Oersted A/S [CPH:ORSTED] – Market Cap as of 06/10/2019 DKK 264.25bn (USD 38.85bn)

Intro

On September 18th 2019 Orsted, the largest energy company in Denmark, signed an agreement to sell its domestic utility business to SEAS-NVE, a customer owned Danish energy company. Orsted has announced its divestment plan over a year ago, as an attempt to fully transition to renewable energy but has since been subject to political backlash due to the Danish government holding majority ownership. The transaction, valued at DKK21.3bn ($3.2bn), will be on an all cash and debt free basis and is expected to close in the first half of 2020.

About Orsted

The Danish state-owned company Dansk Olie og Naturgas (DONG) was founded in 1972 in order to manage Denmarks gas and oil resources in the North Sea. At the beginning of the 2000s, through a series of acquisitions, DONG started to expand its operations in the electricity market. In 2002 it installed the Horns Rev offshore wind farm which was the first large scale farm of its kind in the world. In June 2016 DONG was listed on the Copenhagen Stock Exchange and at the same time divested its ownership of five Norwegian oil and gas fields. In 2017, the company decided to cease to use coal for power generation and sold off its remaining oil and gas businesses to Ineos for $1.05bn. After the sale, DONG had no more oil and gas assets under ownership and hence it decided to change its name to Orsted after the famed Danish scientist.

Orsted is the largest power producer in Denmark, where it holds a 49% market share of electricity production and 35% for heat production. Besides Denmark, it considers Germany, Sweden, Norway, the Netherlands and the UK as key markets of operation. Orsted is also currently the largest offshore wind farm company in the world, having over 16% market share globally and surpassing 1000 offshore wind turbines in 2016. The companies majority owner is the Danish Government, which hold 50.1% of Orsted shares, and according to a political agreement the Danish Government shall hold a majority stake in the company until at least 2025. In 2018 Orsed recorded DKK30bn ($4.5bn) in EBITDA, a roughly 30% increase from 2017, however financial costs grew steadily since 2016 in order to facilitate the expansion of their renewable energy business. The divestment in their distribution business, residential customer business and City Light street light business, accounted for 8 per cent of Orsteds operating profit in the first half of 2019, which will surely have an effect on the financial results for the entirety of 2019. In 2018 Orsted had a 32% operating profit margin, a substantial increase from barely 3% in 2015, before the Danish firm started to fully transition to renewable energy. The company had around 6000 employees at the end of 2018, of which 750 operated in the sold divisions, and is being led by Henrik Poulsen as CEO and President.

About SEAS-NVE

SEAS-NVE is a customer-owned energy company founded in 2005 through a merger of SEAS and NVE, two Danish utilities companies from the beginning of the 20th century. The firm operates in four main business areas through its own brand and a number of subsidies. The core area is energy production, which focuses on an efficient and low-cost supply of energy and increased production of green energy. Besides production, SEAS-NVE also provides energy distribution focused on handling more renewable energy than its typical product mix. SEAS NVE’s distribution unit had a 13% market share in Denmark, coming second after Orsted which had 27% through its Radius unit that will soon belong to SEAS. Being a highly vertically integrated company it additionally operates in the energy sales and solutions sector placing it on both opposite ends of the supply chain. The company has also been providing fibre networks since as early as 2002 and has recently invested DKK3.4bn ($500m) in accelerated fibre roll-out in the Zealand region.

Outside of Denmark, SEAS-NVE has operations across Northern Europe, including Sweden and Germany, where it sells electricity and natural gas and in Scandinavia it has an established network for charging electric vehicles. In 2016 it employed around 900 people and due to the purchase of the Orsted businesses it is looking to add a further 750 to their workforce alongside an additional 2m customers. In 2018 the company recorded revenue of around DKK7.4bn ($1.1bn), nearly double what the group made in 2017 and looking to be even more when the deal is completed. However, in 2018 the operating profit margin was 2% compared to nearly 9% just a year earlier, which can be attributed to a large increase in the use of energy and consumables due to the firms rapid expansion. The company owns a minority stake in Orsted of around 10 per cent, which due to the divestment deal will be reduced to 5 per cent.

