Elliott Management Corp is a master at forcing companies to do something about the gap between a lowly share price and their value on paper. But the activist hedge fund’s campaign targeting UK utility SSE Plc runs up against an awkward reality: Stock markets don’t always obey spreadsheets.
SSE is a fiendishly complicated firm with a simple problem. It wants to spend 12.5 billion pounds ($16.5 billion) on doubling its renewable-energy capacity, but it can’t afford to do this while also paying a chunky dividend and preserving its credit rating. So it plans to raise cash by selling as much as 25% of its business operating power lines and connecting British homes to the grid. Plus, it will cut a dividend that costs about 800 million pounds annually.
This has incensed Elliott, which sees a better alternative – fund investment by spinning off the renewables business on the stock market. The expectation is that this would be a hot stock, which could sell new shares whenever it needed capital.
Split up SSE, and the total value of its networks and renewables businesses would be worth more than today’s integrated company. Elliott reckons the stock market could value the combo at 22.3 billion pounds, nearly 30% above the current level.
That may be overoptimistic, but many analysts agree with Elliott that SSE suffers a conglomerate discount. Value the networks business at 150% of its regulated assets (in line with recent UK deals), then put the renewables arm on the trading multiples of listed peers, and you get to something around 10% higher than the current market value, according to Jefferies research.
It’s typical Elliott. The plan rests on the principle that each business should stand on its own two feet. Analysts have already made the case. The snag is that there’s never any guarantee the market will respond as hoped to such arbitrage strategies. Shareholders prefer simplicity, and maybe ESG investors would push up the share price of the newly independent renewables company. But the break-up value of SSE is already well known. If a demerger doesn’t deliver a sustained valuation improvement, supporting funding through new equity, the benefit of separation tails off.
For its part, SSE argues unconvincingly that there are synergies in keeping the two businesses together. More plausible is its admission that neither of the separated firms would have a strong investment case on their own.
For example, SSE renewables wouldn’t have the support of the state, unlike highly rated Danish peer Orsted A/S.
Nevertheless, Elliott sees that SSE is torn between competing investor demands, to be both an income producer for its shareholders and a fast-growing ESG stock. SSE thinks it can please everyone but risks pleasing no one, as analysts at Barclays Plc put it.
Elliott is right that these businesses don’t belong together. While its favored demerger idea is risky, some of its desired consolation prizes – a more substantial sale of the networks business or a sale of a stake in renewables – look more appealing.
If these businesses are an awkward fit, and may not yet be ready for distinct listings, that leaves the possibility they’re worth more to private equity or rivals. And when a bidder offers a price, you know for sure how it stacks up versus the spreadsheet.