[BETA] Fortnightly

IOUs considering co-op acquisitions are finding fertile territory for growth.

When utility executives consider the options for growing their business within a "back-to-basics" framework, naturally they consider acquiring other utilities. However, the relatively high price/earnings ratios of most investor-owned utilities (IOUs) today means bargains can be hard to find. Also, with PUCs disallowing the recovery of acquisition premiums, and mergers of equals facing daunting "social issues," IOU mergers don't look as attractive as they once did. Thus, many companies are beginning to consider prospects that lie outside the typical utility-merger model to bridge the "growth gap" between Wall Street expectations and the "back to basics" model that the Street has imposed ().

In the course of this analysis, the idea of acquiring electric cooperatives inevitably arises. In the past, conventional wisdom held that such acquisitions were either impossible or not worth the trouble. This "wisdom," however, is ill-founded. Cooperatives can be and have been acquired, and upon examining the fundamentals, utility executives usually sit up and take notice. In fact, at this moment some IOUs are scrutinizing the territory of electric cooperatives with acquisitions in mind.

The reasons are obvious. In short, co-op assets fit into Wall Street's notions of a "back-to-basics" utility business. Co-ops also offer opportunities for significant cost savings and synergies, mainly through rationalized business processes and customer aggregation. And co-op territories are growing faster than IOU territories-in some cases dramatically faster ().

At the same time, however, barriers to co-op acquisition are fairly obvious, too. Namely, co-op directors distrust IOUs and generally rebuff merger inquiries. Co-ops don't have publicly traded stock that IOUs simply can buy. Their financial advantages-vis-à-vis tax-exempt status and government-subsidized loans-are lost in the transition to private ownership. And finally, most co-ops are small and their territories tend to have low customer densities.

All of these barriers are real, and represent negative factors in the cost-benefit calculus. However, in many cases, the pros can outweigh the cons, and IOUs that analyze co-op acquisition candidates are finding fertile territory for growing their core utility business.

Making the Case

Acquiring an electric cooperative differs in some important ways from acquiring an IOU. These differences arise from the ownership structure of an electric co-op. Namely, an electric co-op is literally owned by its members-the co-op's customers. This stake, however, cannot be sold or traded (absent an acquisition or demutualization); it is "trapped" as long as the co-op retains its traditional ownership structure.

Customer/members accumulate their stake in the co-op by contributing a portion of their monthly service bill toward the co-op's "patronage capital." This contribution is involuntary; it is built into the invoice and is not itemized. (While most co-ops refund a portion of long-standing members' cumulative patronage capital contributions each year, individual members usually contribute more in patronage capital than they receive in refunds.) An IOU acquiring a co-op, therefore, typically makes a lump-sum payment equal to each member's accrued stake (with a national median of about $1,400 per member) and retires the co-op's outstanding debt.

The logistics of such a buyout include the need to