Duke's Risky Spin


Lackluster interest in Duke post spin-off bodes ill for the “pure play” electric utility.

Lackluster interest in Duke post spin-off bodes ill for the “pure play” electric utility.

Fortnightly Magazine - February 2007

It was the most anticipated energy deal in the New Year, but not for the usual reasons. The spin-off of Duke Energy’s natural-gas business into a stand-alone company, Spectra Energy Inc., wasn’t unusually large, did not involve outsized personalities, and certainly did not involve a new strategy.

No, interest peaked because the transaction was to have marked the vindication of the so-called “pure play” electric strategy—the idea that an electric utility might maximize shareholder value by segregating returns associated with various asset classes. The deal also has captured attention because the spin-off represented a divestiture strategy that until now hasn’t been universally embraced, with gas assets still seen by some utilities as part of core operations.

The Spectra Energy spin-off (along with the Cinergy merger the year before) marks the reversal of the so-called Duke, PanEnergy transformational “convergence” merger that was to have taken advantage of opportunities in restructured electric and gas markets. This is the belief of Duke Energy CFO David L. Hauser and the observation of the Duke Energy Employee Advocate, an unaffiliated employee Web site.

EES North America

For those of you who may not remember, a $7.7 billion transaction in 1997 united Duke Power’s electric business to PanEnergy’s natural-gas business—the third largest natural-gas company in North America at the time.

The merger created the energy merchant and energy services colossus that Duke Energy was during the late 1990s.

But the merchant overbuild, the Enron collapse, trading scandals, the California crisis, and the reversal of energy restructuring in the early part of this decade contributed to a period where Duke Energy, as one research analyst put it, “doubled debt, destroyed significant value, turned free cash flow negative, and substantially raised operating and financial risk.”

During the last few years, new corporate management has devoted itself to restructuring the utility’s balance sheet and returning Duke Energy to good financial health. And now Duke Energy has come full circle: It is once again a “pure play” electric utility, albeit a larger one than before.

This should be the beginning of a Hollywood ending, but it could be just the beginning of the beginning, as equity research analysts and investor research suggest Duke Energy may have been better off with its gas assets.

Following the spin-off, research analysts moved Duke Energy’s stock rating to “hold” or “sell,” or they maintained their previous neutral position.

The Value Proposition

While many utilities in the industry have been undertaking a “back-to-basics” approach over the last few years, this has not necessarily meant the disposal of natural-gas assets. In fact, over the last few years, many utilities have bolstered their growth profile through greater earnings from gas assets due to the run-up in natural-gas prices.

Take a look at almost any of the utilities in the September 2006 “Fortnightly 40,” the magazine’s financial ranking of the 40 best run energy companies, and you’ll find that diversified utilities with gas assets dominated the list. But some financial advisors have been telling utilities