Trend—How Strong Is the Urge to Merge?

Facing a jungle of uncertainties, electricity businesses have been skittish about mergers and acquisitions over the past few months. But that could change, according to Jeremy Fago, power and utilities advisor for the consulting and accounting firm PwC. “We saw a slowdown for the first half of the year,” Fago told MANAGING POWER recently. “We expect to see that pick up, particularly on the unregulated side” of the industry.

In the first half of 2012, according to PwC, there were a total of seven announced M&A deals with individual values greater than $50 million, totaling $4.1 in deal value. That compares to 32 deals with a price tag of $53 billion in the first half of 2011, so the decline in activity has been pronounced.

Surprisingly, Fago says he’s sensing an increased interest in coal-fired projects as acquisition targets, particularly as the price of the commodity and the generating assets drops and anxiety about the possibility of a return to higher natural gas prices builds. “PwC is getting more and more queries about coal,” Fago says, noting that the interest in the coal is strategic, not just a one-off, single-plant discussion.

The future price of gas, Fago said, is the key uncertainty, although environmental regulations also play a role. “There is still a divide in the industry” over the future of gas,” he said. “Maybe it stays low for an extended period of time, but what happens if and when price volatility comes back?” If natural gas prices increased, as they did after the “gas bubble” of the 1990s disappeared, Fago noted, companies “don’t have a lot of options.” There are renewables, but they have well-known problems related to intermittency and reliability. There is demand-side management, but that quickly tops out. What’s left? Coal and nuclear.

And nuclear, Fago said, faces its own set of daunting economic issues. In a capital-constrained world where short-term returns are crucial to investors, nuclear looks to be at a real disadvantage. Coal, on the other hand, looks relatively attractive, particularly in the merchant side of the business.

A harbinger for the coming months may be the deal announced in July, where merchant generator NRG Energy agreed to buy GenOn energy, another independent power producer, in a $1.7 billion, all-stock deal. Including NRG’s assumption of GenOn’s debt, the total value of the deal is about $4.2 billion, according to analysts.

The combined company, which will keep the NRG moniker, will have an asset value of $18 billion, and a fleet of 47 GW of fossil (coal and gas), nuclear, wind, and solar generating plants. The new company, assuming the merger wins regulatory approval, will move ahead of Calpine Corp. as the largest merchant electric generator in the U.S.

“This industry has needed to consolidate on some level,” NRG CEO David Crane told the New York Times. “This deal creates the first player of this scale in the industry.” Crane will lead the new business and Edward Muller, another veteran of the merchant generating business and GenOn’s chief, will become vice chairman. Both companies saw their stock prices fall considerably in the months before the announcement, and hope the deal will pump up the shares.

Another recent merger announcement, while not directly involving generators, does hold interest for the power industry. Engineering and construction giant Chicago Bridge & Iron in July said it will buy a major rival, Shaw Group Inc., for $3 billion in cash and stock. Both firms are well known in the energy and power business, with long experience building power plants and energy infrastructure, although Shaw is best known. Shaw CEO J. M. Bernard Jr. said, “Shaw’s leadership position in the power, environmental and infrastructure industries will complement CB&I’s current business.” Shaw will operate under the name CB&I Shaw, as a CB&I subsidiary under the overall direction of CB&I chief executive Philip K. Asherman.

While mergers and acquisitions are among the most familiar activities on the energy business scene, there may also be some activity in the opposite direction. Edison International, the Southern California holding company that owns both regulated and merchant generation may put its money-losing independent generator, Edison Mission Group, into Chapter 11 bankruptcy protection, according to Bloomberg Businessweek. That could lead to a spin-off of the under-performing independent generator.

According to the magazine, Edison Mission has seen its losses grow from $30 million last year to $110 million this year. The parent company issued a Securities and Exchange Commission filing saying Chapter 11 reorganization was a possibility. Edison, based in Rosemead, Calif., is also hemorrhaging cash because of the extended outage of its San Onofre nuclear generating plant. The shutdown is reportedly costing the company about $1.5 million a day just in lost revenues.

Also on the nuclear front, there have been strong rumors and distinctly audible whispers that General Electric, one of the original pioneers of nuclear-generated electricity, may spin off its nuclear business entirely to its current Japanese partner, Hitachi. In 2007, the companies set up two joint ventures—one in Japan and one in the U.S.—to go after what they expected would be a growing market for new nuclear generation. Now the buzz is that the two joint ventures would be collapsed into one, run by Hitachi, and aimed at the non-U.S. market.

The GE rumors come at the same time that GE’s high-profile CEO Jeff Immelt has been throwing nuclear under a natural-gas-powered bus. Immelt told the Financial Times, “It’s really a gas and wind world today. When I talk to the guys who run the oil companies, they say look, they’re finding more gas all the time. It’s just hard to justify nuclear, really hard. Gas is so cheap, and at some point, really, economics rule.”

Immelt’s injunction—“economics rule”—is indeed the watchword for the world of mergers, acquisitions … and divestitures.

—Kennedy Maize (@kennedymaize) is MANAGING POWER’s executive editor.

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