Holding Company Act Release 27577
SECURITIES AND EXCHANGE COMMISSION
(Release No. 35-27577; International Series Release No. 1262; 70-10067)
National Grid Group plc
Order Authorizing Registered Holding Company to Issue and Sell Equity and Debt Securities, Enter Into Guaranties, and Invest in Foreign Utility Companies.
October 16, 2002
National Grid Group plc ("National Grid" or "Applicant"), London, United Kingdom, a registered holding company, has filed a declaration under sections 6(a), 7, and 33 of the Public Utility Holding Company Act of 1935, as amended ("Act") and rules 53 and 54 under the Act. The Commission issued a notice of the declaration on August 16, 2002.1
In connection with its intended acquisition of the approximately 3.5 billion outstanding ordinary shares of Lattice Group plc ("Lattice") a United Kingdom gas utility holding company, ("Merger"), National Grid proposes to issue and sell approximately $9.4 billion of its ordinary shares for the purpose of financing the acquisition of a foreign utility company as defined in section 33 of the Act ("FUCO"). Further, National Grid seeks authority to issue and sell an additional amount of approximately $7.4 billion of debt and equity securities and to enter into guarantees all for the purpose of financing the acquisition of or guaranteeing the securities of FUCOs. National Grid currently has FUCO investments of approximately $3.3 billion.
A. Merger Parties
1. National Grid
National Grid was incorporated in England and Wales on July 11, 2000. Its ordinary shares are listed on the London Stock Exchange and its American Depositary Receipts are listed on the New York Stock Exchange. As of April 19, 2002 there were 1,776,636,707 ordinary shares and one special share outstanding. National Grid employs, in conjunction with its subsidiaries, approximately 14,000 employees. As of April 19, 2002, National Grid had a market capitalization of approximately $12.6 billion.
National Grid holds ownership interests in various utility and nonutility businesses outside the United States through National Grid Holdings One plc ("Holdings One").2 Holdings One's principal business in the United Kingdom is the transmission of electricity in England and Wales, which it conducts through its wholly owned indirect subsidiary, The National Grid Company ("NGC"). National Grid through Holdings One has electric utility businesses located in Argentina and Zambia.3 In addition, National Grid is engaged in undersea electric transmission interconnector projects in Australia, Norway, the Netherlands and Ireland that are in various stages of development. National Grid conducts its utility and nonutility businesses4 in the United States through National Grid USA, an indirect, wholly owned registered holding company subsidiary of National Grid.
National Grid USA is engaged, through its subsidiaries, in electric distribution to residential, commercial, and industrial customers in New England and the distribution and sale of electricity and natural gas to residential, commercial, and industrial customers in New York. The company owns all of the outstanding stock of the following public-utility companies: Niagara Mohawk Power Corporation ("Niagara Mohawk"), Massachusetts Electric Company, The Narragansett Electric Company, Granite State Electric Company, and Nantucket Electric Company (collectively, "Distribution Companies"). The Distribution Companies deliver electricity to residential, commercial, and industrial customers, operate and maintain distribution power lines and substations, provide metering, billing, and customer services, design and build distribution-related facilities, and provide related products and services including energy efficiency programs for customers. Niagara Mohawk also provides gas utility service to approximately 550,000 customers in New York State. National Grid USA also holds ownership interests in four other public-utility companies: New England Power Company ("NEPCO"), New England Electric Transmission Corporation ("NEET"), New England Hydro-Transmission Corporation ("N.H. Hydro") and New England Hydro-Transmission Electric Company, Inc. ("Massachusetts Hydro"). NEPCO, a wholly owned subsidiary of National Grid USA, operates electricity transmission facilities in the states of Massachusetts, Rhode Island, New Hampshire, and Vermont, and holds National Grid USA's remaining interests in certain generating units (which the company is actively seeking to divest). NEET, another wholly owned subsidiary of National Grid USA, owns and operates a direct current/alternating current converter terminal facility for the first phase of the Hydro-Quebec and New England interconnection ("Interconnection") and six miles of high voltage direct current transmission line in New Hampshire. N.H. Hydro, in which National Grid USA holds 53.97% of the common stock, operates 121 miles of high-voltage direct current transmission line in New Hampshire for the second phase of the Interconnection, extending to the Massachusetts border. National Grid USA holds directly 53.97% of the common stock of N.H. Hydro, which operates 121 miles of high-voltage direct current transmission line in New Hampshire for the second phase of the Interconnection, extending to the Massachusetts border. National Grid USA also holds directly 53.97% of the voting stock of Massachusetts Hydro, which operates a direct current/alternating current terminal and related facilities for the second phase of the Interconnection and twelve miles of high-voltage direct current transmission line in Massachusetts.
