British Energy: still a bad bet?

Robert Lea
4 Jun 2009

As bets go for those of a punting persuasion, it was a bit like putting money on Manchester United for the Premiership and then the bookie telling you you can have a bonus payout for every point by which United beats the rest.

Last autumn French nuclear giant EDF bought Britain's fleet of reactors owned by British Energy for £12.5 billion. It agreed to pay, in cash, British Energy's shareholders 774p for each of their shares - way in excess of the market value or City analysts' targets for a company whose aging nuclear fleet was figuratively in operational meltdown.

Intriguingly, the French offered British Energy shareholders an alternative: 700p in cash plus a "contingent value right".

This contingent value right would be turned into a tradeable security, a Nuclear Power Note that would pay a dividend every year over a 10-year period calculated on a mixture of the annual output of British Energy's reactors and the prevailing annualised price of electricity.

If British Energy's performance continued to be as poor as it had been in 2008 and power prices over the long term fell and stayed low, then potentially these Nuclear Power Notes would not pay out a penny. They'd be worthless.

If, however, British Energy's performance returned to output levels at privatisation 12 years ago and power prices rose and stayed at a not inconceivably high £95 per megawatt hour then, according to the then finance director Stephen Billingham, the Nuclear Power Notes over their 10-year life could be worth as much 575p to investors.

Those who took the contingent value right-Nuclear Power Note alternative were therefore being guaranteed 700p cash in hand, and given a bet on the future.

Those punters willing to take a wager could happily write off the extra 74p they might have received in the all-cash offer, as the 700p cash in the alternative option was still on most estimates at least 20% more than British Energy's fair value.

Many thought the same way, with almost 40% of British Energy shares in issue effectively being converted into Nuclear Power Notes, including those shares held by the company's former leading investor Invesco Perpetual, which had inspired a revolt against EDF's original lower takeover offer.

The Nuclear Power Note investment is a 10-year marathon but those taking the punt will have been initially pleased. Over the first five months of 2009, British Energy's eight nuclear power stations now under French ownership are producing in excess of a third more electricity on average than they were a year ago.

The French might like to take the credit but the turnaround in performance is the long-awaited fruit of the painstaking remedial work ordered by Bill Coley, the soon-to-retire nuclear veteran who was brought out of his first spell of retirement in the American South four years ago to save British Energy.

Multiple failures at Hunterston, Heysham and Hartlepool meant more than a quarter of the UK nuclear fleet -around 5% of the country's electricity supply - was out of action in 2008 when British Energy produced its worst-ever output of 40 terawatt hours. However, the current performance of the eight power stations is indicating the fleet could produce around 55 TWh in 2009.

That is important for the Nuclear Power Note holders. The annual payment calculations are fiendishly complicated. Except in Year One when for every one TW/h produced over 50 TW/h, a little over 2p per TW/h is paid out.That implies on current performance a payment next February for the first year of around 10.5p.

Which makes the current price of these Nuclear Power Notes all the more intriguing. The instruments are traded on the junior Plus Market stock exchange. Theoretically, they have a notional value of 74p - the difference between the all-cash and cash alternative. Soon after they began trading in January, the mid-market price of the notes topped 107.5p.

Since then: collapse. The notes have been changing hands in the last month at just 35p. That is all the more curious, for if the notes pay out an output-related dividend of 10.5p this year, the potential current yield on the instrument is around 30%.

Does that tell us the market thinks the revived performance of EDF's new fleet of old British nuclear power plants is utterly unsustainble? Have investors been spooked by an electricity price trading this year as low £35 per MWh? Are those who took the punt going to end up wishing they took the all-cash option?

It is far too early to draw meaningful assumptions based on five months of a 10-year security. But those of a punting persuasion will know the feeling well: wouldn't it be nice if one of these apparently attractive bonus bets came off for once?