Can consolidation create sustainable long-term value, or will it prove seductive but, ultimately, disappointing to shareholders, employees, customers, and management alike?
Do regulatory and economic trends favor industry mergers?
Three major electric power merger and acquisition (M&A) transactions have been announced in the last several months, 1 and a number of leading power company executives recently have expressed the need for increased consolidation in the industry. These developments raise some interesting questions.
Not many years ago, the power industry experienced an apparently never-ending wave of merger activities sweeping across the country. The repeal of the Public Utility Holding Company Act of 1935 (PUHCA), and its burdensome regulatory rules, including the requirement that registered holding companies be operationally integrated, opened up the possibility of mergers between geographically distant U.S. companies and made U.S. acquisitions more attractive to regulation-averse foreign companies. Then suddenly, M&A activity dropped off a cliff. The failure of the Exelon-PSE&G merger in September 2006 heightened concerns about state regulatory approvals. Soon after, financial markets dried up, and load growth reversed itself. Prolonged M&A doldrums followed.
Now that some new major transactions have emerged, and financial recovery appears slowly moving forward, some obvious questions arise. Does the recent re-emergence of merger activity betoken a new wave of M&A transactions? To what extent have the changes that have occurred in the last few years altered the regulatory landscape and affected the prospects for obtaining federal and state regulatory approval of mergers with acceptable merger conditions? What new considerations should prospective acquirers or target firms know about and address in their regulatory filings?
The electric power industry remains one of the least concentrated of the major industries in the United States. The industry’s structure includes about 81 separate investor-owned utility corporate families and a larger number of independent power producers. In many mature industries, especially those that are capital intensive, economies of scale and scope result in markets characterized by a small number of leading firms and a smattering of niche players.
Do the forces that drive consolidation in the rest of the economy apply in the electric industry today? Arguably they do. “Consolidation in the electric power industry is inevitable,” says John Rowe, chairman of Exelon, whose actions reflect those views. 2 The cost of constructing large generation and transmission facilities is rising, and the need for them is increasing. These dynamics are reflected in FirstEnergy’s public statements regarding the motivation for its proposed consolidation with Allegheny Power. FirstEnergy identifies the benefits of the pending FirstEnergy-Allegheny merger as including “increased scale and scope in energy delivery, generation, and transmission 3” and CEO Anthony Alexander emphasizes that the merger will create “a larger, financially stronger company that is better positioned to compete for and attract capital on reasonable terms,” and will enhance technology and managerial expertise. 4 Obviously, these reasons could apply broadly to many potential combinations of electric industry players throughout the nation.
But the power industry is unique in many ways. It involves a product that can’t be readily stored and must be delivered instantaneously to meet demand over a transmission grid with finite delivery capability.