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Gas-Electric Mergers: Money Well Spent?

Fortnightly Magazine - March 1 2000

some type of shared savings deal together with them. Right now, traditional gas utility Nicor has negotiated a performance rate structure where if they do better than some benchmark, they can keep [the profits]. We would like to do something similar," Bergstrom says.

As for the merger itself, Bergstrom notes that on the electric side, Dynegy has spun off all the generation to the unregulated side, and has set up a power purchase agreement between the utility and the generating company.

"Our strategy with the utility is to optimize the costs in the transmission, distribution business. Get it to be the absolute lowest-cost service provider in the Midwest for distribution and transmission and make sure that we are completely reliable. We plan on spending quite a bit of money this year to bolster the distribution and transmission system."

Holman considers Dynegy, Enron, AES and Calpine the growth companies of the industry.

Dynegy's acquisition of a utility won't hurt it, says Holman, because as Bergstrom explained, Illinova was further along in restructuring.

"Calpine and Dynegy outperformed the NASDAQ. AES and Enron did better than the Dow Industrials [in 1999]," Holman says. "These growth companies trade at very high multiples of earnings because investors are anticipating today greater earnings power of the company down the road. Enron we estimate 15 percent growth in earnings per share. For AES and Dynegy, we anticipate 20 percent growth in earnings per share."

Jeffrey R. Holzschuh, managing director at Morgan Stanley, says companies like Duke Energy - which targets 10 percent earnings growth per share, up from 3 percent a few years ago - cannot be categorized with utilities, nor can they be classed with Enron and Dynegy. Instead, they are somewhere in between. Many of the electric utilities turned merchant plant operators, traders and marketers, he adds, will become difficult to classify because of the changing nature of the business.

Holman believes within the next three to five years, as more states restructure, Wall Street will be better able to classify the earnings potential of evolving power companies.

Power Trading? Margins Too Thin to

Survive Without Gas

After a second summer of contract defaults and consequential financial losses to energy companies, having a trading floor is not as glamorous as it once was. Yet experts say it remains a necessary part of the electric and gas strategy. Furthermore, power marketing is a zero-margin business, and little revenue enhancement has resulted from convergence deals, claims John Barr.

"What happened is power marketing collapsed with the power marketer defaults [as a result of the Midwest price spikes]," Barr says. "You could hardly call it an industry at this point. The result of all that is too many traders, too much capacity, too much credit risk and zero margins."

Barr concludes, "The only ones that are making money are probably Enron and Dynegy."

In fact, John R. Stephenson, principal at Navigant Consulting, has looked at the margins for both electric and gas revenues. He finds that companies that don't combine their electric and gas trading operations will experience diminishing returns.