Ken Silverstein EnergyBiz Insider Editor-in-Chief

Any company with a solid financial and a pot of cash has its eyes open. Mergers are back in the news because companies with high fixed costs can improve earnings through sharing and reducing variable costs across their combined operations. The secret, though, is to make buys that are reasonably priced and that are synergistic.

Companies are pressured once again to increase earnings. The rationale behind getting bigger and increasing cost savings are compelling for many executives. In fact, some companies that have divested of generation are picking up these facilities as a way to protect their customers from market volatility. In essence, by owning and managing their own assets, they can make better predictions as to how fuel costs will affect them.

"These mergers will happen," says Jim Dillavou, partner with Deloitte & Touche, in Dallas. "While there will be some opposition, these will settle out by companies being able to sell the benefits of the merger. To the extent there are cost savings, there will be some pressure to share those savings with the ratepayers."

Will it be the land of the giants? Exelon is buying Public Service Enterprise Group while Duke Energy and Cinergy have merged. Meanwhile, National Grid is picking up Keyspan and Constellation is uniting with FPL Group. And Warren Buffet's Berkshire Hathaway bought PacifiCorp. Analysts say that that the mid caps -- the smaller regional utilities -- will be forced to partner with others their own size in contiguous regions and all to avoid getting eaten up by the behemoths.

But has the industry learned from the razzle-dazzle days of the last decade? The lessons were so blistering that they surely know to do their homework as well as to ensure that any deals are properly integrated, experts say. Many utilities paid a huge premium to acquire other companies. The synergies that were expected, however, didn't materialize while productivity levels stagnated.

Sheer Magnitude

High stock values in the previous decade helped back then to ignite merger fever. That permitted companies to exchange common stock -- or inexpensive capital -- for ownership stakes. But the more common arguments in recent years have been the perceived need to span geographies and win new customers. With that approach, companies could increase revenues without adding significantly to their expenses. Meanwhile, the scale that companies would achieve would give them greater leverage in the market.

The results are noticeable. According to PriceWaterhouseCoopers the total deal value in 2005 was $196 billion. That's up from $123 billion the year before. North America accounted for about $60 billion of that with a handful of deals exceeding $10 billion each. The consulting firm says that the trend towards the "super regional" utility will continue. Why? Organic growth in most territories is around 2 percent earnings per share. But through regional consolidation, it could be 5 percent.

If the Exelon -- PSEG deal goes through, it would create the nation's largest power generation company, with $79 billion in assets, serving 9 million customers in Illinois, Pennsylvania and New Jersey. The acquisition by Exelon would be worth $12 billion in stock. The main contention that regulators are hearing is that the proposition would harm consumers by allowing the utilities to aggregate market power with their 52,000 megawatts of generation.

"The sheer magnitude of the proposed mergers will have to cause the regulators pause," says Mark Rossi, an executive with Fairfax, Va.-based Gestalt. "Exelon, for example, has promised to divest of some generation assets. In the absence of that, its market power would be huge. Now that federal law removes some barriers, utilities will have more options. But it won't be any easier. They still have to deal with state regulatory proceedings. They still have to show some value to investors."

Executives of both Exelon and PSEG said that consumers and shareholders alike would benefit. They estimate that at least $500 million in cost savings would take place within two years, which would occur in part by eliminating 1,400 jobs out of 28,500.

In the past, financial dealings have encumbered the merging partners while defining a mission or meshing separate cultures were set aside. The result, says the consulting firm KPMG that studied 700 mergers that took place between 1996 and 1998, is that 83 percent of them failed to unlock value one year after the transaction, and 30 percent actually destroyed value.

Those results could improve. According to the Conference Board, smart companies have learned lessons, albeit it has come with practice. Before a merger, utilities must have detailed plans ready well in advance and the resources to assure good execution, it says. After the transaction, they must maintain the personnel and skill-sets that satisfy customers, who want continuity.

"Before, utilities just followed the Enron ball," adds Dillavou with Deloitte. "They got caught in the hype. Today, there is much clearer focus. They are trying to provide stable earnings and focus on cost and cost savings. They realize there is financial strength from owning and building assets."

Market Power

That aggressive posture does not sit well with consumer organizations. They say the concentration of generating assets and marketing power within the regional wholesale electricity market will lead to higher prices across the board for consumers.

In the case of Exelon and PSEG, ratepayers will also bear the costs associated with the proposed buy-out, says Citizen Action. According to PSEG's most recent annual report, PSEG and Exelon expect to incur $70 million in transaction fees and another $700 million in integration costs over four years. The expected benefits will go unrealized because of this high cost, it says.

"The bigger they are, the more political power those companies will have," adds Sean Boland, partner with Howrey law firm in Washington D.C. "They will hold tremendous sway over regulators. But, we won't have a huge anti-trust problem. What if at the end of the day, we end up with a few utilities? That's not the end of the world."

Economic forces will be permitted to play out. But, if the markets coalesce or become distorted, there will be a clamor for change and new regulations. The overriding interest is to ensure markets are fair and toward that end, companies seek greater buying power and synergistic services -- the underlying reason for most mergers.