Power Players

By Jyoti Thottam

The utility industry used to be the place widows and retirees invested their savings for steady dividend payouts and slow appreciation. That, of course, was before Enron--and before a recession and mild winter that crimped the demand for power. Since last October, investors have fled not only from the stocks of energy companies with complex finances and trading operations but also from old reliable electric and gas utilities. Some have lost half their value. Analysts view many of these utilities as prime candidates for acquisition, but even among the stronger U.S. energy firms, few are in a position to buy. Their stocks are battered, and credit-rating agencies have downgraded many of them, effectively drying up their access to capital.

Enter the Europeans. Last month, in a PricewaterhouseCoopers survey of major utilities in 19 European countries, more than half the larger firms said they plan to expand into North America. Some have already begun. Last month shareholders approved a deal to sell LG&E Energy Corp., based in Louisville, Ky., to the German giant E.ON. Its German competitor, RWE, bought one of the largest U.S. water utilities in January, the same month that a British firm picked up Niagara Mohawk of Syracuse, N.Y. Flush with cash and out of room to grow on their own turf, the Europeans see an opportunity in the U.S. to pick up individual plants or whole companies at fire-sale prices.

"They've all opened offices; they've all got advisers," says John Sodergreen, editor in chief of Scudder Publishing, a group of energy-industry newsletters based in Annapolis, Md. He expects five midsize U.S. companies to be bought by Europeans by the end of the year. The objects of their desire don't look very sexy today, but that will probably change once the economy starts growing faster and demand for power surges.

Leading the charge are the two German companies: E.ON, based in Dusseldorf, and RWE, with headquarters in Essen. "Our goal is to achieve a leading position in the U.S.," says E.ON CEO Ulrich Hartmann, 64, a jazz buff who already has transformed his company. He took over Veba--the firm his father once ran as a state enterprise--in 1993, just before Germany deregulated its electricity markets. He focused the company on its core utility business and two years ago merged it with Viag, another major German utility, to form E.ON. Hartmann is sitting on $31 billion in cash and says he wants to spend it on two major U.S. electric companies, completing one acquisition by the end of the year.

Unlike many of its U.S. rivals, E.ON had its balance sheet in order at the end of 2001. After selling off underperforming telecom assets, it lowered its debt-equity ratio from 21% to 2%. (Compare that with 79% for Calpine, the power-generating firm based in San Jose, Calif.) Hartmann's advance team is already on the ground in New York City. Its members arrived to handle the purchase of LG&E, which E.ON took over through the acquisition of LG&E's British parent, PowerGen. Shareholders approved the deal last month, and the company is waiting only for an expected green light from the Securities and Exchange Commission. In the meantime, Hartmann has assigned PowerGen's former chairman, Ed Wallis, and E.ON board member Michael Gaul to run a new company that will push forward E.ON's Stateside expansion.

E.ON isn't openly in talks with anyone yet, but speculation centers on companies that are located near LG&E. J.P. Morgan Chase utility analyst Pierre Stiennon says to look for a deal with Cinergy, based in Cincinnati, Ohio; Allegheny Energy in Hagerstown, Md.; or PPL of Allentown, Pa. All three companies produce and sell power on the wholesale market and also serve a large base of regulated retail customers. Hartmann is known as a careful shopper. When he explored a U.S. acquisition as CEO of Veba, the man on the other side of the table was Enron's Jeff Skilling. Hartmann walked away after deciding that the two companies' cultures and business models wouldn't mesh well together.

RWE is further along in its U.S. plans. About 20% of RWE's revenue in the past fiscal year was generated in the U.S., from a water utility in New Jersey and power plants in Pennsylvania, among other holdings. If its $4.6 billion purchase of American Water Works, based in Voorhees, N.J., is approved by regulators as expected, RWE will own the largest publicly traded water utility in the U.S.

Some energy analysts believe the next item on RWE's shopping list is a large independent U.S. power producer. Stiennon named four of the biggest firms in the industry--Calpine, AES, Reliant Resources and Mirant--as likely targets. RWE CEO Dietmar Kuhnt insists that "we've done a lot of good acquisitions, and now we want to rest." But when analysts asked whether RWE had ruled out buying one of the big merchant generators, CFO Klaus Sturany said, "We are talking about one or two power plants at most."

RWE wisely strikes a cautious public tone. The U.S. Public Utility Holding Company Act of 1935 restricts companies that already have holdings in multiple utilities (electricity, gas, water) from making further acquisitions. "We can't follow a fully integrated strategy in the U.S. because of puhca," Sturany said. The energy bill before Congress includes an amendment that would repeal puhca.

But this regulatory uncertainty hasn't been enough to dampen M&A enthusiasm. Last month Britain's electric and gas utilities announced a merger that would create a national powerhouse with the cash to make its own push into the U.S. National Grid Group, the monopoly electric carrier in England and Wales, and Lattice Group, which owns a British gas network, will form a company worth $21 billion.

The Brits' intentions are clear. The two companies took pains to win the confidence of credit-rating agencies: Standard & Poor's, Moody's and Fitch all affirmed their A-rated debt. And in announcing the merger, National Grid CEO Roger Urwin said he plans to "deploy the combined resources and financial capacity of National Grid Transco [the merged company] to take advantage of opportunities in the liberalizing energy markets abroad, in particular extending National Grid's successful U.S. strategy." Half the company's profits already come from the U.S., thanks to three utilities it owns in the Northeast, including Niagara Mohawk, which National Grid bought in January.

All this attention might be just the thing to boost the sagging fortunes of U.S. energy companies. Without access to the capital markets, power producers canceled an estimated 33% of the power projects on the drawing board for this year, according to Platts, an energy-industry research service based in New York City. "You'll pretty much see the power-plant cycle stopping dead in its tracks," says John Olson, an energy-industry analyst at Sanders Morris Harris in Houston. Selling off some assets may strengthen the power companies' balance sheets, but it's still unclear whether this will be enough to stave off a power-capacity shortage in the next three or four years, when those canceled power plants would have been coming online. Analysts say the Northeast will be particularly vulnerable to price hikes and perhaps even California-style rolling blackouts.

In the meantime, cash-strapped U.S. firms are finding creative ways to meet the demand for power, securing cheaper sources of natural gas (the fuel for many power plants) in Canada and Mexico rather than financing new development domestically. U.S. firms spent more than $27 billion last year buying Canadian oil and gas companies, and the government of Mexico is considering 18 separate U.S. proposals to bring to the Baja peninsula liquefied-natural-gas terminals, which would receive shipments from all over the world and pipe gas to the U.S. European and U.S. energy firms have at least that in common: they know a good deal when they see one.

--With reporting by Cathy Booth-Thomas/Dallas and Steve Zwick/Dusseldorf and Essen

With reporting by Cathy Booth-Thomas/Dallas and Steve Zwick/Dusseldorf and Essen