economies of scale and scope in · pdf fileeconomies of scale and scope in ... new sources of...
TRANSCRIPT
ECONOMIES OF SCALE AND SCOPE IN ELECTRIC UTILITY MERGERS
r 10, 2011
VICE PRESIDENT, PATHFINDER STRATEGIC SERVICES
BLACK & VEATCH MANAGEMENT CONSULTINGBILL KEMPO
ctob
er
AGENDAAGENDAAcademic and industry perceptions
Evidence for merger‐related cost savings
Allocation of benefits
Conclusions
2
ACADEMIC STUDIES MIXEDIAEE – M&A Economics 10‐10‐2011
Representative papers:
• Dube, Francis‐Gladney, Romero, Langdon (2007)• Little evidence of abnormal returns to acquirer shareholders or
increased acquirer operating cash flow for two years after close
• Becker, Mulherin, Walking (2009)E id t t/ i d ti i d t• Evidence supports cost/price reductions in mergers due to economies of scale
• No support for hypothesis that mergers facilitated by have f t d ti titi ll i tilitifostered anti‐competitive collusion amoung utilities
3• Focused on firm level data• Cost savings but few shareholder benefits
INDUSTRY PERCEPTIONS OF MERGER BENEFITSIAEE – M&A Economics 10‐10‐2011
• Depends on how you frame the question of benefits
A k l d t th t i ifi t t i b• Acknowledgement that significant cost savings can be achieved
• Assumption that geographic proximity is major driver p g g p p y jof cost savings
• Recognition that larger financial scale may be required f i f i d f ifor size of required future investments
• Widespread skepticism on whether pain is worth gain
• Belief that mergers hurt acquirer stock performance• Belief that mergers hurt acquirer stock performance
4High level of skepticism
AGENDAAGENDAAcademic and industry perceptions
Evidence for merger‐related cost savings
Allocation of benefits
Conclusions
5
POTENTIAL SOURCES OF COST SAVINGS IAEE – M&A Economics 10‐10‐2011
Illustrative; for vertically integrated utilities.WholesaleM i a
Nonfuel
Coststo Achieve
Avoided/Deferred Capex
Premerger Initiatives
Financing
Coal/Gas Supply Best
Practices/ Process Redesign
Margin
Non
‐Pub
lic Data
CorporatePrograms
NonfuelPurchasingEconomies
T&D Operations Positions
OtherOperations Positions
CorporatePositions
Public Data
TotalPotentialSavings
Gross Merger Savings
Net MergerSavings
Core and Facilitated Savings Strategic
Transactionspecific mix of savings
Core and Facilitated SavingsOpportunities
6
Announced Synergies as % of Utility Total O&M Announced Synergies as % of Utility Non-Fuel O&M
IAEE – M&A Economics 10‐10‐2011
ANNOUNCED SYNERGIES NOT AGGRESSIVE
FirstEnergy-GPU
BUG-LILCO
LG&E-KU
Announced Annual Synergies By Year 3 vs. Combined Annual O&M Expenses Before Closing
(1)
(2)
Exelon PSEG
LG&E-KU
Duke-Cinergy
BUG-LILCO
Announced Annual Synergies By Year 3 vs. Combined Annual Non-Fuel O&M Expenses Before Closing
(1)
(2)
PE-Enova
Puget-WE
OE-Centerior
Exelon-PSEG
Dominion-CNG
KCP&L-Aquila
Nevada-SPP
KCP&L-Aquila
Puget-WE
Dominion-CNG
FirstEnergy-GPU
Exelon-PSEG
CP&L-FPC
AEP-CSW
Union-CIPSCO
Nevada-SPP
Duke-Cinergy
IE-SIGCORP
AEP-CSW
Nat Grid-Keyspan
NSP-New Cent
Delmarva-AE
IE-SIGCORP
PE-Enova
Ameren CILCORP
Nat Grid-Keyspan
WPS-Peoples
Unicom-PECO
NSP-New Cent
Delmarva-AE
CP&L FPC
PEPCO-Conectiv
Unicom-PECO
Union-CIPSCO
OE-Centerior
CP&L-FPC
WPS-Peoples
MidAm-Pacif iCorp
PNM-TNP
PEPCO-Conectiv
Ameren-IP
ConEd-O&R
Ameren-CILCORP
medianMidAm-Pacif iCorp
PNM-TNP
Ameren-IP
Ameren-CILCORP
ConEd-O&R
PEPCO Conectiv
median
0% 1% 2% 3% 4% 5% 6% 7% 8% 0% 5% 10% 15% 20% 25%
(1) Source: SEC filings and press releases. Includes fuel/purchased energy savings(2) O&M from FERC Form 1 and 2 reported costs in calendar year prior to closing; includes all utility
operating companies reported by shown parent firms
Selling the regulators – just enough7
HAVE UTILITY MERGERS REALLY DELIVERED THEIR PROMISED BENEFITS?
