Mergers and acquisitions are occurring throughout the U.S. economy, and the electric power industry is no exception.⁽¹¹⁾ Since 1992, 26 mergers or acquisitions have been completed between investor-owned utilities (IOUs) or between IOUs and independent power producers (IPPs). Sixteen mergers have been announced and are now pending stockholder or Federal and State government approval (Table 3).⁽¹²⁾ The size of IOU mergers, in terms of value of assets, is also getting larger. Between 1992 and 1998, only four mergers were completed in which the combined assets of the companies in each merger were greater than $10 billion. More recently, 10 mergers either completed in 1999 or pending completion each have combined assets greater than $10 billion.

The current wave of mergers and acquisitions is not the first wave in the electric power industry. From 1917 through 1930, mergers of electric utilities were more common than at any other time in the history of the industry. Mergers occurred at a rate of more than 200 per year, peaking at over 300 per year in the mid-1920s.⁽¹³⁾ Most of the mergers in the 1920s combined small operating companies into large holding companies. These holding companies acquired numerous and widely scattered utility and nonutility properties throughout the United States, and they became a dominant force in the industry by permitting concentration of control of many electric utilities in the hands of a few. This era can clearly be considered the first wave of mergers in the history of the industry, but it came to an end in 1935.

In the early 1930s many of the holding companies collapsed financially. The Federal Trade Commission (FTC) investigated the situation and uncovered a host of financial abuses, leading to passage of the Public Utility Holding Company Act of 1935 (PUHCA). (See Appendix A for a discussion of the Act.) Among other things, the Act resulted in the reorganization and divestiture of assets of many of the holding companies, and the requirement that the remaining holding companies be limited to a single integrated electricity system. Between 1935 and 1950, more than 750 utilities were spun off from the holding companies, and by the early 1950s compliance with the requirements of PUHCA were nearing completion.

Following the breakup of the large holding companies, mergers continued, but at a much lower rate. From 1936 through 1975 there were 517 mergers, occurring at an annual rate of less than 15 a year. From 1976 through 1998, 76 mergers have taken place, about 3 per year on average. The distinguishing difference between the heyday of mergers occurring early in the industry and now, is the relative size of the mergers. It is no longer smaller companies being acquired by large companies, but in many cases it is large companies merging with other large companies. "Mega-mergers" is the term used to describe such large mergers.

Some financial analysts say that good economic conditions and relatively high stock values are responsible for the current wave of electric utility mergers. High stock prices allow companies to take an inexpensive source of capital (common stock in this case) and buy other companies in a stock-for-stock transaction. However, the current wave of utility mergers is probably driven more by increasing competition in the electric power  industry,  although  financial factors play a part. Mergers of IOUs can be classified broadly into two categories, each category representing a fundamentally different reason for merging. The first category includes mergers between IOUs and mergers between IOUs and IPPs. These mergers are motivated by the desire to increase power generation capacity and/or transmission and distribution capacity and in general become a larger electric utility. Most utility executives take the position that to compete successfully in today's electricity industry, a company must be relatively large.

The second category includes mergers between electric utilities and natural gas companies. These mergers are motivated by the desire to become a regional or national energy company that produces, transports, and/or sells both electricity and natural gas. Mergers of this type are called "convergence mergers" because they represent the increasing number of companies that own both electricity and natural gas assets and are actively engaged in both industries. Convergence mergers are discussed in Chapter 4.

Investor-Owned Electric Utilities Consolidating Generation Assets Through Mergers and Acquisitions

Mergers and acquisitions among IOUs over the past few years have resulted in fewer electric utilities owning generation capacity. In 1992, 172 IOUs owned generation capacity in the United States. By 1998 that number had decreased to 161 (Table 4).⁽¹⁴⁾ Assuming that all mergers pending as of September 1999 will be approved and completed by 2000, the number of operating IOUs owning generation capacity will decrease to 143. Power plant divestitures, discussed in detail in Chapter 6, have also reduced the total number of IOUs owning generation capacity.

