NB Power sale - a really good idea
Ever since the governments of New Brunswick and Quebec announced their MOU late October, the media (in New Brunswick and around the Atlantic region) and the people have been having a field day denouncing the deal. The common refrain for selling the utility is, “New Brunswickers will lose their sovereignty.” Another favorite of the masses seem to be, “But Graham got elected on a promise that NB Power will not be sold.”
Seriously guys, if you have any objective reason to oppose the sale of NB Power, I am willing to listen. It really does not bode well for New Brunswick’s image as a business friendly province when one hears such statements; statements that are loaded with emotion but devoid of business sense. Things change, business environments change. Businesses need to adapt to changing environments or die. Reminder: NB Power is a business. In the talk shows I listen during my drive to work, I may have heard just a few isolated souls speaking intelligently about the deal. But their voices could not rise above the din to prevent the sale of the utility.
There are actually two decision points here. The first is to determine if NB Power needs to be sold, while the second is how to structure a deal. So, before we figure out the merits (or demerits) of the MOU, let’s figure out if NB Power needs to be sold in the first place. Based on my analysis, I think selling NB Power might just be a good idea. This is also a good time to introduce a disclaimer: The opinions on this topic are solely mine and do not represent any organization. I arrived at this opinion based on my analysis of the data. If you can objectively refute my analysis I will gladly rescind my opinion.
The case for selling NB Power
Here is a summarized version of my analysis. I have included screen shots of their financial statements below too for reference. You are welcome to visit the NB Power site to review the financials yourself.
- Medium to large manufacturing units in the province have closed at a faster rate than new arrivals in 2008 and 2009. This is evidenced by the lower revenues from the sale of electricity within the province decreased in 2009. So unless new businesses arrive in the province to offset the drop in revenues or there is a significant rate increase to offset the drop in revenues, NB Power revenues are headed lower. - See NB Power Income Statement
- Fossil fuels account for close to 50% of NB Power’s power generating assets. Making them compliant to the standards that will significantly reduce carbon emissions will costs billions. Moreover, the cost of power generation using fossil fuels depends on the price of oil. NB Power’s income statement reflects this fact where the fuel prices increased by 50%. - See NB Power Income Statement
The effect of the above two pressures have squeezed NB Power’s gross margins to the point where cash flow from operations is not enough to cover its investing and operating activities. - See NB Power Cash Flow Statement
Consider your household as an analogy. If your net household income is not enough to meet your expenses, then you need to borrow to make up the difference. NB Power has been doing that for the last number of years. There is a point in time where you leverage to such an extent that your payments are not going to reduce your principle, but just enough the pay the interest. The end of that path is bankruptcy. While NB Power is not there yet, it soon will be if it continues on its current path.
Continuing with the household example, it is prudent to cut costs to match your income, failing which you must start selling off your most productive assets to generate sufficient cash to pay off your debts. why most productive assets? Well, you are not going to get a premium on non-productive assets are you?
With fuel being a significant percentage of its expenses, there is only so much that NB Power can do to cut costs. Both the executives and unions are not going to lower their salaries. So it cannot do more much on labor costs unless it resorts to layoffs. NB Power does not really have the luxury of remaining an independent organization. It needs a partner, and quickly, to breathe new life into the troubled utility.
Update 12/25: I researched out another interesting stat from their 2008/2009 financial statement. NB Power has built up its generating capacity to 4,226 MW (Oil: 1254 MW, Coal: 514 MW, Natural Gas: 353 MW, Hydro:893 MW, Nuclear: 635 MW). NB Power’s management discussions state that they sold 13,052 GWh within NB. At a 100% utilization this translates to 1,489 MW and at 80% utilization this translates to 1,862 MW. So NB Power built up capacity (and hence debt) hoping to meet the energy demand that never materialized. Their out of province sale only accounted for 216 MW to 270 MW.
To summarize: Capacity: 4,226 MW - Demand: 1,705 MW to 2,132 MW => translates to excess capacity.
Another point to note that despite rates increases their revenues in 2009 is less than in 2008.
NB Power should be looking for a partner with at least the following three characteristics:
This is a necessary condition. The partner must have enough cash to infuse into the troubled utility. The debt load must be reduced to manageable levels.
Must know the business
The partner must know the electricity generation and distribution business. This again is important. A partner will deep pockets and no knowledge of the power generation and distribution business is akin to throwing good money after bad.
Have similar corporate values and culture
How many times have we seen mergers and acquisitions fail due to corporate culture clash? Synergies need to exist and not only on paper. This is the most important part if the marriage is to work.
So what are NB Power’s options?
- Joint Venture - This is going to be a very hard sell. A JV will only occur if both parties stand to gain something. The only parties who stand to gain are the electric utilities in each of provinces of Nova Scotia, Newfoundland & Labrador, PEI and Hydro-Quebec. Now the question to ask is, will NS Power, Electric Power in PEI, or Newfoundland Power join hands with NB Power to create an Atlantic region electric utility?
