The power generation game is a volatile mixture of skill and chance. A mild winter or a cool summer can make all the difference between your customers turning their heating or air conditioning on or off. And if power companies can’t meet demand, they are forced to buy excess capacity from competitors at full market price. Combine the added pressures of regulation, environmental targets and enforced caps on return on investment and the line between creating shareholder value and destroying it is as thin as 13-amp fuse wire.
David Nish, finance director of FTSE-100 gas and electricity utility Scottish Power, believes that creating value in such an uncertain environment is all about external focus – a concentration on shareholder communications, building relationships with government and regulators and, most of all, managing and communicating risk.
“The biggest lesson that I have learned over the past few years is you never accept what you believe to be the status quo. You never accept that the worst-case scenario cannot happen – because it has happened and it continues to happen,” Nish says.
Worst case, in Scottish Power’s recent history, refers to its #4bn investment in 1999 in PacifiCorp, a large electricity utility in the western United States. The deal itself was ground-breaking – the first time a UK company had taken over a US power generator. But a six-month long malfunction at its Hunter power plant in Utah meant that Scottish Power couldn’t service all its US customers and industry regulation forced the company to purchase electricity to cover its shortfall. The long-term purchase contracts bought at the market peak became massive liabilities as electricity prices crashed during the exceptionally mild American summer of 2000. Regulatory caps meant the group could not raise prices to stem the outflow of cash.
More than £1bn was wiped off Scottish Power’s market value as it was left stranded with a $300m charge following the $160m loss it had already incurred through the shutdown of Hunter.
PacifiCorp is starting to recover and US operations now account for two-thirds of Scottish Power’s business. The US influence is really starting to show: the British end is termed the ‘UK Division’ in the annual report, while the statement by chairman Charles Miller Smith reads: “The executive team now includes three US executives who bring a distinctive American approach and insight to decision-making.”
But Nish is keen to tighten up controls across all of Scottish Power’s businesses, implementing self-enforced financial penalties for underperformance.
And, in typical Scottish accountant mode, he wants to imbue the US business with a sense of prudence, rigour and calculated risk-taking.
“We have just announced five continuous quarters of year-on-year improvement,” Nish says. “We have tried to bring a lot of how we have successfully run the business in the UK to PacifiCorp with the same mindset … The whole area of managing in an uncertain world when people demand certainty is becoming a huge challenge, so the area I am putting most attention to is the area of risk management. We are already good at it, but the world moves a lot quicker than it used to. When events happen, the markets are more inter-related. You have to have structure and systems in place that are very responsive.”
Risk management means dealing with commodity price risk, hedging against dollar exposure, and dealing with increased regulation and best practice (“with all developments such as Sarbanes-Oxley and Higgs”). But it also means taking a second look at the value of potential investments, and steering clear of diversification and growth by acquisition that marked Scottish Power’s strategy in the mid-to-late 1990s.
Since then, Scottish Power has divested all its non-core assets, such as its 50% stake in telecoms company Thus, its ownership of Southern Water and a joint venture to provide financial services with the Royal Bank of Scotland. “A lot of activities were developing at the end of the 1990s.
Whether it was in telecoms, or diversifying and developing our customer base,” he says. The idea was that the company could earn multiple revenues from the same customer by cross-selling electricity, telecoms and water.
But Scottish Power was as quick to abandon diversification as it had embraced it.
“In the last few years, we began to focus on whether all this extra investment would generate cash,” he says. “Our offering was very popular, but if you are selling something you can’t make a profit from, it doesn’t matter how happy your customers are. So we moved out of diversification about two years ago.”
The markets tend to react badly to wild swings in strategy, and Scottish Power’s decision to sell off Thus and Southern Water was no exception.
“There was a shock in the marketplace. Our decision to sell was frowned upon. People thought there was something unique in the fact that we couldn’t (cross-sell to customers). But there was just no cash in it. Look how many companies in our sector are now only focused on gas and electricity. There is no value in diversification,” he now insists.
The trick for Nish is to prove to markets and investors that hopping in and out of business ventures is not perceived as management failing, but the product of a nimble approach to business. “We could easily now be stuck in investment programmes of several million pounds,” Nish says.
“Telecoms was a very good value-enhancing investment. We ultimately invested about £550m to £600m in Thus and the flotation cleared £1.1bn. Notwithstanding the subsequent emotive rise and fall of Thus’s share price – it slumped from 50p to 10p – Scottish Power shareholders ended up with £500m net in the bank.
“You have to make sure when you make those announcements that you communicate the full, whole story and the implication of what you are doing. Take Southern Water. It was a good transaction that realised good value …
Southern Water is not the type of investment you will see again coming from Scottish Power.” You bet it isn’t. A weak balance sheet with net debt of standing at £6.2bn in 2002, a figure almost equal to the company’s turnover, has made analysts sceptical that Scottish Power has enough financial clout.
