Kathleen Davis, Associate Editor
According to the press material sent with PricewaterhouseCoopers’ new study, “the strength of global utilities in the future will be built upon vertically-integrated strategies, rather than the pursuit of multi-utility and specialized portfolios.”
The study, “Movers and Shapers 2003: Utilities,” explores both European and U.S. markets—the U.S. for the first time.
Paul Keglevic, partner with PricewaterhouseCoopers, told EL&P that perhaps such a firm emphasis on the vertically-integrated utility in the press material was a little too exact, a little too precise—at least, when it comes to wording.
“Actually, the European report is more focused on that return to the vertically-integrated company,” he stated. “In the U.S., I would shift it a little bit and say what they are suggesting is a move back to asset-based strategies.
And, while it might not be a return to the full vertical integration—meaning generation, transmission, distribution—most of the U.S. utilities recognize the risk of not owning and controlling your own generation is too high.
“They’ve discovered that owning as much generation as you need for your retail load is a good risk management strategy. It also gives you some economies of scale to support the infrastructure,” he added, pointing out that the industry has seen what happens when utilities are forced to spin off generation assets and rely on third party markets to supply their customers: way too much volatility, effectively stranding a lot of back office and administrative costs.
“It just makes sense to return to an asset-based market, even if just to mitigate the market risk,” Keglevic said.
A monopoly or two on the horizon?
“Certainly when you say, ‘will we follow in the steps of the airline industry,’ I’m hoping the answer is ‘no’ given where the airline industry is these days,” Keglevic joked when questioned about the increasing mergers and acquisitions and whether the industry will be boiled down to a handful of major players in the future—akin to the airline industry.
“However, the substance of your question—whether we will move to bigger regional utilities—is a good one, and I think there is going to be increased consolidation in the industry,” he stated. Keglevic pointed out, though, that he doesn’t believe such consolidation is likely to be quick or immediate given the challenges facing utilities today in the credit arena.
“I think all utilities are hesitant to do a deal that might increase their leverage and impact their credit ratings,” he explained. “Today the focus in on the balance sheet and doing mergers—which can mean increased risk and, generally, increased leverage—are likely to have some potential negative impact on those credit ratings, which is a barrier to short-term mergers.”
Keglevic also gave a nod to the Public Utility Holding Company Act as a barrier to bigger regional utilities. Reform measures and their potential fates are directly related to the ease, or difficulty, of establishing those larger utilities, according to Keglevic.
“If the Act is repealed or reformed, we may never get to the level of the airline industry, but there would be more activity, certainly,” he added. “But the bigger issue today remains credit.”
Brother, can you spare a dime?
Keglevic described one exercise he takes companies through regularly. He asks, “West of the Mississippi, who’s the big, healthy utility positioned and poised to be an acquirer?”
“Virtually all of the bigger utilities in the West tend to be dealing with some type of issues surrounding bad investments, high leverage or other credit problems,” he stated.
“Most U.S. utilities are hoping to make it past the storm. Eventually, they will have to deal with the growth question, but it’s not at the top of anyone’s agenda. And, in the capital markets today, growth is a dirty word.
“To grow, you have to take some level of risk, and we’re trying to mitigate risk, not increase it,” he added.
Keglevic stated that, over the next three to five years, there will be comparatively little merger activity. And, while Keglevic and the utility respondents of the study agree that T&D issues are critical, the lack of clear definition on market design and regulation makes it difficult to attract capital to transmission investment, even though most recognize it is sorely needed.
“How utilities will be compensated for those investments is unknown,” Keglevic stated.
Such uncertainty over transmission investment in this study didn’t catch Keglevic by surprise, but another value-related issue did: How the market saw individual companies, and how the executives rated that market view (see Figure 1).
“I was mildly surprised that almost half of the respondents didn’t feel that the market properly valued their companies,” he said, adding that it was a much higher figure that he would have estimated left to his own devices.
He continued, “For an industry that’s this solid in history and sophisticated with financial reporting and investor relations to believe that the market doesn’t properly value you points to some fundamental flaw somewhere in that process.”
According to Keglevic, there is an opportunity in that arena for shareholder value. Companies obviously could do a better job of working with institutional investors and other stakeholders to explain strategy and the story of the company.
“This is usually a two-way problem,” he stated. “Both the sender and the receiver have to share some of the blame about why the story of the company isn’t properly understood.” In fact, 13 percent of those respondents believed that they themselves were not providing the right information, while others say the market just doesn’t “get it.”
Right hook to regulators, markets
While increasing the value of an individual utility may be as simple as providing the right information in some cases, other problems that U.S. utilities face are not quite as easily fixed—namely the uncertainty of regulation and the lack of capital investment.
In fact, those two ranked first and second when U.S. utilities were asked, “What’s holding your company back from achieving maximum shareholder value?” (See Figure 2.)
“A lack of certainty and lack of action in the transmission area, certainly, is leading to the inclusion of the regulators,” Keglevic stated. “I also think that the utilities have a hard time turning on a dime. We were moving toward deregulation; now we’re going back to threatening re-regulation.
“I think the one thing investors don’t like is uncertainty. And, with the Enron debacle and the failed deregulation in California and other issues of that nature, the system of regulation looks less stable. Therefore, that uncertainty creates a lack of trust.
Utilities, who have to make large capital investments—large ‘bets,’ if you will—feel very uncomfortable these days,” he added, stating that was his opinion why the study respondents are playing the blame game with regulators.
However, Keglevic noted that the respondents blamed one group more often than they blamed the regulators—the capital markets.
“I thought that was interesting. The regulators have been the traditional ‘whipping boys,’ as they have such a dramatic impact on utility performance. But, in terms of ‘what’s holding your company back,’ capital markets was the number one response in the U.S.—significantly different than the European attitude,” he stated.
“I think regulators are happy to be moving down in the rankings,” Keglevic joked. “Now we can blame Wall Street and the banks.”
In the end, however, Keglevic returns to the utility itself to make the first forward step toward clearing up these problems. “A return of investor confidence is critical at this point, and the best place to start may be with that market value for your company,” he added. While companies themselves may not be able to easily “fix” regulators or capital markets, sharing the proper information for company valuation is the one thing they have direct control over.
“It’s an action step. They can have a big impact,” he concluded.