We said yesterday that the new hot topic in the group is M&A, and how many are writing and saying there will be a new wave of mergers coming in this group. While we do not doubt this, we question the benefit for shareholders. In this, Part 2 of our discussion, we will highlight the Bull and the Bear case for utility mergers.
In Part 1 of this theme we set up the discussion, provided some random links to various articles, and briefly highighted my philosophical views on what appears to be an inevitable trend (see: Part 1: A Wave of Utility M&A is Coming ... Is it Good for Shareholders?).
We will also have at least 3 more parts to this discussion (sometime next week, perhaps): a) A real discussion of both the Bull and Bear cases for utility mergers; b) A historical view of the success and pattern of utility strategic decision-making; and c) A review and breakdown of an outstanding analyst report by Dan Eggers of CSFB on utility mergers.
Bull Case For Utility Mergers:
1. Significant economies of scale can be achieved.
2. Cost savings from mergers can be an important tool to reduce the pressure of rising costs.
3. Shareholders of weaker utilities can benefit from merging with a stronger utility both by getting paid a premium, and by being part of a utility with fewer weaknesses (financial or otherwise).
4. Strategic combinations can diversify risk, and provide new opportunities for acquirors to improve operations and find new markets for growth.
5. With the likely repeal of PUHCA, new players and new capital will flow into the utility industry, paying healthy premiums for existing utilities, and freeing capital for greater innovations.
Bear Case Against Utility Mergers:
1. Two poorly-run and inefficient companies do not become better-run and more efficient just by becoming larger.
2. The regulatory hurdles for completing a merger take such a long time to leap over that much of the near-term benefit of any premium paid is reduced (and simply entering into a regulatory proceeding alone introduces plenty of risks).
3. Many utility mergers are mergers of equal with little or no premium paid, resulting in little near-term benefit to the shareholders.
4. Regulators will require much of the cost savings to be achieved to be passed through to the ratepayer and customer, leaving small earnings or valuation benefit for the shareholder.
5. Merging two companies with two different cultures can take a long time, and create substantial execution risk.
6. Regulatory backlash against "financial" acquirors, rather than other utilities could derail M&A.
Part 3 will be a detailed discussion of each of these points.