BREAKINGVIEWS-Energy buyout offers seller a handy escape hatch

The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

By Yawen Chen

LONDON, July 27 (Reuters Breakingviews) - Irish energy distributor DCC Energy DCC.L has found a convenient way to cash out. On Monday, its board recommended selling itself to U.S. private equity groups Energy Capital Partners (ECP) and KKR KKR.N in a deal worth nearly £6 billion. With competition for acquisitions intensifying, achieving its 2030 profit goals was never going to be easy. Selling spares it a harder task of convincing investors its strategy would eventually pay off.

DCC's plan was born of necessity. The group's fuel distribution throws off plenty of dependable cash but offers limited scope for sustained organic growth. Over the past five years, the company has tried to change that through acquisitions and expansion into healthcare and technology. But despite this effort, analysts expect the business will only deliver an average revenue growth of about 2% over the next five years.

DCC Chief Executive Donal Murphy is therefore focusing on profit. He wants to boost the energy division's operating earnings to around £830 million by 2030, up nearly 50% from the previous fiscal year ended in March. It's a goal that hinges on roughly £1 billion of further acquisitions by the end of the decade. DCC has completed close to 400 acquisitions since listing in 1994 and says dealmaking should contribute 6% to 8% annual profit growth. But the next phase will be more demanding than the last.

The strain is already showing. DCC's Energy Products division increased adjusted operating profit by 11% to £404 million last year. Yet fuel volumes fell 3%, highlighting how difficult it is to grow organically. That makes acquisitions increasingly important. At the same time, infrastructure funds and strategic buyers have become more active bidders for energy assets, making it harder to find acquisitions that meet DCC's return hurdles. Meanwhile, some diversification efforts have disappointed. Adjusted operating profit at its Energy Services division fell 68% to £15.7 million last year.

Private equity buyers KKR and ECP are betting public markets are too pessimistic. Their offer equates to 10.5 times the company's forecast EBITDA for this year. If around 60% of the purchase price is funded with debt, EBITDA grows by around 3.5% annually for five years and the business is eventually sold at a similar multiple, the buyers can generate an internal rate of return of roughly 12%, according to Breakingviews calculations. That's in line with typical infrastructure investors' targets. But more importantly, the transaction does not require DCC to achieve everything Murphy has promised.

This looks to be enough to win over shareholders. On Monday afternoon, DCC's shares were trading at £63.65, a minor discount to the offer price which suggests the deal is likely to go through. With analysts forecasting DCC will only generate £670 million of operating profit in 2030, far short of its target, the board's decision to reach for the escape hatch looks entirely reasonable.

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CONTEXT NEWS

Irish energy distributor DCC Energy on July 27 agreed to be sold to a consortium of U.S. private equity firms KKR and Energy Capital Partners for £5.75 billion ($7.68 billion).

Under the offer, DCC shareholders will receive £65.25 per share ​in cash, a proposed final dividend of £1.47 per share, and a potential payment ⁠of up to £1.25 a share upon the sale of its Nexora technology unit.

The ​offer, the third tabled by the consortium, includes a more than 26% premium to the group's closing share price ‌on April ⁠28, the day before DCC received the consortium's first bid.

Shares in the firm were up 1.1% at £63.55 as of 0940 GMT on July 27.

(Editing by Aimee Donnellan; Production by Streisand Neto)

((For previous columns by the author, Reuters customers can click on CHEN/yawen.chen@thomsonreuters.com))