Elliott hurls 'conglomerate' slur at SSE, but its critique is equally messy
The activist hedge fund may be right to take on governance issues, but should stick to the point
Three months after it became known that activist hedge fund Elliott Management had built a stake in UK energy group SSE, the investor launched a public attack against the company, accusing it of “market capitalisation destruction”.
Eliott’s fury was provoked in large part by SSE’s decision, announced last week, not to spin off its renewable energy division and list it as a separate company.
Instead, SSE plans to sell part of its electricity network business, cut its dividend from an expected £0.81 this year to £0.60 from 2023, and use the money saved to invest £12.5bn into climate-friendly infrastructure by 2026.
'Confusing equity story'
Elliott claims that SSE's existing business model, which blends the provision of utility and grid services in the UK with the development of renewable energy projects in various markets, is too confusing for investors to understand, resulting in a market valuation for the whole company that is far below the sum of its parts.
More precisely, the hedge fund says that the company's market capitalisation, at £17bn, is 30% below the combined value of its portfolio of renewables and electricity grid assets as a result of its “inefficient conglomerate structure and confusing equity story.”
Elliott also questions SSE’s corporate governance and the ability of the board to scrutinise its strategy in the renewable energy industry, given what it describes as a lack of relevant expertise among its non-executive directors.
Elliott may well have a point. During chief executive Alistair Phillips-Davies's eight year tenure at SSE, the company’s stock traded more or less flat for three years, then dropped by more than 30% over the next two and a half, appeared to be recovering before Covid-19 but then slumped again and has since underperformed the rest of the market.
This justifies a critical look at management and governance, which is exactly the job of an activist.
But activist hedge funds' claims need to be taken with a grain of salt. Researchers Mark DesJardine of Pennsylvania State University and Rodolphe Durand of HEC-Paris presented research earlier this year suggesting that in the long run, hedge fund activism often harms the long-term value of target companies when compared to peers.
And by pinning the blame for SSE's underperformance on a supposed “conglomerate structure”, Elliott is muddying the waters and undermining its own case.
Not a conglomerate
A conglomerate is a company that consists of a large number of different, often unrelated businesses. The promise of diversified investments and lower overhead costs made them popular in the 1960s.
Afterwards, they went out of fashion — and for good reasons. The subsidiaries that made up the group did not necessarily work more efficiently or perform better together than they did separately, and the parent tended to be valued lower than the sum of its parts.
It is this history that Elliott evokes with its claim that separating out SSE's renewables arm would unleash valuation potential.
But SSE is not a conglomerate.
SSE owns one of the main electricity grids in northern Scotland. Renewable energy assets, like the 3.6 gigawatt wind farm SSE is building off the northeast coast of England, supply power to the grid. This is an example of vertical integration within a clearly defined value chain, not a sprawling conglomerate.
One of the big problems that conglomerates face is that no individual analyst can even get close to a understanding all their businesses and all of the markets in which they operate.
But any power sector expert worth their salt should have enough knowledge of the sector to analyse both SSE’s utility business and its renewable energy projects.
“There is nothing inherently wrong with a utility owning renewables,” said an investment banker with years of experience of the power sector in the US. "I think every utility’s got to be a renewable energy company."
By combining its critique of the SSE's governance with an attack on its business model, Elliott is overcomplicating and stretching its own argument.
Spinning off SSE's renewables into a listed vehicle might be a good way to tap into the fad for all things sustainable and give Elliott a chance to cash in its shares at a higher price, but it wouldn't help the underlying businesses to thrive.
There are plenty of good reasons for grid operators to own renewable energy assets. It helps them to build expertise in technologies and markets that are crucial to their broader businesses, underlines their commitment to the energy transition and, if done correctly, can provide opportunities for growth, steady returns, or both.
No wonder utility holding companies are falling over themselves to buy up renewable energy developers around the world.
If an activist investor thinks a management team is going to be a poor steward of either capital or the environment, or if they exhibit poor governance, then of course activists are well within their rights to get involved and shake things up. But pressuring a utility to sell off its renewable energy assets sounds more like a recipe for making a quick buck than a way to put a company on a sound strategic footing.
And in any case, if investors are too dim to comprehend a business that both generates electricity from wind farms and also distributes it to homes and businesses, what hope do they have of making sense of Elliott's thesis?