Growing through diversification: Montana Power finds gold mine in fiber-optic network

Michael T. Burr

Editor

When a little old lady from Butte received a call from her stock broker last April, she nearly fainted with shock. “Mrs. Smith,” the broker said, “Congratulations. You`re a millionaire.”

Mrs. Smith`s portfolio-heavily weighted with Montana Power stock accrued during her late husband`s 30-year career with the company-quadrupled in value in just two years. A fairly conservative, nest-egg strategy became Mrs. Smith`s golden goose.

While this anecdote is fictional, it`s based on reality. Montana Power`s stock quadrupled in value between April 1997 and April 1999, going from $21 to $85 a share.

This meteoric rise is largely attributable to the company`s investments in the telecommunications industry. Its Touch America subsidiary owns one of the country`s largest fiber optic networks. It spans 12,000 miles today, and is expected to spread to 20,000 miles by 2001.

While Montana Power`s experience is extraordinary, its diversified strategy is typical of U.S. electric utility companies. Utilities have long invested in non-utility businesses-everything from real estate to retail stores. Along with mergers and acquisitions, diversification has been the only significant growth tactic for electric utilities.

As deregulation introduced competition into the power game, the imperative to diversify has become more urgent. As a result, utilities have begun pursuing ever more ambitious growth strategies, both in terms of mergers and diversification. The pace of utility mergers has increased to a fever pitch, and diversification investments have become similarly aggressive. Traditionally conservative utilities have restructured themselves completely in effort to free their assets and organizations for growth pursuits.

Many such restructuring efforts are still in their early stages. Illinova Corp., for example, only recently gained approval to spin off its power generation assets into an unregulated subsidiary, and it expects to be one of the first to successfully implement this strategy.

Diversification efforts, likewise, continue shifting directions as companies struggle to achieve the strongest possible value for shareholders. PacifiCorp last year announced a restructuring that severed many of its unregulated business ventures. Portland General Electric, one of the first utilities to be acquired by a non-utility company, is now reportedly on the auction block, separate from its wholesale energy marketing and telecommunications assets.

“Portland General is not as strategic as it was before, when it had a strong wholesale business that we could integrate with our nationwide wholesale business,” said Jeff Skilling, Enron Corp.`s president and chief operating officer. “So we are looking for alternatives.”

Seeking alternatives is the name of the game for growth-minded companies. Diversification strategies, however, can be risky. The industry`s history is populated with the corpses of unregulated ventures that failed, and Montana Power`s success with Touch America is the exception, rather than the rule.

To find out how the company beat the odds, Electric Light & Power spoke with Bob Gannon, Montana Power Co.`s chairman, president and CEO. As he explained, a successful diversification strategy depends on the same attributes that make any entrepreneur succeed: determination, discipline and flexibility.

EL&P: What is Montana Power`s history with regard to business diversification?

Gannon: We have a huge service territory in a state that is blessed with natural resources. But there is not a lot of growth inherent in our 100,000-mile-plus service territory, because we don`t have a lot of people. We`re a gas and electric utility, with 280,000 electric and 140,000 gas customers. Opportunities arose in this rich resource area to develop natural resources. As long as they were tied to our underlying gas and electric businesses, they seemed to be a natural outreach for us.

In the 1930s, we got into the natural gas exploration and development business. In the late 1950s, we bought some huge coal reserves from Northern Pacific Railroad. We began developing those mines and selling a lot of coal.

In the 1980s we developed a sophisticated, microwave communications system to serve the unique communication challenge we had, talking among substations and plants across a vast service territory. When the Bell system began its breakup in 1984, we created a small telecom operation, designed to address Montana needs-putting telephone equipment into offices and reselling long distance.

Now, with the Internet explosion and the demand for bandwidth, we have created a national fiber optic network. This business grew out of our roots.

EL&P: Montana Power is getting out of the generation business. Why?

Gannon: There were some regulatory challenges with respect to the Montana restructuring law that led us to conclude that we probably wouldn`t be a successful, big player in power generation. We only had about 1 percent of the generation in the Western Interconnected Grid, and the risk profile had really changed. At the same time we had this telecom business with tremendous opportunities. So we decided to sell off the generation assets, and we`ll probably put the proceeds into our telecom business.

We got out of the power marketing and trading business last year because of the risk profile.

We have an independent power business that is small but quite successful. But independent power is more of a passive-equity kind of business for us. We`re in with other players who operate the plants and market the power. It`s more of an investment vehicle, as opposed to being actively involved in the management or trading and marketing of electricity.

EL&P: Some companies are spinning off their generation plants into unregulated subsidiaries.

Gannon: That is a tall order at best, and we wish success for people who think they can do it. Frankly, in our view, as the industry disaggregates into generation, transmission and distribution, different skill sets are required for each. We believe you have to be in one or the other, but it will be very difficult to be in all three at the same time. I know others don`t agree with us on this.

In addition, if you have an unregulated affiliate that is playing the market, trying to get customers in your own service territory, you raise incredible affiliate-interest issues. You need a clean separation.

Some companies are getting an unregulated presence in other states. That`s probably easier. You could focus on generation, but to mix regulated and unregulated in your own territory is a daunting task.

EL&P: Do you follow any cardinal rules in your unregulated ventures?

Gannon: A fundamental principle that has guided us from the beginning is the need to keep our unregulated, non-utility activities as separate structurally as possible from our regulated utility activities.