The majority of electric utilities are wholly-owned subsidiaries  of  public  utility holding companies.⁽¹⁵⁾ The effect of mergers on consolidation of the industry is more evident when ownership capacity is aggregated by holding company. In 1992, there were 70 holding companies owning 78 percent of the IOU-held generation capacity (Table 4). By 1998 the number of holding companies decreased to 68, but yet the percent of total IOU-owned capacity increased to 83 percent, primarily because of mergers and acquisitions between IOUs. Assuming that all mergers pending as of September 1999 are completed by 2000, the number of holding companies will decrease to 53, and the generation capacity they own will increase to about 89 percent of the total IOU-owned capacity. The number of holding companies will decrease because most of the pending mergers are between holding companies, which indicates that relatively large companies are becoming even larger.

Although many IOUs that own power generation capacity have merged or have announced plans to merge, the majority of them have not. Of the 104 IOUs (either electric utility holding companies or independent electric utilities) that owned generation capacity in 1998 (see Table 4), 60 (58 percent) have not been involved in a merger since 1992 and have not announced plans to merge. This suggests that even though the merger trend is strong, most IOUs believe consolidation is not necessary to remain competitive in the industry in spite of the fact that those companies choosing to merge are acquiring a larger share of the industry's assets.

Figure 4. Concentration of Ownership of Investor-Owned Utility Generating Capacity, 1992, 1998, and 2000

The absolute number of companies provides insight into consolidation trends, but concentration of generation capacity ownership is perhaps more indicative of consolidation.⁽¹⁶⁾ As a measure of consolidation of the industry, concentration indicates the extent to which total capacity ownership is dispersed among companies. The data suggest that generation capacity owned by IOUs has been concentrated in the hands of a few companies, and that mergers and acquisitions are increasing the concentration of ownership. In 1992, the 10 largest utilities, ranked according to generation capacity, owned 33 percent of all IOU generation capacity; by 1998 their share had increased to 39 percent, primarily as a result of mergers (Figure 4). Again, assuming that all pending mergers will be completed by 2000, the 10 largest companies' share will increase to about 51 percent. Evidence of consolidation among the 20 largest companies is even more compelling: in 1998 the 20 largest companies owned 60 percent of total IOU generation capacity; by 2000 their share is expected to increase to approximately 73 percent, assuming that all pending mergers are completed.

The conclusion suggested by the data is that power generation capacity owned by IOUs is becoming concentrated in companies that are becoming larger through mergers and acquisitions. However, because of power plant divestitures, IOUs, as a whole, will own less of the Nation's power generation capacity in the future. Mergers and acquisitions also result in consolidation of bulk power transmission systems and distribution systems. This trend is not quantified in the report, but examples of it are discussed below.

Ranking of Largest Investor-Owned Electric Utilities

The 10 largest owners of power generation capacity in the  United  States  are public utility holding companies (Table 5).⁽¹⁷⁾ Presently, Southern Company is the largest, with six electric utility subsidiaries located in the southeastern United States. Southern Company not only has six electric utility subsidiaries, it also owns Southern Energy, an IPP active in the purchase and construction of power plants throughout the United States. As a side note, many public utility holding companies own IPP subsidiary companies that generate and sell power in wholesale markets. The number of IPPs and their share of total generation capacity in the United States are expected to increase.

Reasons for Mergers and Acquisitions Among Electric Utilities

"Electric utilities must be relatively large to be competitive in the electricity industry" is a position argued by most, if not all, utility executives who have directed their companies through mergers. This belief by utility executives underlies many of the mergers and acquisitions among IOUs. Why does size matter? Increased size enables a company to achieve economies of scale. By combining resources and eliminating redundant or overlapping activities, larger companies can benefit from increased efficiencies in procurement, production, marketing, administration, and other functional areas that smaller companies may not be able to achieve. For example, a larger company, because of a high volume of purchases, may be able to negotiate a lower price from its fuel supplier than would be available to a smaller company. Cost savings resulting from increased efficiency can be passed to the utility's customers through lower electricity rates.

Whereas utility executives argue that a merger or acquisition will improve the efficiency of the new company, experience indicates that efficiency improvements are difficult to achieve. One study reported that only 15 percent of mergers and acquisitions have achieved the financial objectives that were expected.⁽¹⁸⁾ Incomplete or underdeveloped plans to integrate the companies was noted as a major factor for not achieving the objectives.

