Standard & Poor's, like Platts, a unit of The McGraw-Hill Companies, is not yet convinced there is a new wave of utility mergers and acquisitions under way, but the rating agency is sure such deals are generally bad news for bondholders.

"Utility M&A is like my new puppy dog. When we're walking him in the park he's incredibly seductive--everyone wants to look at him. But the reality is, it's a whole lot harder to take care of this dog than we ever thought, and the outlook is uncertain at best," said Director Peter Rigby, at S&P's annual "U.S. Utilities Credit Conference" in New York City June 1.

"The best M&A deals boost market share, enter into new markets, and create or enhance value."

But combining two franchised monopoly distribution systems does not boost market share because each already had 100% of customers, Rigby noted. And instead of creating value, the deal could reduce it if regulators require divestiture of valuable assets such as power plants and transmission, he said.

There are three planned mega-mergers and acquisitions in the US, all facing lengthy regulatory review. In late April, MidAmerican Energy Holdings proposed buying PacifiCorp, now owned by ScottishPower, for $9.4-bil. In Mid-May, Duke Energy unveiled its $9-bil plan to merge with Cinergy, and late last year, Exelon proposed buying Public Service Enterprise Group (PSEG).

Earlier at the S&P conference, Director Todd Shipman noted that "we're still up in the air at S&P....is it a trend, or not much of a trend at all?"

"If it doesn't signal a trend, it should at least make us notice things are different," said Director Andrew Watt, who pointed out that "some of the recent announcements got a skeptical response from S&P."

Standard & Poor's has been more skeptical than Moody's Investors Service and Fitch Ratings. Last December, all three rating agencies generally agreed that the acquisition would be good for PSEG, but only S&P thought it could be bad for Exelon (issuer rating A-), which was put on CreditWatch - Negative. S&P's outlook was already negative. It put PSEG (BBB issuer rating and senior unsecured) on CreditWatch - Developing, meaning ratings could be raised, lowered, or affirmed.

In mid-May, S&P was much more pessimistic about Duke Energy's plan to acquire Cinergy (corporate ratings both BBB+) than Fitch and Moody's, putting both companies on CreditWatch - Negative.

On May 25, S&P did put acquirer MidAmerican Energy Holdings (corporate rating BBB) on CreditWatch - Positive, but it put PacifiCorp (corporate ratting A-) on CreditWatch - Negative.

"Many [previous] mergers were disappointing....regulators extracted a pound of flesh for ratepayers in many if not most cases," continued Watt. "What's different now? Mergers are being much more conservatively financed, not with a lot of debt. Management expectations [about cost savings] are more realistic--or they're not talking about them, so regulators can't grab them.

"S&P remains skeptical. There's a history of companies failing to realize savings they thought they'd achieve in a predicted time frame: the organization is too burdened or distracted to execute effectively, cultural issues are more difficult than anticipated.”

Shipman labeled regulators "very reluctant to get enthusiastic [about an acquisition] unless there are clear benefits to ratepayers. The big issues for credit quality are: the savings, how are they apportioned? Who bears the risk of non-attainment? A lot of the time, to get approval, companies have to give the savings upfront [via rate cuts or freezes]."

"Just because only $100-mil of a projected $300-mil in savings is on the utility/regulated side doesn't mean regulators won't go after more money. More often they will go after anything they want and they will get it, overtly or clandestinely," warned Managing Director Ronald Barone.

Watt and Rigby both believe utility management has recently tended to favor the interests of shareholders over bondholders, especially in M&A.

"There's a symmetrical risk--lenders often get the short end of the stick. It should surprise no one that the usual S&P response is a CreditWatch Negative listing for the acquirer, or the higher-rated company," said Rigby.

"We heard a lot about 'back to basics' and repairing the balance sheet. We don't hear as much of that currently, though balance sheets are not fully repaired. The trend seems to be more to satisfy shareholders, rather than bondholders," noted Watt.

This article was first published in Platts Electric Utility Week. Request your free trial now.