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Overview of Market Power Issues in Energy M&A Transactions
Catherine McCarthycmccarthy@dl.com
June 3, 2010
Dewey & LeBoeuf | 2
U.S. Utility M&A Volume
155
84
15
36
81
11
28
126
105 4 5
0
20
40
60
80
100
120
140
160
2007 2008 2009 2010 (YTD)
Total Utility
Electric
Gas
Billions (USD)
91 (est.)
73 (est.)
12 (est.)
Dewey & LeBoeuf | 3
U.S. Energy M&A Volume
125112
75
2611 14 16
190
0
20
40
60
80
100
120
140
160
180
200
2007 2008 2009 2010 (YTD)
Energy
Pipelines
Billions (USD) 190 (est.)
40 (est.)
Dewey & LeBoeuf | 4
Overview of U.S. M&A Market
● U.S. Energy/Utility M&A Landscape
– Financial crisis led to a sharp decline in M&A activity due to:
♦ Uncertain valuation levels
♦ Concerns about liquidity overtaking strategic initiatives
♦ Loss of access to debt financing
– Benefits of economies of scale continue to favor consolidation, particularly with respect to:
♦ Construction of new generation (nuclear and other) and other major infrastructure improvements
♦ Addressing credit, volatility and liquidity concerns regarding trading and hedging
Dewey & LeBoeuf | 5
Overview of U.S. M&A Market cont'd
● U.S. Energy/Utility M&A Landscape
– As valuation levels have stabilized and liquidity concerns have diminished, interest in M&A has increased
– Current level of deal activity on pace to meet or exceed 2008 levels
– Obstacles to M&A remain
♦ Regulatory uncertainty - investors remain concerned about the cost, time and distraction of the regulatory process, particularly when several states are involved
♦ How much of the benefits of mergers will state regulators let companies keep?
♦ Uncertainty with respect to carbon legislation and the price of carbon
Dewey & LeBoeuf | 6
U.S. M&A Market – Energy/Utilities
● Proposed Acquisition of E.ON U.S. (the parent company of LG&E and KUC) by PPL
– Cash transaction with a purchase price of $7.625 billion (PPL to receive approximately $450 million in tax benefits)
– PPL is seeking to increase earnings from regulated operations to “rebalance” its business mix
– PPL is viewed as paying a premium – press reports indicate an active auction with even the City of Louisville putting together a bid
– LG&E has a pending application to increase its rates (12% electric; 8% gas)
Dewey & LeBoeuf | 7
U.S. M&A Market – Energy/Utilities cont'd
● Proposed Merger of Mirant with RRI
– The all-stock merger (fixed exchange ratio) will create GenOn Energy with approximately 24,700 MW of electric generating capacity
– Creates one of the largest independent power producers in the U.S.
Dewey & LeBoeuf | 8
U.S. M&A Market – Energy/Utilities cont'd
● Proposed Acquisition of Conectiv Energy
– Calpine will purchase 4,490 MW of Conectiv power generation assets from Pepco Holdings for $1.65 billion
– Conectiv trading book, collateral requirements and load-serving auction obligations excluded from the transaction
– Includes a fully contracted 565 MW combined-cycle plant currently under construction
Dewey & LeBoeuf | 9
U.S. M&A Market – Energy/Utilities cont'd
● Proposed Merger of FirstEnergy and Allegheny Energy
– All stock merger (fixed exchange ratio) for a value of $4.7 billion in the aggregate, plus the assumption by FirstEnergy of $3.8 billion in Allegheny debt
– Logical combination – parties have adjacent service territories
– Merger requires regulatory approval before FERC and in Virginia, West Virginia, Pennsylvania and Maryland
Dewey & LeBoeuf | 10
U.S. M&A Market – Energy/Utilities cont'd
● Other Notable Energy/Utility Transactions
● Exelon bid for NRG
– Initial bid represented a 37% premium over current stock price (October 2008); NRG stock price: $19.33
– Rejected by NRG board for inadequate price
– NRG announced acquisition of Reliant retail business (March 2009); NRG stock price: $18.56
– Exelon raised bid; revised bid represented an 8% premium over current market price (July 2009); NRG stock price: $24.80
– Exelon slate of directors not elected by NRG shareholders at annual meeting; Exelon terminated offer (July 2009)
– Since Exelon terminated its offer, NRG stock has traded as high as $29.26 and closed on May 24, 2010 at $22.50
Dewey & LeBoeuf | 11
FERC Merger Issues
● FERC Section 203 Review
– Transactions subject to review
– Timing for approval
♦ Term sheet ok
● FERC Standard of Review
– No adverse effect on
♦ Rates
♦ Regulation
♦ Competition
– Review of Potential for Impermissible Cross-Subsidization as a result of or following transaction
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FERC Merger Issues: Rates, Regulation and Competition
– Effect on rates and regulation is largely handled through commitments
– Effect on Competition
♦ HHI Screen Failures
♦ Mitigation
♦ Other Factors
♦ NRG-Exelon
♦ FirstEnergy-Allegheny
Dewey & LeBoeuf | 13
FERC Merger Issues: Cross-Subsidization
– Cross-Subsidization Analysis
♦ Ring-fencing requirements
♦ Approach in recent transactions
Macquarie - Puget
Iberdrola – Energy
NRG - Exelon
FirstEnergy - Allegheny
Dewey & LeBoeuf | 14
DOJ/FTC New Merger Review and FERC’s Market Power Analyses
● September 2009- DOJ and FTC announce intent to revise Horizontal Merger Guidelines (last updated in 1992)
– Comment period follows
● Specific proposal released for Comment on April 20, 2010
● May 20 Comment Period Extended to June 4
● Among other things, proposing to modify use of Herfindahl-Hirschman Index
– De-emphasize the significance of HHI changes at lower levels
– Highly concentrated markets now above 2500 (before 1800)
Dewey & LeBoeuf | 15
DOJ/FTC New Merger Review and FERC’s Market Power Analyses cont’d
● 1996 – FERC begins to use DOJ/FTC Merger Guidelines
– “Basic framework” for reviewing certain deal approvals where M&A result in significant combinations of owned or controlled jurisdictional assets in common market
– HHI is used as part of a competitive analysis screen
● FERC said its analysis “should be generally consistent” with DOJ/FTC
– Did not attempt to make analysis identical
● In market-based rate context – HHI used for applicants that do not pass screen tests
Dewey & LeBoeuf | 16
DOJ/FTC New Merger Review and FERC’s Market Power Analyses cont’d
● Change to FERC policies if DOJ/FTC change will not be automatic
● Although FERC statutory mandate is different, it will likely consider updating its merger review should the proposed changes be implemented by the other agencies
“[W]hile the HHI thresholds contained in the DOJ/FTC 1992 Horizontal Merger guidelines provide useful measures for analyzing market conditions, these thresholds are based on the antitrust agencies’ obligations to prohibit mergers that substantially lessen competition . . . Our standards are based on the Commission’s statutory obligation under section 205 [rate provisions] of the FPA [Federal Power Act] to ensure that wholesale rates are just and reasonable.”
Dewey & LeBoeuf | 17
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