TXU Buyout Heralds Dawn of New Era for Utility Mergers
London, 01/03/2007
The $45 billion buyout of TXU Corp. signals serious private equity interest in the capital-constrained electric power market and new attention by Wall Street on managing environmental concerns. It's changed the face of utility mergers forever.
But the deal, approved by TXU's board of directors last weekend, illustrates the adage, "Where you stand depends on where you sit."
Utility executives are hailing the $32 billion cash, $13 billion debt deal by Kohlberg Kravis Roberts and Texas Pacific Group as a watershed for an industry that needs a major infusion of capital for generation and transmission expansions.
Environmentalists are spotlighting the agreement to scale back TXU's controversial plans to build 11 new coal-fired power plants in Texas to three -- which will avert production of 56 million tons of carbon.
And the company is trumpeting plans to cut customer rates by 10 percent.
Industry analysts say the buyout -- which will make Dallas-based TXU private and parcel it into separate generation, transmission and distribution companies -- indicates that investors may be getting over their fear of the "poison pill" of regulation and all that it entails.
But Richard McMahon, executive director for power supply at the Edison Electric Institute, said the TXU deal is not a likely template for future utility takeovers because each is different and represents different regions. And different financial elements lead up to the individual transactions.
McMahon credits Congress' repeal of the Public Utility Holding Company Act in the 2005 energy bill for laying the groundwork for the buyout. The law, enacted in 1935, put limits on ownership of electric utilities. Lawmakers endorsing its repeal said they wanted to be able to open the industry to new sources of capital for the anticipated expansions that will be necessary to meet consumer demand for electricity.
'Cusp of a major capital expansion'
This is not the first private equity takeover of a utility. Private firms have been busy with smaller capitalized utilities. Last year, Australian equity firm Maquarie led a consortium in taking over Pittsburgh-based Duquesne Holdings for $1.59 billion. Legendary investor Warren Buffett's Berkshire Hathaway owns Iowa-based Mid-American Energy, which recently bought Portland-based PacifiCorp. Babcock & Brown Infrastructure, another Australian firm, is in the process of buying Sioux Falls, S.D.-based Northwestern Energy for $2.2 billion.
"In general, we look at the fact that Berkshire Hathaway, KKR and Maquarie are interested in our sector," McMahon said. "We see that as a positive thing. We're at the cusp of a major capital expansion for generation, transmission and distribution, and access to that part of the capital market is a good thing."
Analysts already are looking for the next development.
From a purely financial standpoint, analysts note that private equity firms now are flush with cash. The deal signals they are expanding their list of potential targets and are willing to wait out the "poison pill" of regulation that sometimes takes merger deals anywhere from 12 to 18 months or more to complete.
To get around that, one insider who requested anonymity suggested the "entire merchant power sector" would be up for grabs, as by nature their operations face far less regulation than regulated utility transmission and distribution facilities.
Likely targets would be any of the big firms -- NRG Energy, which also is based in Texas, as well as unregulated generating assets owned by big utilities such as Public Service Enterprise Group and PPL, and the unregulated merchant nuclear plants of Entergy and Exelon.
"If it's got good cash flow, it's a go," one analyst said.
The environmental angle
The TXU deal's environmental angle cannot be missed. TXU caught tremendous flak for its attempt to build 11 new coal-fired power plants in Texas to help meet the growing demand for electricity there.
Yet in the portion of the deal approved by the advocacy groups Environmental Defense and Natural Resources Defense Council in exchange for dropping their legal challenges to TXU's construction plans, KKR and Texas Pacific will forego eight plants, build three and rely on expanded investments in renewables and energy efficiency to make up the difference. The plan includes $400 million in demand side management programs.
"This is the single largest reduction of greenhouse gas emissions by virtue of what it will not do," the analyst said. "This reduces the risk premium" associated with uncertainty over regulatory approval of the coal-fired power plants and anticipated congressional action on climate change legislation.
Peter Altman, director of the coal campaign for the National Environmental Trust, said the TXU deal "shatters the aura of invincibility many coal plant developers have assumed, by showing that the growing extent and diversity of opposition can stop plants that will make global warming worse." NET notes that companies such as Dynegy, LS Power, Peabody Energy, Xcel, Duke and Dominion are pursuing new coal-fired power plants.
Eric Kane, an analyst with Innovest Strategic Value Advisors, said his firm is monitoring investor risks associated with the coal plant expansion strategy due to rising construction costs and schedule delays.
"Although the TXU case was unique in its proposed scale, the challenges faced are indicative of a growing trend throughout the utility industry, the lessons learned from TXU will have national implications," he said. "Industry peers will face similar challenges as they move forward with expansion strategies that rely on new power plants that utilize outdated, highly polluting pulverized coal technology."
TXU has pledged to reduce mercury, sulfur dioxide and nitrogen oxide emissions by 20 percent from 2005 levels, increase the efficiency of its generating plants by up to 2 percent and double its purchase of wind power to more than 1,500 megawatts. The company also plans to promote solar power through solar-photovoltaic rebates and will join the United States Climate Action Partnership.
Another observer quipped that the deal should have been announced at Sunday night's Academy Awards show, at which former Vice President Al Gore's "An Inconvenient Truth" documentary on the perils of global warming won an Oscar.
But EEI's McMahon downplayed the importance of the environmental angle. He maintains that TXU's circumstances are unique and generation decisions are made on state and local, not national, levels.
"The involvement of environmental groups in this proposal is something that sort of came with what was announced," McMahon said. "We're in a mode of needing more, not less, generation. The question is who will build what. I believe that was one of the reasons why PUHCA was repealed, to bring in capital so investments can be made. I'm not so sure it's going to set a precedent."
And though some observers suggest that the emissions angle to the deal could spark some backlash in Texas because concern about global warming there is not high, Tom "Smitty" Smith, head of Public Citizen's Texas office and a key opponent of the TXU coal plant strategy, said that characterization is a myth and that the coal plant controversy has sparked significant opposition among consumers within the state.
Rate cuts at issue
As for the 10 percent consumer rate cut, TXU has pledged that it will be effective through September 2008, with an immediate 6 percent cut for residential consumers and the other 4 percent reduction coming upon completion of the takeover.
But Public Citizen's Smith says the company's current rates are "probably 30 percent higher than they should be." The company's rates are based on natural gas prices that last were indexed after Hurricane Katrina hit the region and sent prices soaring. The situation has so angered state lawmakers that there are efforts in the Legislature to use the state's utility laws to cut into TXU's Dallas market.
Smith said he is looking for a "win-win-win" situation where TXU could further lower its rates and could avoid building even the three coal plants it wants to build by applying even more dramatic energy efficiency measures to the market.
Ends --
Greenwire
