NSTAR forges new model as wires and pipes utility

Michael T. Burr

Editor

EL&P`s Utility of the Month for March 2000 is NSTAR, formed from the merger of Boston Edison and Commonwealth Energy Systems.

Boston Edison was one of the first U.S. utilities to re-tool itself completely. The company sold all its generating assets and focused its efforts on the wires and pipes business, delivering electricity, gas and telecommunications services in New England.

Striving to attain greater cost-savings through scale economies, the company successfully merged with Commonwealth Energy Systems and is now working to fully integrate the operations of the two firms` four operating utilities under a single banner: NSTAR.

NSTAR`s Chairman & CEO, Thomas J. May, spoke with EL&P in mid-February about his company`s strategy and vision for the future.

EL&P: What is NSTAR`s strategy, and what key changes have prepared the company for the future?

May: It all began a few years ago, as our industry started to go through what was referred to as deregulation. Massachusetts was one of the early states to embrace competition and unbundle our business into its respective wires and generation parts. We assessed our situation and felt that the power generation world would be dominated by a few very large players, and that was not necessarily one of our core competencies. We aligned ourselves toward energy delivery-a wires and pipes business, if you will.

Our restructuring at the state level required us to sell off our power plants and reduce our prices, in exchange for a recovery of the capital we had invested in the power business. We reduced customers` rates by 15 percent, and we were allowed to recover our stranded power assets. We owned a nuclear power plant which we sold below book value. We securitized those costs, issuing about $700 million in state-guaranteed bonds. Our obligation is to collect a transition charge and pay it to the state so they can retire the bonds over a period of about 10 years.

We felt at that time that we needed a larger customer base. We had about 670,000 customers as BEC Energy. We negotiated and merged with one of our neighbors, Commonwealth Energy Systems, to form NSTAR. This gave us about 1.3 million customers-a little over 1 million in electric and 250,000 in gas-and from that platform we are investing in technology that will change the way we do business and the services we provide to our customers.

Also, the Telecommunications Act of 1996 opened up the telecommunications market to competition. Back in 1997, we entered a joint venture with RCN to form a telecommunications company, RCN Boston. We owned 50 percent. We started to build a fiber optic, high-speed network that would provide Internet, local and long-distance telephone and cable television service.

Our focus has been on delivery of services. We have seen some convergence of electric, gas and telecommunications industries. Whether it`s through a pipe or a wire, we`ll deliver it.

EL&P: Please explain NSTAR`s corporate structure.

May: NSTAR is the parent holding company, which owns four utilities-Boston Edison, Commonwealth Electric, Commonwealth Gas and Cambridge Electric. It also owns a service company, NSTAR Services, which provides services to those utilities-customer care, payroll, logistical support, other central services. We also own two other unregulated businesses-in telecommunications [NSTAR Communications, which holds the RCN Boston investment] and district energy [Advanced Energy Systems].

EL&P: How much of NSTAR`s revenues are expected to come from unregulated businesses?

May: We do not have a goal to become a significant unregulated player. We would prefer to provide electric and gas services to more customers if we find an opportunity to do that. Our largest investment was in Commonwealth Energy Systems, and we would be interested in acquiring other properties similar to that. We believe telecommunications offers us an interesting opportunity. We`re looking for other opportunities, and we may even build our own fiber network to lease to others-the carrier`s carrier model.

Every time we`ve seen a company setting a goal to have a certain percentage of profits coming from unregulated business in a set time frame, those goals have not been met. We have no such goal. We believe we have a bright future as we are currently configured, from an earnings perspective, and we do not have any specific intention to grow dramatically the unregulated business.

Telecommunications is a small portion of overall revenues, but it`s not an insignificant portion of potential capital gains and profits. The RCN investment has appreciated considerably. A $100 million investment has turned into $300 million of stock.

EL&P: What is the regional market area for NSTAR Communications?

May: We`re essentially serving people within the service territory of our utility companies. The RCN model looks for high density. It began with a build from Boston to Washington on the theory that while that only represented 6 percent of the geography, it represented 26 percent of the telecommunications traffic in the country. The RCN model is to go to places where you can get the most customers per mile when you`re building a new system. We have been selective in where we build out. It has been primarily greater Boston.

EL&P: Where is NSTAR headed in the transition to competitive retail energy markets?

May: We have stayed away from the energy provider role because we believe that not only do you have to invest significant money in the physical power plant assets but in this new world you also need some very sophisticated risk management competencies. Last summer, when we had the heat wave, lots of utilities who participated in this market lost a fortune. We chose to stay away from that, and went into the service business.

The first thing utilities will decide in this business is what markets they will pursue-retail markets, energy markets, delivery business or in some cases all those markets. We have chosen to stay on the customer service side. As a result, one of the things we`ve focused on is improving and guaranteeing a certain level of service, and a way of doing business that the consumer finds friendly. We`re working very hard toward that end. In the future, people do not necessarily want to do business with a customer service rep. I can remember having to go to the bank between 9 a.m. and 3 p.m. to get cash for the weekend. That`s the only time they were open for me to get my cash out. The world has changed. I never do business with a teller, and I don`t want to. I use an ATM to get cash, my computer to pay bills, so forth. That`s the way the world is moving.

We need to give our customers easy access directly to our computers so they can receive bills, pay bills, apply for service, tell us they`re moving and discontinue or change service. We`re working toward the capability where, through the Internet, people can do business with us in a very efficient and low-cost fashion. That`s our direction for the future-improving service and focusing on the customer.

