A day after the release of an agreement with the state of NewHampshire last week that settled numerous electric restructuringissues, Northern Utilities announced it was buying back YankeeEnergy for $679 million after a 10-year separation originallyordered by the Securities and Exchange Commission.

The deal, if approved, would give NU about 180,000 gas customersin Connecticut, where Yankee is the largest distributor. Themajority of those customers, 160,000, already buy power from NU,New England’s largest electric utility, serving more than 2.3million customers in Connecticut, Massachusetts and New Hampshire.

CEO Michael G. Morris said the main reasons for the transactionwere to broaden NU’s energy “delivery platform” in New England andadd gas to its fuel mix. Charles E. Gooley, CEO of Yankee EnergySystem, said market research has “showed us repeatedly that ourcustomers really enjoy the benefit of selecting from a range ofenergy services but also having one energy provider that canprovide natural gas, electricity and other related services.”

BT Alex. Brown energy analyst Ed Tirello said in five yearsthere will be no more pure natural gas companies. “They will all beowned by the electric companies, and the price does not matter.”

It apparently didn’t matter much to NU, which paid a whopping39% premium to Yankee’s stock price at the close of trading lastMonday. The transaction calls for NU to pay Yankee shareholders$45/share, 45% payable in NU shares and 55% payable in cash.Despite the regulatory risks, Yankee investors loved the deal.Yankee’s stock soared 23%, or $7.44/share, to $39.94 on Tuesday.NU’s stock fell slightly.

Merrill Lynch energy analyst Rebecca Followill said NU paid a”hefty premium” for the small gas distributor, but she noted thereare not too many of them left. “It’s a scarcity factor…[drivenby] the declining number of gas utilities. With new higherpremiums, folks we’ve seen as buyers may turn into sellers at thesehigh prices.

“It’s higher than any of the multiples we’ve seen to date,” sheadded. “It ups the ante on [merger and acquisition] activity outthere. It was 25 times forward year earnings. This was 10.9 timescash flow from operations. The other ones have been 8.1. This was2.7 times book, and the others were 2.5 and this was a 39% premiumto last trade and the others have averaged 28% [more than the lasttrade],” she said.

“It’s almost gotten to a frenzied pace out there on M&Aactivity,” she said, noting others are soon to follow. CTG, theonly other Connecticut utility that has not been bought out, hashired PaineWebber to review its alternatives. CTG’s stock pricesoared $3.75/share last Tuesday after NU’s announcement.

NU’s Morris said this isn’t the last purchase for the largeelectric utility. It plans to continue looking for other potentialcombinations and additions to build its “strategic platform” ofregulated energy delivery businesses. It also intends to build thethree new non-regulated subsidiaries created earlier this year toinvest in Northeast power generation projects.

Energy analyst Paul Fremont of Brown Brothers noted that aselectric utilities continue to build up cash from regulated powerplant divestitures and securitization authorizations by theirregulators and legislators, they will be out shopping to rebuildtheir asset bases and earnings potential.

Over the past few years, NU has been hurt very badly by itsnuclear problems which have made the company financially weak. NUlost $1.12/share in 1998 primarily because of significantwrite-offs of subsidiary Connecticut Light & Power’s investmentin the retired Millstone 1 nuke and the accelerated amortization ofother regulated assets as ordered by state regulators in CP&L’sFebruary 1999 retail rate decision. In 1997, NU lost $1.01/shareafter a small profit of $0.30/share in 1996. The settlement betweenNU subsidiary Public Service of New Hampshire and the state callsfor an 18% cut in utility rates and whittles $500 million of PSNH’sstranded cost recovery plan.

“To their credit, those problems haven’t stopped them fromthinking about strategic moves for the future,” said PaineWebber’sBarry Abramson. “I don’t think [the Yankee purchase is] enough, butI think it’s a first step. When you look at net income in a normalyear, this is about one-tenth their size.”

NU’s Morris said he expects the transaction “can be an accretiveacquisition” in the first 12 full months without “a great deal ofcost reductions, but simply with some growth and some costresponsibility.” No major layoffs are planned, Morris said, butsome efficiencies will be gained because of the overlapping serviceterritories. Northeast has 9,034 employees, while Yankee Energy has800 employees.

Morris said he expects no roadblock from the Securities andExchange Commission (SEC) because of the lighter handed approachthe SEC has taken recently in applying the provisions of the PublicUtility Holding Company Act.

“Because things have changed in a state sense in the regulationof utilities and in the federal sense of restructuring andderegulating the utility industry, we believe the SEC will allow usin fact to say ‘I do,'” said Morris, citing a recent decision thatwas made on the gas properties of Cinergy.

Rocco Canonica

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