A company's strategic objectives are also a factor in the decision to merge. "Does the merger complement or enhance the strategic objectives of the company" is a question asked by company executives in identifying merger partners. Strategic objectives are company specific and depend upon the merging companies' particular circumstances. Building on core competencies, diversifying power generating capability, and acquiring additional managerial and technical expertise are mentioned often as reasons. All of these strategic reasons, however, relate to the desire to remain competitive in the rapidly changing electricity industry.

Mergers Creating Large Vertically Integrated Power Companies

The structure of the IOU segment of the electric power industry is changing in fundamental ways. Industry statistics indicate that IOUs are becoming larger and ownership of generation capacity among IOUs is becoming more concentrated than perhaps any time since the early 1930s. The two mergers pending regulatory approval that are discussed below provide good examples.

American Electric Power (AEP) and Central and South West Corporation (CSW): AEP, based in Ohio, is one of the Nation's largest vertically integrated electric utilities. AEP provides energy to 3 million customers in States in the Midwest. CSW is also a large public utility holding company serving 1.7 million customers in 4 States in the Midwest and Southwest.

In December 1997, AEP and CSW announced an agreement to merge. This merger will be the largest electric-to-electric merger to date, and the new company, which will be named American Electric Power Company, Inc., will be the largest utility holding company in the United States in terms of generating capacity. The combined company will have over $30 billion in assets, and it will provide energy to approximately 4.7 million customers from Michigan to Texas. The company anticipates net savings related to the merger of approximately $2 billion over 10 years from the elimination of duplication in corporate and administrative programs, greater efficiencies in operation and business processes, increased purchasing efficiencies, and the combination of the two work forces.

Each company has acknowledged that the combined company provides the capitalization, resources, and expertise for entry and growth into new areas within the industry. For example, they recognize that wholesale power markets are a growing segment of the industry, and they plan to expand their wholesale electric power activities with an objective of becoming a top-tier national energy trading and marketing business. With more than 38 gigawatts of generating capacity in place throughout the Midwest and Southwest, the new company will increase its capability to sell electricity in wholesale markets in a large region of the country.

Even though the merger was announced over a year and a half ago, it is still being evaluated by the Federal Energy Regulatory Commission (FERC). Because of the size of the combined company with its vast generation capacity and transmission systems, the effect of the merger on competition and the potential for too much market power are being closely examined. Many organizations have submitted comments protesting the merger as anti-competitive. To alleviate some of these concerns, AEP has committed to turn its transmission assets over to an independent regional transmission organization. Regional transmission organizations--a concept being explored by the FERC--would have utilities that own transmission systems transfer the operation and perhaps the ownership of the transmission system to independent companies. The move may eliminate potential market power issues by reducing the company's ability to restrict access to the transmission grid, although an open access transmission tariff submitted to the FERC on behalf of the combined company should also help. Recently, the FERC accelerated the schedule for review of this merger, and its goal is to act on the merger in early 2000.

New Century Energies and Northern States Power: This merger was announced March 25, 1999. The CEOs of both companies cited the need to expand beyond a mid-size company to succeed in today's restructured electricity market. Officials of New Century Energies had stated that the company needed to double its size in order to stay competitive in the energy market. To carry out this objective, the companies that started New Century Energies will have merged twice assuming that this merger is completed.

New Century Energies was created in August 1997 with the merger of Public Service Company of Colorado and Southwestern Public Service. New Century Energies has about $6.6 billion in assets and serves approximately 1.5 million electricity customers and 1.0 million natural gas customers. In March 1999, approximately 18 months after New Century Energies was created, it announced plans to merge with Northern States Power (NSP). NSP is predominantly an electric utility with a small natural gas distribution business. It has about 1.5 million retail electricity customers in the northern midwest States and about 0.5 million retail natural gas customers. If this merger is completed, the new company, which will be called Xcel Energy Inc., will have approximately $15 billion in assets, and it will have power generation capacity covering 12 midwestern and southwestern States. New Century Energies will have achieved its objective of doubling in size in about 2-3 years from when the company was originally formed.

Operations of the merged company will stretch from Mexico to the Canadian border. The combined company will have a total generating capacity of 21.7 gigawatts, of which 15.1 gigawatts will be controlled by regulated electric utility subsidiaries in the United States. The new company will be one of the 10 largest electric utility holding companies in terms of generating capacity. The company expects the merger to result in net cost savings of approximately $1.1 billion over the first 10 years of operation.

