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Utilities on Steroids

What's behind today's oddball mergers?

Fortnightly Magazine - July 2005

Energy. Here, too, industry experts fail to see a clear strategic rationale. Maybe Buffet wanted to park his money and earn a steady return on a larger utility entity?

Prior to his investment, Buffet said, "We'd love to have [an acquisition] in the $5 billion to $10 billion range. At the moment we've got more money than brains, and we hope to do something about that."

Critics can be forgiven for not seeing any attempt through the merger to create a more rational electric utility or service territory. But many believe the billions in capital investment promised to PacifiCorp may provide the real value. Moreover, Buffet has said he would invest more if the Public Utility Holding Company Act (PUHCA) were repealed-so he may have a more elegant combination in mind.

Furthermore, other types of companies like private equity firms and banks also would be able to invest more in the industry if PUHCA were repealed. Most Washington insiders believe that PUHCA repeal may happen in Congress this summer, given the political pressure and the fact that the three deals depend on PUHCA modification, but if not, the Securities and Exchange Commission is expected to relax its interpretations of PUHCA and allow the mergers to go through (See PUHCA Debate - Again ). But in a world where PUHCA is repealed, according to what guidelines will the industry consolidate?

Size Over Synergy

The Exelon, Duke, and MidAmerican deals offer quite a contrast to the mergers of a decade ago. Who can forget the utilities announcing their strategic combinations of telecom, international, power marketing, generation, and transmission plays? It seems many utilities today believe numerical superiority will trump synergy, and even, in some cases, common sense.

More than one chief executive interviewed for Fortnightly’s June cover story proclaimed the manifest destiny of corporate growth. Bigger is better, they said. Consolidation will happen. But this strategy has been met with mixed corporate performance in other industries. What is most startling about such declarations is the scant criticism or critical discussion they receive given the impact such changes would have.

The fact that many utility industry analysts and utility executives predict that someday it won't take more than five utilities to run the country's power infrastructure means a fantastically different industry than we see today.

George Bilicic, managing director at investment bank Lazard, envisions a utility some day twice the size of Exelon-PSEG. That would mean a utility of 100,000 MW and, best guess, a market capitalization of approximately $60 billion to $80 billion. If such an entity were to exist, most agree there would be no hope for competitive markets.

Imagine a behemoth of 100 GW. That would not surprise anyone in banking or telecom, where deregulation has led to relentless consolidation. But many question whether utilities are comparable.

One staffer at the U.S. Securities and Exchange Commission speculated at the recent Exnet M&A conference in New York that, in the absence of PUHCA, utilities might consolidate along the current boundary lines that divide the Eastern and Western Interconnections. If this type of