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National Grid’s FD, Steve Lucas

Steve Lucas

In an elegant converted hotel, National Grid FD Steve Lucas enjoys a rather
cosy spot on one of London’s most expensive stretches of real estate from which
to muse about how safe his company is. And it has been largely true for some
time. Analysts and market observers alike have called National Grid boring
because quarter after quarter, year after year, profits are up, shareholders are
satisfied, competitive threats at home are nil, and the company has one of the
closest relationships with its regulator Ofgem as any corporate anywhere would
dream of possessing.

The stock is an anchor of some of the UK’s largest income funds, including
Invesco’s, and following its interim statement at the end of January – in which
it announced it was increasing dividends for 2008 by 15%, promising 8% annual
increases for shareholders every year until 2012 – was rated a unanimous ‘buy’
by both the UK and US financial media.

This, despite a grosss debt pile of £16bn and some less than perfect debt
ratings (Moody’s placed all 16 of the company’s credit ratings on negative
outlook at the end of January, though it retains BBB+ or better ratings from all
three credit rating agencies, and stable outlooks from S&P and Fitch). Life
seems pretty sweet running the finances of the 22nd largest constituent in the
FTSE-100 when its FD readily admits it has no competitors or competitive
pressures in its home market, where it owns and operates the one grid through
which the entire country receives all its gas and electricity.

Lucas laughs at the mention of his employer’s anodyne reputation. “I agree
with you,” Lucas says. “We move electricity and gas from A to B. How interesting
can it be?”

But the story doesn’t end here. In fact, his employer may be headed for great
change over the next couple of decades, not in a way necessarily favouring the
company, or its currently pleasant finances. Forty-eight hours after our
interview with a very confident Lucas, his chief executive Steve Holliday was
quoted in a newspaper arguing against the government’s decision to tender out
its huge renewables connection project, in which throngs of wind farms, mostly
offshored in Scotland, are to be wired up to the grid by 2020 to meet the
targets of 40% emissions cuts by that year.

The operator of the grid would seem the natural choice for the job, with its
engineering might, grid knowledge and financial power – it has committed to
investing £16bn in gas and electricity infrastructure in the UK and the US by
2012 – but it is at odds with the government over the feasibility of emissions
targets and stands to lose out if another company wins the tender.

Introducing another layer of operators working on connecting wind farms to
the grid, instead of handing the contract to Ol’ Faithful, Holliday argues, will
only cause confusion on a project that is already sprawling and technically
complex – while the cost to other players of securing the requisite finance
would be higher and ultimately be passed on to British taxpayers.

Long-term security
For Lucas, the project is the sort of reliable, long-term deal he likes to grab
with both hands, but for the first time may now have to pitch for it. Lucas
simply gives the whole concept a reality check. “National Grid only runs big
wires in the UK, so the sort of projects we get involved in are very big, such
as the Thames Array, projects that are too big for local networks to handle, so
we connect them directly,” he explains. “In terms of the opportunities for us
from the renewables drive, it wouldn’t be the lion’s share of our investments
over the coming years – more a large minority. But it is a growing share.”

He adds that the nuclear energy ambitions of the government in that regard –
“if you count nuclear as a renewable,” he says – need the Grid’s co-operation if
they are to succeed, since nuclear plants are built in remote areas and need
technical expertise and knowledge of the grid to link them to the demand. “In
every one of these existing sites that may be developed, the current connection
is far too small, so they all need replacing,” Lucas adds. Additionally, the
£16bn infrastructure investment strategy he’s running doesn’t include provision
for nuclear, and the government has stated that it will not provide subsidies
to business for complying with its new regime. In the Grid’s favour, perhaps,
the largest of the possible contenders for the connection gig, such as Germany’s
E.ON, is a minnow compared to the scale, depth and debt markets presence of the
UK monopoly, and this may force the issue in its favour. But as companies of
that ilk invest in constructing alternative energy sources in the UK, the cost
of these projects and of getting regulatory or political deals through to
connect them to the grid is rising, so those companies may look to be closer to
the distribution capabilities they’ll rely on for ROI.

Nearer-term, Lucas is focused on the figures underpinning the Grid’s drive to
increase its infrastructure in the UK. The company will grow its asset base in
the UK by 35% in the next four years and around 25% in the US for the same
period. National Grid is currently split 50/50 between both sides of the
Atlantic, though the markets are quite different in their opportunities.

In the UK, growth will be mostly organic, extending the network and readying
it for nuclear and renewable connections, adding to its gas pipelines, as gas
will drive the business in the coming years, Lucas believes.

Exciting future
In the US, however, Lucas thinks the firm’s future is anything but dull. A
mature regulatory system belies a very fragmented utilities scene in the US
where at least 400 utilities operate. National Grid is currently the
second-largest player in the country by customer numbers, and largest player in
the Northeast in both electricity and gas transmission following last year’s
£4.2bn acquisition of KeySpan. But Lucas is sure that market consolidation is on
the cards and he is clearly hankering after some well–priced acquisitions to
develop the asset base quickly. In the US, Lucas says, regulation smoothes the
way to revenues.

