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TXU Sparks Takeover Talk

Christopher Edmonds

Such chatter will inevitably occur today, and given the industry's stable nature, the "what-if" exercise is worth considering. However, the complexities of the electric power business make big deals challenging, if not downright difficult.

Regulation

Utilities have a great profile for private-equity firms: stable cash flow, predictable demand and a captive customer base, to name just three. But they also entail a significant amount of regulatory risk.

Although deregulation of the power business has helped lessen some onerous regulation, most electric-power companies' core businesses remain highly regulated, primarily by state public utilities commissions and, at least to some extent, by the Federal Energy Regulatory Commission.

If you wonder what that means, just ask Constellation Energy (CEG) and FPL Group (FPL). In October, the two companies walked away from a merger that had been in the works for nearly two years because of regulatory hassles. In addition, Exelon (EXC) and Public Service Enterprise Group (PEG) canceled their proposed merger for similar reasons. Of course, some deals have been completed -- such as Duke Energy (DUK) and Cinergy -- but plenty of uncertainty exists when it comes to public utility mergers.

However, private equity's entrance into the mix may present new opportunities. It is too early to determine what type of hurdles the TXU deal will face from regulators, but objections are already being assuaged. The new TXU said this morning that it will lower consumer power rates and significantly reduce its plan to build new coal-fired generation plants.

In addition, the private version of TXU is courting heavy hitters for its board, including former Secretary of State James Baker, former EPA Commissioner William Reilly and former Commerce Secretary Donald Evans. Furthermore, the press release announcing the deal talks up the new company's commitment to the environment and sustainable energy.

The deal will still require various regulatory approvals, and there's sure to be plenty of opposition and positioning from TXU customers looking for concessions.

TXU is a unique utility in that it has strong portfolios of both regulated and unregulated assets. While the regulated utility provides a solid, stable base of business, the unregulated generation business offers an opportunity for growth, a fact that hasn't likely gone unnoticed by the private-equity group, led by Kohlberg Kravis Roberts and Texas Pacific Group.

Public to Private

For good reason, TXU will be the talk of the town today. Yet, for investors, the more relevant question is what could come next.

Recently, Mirant (MIR) sold assets to LS Power for nearly $1.4 billion, and in April 2006, NorthWestern Energy (NWEC) agreed to sell to Babcock and Brown Infrastructure for $2.2 billion. Although those deals aren't nearly as large as the TXU buyout, they do suggest a keen interest in power assets among private-equity investors.

Other private companies such as Tenaska are also on the prowl for new development opportunities as well as established power generation assets. And, while not private, Warren Buffett's Berkshire Hathaway (BRK.A), through its MidAmerican Energy Holdings, has said it is willing to spend billions in the power market if the right opportunities are found.

Independent power producers like Mirant and AES (AES) have to be discussing the pros and cons of going private with the backing of firms like KKR, Blackstone, Carlyle and others. Although there's no indication that any of these firms are eyeing specific assets, private-equity firms tend to focus on similar sectors.

Consolidation

In addition to private equity's influence on the sector, KKR's move will probably raise the possibility of additional consolidation among the smaller, regional utilities. Although regulatory hurdles remain, the continued growth of large utilities may spark a stronger urge for smaller utilities to get bigger.

In previous columns, I have discussed the potential for regional consolidation. In the Midwest, smaller utilities like Westar Energy (WR), Great Plains Energy (GXP), OGE Energy (OGE), Empire District (EDE) and Cleco (CNL) are always considering options and opportunities.

In addition, Atlanta's Southern (SO) is looking for growth opportunities. With names like Scana (SCG) and Teco (TE) right next door, opportunities exist if the price and regulatory climate look right.

All that said, remember that talk is cheap and power deals are often discussed but much less often executed. While the KKR-TXU deal is a blockbuster, utility mergers rarely happen in pairs.

Still, this morning's deal is likely to give rise to plenty of powerful opportunities.