Utility deals are not like other deals. Utilities do not buy each other to get access to cutting-edge technology or popular products nor to take a competitive asset off the market so that it cannot fall into a competitor's hands. Instead, utility mergers are often about finding a few tenths of a percentage of savings here or there and perhaps about creating a more desirable profile of operating markets. To that end, then, it does not really seem all that likely that Duke Energy's (NYSE:DUK) acquisition of Progress Energy (NYSE:PGN) is going to be the start of a wave of utility M&A.
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The Deal as It Stands
Duke Energy announced Monday morning that it had reached an agreement to acquire Progress Energy in an all-stock deal. Duke will give each Progress Energy shareholder 2.6125 shares of its stock - a ratio that valued Progress Energy at $46.48 per share based on Friday's closing prices. That in turn represents a 4% premium to Progress's Friday close, and a 7% premium to the price of the utility before deal chatter started to build and push the stock higher.
A Logical Deal ... To a Point
Assuming that the various regulators allow the deal to go through unchanged (more on that later), it will produce the largest utility in the country with over $8 billion in annual operating EBITDA and 57 gigawatts of generating capacity in the U.S.. Impressive as that sounds, it is still a small fraction of the total U.S. electrical generation market.
Where this deal makes sense is in the familiar operating environments of the two companies. For both banks and utilities, the Southeast U.S. is an attractive market for the same basic reasons - above-average population growth and relatively friendly regulatory regimes. Both utilities are major players in the utility-friendly Carolinas, and Progress will give Duke good exposure to the also-friendly (and attractive) market of Florida and increase the percentage of earnings it gains from regulated markets.
Beyond that, this deal will help to mitigate some of Duke's risk exposure to possible troubles in Ohio and Indiana. In Ohio, for instance, Duke is losing out to competitive suppliers due to above-market rates and is trying to convince regulators to allow it to move to "market rate option" pricing.
Will Regulators Allow This Deal to Succeed?
One of the limiting factors on utility mergers has generally been the reality that that regulators do not allow the companies involved to make much of a windfall from the deal. Sure, a little synergy here and there is OK, but regulators often clawback most of the gains as rate regulation is generally based upon a company's returns on its equity or capital.
Still, even if the regulatory environment in the Carolinas and Florida changes for the worse, there is some logic to this deal all the same. In addition to the aforementioned diversification benefits, the combined entity should be a bit more effective in getting better financing terms. Moreover, it is possible that the combined entity will see more cost leverage in installing/applying new environmental technologies and in lobbying for new generating assets - particularly the always-controversial nuclear plants that both companies would like to build.
The Bottom Line
Though Duke may be overpaying a bit in this deal, it is hard to see how the transaction will come back to haunt its shareholders. At worst, then, it makes the company bigger and perhaps a bit harder to manage, but not significantly different. On a more positive note, Progress Energy shareholders will see a higher dividend and Duke Energy shareholders may see a slightly more efficient and better diversified utility.
Given the relative lack of competitive M&A, there are not a lot of obvious plays for investors here. Sure, Exelon (NYSE:EXC) may be on the prowl and a condition-free approval from FERC on the Duke-Progress deal could embolden the company to get moving. Apart from that, though, investors may want to check out the likes of Wisconsin Energy (NYSE:WEC), NV Energy (NYSE:NVE) and American Electric Power (NYSE:AEP) - not because they are intriguing takeout candidates (though perhaps WEC and NVE could be attractive in that regard) but because they are solid companies with good prospects. (For more, check out Trust In Utilities.)
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