Drive for growth fuels utility mergers

A parade of electric and gas companies have marched to the auction block this year, as the utility industry undergoes yet another wave of consolidation.

Sparked by the belief that bigger is better, fueled with vast new pools of investment cash and fanned by the repeal of a Depression-era law restricting who can own and operate utility companies, a dozen energy producers and distributors have announced deals so far this year, compared with 10 for all of 2005.

Locally, the trend is about to engulf Cascade Natural Gas, which serves more than 230,000 customers outside the major metro areas of Washington and Oregon. In a $305 million all-cash deal announced in July, Seattle-based Cascade agreed to be acquired by MDU Resources of North Dakota. The deal is expected to close in the first half of 2007.

Analysts say the current spate of mergers is part of a long-term trend that will ultimately leave the United States with just a handful of super-regional utilities.

In such a world, even the Pacific Northwest's biggest investor-owned utilities, Bellevue-based Puget Energy and Oregon's Portland General Electric, may find themselves pressed to join the trend.

If it's true, as veteran utility analyst Jim Bellessa of D.A. Davidson says, "the best way to remain independent is by having a favorably priced stock," Puget Energy may need to watch its back.

Puget's stock has barely budged since the beginning of 2003, lagging behind all other Northwest utilities. Over the same period, by contrast, Avista in Spokane has more than doubled, and Idaho Power in Boise is up 54 percent; the Standard & Poor's utility index has risen 73 percent.

Cascade's stock also languished for years, a situation that Chief Executive David Stevens attributed to its small size and limited growth prospects.

"When you're a $230 million market-cap[italization] company, as we were, and we had only three analysts who covered us, that becomes a challenge," said Stevens, who was recruited from Southern Union 18 months ago to run Cascade.

"We had the opportunity to grow internally, but it would have taken a number of years at that rate before our market cap got to the point where more analysts would have become interested in us," Stevens said. "Over time, it puts you in a position where the board has to look at other alternatives to maximizing shareholder value."

Translation: Put the company up for sale, which is just what Cascade's board did late last year. MDU agreed to pay $26.50 for each Cascade share, a nearly 25 percent premium over where the stock had been trading; MDU also will assume about $165 million in debt.

Waves of mergers

The utility business has gone through waves of mergers and consolidations before, most recently in the late 1990s, when activity was goosed by the prospect of shedding boring old assets like generating plants and pipelines in favor of new, unregulated businesses such as energy-trading and management services.

Relatively few of those unregulated ventures panned out, however. Puget sold its InfrastruX construction-services subsidiary in May for $263.6 million; Avista's energy-trading unit lost millions of dollars before stabilizing and remains a small part of the company's overall business. And after Enron, Dynegy and other new-wave energy giants collapsed, there was little appetite for any deal-making until the latter half of 2004.

Since then, however, merger mania has resumed in earnest. The biggest proposed deal, between Chicago-based Exelon and Public Service Enterprise Group of New Jersey, would have created a behemoth with 9 million customers and some $26 billion in revenue. But after failing to agree with New Jersey regulators on rate relief and other issues, the companies last week scrapped their planned combination.

Several factors are driving the current tide of utility deal-making, analysts and executives say — prime among them, perhaps, the drive for growth.

John McConomy, who leads the team that analyzes proposed power and utility deals at PricewaterhouseCoopers, said that Wall Street expects the average utility to expand by about 6 percent a year.

But between organic growth in their customer base, which mainly depends on the health of their local economies, and squeezing efficiencies out of their operations, most utilities outside Florida and a few other Sun Belt states can only manage about 2 percent growth on their own, McConomy said.

"The idea with the mergers is that, through sheer scale, they'll be able to enhance those growth rates" by combining administrative functions and bringing complementary assets together — such as a company with a lot of excess generating capacity joining one with an experienced sales force.

It's all relative

Sometimes growth is relative. Cascade's service area may only be expanding by 4 percent a year, but that looked pretty good to Bismarck, N.D.-based MDU, whose territory is increasing 1 percent a year, MDU spokesman Dan Sharp said.

The 80-year-old company long ago diversified from its sparsely populated home base and core electric and gas businesses, recognizing that the Upper Midwest offered thin soil for corporate growth.

Today's MDU, which drills for oil and natural gas, build pipelines, mines gravel and even sells appliances and home-security systems, is barely recognizable as a utility company. Its regulated utility operations yielded just 7 percent of last year's profit; it has more workers in Oregon at several aggregate and construction-supply companies than anywhere else.

But those businesses are vulnerable to the ups and downs of the broader economy, Sharp said. The utility business, by contrast, offers stable and predictable cash flow. Bulking up MDU's utility segment by adding Cascade is, in effect, a hedge against uncertainty.

That stability also has attracted nontraditional buyers to the utility market. Infrastructure funds run by Australian firms Macquarie and Babcock & Brown have bid to buy Duquesne Light Holdings and NorthWestern Energy, respectively; MidAmerican Energy Holdings, a subsidiary of Warren Buffett's Berkshire Hathaway conglomerate, bought Portland-based PacifiCorp in March from ScottishPower.

Such deals would have been discouraged, if not banned outright, by the Public Utility Holding Company Act, a Depression-era federal law that limited who could own utilities and where they could operate.

But the law, known as PUHCA, was repealed in February; analyst McConomy and others expect that repeal will encourage other investors — such as vendors or financial firms — to at least explore the utility world.

Any such mergers would still have to clear state regulators, such as the Washington Utilities and Transportation Commission.

"It's hard to get the regulators to buy off on some of these deals," Davidson's Bellessa said.

Bellessa noted that state utility commissions, whose mandate is to look out for the interests of ratepayers, try to make sure at least some of the savings from a merger are passed along in the form of lower rates.

In Oregon, for instance, deals must show a benefit to ratepayers to be approved, he said.

Regulators in New Jersey set tough conditions for approving Exelon's plan to buy Public Service Enterprise Group, requiring more refunds to customers and sales of more power plants than the two utilities had offered. Nearly two years after it was proposed, the deal was cancelled.

Continued high prices for natural gas — which besides being directly used by consumers also fuels many electricity plants — also feeds the urge to merge, with gas-dependent companies seeking to diversify their fuel supplies, McConomy said. But high prices also put increased pressure on regulators to cut the best deal they can for ratepayers.

Those concerns have caused some of the biggest utility players to stay on the sidelines so far this year, he said. Though there have been more deals this year than last, they've been smaller on average.

In the near term, he said, "we'll probably see more regional deals going forward, rather than the blockbusters."

Drew DeSilver: 206-464-3145 or ddesilver@seattletimes.com.