But in its new highly focused strategic mode, Scottish Power’s mission statement is to become “a leading international energy company”. For the company this means investing in new-generation assets, gas storage and renewable energy. For Nish it means travelling back and forth to US board meetings to make sure the company is getting the best value from a stringent regulatory environment.
“We have board meetings in London, Glasgow, Portland (Oregon), Utah – and Wyoming is our next one,” Nish says. “A lot of what we do in board meetings is to ensure the board has good contact with the regulator and the government within each state. Our programme for US board meetings is built around contacts and communication … When we were last in Oregon, we held a dinner for 80 or 90 people, including local government, customers, environmental representatives and people from education. We put a lot into softer issues – learning and communities.”
In the US, it is these soft community issues that make you a leading utility. The power generator is often the third or fourth largest employer in a state, and many employees and customers are also shareholders. The more a utility looks after the community the stronger it becomes, and that, as Nish says, is a strong card to play with the regulator who puts a variable cap on the returns that utilities can make from their investments – creating customer value at the expense of the shareholder.
While Nish looks after Scottish Power’s culture and strategy, his team looks after the numbers. “If I am doing my job properly I shouldn’t be involved in the detail,” he says. “I am a great believer that you are only as good as your team. The most important thing when you are running a large-scale group is to put a lot of investment into the people who run each part of the business. You cannot sit on top of that group and adopt the approach that you are going to be the one who will sort everything out.
“The way the business handled (the Hunter shutdown) was exemplary. And it was the business, not me,” he says. “These situations separate the good companies from the not-so-good. The management team can be mobilised and the whole resources of the organisation were pooled.”
Nish also relies on a strong team to help publish quarterly results, deal with US and UK GAAP and prepare for international accounting standards.
He has an in-house manager who used to be a technical manager at one of the Big Six (as was) accounting firms to handle the really detailed stuff, while Nish concentrates on aligning business objectives and shareholder expectations with evolving standards and industry regulations.
But the plethora of standards are really starting to eat into Nish’s time. “I am concerned about how accounting standards are developing,” he says. “Accounts are only useful for the very professional reader. And by 2005, I will be ploughing through three sets of accounts: US GAAP, UK GAAP and IAS. And how do I translate that to allow business managers to make decisions? These are things where the FD has to play a key role in helping shareholders manage what they expect in terms of risks and returns,” Nish says.
Producing a joint UK-US financial report has helped shareholder communications. “Because we have the US influence we have to conform to a standard on critical accounting policies that makes you appreciate the things shareholders should be thinking about when reading your document,” Nish says. Educating shareholders is also important, encouraging them “to learn how to link the balance sheet, the cash-flow statement and the profit and loss account to get a total picture of what actually goes on in the company”.
Moreover, a new dividend policy effective March 2003 – by which time dividends will be roughly twice-covered by earnings – is designed to strengthen the link between company performance, risks and returns.
Up until now, the policy has been to grow dividends at 5% a year – a hangover from the old utility/yield stock days.
Creating value for Nish is all about being seen to do the right thing by his shareholders. Bad news must be delivered in full in a timely fashion, and business strategy must be clear and understandable. And, in a post-Enron world, he says it is right to take actions – such as Scottish Power’s decision to ban its auditor PwC from doing any consultancy work for it – which are pure plays for shareholder confidence, especially as Scottish Power’s non-audit fees of £16.6m were 10 times its audit fee in 2001-2002.
“We certainly didn’t have any concerns about the independence of the projects we had worked with PwC on, but we felt there was an expectation we should be seen to be doing the best from a corporate governance viewpoint,” Nish says. “When Sarbanes-Oxley came out, we were already doing 90% plus of what was there. But we felt we could be in a stronger position in terms of how people perceived our company. Although it is an intangible act to move things away from a supplier, there may well be tangible benefits at the end of the day in how investors perceive your actions.”
Nish will be hoping when Scottish Power’s year-end results are announced in May that shareholders will appreciate his efforts to generate confidence in a company trying to put an unfortunate 2001-2002 behind it.
Name: David Nish
Qualifications: BAcc, CA
Career: 1999- Group finance director, Scottish Power
1997-1999: Deputy finance director, Scottish Power
1981-1997: Price Waterhouse, various roles
Biggest challenge in your job?
Ensuring my team and I can anticipate how the outside world will change. We should try to be creative rather than reactive.
I am not looking forward to producing three sets of GAAP-compliant financial statements, UK, US and IASs, and trying to work out how best to interpret the three sets of information for my different shareholder classes.
Which company would you like to be FD of?
I would like to be the FD of the New York Yankees. I used to watch a lot of baseball when I was in Canada. I would love to have hit a Grand Slam home run at Yankee Stadium in the bottom of the ninth.