* Utilities increasingly focus on one business
* Spot markets reduce value of vertical integration
* Physics and politics limit potential of cross-border M&A
* Focus on technology acquisition, developing countries
By Geert De Clercq
Under the deal, announced on Sunday, German utility RWE willcombine the renewables businesses of rival E.ON with Innogy's,while E.ON will acquire Innogy's regulated energy networks andcustomer operations.
The deal continues the break-up of E.ON and RWE, which weretwo vertically integrated utilities before they split theirrenewables and grids from their thermal generation assets.
With E.ON set to sell its stake in thermal generation unitUniper to
In response, RWE's and E.ON's first spin-offs two years agowere about getting out of traditional generation.
Now, even highly integrated state-owned utilities like
"European utilities are increasingly specialising in onepart of the value chain," said Colette Lewiner, energy adviserto the chairman of Capgemini, a consultancy.
She said this might be partly because spot markets set thepower price and thus integrate the value chain from powergeneration to electricity retailing.
The Innogy deal is also notable for its lack of foreignutilities' involvement.
Before the 2008 financial crisis, European utilities were ina dealmaking frenzy, all seeking to buy footholds in otherEuropean countries.
But most of those deals fell through or turned sour and nowonly a few EU utilities have a significant presence in other EUcountries.
Investment bankers had floated Enel, Iberdrolaor Engie as potential buyers of Innogy. Butnone of them materialised as bidders.
Electricity, unlike oil and gas, is difficult to transport,which is why utilities never went global. And besides thephysics, politics too has played a part in crimping cross-borderdeals.
A decade ago, the EU tried to drive politics out ofutilities with a push for privatisation and the unbundling ofmonopoly-owned grids. But politics has returned via the backdoor.
Roland Vetter, chief investment officer at PraXis Partners,said that besides valuation and the lack of synergies, politicswas a major reason for foreign utilities not buying Innogy.
"The moment you own these businesses, you are involved inGerman politics. E.ON already is, for them it is not an issue,"he said.
German companies have some impact on politicians, but notforeigners, he said. "If, say, Iberdrola buys a German company,there is no protection, only downside."
Vetter expects no further major M&A deals, neitherintra-country or on a regional scale.
That is not to say there will be no smaller deals.
In a bid to innovate, utilities are buying dozens of smallto medium-size companies in new business areas such as electricvehicle charging, insulation, smart meters and energy services.
Utilities will also continue investing in emerging markets,which have huge power needs and more liberal regulation.
"As new market entrants steal their customers at home,European utilities have no choice but to go seek growth wherethey can find it," said Montpellier University's JacquesPercebois.(Writing by Geert De Clercq. Editing by Jane Merriman)