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Can utility executives find happiness in back-to-basics?
We've read the pitch a number of times in these very pages. Top investment bankers have told us that a "back-to-basics" strategy will never produce a high-enough return to please electric utility stockholders; that the only solution to bridge this "earnings gap" would involve a rash of mergers and acquisitions (M&A) between utilities.
What's more, those bankers warned us that if utilities didn't act fast, they would see their investors lured away by the promise of higher-yielding, fixed-income securities.
After the roller-coaster thrills of the past decade, can utilities ever go back to their traditional role as slow-and-steady performers, with equity performing more or less as a bond equivalent? Or, will the analysts' warnings prove prophetic: that fickle investors will turn their backs on companies that remain happy to stick to the straight and narrow path?
So far, this year has proven no different. The financial community continues to question the concept of success without growth, yet some experts still appear willing to defend the traditional utility vision of slow-and-steady.
I can think of no better example than what I saw just two months ago, as the debate played out at Exnet's annual M&A conference, with the adept title, "Can Mergers and Acquisitions Close the Growth Gap?" held at New York City's Plaza hotel in late January.
A Bit of Growth, for Now
The doom and gloom of the growth-gap appeared to be overshadowed by the extraordinary financial performance turned in by electric utilities over the past year. For the first time in decades, the major utility indexes have been outperforming the S&P 500. That was the most oft-quoted statistic at the conference, by bankers and utility executives alike.
A second piece of good news was the structural shift in the valuation of utilities on Wall Street, brought about in large part by the dividend tax repeal. But as the taxman giveth, the bond trader may taketh away, at least according to Credit Suisse First Boston's Jonathan Baliff, who offered a rather off-putting prediction for the coming year.
Baliff gave pause to many in the hotel audience with his prediction that for 2005, "P/E multiples of utilities [would] decline 10 percent as dividends lose the battle with interest rates." He drew his conclusion from his findings that dividend payout ratios alone explained 21 percent of the variation among price-to-earnings (P/E) ratios in 2004, but that Treasury rates explained 34 percent of the P/E ratios. In other words, interest rate hikes from Alan Greenspan's Fed could likely put utility equities under water for 2005.
Yet Baliff's report that ample credit was available to utilities in the booming institutional loan market, and that traditional banks were again lending large amounts, gave reason for others to believe that the industry's best days might still lie ahead. That's why many executives, speaking to me on the condition of anonymity, expressed skepticism that mergers could be a panacea for the industry's future financial concerns.
Sure, interest rates are worrying, they said, but given that the industry has refinanced