The bid was launched yesterday despite ScottishPower's failure to secure the recommendation of Southern's board for its cash and shares offer.
Southern, which appeared to have given up hopes of holding on to its independence following a 38 per cent surge in its share price, told its shareholders to sit tight while it talked to Southern Electric, which has also emerged as a potential bidder.
Southern Electric is understood to be increasingly keen to forge a deal following its failure to buy rival electricity company Sweb or sell itself to the generator, National Power. But doubts were growing in the City last night about its ability to match Scottish's offer with a deal that would almost double its size. It was also not clear that a merger of the two Southerns would be politically acceptable as it would likely involve heavy job losses, whereas Scottish has stated that it will not impose any compulsory redundancies.
Murray Stuart, chairman of ScottishPower, said: "The merger will lead to increased sales of electricity, gas and water-related services, boost competition and enhance customer choice. We are confident it will deliver benefits to the shareholders of both ScottishPower and Southern Water."
Southern Electric declined to comment on when or whether it planned to return with a counter bid for Southern Water. Some analysts said the electricity supplier may pull out rather than start a bidding war - partly because the two Southern companies' territories do not really overlap, reducing the potential benefits of a merger.
The start of what could be an auction for Southern set off a wave of bid speculation throughout the water sector, with dealers on the look out for the next target. After Southern's shares jumped 260p to 941p, Anglian rose 32p to 572p and Wessex closed 24p higher at 332p. Both are seen as likely targets.
Market sources also pointed to PowerGen and National Power as likely predators following the unexpected blocking last month of their attempted takeover bids for Midlands Electricity and Southern Electricity. Both Severn Trent and Thames Water are thought to be in their sights.
A merger of Yorkshire Electricity and Yorkshire Water is also expected, with the two having a closer customer fit than any other combination.
The bid for Southern Water would be the tenth takeover of a British utility in just 18 months, but only the second of a water company, the first being Lyonnaise des Eaux's bid for Northumbrian Water. Analysts said Scottish's offer, worth 966p in cash, shares and dividend, with a 935.7p cash alternative, represented a relatively generous 12 times earnings compared with the 9 times paid by the French utility. Some believed the offer represented a knockout blow.
Shares in ScottishPower closed 17p lower at 319p, while Southern Electric finished 26p lower at 726p.
The bid by ScottishPower is its latest move in an ambitious attempt to create a powerful multi-utility group ahead of the opening up to competition of the gas and electricity markets from 1998. A takeover of Southern would give it a total of 5 million customers, to whom it could sell the full range of its services.
Scottish said there would be an "immediate and substantial enhancement" of its earnings per share and it promised shareholders a 16 per cent dividend hike to 18p a share in the year to March 1997 if the bid was successful.
Ian Russell, finance director, said he did not expect the bid to run into political or regulatory problems since, he claimed, it raised no competition issues. Analysts agreed, noting that if Ofwat, the water industry regulator, were to wave the bid through, the Government would be unlikely to refer it for a monopolies commission inquiry. Only bids between water companies are automatically referred to the Monopolies and Mergers Commission, they added.
Scottish attempted to sweeten its offer in the eyes of the regulators by offering customers a 3 per cent reduction in their water bills for two years from April 1998. No similar demands were imposed on North West Water when it took over Norweb last year to create United Utilities, or on Welsh Water when it acquired Swalec.
Neither bid was referred and the Government has so far blocked only two bids, both of which involved generators bidding for regional electricity companies. National Power and PowerGen were stunned when their takeover plans were blocked. Both had been confident of approval after Scottish Power was given the go ahead to acquire Manweb, tacitly endorsing "vertical integration".
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