The motivation for this merger was to strengthen the company's position to compete in the emerging electric power market, and to build its natural gas business. Combined, the new company will have a large retail natural gas market. NSP also owns Viking Gas Transmission Company, a natural gas transmission company. The large retail market for electricity and natural gas and ownership of a gas transmission company will make Xcel Energy Inc. one of the growing number of diversified energy companies (i.e., combined electric and natural gas suppliers) operating in the United States today.

Mergers Creating Large Regional Energy Delivery Companies

Many States are opening their electricity industry to retail competition by unbundling electricity supply from transmission and distribution. Retail customers will be free to choose their electricity suppliers, but they will use local electricity distribution systems to receive their electricity. Some companies have chosen not to compete in electricity generation and sales and have divested their power generation assets. Instead they will specialize in delivering electricity. This means the utility will provide the equipment and services to transport electricity to customers but will not produce or sell electricity. Electricity prices will be determined in competitive markets, but prices for transmission and distribution services will continue to be regulated.

It is relevant to note that similar to unbundling practices in the electric power industry, many States are unbundling natural gas supply from gas delivery. Retail customers will be free to choose their gas suppliers, but they will continue to use the sole local distribution companies in their area.⁽¹⁹⁾ For this reason, some utilities will be specializing in the delivery of both electricity and natural gas to retail customers, calling themselves "energy delivery companies." Even though energy delivery will be regulated and not subject to a competitive market, many utilities see a need to grow by merging. Some believe that competitive pressures in power generation and sales will force distribution utilities to keep operating costs down as retail customers seek lower electricity and delivery costs. A merger will create a larger customer base, which will support increased investments in systems and new technology that will help lower the costs of servicing the customers. Also, to offset revenue losses from exiting the power generation business, a merger will increase the combined company's revenue stream and lower its operating costs by eliminating redundant functions.

Figure 5. Overview of Recent Merger Activity in the Northeast Region of the United States

Companies specializing in energy delivery are mostly in the northeast United States. States have deregulated the electricity industry there, bringing retail competition to the region. Most utilities in the region have divested all or a significant portion of their power generation assets. Many mergers have been announced or completed as small and mid-sized distribution utilities seek to increase market share and strengthen their companies. Since the beginning of the year, seven mergers have been announced or completed in the Northeast (Figure 5). Four larger regional energy delivery companies have resulted from these mergers.

BCE Energy and Commonwealth Energy Systems: BCE Energy, parent of Boston Edison, and Commonwealth Energy Systems, a holding company with four gas and electric utility subsidiaries, announced in December 1998 that they will merge. The new company will be named NSTAR. BCE Energy's goal is to grow to 2 million customers, which they believe are needed to be competitive in the region. The combined company will have about 1.3 million customers, which suggests that another merger involving the new company may soon take place.

On a small scale, this merger illustrates the growth of combined electricity and natural gas companies. Both BCE Energy and Commonwealth Energy Systems have retail natural gas businesses. Both companies believed in the importance of having the ability to meet customers' needs for both gas and electricity. They noted quite a few areas where electricity and gas customers of the combined company overlap (e.g., customer billing), which will provide the opportunity to lower administrative costs in delivery systems and, perhaps, to improve services in other ways.

New England Electric System, National Grid Group, and Eastern Utility Associates: Also in December 1998, New England Electric System (NEES) and National Grid Group announced a merger of the two companies. This is one of two pending mergers involving electric utilities in which one of the merging companies is foreign-owned. NEES is New England's second largest electric utility. It was one of the first electric utilities to divest its generation assets and become an electricity delivery business entirely. National Grid Group is the owner and operator of the England and Wales high-voltage transmission network. National Grid Group is interested in expanding in the emerging U.S. electricity market and views this merger as a base operation for possible further growth in the United States.

This is an interesting merger, not only because National Grid is foreign-owned, but because it is a company specializing in operating transmission systems in a competitive environment, which is similar to what NEES faces in New England as an electricity delivery company. This matching of interest and capabilities is probably one of the reasons for the merger. Both companies believe that NEES will benefit from National Grid Group's experience in operating an electric power transmission system.

