A Surge of Mergers
Repeal of a 1935 law spurs power companies' consolidation
It has happened at the movie theaters. It has happened at the car dealer. It has happened at the supermarket. And now it's about to happen to your local utility.
The doors are opening for high-voltage merger mania, as a New Deal-era federal law limiting consolidation among power companies is repealed this week.
Those who have worked for years to relegate the 1935 Public Utility Holding Company Act (PUHCA) to the history books say this will usher in a new era of investment in a sector that desperately needs it. Under their scenario, consumers will benefit from new combinations that produce economies of scale, bolster financial strength, and pour new capital into the nation's aging and inadequate transmission grid. Others are skeptical that the emergence of more megacompanies will lower prices or improve service in an industry that retains monopoly power at the retail level, and some think shareholders and bondholders could get burned as well.
"Utilities provide an essential service to citizens as well as the economy," says Lowrey Brown of the Citizens' Utility Board of Oregon, a public-interest group. "You want to protect them from being dragged around by the business whims of a large holding company, which could use the very regular income from utility customers to support other, much riskier ventures."
One only has to look at Enron, whose former executives were being tried on federal fraud charges last week (story, Page 46), to see what the critics fear. Enron was allowed to buy Portland General Electric by changing its state of incorporation to Oregon, even though Enron's far-flung businesses were by no means limited to the state. The lights stayed on for Portland's customers through Enron's demise, but some analysts argue that was because PUHCA helped keep the utility's revenue in Oregon.
Penniless in Paris. The holding-company law passed Congress in the midst of the Great Depression. The utility industry had collapsed under the weight of a few large, complicated holding companies with interlocking relationships, which had become overly leveraged in their drive to expand. Mastermind entrepreneur Samuel Insull, a onetime secretary to Thomas Edison, had been hailed as the hero who brought cheap electricity to the masses. But he was vilified for his role in a ruined electric empire that spanned 32 states. While acquitted of fraud, he died penniless in a Paris subway, "too broke to be bankrupt," in one banker's words.
The law established a regime for 70 years that sharply limited the business activities of utilities and prevented mergers except among utilities with a geographic connection. Over the past 20 years, the industry--and outsiders who wanted their hands on the steady cash flows that utilities produce--have complained that the law was an outdated relic blocking needed new investment.
The industry is fragmented--there are more than 3,000 U.S. utilities, with the 240 investor-owned companies generating about three quarters of the industry's power. Critics say consumers have been paying excessive prices for electricity in many small systems. "We're the last industry in the United States to rationalize," says Dot Matthews, senior utility analyst at the investment advisory firm CreditSights. "It really hurt the United States because we don't have a national grid system where we can transport power easily from many places to other places."
CreditSights has a list of 10 utilities, led by Alliant Energy in Iowa and Pinnacle West in Arizona, most likely to be taken over, not only because of favorable financial factors but because they have cheap coal, hydroelectric, or nuclear plants. All are seen as attractive, since much of the market is overinvested in expensive natural-gas-powered generators.
Joseph Kelliher, chairman of the Federal Energy Regulatory Commission, says the concerns of consumer groups haven't been ignored. "Congress reaffirmed that competition as a national policy is not the goal but the means" when it voted to repeal PUHCA last summer, he says. "Effective competition is the way to protect consumers."
That hasn't necessarily been the script in other industries, notably cable television, where rampant consolidation has occurred. One of several big utility deals already underway, the merger of Exelon and PSEG in Illinois, Pennsylvania, and New Jersey, now is being challenged by Philadelphia's municipally owned gas utility and others worried that the big new company will be able to manipulate gas and electric markets in the region.
State utility commissions will have the final say on mergers, and they have rejected leveraged buyouts proposed in the past year in Arizona and Oregon. Peter Rigby, analyst for Standard & Poor's, says that the utility industry and prospective investors may be overestimating the value of synergies in future mergers and acquisitions, forgetting the role of the state regulators. "I know one utility lawyer who tells his clients not to talk about cost savings, because you're going to lose them immediately," he says. State regulators frequently require utilities to freeze or reduce the rates to consumers as a condition of a deal.
But Scott Hempling, an attorney who represents state utility commissions, thinks the regulators may be outgunned by the lawyers and investment bankers who put megadeals together. He says unseen costs are passed on to consumers, not the least of which is financing the premium acquirers pay to stockholders of the target utility. "The ratepayer doesn't see an increase, but the rates are being held above the costs" of delivering electricity, he says. Under PUHCA, Hempling says, U.S. customers who still have essentially no choice in their local power company at least could know that they were not being served by a huge conglomerate with only a minor interest in providing reliable electric service. He thinks the very character of the companies involved in the utility industry will change.
The industry is already attracting capital from some well-known investors. Warren Buffett promises to sink $10 billion to $15 billion into the new industry. His strategy is underway, as MidAmerican Energy Holdings, controlled by Buffett's Berkshire Hathaway, is finalizing its $9.4 billion takeover of PacifiCorp in Oregon.
Jonathan Weisgall, a MidAmerican vice president, points out that Buffett has often called utilities "a good business, not a great business." "That may sound like a midwestern platitude, but it is a deep, significant comment," Weisgall says. "It should be a 'good, not great' business, because you're still dealing with a monopoly that sells a commodity--electricity--that is a necessity that, while not up in the field of oxygen, is not down with pork bellies either." Buffett's forte, of course, is seeking out the cash flow of old, reliable industries to support his investment in more-profitable ventures.
That could be good or bad for utilities, depending on whether the industry's new investors are as successful as Buffett. Time will tell if the law's new circuitry will have more dollars flowing into, or out of, the nation's power grid.
POWER FUSION
Four major utility mergers are already underway, with more expected after the law changes this week.
$12.8 billion. Improved nuclear energy performance is promised in merger of Exelon and PSEG, both with large nuke plants in Pennsylvania, New Jersey, and Illinois. Will serve 7 million electric, 2 million gas customers.
$11 billion. Power trader Constellation gains more energy to sell with FPL 's large asset base, while FPL gains growth potential thanks to trading revenues. The long-distance Florida-Maryland marriage wouldn't have been possible under the old law.
$9.4 billion. Billionaire Warren Buffett makes a big bet on utilities. His MidAmerican 's takeover of PacifiCorp builds a base of 3 million electric and gas customers in 10 states and 3.6 million more overseas.
$9 billion. Cinergy 's low-cost coal plants provide balance to Duke 's portfolio, now weighed down with high-cost natural gas. Will serve 3.7 million electric and 1.7 million gas customers in five southern and midwestern states and Canada.
This story appears in the February 13, 2006 print edition of U.S. News & World Report.