Industry leaders see a disaster coming, as the need for infrastructure investments collides with the economic interests of utility shareholders and customers. In a shaky economy and a politically...
Wall Street wants utilities to return to basics, but the CEOs worry it won't be enough.
One can certainly understand why so many utility chiefs steered their companies back to basics over the past two years. They read the newspapers. They knew what the financial community was saying. Investors and debt-rating agencies might have overreacted, I suppose. Some on Wall Street seem to think so. Not all utilities should have been downgraded or downsized, they argue. Not all business plans were suspect. Yet some energy companies certainly deserved to be investigated and downgraded. Or even bankrupted.
But a key problem remains. As the economy improves, utilities recognize they must soon return to the front lines and face the music. How do they generate enough growth to keep investors from being lured away by higher-yielding financial instruments such as U.S. treasuries (interest rates are on their way up) or competing equities with higher-paying dividends-all while remaining to appear as stable, low-risk investments?
While attending a utility industry conference last month in New York City, sponsored by an investment bank, most executives told me this issue would occupy utilities for the next 12 months. They suggest that merger deals will offer the only likely and available route to sustained growth. They say that the common strategy of combining energy trading, international ventures, and retail power distribution has been discredited because of the huge financial losses that utilities have suffered.
This recommended flight to M&A deals should not surprise anyone. Who can argue with the logic of consolidation and greater earnings growth through cost cutting and economies of scale? Naturally, these bankers echo what they believe is possible in the current investment environment.
But for myself, I'm not so sure that the bad experiences seen so far with international, retail, or energy trading rise to the level necessary to fully discredit these ideas as viable business strategies. Many of these business plans would also improve efficiency. Someone eventually will figure out how to do it right.
Everybody Lost Money
The pain of financial losses seen during the past few years ought not be sufficient reason to avoid growth strategies in the future that might go beyond the scope of a simple merger between like utilities. After all, many industries also lost plenty during the go-go '90s.
For example, telecom companies lost billions and over-invested in infrastructure. Yet you don't see calls for that industry to drop their ancillary businesses. In the 1990s, investment banks also lost countless billions in their foray into Russia, but they continue to have an international presence. And Internet companies continue to bring new retail offerings, even as many of their retail strategies failed, dramatically.
Yes, we saw cases of accounting fraud and misrepresentation of earnings. And those cases cut across a number of industries. But Congress and the SEC have dealt with that. Let's move on.
Energy trading, while not the growth engine everyone thought, is acknowledged as a necessary function of the industry. It did, however, need to be cleaned up in the way it reported its earnings