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The Surprising Buy Case for Severn Trent plc

Today I am looking at why fresh takeover talk could push shares in Severn Trent (LSE: SVT) higher once again.

Takeover speculation primed to take off… again

I am a big fan of the British utilities sector, even though rising rhetoric from regulators over future price hikes is jangling nerves in the investment community. I like the chunky dividends on offer and excellent earnings visibility, even though extensive capital expenditure remains a significant millstone around the bottom line. And I believe that utilities giants such as Severn Trent could receive a major share price boost should renewed takeover talk arise.

Severn Trent was, of course, the subject of three takeover offers from LongRiver Partners during the spring and summer of last year, the last of which — a £22 per share proposal — was turned down in June by the company’s management. The fight against the takeover cost Severn Trent in the region of £19m.

Following the final rejection, the water operator commented that

Severn Trent has a value to our shareholders above the level [LongRiver Partners] indicated it was willing to pay,”

and that

the difference in value has been at the heart of this process and the consortium has either not been able, or willing, to bridge that value gap.”

Under the Takeover Code, LongRiver Partners was then prohibited from making another approach for six months. But that prohibition is now consigned to history, and Severn Trent could once again enter the crosshairs of the consortium.

However, I doubt that Severn Trent’s previous suitor would be alone in eyeing up the water giant. Early last year United Utilities reportedly hired Goldman Sachs to fend off approaches from a string of sovereign wealth funds — including from Abu Dhabi and China. And this followed a number of acquisitions of UK utilities in recent years, including that of Northumbrian Water by a Hong Kong consortium back in 2011.

As I have mentioned, a tougher regulatory stance from OFWAT concerning tariff hikes under the new AMP6  regime, due to run from 2015 through to 2020, has raised questions over the future profitability of water firms.

Still, in light of a still-fragile macroeconomic backdrop, the superior earnings visibility of utilities firms such as Severn Trent — not to mention their excellent income profile (Severn Trent currently carries a 4.7% dividend yield for fiscal 2014 based on current projections) — make them ideal targets for sovereign wealth funds swimming with cash.

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> Royston does not own shares in any of the companies mentioned in this article.