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Consolidating Co-ops

Like it or not, changes are coming for electric cooperatives. Fewer and bigger might be the inevitable result.
Fortnightly Magazine - June 2004

agree. "Generally, the utility industry is overly fragmented and would benefit from more consolidation across all areas," says George Bilicic, a managing director with Lazard in New York. "There's no reason that co-ops shouldn't be able to realize the scale benefits of being more diverse, having a larger asset base and eliminating overlapping overhead."

Co-ops remain balkanized, however, largely because of their dedication to local control. For decades this has served to limit consolidation among co-ops, but that might be about to change.

First, customer demographics are changing. Formerly rural service territories are becoming increasingly urbanized, and co-ops' customer/owners might be less concerned about local control than their rural predecessors might have been.

More broadly, the role of agriculture in today's society is diminished from what it was 70 years ago. In the mid-1930s, a much smaller United States had nearly 7 million family farms; today there are fewer than 2 million. Accordingly, rural interest in the locally focused cooperative structure might be diminishing.

Second, in today's market, IOUs are seeking growth opportunities that are consistent with the "back-to-basics" strategies that investors and rating agencies are demanding of them. In such an environment, balkanized co-ops are beginning to look like ripe fruit-especially those that are in fast-growth suburban markets, adjacent to IOU territories.

"These co-ops are especially attractive," Tirello says. "IOUs could acquire them for a fair price, and the transaction would be accretive to earnings upon completion."

The challenges, however, might prove to be substantial. Perhaps the biggest issue involves the cost-effectiveness of pursuing a complicated acquisition that yields a relatively small number of customers. "The biggest co-ops have less than 200,000 customers," says Lange of Lehman Brothers. "That wouldn't move the needle enough for most IOUs to consider an acquisition worthwhile, unless it was a very friendly transaction. You'd almost need to have the co-op show up on your doorstep and ask to be acquired. That's not happening."

Indeed, co-op acquisitions are almost certain to be hostile and contentious. But Tirello notes that such issues are not insurmountable; they just require an intelligent approach. "You have to approach it as though you are marketing a new product, or conducting a political campaign," Tirello says. "There are myriad things you can do to turn the tide in your favor, but you have to be prepared to spend some money up front." As examples he suggests conducting focus groups and placing advertising around the issue.

Williams adds that multiple adjacent co-ops could be acquired in the same effort, which would make such a campaign more cost-effective. He further notes that co-op customers will be receptive to a simple message that offers clear benefits. "Most co-op members don't know they own the co-op. When members realize they've been providing free capital to the co-op, they will begin to wonder where their money has gone," Williams says. "By acquiring co-ops, IOUs can give that money back to members-all at once, in cash-and still reduce rates."

Avalanche Warning

The world is changing around electric cooperatives, and in time they will be forced to adapt to