Fat Prophets take profits

In our last review of Scottish Power (SPI) in FAT41, we took some profits off the table due to takeover speculation driving the share price markedly higher. At the time, a combination with Iberdrola of Spain seemed the most likely. This has proven to be the case and now the acquisition of Scottish Power by Iberdrola is going ahead.

The combination makes sense for several reasons. Consolidation in the European utility sector is active, whether as an effort to form a national champion or self preservation. Those companies, such as Scottish Power, that operate in liberalized markets like the UK are especially tempting targets.

In addition, private equity players have found utilities to be suitable targets for their investors given the companies' steady and dependable cash flows. These often match the income requirements of institutional investors such as pension funds and life insurance companies.

Given this environment, selecting the best partner is a luxury. Consider the acrimonious developments between E.ON of Germany and Endesa, Enel and Acciona as a result of E.ON's attempt to buy Endesa. Scottish Power on the other hand has conceded to a fair offer after previously knocking back earlier attempts which it considered insufficient.

The takeover price from Iberdrola vindicates the company's resistance. Bear in mind, last year E.ON also tried to buy Scottish Power for £5.70. (As the following is for comparison purposes to the E.ON offer, we have left the denominations in British sterling.) Shareholders today are being offered £4.00 in cash, a £0.12 special dividend and 0.1646 of new Iberdrola shares. As of today, the value of the offer is about £8.15.

The size of the enlarged group is also beneficial. New economies of scale will improve sourcing capabilities when it comes to acquiring commodities and capital investments. The greater geographical footprint will also complement the diversification of operational risks.

The two companies also make a good strategic fit, as both are leaders in renewable energy. In this case it is wind power where both excel. Scottish Power's extensive US and UK wind farm assets will complement very well the world leadership position of Iberdrola. We anticipate renewables to be a growth segment within the power industry as environmental concerns come to the fore.

Finally, the new Iberdrola will have the added financial strength of the combined entities with which to invest in infrastructure, as well as future acquisitions once this integration is complete. So additional deals are likely to follow.

All in all, we believe the acquisition of Scottish Power by Iberdrola makes good business sense. It also represents the second largest transaction made abroad by a Spanish company, right after Telefonica's (also in the Fat Prophets portfolio) purchase of Britain's cell phone operator O2. That deal has proven to be inspired and this one has every promise to be as well.

Since our initial recommendation in 2004, Scottish Power has more than doubled in price, reaching an all-time high of $64.82 earlier this month. However, following our previous partial sale recommendation and with less than half the remaining shareholdings to be converted into stock of Iberdrola, we believe that now is an opportune time to lock in the profits on the balance of our position.

Accordingly, we recommend Members sell their remaining holdings in Scottish Power around $63.85.