ERM Power hopes to buy Macquarie Generation, but is it a good move for shareholders?

ERM Power (ASX: EPW) is one of the companies still in the running for the potential sale of Macquarie Generation, a state-owned electrical utility in New South Wales with a net book value of about $2 billion.

The utility would be a prized asset as it generates about 13% of all the electricity needed in eastern Australia from its two power stations, so other big names in power generation and utilities like AGL (ASX: AGK) are in the running also.

State-owned assets and utilities are always attractive buys. They originally start out with little or no competition because the amount of investment needed to create such an asset is cost prohibitive to competitors, and usually government regulations and licencing keep rivals out.

ERM Power started in the 1980s, moving from advisory service to power generation, and in 2007 began its electricity sales business. It has been ASX-listed since 2010, so although we don’t have a full 10 years of business results to analyse, within the past three years we can see impressive growth in both revenue and earnings.

Currently, its market capitalisation is about $525 million, which raises the question as to how it may fund what is reported to be up to $1.5 billion for the purchase of MacGen if its bid is successful. Taking on too much debt will burden the company’s balance sheet — a large capital raising will do the job, but dilute current shareholders’ positions if they receive no extra shares with a deal.

In 2013, the company had net profit after tax before abnormals of $42.7 million, up from $13.6 million in 2012, and revenue of $1.5 billion. Since 2011, revenue has tripled, and its book value has increased about 27% to $1.24 a share.

Foolish takeaway

I like seeing growth and rising earnings — the stuff of business and investing. What I am not sure about is what ERM’s share price will become if it is the victor in the bidding war. In the case of a stock split, shareholders have the same proportion of shares though the number of shares increases.

For capital raisings, much more shares are created for the new equity raised, so it is hard to say what would be the per share earnings even if you add the earnings of the new assets to the business.

When state utility assets come up for sale, to grow in the kind of industry, companies have to take on those opportunities due to the monopolistic-like qualities of the assets. Initial huge investments have to be paid off over the long term, but becoming a larger power supplier and seller will definitely boost future earnings.

Portfolios stay healthy with good dividend stocks

Interested in our #1 dividend-paying stock? Discover The Motley Fool's favourite income idea for 2013-2014 in our brand-new, FREE research report, including a full investment analysis! Simply click here for your FREE copy of "The Motley Fool's Top Dividend Stock for 2013-2014."

Motley Fool contributor Darryl Daté-Shappard does not own shares in any company mentioned. 

Two New Stock Picks Every Month!

Not to alarm you, but you’re about to miss a very important event! Chief Investment Advisor Scott Phillips and his team at Motley Fool Share Advisor are about to reveal their latest official stock recommendation. The premium “buy alert” will be unveiled to members and you can be among the first to act on the tip.

Don’t let this opportunity pass you by – this is your chance to get in early!

Simply enter your email now to find out how you can get instant access.

By clicking this button, you agree to our Terms of Service and Privacy Policy. We will use your email address only to keep you informed about updates to our website and about other products and services we think might interest you. You can unsubscribe from Take Stock at anytime. Please refer to our Financial Services Guide (FSG) for more information.