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Utility deals resume after 18 months of austerity.

Fortnightly Magazine - October 2010

six years old didn’t have what they needed to finance their debt.”

Now, strategic buyers and some private equity and institutional investors are buying generating assets while they’re still relatively cheap—especially, but not only, gas-fired plants. “Across the generation sector, valuations have been down in large part because of the cost of gas,” says Bill Lamb, a partner at Dewey & LeBoeuf.

In recently announced transactions, for example, CCGT plants have been valued between $300 and $500 a kilowatt—a huge bargain considering new capacity can cost $1,200 or more to build.

“Companies are buying merchant plants at half cost today, and getting ahead of the demand curve,” Napolitano says. “They’re making a bet that capacity tightness will drive power prices up, and they’ll see a fair return for their investment.”

The value of generating assets also has factored into strategic deals involving companies such as Sempra Energy, which in late September announced a deal to sell its RBS-Sempra Commodities joint venture to Singaporean commodities trading company Noble Group Ltd. At press time, Sempra was negotiating to sell its Connecticut-based wholesale power and gas business. The sales are part of Sempra’s strategy to exit the commodities business.

“Companies are unlocking value by reducing their overall risk profile, with an emphasis on business model clarity,” Nastro says. “Hybrid companies continue to review their business mix, with a focus on non-core assets, in order to make sure they’re fairly valued in the equity market.”

Additionally, many recent M&A deals seem aimed at reducing risks through market diversification, and capturing scale economy and cost synergy. Examples include the mergers of integrated utilities FirstEnergy and Allegheny, as well as merchant generators Mirant and RRI; United Illuminating’s planned acquisition of three gas utilities from Iberdrola; Chesapeake Utilities’ acquisition of Florida Public Utilities; and PPL’s bid to acquire E.On U.S.

“Resource uncertainties play a significant role in most transactions,” McConomy says. “But the underlying theme is that if you’re going to grow your company and increase shareholder returns, you have to find a way to generate more bottom-line income. One way to do that is by becoming a bigger company that can deliver synergies, and that theoretically has better access to the capital needed to build assets.”

Whether the recent series of M&A announcements portends a coming wave of transactions, however, depends in part on the fate of the current deals—particularly those involving regulated utility assets. Ironically, the shaky economy might actually help some companies make their case to regulators. Where state PUCs previously killed some deals by demanding large ratepayer concessions, regulators today might be more receptive to mergers that simply reduce or delay the need for future rate hikes. PPL, for example, has overcome some objections to the E.On U.S. acquisition by pledging to hold rates steady until at least 2013.

“To the extent two companies can merge together and have rates increase less than they would if the companies continued on a stand-alone basis, regulators should view that as favorable,” Hempstead says.

Further, if some of the current deals make it all the way to the