IAEE – M&A Economics 10‐10‐2011
DELIVERED THEIR PROMISED BENEFITS?
• Were promised levels of synergies achieved? YES
• Widespread success in meeting or beating announcedsynergy targets
• Expectations framed by merger announcement
• High enough to win investor support
• Low enough to keep substantial benefits out of regulatory gain‐sharing
• Cost savings actually achieved (within three years) Cost savings actually achieved (within three years)typically 120‐200 percent of announced synergies.
• Failures to meet expectations less common
• Based on public and proprietary data8
32 U.S. Electric Utility Merger Transactions, 1997-2007
POST‐TRANSACTION CHANGES IN ELECTRIC UTILITY COSTSIAEE – M&A Economics 10‐10‐2011
282%300%
y gSum of Separate Utility Costs in Year Prior to Closing vs. Combined Utility Costs 4 Years Later (1)
Greatest Increase, Greatest Decrease, and Median Change 751%
180%
150%
200%
250%
Cos
t (2
)
Median
crea
se
118%139%
49%59%
50%
100%
150%
ge in
Rea
l C
Cos
t Inc
-33% -44%-23%
-38%-57%
49%
0%-7%
6% 0% -4%
-53%
-10%
-50%
0%
50%
4-Ye
ar C
han
crea
se
-108%-100%
57%
-150%
-100%
4
Cos
t Dec
(3,4) (3)
(1) Source: FERC filings(2) Adjusted for inflation at CPI(3) Generation non‐fuel O&M excluded for transactions with firms that divested generation(4) Uncollectible accounts excluded from all costs
More consistent cost reductions in back office 9
STATISTICALLY SIGNIFICANT COST REDUCTIONS VS. NON‐MERGER UTILITIES
IAEE – M&A Economics 10‐10‐2011
Function Mean 4‐Year Cost Change(1) tStatistic
Comment
Merger Group
Non‐Merger GroupGroup Group
Generation Non‐Fuel O&M ‐0.64% 8.90% ‐2.06 Significant at >90%
Transmission O&M ‐27.70% 17.39% ‐4.67 Very highly significant
Distribution O&M 3.75% 4.83% ‐0.33 Much weaker merger impact
Customer Service 0.04% 24.01% ‐3.72 Highly significant
A&G ‐5.30% 7.08% ‐2.12 Significant at >90%
• 32 merger transactions vs. 19 utilities without mergers
Total Non‐Fuel O&M ‐2.42% 9.68% ‐1.64 Significant at almost 90%
(1) Constant dollars
g g• Real reduction in cost over a 4‐year periods (year before to 3 years after close)• T test for significance of difference in sample means• Also samples tested to confirm no significant secular time trends
Statistical analysis tells the same story 1010
DECLINING IMPORTANCE OF GEOGAPHIC PROXIMITY IN MERGER CHOICES
IAEE – M&A Economics 10‐10‐2011
PROXIMITY IN MERGER CHOICES
• Changing pictureP ili i l b i hb• Past utility mergers mainly between neighbors
• Recent trend of business model creation and extension
• MidAmerican Energy / PacifiCorp, Duke Energy / Cinergy, Next Era / Entergy, AGL / Nicor
• Less dependence on proximity‐related cost savings• Distribution O&M savings larger for close pairs of firms but not
a large driver of merger savings
• No meaningful difference between A&G and transmission f l d f fO&M savings for close vs. distant pairs of firms
• Customer service savings much larger for distant pairs of firms
• Total achieved savings level not related to proximity• Total achieved savings level not related to proximity
11
PROXIMITY VS. REALIZED SYNERGIESIAEE – M&A Economics 10‐10‐2011
Mean Cost Changes in Utility M&A TransactionsDistant vs. Close (1)
20%
25%(1) Close = adjoining or
overlapping; Distant = all others
(2) Includes non
[5 Distant Pairs vs. 11 Close Pairs]
5%
10%
15%
nsta
nt $
)
