Utilities Ponder Break-Ups After PSEG-Exelon Collapse

Reuters — Friday, September 15, 2006

By Caroline Humer

NEW YORK — Utilities that own both regulated and unregulated power generation assets are likely to consider splitting those businesses apart before attempting mergers in some states, following the collapse of the Exelon and PSEG deal, bankers, lawyers and analysts said on Friday.

Exelon Corp. (EXC.N: Quote, Profile, Research) said on Thursday evening that it would not go forward with a more than 19-month old plan to buy Public Service Enterprise Group Inc. (PEG.N: Quote, Profile, Research) after the companies failed to come to terms with New Jersey's state regulator, who wanted more concessions than the companies wanted to give.

The deal had received the approvals that it needed from the Federal Energy Regulatory Commission (FERC), and the U.S. Justice Department, among others.

"The market is now going to be acutely conscious that the states are going to want their piece of the pie on these transactions, and therefore deals are going to be structured to limit the reach of the states into the value of the total transaction if possible," said Chuck Patrizia, a partner in the Washington, D.C. office of law firm Paul Hastings.

That is likely to result in companies spinning off their assets, and regulators looking very closely at the spin-offs, Patrizia said.

Exelon and PSEG, as well as other companies, may be unwilling to approach a merger with both regulated and unregulated assets, one investment banker said, who declined to be identified.

And it seems unlikely that anyone will want to do a deal in New Jersey right now, he added.

"It will probably cause people to pause, but the deals that will chill are the ones with regulated and unregulated businesses where they are looking to extract synergies from the unregulated ones," the banker said.

Having significant regulated transmission and distribution assets creates a hostage situation "that regulators will use to extract some of that gravy that the generation fleet is producing for you," Sanford Bernstein analyst Hugh Wynne said.

Companies are likely to look at spinning off the regulated business in an initial public offering and then look for a sale or acquisition for the unregulated power businesses, where many of a utility deal's profits lay, bankers and lawyers said.

Unregulated power businesses, such as wholesale power plants, are not subject to the rate structures that regulated power plants follow.

Consolidation among unregulated players has started as the sector has improved cash flow and debt levels after a credit crunch at the end of 2001.

For instance, private equity fund LS Power said on Friday it is selling the company's 11 power plants for more than $2 billion. It will also receive a 40 percent stake in Dynegy Inc. (DYN.N).

Exelon's troubles in New Jersey were the latest in a series of face-offs with regulators, including disputes with Illinois politicians over the deregulation process in that state and the approval of a much lower-than-expected rate increase at its Commonwealth Edison utility.

And still under debate in Maryland is whether FPL Group Inc.'s (FPL.N) plan to buy Constellation Energy Group Inc. (CEG.N) will result in a deal. That has been hung up in part on a rate increase that was scheduled to go into place at its regulated Baltimore utility that pushed the politicians into action.

If Exelon does decide to pursue another deal, they are likely to look to the West and East coasts. according to James Halloran, an analyst at National City Private Client group. He said they would not necessarily be compelled to do a deal since they are already the largest player in the sector.

"I think the direction they generally want to go is the Northeast corridor," Halloran said, particularly in terms of finding a nuclear plant portfolio to complement their own.

(Additional reporting by Matt Daily in Houston and Michael Erman)

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