The combination of Akron, OH-based FirstEnergy Corp. and Allegheny Energy Inc. of Greensburg, PA, which was announced last week, would create a monster utility holding company with 10 distribution companies serving more than six million customers in Pennsylvania, Ohio, Maryland, New Jersey, New York, Virginia and West Virginia. But even with FirstEnergy's significant nuclear generating fleet the combined company would still be heavily reliant on coal-fired plants.

Allegheny also would contribute significant transmission projects to the deal, which is worth $4.7 billion in stock and another $3.8 billion in debt.

"Simply put, it provides a far better platform for growth than either company would have been capable of achieving on a stand-alone basis," said FirstEnergy CEO Anthony J. Alexander.

Analysts at Tudor, Pickering, Holt & Co. Securities Inc. (TPH) gave the deal a nod but said it's not likely to ignite a wave of mergers and acquisitions in the power industry.

"This particular combination does make sense to us, but we see it as a special situation tied to the specifics of the PJM [Interconnection] wholesale market and the evolving deregulation of the Pennsylvania and Maryland retail power markets," the TPH analysts said in a note. "The adjacent locations of the 10 utilities, the relatively friendly regulatory environment and similar mix of regulated/unregulated assets would be hard to duplicate with another pair of companies. So while it is always fun to speculate about a gold rush of combining companies and big premiums, this isn't the spark for that to happen."

The combination of the two companies would generate approximately $16 billion in annual revenues and $1.4 billion in annual net income, the companies said. The combined company, to be called FirstEnergy and based in Akron, would have early 20,000 miles of high-voltage transmission lines connecting the Midwest and Mid-Atlantic; approximately 24,000 MW of generating capacity from coal, nuclear, natural gas, oil and renewables; and more than 2,200 MW of renewable energy, including hydroelectric, contracted wind and pumped-storage capacity.

Allegheny shareholders would receive 0.667 shares of FirstEnergy common stock in exchange for each share of Allegheny. Based on the closing stock prices for both companies last Wednesday (Feb. 10), Allegheny shareholders would receive a value of $27.65/share, or $4.7 billion in the aggregate, the companies said. FirstEnergy would also assume approximately $3.8 billion in Allegheny net debt.

The price per share represents a premium of 31.6% to the closing price of Allegheny shares on Feb. 10 and a 22.3% premium to the average stock price of Allegheny over the last 60 days ending Feb. 10. Following the completion of the merger, it is anticipated that FirstEnergy shareholders would own approximately 73% and Allegheny shareholders would own approximately 27% of the combined company.

During a conference call with financial analysts Allegheny CEO Paul J. Evanson was asked why he would pursue a negotiated transaction now, particularly prior to an economic recovery and presumed appreciation in the value of Allegheny shares. "I think everyone believes we're quite a bit leveraged to an economic recovery...You might like to do [the deal] when the stock price is $65, but nonetheless, this is the right time to do it," Evanson said.

"This transaction will provide outstanding value to both companies' shareholders -- offering enhanced earnings growth potential and a more competitive cost structure," Alexander said. "Among other benefits, it would increase generation resources by 70%, more than double the amount of supercritical coal capacity, improve the overall environmental performance of the generation fleet, and increase our customer base by 35%. We also expect to create significant efficiencies and economies of scale as we share best practices across the new organization."

Allegheny is a partner with American Electric Power in the proposed Potomac-Appalachian Transmission Highline (PATH) project, the development of which has been stalled as market demand has been slower to evolve than expected. And Allegheny is a backer of Trans-Allegheny Interstate Line Co. (TrAILCo) along with Dominion Virginia Power. The $1.4 billion TrAIL project is designed to stretch 330 miles through West Virginia, Pennsylvania, Maryland and Virginia. The project has been approved in all relevant states; construction has been under way for some time in West Virginia and Pennsylvania, and the planned in-service date is June 2011.

During the conference call one analyst questioned the wisdom of FirstEnergy's acquisition of regulated assets. Alexander said Allegheny's transmission project's "are obviously a great opportunity for FirstEnergy to mitigate the overall risk profile of the company by increasing the growth on the regulated side...I think that was just a very attractive addition to an otherwise very, very compelling set of assets that fit nicely within the FirstEnergy portfolio," he said.

Alexander said the acquisition is not about "getting bigger for the future," as one analyst asked. "It's really not about size," he said. "It's more about how these assets fit inside the integrated portfolio that we're putting together."

Standard & Poor's Ratings Services (S&P) lowered its corporate credit rating on FirstEnergy and subsidiaries to "BBB-" from "BBB" and affirmed its "BBB-" corporate credit and other ratings on Allegheny Energy. S&P lowered all other ratings on FirstEnergy one notch. The outlook is stable.

However, Moody's Investors Service looked more favorably on the deal. It affirmed the ratings and stable outlooks of FirstEnergy and its subsidiaries as well as the ratings and stable outlooks of Allegheny and its subsidiaries. "The affirmation of both companies' ratings considers the use of stock as the currency for the proposed merger thereby allowing the companies to combine operations without negatively impacting the combined entities balance sheet" said Moody's.

The CEOs said they did not see any issues with market power that might come up during review of the deal. Regulators and credit rating agencies were given short briefings on the deal, the executives said, but they did not provide any view on how the deal is being received.

Allegheny's utilities are under the Allegheny Power umbrella. The combined company's utility customers would continue to be served by their current utilities, including Pennsylvania Electric Co., Pennsylvania Power Co., Metropolitan Edison Co., Allegheny Power (including West Penn Power Co., Monongahela Power Co., The Potomac Edison Co.), Ohio Edison Co. The Cleveland Electric Illuminating Co., The Toledo Edison Co. and Jersey Central Power & Light.

Moody's said state regulators could reshape the deal.

"While it is premature to predict the outcome of any of these proceedings, it remains possible that additional merger conditions will be imposed by one or more of the state regulators in order for merger approval to occur," Moody's said. "It is also possible that today's merger announcement could have implications for other regulatory proceedings currently under way by both companies in various states, particularly given the current economic challenges that exist in their respective service territories.

"Notwithstanding the clear fit that exists by merging the two companies, these regulatory issues make the consummation of the merger under the current terms less certain at this juncture."

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