Just AAsk: Centrica shareholders did and enjoyed a £1.5bn payday

Gas group raises £1.75bn from sale of roadside breakdown arm and invests in energy
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Centrica, the owner of the British Gas brand, yesterday rewarded shareholders with a £1.5bn return of capital following the sale of its AA roadside breakdown business to a pair of private equity firms for £1.75bn.

Centrica, the owner of the British Gas brand, yesterday rewarded shareholders with a £1.5bn return of capital following the sale of its AA roadside breakdown business to a pair of private equity firms for £1.75bn.

The group also unveiled plans to step up its investment in upstream energy assets, pledging to spend an extra £2bn-£3bn over the next five years on gas fields, power stations, renewable energy and its international operations.

Virtually all the proceeds from the sale of the AA to CVC Capital Partners and Permira will be returned to shareholders in the shape of a £1bn special dividend and a £500m share buy-back programme to be carried out over the next 12 months. Centrica is also increasing its dividend, lifting the payout to 40 per cent of net profits this year and 50 per cent in 2005.

Shares in the group climbed 5 per cent to 236.5p on news of the hand-out to investors and are now less than 10 per cent below their all-time high, reached in early 2000.

The disposal of the AA, which was bought for £800m five years ago, will net Centrica a profit of £700m and is the second major divestment in as many years following the sale last year of the credit card business Goldfish. Although the AA has expanded aggressively into insurance and personal finance in the last five years - hence its inflated selling price - Centrica has only needed to invest a total of £80m in the business.

The price that CVC and Permira are paying is about £400m more than analysts calculated the AA would fetch. "We have created a huge amount of value from the AA," said Centrica's chief executive, Sir Roy Gardner. "We have got tomorrow's value today."

Nevertheless, the sale of the business does beg the question of whether Centrica's much-vaunted strategy of cross-selling different products to an enlarged customer base has been a success.

Under Centrica's ownership, the AA's membership has grown from 9.5 million to 15 million, while operating profits increased from £6m to £93m. Including the AA and Centrica's North American business, the group has 50 million "customer relationships" as it calls them. With the sale of the AA, that will figure will fall to 33.5 million.

However, nearly all of the membership growth in the AA came, not from persuading British Gas customers to sign up for roadside assistance, but from car manufacturers including it among the perks offered to new car buyers.

Sir Roy insists that the plan was never to cross-sell between brands but within them so that customers, be they with the AA or British Gas, were persuaded to buy more products from the same supplier. In this respect, he says the AA acquisition was a success with the average number of products bought by each member rising from 1.1 to 1.3 during Centrica's ownership.

But it was never a core business for Centrica. The AA accounted for less than a tenth of turnover and operating profit, and, for all the talk of how complementary it would be fixing broken down boilers and broken down cars, the two businesses remained chalk and cheese.

Sir Roy says the AA was sold because Centrica got to the point where it could not extract any more value from the business or use it as a platform for international expansion But that is only part of the story.

The speed with which the auction was conducted - the sale took less than a month from start to finish - strongly suggests that Centrica also needed to raise money, and quickly, to keep shareholders at bay.

With nil debt in its books, the company had been under growing pressure from investors to make more efficient use of its balance sheet and hand back capital. Strategically, however, the priority for Centrica's management was to invest in upstream assets to avoid being caught in a vicious squeeze by the decline in UK gas production and the growing shortage of gas in Europe generally. In the parlance of the industry, Centrica is long on customers, with some 19 million UK households taking gas, electricity or both from it, but short on generation, with the capacity to meet only 20 per cent of gas demand and 40 per cent of electricity requirements.

The AA deal enables Sir Roy to keep everyone happy. Investors get their pay day and Centrica gets to go on a spending spree. Since 2000, it has invested some £1.7bn on upstream assets including the Rough gas storage complex. In February, it earmarked a further £2bn of investment over the next four years and, following yesterday's announcement, that figure will double to £4bn. The bulk of the additional £2bn will be used to buy equity stakes in gas producing fields but there will also be significant investment in new power station capacity. There will also be some extra spending on renewables, but it will be modest in comparison with the £750m already earmarked.

By the end of the five-year period, Centrica reckons it will be able to supply some 60-70 per cent of its own peak electricity demand, 35 per cent of the gas it sells and some 30 per cent of the power it needs to meet demand in North America, where the company now has some 5 million energy customers.

The spending necessary to achieve all this will leave Centrica with some £2bn to £3bn of debt on its balance sheet. But that still only equates to a gearing of 30-35 per cent, which is hardly excessive for such a cash-generative, utility-style business.

The sale of the AA will take about three months to complete, but already it is as if Centrica had never owned the business. Its new venture capital owners are bringing in their own management team of Tim Parker, who is currently running Kwik-Fit, and Sir Trevor Chinn, who will act as chairman. They will have to sweat the assets hard to justify the £1.75bn purchase price and get it in shape for the flotation which is planned within five years. But at least CVC already has some experience in the motoring business through its ownership of Kwik Fit and Halfords. Perhaps it can even make a success of cross-selling.

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