What a difference a couple of years make. Just two or three years ago, merger mania was all the rage in the utilities industry. Blockbuster combinations of regulated utilities such as AEP and Central & Southwest Corp. or Northern States Power and New Century Energies — to form the newly named Xcel Energy — were heralded as the dawn of new national energy powerhouses.
“Convergence mergers” between gas and electric utilities were going to light up and fire up both a deregulating nation and the individual stock prices of the companies involved. Merger “synergies” were going to drive costs down, while a new national or super-regional scope was going to provide the mass to enter new, exciting, profitable deregulated ventures. The entire utilities industry — for decades among the most staid and stable of industries — was going to be transformed into a bold, daring, popular and increasingly profitable place to be.
But something happened on the way to the revolution. The most obvious external events that halted the move to bigger, bolder national or multinational utilities were California's dismal experience with electric deregulation followed by the demise of Enron — amid dirty financial dealings that the courts are still trying to sort through.
At a minimum, these events, coupled with an overall global economic slump, threw cold water on the merger fire that raged so strong in the late 1990s and early 2000. These events, along with other economic developments of the past three years, have caused the industry to rethink mega-mergers and, in particular, to re-examine the value proposition supposedly inherent in multibillion-dollar cross-regional utility mergers.
|12/2002||Unitil merged its two New Hampshire utilities, Concord Electric and Exeter & Hampton Electric, into one utility, Unitil Energy Systems.|
|10/2002||UniSource Energy, parent company of Tucson Electric Power, is purchasing Citizens Communications' (formerly Citizens Utilities) Arizona transmission and distribution system.|
|08/2002||Potomac Electric Power Co. merged with Conectiv Inc. and formed a registered holding company, Pepco Holdings Inc.|
|07/2002||MidAmerican Energy Holdings is purchasing Northern Natural Gas, a pipeline company, from Dynegy.|
|06/2002||Energy East Corp., holding company for New York State Electric & Gas Corp., acquired RGS Energy Group Inc., a holding company for Rochester Gas & Electric Corp.|
|04/2002||Aquila Inc. (formerly UtilitCorp United) is acquiring independent power producer Cogentrix Energy.|
|04/2002||Ameren Corp. is purchasing CILCORP, the holding company for Central Illinois Light Co., from AES Corp.|
|02/2002||NorthWestern Corp. (formerly named NorthWestern Public Service Co.) acquired the electric and gas businesses of Montana Power Co.|
|11/2001||FirstEnergy Corp. became a registered holding company upon its merger with GPU Inc., itself a registered holding company.|
|10/2001||Northwest Natural Gas Co., a gas distribution company, is acquiring Portland General Electric Co. from Enron. After the acquisition, the two companies will be subsidiaries of a new holding company.|
|09/2001||Reliant Resources, subsidiary of Reliant Energy, is acquiring Orion Power Holdings, a generation company jointly owned by Goldman Sachs, Constellation Power Source (an affiliate of Baltimore Gas & Electric) and others.|
|09/2001||Dominion Resources Inc. is purchasing Louis Dreyfus Natural Gas, an oil and gas exploration and production company.|
|05/2001||DTE Energy Co., the holding company for Detroit Edison Co., merged with MCN Energy Group Inc., the holding company for Michigan Consolidated Gas Co.|
|2001||AES Corp., an independent power producer and owner of CILCORP, acquired IPALCO Enterprises, the holding company for Indianapolis Power and Light Co.|
|Source: American Public Power Association, updated Dec. 4, 2002.|
“Mergers may continue at the pace of about five per year,” says Daniel O'Neill, director of the transmission and distribution reliability and operations practice at Navigant Consulting. “But I don't see the mega-mergers coming back. We are moving to asset transactions along business function lines.”
More Struggles Than Success
Tim Gardner, vice president of the energy practice at Booz Allen Hamilton, concurs, commenting that merger activity has “practically ceased” in the utilities industry over the past two years. One possible reason, he says, is that a study of the companies that pursued mega-merger strategies, along with those that went heavily into deregulated businesses, have very little success alongside quite a bit of struggle.
Xcel, for instance, has seen its stock price plummet by more than 60% in 2002, and recently had to write off a US$3 billion investment in its unregulated generation subsidiary NRG Energy.
Faced with mounting losses throughout the year, Aquila (formerly UtiliCorp United) has announced an aggressive restructuring plan that includes closing its namesake merchant trading business, cutting 1600 employees and suspending its quarterly dividend for an undisclosed period of time.
Dynegy, another deregulatory darling of the late 1990s that announced a loss of $1.2 billion in the third quarter of 2002 and is exiting all third-party marketing and trading, has sold its Northern Natural Gas pipelines in order to increase liquidity and is in the process of selling off transmission assets in Illinois in order to balance its books.
“Our number one priority is to improve liquidity,” said Dynegy CEO Bruce Williamson during an earnings conference call. “We are not in bankruptcy mode, we are in a restructuring mode outside of bankruptcy,” before adding, “there is substantial risk in our position and investors need to be aware of the risk they face.”
Gardner says the experience of all three companies — and many more like them — show that the three biggest drivers that have been cited to support utility mega-mergers have each proven to be little more than fool's gold. Those drivers, he says, were: that a utility needed to be international to compete; that deregulated businesses were the quickest path to profits; and that getting bigger would lead to better economic performance.
To test his thesis that none of these have proven to be true, Gardner and his colleagues plotted the share price of utility stocks against the three different categories: percentage of utility assets that were international; the participation of a utility in non-regulated ventures; and against the overall size of the company.
“We found no correlation whatsoever,” states Gardner. “I cannot say, based on that, that any particular company that did any of these things was nuts, but as a whole those strategies did not work.”
