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Merger Frenzy

KKR’s leveraged buyout of TXU might be the first of many private-equity M&A deals, but traditional utility mergers also will increase.

Fortnightly Magazine - April 2007

Duke Energy did in the Spectra transaction, Morris said, “It made a lot of sense to them.”

But the AEP CEO also showed some skepticism related to the resurgence of such separation transactions being pitched by Wall Street.

“I’m always intrigued by those of you in New York City, particularly those of you involved in the investment-banking business. You talk all of us into merging and cross functionalization and how wise that was. Then you come back about four years later and say the market can’t understand the stock and you have to break the company apart.”

Of course, for decades corporate America and Wall Street have gone back and forth between the conglomerate and the pure-play models. It appears the utility industry will be no different. Lazard’s Bilicic laid out the value of a separation transaction: “Separation is a new topic, as many of you are aware because of the Spectra spin. The circumstances in certain states suggest long-term regulatory strategic tension. We think there are three broad categories of companies where separation is relevant.”

The Lazard banker believes separation is warranted for companies that have businesses across the value chain, like Duke Energy with its previous convergence strategy. The second category, Bilicic says, is companies that have deregulated, where the old utility generation is held by a non-regulated affiliate in the same service territory. “The third category is regulated utilities that have built up a non-regulated generation business beyond the regulated service territory,” he says.

“There may be a structurally practical way of separating. There may be capital or credit constraints or drivers of this separation. Last, when one looks at the appeal of separation, it ultimately is going to have to beat the standalone case or other alternatives that are possible.” And there will be many alternatives in the coming years, as billions upon billions in investment dollars are looking to invest in the utilities industry. Some deals may serve the public interest and some may not (see, “A View on the TXU Leverage Buyout”) . What is certain is what choices utilities make will forever change the operational and corporate landscape of the industry.