The Veolia/Suez merger, finally?

Veolia has made an offer to acquire 29.9% of the Suez share held by Engie at €15.50/share, or a substantial 26% premium over last Friday closing price. The two companies are similar concerning their activities and geographically complementary - this transaction will almost double Veolia’s exposure to the growing Asian market. From Engie’s point of view, this would be a major step forward in its plan to refocus its activities on gas and the development of renewables.

Almost eight years after an aborted merger attempt, Veolia is back on the table with an offer to acquire 29.90% of the Suez stake held by Engie at €15.50/share, a bit more than the pre-COVID-19 level.

Veolia and Suez are two similar companies concerning their activities and complementary in terms of geographical footprint. This operation would, for example, allow Veolia to almost double its exposure to Asia, a growing market that presents currently no more than 10% of its top line.

There is a growing interest by infrastructure investment funds for the, plus the two French companies are also facing the rise of Chinese competitors. The sector remains highly fragmented, and the new entity would still account for less than 5% of the global market share. The concentration of the market is therefore economically sound, especially since economies of scale are the implicit business model for these activities.

But, to avoid a negative decision from the competition authorities, Veolia will have to sell some of its activities, especially in France, where it controls c.40% of the water management. The Paris-based infrastructure funds specialist Meridiam is the identified buyer, at an undisclosed price. Concerning the international activities, the two groups are quite complementary, limiting the risk of refusal by the competition authority. However, this also means that the potential for synergies is limited.

In all, if this operation is carried out successfully, it will be a real positive for the sector and the French industrialist, which would then expand its geographical exposure.

Regarding funding, there are few details at the moment. Frérot (CEO of Veolia) stated that the operation will be financed ‘by the usual means’, evoking a capital increase of an amount still to be determined. If we value the water management activities in France at 1x revenues and consider that the new entity would have an FY21e net debt/EBITDA that can extend a 3.4-4.0x, without impacting investment grade rating, then the capital increase would be expected to be in the order of 10- 15%.

For its part, Suez stated that Veolia’s approach had not been solicited and the group was particularly clear in its negative response published Monday evening. The French state, which holds a 23.6% stake in Engie and 4.59% in Veolia, stated that it will remain vigilant regarding the impact on jobs in France and the conservation of strategic assets for the country - which, in our opinion, limits the potential for a takeover by a foreign player.

As a seller, Engie may well be the real winner of this deal. Indeed, for a total of €2.9bn, this operation would be a major step forward in its plan to divest from noncore operations (announced in July, during the Q2 20 presentation). In the medium term, the new plan could double the already announced divestment plan, or up to €8bn of divestments. At the time, JP Clamadieu had specified that, regarding the stake in Suez, all options were open. The purpose of this strategy is to simplify the group to refocus on gas activities and to develop its renewables operations further, currently highly valued by the market. Accordingly, the group revised upwards its targets for the annual installation of renewable energy sources, from 3GW to 4GW. For the moment, Engie is not officially pronounced, but rumours suggest that the group may demand a higher price, around 17€/share, according to the same rumours.

At first glance, the market seems to approve of the deal. While the positive effect of this operation on the stock price of Suez and Engie is clear and logical, from our point of view it is more mixed concerning Veolia, due to: 1/ the high premium, the €15.50/share implies a P/E of 23x for FY21e EPS, and 2/ the need to sell the French activities in the water sector (c.10% of the top line) at a price which, one can imagine, will not be exceptionally attractive 3/ Suez's hostile response and 4/ the difficulties in setting up an operation of this size. According to our model, economic benefits will only be generated after 3-4 years.

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