Following close behind the announcement of the merger with National Grid Group, NEES announced in May 1999 its intention to merge with Eastern Utilities Associates (EUA). EUA is a public utility holding company based in Boston whose subsidiaries include transmission and distribution utilities in Massachusetts and Rhode Island. EUA recently divested its generation assets and, like NEES, will concentrate on electricity transmission and distribution. The merger strengthens both companies in the energy delivery business in New England, and EUA was interested in growth in the region to create a stronger and more competitive company. The merger of these two relatively low-cost utilities will create, it is believed, a more efficient transmission and distribution company. This merger is not contingent upon NEES's completion of the merger with National Grid Group. According to National Grid officials, it fits into their plans for growth in the U.S. market and it has their full support.

Energy East, CMP Group, and Two Natural Gas Companies: Rounding out the surge of utility mergers in New England, Energy East, parent of New York Electric and Gas, and CMP Group, parent of Central Maine Power, announced in June 1999 that they will combine the companies. To expand its gas operation and presence in New England, Energy East recently acquired Southern Connecticut Gas Company, a small natural gas company. Before that acquisition, Energy East and CMP Group had created a gas distribution joint venture. Now Energy East's merger with CMP further expands its electricity and gas distribution operations in New England, making it one of the major energy delivery companies in the region. According to Energy East officials, the company is likely to have more acquisitions in the region.

Consolidated Edison and Orange and Rockland Utilities: Consolidated Edison (ConEd) supplies electric services in all of New York City and one county outside the city. It has a smaller market for natural gas customers in the city. ConEd has divested most of its power generation assets. Orange and Rockland provides electricity and gas services to three large counties in the State of New York and will divest all of its power generation capability. Basically these companies are now distribution-only companies serving customers in New York City and surrounding areas. The strategy of both companies was to enlarge their transmission and distribution business and customer base. The merger of the companies contributed to that goal. They expect to improve operations and achieve efficiencies from the merger. Because both companies have combined electric and gas operations, there may be opportunities for improved service and efficiencies in both areas.

Independent Power Producers Getting Bigger by Acquiring Electric Utilities

IPPs are a growing segment of the electric power industry. Spawned by the deregulation of power generation and the opening of wholesale power markets to competition, many IPPs have built or are building new merchant power plants throughout the United States. Some IPPs have purchased generation assets from IOUs and recently a few IPPs have used mergers to grow. For the first time in the history of the electric power industry, IPPs are now acquiring IOUs. One such acquisition was recently completed, and another is pending.

CalEnergy Company and MidAmerican Energy: CalEnergy is an IPP that owns generation capacity in the United States and globally. Before the merger, CalEnergy managed and owned interest in over 5,000 megawatts of power generation facilities, including 20 generation facilities it operated. MidAmerican Energy Holding Company is the parent company for MidAmerican  Energy,  a  regulated  electric  utility. MidAmerican Energy provided retail electricity service to customers in Iowa, and parts of Illinois and South Dakota. It owns more than 4,400 megawatts of generation capacity. The merger, which was completed in March 1999, was the first acquisition of a U.S. regulated utility by an IPP. Although CalEnergy acquired MidAmerican Energy Holding Company, CalEnergy reincorporated in Iowa under the name MidAmerican Energy Holding Company. In effect, MidAmerican is a new company.

MidAmerican Energy Company, one of the largest utilities in Iowa, will be a wholly-owned subsidiary of MidAmerican Energy Holding Company, and it will continue to generate power and provide energy delivery. This merger gives CalEnergy a foothold in the growing Midwest power market, a location where the company has a long-term business objective. CalEnergy's experience in global competitive markets can be applied to the competitive market in the Midwest.

AES Corporation and CILCORP: In late 1998, AES and CILCORP announced a merger. AES is also a global power company and one of the largest IPPs in the United States. It owns about 7,300 megawatts of U.S. generation capacity, and the merger with CILCORP will give it an additional 1,200 megawatts located in the Midwest power market. CILCORP is an energy services company whose largest subsidiary is Central Illinois Light Company, an established gas and electric utility in Central Illinois. After the merger, CILCORP will become a wholly-owned subsidiary of AES. Like CalEnergy, AES is interested in expanding its operations and was particularly interested in entering the competitive market in the Midwest.