(2) Includes non‐normalized fuel/purchases
(3) Several close pairs had large RTO‐related increases in transmission costs; rising transmission
-5%
0%
5%
AnnouncedSynergies Non-
Fuel O&M
Total Non-FuelO&M
Electric O&M A&G Cust Service Dist O&M Trans O&M
n C
ost C
hang
e (C
on rising transmission costs for almost all pairs
(4) T test of statistical significance of difference in sample means between Distant vs. Close
(2) (3)
-20%
-15%
-10%Mea
n Distant vs. Close groups
-25%
20%
Cost Category Distant CloseStatisticalSignificance (4) high low moderate low very high high low
Announced Year Before Closing vs. 3 Years Later
• Distant pairs of firms extracted higher Customer Service savings• Close pairs of firms achieved savings across broader range of functions 12
NEW SOURCES OF SCALE ECONOMIESIAEE – M&A Economics 10‐10‐2011
• Growing significance of information‐related synergies
• Portability of metering data, customer data, back office data
• Large savings from combining non‐T&D systems and processes
• More aggressive execution by separated utilities
• Emerging technologies reinforcing economies of scale
Ad d i d S G id h l i• Advanced metering and Smart Grid technologies
• Customer relationship management technologies
• Back office (ERP) systems and delivery modelsBack office (ERP) systems and delivery models
• Total achieved savings level not related to proximity
13
FEW STUDIES OF ECONOMIES OF SCOPEIAEE – M&A Economics 10‐10‐2011
• Most utility mergers involve firms focused on production of same commodity servicey
• Electric and gas utility mergers do produce savings
• G&A and Customer Service synergy levels similar to electric‐electric or gas‐gas mergers
• Very limited synergies in operations functions. Fuel procurement, logistics support.p , g pp
• Economies of scope for regulated and unregulated services complicated by required ring‐fencing
• Poor utility industry performance in entering unregulated markets, especially outside of same industry
14Little evidence for significant economics of scope
AGENDAAGENDAAcademic and industry perceptions
Evidence for merger‐related cost savings
Allocation of benefits
Conclusions
15
CLEAR SHORT‐TERM BENEFITS TO CUSTOMERSIAEE – M&A Economics 10‐10‐2011
• Lower rates• Regulators and utility negotiate allocation of cost savings
T i ll 50% f i fl h h• Typically 50% or more of core savings flow through to customers
• Utilities attempt to keep facilitated and strategic benefits off h blthe table• Not directly related to redundancies and scale economies
• Compensation for shareholder risk and management initiative
• Improved service
• Larger post‐merger utility can adopt new technologies more quicklyquickly
• Improved access to capital, ability to finance needed investments
• Longer term impacts on generation costs less clear16
DID SHAREHOLDERS END UP BETTER OFF?IAEE – M&A Economics 10‐10‐2011
• Shareholders of acquired entity clearly benefit• Acquisition premium received
• Assumes stock fairly priced pre‐announcement
• Mixed picture for acquirers
• Most acquirers’ stock performed about as well as the S&P Utility Index
• Slightly more clear outperformers than clear g y punderperformers
• Larger acquirers accounted for disproportionate share of recent growth in industry stock valuerecent growth in industry stock value
• Points to two major challenges
