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Black Hills Proposes 'Strategic' Merger with NorthWestern Energy

Two South Dakota-based energy holding companies that have struggled at times in recent years are in play for a "strategic combination." Black Hills Corp. has proposed a stock-for-stock merger with NorthWestern Corp. However, the deal could face some steep political and legal hurdles given current Montana law prohibiting utilities from owning their own power generation.

The proposal was outlined in a letter dated Nov. 21 from Black Hills' CEO to the CEO at NorthWestern. It was made public before the Thanksgiving holiday. A definitive agreement on conditions, due diligence by both sides, and ultimately state and federal regulatory approvals, all will be necessary before the companies can be combined, assuming NorthWestern's board gives its approval to pursue the offer. It's a deal potentially worth up to $1.25 billion.

The proposed merged company would have nearly 700,000 electric and natural gas utility customers in four states (South Dakota, Montana, Wyoming and Nebraska) and merchant energy and electricity investments in various other states. Black Hills senior executives said they intend to talk with regulators and community leaders in the four states in which utility operations are involved.

NorthWestern announced that its board would review the proposal before deciding whether to start negotiations with Black Hills. The offer stated a range of $33 to $35/share to NorthWestern shareholders with the precise amount to be determined "after mutual due diligence in conjunction with the requested negotiations," Sioux Falls, SD-based NorthWestern said in its prepared statement.

"The company's board, consistent with its fiduciary duties and in consultation with its financial advisor and legal counsel will meet to review and evaluate the Black Hills proposal and other potential strategic alternatives," NorthWestern's spokesperson said.

Black Hills said that NorthWestern shareholders would receive Black Hills stock based upon the implied exchange value of between $33 and $35/share, or what it called a 13% to 20% premium based on NorthWestern's closing stock price of $29.15 Nov. 23 (Black Hills closed at $37.36/share on Nov. 23, down 53 cents.)

Black Hills said that it would consider paying a part of the consideration in cash; based on 35.7 million NorthWestern shares outstanding, the total equity value of the transaction to NorthWestern stockholders would range between $1.178 billion and $1.25 billion.

Black Hills CEO David Emery outlined the proposal in a letter to Michael Hanson, NorthWestern CEO, and Linn Draper, board chairman. "We felt compelled to make our interest in NorthWestern known after witnessing public overtures from another potential buyer and the strong support for a sale of the company from NorthWestern stockholders, " Emery said. "We believe our proposal represents a full and fair price for NorthWestern stockholders and represents a high certainty of successful execution."

NorthWestern emerged from Chapter 11 bankruptcy a year ago and has been the target of a hostile bid from a public sector coalition of cities in Montana, where it provides natural gas and electric retail utility services to most of the state. For several months, NorthWestern's board has been urged by the Montana public sector coalition to consider an offer, but the board finally formally spurned the deal last month.

Emery told NorthWestern's CEO and board chairman that the "increased scale" of the combined companies will provide what he called "meaningful operating, financial and strategic benefits" to both of the companies' shareholders, particularly the consolidation of the two companies' utility operations. NorthWestern serve 617,000 customers in Montana, South Dakota and Nebraska. Black Hills is a vertically integrated energy and utility holding company based in Rapid City, SD, has 62,000 retail utility customers in South Dakota, Wyoming and Montana, and substantial merchant wholesale energy operations.

Last month, Black Hills reported a third quarter loss of $23.9 million, or 73 cents/share, compared to net income of $17.1 million, or 52 cents/share, for the same period last year. For the nine months of 2005 ended Sept. 30, the company showed a profit of $6.6 million, or 20 cents/share, compared with $38.2 million, or $1.17/share, for the first nine months of 2004.

In contrast, NorthWestern reversed red ink from last year and reported operating profits of $9.3 million, or 26 cents/share, for the third quarter of this year, compared to a $25.2 million loss for the same period in 2004. On a consolidated basis for the first nine months this year, the company earned $34.1 million, or 96 cents/share, compared with a loss of $27.4 million for the same period last year.

"We are eager to move forward with our proposed combination with NorthWestern, and we invite NorthWestern's stockholders, who are interested in such a combination to share their views with their company's management and directors," Emery said. Ultimately the combination's success, he said, will depend upon the combined company's ability to work "as partners" with various state regulators and community leaders.

Black Hills filed a Securities and Exchange Commission 8K filing last Monday and expects to close the deal by the end of next year, Emery said.

The offer is being characterized as "accretive" for both earnings and credit to both sets of shareholders in the first full year after the deal closes, Emery said during the conference call. In response to questions on the call, Emery indicated that Black Hills would not close the door on lowering retail utility rates in Montana as a condition for approving the merger, nor would it preclude the need to be able to supply power from its merchant generation plants to Montana retail customers and perhaps expand into coal production for use in coal-fired generation projects in the state.

Emery said his company has been eyeing NorthWestern since the latter was immersed in Chapter 11 bankruptcy last year. He said NorthWestern is obviously strong on the regulated utility side and in the regulatory arena, while Black Hills' strengths lie in its wholesale generation and fuel management assets.

The two companies -- both based in South Dakota -- are "very complementary" to one another, said Emery, noting that Black Hills' "refined strategic objective" has been to expand its regulated utility business holdings. Black Hills has 131,000 electric/gas utility customers, NorthWestern has 617,000 customers. Black Hills owns 1,400 MW of generation (nearly 1,000 of merchant generation) operating almost all of it, while NorthWestern owns about 550 MW, operating only 107 MW.

An issue surfaced as part of the questions from financial analysts concerning the current Montana state law banning distribution utilities in the state from owning power generation (NorthWestern relies on contracts with PPL Montana and 13 qualifying facility contracts for the power it distributes in Montana). Emery has indicated his company would be ready to work with state lawmakers and regulators to obtain a change or exemption that would give the NorthWestern operations a chance to provide some of its own electricity.

"My understanding of Montana law is that as of today utilities are precluded from owning generation to serve their own customers," Emery said. "There could be a modification of that, and it is our belief that is something that is going to probably be received somewhat favorably in Montana, but certainly not without a lot of discussion and work."

Emery would not comment on what a merged entity might do with the expiring power supply contract with PPL Montana that runs out in 2007.

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