Lattice is incorporated in England and Wales, and is one of three successors to the former British Gas plc. The company's ordinary shares are listed on the London Stock Exchange. As of April 19, 2002, there were 3,528,149,704 ordinary shares and one special share outstanding. Lattice employs, in conjunction with its subsidiaries, approximately 17,000 employees. As of April 19, 2002, Lattice had a market capitalization of approximately $8.8 billion. On September 25, 2002, National Grid claimed FUCO status on behalf of Lattice.
The Lattice system is subdivided into two holding companies: Transco Holdings plc ("Transco Holdings") and Lattice Group Holdings Ltd. ("Lattice Group Holdings"). Transco plc ("Transco"), the principal subsidiary of Transco Holdings, owns, operates, and develops the majority of Great Britain's gas transportation and distribution system.
Through subsidiaries, Lattice Group Holdings: provides advanced technology and systems solutions for energy and utility companies; provides gas connection services to the gas transportation network under a service provider contract with Transco;5 provides multi-utility infrastructure services to industrial and commercial customers and developers; manages the Lattice system's non-operational real estate portfolio;6 offers leasing and vehicle management services; provides managed payroll services, pensions administration, accounting, business process outsourcing and consulting services; and acquires, builds, leases, and manages sites for mobile telecommunications operators in the United Kingdom.
The terms of the Merger are governed by a Scheme of Arrangement ("Scheme"). Under the Scheme: (1) the issued shares of Lattice will be cancelled, and new shares will be issued to Holdings One; (2) National Grid will be renamed National Grid Transco plc ("Grid Transco"); and (3) Grid Transco will issue 0.375 shares of its stock to Lattice shareholders in exchange for each Lattice share held. Applicant states that, upon completion of the Merger, National Grid and Lattice shareholders will hold approximately 57.3% and 42.7%, respectively, of the issued shares of Grid Transco. Grid Transco will retain National Grid's listings on the London and New York stock exchanges.
C. Current Authority
By the Prior Order, the Commission authorized, among other things, National Grid to (1) invest up to $5.406 billion in FUCOs; and (2) issue and sell equity and debt securities the value of which will not exceed an aggregate amount of $6 billion at any one time outstanding ("Aggregate Limit") through September 30, 2004. More specifically, National Grid was authorized to issue up to $4.5 billion in equity securities and $5 billion in debt securities, subject to the Aggregate Limit.
D. Requested Authority
As of August 31, 2002, National Grid had invested, in the aggregate, approximately $3.251 billion in FUCOs; therefore, National Grid's current unused FUCO investment authority is $2.155 billion. The Merger alone will require the issuance of approximately $9.4 billion in Grid Transco shares, and a corresponding increase in the holding company's authorized level of FUCO investment. Consequently, Grid Transco's aggregate investment will be approximately $12.6 billion. To effect the Merger and maintain flexibility to make other FUCO investments, National Grid requests authority, through September 30, 2004, to: (1) issue and sell equity and debt securities and to enter into guarantees up to an aggregate limit of $20 billion, subject to the following subcategory limits: up to (a) $18 billion in equity securities; (b) $12 billion in debt securities; and (c) $6 billion in guaranties; and (2) invest up to $20 billion in FUCOs.
Under rule 53, in determining whether to approve the issuance or sale of a security by National Grid to finance a FUCO investment, the Commission must consider the circumstances surrounding the proposed issuance and, if the issuance cannot qualify for the safe harbor in rule 53(a), the applicant must demonstrate under rule 53(c) that the proposed FUCO financing will not have an adverse impact on the financial integrity of the registered holding company system, any utility subsidiary, its customers, or the ability of state commissions to protect those subsidiaries or customers.