Industry Overview

The renewable energy industry has been following a rapid transition that will bring significant changes to many mundane activities: fueling cars, heating homes, powering industries. These trends are having and will continue to have widespread implications for businesses, governments, and individuals.

During 2018, the industry managed to remain resilient despite the uncertainty of new tax and tariff policies. President Trump later imposed 30% tariff on imported solar panels, causing the cost of solar to American households spiked. Some of the core fundamentals that drove growth in 2018 were declining costs of wind and solar generation, advances in battery storage technology, and growing expertise in operators. In terms of costs, the cost of renewables has declined further and many countries expect to reach a tipping point in the near future, where new-build solar or wind capacity is cost-competitive with the fuel cost of existing conventional plants. Globally, onshore wind schemes cost approximately $0.06 per kilowatt hour(kWh), while the cost of electricity generation based on fossil fuels typically range between $0.05 to $0.17 per KwH. The cost of generating power from onshore wind has fallen by around 23% since 2010. Likewise, the cost of batteries has come down further, resulting in promising expectations for an economical competition between electrical vehicles and internal combustion engine vehicles.

The industry has been leveraging on economies of scale with its increasing array of tools and experience to integrate greater volumes of renewables on the grid, due to advancing technology. Additionally, as digital solutions developed for the renewable industry spread across the electricity value chain, renewables are at the vanguard of technology innovation that can open new revenue and business models in the electricity sector. Amongst the many digital solutions being explored, two cutting-edge techniques are IIot and AI. The Industrial Internet of Things(IIoT) has made it possible to collect enormous sets of essential data. Moreover, through Artificial Intelligence, the renewable energy industry advanced in algorithms built to analyze data, forecast models, and even act autonomously. One example is the case of Orsted’s digital strategy with Microsoft Technology that transforms data from its 1300 offshore wind turbines into insights for predictive maintenance that saves time and resources.

The industry leaders by descending order in capacity are: Siemens, Vestas, GE Energy, NextEra Energy, and Orsted. The dominators of the industry all have in common the ability to adapt to the era of digitalization and to diversify across fields for local supremacy. In order to guarantee first-mover’s diversification in local markets, many firms have adopted the strategy to diversify into solar and wind energy, specifically. The diversification could really benefit given the fossil fuel industry’s large balance sheets, synergistic services and capabilities, built-in customers, and very low cost of capital.

One of the critical threats to the industry is the access to rare earth metals. The blooming wind and solar industry require one of the rarest earth metals of all: tellurium. Furthermore, some countries, such as China, are taking advantage of their geographical position to assemble a near monopoly on crucial elements such as tellurium poses uncertainty, considering the effects of political instability on trade.

Some of the world’s leading wind turbine manufacturers are Vestas, Siemens Gamesa, GE, Goldwind, and ENERCON. The wind farms are generally located in North America, China, Germany, and India. In a research for 3.5MW wind farm, it has been found that the total capital cost of a wind turbine project is around $5.9Bn, while the total revenue generated is approximately $880k per annum, in which the value is based on a unit(kWh) price of $0.09. The four turbines in the wind farm arrangement produced an average combined energy output of 9,808,318 kWh units of energy per year.

Deal Structure

Orsted has agreed to sell its power distribution business, Radius, to customer owned Danish energy company SEAS-NVE for $3.2bn (DKr21.3bn). The company’s shares dropped by 2.2% after the deal has been announced. As an existing shareholder at Orsted, SEAS-NVE announced that it will sell part of its existing stake and the asset purchase, decreasing SEAS-NVE’s holding from 9.54% to 5%.

The structure of the transaction is an all-cash and debt free basis, representing an 87% premium to the value of the business in the first half of 2020. Orsted expects to hit a revenue range of DKr11bn to DKr12bn once the transaction finalizes. The transaction comprised 8% of Orsted’s operating profit, which includes Orsted’s distribution business, City Light street light business, and residential customer base, accounting for nearly 2m customers. Under proposed terms of sale, 750 of Orsted’s employees in the division will be transferred to SEAS-NVE. The deal is expected to close in the first half of next year.

