Aslew of recent electric utility merger approvals in the face of long odds mayserve as evidence to acquiring companies that while the economic benefits of aproposed transaction seem self-evident, the political maneuvering necessary towin regulators' votes remains unpredictable as ever.
Agroup of investors led by MacquarieInfrastructure & Real Assets Inc. seemingly snatched victoryfrom the jaws of defeat on March28 when Louisiana regulators approved the acquisition of , about a month afterroundly rejecting it.The week prior, Exelon Corp.won approval fromDistrict of Columbia regulators to acquire Pepco Holdings LLC after two years of negotiations andmultiple rejections, closing the deal the same day. One day after Exelon,Texas regulators approvedthe acquisition of Oncor ElectricDelivery Co. LLC by a group of investors led by , with plans toconvert the utility into a Real Estate Investment Trust and eventually merge itwith InfraREIT Inc.
Noneof these deals were foregone conclusions, and in the case of Cleco and Pepco,it took roughly two years to earn key approvals. Lillian Federico, researchdirector for S&P Global Market Intelligence affiliate Regulatory ResearchAssociates, noted that regulators made these decisions over the stridentobjections of key intervenors in the merger proceedings.
"Thefact that these three mergers, one right after the other, have gotten done overthe roar of the crowd, so to speak, without having virtually 100% buy-in, isunusual," Federico said. "Things are changing and I'm not really surewhy. But a few years ago I would have said there would have been no way anycommission was going to approve a merger if you didn't get everybody on board."
Guggenheim Securities LLC had forecast as a "stronglikelihood" that D.C. regulators would reject Exelon, noting the staunchopposition. Afterward, Guggenheim analyst Shahriar Pourreza described theoutcome as the natural endpoint of prolonged negotiations in which iteventually became clear to regulators unanimous support for the deal wasunattainable. "They were playing a very dangerous game and there was apoint where Exelon was going to walk," Pourreza said. "There is apoint where the regulators realize, 'We have extrapolated as much of what wecan get out of this deal; now it's time to go through the process to approveit.' So I'm not that surprised."
Thealternative scenario where regulators will only approve unanimous settlements,Federico noted, can be one that essentially confers veto power over a deal toany stakeholder. "That is not necessarily a productive environmenteither," she said, recalling Exelon's ill-fated attempt to acquirePublic Service Enterprise GroupInc. 10 years ago, and whichran aground for those very reasons. "After those kind of dealsthere has been some thought that if we want to be viewed as a business-friendlyregulatory climate and we want to attract business to the state or thejurisdiction in D.C.'s case, you can't let any kind of consumer advocacy agencyhave that kind of a veto power," Federico said. "I think there issome of that going on."
While there were some broad similarities among the threedeal approvals, each acquisition also had its own unique circumstances exertingpressure on regulators to greenlight the transactions, and in all three cases,that pressure had a political nature.
During proceedings in Louisiana, Public Service CommissionerFoster Campbell, who had initially opposed the deal, the purchasers forcommitments to lower Cleco's residential and small-business rates, which arethe highest in the state, to the state average for as long as five years.Although the purchasers increasedtheir offer of ratepayer credits, Campbell seemed swayed byeventually wringing a concession from Cleco management that the utility wouldnot file a rate case until mid-2019, putting off any effective rate increaseuntil 2020.
When some intervenors opposed to the deal asserted the newprovision was not much of a concession since the PSC always has the authorityto approve or reject rate requests, Campbell, a candidate for U.S. Senate,pushed back. "For you to say that that is not a good deal, it's a hell ofa deal," he said. "I've listened to it, and we've added some thingsto it; it has become palatable to me."
Anotherkey argument by Macquarie and Cleco wereguarantees to maintain Cleco's headcount, salaries and benefits foremployees and retirees for 10 years. If the PSC rejected this deal, in aclimate of intense utility M&A, the purchasers argued, Cleco wouldimmediately become an acquisition target of American Electric Power Co. Inc. or , which could lead to joblosses in rural central Louisiana. "When that happens the portablejobs — so human resources, executive, legal, engineering, call center,accounting — those jobs end up going generally to the company that is thebuyer," MacquarieInfrastructure Partners Inc. Senior Managing Director Andrew Chapmansaid. "We are not consolidating these businesses and eliminating jobs."
In Texas, pressure on regulators to approve the deal stemmedlargely from the fact that failure to do so would throw a major wrench in theworks of Oncor's majority owner, EnergyFuture Holdings Corp.'s, broader Chapter 11 bankruptcyrestructuring plan, in which nearly $13 billion in debt and equity the Hunt-ledinvestors provide will address billions in creditor claims at EFH.
Anotherpressure on the Public Utility Commission of Texas was that while Hunt's plansto convert Oncor to a REIT prompted concerns over increased risk, sharing taxsavings and internal lease structures, it offered the benefit of placing Oncorin the hands of a well-regarded Texas business.
"This transaction probably would have been better forlike a [NextEra Energy Inc.]to come in there and make anacquisition because they would have come in there, acquired Oncorwithout doing any sort of this financial engineering and tax sharing. Theywould have just made an acquisition and they would have been done with it,"Pourreza said. "But Hunter Hunt is a very powerful guy in Texas andfrankly I think there were a lot of other things that were at play here versusthe net benefit."
Those pressures — of bankruptcy and rural job losses — didnot exist in the case of Exelon-Pepco, which was a more traditional utilitymerger in many ways. And while Pepco wasn't in a state of crisis, it was also, "nota healthy standalone utility," according to Pourreza.
"And if D.C. were to walk away you're left with autility that would trade at north of a 7% yield. So what you would see iscertainly a dividend cut. You would certainly see the credit rating downgraded.So I think this is an instance, and we've seen too many deals like this, wherethe commissioners will push back and intervenors will push back to the pointwhere they can't really push anymore. And then they'll give in," he said. "Alot of this was political posturing and frankly in the D.C. instance it wassurprising that the commissioners even let it go this far."
That Exelon, Macquarie and Hunt were successful in gainingapprovals might be encouraging for NextEra as it persists in trying to acquireHawaiian Electric Industries Inc.,another protracted, deeply political merger effort that many observers regardas a likely futile.
"What you've seen certainly in Louisiana and Pepco,multiple states, as well as Hawaii, is that there was too much complacency whenyou went into these deals that they were going to be relatively easytransactions. And I think in most of these cases the acquirers underestimatedthe political ramifications and the political pushback they would get,"Pourreza said. "Don't underestimate the political angle of thesetransactions and irrespective of the acquirer being a blue chip utility, itdoesn't mean anything. I think that is the big lesson learned here."