The proposed issuance of securities for the purpose of financing additional FUCO investments does not qualify for the rule 53(a) safe harbor because National Grid's aggregate FUCO investment exceeds fifty percent of its consolidated retained earnings. National Grid's "aggregate investment," as defined in rule 53(a), in FUCOs as of August 31, 2002, was $3.251 billion,7 and its consolidated retained earnings as of March 31, 2002, calculated in accordance with U.S. GAAP, was $2.976 billion. National Grid had no EWG investments. National Grid's National Grid's aggregate investment in FUCOs as a percentage of its consolidated retained earnings was 109%.
Additionally, as provided in rule 53(b)(3), relief under rule 53(a) is not available because write-downs of $1,140.9 million associated with National Grid's telecommunications investments, held indirectly by National Grid Holdings Limited, a FUCO and wholly owned direct subsidiary of Holdings One, contributed to reported operating losses of $186.3 million for National Grid on a consolidated basis in the fiscal year ended March 31, 2002. Those operating losses exceeded five percent of National Grid's consolidated retained earnings for the year, which was $2.976 billion, and therefore the threshold in rule 53(b)(3) is triggered.
As mentioned above, National Grid is currently authorized to invest up to $5.406 billion in FUCOs. As of March 31, 2002, the company had invested approximately $3.1 billion in FUCOs ("Current Investment"). Applicants estimate that $9.4 billion is necessary to fund the Merger ("Merger Investment"). Applicants' request therefore includes $7.4 billion in uncommitted FUCO financing ("Uncommitted Proposed Authority"), including approximately $2.2 billion in unused FUCO investment authority.
Applicants state that the Uncommitted Proposed Authority will provide Grid Transco with necessary financial flexibility to finance the Merger, to allow for the future financings of its increased operations, and to finance the acquisition of other FUCOs. The Uncommitted Proposed Authority could be used, Applicants point out, (1) in the event that Grid Transco's "aggregate investment" in FUCOs increases as a result of an increase in the market price of National Grid's shares and/or the dollar-to-pound exchange rate; and (2) to provide guaranties necessary to refinance current debts of Lattice's subsidiaries.8
The size of National Grid's overall proposed FUCO investment is within the standards previously approved by the Commission. The proposed $20 billion FUCO investment represents 57.1% of Grid Transco's pro forma capitalization, 73.8% of its net utility plant, 47.4% of its total consolidated assets and 93.5% of its market capitalization. In E.ON AG, Holding Co. Act Release No. 27539 (June 14, 2002), the authorized $65 billion EWG and FUCO investment limit represented 114% of the holding company's consolidated capitalization, 63% of its total consolidated assets and 182% of its market capitalization.
Additionally, the Uncommitted Proposed Authority is not an unduly large portion of National Grid's overall proposed FUCO investment authority. National Grid currently has $2.155 billion in unused FUCO investment authority, which is approximately forty percent of its total FUCO investment authority ($5.406 billion). The Uncommitted Proposed Authority ($7.4 billion) constitutes approximately thirty-seven percent of National Grid's requested $20 billion in FUCO investment authority.
The Merger Investment, which constitutes a majority of the additional requested financing authorization, will have an immediate positive impact on the financial condition of Grid Transco. Specifically, as a result of the Merger, the ratio of equity to total capitalization will increase from 31.7% for National Grid on a consolidated basis as of March 31, 2002, to 40.4% for pro forma combined Grid Transco as of March 31, 2002.
