Europe's vast web of power and gas networks continue to be fertile grounds for big-ticket M&A activity, with deep-pocketed infrastructure funds capitalizing on utilities' efforts to simplify their business models and invest in renewable power.

A number of sizable networks acquisitions were announced in 2021, involving companies that collectively own and operate hundreds of thousands of kilometers of wires and pipelines across Italy, France, the U.K., Germany and elsewhere.

Activity is driven in large part by a shift within the utilities sector: Companies that once operated right across the value chain — from power generation to networks and retail supply — are becoming more streamlined, and in many cases going all in on energy transition businesses like renewables.

"There was a time when [utilities] were looking to broaden their businesses," said Munir Hassan, partner and head of the energy and climate change group at law firm CMS. There used to be "value in diversity," Hassan said, but now utilities are "refocusing."

As part of this transition, Britain's National Grid PLC and SSE PLC are both gearing up to sell significant stakes in U.K. grids networks. In both cases, infrastructure funds and other financial investors are seen as likely buyers, lured by the regulated returns and the relatively low risk that grid assets offer.

National Grid is stepping back from gas as part of a strategic repositioning toward electricity, fending off competition from infrastructure investors to acquire U.K. power distribution operator Western Power Distribution PLC from U.S.-based PPL Corp. for £14.4 billion in one of 2021's largest power-sector M&A deals.

Meanwhile, SSE will use the proceeds from its power networks sell-downs to invest in renewables, as it continues to face activist investor pressure to spin off its renewables assets.

Big money required

Beyond being seen as a stable bet, both electricity and gas networks also come with significant investment requirements.

In power, grid spending needs to keep pace with the massive amount of finance going into renewables. Europe's electricity distribution grids alone need between €375 billion and €425 billion of new investment this decade — 50% to 70% higher annually than 2019 — according to a January 2021 study by industry group Eurelectric.

"With the decentralization of electricity generation, there will be a big need for [capital expenditure] investments in electricity networks across Europe," Sunny Aurora, partner in the power and utilities team at consultancy EY, said in an interview. "Because you need a lot of money, that will attract investors."

The growth of gas networks is predicated mainly on the push for hydrogen. The European Hydrogen Backbone initiative, a group of 29 European gas grid operators, is planning a 40,000-kilometer network of hydrogen transportation infrastructure by 2040, two-thirds of which is based on repurposed gas pipelines. The plan will require investment of more than €80 billion.

Hydrogen will likely be a major factor in National Grid's majority stake sale of its gas transmission business in the U.K., National Grid Gas PLC, which it plans to conclude by the summer. National Grid declined an interview request.

"On the one hand, the sentiment might be a little bit more negative on gas generally, but on the flip side ... these transactions are focused on the hydrogen story," Doug Land, partner at CMS, said in an interview.

Investors struggled with hydrogen as recently as one or two years ago but that has now changed, according to Alistair Ray, chief investment officer at Dalmore Capital Ltd. Dalmore is a shareholder in Cadent Gas Ltd., National Grid's former gas distribution business in the U.K., which was sold to a consortium of financial investors in 2017.

"I think any successful bidder for [National Grid Gas] will take a view on hydrogen," Ray said in an interview.

'Capital to deploy'

Financial investors like Australia's Macquarie Group Ltd. and Canadian heavyweights Brookfield Asset Management Inc. and Ontario Teachers' Pension Plan Board are just some of the funds chasing networks assets in Europe.

In 2021, Macquarie acquired power and gas grids in Romania and Germany, while Brookfield and OTPP bought SSE's 33% stake in U.K. gas distribution business Scotia Gas Networks Ltd. OTPP also invested in Caruna Networks Oy, Finland's largest power distribution company.

Market observers expect infrastructure funds to dominate the bidding pool on the National Grid Gas transaction, as well as the minority stake sales that SSE is planning for its U.K. power transmission and distribution businesses later down the line.

"The infrastructure funds are still going to be the dominant force and they have a lot of capital to deploy," said Chris Staples, corporate partner at law firm Linklaters.

The stakes are expected to command significant price tags, and while the size means investors might need to club together to bid, it is unlikely to suppress appetite too much. The £1.225 billion valuation of SSE's Scotia Gas Networks stake, for example, showed "that core infrastructure players are willing to pay a premium for these types of assets," Dalmore's Ray said.

SSE's sale of its networks units will see the company bring in a "minority partner that has limited operational and strategic influence," Finance Director Gregor Alexander said on an earnings call in November 2021.

"We think [a] 25% [stake] is a good fit for probably a financial investor. And bear in mind, the transmission business is a lot of new assets, which are ideally very good for pension funds on an annuity basis," Alexander said.

SSE did not respond to an interview request.

Activity comes 'in waves'

Beyond National Grid and SSE, investors are waiting for the next deal. Because grids are subject to regulated reviews, M&A activity "tends to come in waves," Ray said. "Where you've got a five-year cycle, you tend to see deals after that," he added.

In many European countries, networks are under state ownership, which limits opportunities for private investment. But while utility disposals have fueled a large chunk of investment activity in the space, infrastructure funds are also increasingly creating deal flow themselves by selling existing assets to competitors and other financial players.

Macquarie bought back Thyssengas GmbH, Germany's second-largest gas transmission operator, in 2021, five years after selling the company to DIF Management BV and EDF Invest. It now plans to sell Open Grid Europe GmbH, the largest gas transmission operator in Germany, according to a March 2021 report from Reuters. Macquarie and Open Grid Europe declined to comment.

"Once the infrastructure funds are in, there's always a natural level of turnover," Staples said in an interview.