Duke Energy (DUK) is to acquire Progress Energy Inc. (PGN) in a $13.7 billion stock deal that would create the country's largest utility, serving 7.1 million power customers in six regulated territories, the companies said Monday. While the majority of the combined company's generation would be coal-fired, natural gas and oil units would account for more than one-third of owned generating capacity.

The combined company, to be called Duke Energy, would also have the nation's largest regulated fleet of nuclear power plants.

"Our industry is entering a building phase where we must invest in an array of new technologies to reduce our environmental footprints and become more efficient," said Duke CEO Jim Rogers.

"By merging our companies, we can do that more economically for our customers, improve shareholder value and continue to grow. Combining Duke Energy and Progress Energy creates a utility with greater financial strength and enhanced ability to meet our challenges head-on."

The combined company would rank first among its peers based on market capitalization, followed by Southern Company, Exelon Corp. and Dominion Resources Inc. Based on owned generating capacity, the combined company would rank first again, followed by Southern Company, NextEra Energy Inc. and American Electric Power Co.

Owned generating capacity of the combined company would be composed of coal-fired units (42%), natural gas and oil-fired units (35%), nuclear (16%) and hydropower and wind power (7%).

Progress shareholders would receive 2.6125 shares of common stock of Duke Energy in exchange for each share of Progress Energy. Based on Duke Energy's closing share price last Friday, Progress shareholders would receive a value of $46.48/share, or $13.7 billion in equity.

Duke Energy also would assume approximately $12.2 billion in Progress Energy net debt. The price represents a 7.1% premium to the unaffected closing stock price of Progress last Wednesday and a 3.9% premium to the closing stock price of Progress last Friday. The price also represents a 6.6% premium to the average closing stock price of Progress over the last 20 trading days ending last Wednesday, and a 6.4% premium over the last 20 trading days ending last Friday.

Duke shareholders would own 63% of the combined company and Progress shareholders would own 37% on a fully diluted basis. The combination is anticipated to be accretive to Duke Energy's adjusted earnings in the first year after closing. Based on Duke Energy's current quarterly cash dividend of 24.5 cents/share, Progress Energy shareholders would receive an approximate 3% dividend increase.

Analysts at FBR Capital Markets said the standalone Duke has been challenged when it comes to earnings growth. "This transaction could potentially change this outlook if significant synergies are realized..." they said in a note Monday. "Excluding synergies, this deal would be modestly dilutive and would not seem justifiable to us. Thus, our initial take is that this merger brings some strategic benefits to DUK that until now faced rather dim prospects, and lowers the share count to boot (better optics). From a PGN standpoint, the offer is a very handsome one and values the company at 14.8x consensus 2011 earnings, which is almost where [Southern Company] is trading."

The combined company would have $65 billion in enterprise value and $37 billion in market capitalization. It would serve customers in North Carolina, South Carolina, Florida, Indiana, Kentucky and Ohio and have about 57 GW of domestic generating capacity from a mix of coal, nuclear, natural gas, oil and renewable resources.

Units of the combined company would include Progress Energy Carolinas, Progress Energy Florida, Duke Energy Carolinas, Duke Energy Indiana, Duke Energy Ohio, Duke Energy Kentucky, Commercial Power, Duke Energy Generation Services and Duke Energy International.

Moody's Investors Service affirmed its ratings and stable outlooks on both companies, reflecting "their strong financial positions, sizeable regulated utility business operations and diversity among regulatory jurisdictions," said Mike Haggarty, Moody's senior vice president.

Jim Hempstead, another senior vice president at Moody's, said the deal has several positive attributes. "The inherent logic behind the merger is the consolidation of two homogeneous, capital-intensive companies to spread fixed costs across a larger asset platform," he said. "We also see good incremental diversification benefits with the proposed merger, including the addition of a Florida service territory, generation dispatch efficiencies in the Carolinas, and the ability to wring out other operating cost efficiencies across both organizations."

Standard & Poor's Ratings Services (S&P) placed its "BBB+" corporate credit ratings on Progress Energy and its subsidiaries, Progress Energy Carolinas and Progress Energy Florida, on CreditWatch with positive implications and affirmed the "A-" corporate credit rating on Duke Energy and its subsidiaries, Duke Energy Carolinas LLC, Duke Energy Ohio Inc., Duke Energy Indiana Inc. and Duke Energy Kentucky Inc.

"The positive CreditWatch listing on Progress Energy and its subsidiaries reflects that the company's credit quality will benefit from the merger with the higher-rated Duke Energy," S&P said. "The ratings affirmation on Duke Energy reflects our expectation that the combined entity will have an 'A-' corporate credit rating, based on excellent business risk profile and significant financial risk profile. The premium to be paid to Progress shareholders, which we calculate to be about 33% to book value, has a reasonable chance to be recouped through the retention of merger synergies."

Progress CEO Bill Johnson would be president and CEO of the new company. Rogers would be executive chairman and would advise the CEO on strategic matters, play an active role in government relations and serve as the company's lead spokesperson on energy policy. Both Rogers and Johnson would serve on the board of directors, which would be composed of 18 members, with 11 designated by Duke's board and seven designated by the Progress board.

The combination "makes clear strategic sense and creates exceptional value for our shareholders," Johnson said. "Together, we can leverage our best practices to achieve even higher levels of safety, operational excellence and customer satisfaction, and save money for customers by combining our fuel purchasing power and the dispatch of our generating plants."

The combined company would be headquartered in Charlotte, NC, and would maintain substantial operations in Raleigh, NC.

Closing is expected by year-end and depends upon shareholder approval and antitrust clearance as well as regulatory filings with the Federal Energy Regulatory Commission, Nuclear Regulatory Commission, North Carolina Utilities Commission and South Carolina Public Service Commission. The companies said they also would provide information regarding the merger to the Florida Public Service Commission, Indiana Utility Regulatory Commission, Kentucky Public Service Commission and Ohio Public Utilities Commission.

"As usual, the public utility commissions will play an important role in how this unfolds," FBR said. "Some of the synergies will accrue to the benefit of ratepayers. It is possible that large layoffs, or a shift in headquarter location, could prove a dicey issue for the North Carolina commission in the current economic environment, which was evident in the [FirstEnergy Corp.-Allegheny Energy Inc.] merger process" (see Daily GPI, April 26, 2010).

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