Additionally, National Grid states that all of the proposed debt and equity securities will issued on the same terms as previously authorized by the Commission. Specifically: (1) all long-term debt or preferred stock issued by National Grid in a public offering will, when issued, be rated investment grade by a nationally recognized statistical rating organization; (2) National Grid will maintain common stock equity as a percentage of total capitalization, measured on a book value U.S. GAAP basis, of at least 30% or above; (3) the cost of money on National Grid's debt or preferred stock financings would not exceed the cost of comparable term U.S. treasury securities or government benchmark for the currency concerned plus the margin demanded in the financial markets in a competitive offering by an issuer of such securities with National Grid's credit rating; (4) the underwriting fees, commissions or other similar remuneration paid in connection with the non-competitive issue, sale or distribution of a security would not exceed five percent of the principal or total amount of the security being issued; (5) National Grid USA, on a consolidated basis, and National Grid USA's electric utility subsidiaries, on an individual basis, would maintain common stock equity of at least 30% of total capitalization;9 (6) securities issued by National Grid USA and its electric utility subsidiaries would, when issued, be rated investment grade by a nationally recognized statistical rating organization; (7) the cost of money for debt securities issued by Niagara Mohawk, Massachusetts Electric Company, Nantucket Electric Company, Narragansett Electric Company, NEPCO and Massachusetts Hydro to third parties will not exceed the cost of comparable term U.S. treasury securities or government benchmark for the currency concerned plus the margin demanded in the financial markets in a competitive offering by an issuer of such securities with the respective utility subsidiary's credit rating; and (8) the cost of money for National Grid USA's debt or preferred stock financings will not exceed the cost of comparable term U.S. treasury securities or government benchmark for the currency concerned plus the margin demanded in the financial markets in a competitive offering by an issuer of such securities with National Grid USA's credit rating.
Currently, National Grid is rated A2 by Moody's Investors Service ("Moody's") and, although Moody's placed National Grid's "A2" long-term issuer and "Prime-1" commercial paper ratings under review for possible downgrade, the company expects to have a post-Merger investment grade long-term debt credit rating that remains in the single A band. Applicants state that Standard & Poor's and Moody's affirmed the investment grade credit ratings for National Grid's public utility subsidiaries following the announcement of the Merger.
Recently, National Grid Holdings Limited's telecommunications investments have under-performed. Applicant argues that its Latin American telecommunications businesses, Energis, and Energis Polska Sp will not adversely affect National Grid's financial condition in the future because they have been written-down fully, including provisions for associated liabilities.10 Additionally, National Grid states that it has refocused its telecommunications strategy and is in the process of withdrawing from its investments in alternative telecommunications networks.11
National Grid states that it subjects all project proposals, including the proposed Merger with Lattice, to careful and stringent reviews, and will continue to do so in the future. Its general investment review process is described below. Grid Transco's investment review process will include as one of its objectives minimizing the risks associated with FUCO activities. Before Grid Transco or its subsidiaries make any investment in a project, the project will be analyzed in detail, including the specific country risk, where applicable. The project review process will include a series of independent internal reviews, both at the subsidiary and Grid Transco levels.
In the United Kingdom, the majority of projects by number will relate to the utility businesses of the National Grid Company plc, a direct subsidiary of National Grid Holdings Limited, and Transco. Each potential project will be subjected to a series of formal reviews to ensure its financial robustness. The process will begin with a consideration of the group's strategic plans, which will be updated periodically according to Grid Transco's planning cycle. Individual project business plans would be prepared as part of the process of including potential investments in the overall business plan of Grid Transco. All projects identified as requiring future funding must be included within the planning cycle. This planning procedure will ensure that all capital and non-recurring revenue project expenditures can be justified on business, technical and economic grounds. In addition, project progress will be monitored and subject to normal business control to ensure that approved projects meet their performance targets.
The project review process will include consideration of business, financial, regulatory, environmental and legal risks. Foreign projects would be subject to an additional level of scrutiny concerning:
- the political and economic stability of the particular country;
- the host government's commitment to private enterprise;
- the legal and regulatory framework for private investment in utility facilities;
- local business support for long-term investment of private capital;
- the economic viability of the project;
- the environmental impact; and
- currency conversion and repatriation of dividends issues.
Project proposals will be subject to successive stages of review by senior management and directors depending upon Grid Transco's projected financial exposure in a particular project. Generally, the process by which Grid Transco will identify, manage and approve its business development activities, broadly follows the following lines:
- The production of a Project Evaluation Paper ("PEP"), which covers, in outline form, a description of the opportunity, a brief description of the investment environment, the strategic importance of the investment and future actions. The PEP would be presented to the Group Executive for approval.