Aside from that, we`ve always had a guideline not to pursue anything that doesn`t have an opportunity to contribute a significant part to the financial strength of the company. Specifically, 10 percent of operating income was always a loose target we were trying to hit. We would, of course, give ourselves some time to get to that point.

Also, we`ve tried to keep a connection to our basic business. Each of the businesses I`ve described had some underpinnings in our underlying utility activities. They`ve moved out and become more separate, but we`ve been very careful not to get involved in what we`d consider unrelated activities.

Finally, they had to be sustainable opportunities. We weren`t interested in short-term, drop-of-the hat businesses. We`re more interested in building businesses rather than getting something prettied up and selling it.

EL&P: What`s the biggest risk of diversification?

Gannon: If you get too far afield from your underlying skill sets, your risk of failure is greater. Getting into the grocery business or banking, for example. They might be successful for someone, but as utility folks, we shouldn`t presume we have skills to do everything. We have a certain skill set, but it`s not for everything.

We haven`t had 100 percent success. We`ve had some businesses we got into and found out quickly we need to get out. That`s a tough discipline. You don`t just stay there and let it bleed you to death.

In real estate, a lot of utilities have great real estate properties. We were one of the original investors in Big Sky Ski Area in Montana. It`s now a very successful ski area, but we found out that business was not a strength of ours. We exited it after a very short period of time. It was misdirecting management time, which is another issue that is critical to us. We don`t want to get so far afield that our management time is consumed and taken away from other opportunities that are more positive for us.

EL&P: How have you developed an entrepreneurial culture?

Gannon: One of the helpful facts for us is that we`ve been involved in competitive businesses for a long time. For 40 to 60 years we`ve had people working in unregulated, successful businesses. Our own history has assisted us in that regard.

Also, we`re in a fortunate position, being the largest employer in Montana. We`re looked upon as an employer of choice, so we get talented young people continually fed into our operations.

But the culture issues are huge. It`s an ongoing challenge. The utility industry is a low-risk kind of business, not really competitive. Some people who grow up in that side of the business can`t change. But some people are more malleable than others, if given the opportunity.

Leadership is key. An important ingredient to good execution is proper leadership to help the culture-the entire employee base of a company-feel confident enough to succeed.

One thing that has helped us is our EVA program-economic value added. It`s a management tool that focuses all employees on continuous improvement. All our employees, even the union ranks, now have some of their compensation tied directly to the financial performance of the company. That`s the best thing we`ve ever done, to get people to focus on the realities of the competitive world.

EL&P: Are you facing competitive pressures already in Montana`s electricity market?

Gannon: Absolutely. We, along with Oklahoma, are the two low-cost states that have embraced the competitive choice model. Montana did it through legislation in 1997, which we supported.

When you`re in a business that has 100 percent market share, and you`re going to a market model, that`s a pretty dismal future if you don`t have any alternatives. We were a company, fortunately, that had other alternatives. We had a successful telecom business that was getting more successful by the minute. Our decision to embrace customer choice and competition was helped by the fact we had these other avenues that had upside opportunity written all over them.

Also, because of what we have seen in our unregulated, competitive businesses, where the customer`s wishes are king, we saw what customers wanted. In the utility business, they wanted choice to competitive supplies of power. In the early 1990s, we concluded that rather than deny customers the ability to choose their own power, we should help facilitate that.

We`re now on a course, in both our electric and gas businesses, where all customers will be able to choose their own suppliers in 2002. Right now, 25 percent of our electric load is off our system, and supplied by others. In the gas business, it`s closer to 50 percent. This move to customer choice was inevitable, and would have happened with or without us. We wanted to shape our future. As difficult as it was to make these decisions, that`s the model we chose to pursue.

EL&P: How important are unregulated ventures for Montana Power now?

Gannon: The operating income is about 50/50 right now, regulated to unregulated. It will grow more on the unregulated side, first of all from Touch America and its fantastic growth opportunities. At the same time, selling generation will shrink the regulated part. It won`t take much to see a 30/70 combination. We`re focusing our attention for growth on the telecom business.

Telecommunications has grown and is now perceived by most analysts to be more than two-thirds the value of Montana Power`s stock. In the next two to three years, telecom alone could become the dominant earning engine.

We have about $3 billion in assets, and our market capitalization is about $3.4 billion. In April 1997, our stock price was at $21, and probably less than $1 of that stock price was attributable to our telecom activities. In April 1999, our stock price hit $85, and probably two-thirds at least was attributable to our telecom activities. We have since split the stock and we`re trading at around $32 or $33-or $66 on a pre-split basis.

There was about $190 million invested in Touch America by the end of 1998. In June of 1999, we`re looking at about $215 million invested, and by the end of 1999 we expect to have about $250 million invested.

EL&P: That results in a phenomenal stock valuation.

Gannon: It sure does. We`ve had an interesting ride. The opportunities that continue to exist in our telecom business are awesome. It`s really fun. The traditional utility businesses are undergoing dramatic change too. There`s a lot happening.

We see interesting opportunities to joint venture with other utilities that have a local fiber play that may fit in well with our national network. The future is bright, filled with challenges, and pretty exciting.

Previous articleELP Volume 77 Issue 11
Next articleELP Volume 77 Issue 12
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.

No posts to display