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Business & Money

Is the industry on the verge of a new consolidation wave? Should it be?
Fortnightly Magazine - September 15 2003

and power industry as a result of the regulated nature of business (e.g., increases complexity of headquarters issue) and the long history of discussions between some strategically logical merger partners. Also, the fear that regulators will confiscate the economics of mergers or delay approval of mergers beyond what the market can tolerate is preventing, and may continue to prevent, mergers that are good for shareholders and also good from a public policy point of view. A company that is stronger financially should be able to serve customers more ably and invest more effectively in systems. To the extent mergers are not supported by regulators, various system investment opportunities that are readily accessible as a result of the financial benefits of mergers will not be realized.

Moreover, while the repeal of PUHCA (or failure to repeal PUHCA) should not have a material impact on industry consolidation, it is possible to imagine regulatory/legislative action (or inaction) on material topics having a chilling effect on mergers. For example, if as a result of the 2003 Northeast blackout or otherwise, transforming regulatory/legislative changes are suggested or actually enacted, consolidation activity could be stalled or impeded. Furthermore, continued concerns about how the stock market will react to companies that decide to enter into merger arrangements could impact consolidation activity. Many industry participants well remember a series of announced mergers that were ill-received by the equity markets. While these memories are good to retain, such reactions are better explained in terms of whether the relevant mergers were strategically and financially sound as opposed to the market voting in an absolute and adverse way on industry mergers.

There is also a concern about the time it has taken to close many industry mergers and a perception that such passage of time could impede consolidation activity. Adverse consequences identified include: the market will treat deal participants as "dead money" during the pendency of the merger; deal participants are unable to pursue other strategic alternatives during the pendency; and the circumstances under which the investment decision (i.e., the merger agreement) was made can dramatically change between signing and closing.

While it will always take a long time to close a utility merger, there are means available to mitigate the timing issues. These include an effective and sustained market communication program, continued implementation of strategic decisions during the pendency, accelerated preparation of regulatory filings, and reasonable approaches to regulatory issues. Effective use of the foregoing tools (and others) should make the time-to-closing issue less of an irritant.

Additionally, the increased focus of the marketplace and rating agencies on balance sheet quality will create concern about certain transactions that would have otherwise occurred in the not so distant past. Among other things, industry participants may be less able to utilize large cash components for merger consideration without experiencing ratings pressures and some market concern about credit quality. Accordingly, more equity will be necessary in the first instance, or visibility at the time of announcement regarding specific arrangements to "re-equitize" the balance sheet may equally be necessary. While the balance sheet question is manageable,