Eastern promise

Take an average, rather dull, recently privatised utility, grinding along with little change from its state-owned days, its share price slowly sliding further and further off the pace. Add new management and four changes of ownership, a dramatic asset acquisition policy followed by an equally dramatic asset divestment policy and a complete 180-degree switch of strategy that leaves almost nothing of the original entity remaining, and what do you have?

According to TXU, the proud owners of whatever remains of what was once Eastern Electricity, the answer is: a successful, emerging, global utility player. TXU Europe COO Paul Marsh argues that where there was once simply a grimly linear “sweat the assets” policy, which was enmeshed in a regulatory system, there is now an ambitious, focused strategy and policy framework for building a Europe-wide, and ultimately global, energy company.

Tracing the transformation of Eastern Electricity into this new breed of post-Enron, semi-virtualised power player turns out to be an instructive exercise in mapping the way management strategy has turned inside out in the sector over the past five years.

ARE YOU SITTING COMFORTABLY?
The Eastern Electricity story begins, officially, with privatisation in 1990, but it only really starts to roll 18 months later, when John Devaney was head-hunted to take over the job of managing director (becoming CEO in 1997). He arrived at Eastern from Detroit brake-systems company Kelsey-Hayes, and it was immediately obvious that the utility had so far failed to break out of its state-owned mould.

“Management at the time realised the company was under achieving by comparison to others in the sector and something needed to be done,” Devaney says.

Part of the problem was that Eastern was still coasting along at near pre-privatisation staffing levels, there had been little movement toward cutting-edge private-sector quality-control processes and the assets were chugging along at their old pace.

“There was the usual deep hierarchical structure, with little or no delegation of responsibility,” he says. “The company I had just come from was very different, with much flatter management structures and a much leaner approach. The start of the 1990s was a time when everyone in the US automobile sector was full of Japanese manufacturing and quality control ideas – but nothing of this was visible at Eastern when I arrived.”

There was nothing unusual about this. A similar scenario could have been found in many recently privatised organisations, and the cure was well understood. Devaney and Steve Connock, Eastern’s HR director, who had been recruited just after Devaney, set about flattening Eastern’s management and installing a quality control programme.

“Eastern was heavily influenced by industrial relations and trade unions, even at main board level, where the discussion would often centre on industrial relations rather than customer service or efficiencies. So the culture had to change to focus on the customer,” says Connock. Key to this shift was a move to performance-related pay, but at the same time around half the work force was cut and the board created much more sharply defined areas of management responsibility.

Meanwhile, Devaney changed Eastern’s strategy. “When it was launched, Eastern had no generating capability,” he says. “It consisted of a wires business for distribution, and a set of retail customers. This left it at the mercy of the generators when it came to buying the power it needed to sell to those customers,” he says.

POWER PLAY
The solution was for Eastern to look for a handful of power stations to add to its portfolio. At the time, the concept of virtual power stations, where the supply company contracts for the output of someone else’s power stations (rather than just buying power on an as-needed, per-kilowatt basis) had yet to be devised. It was physical ownership or nothing.

At the end of 1993, Devaney recruited a new finance director, Eric Anstee, who played a key role in helping build generating capacity at Eastern.

As Anstee recalls, with Devaney’s new structures in place, Eastern turned around from being viewed by the City as one of the dullest of a dull bunch of utilities, to become a ground-breaking company that had the potential to breath fresh life into the energy sector, not just in the UK, but in Europe.

By 1995 Anstee and Devaney, together with Anstee’s deputy, Paul Marsh, who is now TXU COO, identified five power stations, three held by National Power and two by PowerGen. They would be a huge purchase for Eastern, but if it could be pulled off, it would give the company the generating scale it needed. Before matters could proceed however, Eastern Electricity was the subject of the first non-hostile bid ever made by the Hanson group.

“Hanson recognised that we were creating a lot of value and they put up a price that placed what appeared to be quite a high premium on the company,” Anstee says. The bid was not unanimously well received by the City, but the majority were happy enough with the premium valuation the bid gave Eastern.

