Utility M&A: Buying Time
rate reviews for several years, because their costs have remained stable or have decreased. Utilities' cost of capital, for example, has fallen along with lower interest rates. Thus, going to the commission now can be a risky prospect.
"Will utilities get the rate increases they are asking for, or something less?" Rigby asks. He points to Idaho Power's recent experience as a cautionary example. The utility sought a 17.7 percent increase in average rates in October 2003, but the Idaho PUC approved only a 5.2 percent increase.
Many utilities have been perusing power plants on the auction block to find distressed merchant power assets and other unregulated power plants that could be brought into rate base. "There's no question; all around the country utilities are buying power projects in various stages of development," says Jeff Bodington, principal of Bodington & Co. in San Francisco.
Several such deals have gone forward, including Oklahoma Gas & Electric's acquisition of NRG Energy's McClain power plant. But that deal and others have raised challenges from FERC, which is concerned about how putting wholesale capacity into the utility rate base will affect wholesale market competition ().
Additionally, utilities that plan to leverage their acquisitions of power plants or other horizontal assets will face questions from rating agencies, which are keeping close tabs on their levels of indebtedness. After having extricated themselves from a morass of debt, utilities are in no hurry to leverage themselves again.
This is the approach that seems to represent the greatest opportunity for increasing share value and profits (). "There's likely to be a pickup in the consolidation of utilities," Morash says. "The best prospects at the regulated utility level probably will involve neighboring utilities merging to capture operating savings."
The challenge will be to do so without hurting either company's financial position. Accomplishing this in today's still skittish market will require utilities to take an excruciatingly careful approach to due diligence and planning. Those that can manage it, however, will be rewarded in the capital markets.
"Growth by itself wouldn't necessarily affect credit quality if done prudently, and with a balanced use of debt and equity," says Haggarty of Moody's. "If a company can put forth a compelling business case and it's within their field of expertise, we would probably look favorably on such a transaction from a ratings standpoint." He points to the example of Ameren Corp., which received FERC approval this summer for the $2.3 billion acquisition of Illinois Power Co. "We confirmed Ameren's ratings, even though they are buying a smaller and weaker utility," Haggarty says.
Getting to 'Yes'
Despite the economic drivers, utility mergers today face a variety of impediments that likely will prevent utilities from clumping together very rapidly.
First, while utilities' current financial strength puts them in a position to begin considering growth opportunities, it also means that many acquisition prospects are priced at a high premium. "We've heard rumblings that utilities are considering M&A, but we haven't seen a lot of evidence, partly because there aren't a lot of good buys out there," Rigby says.