Some industry analysts see these two mergers as the start of a trend in which big independent generation companies may favor buying small and mid-sized utilities with favorably positioned generation assets, because it is cheaper than entering into competitive bidding for generation assets that utilities are seeking to divest and cheaper than building new generation plants. Also, merging with an established company is a reasonably quick way to obtain a presence in new markets. On the other hand, with the current wave of mergers and acquisitions, small to mid-size utilities are quickly being combined into larger companies, and opportunities are becoming limited.

Foreign Ownership of Investor-Owned Electric Utilities

For years, U.S. utilities have been expanding overseas by investing in foreign energy companies and foreign electric utilities. Recently, a reversal in this trend occurred when two foreign-owned energy companies announced that they will acquire U.S. electric utilities.

PacifiCorp and Scottish Power: In December 1998, Scottish Power announced that it was buying the U.S. utility PacifiCorp. PacifiCorp is a large utility holding company for Pacific Power and Utah Power. Scottish Power is Scotland's largest utility. Previously government-owned, it was privatized in 1991. Scottish Power, seeing opportunities in the U.S. electricity industry and eager to enter the market, had been shopping for a U.S. electric utility for about a year prior to this announcement. While foreign companies have invested in U.S. power plants in the past, Scottish Power's purchase of PacifiCorp will be the first purchase of an entire U.S. utility holding company by a foreign company.

Through this acquisition, Scottish Power gains access to California's energy market, and it could redirect PacifiCorp into the power marketing area, an area where Scottish Power has some expertise. Scottish Power's CEO suggested that his company will apply its experience in deregulated markets to help PacifiCorp improve customer service and achieve cost reductions.

New England Electric System and National Grid Group:⁽²⁰⁾ The other acquisition involving a foreign-owned company is National Grid Group's acquisition of NEES. This acquisition was mentioned earlier in the context of the development of regional energy delivery companies. Both this acquisition and Scottish Power's acquisition of PacifiCorp have recently received approval from the FERC. Approval also is required from several other Federal agencies and from the relevant State public utility commissions (see Table 6).

Regulatory Review and the Approval Process

Electric utility mergers or acquisitions of substantial size go through a review process involving a number of Federal and State government agencies (Table 6). At the State level, the public utility commission or its equivalent reviews the merger for potential anti-competitive effects and potential cost savings. States may also review the merger's affect on a utility's stranded costs,⁽²¹⁾ an issue brought on by industry deregulation. Because most electric utility operations cross State boundaries, it is not uncommon for multiple States to review a merger. The extent and depth of the review can vary widely between States, depending on the merger's expected impact in the State and the resources available to conduct an evaluation.

Federal review of a proposed merger may include up to five different agencies. Either the Federal Trade Commission (FTC) or the Antitrust Division of the Department of Justice (DOJ) could conduct a review to determine whether the merger is consistent with antitrust laws. Recently, the Antitrust Division of the DOJ, rather than the FTC, has reviewed electric utility mergers, but for most electric utility mergers the DOJ relies on the FERC to take the lead in evaluating the competitive effects of the merger. The DOJ limits its role to participation as an interested party.⁽²²⁾ The Securities and Exchange Commission (SEC) can become involved in a merger or acquisition when a holding company gains control of 10 percent or more of the voting securities of another electric utility. If that is the case, the SEC reviews the merger for compliance with requirements of the Public Utilities Holding Company Act of 1935 (see Appendix A). The Nuclear Regulatory Commission (NRC) reviews a proposed merger or acquisition when it involves the transfer of a nuclear power plant operating license.

Of all Federal Government agencies involved in reviewing a proposed merger between electric utilities, the FERC's review is probably the most extensive, covering the merger's potential effects on competition in the industry, electricity rates to customers, and regulation. The FERC sometimes will request merger applicants to prepare special reports showing the merger's effect on market power or the cost savings and efficiencies that are expected from the merger. These reports and other documents, such as public comments about the merger, are available on the Commission's website (www.ferc.fed.us). Depending on the level of public interest, the size of the merging companies, and the merger's potential impact on the industry, the FERC may hold public hearings to obtain information and to discuss important issues associated with the merger.

Cost Savings and Other Benefits Derived from Mergers

Controlling and reducing costs is the most frequently used and strongest justification for merging. Companies attempting to merge always present estimates of cost savings to the reviewing agencies for consideration. As regulatory authorities, government agencies are looking to pass these savings on to the consumer by lowering electricity rates. Because of unanticipated events and circumstances, however, the cost savings expected from the merger may not be fully attainable. Difficulties in integrating the operation and culture of two large companies, for example, might require more resources than originally expected, and efficiencies may not materialize.

