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M&A Forecast

Will shifting winds bring consolidation?

Fortnightly Magazine - August 2010

sitting on large sums of cash are eyeing regulated utilities, generally below an $8 billion market capitalization. This interest is expected to continue as infrastructure funds look to the power and utilities sector as a way to balance their overall portfolios with steady cash-based returns available from regulated utilities. As more financial buyers form these funds, there could be more competition than in the past for sector acquisitions.

Providing another potential boost to M&A activity is the industry’s return to basics. Regulated utility companies are expected to continue divesting themselves of noncore assets. Examples include the moves by Dominion Resources to spin off its exploration and production business and Duke Energy selling its natural gas business.

The rationales for these types of moves are to enhance shareholder values and also to answer the question of whether an entity is a power company or an energy company. As regulated utilities continue selling off the noncore parts of their businesses, such activities should create a bright spot for M&A transactions going forward.

Green Drivers

All the industry’s M&A drivers will be affected by renewable energy and the increased attention it’s drawing within the power and utilities industry.

Many states have unique renewable portfolio standards that companies must meet. And so there is growing interest from inbound investors, including sovereign wealth funds, infrastructure funds, and foreign power companies, all of which see the renewable energy space as a window of opportunity because of the tremendous amounts of new capital required to meet those standards. They also fully are aware of the current government economic assistance available to the sector via the American Recovery & Reinvestment Act.

Renewable energy is expected to have a positive effect on M&A activity, but that optimism largely is contingent on the continuation of federal tax incentives.

The extent of renewables growth also will depend on new transmission line construction to move power from where these renewable energy facilities are being built to where the power is needed. Additionally, fossil-fuel commodity prices, currently experiencing a competitive advantage over renewable energy sources such as solar and wind energy, will play an important role in influencing M&A activity.

All these trends, from energy policies to commodity prices, will continue driving M&A activity for the next 12 to 18 months. Although it’s difficult to forecast whether the trends will last or fade quickly, an improving economy along with the announcement of several deals in early 2010 are expected to result in more, not fewer, deals within the power and utilities industry.

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