With gas and electric utility stocks continuing to probe thedepths after a brief spike in a January fuel-cell frenzy, someobservers and executives are keeping their eyes peeled for the nextseries of corporate takeovers in the industry.

Peoples Energy CEO Richard E. Terry, for example, noted lastweek his Chicago-based utility is much more vulnerable to atakeover right now. Peoples is repurchasing up to 3.5 millionshares of its common stock, or 10% of its outstanding shares.”Recognizing the general direction of the stock market and ourindustry sector, it is our view that at current prices, PeoplesEnergy’s stock is undervalued and its repurchase represents aprudent investment,” said Terry.

However, it’s somewhat ironic that the very thing that appearsto be making energy companies ripe for takeover might be preventingthe next wave of mergers from arriving.

“On the one hand, sure there are some cheap stocks out therethat might be vulnerable for takeover, but on the other hand who’sgoing to take them over?” asked Edward Jones utility analyst ZackWagner. “It’s really kind of a [Catch 22].

“For any company when their stock is depressed it makes themeasier to take over. The only problem with that in the utilityindustry is that most mergers involve one utility buying another.There’s not going to be many utilities using their own stock as acurrency if it’s so depressed as it is right now,” he noted.

There were 18 gas utility mergers last year and most of themoccurred in the first quarter. But in the last six months, therehave been only a couple.

Utility stocks have been hurt by rising interest rates and bythe lack of investor interest in the utility segment. “They’ve beenunderperforming for the past five years. Most of the money today ischasing the fast growing companies. The utilities are certainly notgrowing fast.”

Electric stocks have been hammered. While the NASDAQ has grown90% over the past 12 months, the electric-weighted Dow JonesUtility Average inched up 2.7%. In the past 30 days, the DJU isdown a little more than 8%.

“We do have companies like Williams, like Enron, like MontanaPower, who have successfully diversified into non-utility areas andthey are doing very well – their stocks are doing extremely well.There are some very select examples of companies who havesuccessfully navigated through changes in the industry and haveprospered. The bottom line is utilities are not in favor…”

Companies need to continue diversifying into telecommunications,fuel cells, or whatever fits well with their in-house skills, saidWagner. “There have been very few big winners. The other 115utilities are languishing.”

Referring to PowerGen’s plan to purchase LG&E for $5.4 billion Wagner predicts more purchasing activity by international firms.

“I think we’ll see more cash deals than there have been,” saidEdward Jones analyst Robin Diedrich. “LG&E for example was notactively seeking a partner. They had some rough times but they hada lot of offers and never took them. I think because their stockwas down so far when they got this cash offer, they just couldn’tignore the premium they received.”

“On any given day any of these utility companies could beacquired.”

To put a positive note on all of this, the outlook is fairly good, according to Wagner. “These stocks are so cheap but there’s a lot of great value in the industry. We’ve seen that. Warren Buffett is investing in the industry; [Berkshire Hathaway was part of a consortium that bought MidAmerican Energy (see NGI, Nov. 1)]. Bill Gates’s investment fund is investing in the industry [buying into Avista (see NGI, Jan. 24 and Feb. 14)]. KKR is buying a chunk of Dayton Power and Light.

“I think investor sentiment will shift; it will shift back infavor of these lower growth but more stable companies at somepoint. I don’t know when but maybe if the bubble bursts intechnology we might see new money flow back into utilities.”

Rocco Canonica

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