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<title>April 2002: Alice in Powerland</title>
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<p align="left"><font face="Arial"><strong><small>About The Author:<br>
<br>
</small></strong><span lang="X-NONE" style="color: black"><font size="2">
ROGER FELDMAN, Co-Chair of Andrews Kurth LLP Climate Change and Carbon
Markets Group has practiced law related to the finance of environmental and
energy projects and companies for 40 years. In particular, he has analyzed
and executed a wide variety and substantial value of project financings. He
chairs the American Bar Association’s Committee on Carbon Trading and
Finance, serves on the Board of the American Council for Renewable Energy,
and has been a senior official in the Federal Energy Administration. He is
a graduate of Brown University, Yale Law School and Harvard Business School.</font></span></font></p>
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<img src="../images/feldman.gif" alt="Washington Viewpoint by Roger Feldman" border="0" width="375" height="75"><p><b><u><br>
April 2002</u><br>
</b></p>
<p><font size="6">Alice in Powerland</font></p>
<p><strong>by Roger Feldman -- Bingham, Dana L.L.P.<br>
</strong><font face="Arial" size="2">(<em>originally published by PMA OnLine Magazine:
2002</em>/05/16)<br>
</font><span style="font-size: 10.0pt; font-family: Palatino; color: black">
</span></p>
<font FACE="Times New Roman" SIZE="1"><i></i></font>
<p class="MsoNormal">Something there is about the prospect of European
investment in the U.S. power industry that makes the bankers go giddy, and
the cross-border strategic consultants break into songs from The Producers:
“Springtime for Germany in Louisville. . .” Will it be a real hit?</p>
<p class="MsoNormal">We were led recently to look down this particular
“Alice in Wonderland” rabbit hole by the proclamation in a recent news
article of “The Return of the Double-Headed Merger,” which turns out to be
not hype for Austro-Hungarian Empire double-eagle war bonds but for
cross-border deals that, while establishing a single economic entity, enable
the merging parties to keep separate stock market listings, boards and
headquarters in their home countries. Bankers love not only the fees
achievable through reconciliation of the monumental egos of merging CEOs,
but also the opportunity it may afford to head off post-merger stock market
“flowback” (think Daimler shares being dumped post-Chrysler). Three small
business problems with this idea for electric power deals: no acquisition
premium; norelief from Public Utility Holding Company Act regulatory
requirements; no apparent enhancements in operational management from the
resulting corporate structure.</p>
<p class="MsoNormal">But if mogul ego-salving provides insufficient
rationale for trans-Atlantic power deals, lusty dreams may yet. One foreign
utility finance director at a recent conference reportedly cooed that: “The
girl I’m going to marry is vertically integrated, probably [does] not own a
lot o of merchant energy, and lives West of the Rockies.” His ardor and that
of similar would-be continental swains was unctuously stoked by a Wall
Street MD, who assured his audience that European utilities might have an
easier time wooing American investor-owned utilities because, as foreigners,
they seemed more, well, exotic (like debonair foreign exchange students
appealing to domestic Alices, distracted from their looks by their charm).</p>
<p class="MsoNormal">Still, there may be some economic logic to this still
mostly hypothetical mating game, if, as has been suggested, European suitors
prove willing to accept 12-14percent on equity (higher than available at
home); adopt a never-forgiving, long-time return horizon (15 to 25 years);
and are willing to use their available big bucks to sweep America’s
full-figured, “plain Jane” Alices off their feet, just so long as they make
a contribution to suitor earnings. Certainly, there are five or six European
utilities with an equity value of $20 billion or more that tower over
potential American mates and can pay the required premiums, given their PE
ratios.</p>
<p class="MsoNormal">But will the Europeans come? That would seem to depend
on the interplay of several variables: the choice of business models of
“Euro-globalization”; the impacts on such choice of acquisition lessons
learned to-date; and the influence on it of the market structure of the
American power scene, as the FERC and Congress currently are remaking it.</p>
<p class="MsoNormal">The business models in play to choose from seem to be
of three basic types: (1) mega-globalization; (2) global multi-utility
holding companies comprised of power and other public services; and (3)
opportunistic value creation through exploitation of acquirer operating
management skills developed at home.</p>
<p class="MsoNormal">The globalized business model is one of oil and gas
majors taking over the power industry as the delivery point for their
commodities. To the consolidating but still-fragmented industry in Europe
and America, this model seems both abstract and pass�, as they themselves
pursue the new growth opportunities needed for stock price support by
seeking to become something slightly different – large multi-fuel,
multi-national holding companies. The con-sultants to these global venturers
