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Innogy, SSE call off UK retail merger

German utility Innogy SE and Scottish energy firm SSE PLC called off a planned merger of their U.K. retail businesses after failing to reach an agreement on the terms of a deal that would have created the country's second-biggest energy supplier by market share.

The two companies said Dec. 17 they stopped discussions for the planned merger, citing an impending energy price cap by the British regulator and disputes over their financial contributions.

"This was a complex transaction with many moving parts," Alistair Phillips-Davies, SSE's CEO, said in a statement. After exploring whether the deal would be beneficial for stakeholders, "ultimately, we have now concluded that it is not," he said.

The share prices for Innogy and SSE opened 3.6% and 1.7% lower on Dec. 17, respectively, following the announcement. Shares in Germany's E.ON SE, which is in line to absorb parts of Innogy including its U.K. retail arm, were down by 2.4%. Innogy said it would cut its earnings outlook for the current fiscal year by £100 million to reflect the termination of the deal.

SSE said it still wants to spin off its household energy division, SSE Energy Services, noting that the unit could still be sold, undergo a stand-alone demerger and listing, or face an "alternative transaction." The company said its board no longer felt the merged entity could meet trading collateral requirements "in a sustainable way" and achieve a listing in the Premium category on the London Stock Exchange.

In a statement, it cited the performance of the two businesses, clarity on the government's price cap and a changing market environment as some of the reasons for terminating the deal, originally announced in November 2017 and cleared by the U.K. competition authority in October. Innogy, meanwhile, highlighted disagreement over "the necessary direct and indirect financial contributions" and added that it was looking at alternative plans for subsidiary NPower's retail segment.

Under the original terms of the deal, SSE shareholders would have held 65.6% of shares in the new company, with Innogy retaining 34.4%.

Tariff trouble

Both companies had said they were renegotiating the terms of the deal on Nov. 8, a day after the U.K.'s Office of Gas and Electricity Markets, or Ofgem, announced the final level of its price cap for the most expensive default tariffs starting 2019. The companies pushed back the deal's expected closing date beyond the first quarter of 2019 and Innogy CFO Bernhard Günther told journalists that the transaction faced the "possibility of failure."

Ofgem said the cap would hit some suppliers more than others, with NPower customers saving £104 on average, while SSE's would see bill reductions of £55. The cap would mean that the merged company would have faced "very challenging market conditions, particularly during the period when it would have incurred the bulk of the integration costs," SSE said.

Analysts at investment bank Jefferies wrote on the day of the deal's collapse that the termination was positive for SSE, noting that the alternatives being considered would be better for the company than a merger with its "troublesome" competitor.

"Fears around a complex and potentially value-destructive merger with NPower have been an overhang on the stock, and with today's newsflow, we expect to see some relief," the analysts said. While SSE's retail arm was currently expecting an annual profit and positive cash flow between now and 2020, NPower has been making a loss, potentially requiring a capital injection from SSE to salvage the merger.

"No deal is better than a bad deal for SSE," the analysts said.

Innogy's retail business could pass to German rival E.ON in 2019. The company is planning an extensive asset swap with Innogy owner RWE AG that will see it absorb most of the subsidiary, excluding its renewables business.

A spokesman for E.ON said the failure of the SSE-Innogy merger would not have a “material effect” on the asset swap, since the outcome of the deal had not been a condition for E.ON's agreement with RWE.

Innogy said it would adjust its group outlook for the current fiscal year, since it would now have to consolidate NPower again. It expects an adjusted EBIT of around €2.6 billion, down from its previous guidance of €2.7 billion, and adjusted net income of above €1 billion, down from above €1.1 billion. For its retail division, it forecasts an adjusted EBIT of around €650 million, instead of above €700 million.

It also said that it would not be possible to pay a dividend for 2018 at the previous year's €1.60 per share based on a targeted dividend payout ratio of 70% to 80% of adjusted net income. Including NPower in Innogy’s group figures for 2019 would have a negative impact on adjusted EBIT in the area of €250 million, it said.