[BETA] Fortnightly

Some big utilities are looking to get bigger.

When Morgan Stanley last October asked 30 of the top 50 utility chiefs whether they expected to merge with another company in the next two years, two-thirds of them said they did. Asked whether they expected to merge within the next five years, the utility chiefs unanimously said yes.

"The big will get bigger and the strong will get stronger. We fully believe that the winners will get differentiated," said Jeff Holzschuh, managing director, and head of the global energy and utilities group at investment bank Morgan Stanley.

Speaking at the Exnet Utility M&A Symposium in late January, Holzschuh said merger considerations, like utility balance sheet considerations, are following a "back-to-basics approach," only in investment banking parlance it's "M&A 101."

"M&A 101 [is] taking synergies out, providing revenue opportunities, cheaper access to capital-all the things that you think of M&A as a tool to do," Holzschuh said.

But the success of mergers will depend on how the market understands strategic combinations and how that combination will play a role in growth, Holzschuh explained.

Of course, growth, he admitted, has been a taboo word in the industry for the last 18 months. But as the general market begins to rebound, he predicted growth would again be in investor's sights. Also, experts believe that some utilities exhibiting anemic 1 to 2 percent organic (internal) growth will need to explore other sources of potential growth.

"We see that power utilities have been placed in a box shaped by many factors. Despite these many obstacles, the market's growth expectations are far in excess of what the utility core businesses are capable of delivering," says George Bilicic, managing director and group head at investment bank Lazard LLC.

Bilicic says the first step to meeting growth objectives is self-help by developing the best stand-alone strategy possible. Self-help strategies involve cost cutting, improved regulatory relationships, optimizing capital expenditures, divesting non-core or under-performing assets, capital market strategies, aligning liquidity, and growth. Much of this falls under the heading "back-to-basics," he says.

"But self help … is [not enough] shareholder value creation to provide between 5 percent, 7 percent or 8 percent growth [in shareholder returns]," Bilicic says.

Furthermore, the pursuit of non-regulated strategies such as telecommunications, billing, energy technology, and security may not provide greater returns, as it is not viewed as a core utility competency by investors. Not to mention that the industry has a track record of abject failure in regard to its non-regulated ventures, an expert says.

"Merchant energy strategies may work in one-off opportunistic situations but require significant investment scale to achieve meaningful returns. It would also invite significant market and regulatory skepticism, and would be difficult to implement in the current market environment. Neither of these options is viable for most companies," says Bilicic. Instead, Bilicic believes that if self-help is inadequate or non-regulated strategies are not viable, a consolidation strategy is likely one of the only growth vehicles for power and utility companies.

"Receiving a premium … may deliver immediate shareholder value in excess of long-term