While there are economies of scale for power generation to be attained, I highly doubt the four provinces will join forces. Hyrdo-Quebec is large enough to buy out NB Power so that ’s its option. I have not researched if any company in the north eastern US states can purchase an electric utility in Canada. So I cannot comment on that. But it is an option.
However, I do not see a JV reducing NB Power’s debt. In fact I see more capital requirement of NB Power if a JV were to be formed.
- Merger - NB Power cannot acquire another company. It just does not have the cash. However, it might want to look for another utility in a better position to join forces. Then again we need to answer what’s in it for the partner
- Acquisition - Given NB Power’s cash position this is the most likely scenario. NB Power will need to be bought out.
- Remain independent - I would not consider the status quo as an option at all. The question you need to answer is, “Where is NB Power’s revenue stream? If it is within NB, then rates HAVE to raise. If we are looking to the North Eastern states in the US, then it has a very powerful competitor in Hydro-Quebec who can use its own lines via Quebec to distribute electricity. It’s generation costs are also significantly lower and hence can bid lower in the US. NS, NFL and PEI would also have to bid against Hydro-Quebec to win business in the States.
Current ratio: Current Assets/Current Liabilities: 736/1377 = 0.5. This implies that for every 1 dollar in assets NB Power has $2 in liabilities. With falling revenues and rising costs, wonder how will NB Power continue to service its liabilities and reduce it to more manageable levels?
Newfoundland power in comparison has a current ratio of 0.9. This means that for every $1 in debt they have 90 cents of equity. If you were to compare these two organization’s credit rating, Newfoundland power should have a better score than NB Power.
Cash ratio: (cash + securities)/current liabilities: (6+147+82)/1377 = 0.17. This implies that if NB Power’s creditors were to demand repayment immediately, NB Power can only replay 17 cents to the dollar. Of course I have assumed that NB Power’s derivative contracts are marketable quickly.
Newfoundland power on the other hand has a cash ratio of 0.76. This means that Newfoundland Power can pay off 76 cents to the dollar if debtors were to collect immediately.
The point I am driving with the above two points is that Newfoundland Power is in a much better financial position than NB Power.
- Here is the bottom line: NB Power had $6 million in cash and about $4.8 billion in debt as of March 31, 2009. It’s operations do not generate sufficient cash-flow to pay down the debt AND sustain operations over the medium to long term. Am I the only one who sees something is wrong here?
So as residents of New Brunswick, you have two options: Sell NB Power or brace for HIGH power rates given the current demand for power in New Brunswick.
Update 12/25: NB Power Sale - NERC, FERC, NPSS, NBOS - Making sense of it all
We’ll dissect the MOU in my next post.
NB Power Financials
Here is a snapshot of NB Power’s income statement. You may click on the image to zoom in (will open in another window)
As you can see, revenues from the sale of power within the province dropped from $1.24 million to $1.22 million.
Their financial statement does not break down the segmented information on residential and industrial customers, but it would have been useful to have some numbers associated with the closure of all those mills across the province.
I managed to get some information on revenue breakdown by segment (page 12). Industrial revenues dropped from $362million in 2007/2008 to $307 million in 2008/2009.
Let’s assume that the closure of manufacturing units were responsible for the drop in revenue. I think that’s a fair assumption. We constantly hear that there is an exodus of people from NB westward. I also think that the industrial users will pay a lot more than the residential users. So if our assumptions are valid, do we see a rebound in revenues with new manufacturing units opening in NB? I do not think so.
Did you notice the 48.5% increase in the fuel and purchased power in the expense site from 2008 to 2009? It does not take a lot of business sense to figure out that if revenues dropped 1.5% in 2009 while some of the cost items went up nearly 50% over the year, profit margins are going to be squeezed. The problem is that most of NB Power’s raw material for fuel generation is fossil fuel. Given the spikes in oil we have seen over the last year, it is certain that high energy prices are here to stay. Even if NB Power is a not-for-profit organization, it does need to generate enough revenue to cover its costs.
Now here is the statement of cash-flows:
Cash-flow from operating activities dropped significantly in 2009. NB Power had to resort to financing activities (like borrowing) to fund its operations and investing activities.
Finally here is the liabilities side of their balance sheet showing all of their $4.8 billion debt of which $1.37 billion are short term debt and payable most likely within the next year.
Let’s do some quick financial analysis:
Update 12/25: It has been a fascinating journey of discovery on the trials and tribulations of an entity called NB Power. Just discovered a rather disturbing document by AIMS authored by Dr. Thomas L. Tucker titled Power Trip: Stumbling Toward a Policy for NB Power. NB Power’s debt has been chronic for well over two decades. It had $3.1 billion in long term debt in 2000. Over the last decade it added an additional $1.7 billion in long term debt to $4.8 billion today. For this reason alone, I would recommend a sale of NB Power.
Finance, Strategy categories.