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M&A Uptick

Do regulatory and economic trends favor industry mergers?

Fortnightly Magazine - October 2010

in the evaluation and approval of merger proposals.

Economic Factors : A number of industry economic factors have changed in recent years in ways that affect both the appeal of potential transactions and the issues involved in their regulatory review. In the past, a number of mergers have been motivated by the view that generation assets were undervalued. In such a scenario, combining complementary merchant-generation portfolios clearly offered potential scale and scope economies that could enhance operating efficiencies and increase net profits. While efficiency gains from such consolidations may remain achievable, at present the prevalence of low gas prices has held down energy prices at the margin, diminishing the potential returns from merchant baseload and mid-merit generating assets. To the extent this situation continues in the medium- to long-term future, as some project, it can affect the strategic reasons for consolidation. There might be a lower premium placed on the potential future gains from a generating portfolio and a greater premium on efficiencies of scale and scope and technical acumen. Some of the focus also might be shifted from generating-asset efficiencies to the benefits of consolidating transmission and distribution assets.

Financial Strength : Mayo Shattuck, CEO of Constellation Energy Group, Anthony Earley, CEO of DTE Energy, and others who perceive the need for increased consolidation have emphasized the need for enhanced financial strength. 9 To the extent the public interest warrants new nuclear power plants, large extra high-voltage transmission lines, and other highly capital-intensive infrastructure investment, the formation of larger, financially stronger companies could serve that end.

Renewable Goals : Generalizations about the ramifications of renewables policy on power industry consolidation are risky. Nonetheless, because of the importance of the issue at the state level, the interplay between a prospective merger and the renewables policies of affected states should be assessed carefully. In most areas of the country, meeting renewables targets will require building significant new transmission, hence considerations regarding transmission should apply. Obviously, state commissions considering merger applications will require assurances that consolidation will have no adverse effect on attainment of their renewables requirements.

Merger Filings

Tolstoy wrote in Anna Karenina that all happy families resemble one another, while all unhappy families are unhappy in their own separate ways. So it is with electric power industry mergers; the mergers that are approved and consummated seem to march along without major mishap, with the combined companies better able to serve their customers and shareholders. The transactions that founder all seem to hit the shoals for a different reason, with each firm left to re-play its own what-if scenario. Potential acquirors and targets are much more likely to end up in the happy family category if the changes in the industry landscape are carefully examined in any analysis of a potential transaction and creatively addressed in any application to consummate it.

On the competition front, a different mode of competitive analysis may be required at the Department of Justice, at FERC, and before state commissions. It’s important to be aware of this in advance in assessing the need for, and