4 Utilities That Know How to Scale Up

11/17/2011 8:15 am EST


Roger Conrad

Chief Analyst/Managing Partner, Capitalist Times

Providing essential services is a scale business. The bigger the company, the better it can handle heavy capital needs and spread out costs, writes Roger Conrad of Utility Forecaster.

Scalability is the clear message from the thousands of power, gas, water, and communications mergers since these industries’ origins in the late 19th century.

Unfortunately, many regulators and politicians aren’t hearing it, or have chosen instead to bash merging companies as Big Brother monopolists in hopes of scoring a 2012 election advantage.

The rhetoric continues to ratchet up for AT&T’s (T) $39 billion bid for Deutsche Telekom’s (DTEGY) T-Mobile USA. US District Court Judge Ellen Segal Huvelle apparently won’t allow Sprint (S) and others to join the US Dept of Justice’s lawsuit to block the deal, or potential competitors like Google (GOOG) access to confidential information from the case. And there’s still a chance of a settlement before the trial begins.

On the other hand, the Federal Communications Commission (FCC) has yet to rule, and DoJ is bringing in pricey outside council, indicating it’s prepared to go the distance. The upshot is this thing could go on a while.

That won’t hurt AT&T, which is firing on all cylinders. AT&T is a buy up to $33. But it could be disastrous for the owner of underfunded and iPhone-less T-Mobile USA. Sell Deutsche Telekom.

Northeast Utilities (NU) and NSTAR (NS) are waiting for Massachusetts regulators to rule on their proposed merger. Meanwhile, Attorney General Martha Coakley is demanding either a five-year rate freeze or $314 million in one-time credits.

Even those conditions won’t take away the deal’s main benefit, improved ability to execute major transmission projects in New England. Here, too, however, Coakley is sticking her beak in, calling for the Federal Energy Regulatory Commission (FERC) to cut $113 million off power transmission rates. Joined by officials in neighboring Connecticut, Coakley has charged companies with making “unreasonable” profits based on “excessive” rates.

FERC currently allows an 11.14% return on equity for constructing new transmission lines that Coakley wants cut to 9.2%. Such a move would no doubt choke off transmission construction in the region, as it’s basically a bait-and-switch move.

Merger approval is still likely. But Northeast Utilities and NSTAR are holds until this is resolved.

Exelon Corp (EXC) and Constellation Energy Group (CEG) have reached a settlement with the Pennsylvania/Jersey/Maryland (PJM) system that should assure FERC approval of their merger. The deal would limit prices and requires the sale of 2,648 megawatts of capacity, close to the 3,389 megawatts figure posited in a filing by Maryland’s consumer advocate.

The companies are also offering rate credits and a pledge to build a new headquarters building in Baltimore. Even that may not sway Maryland officials. But Exelon isn’t pricing in success; a win would take it well north of my buy target of $50. Constellation Energy is a buy on dips to $37.

Duke Energy (DUK) and Progress Energy (PGN) appear to have hit on a plan to satisfy both Carolinas regulators and FERC, which conditionally approved their merger on September 30. Rather than divest plants, the company would sell 800 megawatt-hours at a regulated cost-plus rate for eight years.

I continue to expect an end-year close. Buy Duke up to $20, Progress up to $50.

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