have advised them to foresee three stages of growth: first, random growth to
achieve size; second, purchase and sale of assets to obtain locale-specific
strategic value; and finally, the summum bonum, achievement of “focus” to go
with scale, leading to portfolio rationalization. It all sounds like a
soaring hymn to rational strategic planning, till we read that the exemplars
of this strategy of sectoral focus (e.g., asset-backed trading; consumer
products; wires) and global scale, until recently, were said by the
consultants to be Enron and AES.</p>
<p class="MsoNormal">Once noted, this observation has driven empirical
managers to examine what has happened to date in actual cross-border
acquisition.</p>
<p class="MsoNormal">There’s Scottish Power that arguably overpaid its
premium, and has wrestled with state regulators using a newly-substituted
management team, which has achieved mixed results to date. There’s Power
Gen, acquirer of LG&E Energy (now gobbled up by E.ON), where some
traditional merger savings/cost-cutting has been achieved, which may or may
not have offset the 27 percent premium paid. LG&E may, of course, yet prove
the first hoof print of a larger E. ON, US Trojan Horse, or it could
be a one-trick pony.</p>
<p class="MsoNormal">Finally, there’s National Grid’s market entry, which
perhaps may suggest a generic, third category of Euro-penetration: focused
growth on focused targets with particular characteristics, e.g., skillful,
home-grown management held over and able to deal with regulators;
acquisitions where specific management skills and techniques developed in
homeland operations can be applied to achieve more than generic cost
savings; and concentration on contiguous U.S. geographic regions, which are
compatible with the focused strategy. Yet even in the National Grid case,
hiccups have begun to crop up – as in the Middle West, where proposed
continued expansion, accompanied by management control, has encountered the
aversion of regulators to the putative harmful effects of a concentration of
market power.</p>
<p class="MsoNormal">Which leads us to this bottom line on choice of
business models: the bankers and counselors of any Euro Queen of Hearts can
be no wiser in their advice than the local white rabbits regulating the
local utility markets they desire to enter will allow them to be. There are
two facets of this observation. First, the treatment afforded by regulators
to power and/or transmission commodity prices and, second, the extent to
which regulators’ concerns with market power of any type gained by any
person – European or American – may interfere with a consolidation strategy
designed to create properties large enough to have an investment impact.
Paradoxically, these two concerns may be perceived by regulators as pulling
in opposite directions: price deregulation may be perceived as consumer
friendly only if the “market power” of individual players has been squeezed
out of it by special oversight regulation. This perceived adversarial nature
of deregulation and the exercise of market power also may continue to fuel
the ongoing State-Federal mad tea party contest for jurisdictional control
of electric utility market structures, notwithstanding the Supreme Court’s
recent upholding of Order No. 888. In short, not only will investors face
market uncertain-ties, but regulatory ones as well.</p>
<p class="MsoNormal">Specifically, therefore, before sending too many Euros
down the rabbit hole, shrewd continental investment planners should check
out the final profile in the U.S. of the RTO governance issues, the
treatment of incentive transmission rates, the regulation of trading
securities derived from bilateral trading contracts and, above all, the
extent to which concern with denying market-based rates to parties with
geographic market power may cut down the levels of cash flow available as a
result of acquisitions. While in the first instance these deci-sions will be
FERC decisions, increasingly on individual subject areas, they are becoming
the province of special-purpose congressional legislation as well. It is, in
short, desirable to main-tain one’s head in developing asset acquisition
structure.</p>
<p class="MsoNormal">It is the Euro buyer – not the U.S. target – that’s
really “Alice” in this fable. And the question is: What regulation is in the
bottle marked “DrinkMe” that Alice has stumbled upon at the bottom of the
rabbit hole? Will it make the buyer very large, very small, or simply give
it a headache?</p>
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text-align:left"><font face="Arial" size="2">
<span lang="X-NONE" style="color: black">ROGER FELDMAN, Co-Chair of Andrews
Kurth LLP Climate Change and Carbon Markets Group has practiced law related
to the finance of environmental and energy projects and companies for 40
years. In particular, he has analyzed and executed a wide variety and
substantial value of project financings. He chairs the American Bar
Association’s Committee on Carbon Trading and Finance, serves on the Board
of the American Council for Renewable Energy, and has been a senior official
in the Federal Energy Administration. He is a graduate of Brown University,
Yale Law School and Harvard Business School.</span></font></p>
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