Utility Merger Mania

 | Dec 19, 2011 | 3:30 PM EST
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This was supposed to be the year for big utility mergers. Money is cheap, costs of mergers were thought to be low, and arguments for savings are compelling. But as simple as it may seem, utility mergers can be political, difficult and costly. So as we find ourselves at the end of the year, it seems as though some mergers may come about while others may not.

The motivation to merge utilities varies regionally. Regulated utilities in the South can use scale to bring about savings for consumers and shareholders. While most deregulated utilities lack generating assets, they also need scale to deploy reliable distribution networks and smart energy equipment and related services. Regulated utilities offer megawatts, and deregulated utilities offer negawatts (energy efficiency).

But regional differences do not affect merger approvals. Some smaller and less controversial mergers have been completed or are essentially completed. AES Corporation (AES) recently finalized its $4.7 billion acquisition of DPL Incorporated. DPL has approximately 500,000 retail customers in the greater Dayton, Ohio, area and owns regional wholesale power operations.

Gaz Métro Limited Partnership has all but completed its acquisition of Central Vermont Public Service (CV). While Gaz Métro's merger is not finalized, the company earned the approval of the state, the governor, its shareholders and most other stakeholders. The final decision is waiting an announcement from the state's Public Service Board, and that announcement is expected to be positive. While there could be surprises, it is not wise to bet against this merger.

One surprise is Exelon's (EXC) proposed $7.9 billion acquisition of Constellation Energy Group (CEG). It looks like this acquisition earned the approval of the state of Maryland. It's a surprise because the state nixed previous attempts when Constellation tried to merge with DC-based Pepco Holdings (POM) and Florida-based NextEra Energy (NEE). A merger with Pepco had the potential of expanding Constellation's footprint in the Mid-Atlantic region. A merger with NextEra had the potential of expanding Constellation's nuclear fleet and adding non-contiguous service areas.

When Constellation's board hired investment banker Mayo A. Shattuck III to be its President and CEO in 2001, shareholders knew their new leader would not be worrying about best practices in utility systems -- he had no utility background. Shattuck's stormy tenure brought Constellation one disaster after another winning him a coveted place on "Mad Money's" Wall of Shame. With Constellation's acquisition likely to go forward, the state of Maryland and its consumers are emerging as the real winners; the local utility will return to the safe hands of experienced utility managers, infrastructure will be built, and consumers will save money.

The news is not so good for two other mergers. The acquisition of NSTAR (NST) by Northeast Utilities (NU) remains mired in the ruts on the bumpy road of regulatory approvals. NSTAR is a Massachusetts-based electric and gas utility and the Commonwealth's approval process has become onerous. The only state more difficult than Massachusetts is Connecticut, and Connecticut is where Northeast Utilities' headquarters and one of its distribution systems are located.

Mixing it up is NRG Energy (NRG), which suddenly jumped into Connecticut's regulatory review process as an intervener. NRG recently petitioned Connecticut to re-examine its previous approval based on Northeast Utilities' response to the recent storms. NRG owns several generating assets within Northeast Utilities' service area.

Further south, Duke Energy's (DUK) proposed merger with Progress Energy (PGN) was handed a surprising setback. Regulatory approval was just derailed by the Federal Energy Regulatory Commission (FERC), which refused to provide unconditional approval.

Duke is learning that FERC's decision could be devastating for its merger plans. Worse, it appears as though Duke lost control to competing regulators.

At the state level, North Carolina strongly objects to any attempt by the federal government to introduce a market-based regional transmission organization (RTO) in their state. The state will not approve Duke's merger if an RTO is part of the deal.

At the federal level, FERC objects to any new entity that engages in interstate commerce and gains market power over other utilities. FERC believes that the proposed merger will allow Duke to gain market power over North Carolina's public utilities. FERC will not approve the merger until that advantage is mitigated.

Duke is caught in the middle, and the company will have to find a way around the regulators' concerns or forfeit its merger. At this point, the odds that Duke will walk away are significant and growing.

Investors should be careful about troubled mergers similar to the Duke-Progress and Northeast-NSTAR deals. If their mergers fail, acquiring utilities' forward earnings could become damaged. The market could punish all shareholders involved. Use caution with unresolved mergers.

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