"I knew it sounded bad when you said "no regrets" and then said nothing more."
Sleepy electric utility companies are not supposed to make headline news. They're supposed to churn out energy for customers at regulated rates that give the companies the chance for 5-7% earnings growth annually. The steadiness allows the companies to return earnings to shareholders at 4-5% dividend yield rates. If a utility company shows up on the front pages, either it's a story about renewable energy and similar innovation or a natural disaster has struck.
We now have to add Shakespearean power grab to the list of ways power companies can make the headlines. The drama surrounding the Duke Energy (DUK) merger with Progress Energy (PGN) has left behind intrigue, falling stock prices, and metaphorical blood on the floor. Current shareholders of the company may feel rightly annoyed at the collateral damage, but other investors might be curious about the opportunity this offers.
The story so far: the two Southeast utility giants agreed to a merger on January 10, 2011, an equity deal in which Duke assumed Progress' debt and gave Progress shareholders 2.6125 shares for each Progress share they owned. As part of the deal, Duke CEO James Rogers was to become executive chairman of the new company, while Progress CEO William Johnson was earmarked to become the CEO of the new company. While the arrangement raised questions about Rogers' willingness to take a back seat, and while the merger took a long time to gain regulatory approval, all reports were that the deal would finish just fine and that Johnson would take over the CEO office upon closing.
Johnson did take over as CEO ... for a few hours. The Duke Energy board, comprised mostly of legacy (i.e. pre-merger) Duke Energy directors, voted by majority decision to replace Johnson with Rogers, and so ended the former Progress CEO's reign as CEO of Duke Energy. And that's when all the accusations started flying, with the former Lead Director of Progress Energy, John Mullin, calling this, "the most blatant example of corporate deceit" he had ever witnessed. The "no regrets" feeling surrounding the initial merger announcement has turned into nothing but bad news for Progress.
Our job as investors is not necessarily to arbitrate between the aggrieved former Progress board and the current Duke board, nor to lament Mr. Johnson's fate - he may have been stabbed in the back here, but he's being paid handsomely for it, with a severance package adding up to the tune of $7.4M. Ours is to decide if the current pullback in the stock creates a major buying opportunity in the newly formed giant, or if the stink set off by the backroom maneuvering will have a material impact on the company going forward that is best avoided.
There are a few practical concerns that this corporate chicanery brings up. First, North Carolina regulators have raised the possibility that they might look again into the approval process, given that the regulatory approval came under the assumption that Johnson would be CEO. The approval process was long and arduous in the first place, and if the government has reason to open the case again, it would pose a significant problem for Duke Energy.
The sudden left turn also raised the alarm of the debt agencies, specifically the S&P, which put Duke Energy's credit watch on negative, citing the questions over the "lack of clarity" about the move. That said, Duke Energy's rating is A- with the S&P, and Fitch affirmed a BBB+ rating for the newly-merged company, so the debt rating is not in true danger.
The last practical concern is that, in going with Rogers, Duke Energy has created the likelihood of another CEO transition in the near-term. Rogers, 64 years and six years older than Johnson, has a contract that runs until the Dec. 31st, 2013. Whether by that date or in the short-term thereafter, Duke Energy will need to find a replacement for Rogers, creating additional uncertainty. I imagine Johnson won't be interested in returning.
Of course, the biggest hit the company takes in this snafu is the blow to Duke's integrity. Rogers especially appears to be a man with blood on his hands, and anybody forced to read Macbeth in high school knows how difficult blood can be to wash off. Duke will have to work hard and long to restore its corporate reputation, though it could be that analyst and investor memories and anger will not last that long.
As an aside before considering the "opportunity" side of the ledger, it's worth noting that as far as shareholders' main concern - stock performance - goes, both CEOs have done well compared to the sector as a whole. While share price is a very inexact way to measure CEO performance, it is still what ultimately matters to most investors. The charts below show that both companies outperformed under their respective CEOs before the merger was announced.
(Note: Charts run until date of merger announcement - January 10th, 2011)
(Note: Duke spun off Spectra Energy (SE) at the beginning of 2007, leading to a big drop in Duke's share price that didn't reflect the business. Rogers came into the CEO position in April, 2006)
The case for investing in Duke Energy is fairly simple. The merger makes sense, giving Duke a growth path and a very strong market position in the Southeast. Duke is now the largest energy utility in the country as judged by market cap. The company now trades at under 15x 2013 earnings, which is low for a major utility in a safety-seeking environment. Duke just increased its dividend, the 8th consecutive year of increases. Continued pressure on the stock could send it down to the low 60s - at 61.2/share, the stock will hit the 5% yield barrier.
That level, arbitrary as it may be, seems like the point where the balance swings in favor of investing in Duke's pullback. The stock has already come down 7% from its pre-merger level, which was also its 52-week high. A move to 61.2 would double that drop. While regulators and former Progress directors are angry about being misled, it is unlikely that any action can be taken against the company without written proof that this was a premeditated decision that misled investors and regulators. The combined company has prior concerns - Duke has an over-budget coal plant in Indiana causing complications, while Progress is seeking a renewed license for a nuclear plant in Florida - and so these CEO shenanigans might constitute strike 1.5 of the allotted three for the company. And while people who prefer to invest in keeping with their values might not like Duke Energy - unless those people hold Machiavellian tactics and backstabbing as positive values - Duke was founded with tobacco money, so it was never exactly the best "values" play.
In the wake of Johnson's ouster, Duke Energy might linger in the headlines more, and its stock might drift in value somewhat. Investors looking for a bargain should hope that once the drift has gone on long enough, Duke makes sure it stays out of the headlines and goes back to being a boring utility company. Otherwise, a second act to this drama could leave blood and regrets on investors' hands.