British Gas fracture leaves City uncertain
Flickering response: Investors give demerger a muted welcome as impact of costly take-or-pay North Sea contracts comes into question
Wednesday 07 February 1996
and NIGEL COPE
The City gave a muted welcome to the early retirement of Cedric Brown and British Gas's plans to demerge into two companies, with the shares climbing but falling back later as scepticism began to take hold.
Investors were concerned that the smaller company, British Gas Energy, might be undercapitalised because it will take all the potential losses of at least pounds 1.5bn from the group's long-term take-or-pay contracts in the North Sea.
Investors believe that TransCo International, the bigger of the two demerged companies from the pounds 10bn group, could become a potential takeover target, but Richard Giordano, who is to be chairman of both, said: "I haven't seen a predator yet that is going to snap up TransCo."
Mr Giordano rejected suggestions that BGE was being used as a shell company to insulate the much more valuable transmission company that will own the monopoly pipeline system from the potential losses.
He announced that to give BGE financial strength British Gas had decided to inject the Morecambe Bay gas fields, worth more than pounds 2bn, into the new company supplying UK customers. BGE would be a separate entity with net assets he said were worth pounds 2.6bn.
This asset value includes current provisions for the cost of supply contracts but not any future increase in the losses.
Mr Giordano said the flotation of BGE, which would be put to shareholders as part of the demerger package next spring, could go ahead before the disputes over the take-or-pay contracts with North Sea suppliers were resolved.
BGE will employ 22,000 people and will have annual sales of around pounds 8bn. Cost savings of more than pounds 500m are expected for 1996.
The other much bigger company - except in terms of employees - is TransCo International, which is the heart of British Gas because it owns the monopoly 267,000km pipeline system. It has gross assets of pounds 18bn and employs 20,000.
It will also embrace the international exploration business of the group, which has pounds 2.6bn of assets, half of which are at the development stage.
Mr Giordano said the split would not affect the company's overall dividend- paying ability, but the plan was for TransCo International to be the principal source of dividends for shareholders.
The other new company, British Gas Energy, will return funds to shareholders by dividends or share repurchases when circumstances justify it, Mr Giordano said.
The key issue for TransCo is a review by the regulator, Clare Spottiswoode, of its price-control formula, which expires in March 1997. The result will be critical to its future profitability.
Mr Giordano said that if the proposals were unacceptable to British Gas, Ofgas would be obliged to take the issue to the Monopolies Commission, but he hoped to obtain an acceptable result without that.
The names of the two companies have not been settled because both are demanding to remain as British Gas because it is so well known in the UK and abroad.
All the group debt - pounds 3.6bn at the end of the last full year - with the exception of BGE's working capital needs will be kept in TransCo. Mr Giordano said the split would bring new skills to British Gas and allow the two sets of managements to focus on their businesses.
Employees, who had been through a period of great uncertainty, would also benefit from the strategic clarity and better long-term prospects for both companies, he said.
Mr Giordano is to be chairman of both companies and will also be chief executive while two replacements are sought over the next few months. He said internal and external candidates were being considered. The principal internal contenders are the finance director Roy Gardner, who said: "I have too much to think about to consider it," and Philip Rogerson, another director, who said the decision was a matter for the board.
City analysts and fund managers were split on British Gas's break-up decision, with most saying they would need more details to judge its merits. The uncertainty was reflected in the company's share price, which moved 14p higher at one point but closed 2p lower at 242.5p.
Most said the split was "no surprise" although there were concerns that the smaller company, British Gas Energy, might be under-capitalised. Irene Himona, analyst at Societe Generale Strauss Turnbull, said: "It is clearly weaker but there were not many alternatives." She said it was unclear how long the problem over long-term contracts would persist. "If you have a few very cold winters the problem of over-supply could reduce. But you can't wait for the next Ice Age to return."
Fund managers were broadly supportive. One said: "You have to ask how much further we have moved ahead." According to another, the spilt would make the company "more flexible" and was to be welcomed, while one said the jury was still out: "The whole way this company has been managed has been a disgrace." The demerger prompted Standard & Poor's to put British Gas's credit rating under review.
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