January, 2004

Feature Story:

Wind Investing:
The Vestas/ NEG Micon Merger

December 12 brought big news to the wind industry. Vestas Wind Systems (VWS.CO) and NEG Micon (NEG.CO) - the world's two leading public wind turbine manufacturers (respectively) both based in Denmark - announced they would merge. The all-share deal is worth about 2.5 billion Danish crowns (US$409 million). Shares of NEG Micon rose 45% on the news that they would receive shares equal to 20% of the combined group. Shares of Vestas held their value.

Is the merger a good thing? Bob Preston ofCraigmillarthinks it makes sense for a number of reasons:

* the Danish wind market is mature with fewer opportunities;

* the global wind market is growing quickly;

* turbines are becoming very large, increasingly requiring greater capital outlays;

* scale is necessary to compete with General Electric (GE), a fierce competitor.

As the news announcement states, "Size, technological know-how and development as well as financial strength are prerequisites for growth and long-term survival in the highly competitive international wind energy market." As one company, Vestas/NEG will be better able to compete in the rapidly growing global market and will perform better for investors. Very importantly, Bob says, it gives them the capital base to play in markets that demand very high megawatt turbines - supplying the offshore market and big buyers like FPL and utilities around the world.

The December 18th announcement by the UK government shows the huge potential for offshore wind. The UK announced approvals for US$12.4 billion in offshore wind projects that will generate 7% of current energy demand in the UK. The "new" Vestas will be better positioned to participate in these mega-deals. "Serious capital has to be pulled together. This mind-boggling project effectively doubles the installed base of wind energy worldwide!" Preston exclaims.

Bob believes NEG investors will fare better as Vestas investors. Although NEG investors will receive a 40% premium to its current stock price, the stock has been so beaten down over the past few years that many investors way view the deal as below fair value. Vestas is able to purchase NEG at this price because there is a pause in the market (due to the languishing US energy bill and similar legislative issues in Germany), and the competitiveness in Denmark.

NEG has a fair amount of debt, which Vestas will have to take on. "I think these liabilities are outweighed by the advantages of being able to significantly reduce costs ranging from administrative overhead to sourcing components. With its major competitor absorbed, Vestas may well be able to increase its margins.

On the other hand, will the "new" Vestas become less competitive without constant pressure from its Danish rival? Vestas may raise prices, opening the field to new competitors. Gamesa, Nordex and other wind turbine manufacturers will also have greater opportunity to improve sales and margins, since they too, will have one less competitor. And they should feel less pressure during the time Vestas and NEG are focused on combining the two organizations.

Until now, a reasonable wind technology portfolio consisted of owning the two leaders, Vestas and NEG. Now, as we discussed in Progressive Investor's How To Invest in the Booming Wind Industry report, you can own the world leader, Vestas, but if you want to invest more broadly, you have to find the new competitor to the "new" Danish power house.

NEG's difficult stock performance shows that it's possible to be a leader in a growth industry and still lose money. You have to be selective about which company you buy and when you buy them - the timing is so critical, cautions Preston. Since it's hard to know which company(s) will be successful going forward, an investor who believes in the growth of the market might want to diversify by investing in the other wind companies also. There aren't many: Nordex (NDX) based in Germany, is struggling, and Gamesa (GAM) based in Spain.

Although GE Wind and Mitsubishi are formidable players, the wind business constitutes less than one percent of these behemoths' revenue. FPL is increasingly tied to the wind business - about 25% of its electricity comes from wind now. (See previousProgressive Investorissues for discussions on FPL).

Another way to invest in wind is to take a partner interest in a project. This type of investment is provides a long-term income stream generated through the sale of electricity to the utility market. Until now, renewable energy projects have been too small to attract the interest of the brokerage firms. Bob points out, "I think it's getting to the point where we might start to see limited partner syndications for wind because of the size of the projects. Think of the oil and gas syndications; people could invest $5000-10,000 in limited partnerships sold through brokerage firms and get tax advantages and income benefits."

Preston speculates it may be the project side of the business that spawns new players. "Look at FPL," he points out. "The repeal of the public utilities regulatory act, which is in the U.S. Energy Bill, would deregulate the utility business, allowing for considerable consolidation and a change in utility business plans. FPL, by far the biggest wind project developer, could spin off a subsidiary that manufactures turbines."

Over the next couple of years, while the overall market grows and Vestas consolidates its new assets, Bob thinks its market share may fall from 35-30%. But he says, both market share and improved margins can do wonders for a stock position. "In the past, Vestas has been really aggressive on market share; now the emphasis will change to be more on margins. It's exciting that Vestas has a strong position in a growth sector, and now has the ability to improve its margins.

Do our otherProgressive Investorcontributing experts concur with Bob's take on the situation? Matt Patsky, managing partner with Winslow agrees that the merger makes sense and will ultimately be good for shareholders. NEG wasn't in a great position to go it alone, Matt says. "The combined entities have more critical mass and will be able to reduce costs and be more profitable." He points out that the entire alternative energy space has been a difficult place to invest in the past several years, although the wind sector has generally done better.

Patrick McVeigh, of Lowell, Blake, says they are basically sitting on sidelines right now. He is concerned about the debt Vestas is taking on, predicting they will need to raise money over the next year to pay some of it off. "Merging two companies at the same time you're leveraging it up so highly creates the potential for things to go wrong, and when they do go wrong, there's more of a problem," he says. "We bought Vestas last year when the stock had fallen so we own it at a good profit. We bought it because we thought the stock had done so poorly that there wasn't much risk in the stock. Now there is much more risk."

Terry Foecke, of Materials Productivity, calls it a shotgun wedding. "They had to do it. There was no way the two could go on separately the way they were. Year after year, they haven't met their lofty projections. They have been playing their cards too fast and too furious banking on lots of government support and saying the curve would continue at the same slope - and its not. It's flattening out. A lot of the easy gains have been made and now they are into some pretty tough deals." Terry is wary of any of the pure plays in wind because when capital gets expensive, he thinks GE and FPL will be the only companies that can raise money at low enough rates. "I'd be happy with 10-15% growth - I don't need 25% growth - but I don't see how the pure play wind companies will pull it off."

Concludes Bob Preston, "You have to believe the wind business is a good business to be in and that Vestas will take the advantages offered through the merger to position itself as a stronger player. Wind is the fastest growing source of global electricity and the electricity market continues to grow. I think wind will be a strong growth sector for at least the next decade."

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