“In contrast to Europe, there is long-established and clear regulation there,
and there is no impediment to us acquiring whatever company we want, provided it
fits our strategy and we get it at the right price,” he says, “whereas in
Europe, it’s hardly the case that we can simply write a cheque and buy anybody
we want to buy.”

The potential can be illustrated by the numbers: in a population of about 300
million in the US, the Grid is the second largest player, serving just eight
million households and corporate customers. “A tiny fraction of the market,”
says Lucas. “So there is still huge opportunity for consolidation and we believe
some of those opportunities will come our way. And because we are laying down
investments that need to pay back over 20 to 30 years, we need a high level of
clarity on regulatory arrangements and how we are going to get our money back,
which we can get in the US.”

Far from regulation on either side of the Atlantic inhibiting the monopoly,
Lucas champions it. “In the UK and the US we have our investment profile wired
into future revenues. So it isn’t really a matter of me hoping that I will get
our money back – I know I will get the money back,” says Lucas. “Because so much
of our business is regulated, it’s almost like a bond proxy in terms of the
bankability of revenues going forward.” The firm has fringe interest outside
those two markets – a pipeline to France that has been running for two decades,
a new link to the Netherlands and a feasibility study is underway to seek out
the possibility of a link with Belgium. Norway was a temporary blip on the
radar. Further afield, the firm sold its interests in Australia, an
interconnector that ran from hydroelectric power in winter and thermal power in
summer, between Tasmania and Victoria.

Meanwhile, the regulatory environment in euroland – for example, in Germany
which only got a dedicated energy regulator in 2007 – is still a barrier to
meaningful investment. “There are too many structural impediments to foreign
ownership of strategic assets in Europe,” Lucas says. “If that wasn’t enough,
others seem happy to pay very high prices, notwithstanding the lack of clarity
in that market. So we are happy to absent ourselves from it. We aren’t holding
our breath for change there. In terms of any other markets, we need to be
confident that we can make money there for a very long time because we don’t
tend to get very high returns, even in emerging markets – though there are some
big exciting markets evolving, like India and China – but we have more than
enough opportunity in our core markets for us to not have to worry at all about
having to go elsewhere.”

Beat the credit crunch
If safe turns analysts off in this age of exhilarating, never-ending financial
crisis, National Grid can offset its bland reputation with a couple of success
stories about pulling off important deals, both as buyer and vendor, amid the
credit crunch. Lucas cites the KeySpan acquisition as one such achievement,
completing late last August as the credit crunch dawned on financial markets.

“I remember that August was a really bad time to complete any deal… really
bad,” Lucas says. “The headlines were full of companies whose deals were failing
because they couldn’t get the money together. We wrote a cheque for $7.5bn in
August to buy KeySpan because we took the decision in mid-2006 that we would
pre-fund the deal,” he reveals. “For one, we knew debt rates were uniquely low
at that point, so this was not a big risk in terms of whether we would end up
raising finance that would end up being more expensive than it needed to be.

“Second, between myself and my treasurer we had lived through at least three
‘crises’ – Asian, Russian and the hedge funds – and in each of those occasions
it was challenging to raise finance. So we thought, if we were able to capture
the benefits of low rates and minimise risk we will pre-fund the deal. That’s
opposed to how companies normally do it, going to their investment banker,
paying them a huge commitment fee and the banker coughing up the money on the
day you complete the deal, followed by you spending the next two to three years
terming out the debt facility. Can you imagine what it would be like doing that
now?” he says.

“Pre-financing our deal saved our shareholders between $300m and $500m in
July. If I calculated the savings now, it would be a heap more.” Suddenly, it’s
more evident why Lucas feels so sure of himself and the company. That said, the
Grid was forced to retain its valuable brownfield sites portfolio, an asset it
hoped to offload to plough the cash into its expansion plans, because the credit
crunch has stymied any meaningful interest for the time being. Meanwhile, Lucas
says he will go back into the debt markets in 2008 for finance.

Lucas is unrepentant about his company being perceived rather grey. The
market it inhabits is on the cusp of unprecedented upheaval from the shift to
cleaner energy and what that means for how the Grid does business, and that
change contains many more vibrant challenges and opportunities. But as FD of the
company, he remains close to his core aim of financial stability, which, in this
latest crisis, is valuable.
“Our shareholders are quite happy to take dull. If the environment around you is
very tight, even a company like National Grid can find itself in circumstances
in which it is more challenging to finance the business. So that’s why we always
aim for a lot of resilience. The balance sheet isn’t there for when times are
good – it’s there for when times are difficult – like now.”

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