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Where Have All the Mergers Gone?

EPACT and the repeal of PUHCA have not affected the pace of utility acquisitions.

Fortnightly Magazine - June 2007

yawn. Perhaps there would have been even fewer deals had PUHCA remained in place, but the fact remains that PUHCA’s evisceration, if not its complete elimination, in EPACT has had no perceptible impact on utility M&A.

Is Less More?

Both before and since EPACT, the only segment of the private sector that has participated in M&A activity outside of electric utilities themselves has been the financial institutions, in particular the hedge funds and equity funds. No new European utilities have entered the United States (though some already here have been involved in the deals that have proceeded); no oil and gas companies have done so; and no other infrastructure-intensive or other regulated industries ( e.g., telecomm, gas) have done so either.

Overall, the reason for such lack of activity is that utility M&A is a complex consideration that involves much more than the restrictions imposed by PUHCA. That is, the presence of potential efficiencies may be necessary, but is not sufficient to support a utility merger or acquisition.

What are some specific reasons this might be the case? Some commentators have suggested that state approvals have become increasingly difficult to achieve while maintaining the financial benefits of the transaction (some cite state “mini-PUHCA” statutes). But while state approvals can be challenging, there is more to the story.

Barriers to Entry

Why might a successful entity in another industry not want to get involved in the electric-utility business? Electricity might not create a sufficient hedge to the core businesses, or managing the electricity business may be unfamiliar turf. Perhaps there are more pressing needs, or better uses of capital within industries

On his or her own, an industry executive might be able to get past these barriers, but financial structure and “bottom-line” reasons also might give a potential acquirer pause. For example, some electric utilities may be fully valued, if not expensive. Tens of billions of dollars in investment are required across all segments of the industry in the next decade, and taking on that substantial burden might not be prudent. Also, long-term returns may not be attractive, and may have limited upside.

Furthermore, in an industry with few qualified buyers, the “exit” strategy could be unclear. In addition, the utility’s tendency to utilize debt is higher than in most industries, so it might affect the parent company’s credit rating.

Then there are issues related to industry dynamics. There may be major challenges of merging utility cultures, which could limit the realization of synergies and transfers of skills. In fact, consolidating staff and implementing a major outsourcing effort can be significant challenges.

Moreover, because of competition and contracts with others, utilities might not be able to take advantage of vertical integration ( e.g., access to coal or gas). Then again, the biggest reason a deal may not get done is the because of the perception that the best utilities may already have been acquired.

The Regulators

There are a number of concerns over regulation, both initially and once an acquisition is completed, which eventually may prevent a merger from happening. Potential