Behind-the-meter energy threatens the utility business model. Does history offer a lesson for crafting a response?
The Pulse of a Utility
The market-to-book ratio is a vital sign of a utility’s health.
independent operation in the past decade: All of the now-defunct utilities had MtB ratios well below 1.0 prior to their demise (see Figure 6) . Performance near or below this critical 1.0 level should be a cause for alarm among executives and directors alike. Indeed, the utility’s very independence as a firm openly is being challenged by the market.
Similarly, it is axiomatic that for a successful change of control event to occur, the acquiring firm must offer the acquisition company a premium over its then existing market price (implicitly a MtB ratio greater than current) and it also must acquire the utility at a market competitive price. Thus, transactions commonly occur at price levels around the industry average MtB ratio ( e.g., 1.33 in 2007). Further, this implies the most likely target companies are those utilities with MtB ratios well below this industry value average and are more likely to yield a premium.
The key implication is that stakeholders should take notice when a utility’s MtB ratio is well below industry average (especially those below 1.0) as it is a clear signal that change of control is both feasible and more likely.
The predictive powers of the MtB ratio can be seen in Northwestern Corp., whose MtB ratio already was at an industry average or better level before the company’s recent ill-fated proposed sale to Babcock and Brown (announced April 26, 2006, cancelled July 27, 2007) (see Figure 7) . The ultimate failure of that transaction was predictable from a MtB perspective: It was difficult to anticipate a value-creating acquisition scenario where a regulated utility already is valued at industry average MtB levels.
Similarly, PNM Resources and Pinnacle West Capital Corp. currently are struggling with significant strategic and regulatory challenges. These utilities are showing declining MtB ratio performance and performing well into the range where one could reasonably expect a change of control or a change of management event on the horizon.
The MtB ratio is an inherently stable measure that avoids the pitfalls of purely accounting based measures. It isn’t biased by past events like the TSR is, and it captures the essence of when genuine shareholder value is being created ( i.e., ROIC-WACC). Most important, it has some predictive power that anticipates valuation changes resulting from structural events (rate cases) and competitive threats (change of control). Best of all, it is an intuitive measure that can be understood easily without complex accounting or financial details.
Although no single measure of enterprise performance is perfect, the MtB ratio offers a concise and insightful measure of overall enterprise performance. The MtB ratio should have a prominent role in internal enterprise-level strategy and performance assessments ( e.g., in balanced scorecards) and in external shareholder and other stakeholder communications.