WHO’S BUYING WHO: MERGERS AND

ACQUISITIONS OF UTILITIES ARE ON THE RISE

By Catherine A. Asaro and Thomas Tierney
Exelon Corporation, one of the nation's largest electric utilities with approximately 5.2
million customers and more than $14 billion in annual revenues, has cleared a few hurdles in its
quest to create the largest electric utility in the United States. On June 30, 2005, in the first of a
number of regulatory reviews, the Federal Energy Regulatory Commission (FERC) sanctioned
the proposed merger of Chicago-based Exelon Corporation with Public Service Enterprise Group
Inc. (PSEG) of New Jersey. PSEG is a major integrated energy and generation company serving
2 million electric and 1.6 million gas customers in New Jersey with more than $10 billion in
annual revenues. With 97% of the votes cast, Exelon’s acquisition of PSEG received
overwhelming approval from PSEG’s shareholders. The merged company to be known as
Exelon Electric & Gas Corp., will serve 7 million electric customers and 2 million natural gas
customers in Illinois, New Jersey, and Pennsylvania and will be the largest electric utility in the
United States with assets close to $80 billion.

Exelon is just one example of the rapidly growing trend toward strategic utility mergers.
Combining operations gives utilities with heavy debt levels a way to grow. Utilities are
motivated to search for earnings growth beyond the “back to basics model” and more mergers
are occurring as companies seek scale and strategic advantage. The dramatic rise in oil prices
and costly upgrade to aging power systems have been significant factors contributing in large
part to this trend.

The current surge in oil and gas M&A activity can be traced back to 2003 when 331 deals
valued in excess of $73 billion dollars in the U.S. and Canada.1 In 2004, the strong activity
continued with 426 deals with transaction value of nearly $141 billion. Also, in 2004,
spending on deals shot up to $777 billion which was the best overall performance for U.S. M&A
since the record-breaking market of 2000.2 Mergers in the power sector in 2000 were roughly
$74.9 billion considered to be the height of the power trading boom. Last year, merger activity
in the power sector hit a 4 year high of $50.8 billion, more than half of which stemmed from
Exelon’s bid for PSEG which was valued by Thomson around $27 billion including a $12 billion
stock swap and assumed liabilities of PSEG.

This surge has continued through the first quarter of 2005 with a reported 122 deals. It is
anticipated that corporate M&A activity will continue to remain strong during the second half of
2005 as companies seek growth through acquisitions in consolidating industries such as utilities,

1
Ernest & Young “Tread Carefully Through the Oil Patch”
2
FactSet Mergerstat’s M&A Roundup in 2004, January 3, 2005
energy, and financial services. Analysts at ABN Amro highlighted more than half a dozen
utilities that were well positioned heading into 2005 to hunt for bargains and assets. Those
companies may see mergers as an option "because they've run out of other things to generate
some kind of growth story," said Peggy Jones, an analyst with ABN Amro.

M&A activity is a crucial component to the overall growth of the economy. The
infusion of fresh capital and new ideas into existing business enterprises leads to building new
wealth and even creating new jobs. By turning around troubled companies, arranging strategic
alliances, and merging disparate resources and talents dealmakers have the ability to create a new
and better entity.

An obstacle to utility mergers is the Public Utility Holding Company Act of 1935
(PUHCA) 3, the repeal of which many feel is long overdue. There are strong arguments from
both sides of the table as to the impact that repealing PUHCA would have on the industry. One
argument proposed by many politicians and economists is that this antiquated regulation has
outlived its value and that the market should determine prices. It is felt that this PUHCA is no
longer appropriate for the utility industry because it inhibits the market.

On the flip side, its repeal would make mergers easier but would also make it more
difficult for state agencies to protect consumers. There is a fear of radical change in the utility
industry by removing restrictions on utility holding companies as it will open the door to more
and bigger mergers which could lead to huge unregulated monopolies. If PUHCA is repealed,
oil companies would be free to buy up both electric and natural gas holding companies creating a
cartel that would set prices. Without PUHCA’s structured guidelines for mergers, it is feared
that there will be no limit to the size and scope of utility mergers. It was not too long ago that a
partial repeal of PUHCA led to the Enron and the California energy crisis.

PUHCA, a cornerstone of FDR’s The New Deal reforms, was enacted during the Great
Depression and was considered an important electricity consumer protection statute. PUHCA
was enacted because huge holding companies were using utility revenues to finance and
guarantee other riskier business ventures. From 1929 to 1936 there were 53 utility holding
companies that went bankrupt after banks called in their loans. One of the chief objectives of
PUHCA was to break up the huge, multi-state utility holding companies that could not be
effectively regulated by any single state, and to prevent their re-creation. PUHCA was designed
to simplify the structure of the utility holding companies by outlawing the pyramidal structure of
interstate utility holding companies and requiring companies owning 10% or more of a public
utility to register with the SEC and provide detailed accounts of their financial transactions and
holdings.