• Excessive acquisition premiumsExcessive acquisition premiums
• Regulatory capture of cost savings17
ACQUIRERS’ RELATIVE STOCK PRICE PERFORMANCEIAEE – M&A Economics 10‐10‐2011
Acquirer Stock Price Performance vs. S&P Utility Index - 16 Acquirers, 18 Transactions250%
150%
200%
rman
ce (
1)
100%
150%
tock
Pric
e Pe
rfo
LowHighMeanMedian
50%
Rel
ativ
e S
(1) Indexed to 100% at time of closing; 100% = same performance as S&P utility index over period
(2) Sierra Pacific significantly lower
(2)
(2)(2)
0%1 Year Later 2 Years Later 3 Years Later 4 Years Later 5 Years Later
significantly lower than range of other acquirers
(2)
( )
Time From Closing
• Mergers typically depress stock prices before and after close• Stock performance improves 23 years after close, as savings are realized 18
OBSERVATIONS ON ACQUIRER STOCK PRICE PERFORMANCEIAEE – M&A Economics 10‐10‐2011
● Major outperformers● Generally used mergers to pursue clearly defined strategy
E g merchant generation or electric deli er● E.g., merchant generation or electric delivery
● Major underperformers● Resource short; Street concern about full recovery of market purchases; y p
● Market performers (bulk of acquirers)● Lagged utility index during integration process
● Many outperformed utility index in the period 3‐5 years after transaction, but later regressed toward average group performance
● One‐off deals created little long‐term value for acquirer
Longterm shareholder value from utility mergers requires:g y g q• Sound, extendable strategy• Disciplined execution of both transaction and integration
19
AGENDAAGENDAAcademic and industry perceptions
Evidence for merger‐related cost savings
Allocation of benefits
Conclusions
20
CONCLUSIONSIAEE – M&A Economics 10‐10‐2011
• Utility mergers do produce abnormal cost reductions• Variety of utility mergers have achieved significant non‐fuel
cost savings in both real and industry normalized termscost savings, in both real and industry‐normalized terms
• Typical savings of around 8‐12% of the combined firms’ non‐fuel expenses
i b f i l• Savings vary by functional area
• Percentage savings not related to deal size
• Similar core business models• Accessible economies of scale
• Manageable execution risk
E i f t i ifi t• Economies of scope are not significant
• Challenging to achieve financial benefits for acquirer • Regulatory strategy to meet both public and private interestsRegulatory strategy to meet both public and private interests
• Timely savings realization
• Serial acquisitions in pursuit of well‐defined strategy 21
QUESTIONS?
BILL KEMPVi P id t
QUESTIONS?
Vice President,Pathfinder Strategic Services
Cell (941) 448‐5674
Office (941) 342‐6941
2222
23
REFERENCES
IAEE – M&A Economics 10‐10‐2011
• S. Dube, L. Francis‐Gladney, R. Romero, and W. Langdon (2007), Merger Motives For U S Utility Acquirers: Evidence From Performance Risk Metrics
REFERENCES
Motives For U.S. Utility Acquirers: Evidence From Performance, Risk Metrics, And Executive Compensation, Journal of Business and Economics Research, Vol 5
• D. Becker, J. Muherin, R. Walking (2009), Synergy versus Collusion in Mergers: An Analysis of Stock and Product Prices in the Utility Industry published byAn Analysis of Stock and Product Prices in the Utility Industry, published by Wharton Financial Institutions Center
2424