The pros and cons of selling the transmission system.
For an electric utility these days, selling the dry-as-toast wires business can seem awfully tempting. CMS thought so. It took in $290 million (or 1.2 times book value) for selling its transmission system. Trans-Alta pocketed even more-1.4 times book ($560 million). The buyer in each case was Trans-Elect. But then DTE garnered a whopping $610 million-1.5 times book-in selling the Detroit Edison grid system to Kohlberg, Kravis, Roberts & Co. (KKR), kings of the leveraged buyout. Not to be outdone, Trans-Elect has now offered to pay 1.6 times book ($239 million) for Illinois Power's transmission lines, but that deal may have run into some snags on the regulatory front.
With prices like these, how could any utility choose to sit on the sidelines, spurning all that cash when the opportunity might not come again? Yet there has been no rush to sell. The tax liability appears daunting, given all those years of depreciation deductions. And then there is the question of what to do with the money, and the implications for the future health of the utility company, not to mention how shareholders and ratings agencies will view the sale.
Selling Isn't for Everybody
Morgan Stanley's Gary S. Barancik, a managing director in the bank's global energy and utilities group, agrees that the selling of transmission assets is not going to be a winning proposition for every utility. The utilities most likely to sell are those that have liquidity issues, or those that will otherwise lose control over the asset, as it will become part of an ISO or RTO.
"The key issues," says Barancik, "are whether they are giving superior value to their shareholders, how much taxes would be paid, how much from the sale would be shared by ratepayers, and whether owning transmission continues to benefit generation."
Barancik says the theory is that you cede functional control of your assets to an RTO, which runs all the day-to-day transmission operations. The utility no longer has any ability to use the transmission system to influence generation in their market. But the reality, he says, is that even under the RTO system there are still ways that many utilities think that ownership of transmission can have benefits to their generation.
Barancik also says that utilities selling transmission assets must have a strategic view of what they will do with the proceeds of a transmission asset sale. Shareholders and credit ratings agencies may respond favorably to reducing debt, but they also may show concern that the utility has given up a stable earnings business. They might also be concerned if the proceeds went toward a risky, unregulated business outside of the utility's core competency, he says. And, utility shareholders are savvy enough to see the efficiency benefits of vertical integration.
The Dangers of Sitting on the Sidelines
It would seem that the decision to sell transmission assets is a proposition that requires serious consideration by utility chiefs, but a decision not to sell carries its own set of risks. Potential buyers of transmission are defining these risks. Utilities executives should take note.
Many have argued that recent grid incentives from the Federal Energy Regulatory Commission (FERC) make a compelling reason why a utility transmission system might now command a premium in the resale market. Of course, the incentives are far higher for those utilities that divest their transmission to an independent entity.
But there is a danger that in the coming years FERC, due to a shift in policy or leadership, might find that the ROE is too high as compared with the true economics of the transmission grid, he says.
Furthermore, Barancik adds that private firms like KKR are banking on the fact that they will not only be able to retain the ROE for a significant period of time, but at some point will want to monetize their investment or sell. But spinning a transmission asset in the coming years may be difficult, and realizing a profit impossible. The fact that at any time a merchant generator can site its plant wherever it wants can quickly change the economics of any transmission system. The pressures to lower the ROE from where FERC has placed it could be very strong at some point in the future.
That's why utility executives continue to seriously consider selling the transmission assets: They may not get the high ROE promised by FERC, and they may never again get the opportunity to sell these assets at the market values now being paid, Barancik says. He adds that there is reason to believe that sale prices of transmission assets are currently at peak levels.
And that brings us back to the earlier discussion of the considerations needed to be made before selling-namely, the future health of the company.
Meanwhile, utility executive don't really see the transmission system as a growth engine of any kind. In a report by Accenture called Mergers & Acquisitions in the Utilities Industry, utility executives told the consultancy that when discussing ways to create value for themselves over the next five years, it was going to be through selective asset acquisition. Only those executives preferring the benefits of vertical integration referenced transmission.
"[Otherwise], among the industry's various segments, a focus on generation and distribution were identified as the best avenues for delivering high shareholder returns over the next five years. … The corporate functions that were identified as the two most important contributors to a company's long-term, ongoing profitability … [were] customer care and information technology."
So, whether you decide to buy, sell, or hold on to transmission, one thing is for sure: No decision will be without its risks, and no bet is guaranteed. Not even by FERC.
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