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A Constellation Of Risks

Will the deal with FPL serve the best interests of ratepayers? 

Fortnightly Magazine - February 2006

It’s no big secret: The utility industry has assembled a checkered past, earned through a series of bad decisions, often in pursuit of dubious ambition. Sometimes the investors have had to cover the losses. Other times, ratepayers have bailed out billion-dollar blunders.

And the memories are fresh. Only recently have merchant-energy trading houses such as Mirant and NRG come out of bankruptcy, while other merchants now are seeking protection through Chapter 11 (Calpine).

That’s the reason for concern. For, even as many hope that repeal of the Public Utility Holding Company Act (PUHCA) will lead to more efficient and rational corporate structures, they also fear that repeal could foster irrational exuberance, with mergers that fail spectacularly.

Maybe that explains why every new utility merger announcement is being met with a much higher level of scrutiny than in past decades. For example, the merger proposal involving FPL and Constellation has failed to dissuade the typical chorus of opposition and indignation, coming, as it has for years in these cases, from all sorts of investors, industry experts, and consumer advocates. They say the deal should be stopped in its tracks. Why?

Some investors appear adamant that the deal offers no real value. Industry experts say there are no operational synergies to be had between the two companies. And consumer advocates are leery that ratepayers may have to bail out FPL if Constellation makes some bad bets in its trading operation.

FPL, whose earnings are derived mostly from its regulated utility, believes that Constellation, whose earnings are derived mostly from unregulated operations, such as trading, will provide the company with greater growth to meet investor expectations.

But the merger also has attracted criticism for its failure to reduce operational costs in any significant way (the deal leaves both headquarters in place) while increasing the risks of the overall entity (the unregulated businesses faces margin pressure, while electric competition is stalled throughout most of the country). Also, the deal fails to make any rational business sense, with many saying FPL is getting only a few nukes and a risky trading book, at best.

In fact, one investor blogging under the name sweetbasilsf at the Yahoo! investor site goes so far as to say “the nukes are the crown jewel of the company, but the unregulated side is nothing more than smoke and mirrors.”

Constellation’s business model is not a focus of this column, but the comment illustrates how investors still do not fully understand the company’s business, or the risks. Many investors are concerned that FPL won’t either.

In its quarterly filing at the Securities and Exchange Commission, dated Nov. 9, Constellation reported lower gross margins for its wholesale marketing and risk management division, as well as for its retail competitive supply business during the quarter and nine months ended Sept. 30, compared with the same periods during 2004. Constellation, in its filing, blamed a combination of higher market prices for electricity and

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