ncreasing investor confidence is fuelling small-cap M&A activity in the power and utilities (P&U) sector, EY reports. The EY Capital Confidence Barometer Report predicts that nearly three quarters of deals taking place over the course of the next 12 months will have values below USD $250 million, and that the P&U sector will see more M&A activity than it has in the past two years. The survey also reveals that 44% of P&U executives expect their M&A strategy to be primarily driven by the need to move into new geographical markets, and 40% will focus on shifting towards renewables.

Small-cap deals are taking center-stage

lthough we have seen a slight increase in the number of large deals over the course of the past six months, the survey anticipates that deal sizes will typically be smaller next year. With confidence in the global economy and corporate earnings on the rise, deal pipelines are growing and are expected to continue to grow.

The spotlight it on emerging markets and renewable energy products

Growing electricity networks in Africa, India, China and South-East Asia are expected to continue to drive deal flow in the P&U sector. What’s more, large utility companies in Europe are expanding into emerging markets such as Mexico, Brazil and Turkey.

The study also demonstrates that P&U companies are transforming their portfolios in response to changing markets and, accordingly, are investing in renewable energies such as wind and solar power. This is a global phenomenon: renewable power technologies are becoming increasingly competitive in the marketplace as a result of declining costs and governmental subsidies. For example, important solar projects are taking off in Thailand, the Philippines and Malaysia, and geothermal projects are gaining momentum in Indonesia. As a result, renewables have been the focus of a sizable fraction of the small-cap P&U deals seen over the course of the past six months.

New financing structure: Yield Cos

In the renewable energy sector, Yield Cos are a popular investment structure whereby companies exclusively place their operating assets producing long-term stable cash flows into a new subsidiary entity and offer some of its shares to the public. The more volatile development and construction risks borne by the parent company are therefore separated from the operating pipeline. For the company, the Yield Co serves to reduce capital costs while maintaining control over the subsidiary entity and operating assets. For investors in the renewable energy sector, Yield Cos are a highly attractive vehicle because they tend to offer high dividends (hence the name), significant tax benefits, and also they provide protection against regulatory risk.

The author would like to thank Carole Gilbert, articling student, for her assistance in preparing this legal update.