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Interesting Times

Utilities stay the course in a volatile market.

Fortnightly Magazine - October 2011

high churn factor in this area of transaction activity. We also continue to think the presence of a non-regulated generation business attached to a regulated utility will raise a strategic question about whether those two businesses belong under the same holding company. The non-regulated business is very cyclical, and that’s different from the regulated business. Capital allocation questions also need to be addressed very differently.

Eisenstat, Dickstein Shapiro: Right now regulated returns look pretty good to the financial markets. People have become very risk averse, both politically and financially. That increases pressure on the independent side of the business and gives an advantage to regulated utilities.

Wobbrock, Moody’s: The industrial logic behind consolidation makes a lot of sense. This is a highly fragmented industry, and it makes sense for companies to get bigger and spread costs across a larger platform, and gain access to lower-cost capital. Also where companies change the business mix to provide a more predictable cash flow, that will reduce the risk profile of the company. We expect to see more of that activity in the future.

Nastro, Morgan Stanley: The catalysts are all in place for continued M&A activity. Capital is still cheap and readily available; companies have large cap-ex plans; and, in the near to mid-term, we expect only modest growth, which is a challenge especially for a commodity-linked business. These catalysts are prompting utilities to seek larger balance sheets. In addition, if a utility deal has demonstrated strategic logic and has the opportunity to create value, then equity investors are rewarding acquiring companies. This is one of the few times I’ve seen where the stock prices of acquiring companies have outperformed their peer group and the broader utility index. That market reaction helps give management teams the incentive to look at strategic opportunities.

Redinger, KeyBanc: There are more people thinking about strategic transactions now than in the near past. Companies are looking to find a strategic partner that they can execute a deal with, and produce a win-win situation for shareholders and ratepayers. It comes down to regulatory risk, as it always does.

Fortnightly: Some recent deals are moving forward more quickly than some earlier utility mergers did. Is it true that regulators are more amenable to mergers today, because they see rates going up in the future as a result of rising commodity prices and cap-ex requirements?

Nastro, Morgan Stanley: We’re seeing a more constructive regulatory approval process. Regulators recognize there’s a need for balance sheet strength to finance large cap-ex requirements. And utilities are making commitments to preserve jobs, so that takes that issue off the table. Regulatory approvals are getting done on a more expedited manner. The FirstEnergy-Allegheny merger was approved by four states in 12 months. When PPL acquired E.On in Kentucky, they got approvals from three states in six months. These recent precedents help give utility boards the confidence to proceed with well-conceived combinations.

Redinger, KeyBanc: I haven’t seen direct evidence that regulators are more amenable, but that’s the thinking in the industry. On a macro level it makes sense, but it