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Business & Money

Some big utilities are looking to get bigger.
Fortnightly Magazine - March 15 2003

growth potential. . Scale in itself can be a catalyst for growth. It provides synergy benefits, mitigates operating challenges [and] also gives regulatory and market diversification. Furthermore, it enhances credit capacity, business diversity, and there is more room for error."

But a consolidation strategy is no cakewalk. Bilicic says an M&A strategy carries its own challenges, such as the proper time to buy, the bringing together of two once independent cultures, the review of earnings and credit impacts, the design of a new corporate structure, shareholder protections, and, of course, overcoming regulatory scrutiny.

Yet, before a merger wave is to take off, most utility executives and bankers agree that valuations of the industry must stabilize, given that most utility stock indexes were down 35 percent last year and 20 percent the year prior. The most often asked question is when.

Morgan Stanley's Holzschuh believes that while valuations will stabilize within the next year, volatility in reported earnings will continue. "On a P/E [price-to-earnings] basis, clearly there is a big desire to have stable earnings and be predictable to get some of the volatility out of the valuations," he says.

Generally, investment bankers believe strategic M&A activity will be available only to the strongest credit quality utilities, which may not be many companies. Almost 40 percent of utilities are still on some type of negative credit watch.

"For those being challenged by credit issues, it's expected to get worse before it gets better," Holzschuh says.

Rodney Miller, managing director, Credit Suisse First Boston (CSFB) and global head of The Power Group, says, "Credit quality will be the key. M&A will not be a solution to a liquidity crisis." But to those that have a good credit rating, the money will be there, Miller says.

"The real key is, show me the money. What we are finding in this current environment is the fact that utility M&A is no different than any other. M&A is driven by money. That's what is going to drive the deals," he says. Miller explains that as the cost of capital has increased for utilities, and traditional lenders have backed away, private equity and institutional investors have taken up the slack as lenders to the industry (see "The New Utility Lenders: No Need To Buy Them Steak," March 1, 2003.) "Whether you look at several of the deals of last year, there is a broad body of thoughtful, well-informed, educated investors looking to put money to work in this industry. Take advantage of it," Miller says.

After a Perfect Storm: Reading the Signs of Recovery

Much of the debt restructuring in reaction to credit rating pressures and management changes are precursors to a fair amount of strategic activity, Holzschuh says. For example, according to Morgan Stanley, of today's top 50 utilities by market capitalization, only 39 percent of CEOs in 1997 still have their positions. Furthermore, only 17 percent of CFOs in 1997 still have their positions.

"[In addition], looking at the difference between U.S. and non-U.S. deals as a function of a number of transactions, they have been