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Do Utility Mergers Deliver?

Not in all cases, or for all stakeholders. Here’s why.

Fortnightly Magazine - June 2006

like these are becoming more commonplace as regulators look for any available path to soften the blow of recent step-function rate increases caused by higher fuel prices. Constellation has proposed to link a rate phase-in directly to its proposed merger with FPL to compel merger approval from the Maryland Public Service Commission. Maryland customers are facing a 72 percent rate increase as Constellation shifts to market-based pricing.

Mergers also may be approved in the context of broader settlements, and it is therefore difficult to measure with precision the ultimate customer impact. Of longer-term importance are the company’s business decisions, credit quality, and operational changes that affect the cost and quality of service provided. These factors must be weighed by regulators without the benefit of programmatic commitments. Rather, the regulator must examine the track record of the management team and the consistency of the merger proposal with the industry environment and broader policy objectives.

Benefit or Bust?

So, do utility mergers deliver? Not in all cases and not necessarily for all stakeholders, evidence from these mergers suggests. Shareholder returns likely will beat the industry over the year following closing, but thereafter will be affected more by events outside the merger than by the merger itself. Electric and gas rates may benefit in the near term from committed cost synergies or rate freezes, but likely will not change significantly.

The probable effect on employees is clearer. While a merged company may bring with it a host of career-boosting opportunities, employment at the merged utilities we studied fell by an average of 15 percent during the four years after closing, even after adjusting for the recent decline in employment at all utilities.

In past research, we have reported that corporate scale has not been an identifiable factor in superior utility financial performance. 3 This is a surprising result in a capital-intensive industry. Since achievement of scale is one of the driving forces behind utility mergers, scale may emerge as a key driver of returns in the future. We believe this is not so much a condemnation of mergers, but may indicate that strategic positioning of the merged entity and post-merger decision-making by the management team are more important. For example, Unicom’s merger with PECO brought the largest nuclear operating position in the country into Exelon just prior to the significant run-up in fossil-fuel prices. The combination of assets and strength of the management team likely will far outweigh the more modest changes in day-to-day operations resulting from any given merger.

Successful mergers ultimately need to satisfy shareholders, regulators, customers and employees. Given a mix of historical merger results for shareholders, management will need to continue to provide assurance that any proposed merger is based on a sound strategic rationale. As many utilities have retained generating assets, FERC likely will continue to wrestle with market power while promoting its policies on transmission and wholesale market development. State regulators will look to the track record of merged companies, and likely focus on maintenance and innovation in service quality, competitive rates, financial stability, and corporate progress toward economic