- The production of a Project Development Paper ("PDP"), which identifies the development strategy for the investment and covers, in outline form, market conditions, competitive position and an action plan. The PDP would also be presented to the Group Executive for approval.
- If an acquisition is contemplated, an Investment Proposal Paper ("IPP") seeking approval for a bid would be prepared. This paper would cover the investment opportunity, a financial appraisal, existing strategy, the transaction, bid details, and planned future actions. The IPP would be used to brief the Grid Transco board to seek their approval of the acquisition.
Once development of a project is undertaken, milestones will be established to ensure that continuing expenditures produce acceptable results. In addition, project teams would be established to identify the major technical, financial, commercial and legal risks associated with a particular project and risk mitigation strategies. The process would follow the following broad outline:
- undertake due diligence;
- prepare valuation;
- prepare business plan;
- obtain internal approvals;
- obtain acquisition financing;
- develop corporate and tax structure;
- prepare corporate communications plan;
- prepare and submit bid/offer; and
- prepare post acquisition plan
The final project review process in many cases may be duplicated by lenders that may agree to provide construction or permanent debt financing on a non-recourse basis, since repayment of that debt will depend solely upon the success of the project.
Applicant states that Grid Transco's system of internal controls will be designed to safeguard shareholders' investment and the group's assets. The process of managing material risks to the achievement of business objectives is an ongoing process that will be conducted at all levels of the group. All parts of the group will be required to capture and report, in a standard format, their key business risks, categorize all risks to highlight the sources of risk, subjectively score risks to reflect both the financial and reputational impact of the risk and the likelihood of its occurrence, and validate and approve the risk report with the participation of local management. Material changes in risks and associated responsive actions will be reported periodically through a network of risk coordinators throughout the group to maintain a current perspective on overall group risks. A risk steering group chaired by the general counsel of Grid Transco will provide direction and impetus to the implementation of risk management at all levels of the group, act as a catalyst for change and provide visible senior executive support to the process.
All of Grid Transco's investments in FUCOs will be segregated from its public-utility company subsidiaries; none of the public-utility company subsidiaries will provide financing for, extend credit to, or sell or pledge its assets directly or indirectly to any FUCO in which Grid Transco owns any interest. Grid Transco also commits not to seek recovery in retail rates for any failed investment in, or inadequate returns from, a FUCO investment.
Applicant states that its proposed investments in FUCOs will not have any negative impact on the ability of its public-utility company subsidiaries to fund operations and growth because they will continue to have financial facilities in place or access to National Grid financing facilities that will adequately support their operations.
Grid Transco will comply with the requirements of rule 53(a)(3) regarding the limitation on the use of the utility subsidiaries' employees in connection with providing services to FUCOs. Applicant states that Grid Transco's FUCOs will have experienced and extensive staff resources. Grid Transco will comply with rule 53(a)(4) regarding the provision of EWG- and FUCO-related information to every federal, state and local regulator having jurisdiction over the retail rates, as applicable, of its public-utility company subsidiaries.
The Commission has received letters from the Rhode Island Public Utilities Commission, New Hampshire Public Utilities Commission, Massachusetts Department of Telecommunications and Energy, and New York Public Service Commission. Specifically, with respect to this proposal: (1) the New Hampshire Public Utilities Commission and New York Public Service Commission attest that it will not have an adverse impact on their ability to protect local ratepayers and jurisdictional public-utility companies; (2) the Rhode Island Public Utilities Commission asserts that it will not have an adverse impact on the agency's ability to protect local ratepayers; and (3) the Massachusetts Department of Telecommunications and Energy took no position on the proposal, but noted that its jurisdiction over Massachusetts Electric Company and Nantucket would not be affected by the proposal. Significantly, none of the State commissions objected to National Grid's requested FUCO investment authority.
No federal or state commission other than this Commission has jurisdiction over the proposed transactions. Applicant states that fees and expenses in connection with the Merger will be approximately $54.3 million.
Due notice of the filing of the declaration has been given in the manner prescribed by rule 23 under the Act, and no hearing has been requested of or ordered by the Commission. Based on the facts in the record, the Commission finds that the applicable standards of the Act are satisfied and that no adverse findings are necessary.
