Bill Collet, Christenberry Collet & Co.
This spring, Vermont Electric Co-op. closed on its purchase of the sub-transmission and distribution assets of Citizens Communications Co.’s Vermont Electric Division (VED). The $18 million acquisition added 21,000 consumers to the cooperative, more than doubling its size.
The cooperative is one of many electric utilities turning to mergers and acquisitions to gain operating efficiencies through territory growth. In 2003, North American electricity and gas transactions totaled $18.2 billion, up from $11 billion in 2002, according to Pricewaterhouse Coopers. More transactions are expected in 2004. As of mid-June this year, electric utilities-along with gas, water and sanitary services-have engaged in 80 M&A deals with a combined value of $7.6 billion, according to Mergerstat, a financial information provider.
There are many reasons for utilities to explore mergers and acquisitions: to build up a customer base, to improve cash flow and stabilize rates, to more effectively and economically serve its customers, and to increase equity value. A well-researched, well-executed deal can bring a number of benefits, including expanded service territory, leveraged resources, expanded product offerings, enhanced competitiveness-even lower rates.
However, before beginning to pursue M&A, a utility should make sure it is prepared in five key areas: strategy, board of directors, management team, balance sheet and backup.
Mergers and acquisitions growth is the execution of a strategy designed to mitigate cost increases, provide rate stability and rationalize cost of service. Transactions are not the strategy itself. A utility must know why it is doing a deal; if the rationale can’t be explained, don’t do it.
If a utility’s strategy is to leverage its existing costs to provide rate stability or offer rate decreases, M&A can be a great fit. A utility’s costs do not increase proportionately as it adds territory, creating the operating leverage to allow for more stable or even lower rates. For example, Vermont Electric Co-op.’s acquisition of VED allowed the co-op to offer an 8.3 percent rate reduction to existing members.
M&A also complements a strategy to invest in improved service quality and implement best practices for increased competitiveness. The larger, post-deal system can afford state-of-the-art technologies and capital investments that improve service quality beyond what the pre-deal system can often afford.
The utility’s board of directors must believe in the strategy and fundamentally understand what the M&A deal brings to the table. Board members must believe that M&A is a viable method of executing the existing strategy and be willing to allow management to spend the time and resources looking for M&A opportunities.
the management team
People inherently dislike change; this is truer in the utility environment than in other, more volatile areas of business where change is a way of life. Start implementing a new corporate culture, one that emphasizes creative thinking, embraces challenges and does not fear change. Within this culture, employees must be comfortable enough that personal or territorial concerns become secondary to the execution of a strategy that delivers value to the customer. Building such a culture is an important step, and one that does not just happen.
the balance sheet
Recognize that financial liquidity is important to the ability to execute mergers and acquisitions. One rule of thumb: If the equity-to-assets ratio after the acquisition is more than 20 percent, it’s generally a financeable transaction.
Mergers and acquisitions have different effects on the balance sheet. Mergers build consolidated equity and cash flow; they add to, rather than use, liquidity. Mergers do not involve new debt, so they leave the balance sheet in a strong position. Acquisitions, however, require payment in cash, which necessitates debt, but they expand utilities’ customer bases and leave them better positioned to leverage existing costs.
Prepare a seasoned advisory team to assist with M&A transactions. Many utilities do not have a relationship with a law firm that is well-versed in the execution of M&A deals; they may simply have general counsel who tends to everything from easements to employee discrimination claims. M&A transactions require specific expertise.
In addition, most of these deals will require some level of public utility commission approval; it is necessary to have a lawyer who does regulatory business in that state. Accounting advice is also imperative, for both due diligence and the financial statement impact of the transaction on the merger partner or acquirer. A utility may need to engage environmental and engineering due diligence advisers. An experienced investment banker will coordinate all facets of the transaction process.
This does not mean a utility must put several professionals on retainer, but it should know who and where to go to for regulatory, transaction and due diligence services. Having a team of experts in mind can substantially smooth the process later on.
Collet is a principal at Christenberry Collet & Co., Inc., a Kansas City-based investment banking firm that has advised cooperatives on merger and acquisition transactions ranging in size from $20 million to more than $1 billion since its founding in 1994.