Deal Rationale

Finalized in the latest weeks, the deal at issue is backed by two main reasons: the company’s strive for being a global leader in green energy and the widespread industry trend to focus on renewable energy. The incipient paragraph will give some insights about these two aspects.

Since late 2019, Orsted’s BoD and executive management team have started implementing a plan for the company’s global expansion. The program embedded both further investments and divestitures. Specifically, the Team planned to simultaneously invest on renewable energy projects and leave aside all business units that would not help the company achieve a leading position in the production and distribution of green energy.

To this extent, Hornsea One currently represents the firm’s main project in pipeline for the years to come, since it is supposed to be the world’s largest offshore wind farm (located in the North Sea). To the same extent, Ocean Wind Project (New Jersey) and Sunrise Wind Project (which Orsted owns in a joint venture with Eversource, in New York) will further build momentum for the company’s international organic growth. Moreover, in the latest months Orsted officially inaugurated wind farms in Germany and acquired construction-ready sites in South Dakota, for the placement of brand new onshore wind farms. Needless to say, this depicted worldwide expansion phase requires a significant effort in capex terms. As a matter of fact, the capital expenditures for the next six years are expected to hit $30bn for the Danish energy company, three fourth of which will be devoted to the development of offshore wind sites. In return, these projects will eventually bring a significative contribution to the company’s profits in the short-run; indeed, analysts expect EBITDA from these wind farms to increase by 20% per year from 2017 to 2023, and the ROCE to hit the firm’s long-term 10% target.

Exactly on these grounds, Orsted started divesting all satellite business units, which were not aligned with the company’s new focus on worldwide growth in renewable energy. Through the sale of these said units, the Danish firm expected to collect some of the capital needed to fuel its growth plans. As a consequence, the company started to seek potential buyers for its residential customers, distribution and city light business units, specifically targeting consumer or state-owned bidders. When an unsolicited and non-binding offer came from customer-owned SEAS-NVE, the executives and the management clearly welcomed the bid, thus making a further step towards the achievement of their ambitious plans.

Through the sale of the said units, Orsted secured $3.2bn (cash) for its funding needs, also achieving what RBC analyst John Musk defined a smart “simplification” of the company’s business model.

Orsted’s chief executive Henrik Poulsen was particularly satisfied with the move because, from his standpoint, the offshore wind is an industry where, despite an acceleration in demand, competition is significantly intensifying, to the detriment of profits. Moreover, he pointed out, state subsidies are progressively fading, and new projects are mainly driven by auction-based awards, undoubtedly leading to a compression in margins.

These pressures have ultimately led to the privatization and restructuring of the Dutch utility publicly-owned company ENECO, and to the €43bn deal between German energy company RWE and EON. In Mr. Poulsen’s opinion, the time has come for companies in the energy distribution industry to focus on their core businesses, and to secure funds to fuel a long-term growth, so as to successfully overcome all the threats listed above.

Anyhow, as hinted at beforehand, the deal at issue was not only backed by the ambitious projects that Orsted has been pursuing in the latest years, but also by the industry’s current trend to switch to renewable energy. This said trend is aimed at both boosting profits (in the long-run) and at improving on ‘green credentials’. In Mr. Paulsen’s own words: “As you switch from black to green energy, there will be profits that you will forgo. There will be margins that you will leave behind on the black energy side, but I am sure they will be more than compensated by the growth that you will achieve on the green energy side”.

Market Reaction

The way Orsted’s stocks reacted to the announcement of the deal was somehow controversial. Indeed, at first the company’s share price dropped by approximately 2%, since the business unites that Orsted was selling could count on about 2m customers, representing 8% of the company’s profits for H1-2019. However, the trend reverted as soon as the company’s representatives notified the investors that the firm would have matched 2019 earnings forecasts, even if deprived of the said business units. After the announcement, the share price rose again, closing at DKK633 on September 23rd.

What is worth pointing out is that the company’s share price could rely on a strong H1-2019 earnings release, which disclosed a 2% increase in EBITDA and a 6% increase in profits, compared to H1-2018. Undoubtedly, these optimistic figures helped the company re-gain investors’ appetite for its shares, after the announcement of the sale of its Danish retail business.

Advisors

Danske Bank and Citigroup advised Orsted.

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