IT IS ORDERED, under the applicable provisions of the Act and rules under the Act, that the declaration, as amended, is permitted to become effective immediately, subject to the terms and conditions prescribed in rule 24 under the Act; provided that: National Grid shall: (1) report the following additional information in the semiannual rule 24 certificates it files in accordance with the Prior Order: (a) a current calculation of its "aggregate investment" in FUCO investments as a percentage of its "consolidated retained earnings," as both terms are defined by rule 53(a); (b) a statement of its aggregate investment as a percentage of the following: total capitalization, net utility plant, total consolidated assets, and market value of common equity, all as of the end of the reporting period; (c) consolidated capitalization ratios of National Grid and each of its public-utility subsidiaries as of the end of the reporting period; (d) the market-to-book ratio of National Grid's common stock at the end of that reporting period; and (e) an analysis of National Grid's consolidated earnings that segregates total earnings attributable to FUCOs from those which are attributable to National Grid's other subsidiaries; (f) a statement of National Grid's authorized FUCO investment limit and the amount of unused investment authority based on the aggregate investment as of the end of the semiannual period; (g) a statement of revenues and net income of each of National Grid's FUCOs for the twelve months (or six months, as applicable) ended as of the end of the semiannual period (such statement to indicate which FUCOs were acquired during the reporting period); and (2) file a report12 with the Commission within five business days after the occurrence of any of the following: (a) a ten percent or greater decline in common stock equity for U.S. GAAP purposes since the end of the last reporting period for National Grid or any of its public-utility company subsidiaries or a decline causing the capitalization of any of those companies to fall below thirty percent common stock equity; (b) National Grid or any of its public-utility company subsidiaries defaults on any debt obligation in principal amount equal to or exceeding $10 million if the default permits the holder of the debt obligation to demand payment; (c) any event described in rule 53(b) under the Act; and (d) a nationally recognized statistical rating organization downgrading the senior debt ratings of National Grid or of any of its public-utility company subsidiaries.
For the Commission by the Division of Investment Management, pursuant to delegated authority.
Margaret H. McFarland
1 Holding Co. Act Release No. 27561.
2 Holdings One, formerly known as National Grid, was the former top registered holding company in the National Grid group. It became a subsidiary of National Grid in connection with the acquisition of Niagara Mohawk Holdings, Inc. See National Grid, Holding Co. Act Release No. 27490 (January 16, 2002) ("Prior Order"). On February 22, 2002, Holdings One has filed an application (File No. 70-9849) with the Commission seeking deregistration under section 5 of the Act. Applicants state that, after it deregisters, Holdings One will file Form U-57 to certify itself as a FUCO under the Act.
3 National Grid is joint owner of Transener SA, the owner and operator of the principal high-voltage electricity system in Argentina. In Zambia, National Grid is joint owner of Copperbelt Energy Corporation, the former Power Division of the Zambia Consolidated Copper Mines.
4 National Grid USA's nonutility subsidiaries, among other activities, construct and lease of fiber optic telecommunications systems and provide electric utility restructuring and customer choice consulting services to nonaffiliated utilities.
5 Lattice Group Holdings also seeks to provide indirectly facilities management services in other non-gas markets.
6 Applicant states that the portfolio consists largely of land and buildings either currently or previously occupied by a Lattice system company.
7 By the Prior Order, the Commission authorized National Grid to invest up to $5.406 billion in FUCOs.
8 Applicants state that NGC and Transco currently have a total of $11.3 billion in debt outstanding and, of that amount, $3.1 billion is expected to mature during the period of on or before September 30, 2004.
9 This requirement does not apply to NEET. See Prior Order.
10 Applicant states that it has already written down the entire carrying value of: (1) its Latin American telecommunications investments ($418.2 million); (2) its stake in Energis ($564.6 million); and (3) its investment in Energis Polska Sp. ($158.1 million).
11 National Grid may continue to pursue attractive opportunities, however, to leverage its infrastructure skills and assets in the United Kingdom and United States to provide sites and related infrastructure services to the wireless communications industry because its board believes that the risk profile of these opportunities is more closely aligned with the group's core businesses.
12 This report shall describe all material circumstances giving rise to the event(s).