In fact, that`s where our name, NSTAR, came from. We view our North Star as the customer. If we can anticipate and meet their needs, we will be successful. We try to focus all our employees on that same North Star, and try to make sure our customers are in the dark neither literally nor figuratively.

EL&P: How much progress have you made in your e-business strategy?

May: Boston Edison`s website gives people the ability to review bill history and pay their bills. We are trying to make it happen for all three electric utilities and the one gas company that form NSTAR.

We haven`t yet started to really market and move customers in volume to doing business electronically with us. But our goal for the year 2000 is to have a significant number of customers who take advantage of this easier way to do business, and eliminate the paper.

EL&P: What factors and changes have been most important for NSTAR`s stock value and cost of capital?

May: With respect to our stock value, we were one of the top half-dozen performers in 1999. We must continue to push our prices and our costs down, and we have committed to growing both earnings and dividends consistently for the last five years. We just raised our dividend this past December, and we`ll continue to look at it annually.

Our merger is allowing us to take costs out of the business and help us fuel some of that earnings growth.

Second, our investment in RCN, and the strong performance of RCN`s stock itself, has been an important factor. RCN is a NASDAQ-traded company, and we have the ability to convert our interest in the RCN Boston venture into stock in the RCN parent company. We have created a lot of value there, and Wall Street has certainly been interested in that and our future investments in telecommunications. The utilities that have made substantial investments in telecommunications have generally been rewarded by Wall Street, vis-a-vis their stock price.

EL&P: Has the ownership arrangement in your telecom subsidiary allowed you to avoid the downside that new venture investments often have on utility stocks?

May: I can`t say we`ve avoided it entirely. To be honest, anything that is a startup venture has an earnings drag. We have been able, through the way we`ve structured it, to minimize that by converting our share in the local venture. The operating losses in that venture go away when we convert our interest into shares of stock in the parent company. We have been conscious of that, and we wanted to protect our investors from the operating losses that could affect earnings. So we have minimized that, but I can`t say we`ve eliminated it entirely.

EL&P: How has your cost of capital fared through all these changes?

May: We have generally been in a very strong cash flow mode. We are buying back shares of our stock in the market right now, so we have no need for capital. Right now we have excess capital, despite the fact that we are investing in this telecommunications venture.

When we did the securitization that raised $700 million, we bought back a lot of our debt and shares of stock, and Standard & Poor`s, Moody`s and Duff & Phelps all raised their ratings on our commercial paper, and they raised our bond ratings to the highest levels we`ve experienced in 25 years. So obviously the higher credit ratings transfer into lower capital costs going forward.

EL&P: What are the most important management steps you`ve taken with NSTAR?

May: We made a decision early as to what we wanted to do and where we wanted to be within the myriad of opportunities that were available to us in this industry, and then we worked very hard and quickly to get there.

When we set our course a few years ago to become a wires and pipes company, we were the first utility in the Northeast to sell its fossil-power plants. We were the first utility in the nation to sell a nuclear power plant. We were the first in our region to merge and integrate two companies into one to get the scale we needed.

Our strategy is to lay out what we`re going to be and why, and then move very quickly to get there. We`ve done that pretty well.

EL&P: What`s your overall goal for NSTAR for the next five years?

May: We`re in a consolidating industry. Five years ago, no one would have guessed what we`d look like today, and a lot of people are trying to guess what we`ll look like five years from now. We have a strategy to focus on the customer, to provide an above-average return for our shareholders, and to look for opportunities to make investments which will benefit our shareholders and our stock price. We are disciplined investors. We`re not going to invest just to get bigger or to achieve some arbitrary goal of having 50 percent of our earnings coming from non-regulated ventures. We`ve got a good strategy to grow the business we have, and we will look for opportunities as the industry consolidates to enhance our position in the market. n

MILESTONES IN BOSTON EDISON`S TRANSITION TO NSTAR

– 1995: Boston Edison (BEC) proposes restructuring along functional lines, plans to offer customer choice. BEC adopts wires-and-pipes strategy.

– 1996: Telecommunications Act of 1996 opens telecom market to competition.

– 1997: BEC reaches agreement with Massachusetts attorney general to restructure the company and the industry-including provisions for sale of its generation assets and stranded asset recovery through transition charges. BEC forms RCN Boston telecom joint venture to build a fiber-optic network to provide Internet, telephone and cable TV services.

– 1998: Customer choice becomes reality in Massachusetts on March 1. BEC and Commonwealth Energy Systems announce planned merger in December; Entergy agrees to buy Pilgrim nuclear plant

– 1999: BEC completes sale of Pilgrim unit, BEC`s sole remaining generating asset. Total proceeds from all generation sales: $560 million. BEC securitizes $725 million in stranded assets. BEC reduces rates to customers by 15 percent. Merger with Commonwealth Energy Systems completed in August-less than 10 months after announcement. Expected cost savings: $3 billion. New NSTAR name unveiled in August with aggressive marketing campaign, focusing on customers as the company`s North Star. Operating companies retain their old names. Goldman Sachs ranks NSTAR seventh among U.S. utilities for total shareholder return.

– 2000: NSTAR plans to convert “significant number” of customers to electronic bill payment by end of year.

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The Clarion Energy Content Team is made up of editors from various publications, including POWERGRID International, Power Engineering, Renewable Energy World, Hydro Review, Smart Energy International, and Power Engineering International. Contact the content lead for this publication at Jennifer.Runyon@ClarionEvents.com.

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