M&A Climate Grows Chilly for Utility Dealmakers: Large Transactions Fall Short Because Of Regulatory Problems, Tough Markets

Utility industry dealmakers are finding it tougher to shepherd transactions through to completion due to changed valuations, integration problems, volatile energy prices, and a tougher regulatory climate. Consolidated Edison Inc.’s $3.8 billion takeover of Northeastern Utilities System fell apart in early March accompanied by mutual recriminations and lawsuits. A month later, another megamerger, the $7.6 billion proposed union of FPL Group Inc. and Entergy Corp., was dissolved, with the parties citing integration issues, governance problems, and valuation differences as the main stumbling blocks. A third potential megadeal, the hookup between Public Service Enterprise Group Inc. and Cinergy Corp. for $5.6 billion in stock, never got past opening discussions after both stocks took a nosedive on news of the talks. Even the one big utility deal that squeaked through in recent months, the acquisition of MCN Energy Group Inc. by DTE Energy Co., was slowed down by regulatory and valuation hurdles. Terms of the pact between the Michigan utilities, which announced merger plans in October 1999, also had to be reduced to account for volatile natural gas prices and regulatory demands. In the Consolidated Edison/Northeastern breakup, the role of the Connecticut Public Utilities Commission was a frequently cited deal-breaker. “You had a hostile environment from the start with the Connecticut commission. The terms they suggested were onerous, plus you had the attorney general challenging the deal itself,” says Michael Worms, a utility analyst at Gerard Klauer Mattison, New York. He adds that although Northeast has maintained that it could easily find a replacement partner for Consolidated Edison, that isn’t necessarily the case. Consolidated Edison justified pulling the plug on the deal in part due to what it called an unfavorable power contract between parent utility, Northeast Utilities, and its unregulated power trading and brokering unit, Select Energy Inc. In its lawsuit, Consolidated Edison said that exposure to the Select Energy arrangements became more problematic as energy prices increased in the 16-month period since the merger was announced in October 1999. In the case of the FPL/Entergy deal, David Burks, a utility analyst at the Louisville, Kentucky, brokerage of J.J.B. Hilliard, W.B. Lyons, says that the transaction hit snags due to the rapidly changing market conditions. “The assumptions made at the time of the announcement of the deal, have clearly become obsolete,” Burks states. In its statement, FPL said that it disagreed with some of Entergy’s financial projections. The Florida utility also cited a lack of transparency in Entergy’s release of financial information. For its part, Entergy said that the transaction lacked a premium that would justify the deal. As it was set up, FPL would have owned 57% of the combined company. And it is not only utility industry combinations that are struggling to get off the ground, since at least one spin-off also looks like it won’t fly. Enron acquired Portland General Electric Co. in November 1996 for $3.2 billion. In November 1999, it agreed to sell the utility to Sierra Pacific Resources Inc. for $2.1 billion in cash and the assumption of $1 billion in debt. Enron said in January that Sierra Pacific might be having trouble selling a generating plant in Nevada that it planned to use the proceeds from to complete the Portland General acquisition. In addition, Nevada regulators, in reaction to energy supply problems in California and elsewhere in the West, slowed down their deregulation plans, part of which would have allowed the sale of the Portland General assets. According to Worms, while the California energy crisis affected Enron’s proposed spin-off of Portland General, the two East Coast deals weren’t directly affected by the turmoil in the Golden State. He says that the California crisis had little effect on Consolidated Edison/Northeastern or on FPL/Entergy. “Although New York has deregulated its wholesale power markets, it wasn’t fear of a California-like situation that killed the Consolidated Edison/Northeastern deal.” Worms also notes that since the states in Entergy’s south central states service area and in Florida have not put any deregulation plans into place, the failure of California’s deregulated power markets would have had little effect on the breakdown of the FPL and Entergy deal. p