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Winning the Merger Game

A new wave of consolidation is coming. To succeed, a company must understand where its strengths are.

Fortnightly Magazine - March 2006

The U.S. power industry is poised for consolidation. Regulatory barriers to mergers and acquisitions (M&A) are lessening, many companies now have the resources to finance acquisitions, and the industry is highly fragmented. Yet common wisdom says that M&A frequently destroys value. Several studies have concluded that most deals fail to generate the anticipated synergies.

There is no question that M&A is challenging, but we believe that these negative assessments are misleading. Analysts often account only for fluctuations in total shareholder return (TSR) that occur in the days or weeks following an acquisition or merger. This is an insufficient amount of time to determine success or failure, and most executives know it. Most senior leaders are concerned with companies’ longer-term prospects, not with short-term fluctuations in their stock prices.

Our analysis of the long-term performance of companies that have M&A-intensive strategies suggests that M&A can generate tremendous value. We found that companies that relied heavily on M&A generated more than half of the value 1 in the power industry during the 10 years ending in September 2005.

Furthermore, we found that more than half that value was generated by a handful of companies (four of the 58 we examined). This was no coincidence. These companies had the ability to assess their own skills and select the opportunities that would allow them to make M&A a success.

How did they do it? We identified five key capabilities that enabled these companies to excel in M&A:

Operational excellence;
Superior regulatory management;
Commercial excellence;
Superior capital management; and
Research excellence.

To succeed, a company must understand where its strengths are relative to these five capabilities. This knowledge will enable it to determine whether it is in a position to acquire, to identify appropriate targets, and to select one of four key strategies for success in M&A:

Utility roll-up;
Merchant asset rationalization;
T&D roll-up; or
Fuel diversification.

We estimate more than $400 billion of present value savings (for shareholders as well as ratepayers to share) in the industry. M&A is the key to unlocking this value.

The Time Is Right

Not only is the power industry recovering from the crisis it suffered between 2000 and 2002, but it began to outperform the S&P 500 for the first time since the beginning of the century. But while this high performance suggests that many companies may have the resources to invest in growth, prospects for organic growth are somewhat limited.

Sales, measured in megawatts per hour, have grown at a meager compound annual growth rate of about 1.8 percent since 1990, which is expected to remain flat for the foreseeable future. Retail deregulation, an organic growth vehicle for some companies, has stalled and is not expected

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