Eastern Europe power firms a hot buy, despite high costs

Global utility firms are on the hunt for central and Eastern European power companies, betting that profits from markets expanding as they near EU entry will offset hefty modernization costs and a hazardous regulatory environment. Utilities in Eastern Europe are relatively expensive, with price tags boosted by their often dominant market positions and forecasts of power consumption growing by up to 50% in households as European Union entry increases wealth. Yet EU entry, forecast in 2004 for eight ex-communist states, will drive a power market liberalization that should deliver the returns needed to justify high prices, even when big layoffs and the costs of modernizing are factored in. "We are betting on those markets becoming more transparent and liberal after 2004, but also on the economy fueled by EU membership after accession," said Jean-Claude Dorcimont, the vice president of Belgium's Tractebel Electricity and Gas. "And we are willing to pay the price," he added. Analysts said investors are valuing a central European utility customer at $400-$500 on average, still much below the $650-$1,200 seen in more developed European energy markets, like Germany. But the hottest targets may fetch a much higher price, with reported bids for a majority stake in Poland's largest power distributor, G-8, valuing its customers at around $700. "Poland is a large market in the European context and utilities bet that even if they lose money now they can win in the long term. It is a risky bet, but large companies can take it," said Anatoli Kaminov, an analyst at Merrill Lynch in London. The approaching sale of some of the most lucrative groups in the region - such as Czech firm CEZ and other power distributors in Poland - may even up the ante, analysts said.

Sensitive issue The most active acquirers so far are Germany's RWE and E.ON, Electricite de France (EdF) and Tractebel. RWE, E.ON and EdF have each just bought stakes in power distributors in Slovakia where grids are connected with Czech, Hungarian, Polish and Ukrainian networks, giving the firms strategic holdings for future cross-border power sales. Across post-communist Europe, the toughest challenge acquirers face is opposition to the social costs of change. Trade unions fight hard to protect jobs and governments use power price caps to ease social tensions or win popularity. In Poland, trade unions have cajoled investors into generous compensation packages as part of most privatization deals. With unemployment running just below record highs of 18%, layoffs are a prickly issue. Tractebel's buy of Poland's 1,800-megawatt power plant in southern Polaniec two years ago set a difficult precedent after the Belgian group agreed to a 10-year moratorium on layoffs. "We are always shocked to see unions coming with incredible negotiating positions - in Polaniec it was not even employment forever, it was employment by inheritance," Dorcimont said. The firm has since implemented a voluntary leave program with 700 of 2,300 workers leaving, but had to pay handsome severance compensation, reportedly reaching zł. 100,000 per head. "Such demands are nothing but a threat to competition - deadly in the longer-term perspective particularly ahead of EU accession," Poland's Treasury Minister Wiesław Kaczmarek said. Analysts said Poland should adopt a uniform compensation policy, mirroring that successfully implemented by Hungary when it privatized the sector in 1995-1996.

Pricing concerns Investors also said Central Europe needs more transparent prices and an end to cross-subsidies, where industry buyers often pick up a part of the tab for household consumers. Prices are often capped, despite growing production costs, while some of the biggest customers from ailing state-owned heavy industries are allowed to buy power on credit. "We see a low collection rate from some of the industrial giants, while at the same time it is problematic to adjust power prices paid by households to true economic levels," said Josef Pospisil, a sector analyst at FitchRatings in London. A bitter pricing policy dispute between Hungary's power distributors and wholesaler MVM ended up in an arbitration court last year after the power watchdog boosted wholesale prices by much more than consumer prices were allowed to grow. Poland's power distribution prices, which the industry said fail to compensate for a new power excise tax, show the country has a long way to go in rebalancing its tariffs. Analysts said pricing policies in neighboring Czech Republic and Slovakia are more transparent. But delays in implementing price hikes and sector reforms in Bulgaria have recently prompted harsh warnings from the International Monetary Fund.

Social painkillers Meanwhile, the power sector's dependence on coal makes it tempting for politicians to help the ailing mining industry at the cost of foreign investors, market insiders said. A sale of Eastern Europe's top utility, the Czech Republic's CEZ, fell through this year after the government demanded a high price tag linked to tough conditions, including guarantees of coal purchases. But analysts said a new Social Democrat government may be willing to take a more market friendly approach to the sale now. "The previous government wanted to solve too many social issues with the CEZ sale, and the Social Democrats will probably change tender terms to make them more market friendly," said Jindrich Svatek, an analyst at Raiffeisen Securities in Prague.

- Reuters