Average North America power-plant asset value is at $725/kW.1 Compared with our winter 2005-2006 analysis, this figure has barely changed; however, we have seen significant value...
What to do with All that Cash?
year over the next five years. Of course, any growth in earnings per share would depend on the prices at which the stock was repurchased. At present prices, about 1.2 billion shares of common stock would be repurchased, and earnings per share would grow about 3 percent per year.
A much different picture emerges if utilities should invest their unabsorbed funds outside the core business. Again, let's assume that the dividend payout ratio and capital structure remain constant, which implies borrowing to leverage retained earnings. In this case, outside investment would run about $14 billion annually, yielding a total of $70 billion between 1996 and 2000. By 2000, these investments would account for over 15 percent of earning assets; earnings growth between 1996 and 2000 would depend entirely on the profitability of these investments. With a 12-percent return on incremental equity, earnings per share would grow 3 percent per year. With no return on outside investments, however, there would be no earnings growth.
Shareholders at Risk?
How utility managements choose to invest their unabsorbed cash will test their commitment to shareholders. The pivotal question is how willing utility managements will be to shrink their capitalizations and remain within their core businesses if attractive investments are not available. Conversely, to what extent will managements feel compelled to expand beyond their core businesses regardless of the quality of the investment opportunity?
The decision to retrench or diversify is made more complicated by competitive restructuring. Future utilities are unlikely to resemble their former selves. They will not be able to downsize and become smaller capitalized versions of themselves. The outlook for utilities investing in the electric power industry beyond their franchise areas also remains highly uncertain. The risk for investors is that managements will invest despite unfavorable prospects.
Apart from a few notable exceptions, such as Florida Power & Light, managements exhibit a strong preference for investment, as is evident in purchases of foreign utility properties and domestic merger agreements. In many instances, these investments do not appear directed toward strategic goals. Too often, foreign investments have taken the form of passive portfolio participations, instead of direct management involvement that would build expertise. One frequently has the impression that investment professionals could develop these portfolios just as well as utilities.
Similarly, merger agreements tend to be driven by a desire to grow, rather than by strategic objectives. Given the success of management efforts to cut costs, it seems plausible that cost savings equivalent to those claimed for mergers could be achieved without the mergers. Utilities naturally manage their cost-cutting in ways that will enable them to enjoy the benefits as long as possible. This strategy sometimes means a delay in cost reductions if regulators are in a position to pass the benefits on to customers immediately (thus denying such benefits to utility stockholders). However, by attributing such cost savings to a merger, a utility can capture the benefits of the cost-cutting opportunities by using them to finance the merger. In the process, the utility gets bigger but not necessarily better.
Given a history of