Merger, acquisition trend fueled by race toward competition

Issue 8 and Volume 100.

Merger, acquisition trend fueledby race toward competitionThe mergers and acquisitions of 1995, and the ones that have been announced so far this year, are mostly what have been termed “mergers of equals.” The companies involved in the combinations are roughly equal in size, and in most cases, in their financial and market strengths.

Since 1992, the investor-owned utility (IOU) segment of the industry has witnessed more mergers than ever before (see table). In not limiting themselves to U.S. mergers, IOUs, in 1995 alone, involved themselves in an unprecedented number of mergers, acquisitions and partnerships with international companies. One of the latest international bids by a U.S. utility was made by The Southern Company, which paid an estimated $1.7 billion to acquire South Western Electricity in England.

Electric cooperatives also saw, from 1992 to 1995, a record number of consolidations. With the multitude of combinations among electric utilities over the last few years, it becomes more obvious the reason most utilities aren`t fighting merger mania is that they have owned up to the fact that cost cutting is mandated for competition. What better way to accomplish a streamlined organization than through the one-company-is-better approach. Economies of scale, increased efficiency and the elimination of costly duplicative efforts naturally follow a merger or consolidation.

The merger and acquisition trend has taken hold throughout corporate America and utilities are among the leaders of the pack. In fact, 1995 was dubbed by many securities and financial analysts as “the year of the merger.” Looking to November of last year, American companies had announced $359 billion of mergers and acquisitions. 1994 also saw a record number of corporate mergers, with a total of $347 billion. By the end of 1996, it has been estimated that the merger dollar figure may top $350 billion.

According to Allen Sinai, Lehman Brothers chief economist, low interest rates, a strong stock market and intense competition in nearly every industry and every country are driving the record number of mergers. Many utilities are recognizing that a global approach is the only way to keep pace with the competition. KPMG Peat Marwick, an international assurance and advisory firm, said U.S. electric utilities spent $14.8 billion on 142 cross-border deals in 1995, a 36 percent jump in value on 12 percent more deals than in 1994. The largest cross-border deal was the $1.7 billion purchase of Britain`s South Western Electricity by The Southern Company, Atlanta, Ga.

Dennis Aronson, KPMG`s Utilities Practice national director, said, “These organizations are financially strong and don`t have to spend as much on construction, but are stuck in slow-growth markets. To grow, they have to look internationally to produce greater returns for shareholders. In addition, most are looking globally because it`s easier to do business in other countries with the rush of privatizations and governments eager to sell their utilities.”

Steve Blum, KPMG`s U.S. national director of corporate finance, said utilities may soon have another reason to merge or acquire. “If the proposed cut in U.S. capital gains is passed, the traditionally high dividends paid by utilities here will look less attractive as a means of sustaining shareholder value than a well managed and focused global acquisitions program. Conversely, dividend payers here who don`t act, risk becoming cross-border targets themselves.”

Looking ahead

A study conducted by the Washington International Energy Group (WIEG), “The 1996 Electric Industry Outlook,” polled 3,277 senior U.S. and Canadian electric industry executives. Among the study`s overall findings was that 90 percent of respondents expect mergers and acquisitions to increase. WIEG asked respondents what kind of mergers they expect in the future. According to the study, “1995 reminded the industry that hostile takeovers are not easy to accomplish and that for now electric utility insiders will continue initiating mergers and acquisitions–making what they anticipate will be win-win deals with each other in order to strengthen competitive positions.” The study also found that half the respondents believe their company will eventually acquire or be acquired by another company. Sixty-two percent believe the number of hostile takeovers will increase.

Crossing over

The study found that in the future, takeovers launched from outside the electric utility industry are likely. In 1996, 64 percent of industry respondents feel it is likely that electric utilities will merge or form alliances with natural gas companies. More than half believe electric utilities will do the same with telecommunications companies. Last year, only 21 percent believed that mergers in the telecommunications area were likely.

Much like their IOU counterparts, co-ops are looking at mergers and acquisitions as a way to save money. The National Rural Electric Cooperative Association has conducted studies indicating that on average distribution costs per consumer drop as co-op size increases and spreads fixed costs across a broader customer base.

Gerald Lange, Sioux Valley Empire Electric Association director, said that 75 out of 100 mergers do not work. What makes a merger successful to most industry stakeholders is cost savings. However, success can also be measured in other ways, including customer satisfaction, service, and employee and community support.

“Mergers are destabilizing events,” Lange said. “You can`t put toothpaste back into the tube.” In its latest electric utility industry study, WIEG has offered a list of 10 things it feels every utility needs to do to meet the new competitive agenda. They are:

1. Know your competitors and stay ahead of them. Nobody knows what the future industry structure will ultimately look like, but if you`re in front, you`ll see it first.

2. Beware of the state regulator. Regulators desire to slow the pace of change. Don`t fall for offers to improve the old regulatory compact.

3. Stop protecting dividends. Many utilities will be forced to cut dividends whether they like it or not.

4. Announce a retail choice program so you can set the pace of change. Start getting used to retail choice by starting your own demonstration program.