This legislation had a dramatic effect on the operations of holding companies between
1938 and 1958 with the number of holding companies having declined from 216 to 18.4 From
1947 to 1973 the growth rate for the industry held steady at about 8% per year and there was

3
Pub. L. No. 74-333, 49 Stat. 803 (1935) (codified as amended at 15 U.S.C. §79a et seq.).
4
Dr. Richard Hirsh. “Emergence of Electrical Utilities in America.” From Smithsonian Institute exhibit “Powering
a Generation of Change”
little change in the industry structure.5 The energy crisis of the 1970’s resulting from the 1973
OPEC oil embargo created shortages contributing to rate increases resulting in the cultivation of
new sources of energy contained in the National Energy Act of 1978. One part of that act was
The Public Utility Regulatory Policies Act (PURPA) designed to encourage efficient use of
fossil fuels. The primary effect of PURPA was to introduce competition into the generation
sector of the electricity marketplace, thereby challenging utilities’ claims that the electricity
market encouraged a “natural monopoly”.

The 1980’s and 1990’s brought further challenges to that notion impacted by deregulation
of the telecommunications, transportation, and natural gas industries. The 1992 Energy Policy
Act (EPACT)6 further facilitated the development of a competitive market by exempting
wholesale generators from regulations faced by traditional utilities. Under EPACT the FERC
required investor-owned utilities to provide access to their transmission grids to all wholesale
customers and other utilities.7 With the passage of EPACT states with historically high
electricity prices, such as California, began investigating whether competitive deregulated
markets would benefit their consumers. In 1996, California and Rhode Island passed
deregulation legislation allowing consumers the right to choose their electricity suppliers. By
May 2001, 24 states including the District of Columbia either passed legislation or issued a
comprehensive order restructuring their electric power industry.

PUHCA has forced utilities to refocus their corporate structure on their core obligation,
the delivery of low cost and reliable electricity. It placed restrictions on mergers involving
registered holding companies by imposing substantial costs on shareholders and customers of the
electric utility industry with no offsetting benefits. Since its enactment, proponents of PUHCA
point out that we have benefited from reliable, cheap electric power that allowed strong
economic growth and that no PUHCA-regulated energy holding company has ever gone
bankrupt.

However, within the industry, PUHCA stands as a roadblock to mergers and keeps
speculative finance at bay because it prevents companies outside the industry from controlling
electric utilities and requires a physical connection between electric utilities before they can
merge. Supporters of the repeal argue that it would improve competition and allow new money
and innovation to improve efficiency and reliability.

The Energy Policy Act of 2005 contains the most sweeping energy legislation in
decades. One unifying point in both proposed bills from the House and Senate was the PUHCA
repeal provisions. There are expectations that the repeal of PUHCA would deregulate $1 trillion
of electric generation, transmission and distribution assets and natural gas distribution assets
putting them up for sale at a time when financial institutions are beginning to show interest in the
utility sector. It is also anticipated that the repeal of PUHCA may spark further consolidation,

5
Dr. Richard Hirsh. “Post World War II Golden Years.” From Smithsonian Institute exhibit “Powering a
Generation of Change”
6
Pub. L. 102-486, 106 Stat. 2776 (1992).
7
Geddes, Richard R. “Time to Repeal The Public Utility Holding Company Act” Cato Journal Vol. 16, No. 1
(Spring/Summer 1996).
the entry of foreign buyers, and the use of non-traditional financing as well as change the role of
state regulators.

David Sokol, CEO of MidAmerican Energy Holdings Company, a subsidiary of Warren

Buffet’s Berkshire Hathaway, currently in the process of acquiring PacificCorp, a western utility
based in Portland, Oregon, claims that “Consumers have saved tens of billions of dollars since
Congress began the process of opening wholesale electricity markets to competition 10 years ago.”
He also contends that by restricting utility ownership, PUHCA is keeping much needed new capital
for upgrading the electric power transmission grid out of the energy industry.

According to rating agency Standard & Poor’s, the utility sector is slow-growing and
combinations can not significantly increase market share. On the other hand, James Hempstead,
Senior Credit Officer of Moody’s Investors Services “sees a real need for consolidation in this
fragmented, capital-intensive industry”. Yet, he also does not foresee a big wave of utility
mergers since the regulator process is so daunting, especially at the state level.

Many analysts agree that there will be “substantial consolidation” in the utility industry
once PUHCA is repealed. A more active corporate control market, more entrepreneurial
managers, and firms that can efficiently manage risk will rise to the forefront. Since PUHCA
was designed to reduce over-concentration of economic power in just a few companies, its repeal
will enable interstate holding companies the freedom to buy up and consolidate distribution
companies. Given the controversy generated by the repeal of PUHCA and the opening of the
industry, risk managers need to be aware that changes are on the horizon.

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Catherine A. Asaro is an Assistant Vice President at Beecher Carlson’s Executive Liability

Practice in New York. Catherine holds a B.S. degree in Business Management from St. John’s
University and a J.D. from New York Law School. Catherine is admitted to practice before the
New York State and Federal Bar. She can be reached at casaro@beechercarlson.com

Thomas Tierney is a Vice President in Beecher Carlson’s Executive Liability Practice in New York.
Tom works closely with Beecher’s Energy Practice with respect to Executive Liability Issues. Tom
holds a B.S. degree in Business Management from Salve Regina University. Tom can be reached at
TTierney@beechercarlson.com

Disclaimer
This publication is for informational purposes only. It is not a guarantee of coverage and should
not be used as a substitute for an individualized assessment of one’s need for insurance or
alternative risk services. Nor should it be relied upon as legal advice, which should only be
rendered by a competent attorney familiar with the facts and circumstances of a particular matter.

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