However, as far as the incumbent management team of Jim Smith (chairman), Devaney, Anstee and Connock was concerned, it was marvellously timely.

On its own, Eastern might have struggled to carry sufficient credibility to raise the capital required to purchase five power stations in one go.

But, as part of Hanson, it gained a tremendous amount of credibility that helped its plan to use generating assets to balance its supply-side requirements.

So, far from being put out by this latest change of ownership, the management team found themselves with a considerably larger head of steam to pursue their ambitions for Eastern. “The acquisition made us about the same size as PowerGen. At that time, we were the fastest growing energy business in Europe and things looked very good,” Anstee says.

DEMERGER
However, three months later, in a move that had to do both with the death of Hanson’s partner Gordon White and with City pressure, Lord Hanson decided to demerge Eastern along with everything else. Derrick Bonham, former Hanson CEO, explains that the reason for the demerger lay in large part with the City’s difficulty in “reading” the fine detail in a large conglomerate.

“We knew there were exciting things happening in Eastern, but the market did not see this. The acquisition of Eastern and our plans for it were not rewarded with any raising of the share price,” he says.

Hanson decided to lump Eastern together with Australian company Peabody Coal, which it had also acquired, to form a new listed entity, The Energy Group, with its two constituent companies each forming a separate division.

Bonham left Hanson to take up the full time position of chairman of The Energy Group, with Devaney as CEO and Anstee as FD. “I could have stayed with Hanson, but the energy market was at a particularly exciting stage of its development,” says Bonham. “Eastern had some very interesting ideas for pioneering a new approach to the market, using a strategy based on balancing a combination of merchant trading, generation and supply.” Bonham adds that he is more than content to see the “outlines of the ideas we had at the time now showing through in the TXU management strategy for the company”.

It seemed that the joining of Eastern and Peabody Coal had only the thinnest of rationales. They were simply the only two bits of Hanson that had anything energy-related in their make up. However, in the US context, where Peabody was one of the largest producers of coal, this strange partnership had a certain appeal to the management of Eastern.

“Privatisation had given UK energy companies a real head start, particularly in terms of energy trading. Ironically, the only company doing significant energy trading at that time in the US was Enron,” Anstee says. With Peabody’s scale in the coal mining sector, it looked as if it might be possible to launch an energy trading operation based on coal.

Eastern put in a bid for Boston utility Citizens Power as it looked for a way of taking advantage of its new US connection. It also began exploratory merger discussions with US utility company PacificCorp. John Devaney says that he and his fellow directors then went off the idea. But PacificCorp’s management clearly liked the underlying concept of being part of an emerging global utility player and when Eastern ended merger talks, PacificCorp launched its own bid for Eastern.

That bid was scarcely on the table when Texas utility company TXU decided to enter the fray. It made it plain from the outset that the only part of The Energy Group it was interested in was Eastern – and it put down a bid that again valued it at a substantial premium.

TXU won, and it never took possession of Peabody. The Energy Group’s US mining operation was pre-sold to Leyman Capital as part of TXU’s bid financing mechanism. This left it with Eastern’s UK and European operations.

At that stage, Eastern’s management had already made a fair fist of gaining a foothold in Europe, though those operations were to become more significant under TXU. Eastern had created an energy trading business in Holland which gave it a better understanding of that sector. It had also bought a generating business in the Czech Republic and Hydro Cantabrica in Spain, which became valuable as Spain deregulated its electricity industry.

CONTROLLING STAKE
However, TXU was not quite the hands-off owner Hanson had been and this time there was a substantial changing of the guard in senior management.

TXU was, after all, a utility company itself and the main board was in Texas. Confronted with the choice of becoming a TXU man, with all that meant in terms of control from Texas or – as is the case with his successor, Phil Turberville, becoming a TXU director and living in the US – John Devaney decided he’d seen the business through enough changes of ownership.

