Scramble to stay in control

Amid takeover rumours, British Gas faces an uphill task to burn brightly in the future

A WHIFF of intrigue has hung around British Gas in the last few days. It comes, for once, not from the company, but the market, where a rumour has circulated that the company is the subject of a hostile takeover bid. Hanson and BP are names in the frame as potential predators.

A few months ago, the suggestion would have seemed ludicrous. Even now, it is probably little more than an attempt by brokers to spark the price and unwind unprofitable positions. If that was their intention, it has worked: at one stage, British Gas shares were up 13p from Monday's close of 287p.

The perceived vulnerability of British Gas is a reflection of the deterioration in its standing over the last few months. The catalogue of public relations gaffes and blunders is enough to make John Major's Government look like the master of its own destiny. It has also convinced many that the company's management has lost touch with reality. Stories of continued staff cuts and showroom closures do not alarm the City. But when they are announced in conjunction with gigantic salary increases for chief executive, Cedric Brown, they beg some questions.

Simon Flowers, analyst at NatWest Securities in Edinburgh, says the takeover story does refocus attention on the company's underlying value. There is potential for an asset-stripping operation to squeeze value out of the carcass. But such a move would have a political mountain to climb.

There are still some 1.8 million small shareholders in the company - although that figure has been declining from a peak of 4.5 million in 1987. Tomorrow, they will receive the latest copy of the company's report. In many ways, it shows a company with a good story to tell. If you were one of the first Sids, and bought the shares for £1.50 in late 1986, a current price of 298.5p might seem money well spent. But relative to the market, British Gas has struggled. And the last two years, from the investors' perspective, have been disastrous, with a vertiginous descent from a 350p peak in late 1993, to 250p, before a fitful recovery.

Shareholders' real concern is what the company can do to grow in the future. The battle lines are clearly drawn. On one side is Ofgas, the company's regulator, headed by Clare Spottiswoode. In one sense, British Gas's bland performance is a compliment to Ofgas's effectiveness: neither too hard nor too soft. This is unlike the regional electricity companies, where share prices bounded ahead, on expectations of apparently unlimited dividend growth - until Professor Steven Littlechild's recent bombshell rewrote all the rules.

On the other hand, Ofgas has already opened up the commercial business of British Gas to competition, to deadly effect. The regulator stipulated that the company's market share should decline to 55 per cent by 1995, and British Gas now retains only 47 per cent, compared with 61 per cent in 1993. It claims it is at a disadvantage to competitors. Even if it wins back some ground here, it is unlikely to reverse the overall trend.

The backbone of British Gas, its domestic residential gas business, has seen prices fall 22 per cent since 1987. From 1997, this market will also be opened up to full-scale competition. Threatened on all sides, how can it fend off the challenges ahead?

The first weapon has been cost-cutting. Mr Brown announced Britain's biggest ever corporate restructuring in 1993, with 25,000 jobs to be phased out. This will yield annual savings of £600m by 1996. British Gas showroom employees will bear the brunt of this, along with the service business.

Optimists argue that the cost-cutting could unleash a slumbering giant, which has yet to wake up to the 1990s' harsher business environment. But while it may maintain the company's dividend yield, cost-cutting is a finite solution to its problems.

The centrepiece of its longer-term strategy lies abroad. Overseas exploration and production have already begun to make a noticeable contribution to profits. Last year, operating profits in these fields were £289m, or 29 per cent of the company's total profits, after exceptional items.

The company embarked on its international expansion under its former chairman Sir Dennis Rooke. Since then it has pumped £3bn into the business. But the returns on capital are hardly overwhelming. It is a big gamble, and analysts are yet to be convinced it will pay off. Hedged and harried at home though, this looks like the only real avenue left for growth.

Richard Giordano, now non-executive chairman of BOC, has been drafted in as chairman. Not only has he re-established cordial relations with Ofgas, but his international nous should help create a coherent plan for the overseas arm. The next big Ofgas review will be announced in April 1996, with a further year allowed for the company to implement any recommendations.

There is no doubt British Gas has had to adapt to traumatic changes on its home turf. It would be reasonable to assume that the next round of regulation will be the last large overhaul. Hopes that the company can grace the world stage as one of Britain's substantial foreign earners, however, remain some way off. There is little to tempt new investors. Shareholders wanting to sell could do worse than to exit now while takeover speculation buoys the share price.

Activities

Britain's biggest supplier of gas to homes, factories and businesses. International exploration and production, with gas reserves in Pakistan, Thailand, Russia and North Africa.

Share price 298.5p

Prospective yield 5.09%

Prospective price-earnings ratio 12.7

Dividend cover 3.4 1993 1994 1995*

Turnover £10.38bn £9.70bn £10.4bn

Pre-tax profit/(loss) (£569m) £918m £980m

Net profit/(loss) (£534m) £410m £979m

Earnings per share (4.2p) 17p 23p

Dividend per share 14.5p 14.5p 15.3p (* forecast)

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