An Uncertain Future for Europe's Utilities

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Not Nearly Hitting the Target

On Feb. 22, for example, Germany's No. 2 utility, RWE (RWEG.DE)—whose 2007 net profit rose 20% annually to $4.4 billion—announced a $44.5 billion renewable investment plan to cut its carbon emissions by 60 million tons per year by 2015. According to analysts at Citigroup (C), this strategy will limit future shareholder returns as RWE pours money into green technology instead of dividends.

And yet it still may not be enough. A study by France's Environment & Energy Management Agency shows Europe currently produces 6.9% of its energy from sustainable sources—high compared with other parts of the world, but only one-third of the 2020 goal. To hit the target, companies will have to spend billions more to ratchet up capacity, just as they're contending with potential breakups and mergers.

Indeed, European markets are alive with speculation about potential utility mergers and acquisitions. In search of new revenue sources, some companies are looking to expand in North America and Asia, which could leave them more vulnerable to the ups and downs of the global economy. Others continue to focus mainly on European consolidation.

May Be Overstretching

The merger bug certainly has caught on. According to PricewaterhouseCoopers, companies stumped up $131.3 billion for takeovers in 2007, a 12% increase over the previous year. The main impetus was megamergers between European heavy hitters, such as the deal by Italian giant Enel (ENEI.MI) and its Spanish partner ACS (ACS.F) to take over Spain's Endesa (ENDE.BE) for $64 billion.

Analysts worry, though, that companies may be overstretching themselves to meet shareholder expectations for global strategies. Companies such as E.ON and Spain's Iberdrola (IDRO.BE), itself a perennial takeover target, have expanded into emerging markets, particularly Russia and Latin America. But experts say the moves could expose the utilities to changes in local regulation and global market volatility.

Nervous About the Future

As an alternative, Datamonitor's Akbar reckons energy companies may try for smaller, local deals. "You're going to see a lot more regional deals going ahead, rather than two large companies announcing a merger," he says. "In the tighter credit markets, M&A activity will depend even more than normal on the available cash flows of the companies involved."

Whether such strategies please investors is anything but certain. Despite booming profits for utilities, shareholders are understandably nervous about the future. Indeed, EDF shares shed 9.4% on Feb. 22 despite its record results because the company's 2008 growth estimates came as a disappointment to investors. Such volatility underscores the dilemma for European utilities: 2007 may have been a record-breaking year, but with so much uncertainty ahead, investors may start looking for better returns elsewhere.

Scott is a reporter in BusinessWeek's London bureau .