Merger Week in Energy Ends with Four New Deals
Merger fever swept through the downstream sector of the energy industry
last week with four new combinations announced and three others approved
by FERC. It was one of the hottest weeks yet for corporate marriages and
many observers still believe it's only the beginning.
Dynegy kicked it off Monday morning with a marriage to Illinois electric
utility Illinova (see story this issue) that
will create a $7.5 billion company. Also on Monday, Indiana Energy, parent
of Indiana Gas, announced a merger with Sigcorp, the holding company for
Southern Indiana Gas and Electric. The two will create a new $1.9 billion
holding company called Vectren Corp. (see story
this issue). Day two featured two northeastern combinations, one involving
Energy East, the parent company of New York State Electric & Gas, buying
CMP Group, parent of Maine's largest electric utility, Central Maine Power,
for $1.2 billion in cash and debt, and another involving a $679 million
purchase, including assumption of $201 million in debt, of Yankee Energy
by its former parent company Northeast Utilities.
In addition to those making new marriage vows last week, several long-standing
mergers received FERC's blessing. FERC okayed ScottishPower's acquisition
of Portland, OR-based PacifiCorp, as well as the purchase by Britain's
National Grid Plc, the world's largest privately owned independent transmission
company, of New England Electric System (NEES) of Westborough, MA. The
Commission also gave the green light to the merger of CILCORP Inc., parent
of Central Illinois Light, a Midwest electric and gas utility, with AES
Corp. (see story this issue).
"It just keeps rolling along," said Ed Tirello, an energy
analyst with BT Alex. Brown. "You watch next week. I'm sure there
will be a couple more [deals] announced," he said. "They're just
moving hot and heavy."
PaineWebber energy analyst Barry Abramson is expecting many more utility
mergers in the Midwest and Northeast regions. "Anywhere from Illinois
on east to the Atlantic and straight up to Maine we expect to see a lot
more merger activity. That whole sector contains a lot of companies that
are likely to combine, and the main reason is because most of those states
have completed [or are completing] the deregulation process.
"The electric companies now know what their future is going to
look like," Abramson added. "Many of them will have a lot of
cash on hand because of power plant divestitures [ordered by regulators]
and many of them also have cash from securitization financing. Those that
want to control their destiny are going to look for compatible partners.
They'll want to be able to get bigger, sell electricity and gas, become
more efficient through post-merger cost-cutting and some need to move from
a situation in which they lack critical mass. Competition definitely puts
pressure on the smaller companies."
All of the transactions last week were done for slightly different reasons.
Dynegy, for example, is buying Illinova to add some stable earnings from
regulated operations to its volatile marketing mix and gain a solid power
generation foot print in the Midwest. The merger of the two Indiana utilities
is a case of two small companies that need to build critical mass and gain
cost-cutting efficiency, said Abramson. In one northeastern merger, Energy
East is branching out of New York in an attempt to build a regional energy
distribution operation. And Northeast Utilities is growing its customer
base and adding gas to its fuel mix with Yankee.
"Keep in mind, most utilities, electric or gas, have grown their
earnings by cost cutting and streamlining efforts with precious little
in the way of higher rates," noted Sanders Morris Mundy analyst John
Olson. "Doing mergers or cross mergers, gas and electric, provides
another way of eliminating overheads to continue to provide streamlining
gains in a stock market, which tends to favor gas over power by a fair
Olson called the energy merger scene a "four-ring circus."
There are major oil companies, major electric companies and energy conglomerates
"looking at the fourth ring, which is what I call the red meat, the
various integrated natural gas companies, smaller electrics and some miscellaneous
other kinds of businesses. And that ring is always active. Everyone talks
to everyone else in this business. The only continued surprise is the failure
of the major oil companies to come into the market."
The major oils, with the exception of a Shell "niche deal"
in Georgia and Chevron's Dynegy investment, are still focused on streamlining
operations and are largely ignoring power marketing and other opportunities,
FASB Prefers Purchase Over Pooling
In related merger news, an accounting change is afoot that will make
it more difficult for unrealistic deals to go forward. On April 21, the
Financial Accounting Standards Board (FASB) decided the purchase method
of accounting for business combinations is preferable to the pooling of
interests method. The change is to be effective for combinations begun
after the FASB issues a final standard on the issues, expected to be late
"We believe that the purchase method of accounting gives investors
a better idea of the initial cost of a transaction and the investment's
performance over time than does the pooling of interests method,"
The Dynegy-Illinova deal is being accounted for as a purchase. The Energy
East-CMP Group deal will be a complete cash-out of CMP common stock. Many
of the deals done over the last year or two have used pooling of interest
The purchase method identifies one company as the buyer and records
the company being acquired at the price actually paid. Under the pooling
of interests method, the combining companies just add together the old
book values of their net assets. "Using the purchase method in a business
combination is consistent with how other acquired assets are accounted
for because all assets, whether a piece of inventory, a building, or a
whole company, are recorded on the balance sheet when initially acquired
at their cost, which is the current market value at that date."
Abolishing pooling of interests will make it more difficult for companies
to do unreasonable acquisitions, Olson said. Under pooling of interests,
an acquiring company could theoretically pay any price for its target because
all transaction costs were just added together on the balance sheet. "There
was never any ceiling on purchase prices except those dictated by common
sense." Olson said the impetus for the FASB change came from the fact
"there were so many deals being done with poolings that don't really
reflect the underlying economics of the business. And there were a number
of poolings that were being done that would take a huge, one-time write-off
at the time of the merger."
Rocco Canonica; Joe Fisher, Houston