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Utility Valuation: Shedding Light on the Black Box

Experts debate how energy companies should be valued in the wake of electric restructuring and Enron.
Fortnightly Magazine - April 15 2002

flow.

What contributes to EBITDA are factors that impact revenues or factors that impact cost of operation, Malko says.

"Clearly, in this growingly complex environment more scenario analysis sensitive to business risk with respect to forward looking cash flows needs to be done. That is clearly one weighted for potential buyers and sellers to get a handle on," he says.

Focus On Regulated Utilities: True Love at UBS

UBS Global Asset Management's John D. Quackenbush won't mind if you call him conservative. As a utility analyst, his recommendations help drive the firm's investment decisions for its equity funds. In fact, UBS Global Asset Management has $405 billion dollars in assets under management as of December 31, 2001. UBS Asset Management is one of four business groups of UBS AG, along with UBS Warburg, UBS Paine Webber and UBS Switzerland.

The firm's outlook on utility companies hasn't changed in the last decade, he says. They like regulated businesses, regardless of whether they are in generation, transmission, or distribution.

"We take a fundamental long-term investment view and that hasn't changed. ... We still prefer the integrated providers because of our long-term focus."

In fact, it is this long-term focus that has kept Quackenbush from investing in highflying energy trading or merchant generation companies.

He says that unregulated businesses are not out of the question, but he looks unfavorably on companies that would stray away from its core competence of running a utility.

Quackenbush says that, although evaluating regulated companies on a case-by-case basis, he looks to see whether the utility has incentives for achieving cost savings that they can keep. "[Furthermore] I think there are some marketing, trading and generating opportunities that are far astray. However, if marketing and trading activities are focused on trading around assets, or targeting certain niche customers, that could be a business we would look on favorably," he says. Quackenbush also evaluates long-term supply and demand forecasts. "It still appears to us that there is plenty of supply to meet demand over the long-term,... even after considering plant cancellations, and other plants that haven't been formally cancelled but are unlikely to be built. There are exceptions regionally, but from a national perspective, there seems to be plenty of supply to meet demand over the long-term. For specific companies, we determine the valuation by projecting cash flows and reach some type of probability assessment of the likelihood that they could meet those cash flows."

He explains that UBS Global Asset Management works on a globally integrated investment platform that allows analysts to compare companies on a global basis. "We have analysts in London and Tokyo and elsewhere (that work together). If we decide to compare U.S. utilities to European utilities, this global platform will permit us to make those types of comparisons." Furthermore, UBS Global Asset Management uses techniques such as internal price projections to come up with expected cash flows to determine the current value of companies.

Quackenbush believes that there can be negative results when utilities go too far astray from their core competencies. "I think it is