“I stayed until they found my successor, then I left to get on with other projects that interested me,” he says.

Eric Anstee also decided enough was enough and left for Old Mutual. Continuity was maintained however, in that he was succeeded as FD by his deputy, Paul Marsh.

Looking at the state of play today, Devaney expresses himself reasonably content with where TXU has taken the company. “They’ve built up the supply side to five million customers, second only to Centrica, which started with a hugely better position anyway, since it inherited all 19 million British Gas customers,” he says. “They’ve extended the trading operation into Europe and they’ve got rid of the regulated assets, which they were never going to be able to do much with anyway, other than make the regulated returns. All in all, it looks to me as if Eastern is still in good shape.”

Anstee admits to far more mixed feelings on the matter. “TXU has certainly moved the company on quite significantly. However, I look back, having sweated hard to acquire the power stations, and now most of them have been disposed of,” he says. “That definitely causes at least a twinge of sadness and one wonders at the wisdom of relinquishing these assets.

Then too, my hope at the time was that TXU would take the knowledge that Eastern had gained and apply it in the US market. As far as one can judge, that has yet to happen.”

One way of summarising what the management of Eastern had managed to do from Devaney’s arrival until TXU came in, is to look at the shareholder value created. As Anstee points out, taking the TXU bid as a marker, the board had created almost £1.9bn of shareholder value in the 15 months following the £3bn demerger from Hanson.

According to Marsh, inevitable senior management changes aside, what has enabled Eastern Electricity to survive and move forward through what is now arguably six major shifts (the sixth being the sale of the wires infrastructure business in 2001 to EdF subsidiary, London Electricity), has been continuity in the mid-management ranks.

“A lot of our core people have between five and 15 years experience with the company. They have seen the business move from its early 1990s roots as a wires distribution business, into a generation and supply business in the mid-1990s. Over much of that time, the core business strategy stayed the same and this helped everyone keep focussed,” he says.

Marsh reckons the major preoccupation of senior management, at least from Devaney’s time onwards, was to think about how they wanted to see the industry grow, and what they needed to do to re-shape the sector.

“There was a clear sense of purpose. When new owners bought the company, they bought it in part for the strength and vision of the management team, so they left us to get on with it,” he says.

Another point that has helped Eastern has been the fact that new owners, from Hanson to TXU, have made capital available to senior management to fuel growth. “We have had parent companies with a very hands-off attitude to running the business, but they have been supportive in backing us to develop the business in the UK and Europe,” Marsh says.

According to Marsh, TXU’s aim in buying Eastern was to diversify into new markets. It realised that the US market was going to take time to become more fluid. Distribution is still highly regionalised in the US, which makes inter-state, coast-to-coast trading difficult, and the market is still in the process of deregulating. TXU wanted to get ahead of the game in the US by gaining a deeper understanding of competitive markets.

At the same time as it bought Eastern, it bought utility assets in Australia, which was also ahead of the US.

Marsh disagrees with Anstee’s view that TXU has been slow to roll knowledge back to the US. “The portfolio business model that we have pioneered here has been adopted by TXU and is now implemented by the group across the world,” he says. Marsh points out that the Texas energy market only became fully deregulated in January 2002 for energy trading and retail supply, and the company is now in great shape to exploit that new opportunity.

In essence, TXU’s European and global strategy is based on the “three-legged stool” approach, with the three legs being retail supply, generation and trading. “The name of the game is to operate these three arms as one interlocked business. A few other energy companies have all three strands, but they operate each arm as a highly independent entity. Our whole proposition is to integrate all three very tightly across the value chain,” Marsh says.

Henry Birt, senior vice president, finance, under Paul Marsh, and in effect, his successor as FD, joined TXU Europe from Unilever and was specifically recruited for his expertise in managing pan-European operations. When TXU made Europe its base for energy trading, to give the “third leg” of its strategy the prominence the board felt it required, he oversaw the creation of this Geneva-based operation.

