Energy Central

Merger Denied

Energy Central / Energy Biz Insider — Wednesday, September 27, 2006

The proposed mega merger that led off the 21st Century has faltered. Exelon and Public Service Enterprise Group (PSEG) will now go their separate ways, all on good terms. New Jersey state regulators wanted to see more benefits for customers – something that they felt would have required the combined entity to divest of generation assets and avoid any supposition that it could exercise undue market power.

Ken Silverstein
EnergyBiz Insider
Editor-in-Chief

While the deal survived the regulatory obstacle course on the federal level, it was unable to persuade state regulators that it was a good thing for ratepayers. In fact, the New Jersey Board of Public Utilities raised the bar somewhat by saying that the threshold was about more than "doing no harm." It wanted customers to see greater benefits. It's a reasonable position, given that the merger would have created the nation's largest power generation company with 52,000 megawatts and $79 billion in assets serving 9 million customers in Illinois, Pennsylvania and New Jersey.

The two companies pulled out of the deal more than a week ago, ending 21 months of countless regulatory meetings that began shortly after the merger was proposed in December 2004. Seven state and federal agencies gave relatively fast approval. But, the U.S. Justice Department's anti-trust division and the New Jersey's utility commission were the last hold outs. The former gave permission in July contingent on the sale of four fossil fuel power plants. But the latter had wanted to see further sales to avoid monopolization of the generation market – ending the nearly $18 billion deal.

"We have spent a lot of time and effort on this transaction because of the value it would have created for the companies and their customers," says James Ferland, CEO of PSEG. "We are equally disappointed but remain committed to continuing our tradition of providing exceptional service to our customers in New Jersey."

Executives of both Exelon and PSEG had said that consumers and shareholders alike would benefit. They had estimated that at least $500 million in cost savings would take place within two years, occurring in part by eliminating 1,400 jobs out of 28,500. In anticipation of the transaction going through, many employees left both companies and now those positions will have to be replaced. Meantime, PSEG said that its customers can expect to pay more for power – a regulatory process that it had promised to forego if the merger was approved.

Just as notable: Investors had benefited from the initial announcement and subsequently witnessed the values of their shares rise by 50 percent. Now that the merger hoopla is done, expectations exist that those values might drop. Indeed, mergers are carried out because they are intended to add value to the overall enterprise. But, oftentimes share prices decline because the predicted synergies never materialized.

Super Regional Utilities

In the past, financial dealings have encumbered the merging partners while defining a mission or meshing separate cultures were set aside. The result, says the consulting firm KPMG that studied 700 mergers that took place between 1996 and 1998, is that 83 percent of them failed to unlock value one year after the transaction, and 30 percent actually destroyed value.

In the case of Exelon and PSEG, ratepayers would have borne the costs associated with the proposed buy-out, says Citizen Action. According to PSEG's most recent annual report, PSEG and Exelon had expected to incur $70 million in transaction fees and another $700 million in integration costs over four years. The expected benefits would have gone unrealized because of this high cost, it says.

PSEG's CEO Ferland says that while he was disappointed the proposed merger would not be completed, the business outlook for his company remained strong. He emphasized that PSEG's current stand-alone business outlook is positive, given the favorable pricing in energy markets and improvements in the performance of its two nuclear plants. And the company took steps over the last two years to trim its debt, streamline its processes and reduce its international exposure.

"While the combination of PSEG and Exelon would have produced strong results in the years ahead, I want to assure all our important constituents – investors, customers, vendors, employees, and the communities we serve – that our prospects on a stand-alone basis are bright and our commitment to our constituencies remains as solid as ever."

The Exelon-PSEG proposition has been one of a handful of proposed mega mergers in recent years. Duke and Cinergy combined in a $9 billion deal. Meantime, NRG acquired Texas Genco LLC for $7 billion and Berkshire Hathaway bought PacifiCorp for $5 billion while FPL Group and Constellation Energy are planning to merge.

The market is putting pressure once again on utilities to grow their earnings and dividends. And one way is through acquisitions that can create economies of scale and potential cost savings. Some shareholders say that traditional earnings of 2-4 percent are too little, which is giving companies the incentive to buy assets to win new efficiencies and reduce operating costs.

And many utilities are now able to buy assets or even whole companies. They have hunkered down and reduced their debt levels, largely by selling troubled assets and participating in a low interest rate environment. The efforts have paid off: The Dow Jones utilities index grew by 23 percent in 2003 and by 25 percent in 2004. In 2005, the index was up more than 20 percent – a trend that could be buoyed by higher electricity prices and new investments in transmission reliability and renewable energy technologies.

While the Exelon-PSEG merger is now dead, the trend towards the "super regional" utility is expected to endure. That's because organic growth in most territories is around 2 percent earnings per share. But through regional consolidation, it could be 5 percent.

Regulators are charged with ensuring that the marketplace operates fairly and they cannot be faulted for asking the tough questions. While natural synergies among utilities are compelling reasons to merge and may ultimately benefit stakeholders, any proposed combination must clearly demonstrate that it is not harmful to consumers. The no-go between Exelon and PSEG is not regulatory blather but rather an extension of that thinking - one that sought to avoid distortion of the overall market.

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