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Consolidation: Key to the Future?

Why integration may win out in the long run.

Fortnightly Magazine - August 2005

In the electric power industry, the urge to merge has gained a new lease on life. American Electric Power Co. (AEP) had thought it successfully wooed distant Central and South West, and despite a setback in the D.C. Circuit on account of the Public Utility Holding Company Act (PUHCA), AEP probably still will achieve a happy coupling. Exelon (itself a product of merger) is taking nearby Public Service Electric & Gas Co. under its wing, and most recently, Duke Power has proposed a merger with Cinergy, a close-by but not contiguous utility.

These combinations are witness to the powerful forces of consolidation let loose when deregulation makes consolidation a preferred tactic in an uncertain world. But to what extent will government policy encourage or resist this trend? What exactly is the regulatory environment that nurtures combinations or, for that matter, supports fragmentation? As we shall see, there are many cross-currents.

PUHCA is a good place to start, for although that statute has lingered on its deathbed for a number of years, it is still alive and kicking as of late June. If repealed, it should be replaced by some policy governing the structure of the industry that will either encourage consolidation or discourage and perhaps virtually forbid it.

The Hon. Richard Cudahy

In a similar way, for many years the national transportation policy favored the consolidation of railroads, 1 but this has now advanced to a point where concern about competition has replaced sympathy with consolidation.

PUHCA incorporates concepts that may continue to be important under any regime that replaces it. The statute was a powerful reaction to the financial (but not necessarily operating) consolidation in the electric power industry in the years before the 1929 stock market crash. This mostly was the work of pioneers in the industry who, as they continued to buy up or launch electric enterprises, were struck by the ease with which they, as seasoned operators, could borrow money to buy or build in pursuit of an empire. This was in contrast to the difficulties and soaring interest rates encountered by owners of individual properties with no track record. The strongest talking point for holding companies was that they could raise money for expansion more cheaply than separate companies relying on their own credit.

Pyramids

Samuel Insull, perhaps the most renowned of the holding company promoters, acquired some small electric plants in southern Indiana in 1912 and combined these under the mantle of the Middle West Utilities Co., soon to win prominence as a major holding company. As Insull's holding company empire developed, it grew as a pyramid, with holding companies atop holding companies, all financed with generous portions of debt and preferred stock so that the leverage at all levels-but most markedly at the top-continued to increase as the empire expanded. This pyramidal configuration also enabled control of the company to be exercised with only a relatively small

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