Ian McKinnon
National Post
July 7, 2000

CALGARY – A giant British firm will pay $912-million for the assets of Calgary-based Direct Energy Income Fund, a move that gives Centrica PLC an important toehold as the electrical industry deregulates across North America and ratchets up competition in the key market of Ontario.

Created in 1997 from the privatization of British Gas PLC, Centrica is a $20-billion behemoth that brings marketing expertise and financial might to Direct Energy, the largest unregulated seller of natural gas in Ontario where the bulk of its 820,000 customers reside.

Direct Energy officials said Centrica approached with an unsolicited offer in May, the second time in less than six months that a bidder tried to buy the income fund, which went public in 1996 at $10 per share.

The first offer was rejected last February in part because of the potential of Ontario’s multi-billion-dollar electrical industry, which was scheduled to open up retail sales to competition this November. The timetable has since been delayed indefinitely.

Direct Energy owns and operates gas properties in Alberta that supply up to 20% of its demand.

In addition to its Canadian operations, Direct Energy has a 27.% interest in Energy America. The joint venture with Sempra Energy sells gas and electricity to some 450,000 customers in the United States.

But the beachhead in North America was not cheap. Centrica’s offer for Direct Energy’s assets works out to a payment of $28.25 per unitholder, a 23% premium to the closing price of the units on Wednesday. Units of the income fund yesterday jumped 20% to finish at $27.60, up $4.60, in volume that was 14 times heavier than daily average of the past six months.

Chris Milburn, a Centrica spokesman, said the two companies have a lot in common despite the huge difference in size. The United Kingdom firm employs approximately 30,000 staff while Direct Energy has about 100 workers.

"Our asset over here is our customer base and that is very similar to the way Direct Energy sees things," he said. "The opportunity to have a management team with a similar vision to ours really gives us an opportunity to develop the sort of model that we developed in the United Kingdom in North America over time."

He said that Centrica has been looking to expand in North America and Europe for about a year.

Brad Hurtubise, senior vice-president of finance of the Calgary firm, said Direct Energy will keep its name, senior management and operating style.

"We think it will be the same as it was before with a $20-billion company behind us," he said. "They (Centrica) market a variety of products to their customers base so it would be logical to assume that they will export their modus operandi" to Canada.

Tom Adams, executive director of Energy Probe, said the entry of an experienced company such as Centrica puts more pressure on established players Ontario One, a successor to Ontario Hydro which has a marketing division, and Toronto Hydro than new players that don’t have any infrastructure. A number of retail chains, petroleum companies and energy mega-marketers, such as Enron Corp. and Duke Energy Corp., have been rumoured to be interested in entering Canada’s largest electricity market.

"Making a go of it in the unregulated market is something we expect to be a very tough haul," he said. "I think the pressure falls on those that have been investing money, such as Toronto Hydro and Hydro One, on their marketing."

A spokesman for Toronto Hydro, whose daily load of 4,600 megawatts accounts for roughly 25% of the province’s demand, said the firm is ready for competition.

Blair Peberdy, vice-president of corporate planning, said the municipal electrical utility has been building brand awareness and hiring sales staff in anticipation of a tough fight over the richest market in Ontario.

"As the incumbent, we have the bull’s-eye on our back. We accept it and welcome the competition … because we feel ultimately it will benefit the customer, " he said.

Generally, retail accounts for about 20% of a consumer’s monthly electrical bill, transmission eats up another 20% and power generation takes the lion’s share at 60%.

Increased competition will reduce inefficiency on the retail side but bigger gains for consumers could come from pressure exerted by retail players on other segments of the industry.

Jake Brooks, executive director of the Independent Power Producers Society of Ontario, said electricity sellers could use their customer counts to negotiate better rates from power generators as deregulation progresses. "We hope to see more sizable benefits for consumers by getting more competition for the underlying commodity as well as on the retail side."

Mr. Milburn of Centrica said it is too early to say whether his company will make other acquisitions in Canada. Alberta is scheduled to deregulate power generation and retail sales starting next year.

The price for Direct Energy includes $90-million in debt for its operating subsidiary plus another $90-million for convertible debentures.

The delay in introducing more competition into Ontario’s electrical sector may have some positive benefits, Mr. Milburn said. "It does give us the opportunity to compete the transaction, get comfortable with the business and prepare a strategy with the management team to take advantage of deregulation."

The purchase has to be approved by 67% of Direct Energy’s unitholders and a vote is scheduled for Aug. 18. The deal also needs regulatory approval in Canada and the United Kingdom.