Figure 6. Estimated Cost Savings from a Merger (Percent of Total Savings)

It is difficult to generalize about the effectiveness of a merger in reducing costs. Some mergers may be very effective while others may not. For most mergers, the majority of cost savings are expected to be in labor cost reductions. Usually, over 50 percent of the expected savings will come from a reduction in corporate and operations labor (Figure 6). Consolidation of corporate and administrative programs, such as customer billing, is another potential area for significant cost savings.

Two case studies of mergers completed in 1993 and 1994 were conducted to determine whether the expected cost savings were actually achieved. These mergers were selected, in part, to obtain a pre-merger and post-merger view of the companies. The case studies also looked at the merging companies' objectives and whether they were realized. Following is a summary of the results of the studies. Appendices C and D contain a full discussion of the case studies.

Case Study of the Cincinnati Gas & Electric and PSI Resources Merger: In 1994, Cincinnati Gas & Electric Company (CG&E) and PSI Resources, Inc. merged to form CINergy Corporation (CINergy). The primary objectives of the merger were to create a larger and more efficient utility to better meet the challenges of competition and to receive the benefit of $750 million in merger-related savings, which could be passed through to both ratepayers and owners of CINergy. Appendix C contains a full discussion of the CINergy case study.⁽²³⁾

The merger succeeded in creating a larger company, primarily because the companies were approximately equal in size. In fact, the merger produced the thirteenth largest electric utility holding company in the Nation in 1994. From 1994 to 1997, electricity sales of the combined company more than doubled from pre-merger years, and operating revenues increased by 43.5 percent. Wholesale electricity sales, which were declining slightly before the merger, increased fivefold. By 1997, CINergy ranked seventh in the Nation among electricity commodity trading companies, as measured by purchases from power marketers. During 1997, the New York Mercantile Exchange selected CINergy to be one of only four electricity futures market trading hubs in the Nation. The merger has to be given much of the credit for these growth accomplishments, because it resulted in the integration and upgrade of, and customer open access to, the transmission systems of PSI Energy, Inc. and CG&E.

The merger also resulted in operating efficiency gains under several measurements. By 1997, real operating and maintenance costs had declined by 11 percent from their 1994 level, and customer expenses had declined by 12 percent over the same period. Worker efficiency within the electric departments also apparently increased, although this conclusion is less certain due to the probable shift of some administrative functions housed within electric utility departments before the merger to a new nonregulated subsidiary of CINergy, CINergy Services, Inc. In any case, megawatthour sales per electric utility department employee increased by a factor of four between 1994 and 1997, and the average number of customers served per electric department employee more than doubled.

The merger has had little effect on retail electricity rates. Retail electricity rates equal the utility's revenue per kilowatthour of sales to retail customers. Average electricity rates (adjusted for inflation) declined by 1.5 percent annually before the merger and continued to decline at the same rate after the merger. Common stock shareholders of CINergy experienced a boost in common stock prices in the early years after the merger and in total returns on common equity. However, the effects of the merger had dissipated by 1998, and total common stock shareholder returns were negative in that year.

There was evidence of merger savings over the 1994-1997 period from workforce reduction, deferral of the construction of new generation capacity, and greater efficiency in electricity production (due to coordinated generation plant dispatch). These observed savings make probable total merger savings of approximately $950 million over the decade following the merger, which is within the range provided by CINergy's two merger savings estimates, namely, $750 million to $1.5 billion. Merger-related costs are now included within CINergy's financial statements over the period 1994-1997, and therefore are known to be $225 million. Thus, net merger savings are likely to be about $725 million, which compares well with CINergy's original public announcement in December 1992 of $750 million of merger savings. At that time, CINergy did not include an estimate of costs associated with the merger.