O'Neill offers a few more reasons why they might not have worked. One, he says, is the fact that a strategy focused on increasing a utility's geographic size ignores the fact that electric deregulation remains a function of regional entities, namely state legislatures, state regulators and state governments. “You still have to do state-by-state deals of any acquisitions you do,” O'Neill says, offering as an example AEP's post-merger experience trying to offer service in Texas. “The structure of deregulation in Texas is so severe that they can't own generation there,” he says. Distributed generation is likewise, out of bounds for AEP in Texas.
Another obstacle is the agreements utilities often sign in order to gain multi-state merger approval. “The agreements you have to make with the states in the acquired territories are pretty severe,” O'Neill says. “Utilities are paying fines of $500,000 or $750,000, mainly because folks are concerned about post-merger layoffs, assuming that this foreign entity is going to allow service to degrade. Look at Xcel, this whistle blower problem they are having now is about a performance standard they agreed to as part of the merger.”
|No.||Value of Transaction (US$ million)||Date Announced||Target Name||Target Nation||Acquirer Name||Acquirer Nation|
|1||18,140.4||April 22||Lattice Group plc||United Kingdom||National Grid Group||United Kingdom|
|2||2,059.2||June 18||Seeboard plc||United Kingdom||EdF||France|
|*3||1,700.0||May 20||Ruhrgas AG (18.4%)||Germany||E.ON||Germany|
|4||1,693.0||June 27||Sithe New England Holdings (50.1%)||United States||Exelon Corp.||United States|
|**5||1,540.0||April 30||Cogentrix Energy Inc.||United States||Aquila||United States|
|6||1,400.0||April 29||CILCORP Inc.||United States||Ameren Corp.||United States|
|7||961.2||May 6||Czech Government (eight power distributors)||Czech Republic||Ceske Energeticke Zavody AS||Czech Republic|
|8||929.0||May 17||Enbridge Inc.||United States||Enbridge Energy Partners||United States|
|9||836.6||June 11||HEW (25.09%)||Germany||Vattenfall AB||Sweden|
|10||836.6||April 15||Investor Group-Seabrook Nuclear Generating Station (88.2%)||United States||FPL Group||United States|
**Deal announced and subsequently withdrawn Aug. 2, 2002.
On an international scale, O'Neill sees cross-border mergers making even less sense. “The international acquisition bug has definitely had time to take its bite back,” he says. “In the case of TU alone, the European operations are what caused it to cut its dividend by 80%.” Other utilities, he says, have seen international operations in Argentina and England fail. “The glint is definitely off the jewel of expanding globally,” O'Neill says. “That car is definitely in reverse.”
Gardner adds that even if utility mega-mergers continued to make economic sense today, companies would be hard-pressed to find backing on the part of Wall Street or the financial community. That, he says, is partially a response to supply and demand in a commodity market, but another part of it is what he calls “the financial community's visceral horror at what has been happening in the energy industry.”
“The risk management models they have been using don't make sense any more,” Gardner says. “So much negative news is out there right now that there is even something new I will call ‘headline risk,’ where the news about a company may or may not have a material substantive impact, but when worry piles upon worry, the overall sense of risk starts skyrocketing.”
In fact, O'Neill and Gardner both say the only real merger activity in the utilities sector seems to be interest on the part of a few select outsiders in picking up assets from utilities desperate to shore up their balance sheets. One such suitor is Warren Buffett's Berkshire Hathaway, which has purchased pipelines from both Dynegy and Williams, and has expressed an interest in increasing its utility holdings.
“Those are, again, asset plays,” says O'Neill. “The list of utilities that have seen their stock drop more than 50% is a good list, so there are distressed companies looking to raise cash.”
“This is not a flash-in-the-pan industry,” adds Gardner. “There are some great assets there and some may be totally undervalued. Right now, the risk is very high, but someone who can come up with their own risk evaluation may be able to come in and have some real opportunities, if they also have some cash or access to it.”
On a relatively small but representative scale, that is just what Ameren appears to be doing with its agreement to purchase CILCORP, the parent company of Central Illinois Light Co., for $1.4 billion. Bob Porter, manager of acquisitions for Ameren, says the company has never strayed from a fairly conservative acquisitions strategy, even during the heated days of mega-merger announcements in the late 1990s.
“We want to stay within our core business and stay fairly close to our knitting as we always have,” Porter says. “We are looking at taking small bites at a time, making sure our acquisitions are immediately accretive, with synergies that we can achieve fairly readily through centralization of services.”
Porter observes that to some extent, the overall utilities industry has come full circle, back to a position Ameren has held all along. “Five percent earnings growth has always been our target, and three or four years ago we were being laughed at for that,” he says. “Everyone else was saying 12% growth, but that turned out to be unrealistic. Now 5% looks pretty good, and our story has not changed.” Porter also adds another rather obvious reason mergers are down: “there are only a few players that can actually afford to do any buying right now,” he says.
O'Neill comments that to the extent that a company has cash, it can use to pursue mergers, its strategy should be “very opportunistic and wherever possible, avoid any multi-state or cross-state acquisitions.”
“It is not the same industry as it was 10 years ago,” sums up Gardner. “The level of strategy today is less cosmic mega-strategy and more business unit strategy.”
That, he concludes, can be seen as good news for executives, managers and employees in the transmission and distribution sides of traditional electric utilities. “For a couple of years, transmission and distribution have been the traditional spear-carriers,” he says. “Now they are front and center and are the guys who are rescuing the company. I think it shows that for a while at least, innovations will be around the maintenance of distribution and transmission facilities.”
James R. Dukart is a freelance writer based in Minneapolis, Minnesota, U.S.