Business Analysis: How Guy Hands' £453m utility takeover has gone horribly wrong

The issue is bigger than the takeover of a gas business, as the behaviour of the regulator could affect other investment in Northern Ireland, just as the province is hoping for a big economic uplift from the success of the peace process.

East Surrey Holdings, the target of the bid from Mr Hands's Terra Firma private-equity group, insists he must proceed with the offer. Terra Firma did, after all, offer a 30 per cent premium to the ESH share price, so the company is not going to give up that easily.

The dispute is now before the Takeover Panel, which must decide whether Mr Hands is obliged to pay ESH the promised 535p a share or whether he can be allowed to withdraw the bid.

It is very rare that an agreed offer is permitted by the panel to lapse, so Mr Hands is going to have to have a tough fight. The advertising giant WPP failed to convince the panel that there had been a material change in circumstances after the 9/11 attacks and had to proceed with its takeover of the media-buying company, Tempus.

The furore has meant that a perfectly ordinary takeover of an apparently straightforward utility business (and Mr Hands has bought a lot of businesses over the years) is now the subject of complicated legal arguments and calls for political intervention.

East Surrey has a small water business in southern England but the exciting bit for the canny Mr Hands is Phoenix Natural Gas, its natural gas venture in Northern Ireland . This is a young but growing asset, and possibly the only regulated growth utility in the UK. ESH was expanding this business but its capital was limited. It is thought that Mr Hands would throw a lot more money at rolling out the domestic gas network in the province and, having increased the scale of the business significantly, he would then presumably have flogged it.

The Terra Firma offer document went out in May and ESH shareholders subsequently voted to accept the offer. Ofwat, the water regulator for England, had no problem with it. And Northern Ireland's Energy minister, Angela Smith, waived through the deal last month.

But Douglas McIldoon, the chairman of the Northern Ireland Authority for Energy Regulation, was not happy. The grounds for the NIAER to intervene, and the reason why the takeover has become so complicated, was the fact that a new regulatory settlement for Phoenix was just being put in place when the Terra Firma bid emerged.

The question now is whether that settlement was already in place and whether the NIAER's view that it had not been implemented means that Terra Firma can pull out. Crucilly, a condition of the private-equity bid was that there would be "no modifications or amendments" to the licences held by ESH.

Two years ago, Phoenix had gone to the NIAER to ask that the 20-year licence it was granted in 1996 be extended because, as it turned out, it argued that the licence term did not allow enough time to make back its money. The company argued that it would have to raise prices to cover its £300m investment, and so to prevent this it should be allowed to make a return over 40 years.

The NIAER "agreed" in August last year to the new 40-year licence but the nature of that agreement is now the subject of furious debate. The regulator contends that it was only an "agreement in principle" and did not amount to a new licence.

The apparent change in heart on the NIAER's part came after it saw the amount of money that Mr Hands was prepared to pay for ESH. Mr McIldoon smelt a rat and this month lambasted what he called a "cynical" deal. He demanded that ESH share what he saw as its "windfall" with Phoenix customers. According to Terra Firma he has demanded that £55m be distributed to Phoenix households.

"It bothers me that people in Belfast will see ESH shareholders exiting with an enormous profit having done nothing for Northern Ireland energy users," Mr McIldoon told one Irish newspaper last week.

He seemed to ignore the £300m that ESH has already spent and the 80,000 customers that its Phoenix business had connected up to the gas network.

"A new utility like that has got to be squeaky clean, got to be able to show the public that it's making a decent return for its investors but above all is delivering a worthwhile service and not ripping people off," he said at the time.

Mr McIldoon is not feeling quite so vocal any more. He has not commented since ESH announced on Wednesday that Terra Firma was seeking to withdraw its offer. He was not said anything since. Yesterday the energy regulator left it to the authority's deputy chief executive, Dermot MacCann, to do the talking.

Mr MacCann could not explain why his boss felt that the ESH takeover was "ripping people off". But he was adamant that the August 2004 deal was "clearly too generous" in the light of subsequent developments - he points to the negative response results from a subsequent public consultation exercise, rather than the Terra Firma bid.

Mr MacCann insists that there was no firm deal as such in August 2004, although strangely the press release that he issued at the time is headlined "NIAER and Phoenix reach a deal on licence", while in the text Mr McCann is quoted as talking about an "agreement". He said yesterday: "The bid crystallised a situation and raised a lot of concerns about a new licence that had not been agreed yet."

He said there were aspects of the licence deal, especially the benefits for consumers that had not been agreed. Certainly there was no new licence signed off at the point at which Terra Firma came in.

The NIAER seems to feel that the value implied in the Terra Firma means that it was somehow hoodwinked by Phoenix which had pleaded financial difficulties to try to get its licence amended.

Last night ESH wrote to the Northern Ireland Energy minister to complain that Mr McIldoon had behaved improperly. But it will also argue before the Takeover Panel that, as the regulator has not actually changed the Phoenix licence (despite his bluster), Terra Firma cannot not use this as a pretext to abandon its bid. The Takeover Panel is likely to take days or even weeks to make a decision on the matter. Mr McIldoon, ESH shareholders and Guy Hands have a tense time ahead of them.

Rise of Phoenix

Northern Ireland did not have a piped gas network until the Phoenix venture was started as a result of British Gas buying a power station in the province. East Surrey Holdings bought a 25 per cent stake in the new business in 2001 and paid £240m to buy the remaining 75 per cent two years later.

The people of Northern Ireland rely mostly on oil to run their central heating, although some boilers still run on coal. Phoenix operates only in the Greater Belfast area (so far), where it has 80,000 connections - mostly homes but also some businesses.

The company is connecting between 14,000 and 15,000 customers a year and aims to have 240,000 of the 300,000 properties in the Greater Belfast area. It could also look at other regions of Northern Ireland, and Terra Firma's greater resources could have significantly boosted Phoenix's geographical spread.

Northern Ireland is still bitter from the way that the liberalised electricity market in the province has landed it with some of the highest electricity prices in the UK. That may well explain why the Northern Ireland energy regulator - who has picked a fight with the local electricity supplier Viridian in the past - is so sensitive about handing over the natural gas network to the uber capitalist, Guy Hands.