TRADING PLACE
Of course, post-Enron, energy trading does not quite have the glamorous profile it once had, and eyebrows tend to rise when companies speak of trading as a mechanism for creating above average growth. However, Marsh and Birt argue that trading has to be an integral part of life for any utility company worth its salt, since it has, at the very least, to create hedge positions to control its pricing risk.

However, TXU’s approach goes beyond this. Trading is essentially its vehicle for understanding new markets. As Birt explains, the company’s strategy is to go into a new European market with a limited amount of risk capital – no betting the bank here.

The company then trades in order to gain an understanding of the new market, then it looks around for a decently priced generating asset to acquire, or for a joint venture that will enable it to support its merchant trading with physical assets. The next step is to acquire a retail position in that market, recreating its three-legged policy in the new zone.

Marsh reckons that, ultimately, TXU’s integrated approach will be seen by the whole energy sector as the only way forward. “Pure trading, post-Enron, has a limited future. Any other position, being purely retail, or purely generation, leaves you exposed to too much risk. Our model works.

Moreover, it has the huge benefit of not being a pure scale play. Our strategy is to maintain growth at around 13%. We don’t need to do 50% growth per annum to sustain our business, so we aren’t vulnerable to an Enron-like implosion,” he says.

And he sees this whole strategy, in energy trading, supply and generation, as a continuation of the approach that Eastern Electricity began. “We don’t have the wires business any more, but we are now four times the size in the UK and Europe that Eastern was when it began. We’re in great shape,” he says.

 

HISTORY OF THE CHANGES AT EASTERN

1990: UK electricity privatised, Eastern Electricity plc created
1994: EE becomes Eastern Group
1995: Eastern Group acquired by Hanson for £2.5bn
1996: Eastern Group purchases 6,000 megawatts of generating capacity
1997: EG demerged from Hanson
May 1998: EG acquired by Texas Utilities for £4.45bn
November 1999: EG changes its name to TXU Europe Group plc
December 1999: TXU forms joint venture with London Electricity to operate the two companies’ distribution networks
August 2000: TXU buys Norweb Energi Supply business for £310m, bringing its total number of gas and electricity customers to 5.6 million
November 2001: TXU sells Eastern Electricity’s distribution business to EdF, along with service delivery arm 24Seven

SPOT THE REAL EASTERN ELECTRICITY

When Eastern Electricity was privatised, it owned the wires infrastructure necessary to deliver electricity to consumers and businesses in East Anglia, plus a retail business. It also owned the home metering business that went with its role as a distributor of electricity.

The home metering business was sold to Siemens a few years ago. The wires infrastructure business was first merged in a joint venture with London Electricity, and then sold to Electricite de France (EdF), owner of London Electricity, in 2001. A specialist maintenance operation, 24Seven, itself a ground-breaking innovation that split service maintenance from infrastructure ownership, has also been sold to EdF.

David Owens, managing director of 24Seven, went across to EdF along with his people after the change of ownership. He joined Eastern in 1998, just before the TXU acquisition. “I was recruited by John Devaney and I remember that the dominant feeling among the management was that the TXU takeover was a positive thing. It gave Eastern a global reach. People could see the way the market was going, and that scale and reach would be important,” he says.

For Owens, it is a moot point as to where the “real” Eastern now lies.

“Which part the soul is in, people have to decide for themselves,” he says. “Is it in the wires? Then it’s now with EdF. Is it in some strategic vision that the post privatisation management forged? Then it’s probably with TXU.” However, if forward thinking and vision is what characterises Eastern, it could even be argued that the light of Eastern Electricity now illuminates 24Seven, which again places it with EdF.

As Owens explains, 24Seven has created a pure service management concept that is outside the regulated structure. He argues that this service model can ultimately be extended to any infrastructure business, from gas to facilities management. “The model we have created here, separating asset ownership from service, has breathed new life into what was the old networks part of Eastern,” he says.