Utility M&A: How Many Deals, and How Soon?
By opening the field to far-flung deals, PUHCA’s repeal changes the merger game.
could acquire LG&E from Germany's E-On.
"It would be a perfect fit in-between those two guys," Tirello says. "This makes a lot of sense, and people are starting to look at plans for methodically expanding the company in a smart way. They will merge and then fill in the spread over time."
On the other hand, not all utilities are in a geographic position that allows them to "fill in" with a far-flung suitor, because they are blocked by large neighbors or the territories on their boundaries are not attractive. Such companies still might contemplate mergers with distant companies on the basis of benefits other than geographic proximity.
"If companies aren't contiguous, there are still some synergies, but they might not be as compelling as they are for utilities next to each other," says Raymond Leung, a managing director with Bear Stearns in New York. The flip side of contiguity is geographic diversity. "The biggest variables in the utility sector tend to be regulatory issues and fuel sources. You can be on different coasts, and that potentially will help smooth out peaks and valleys in your earnings."
Indeed, complementary positions on generation, fuels and other characteristics can drive mergers for many companies, contiguous or not. For example, a utility that is long on coal-fired generation can achieve greater fuel diversity by combining with a utility that has a lot of gas-fired capacity. In other cases, a company with a lot of cash on hand but nowhere to invest it might benefit by merging with a utility that faces large capital expenditure needs, whether for upgrading transmission and distribution systems or installing environmental controls on coal-fired power plants.
Again, the large mergers proposed this year exhibit various non-geographic synergies. PacifiCorp needs to spend an estimated $5 billion through 2010 on transmission systems, and Berkshire Hathaway, which owns MidAmerican, is well positioned to raise the capital. Exelon's experience operating nuclear power plants was attractive to PSEG, and the companies' past co-ownership of nuclear facilities lent a degree of comfort to the match-up. And one factor in the Duke/Cinergy merger is succession planning, which could become a major issue for many companies as Baby Boom-generation managers and executives begin retiring.
In any case, M&A options mushroom with PUHCA's repeal, as companies can look further afield for potential suitors. "It changes the planning dynamic," Tirello says. "A utility's possible map is no longer just three states, it's the whole country."
Facing the States
Utilities might have a bigger planning map, but that doesn't necessarily mean the repeal of PUHCA will make mergers easier to accomplish. All the major complications and challenges facing utility mergers remain in full force, irrespective of PUHCA.
"We'll see utility consolidation go forward, but deals that succeed are special transactions that address a bunch of issues," Hempstead says. "The fundamental questions affecting utility mergers still apply. How do you make it work from an earnings perspective? You have to work through synergy and growth questions. Where will the headquarters be? Who will sit in the corner office? Who will get laid off?"