OUTLOOK : Government's power embarrassment grows daily

Click to follow
The Independent Online
Every day seems to throw up a new story to illustrate quite how seriously the Government underpriced the electricity industry when the 12 regional electricity companies were privatised four years ago. Opposition MPs are having a field day. Hot on the heels of Trafalgar House's announcement that it is considering a bid for Northern Electric at a price analysts confidently expect to be about six times what the company was sold for comes news of a 90p-a-share special dividend from Yorkshire Electri city.

What is wrong with that, asks Yorkshire, pointing to a 19 per cent real reduction in domestic prices since privatisation at a cost of £100m in revenues. Customers are sharing in the spoils too, it claims. Well, barely. Despite the squeeze on prices, Yorkshire added more than £80m to its bank balance during the first half.

So it is hard to take too seriously the company's claim that its days as a licence to print money are numbered. The fact that Trafalgar House can contemplate a highly leveraged takeover and still leave enough in the bank from the deal to fund cash-flow problems in other parts of the group suggests the party has a while to run yet.

Others too - notably Hanson and Tomkins - are working on similar takeover plans. The only thing holding them back is the Government's golden share, which runs until the end of March. Taking into account the two months a bid timetable takes to run, that means potential bidders can begin going public from the end of January onwards. At a time when the Government could do without any further embarrassments, these bids are going to make it look foolish in the extreme. It might as well have settled for a trade sale in the first place rather than the costly public share offer it chose.

Defensive mergers among the RECs are unlikely to see off the threat. In any case there are practical barriers to such mergers. The enormous, complex computer systems required to deal with millions of customers are likely to be next to impossible to combine. Not doing so takes away the bulk of the notional benefits of putting RECs together.

Buying a REC is not without its risks. Licences guarantee customers minimum levels of service, making wholesale cuts difficult to carry through. The ever-present shadow of Professor Stephen Littlechild takes the shine off any deal's attractions. There isno guarantee, for example, that any cost savings achieved will not be snatched away by Offer. Then again, for that sort of cash flow the odd uncertainty is probably a price worth paying.

The logic behind more restructuring is still there

Does this week's Warburg fiasco mean Big Bang Mark Two was a chimera that vanished as quickly as it appeared? Judging by merchant bank and investment management share prices last night, investors think so. The bid premiums prompted by the announcement ofthe Morgan Stanley-Warburg merger a mere nine days ago have nearly vanished.

But this was far from a bout of winter madness. The basic logic behind another round of restructurings is still there. Indeed, hardly anybody believes Warburg itself when it says it will now forge an independent strategy. All the share prices are tellingus is that the process will be lengthier than it seemed a week ago when all hell seemed to have been let loose in the City.

Investment banking and asset management are among a number of industries where the squeeze is on middle-sized operations that are neither specialists nor multinational players. Though there may be a busy period coming on the takeover front, there is long-term overcapacity in the British market for mergers and acquisitions and corporate finance work, partly because of the arrival of American investment banks eager to get a slice of the action. And the securities trading that brings mind-boggling profits to Wall Street firms every few years is just not on without a lot more capital backing than middle-sized investment banks in London now have.

British firms such as Warburg are having to work harder to keep hold of their market share. In short, the UK market is not big or fast growing enough and British firms are undercapitalised. You could have said the same about the motor industry a few years ago.

The choice is between specialisation in a local market and expansion that will have to come mainly abroad, and particularly in Europe. As the Americans have demonstrated, the way into Europe is to promise international placing power - the ability to sella client's securities in New York and the Far East as well as Europe. The other side of the same coin is that big investment management clients also want to know that their advisers have the widest possible experience in international markets.

The two big stories in investment banking on the Continent, from Italy to Germany and the former Soviet satellites, are privatisation and the switch by big companies from bank borrowing to issuing securities. Both of these trends create powerful pressures to internationalise. That is exactly what the failed deal confirmed. The way it broke down has served to highlight this in a particularly cruel way: Mercury Asset Management looks more like a big league player in investment management than Warburg doesin its own world.

It may well be that Kleinwort Benson, Cazenove, Smith New Court, Schroders, Robert Fleming, Hambros and others will - like Warburg - tell us how committed they are to independence. But then look at the list of much bigger European and American commercialbanks - and possibly one or two in the UK - that are desperately trying to adapt to the new world in which securities are as important as the traditional business of bank lending.

Add in the US investment banks that fear they are still below critical mass in Europe, and you get an explosive mixture. When it comes down to it, these people have cash that will be hard to resist, even for the most determined independent.

Comments