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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

opportunities. M&A is an opportunity for these types of players to extend their best practices into companies that don’t operate as efficiently, and to capture scale benefits.

Superior regulatory management involves creating and maintaining a collaborative relationship with key regulatory bodies. Those that do this well are better able to appropriately influence policy decisions and create favorable regulatory conditions for themselves. In particular, those that develop collaborative relationships are more likely to be able to persuade regulators to let them keep a larger percentage of the cost savings they generate through acquisition ( e.g., via synergies or scale benefits).

Commercial excellence is the ability to exploit opportunities in the commercial and competitive areas of the business, including wholesale trading, marketing, merchant generation, and retail.

Superior capital management involves efficient prudent capital expenditures relative to profit. The most effective means of achieving this goal include establishing best-in-class capital allocation and capital project portfolio optimization skills. Project execution is also critical. In most cases, the asset base of an acquired company will be well established at the time of purchase, but the acquirer can still use its capital management skills to make more efficient the target’s expected capital expenditure requirements.

Research excellence is the ability to develop superior understanding of the key drivers of the market microeconomics, particularly from a micro-market perspective. Companies that develop robust proprietary perspectives often are able to take advantage of sudden changes and emerging trends. Those that understand where the market is headed can position themselves to capitalize on developments as they unfold.

Remember that M&A is more than just a path to growth. It can be a significant “unfreezing event” for the target company, bringing needed change throughout the organization and helping to unlock latent opportunities. Such events are particularly important in the power industry, since target companies often lack critical capabilities and are not given adequate incentives by regulators.

Capabilities Dictate Strategy

Companies must start with a thorough self-assessment that enables them to identify their strengths and weaknesses (see Figure 3) . Based on this assessment, they should determine their goals and develop a plan to meet them. This process will involve taking inventory of current assets, identifying a universe of potential deals, determining compatibility with potential targets, and identifying likely competitors for specific deals.

These analyses are likely to lead most companies to adopt one of four main strategies for success in M&A.

Utility roll-up. Utilities that possess superior regulatory management and operational skills can seek to acquire or merge with other integrated utilities to develop geographic diversity and to capture synergies that result from sharing best practices.

Merchant asset rationalization. Those that excel at commercial activities and possess superior market insight could acquire merchant players that don’t have the skills to compete in the market.

T&D roll-up. Companies that have excellent operational and regulatory skills but lack commercial capabilities could acquire transmission and distribution assets and focus on the wires segment. Transmission and distribution are considered the natural monopoly segments of the business, and they will not experience deregulation. As a result, regulators usually