Case Study of the Entergy and Gulf States Utilities Merger: In 1993, Gulf States Utilities Company (GSU) merged into Entergy Corporation (Entergy). GSU was about one-third to one-half the size of Entergy when it merged, but the merger created the second largest electric utility in the Nation. The primary objectives of the merger were to save an estimated $1.7 billion in costs over 10 years, which could be passed through to both ratepayers and stockholders, and to better position the combined company for growth and profitability in the emerging competitive industry. The merger responded to a need by GSU to better its financial condition because State regulatory agencies had disallowed recovery of a large portion of construction and related costs associated with its one nuclear power plant at River Bend. The merger was also consistent with an aggressive acquisition policy being implemented by Entergy at the time. Appendix D contains a full discussion of the Entergy case study.⁽²⁴⁾

The merger succeeded in stimulating growth in both retail and wholesale kilowatthour sales over the first 4 years after the merger (1994-1997) by the five operating utilities of the combined company. Growth in operating revenues was slowed, however, primarily because of a sharp decline in retail customer rates over this period, at least partly due to concessions made by the merging entities to various regulatory commissions when seeking approval of the merger. Nominal retail customer rates declined by 9.1 percent over the 1994-1997 period; retail electricity rates for the original operating utilities of Entergy declined by 3.1 percent over the same period. As  a  whole, Entergy/GSU's average retail rates fell faster than the average retail electricity rates for all IOUs over this period.

Operating efficiency at Entergy/GSU was boosted by the merger, mostly due to the consolidation of purchasing, customer service, and administrative functions, the coordination of generation dispatch, the operation of GSU's one nuclear plant by Entergy after the merger, and the functional integration of GSU along the lines of Entergy's operations. Real operations and maintenance (O&M) costs per net generation kilowatthour for Entergy/GSU declined by 13 percent over the first 4 years after the merger, as compared with an increase of 2.5 percent over the 2 years before the close of the merger. Other measures also showed efficiency improvements for Entergy/GSU: megawatthour sales per electric department employee increased by 168 percent; the average number of customers served per employee increased by 147 percent; and real customer expense per customer declined by 27.3 percent.

The ratepayers received nearly all the benefits from the merger. GSU's stockholders at the time of the merger also may have received a premium price when converting their stock into Entergy's. However, owners of Entergy's common stock after the merger did not experience improved profitability. Net electric operating income from the five operating utilities of Entergy fell by 13 percent over the first 4 years after the merger. Net earnings per common share fell from $2.62 to $1.03 in 1997, and dividends were cut in 1998 from $1.80 to $1.50 per share. Average total returns to the common stockholder (dividends and stock price appreciation) were only 6.6 percent over the 1994-1998 period, approximately equivalent to the yield of a long-term Treasury Bond that has no risk. During the middle of 1998, the CEO of Entergy, who was responsible for the merger and Entergy's aggressive acquisition policy, was replaced and a new strategy was put in place. Its purpose was in part to remedy reliability and customer service problems suffered in its core domestic utility operations due to cost-cutting measures implemented over the past several years.

Based on an examination of public data, it is likely that Entergy will achieve its estimated merger cost savings in the categories of fuel costs and nonfuel O&M expenses. Savings associated with the costs of fossil fuels for electricity generation at GSU, after the end of the 4 years following the merger, were right in line with expectations. Merger savings associated with nonfuel O&M expenses at GSU over the 4 years after the merger were already higher than estimated for the first 5 years, and GSU was expected to accrue more than 86 percent of the merger savings in this category. The other Entergy major utilities had achieved substantial savings in nonfuel O&M expenses over the first 4 years after the merger, far greater than that estimated for the merger, primarily because of Entergy's reorganization and restructuring of these utilities which began in the third quarter of 1994.

Recorded merger costs were slightly higher than estimated by Entergy when the merger was announced, and even higher when merger-related capital costs and pre-1994 merger transaction costs are counted. Total merger-related costs probably will be approximately $194 million. However, with merger savings in the nonfuel O&M category also running higher at GSU--and recognizing that the nature of the cost-saving measures that were implemented resulted in permanent savings--it is likely that Entergy/GSU's estimated net merger savings associated with fuel costs and nonfuel O&M expenses (estimated at $849 million and $673 million, respectively) will be realized over the 1994-2003 period. These savings, which total $1.5 billion, compare favorably with Entergy's 10-year pre-merger estimated savings of $1.7 billion.

Endnotes

24. The study was conducted using public data gathered from FERC Form 1, Securities and Exchange Commission 10-K filings, and company annual reports. Conclusions about the effects of the merger are based only on the data available from these sources.

• Proceed to Chapter 4
• Return to Chapter 2
• Return to Front--Table of Contents