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Utilities on Steroids

What's behind today's oddball mergers?

Fortnightly Magazine - July 2005

Look at the gargantuan, gerrymandered service territories you would get with the latest pending merger deals: Exelon-PSEG, Duke-Cinergy, and Warren Buffet's bid to combine PacifiCorp with his MidAmerican Energy. Now ask yourself if they make any sense.

Some engineers say that merging two widely distant electric utilities, connected only by a highly tenuous contract path, betrays the mind of a "raving lunatic." But we've heard that before.

More than one M&A expert has told the Fortnightly the non-contiguous mergers of the late 1990s also appeared a bit screwy, with their physical and geographic obstacles to rationalizing labor, capital, operations, maintenance costs, technology, and assets.

One merger expert-involved in almost every major utility merger since the early 1990s, and speaking on the condition of anonymity-says a non-contiguous merger such as Duke-Cinergy would sacrifice as much as 10 percent of the savings otherwise available if the two utilities could claim a significant common boundary.

Yet many equity research analysts have said on-the-record that the gerrymandered mergers that built today's AEP and Exelon have in fact achieved a high level of efficiency, performance, and cost reduction.

No Strategy, No Problem

In his bestseller Good to Great , Jim Collins warns, "Two big mediocrities joined together never make for a great company.

"Mergers and acquisitions play virtually no role in igniting a transformation from good to great."

Consider the merger of Exelon and PSEG. The parties cite the economies of scale of applying world-class nuclear skills across a larger collection of assets. But opponents warn of a contentious cross-fertilization of low-cost nuclear capacity from the Midwest, with a beckoning, high-cost, and capacity-short retail market on the East Coast.

Naturally, this potential mix has elicited hundreds of pages of protests from competing utilities filed at the Federal Energy Regulatory Commission (FERC), worried that the huge new company would stifle competition in the PJM region. (At press time, FERC was to decide whether it would hold hearings on the merger's effects on market power. In the meantime, Exelon sweetened its divestiture offer to FERC to avoid such hearings.)

Critics have called for the federal government and state regulators to reject the merger summarily so as to not upset the balance of power in PJM. But a more fundamental objection is the lack of any good idea supporting the deal, other than that it would make for a larger utility.

Also of concern is the Duke-Cinergy merger. In a report titled We Really Don’t Get It , released on May 9, Deutsche Bank Securities analyst Robert Rubin writes:

"We do not believe the merger … makes sense. We do not believe that the most meaningful strategic rationale outlined here, the ability for [Duke] and [Cinergy] to combine MW in the Midwest, is a reasonable foundation for a deal.

"Further, we are not more comfortable with [Duke] being run by [Cinergy] management."

Rubin said he was maintaining his Duke rating at "hold."

That brings us to Warren Buffet's bid to buy PacifiCorp and combine it with his privately held utility, MidAmerican

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