A Michigan Mega-Merger: DTE to Buy MCN

In a move creating an entity that will challenge CMS Energy Corp. for the title of Michigan's largest gas and electric utility, DTE Energy Co. announced the purchase of MCN Energy Group last week in a cash and stock transaction valued at $2.6 billion. The combined company will be headquartered in Detroit and named DTE Energy Co. The merger is expected to be one of the speediest among utilities, closing in six to nine months.

Including the assumption of MCN's debt, the value of the transaction is around $4.6 billion. Upon completion, the new DTE will have approximately 11,500 employees, serving 2.1 million electric customers and 1.2 million natural gas customers in Michigan. It will have an energy portfolio consisting of more than 11,000 MW of generating capacity, 600 Bcf/year of natural gas deliveries and 185 Bcf of natural gas storage capacity, with assets totaling more than $17 billion and annual revenues exceeding $6 billion. DTE will also gain MCN's 25% interest in the Vector Pipeline project, 10.5% interest in the Millenium Pipeline project and 23% interest in the Portland Natural Gas Transmission System Pipeline project.

It's intrastate rival, CMS' Consumer's Energy, has 1.6 million electric customers and 1.5 million gas customers. Overall, CMS Corp. has annual sales of about $6 billion and assets of about $14 billion.

DTE, which announced it was in the market to acquire a gas supplier last Spring (see NGI, May 3), said the synergies of this combination will position the new company to market coal, gas and electricity in the region and to compete more effectively in the development of new power plants and distributed generation. MCN's Michigan Consolidated Gas (MichCon), a gas utility serving 1.2 million customers in 500 Michigan communities, and DTE's Detroit Edison, Michigan's largest electric utility serving 2.1 million customers, will retain their corporate identities and be operated as subsidiaries of DTE. The two utilities have 775,000 customers in common.

"The transaction is expected to be accretive to DTE's earnings per share within the first full year of operation and will provide immediate and meaningful operating synergies by creating economies of scale and by leveraging the contiguous and overlapping service territories of our two companies," said Anthony F. Earley, DTE's CEO.

"The [merger] is expected to produce annual cost savings of approximately $60 million. The combined company will be well positioned to capture the enormous growth opportunities in the attractive Great Lakes-to-Northeast corridor, which currently accounts for about half of the nation's total energy consumption." Most of the savings will come through cutting overlap in the support services and information systems areas of the new company.

Earley said the utilities are committed to keeping layoffs to a minimum. DTE expects a staff reduction in the 500-person range because of the transaction.

While the merger itself did not surprise Mike Heim, an analyst for A.G. Edwards, the timing of the announcement did. "It's fair to say that before this merger, MCN was a struggling company. The fact that it was bought isn't surprising. What is surprising is that this deal was made so soon after MCN made its new corporate strategy public. They didn't give that much time to succeed."

The corporate strategy Heim alluded to was announced in early August (see NGI, Aug. 9). It called for an increased focus on regional operations and caused the cancellation of some major asset sales. The change of direction was a main contributor in MCN's $86.2 million net loss for 2Q99. It also was the latest in a string of bad news for the company which included rogue traders falsifying earnings and disappointing financial performances due to poor market conditions (see NGI, June 14).

Despite MCN's struggles, Heim said the merger made sense and has a tremendous upside. "Anytime management moves to increase the company's stock price over 30%, there must be lots of positive signs. One thing that I like about this marriage is that it appears to be very clean. By that I mean there appear to be few regulatory hurdles. The utilities do not have to file with the Michigan Public Service Commission, and they only have to sell a few power plants to satisfy the [Department of Justice's] Security and Exchange Commission (SEC). The ability to close a merger of this size in six to nine months is attractive."

The merger is basically a defensive move on Detroit Edison's part, said Curt Launer of Donaldson Lufkin & Jenrette. Given MCN's recent troubles, there was little doubt that it was going to be bought, most likely by an electric company. Rather than face additional competition on its own home turf, Detroit Edison correctly decided it would be better off buying MCN and determining its own destiny.

In order to satisfy federal requirements, Alfred Glancy, MCN CEO, said interest in four power plants will have to be sold. Three of them, including the Midland Cogeneration Venture, are located in Michigan and the other is in California. Glancy said the sales will be completed before the merger closes. He estimated the total book value for the assets to be between $125-$175 million. In addition to the SEC, the utilities also need FERC and shareholder approval. Cheryl Conway, a spokesperson for MCN, said the merger will be filed with FERC soon. The union has been unanimously approved by the boards of both companies.

Under the terms of the agreement, the holder of each share of common MCN stock can elect to receive either $28.50 in cash/share or 0.775 shares of DTE Energy common stock per share. DTE intends to continue its dividend policy of $2.06/share annually, representing a dividend increase per share to current MCN shareholders of approximately 56.5%.

DTE's offer represents a 60% premium over MCN's Oct. 1 share price. Early was quick to defend the offer at the press conference. "The MCN stock is trading at a discount because of some of its write-offs and issues that they've had to deal with. The [MCN] stock is really a $21 to $22 stock, rather than a $17 stock. Our due diligence confirmed that and if you take away the perceptional impact of some of those write-offs, this stock should be trading in the $21 to $22 range. This is a premium in the 30% range, which is right in the median for a utility transaction like this." MCN's stock soared after the merger news was released, increasing over 30% to finish at $23.44. DTE's stock value dropped nearly 10% to finish at $33.23.

Upon completion of the merger, Glancy will retire from MCN and join the board of directors of DTE, and Earley will serve as chairman, president and CEO. Joining Earley in the office of the president will be Stephen E. Ewing, current president and COO of MCN, who will serve as president and COO of the gas business.

John Norris

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