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Measuring the Merger: Fact, Fiction, and Prediction

Fortnightly Magazine - October 1 1996

holding companies. Western, Frontier, Republic, Southern, Piedmont, and dozens of other airlines were merged off.

The energy business is no different. During the last 10 years, over 40 electric and gas companies have found merger partners. In the recently privatized British electric industry, 70 percent of the new

companies have been acquired, leaving those without a mate to wonder if they've become wallflowers.

Why mergers? The usual answer is synergy. With a merger, costs can be saved, there will be economies of scale, plants can be closed. Will two companies, with high costs or low growth potential, somehow emerge as a single new dynamic competitor, with new ideas, new vigor, and new direction?

Experience says otherwise. Put two unfocused or unimaginative companies together and all you typically get is one larger, unfocused, and still unimaginative company.

Most mergers are opportunistic. They are tactical, not strategic. They are done because they can be done, not because they should be done.

If you're going to do a deal, do it for the right reasons. Do it for success, not synergy. Do it with someone who shares your vision, not your fears. Do it with a strategic purpose. Do it for shareholder value.

Find the value, not the flowers. In the end, the flowers wind up in the graveyard."

Are mergers of equals the way to go? Or are they marriages of convenience?

Although merger transactions can be costly (em in terms of out-of-pocket fees as well as in the attention and time they demand of key management (em the need to protect and enhance shareholder value will continue to drive many utilities to forge themselves into integrated energy services companies. The resulting synergies and access to new markets may ultimately enable management to realize greater values for shareholders.

Taking Stock:

Mergers and the Market

To measure the short-term impact of the merger transactions on shareholder value, we compared participants' stock prices at the month-end prior to each merger announcement to their prices at the month-end of July 1996. The stocks generally either outperformed the S&P Utility Index, or underperformed the Index by at least 10 percentage points (see Graph 2). These results reveal the market's generally positive reaction to the merger transactions, as well as a generally positive, albeit modest, enhancement to shareholder value.

Shareholders for many of the merging companies will receive increased dividends as a result of the merger. Based upon announced postmerger dividend rates and the stock exchange ratios of the merger transactions, six of the merging companies will increase dividends by more than five percent (see Graph 3).

The merger participants predict cost reductions due to enhanced operating efficiency and elimination of certain fixed costs and duplicate functions. Of the selected transactions, six estimates of undiscounted expected savings over the 10 years following the effective merger date ranged from

approximately $550 million to $2 billion, net of merger-related costs. On average, the annual savings represents approximately 3.5 percent of premerger operating expenses (see Graph 4).

Labor reductions are expected to produce approximately half of the merger savings (see Graph 5).