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Utility M&A: How Many Deals, and How Soon?
By opening the field to far-flung deals, PUHCA’s repeal changes the merger game.
factors continue to complicate utility M&A transactions. Most notably, state utility commissions have proved to be a tough sell for utilities seeking merger approvals, and this regulatory overhead can make transactions too expensive to justify.
To learn what the financial community is thinking about utility mergers, Fortnightly spoke to several leading bankers, investors, and finance lawyers. Their insights suggest PUHCA's repeal indeed will influence utility asset sales and mergers. But the effects of that influence might be more subtle and complex than a perfunctory analysis might suggest.
Beating the Street
In some sense, a merger wave already began in 2005, with three merger announcements involving leading utilities: Exelon and Public Service Enterprise Group (PSEG); Duke Energy and Cinergy; and MidAmerican Energy and PacifiCorp.
The fact these mergers were proceeding before PUHCA's repeal suggests the 1935 act wasn't necessarily a major deterrent to utility consolidation. "The contiguous-network impediment was stretched," says Mike Haggerty, vice president and senior credit officer with Moody's Investors Service in New York. "It was out there as an issue, but wasn't really enforced. Duke and Cinergy aren't interconnected, and nobody questioned it."
Notwithstanding AEP/CSW's dilemma—which arose because of the one-way contract path they had arranged—the contract path concept already had emerged as an acceptable way to create a "single area or region" to comply with the '35 act. For example, if PUHCA's repeal had failed, Duke/Cinergy and MidAmerican/PacifiCorp were expected to secure contract paths as token solutions for a regulatory problem that even the D.C. Circuit Court of Appeals acknowledged "might well be … outdated." (NRECA and APPA v. SEC, No. 00-1371 (U.S. Ct. of Appeals, D.C. Circuit, Jan. 18, 2002) . Thus PUHCA's long-anticipated repeal is being favorably received.
"We have a lot of fiefdoms in the country," Wenner says. "Absent PUHCA, I doubt any Business 101 student would say we want separate back offices for 200 different companies. The utility's headquarters doesn't need to be in your state any more than the phone company's does."
The quest for greater scale economy and rationalized business processes have long been the primary motivations for utilities considering M&A transactions, and they remain the foundation of most M&A business cases. But PUHCA's repeal opens up the field and forces companies across the industry to re-think their market positions. In the post-PUHCA world, size likely will matter more as time goes on, and the scale for measuring U.S. utilities might need to be redefined.
"People say 'small is beautiful,' but bigger companies can achieve greater scale economy," Tirello says. "As companies mesh, competition will increase and the drive toward economies of scale will get stronger."
Consolidation pressures are being felt along geographical, strategic and financial tangents, and PUHCA's repeal changes the direction of these pressures.
"There will be capital-market pressure for companies to look for earnings growth," says Ken Marks, managing director in Morgan Stanley's global power and utility group in New York. "We've come out of the period of back-to-basics and we're still in a period of low interest rates. It's likely that interest rates will move upward and investors will have