[BETA] Fortnightly

Time to rethink conventional

mergers? For

instance, why

combine two vertically integrated utilities when the market may call for disaggregation?

All deregulating industries share the same lesson: profits eventually decline, leading to consolidation. Electric utilities are no different. But as the electric industry jockeys for competitive position, and as the merger din grows louder, will prior deals prove instructive? Will they epitomize the future market? Or will more innovative mergers overtake the utility industry?

Prior to the 1990s, utility combinations often stemmed from the target company's weak management or financial condition. Others were fueled by the perceived value of transmission interconnections or the utility's desire to protect itself from an unwanted suitor. On the other hand, the mergers of today and tomorrow will more likely focus on versatility and value.

Earnings growth and market share are the elusive quarry of utility executives who seek to dominate tomorrow's competitive landscape. Utilities will seek to gain market share through customer ownership and skill extension, and to emphasize growth through product and service leverage and earnings and cash flow diversity. While the debate continues on "owning the access" versus "owning the meter," a merger may provide the best means to defend and grow the business.

Mergers and acquisitions (M&A), though not without drawbacks, can accomplish multiple objectives: improve competitive cost position, create earnings, increase market share, and provide a strategic growth platform. However, financial success and

competitiveness depend directly on the ability to identify and capture the synergies or cost savings available through integration. Utilities usually share the same core businesses (generation, delivery, retail services, and corporate and administrative support). Thus, the mirror aspect of utility combinations (em core business merging with core business (em makes synergies easier to obtain than in other industries.

Nevertheless, the industry has evolved to the point where the merger of two companies may produce more than a single new company. Instead, the merger may yield to disaggregation and create two separate companies, such as a power generator and a separate delivery and retail firm.

The Nature of Synergies

A merger enables the succeeding company to streamline operations and integrate critical functions to minimize total costs. Typically, a utility merger provides three quantifiable benefits:

Cost reduction. Avoiding duplication of the cost input required to achieve the same level of output.

Cost avoidance. The ability to forego certain types of expenditures due to a reduced need for parallel capabilities.

Revenue enhancement. The creation of additional revenue streams from existing assets.

Conventional wisdom once held that utility mergers would yield substantial cost savings because they would forestall expensive capital investment for new capacity. However, the 1990s have found most utilities long on capacity, thus minimizing the actual contribution from this savings area. Figure 1 (see page 32) illustrates the source of savings from 12 announced M&A transactions. The primary costs savings can be further quantified as follows:

Corporate Functions:

s Consolidation of corporate, administrative, and technical support positions.

s Nonlabor cost reduction or avoidance from facility

consolidation.

Corporate Programs:

s Reductions in nonlabor programs (em such as insurance and shareholder services (em