
MR. MCGRATH: The answer is different for each company. That may have been absolutely the right thing to do for Entergy shareholders. I am sure it was. For us, abandoning the assets in Argentina was the right answer, but we made the judgment that our shareholders were not interested in our selling other assets in a down market. We told the shareholders that new investments were on hold and we planned to manage what we had. Every company must make its own choices.
MR. MARTIN: Bob Burke, I believe PPL Global decided it was better off staying in most of the markets in which it was invested, but not putting in more money?
MR. BURKE: Internationally, we focus on electric distribution. We have about three and a half million customers internationally. We reassessed our markets one at a time. In Brazil, we got out because we did not think it had a future. In Chile, the question was, “If you divest those assets, how are you going to replace the earnings?” We had no ready answer, so we kept the assets that were performing. We kept our investment in the UK.
MR. MARTIN: Will you be making additional investments in the countries where you remained?
MR. BURKE: We might consider it to the extent that it made sense with our existing asset base, but that is tough story to sell on Wall Street.
MR. MCGRATH: What Wall Street requires may change over time. I can only speak from the perspective of a traditional utility-based company, but if you look at what the growth opportunities are in the US, they are not huge. One must ask: if it is a requirement that one grow, where will one grow?
In time, companies may start looking abroad again, but they will go abroad in a much more sensible way. Rather than putting together serendipitous portfolios and approaching things opportunistically, they will ask what is making them successful in their home markets and how they can replicate that success in target markets.
MR. CUSHMAN: Life does not change. That is no different than what we heard from almost everybody venturing abroad in the 1990’s. It was, “I have a certain skill set that I have used to good effect in the US, and now I am going to replicate that success overseas.” Boards of directors have long memories. It will be a while before they allow their managements to pursue a growth strategy overseas.
MR. MCGRATH: But that story could have been true in the 1990’s and, in some places, it was true. There is nothing particularly wrong with the story.
MR. BURKE: The irony is during the rush to invest overseas in the 1990’s, many people overpaid badly for assets. Now that such investment is no longer in vogue, the prices are reasonable.
MR. MARTIN: Do American companies approach markets differently than European ones?
MR. MCGRATH: I think yes. American companies carefully construct pro formas that go out for 20 or 30 years — and then they consider it extremely important to have a return by the next quarter after the acquisition. My guess is European companies do not look at things the same say. We go in with long-term projections and short-term expectations. Americans want very healthy returns by the next quarter.
MR. MARTIN: Merrick Kerr, your parent company is Scottish Power. Are European shareholders more patient in the sense that they allow more than one quarter to earn a return?
MR. KERR: No. [Laughter.]
MR. MARTIN: Let me ask a few other questions quickly. Has the collapsing dollar affected how any of you US companies do business abroad?
MR. BURKE: It has helped boost earnings from our UK operations since the same number of British pounds translate into more dollars.
MR. CUSHMAN: It also helps US companies that are still in the process of selling their overseas assets. You can sell for a lower price and still show a profit when the amounts are translated into dollars.
MR. MCGRATH: We have had the same experience. We sold a project in Tunisia and the weak dollar helped grease the negotiations.
MR. MARTIN: Has the war on terrorism affected how any of you do business abroad?
MR. MCGRATH: We have assets in Oman, for instance, and it translates into a basic security issue, but nothing more than that.
MR. MARTIN: None of you is experiencing any anti-American sentiment in France, Tunisia or anywhere else abroad?
Okay. Matthew McGrath, you told me before this session that the privatization model has not worked, and that it is one of the reasons US companies soured on doing business abroad. What is wrong with the privatization model, and what would a country like Russia be wise to do with UES when it privatizes.
MR. MCGRATH: PSEG Global has a lot of experience with privatization in Latin America where the model was simply sell the nationalized assets, get a lot of money into the treasury, and then proceed with a regulated environment and give the investors a regulated return. What many participants in these privatizations have come to realize is that the governments have an inflation knob that lets them adjust the price of electricity.
Once they sell the assets and get the money in the treasury, they reach for the knob. I am not sure that the populations in these countries were very happy about having to pay more for electricity. You can make all the sensible arguments, but you cannot get between the people and what they want, which is cheap power.
Everyone may be once bitten and twice shy, and there may be a reluctance for some time to put new capital into markets that are just sorting out what return will be allowed on capital. Russia is pretty funky by most people’s standards. If Russia needs expertise in the power sector and wants to develop long-term credibility in the market, it should consider having companies bid on operating contracts rather than the assets themselves. That will give Russia the knowledge transfer it requires without requiring companies to put a tremendous amount of capital in the ground.
Look at what happened in India where you put $300 million in the ground, and you have a power purchase agreement, but then the local government says it no longer likes the price at which it agreed to buy electricity. We can talk about political risk; the same thing happened to us in California. I never know whether I am in Tamil Nadu or San Diego. [Laughter.]
Unless the industry gets collective amnesia, I would think governments would do better in the near term to offer operating contracts rather than adopt an approach that requires bidders to throw in big wads of cash.
MR. MARTIN: Is the choice for the government between maximizing the cash today it can get from the asset or taking out a return gradually over time?
MR. MCGRATH: It may not be prepared to make such a choice. Maybe if it offers the assets for sale, people will come clamoring to buy them, but perhaps not.
MR. MARTIN: Bob Cushman, what would Entergy do differently the next time it goes overseas?
MR. CUSHMAN: It was not a good idea to try to plant the flag in 15 different countries with a limited amount of resources — limited not just in the number of people but also the capital that you can invest in any one country. If we did it again, we would focus on one or two regions. We made money overall, but it was a tough way to make a buck.
MR. MARTIN: Matthew McGrath, do you have to be overseas to figure out where is the best place to focus?
MR. MCGRATH: No, I think the decisions about which markets to target should be made from home. You do not need to establish a foreign office and start spending G&A costs in order to figure out where to focus your efforts. Europe is perfectly observable from New Jersey. The last time round, we wound up with a large office in London but no investments in the UK. It was an unnecessary cost.