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Utility Hunger for M&A Rising, Merrill Lynch Report Finds

After a lull following the post-Enron credit crisis, corporate merger and acquisition (M&A) activity once again is on the rise, driven by interest in regional market scale and rising cost pressures among several other factors, according to a new report by Merrill Lynch analysts Steve Fleishman, Jonathan Arnold and Elizabeth Parrella.

"We are hearing many U.S. utilities openly discuss interest in corporate M&A activity for the first time since the late 1990s," the analysts said. "We see a number of factors driving this interest, particularly on the unregulated side where cost synergies can be retained."

The main factors prompting this interest include the following:

The Merrill Lynch analysts noted there have been four major utility mergers announced in the last 18 months: Exelon-PSEG, Duke-Cinergy, FPL-Constellation and National Grid-KeySpan. "These deals have two characteristics in common that we believe are likely to continue in future deals: both buyer and seller are among the top-30 utility market caps (big to big) and generally low premiums for sellers (14% average). In addition, all but the recent [National Grid-KeySpan] are primarily focused on synergy benefits in the nonregulated businesses."

While the low premiums aren't what an investor would be looking for, they are "positive for the long-term value of the sector as a whole," the analysts added. The winners are the merged companies that have low premiums to pay off, significant synergies in their nonregulated operations, and improved strategic and financial positions.

However, there still are some barriers to M&A. The utility sector remains largely regulated and a significant number of approvals are required. Utilities also have seen pretty solid share price growth in recent years, so CEOs may be under less pressure to act. One interesting finding is that utilities with CEOs closer to retirement age have been more inclined to push their companies into M&A.

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