Carolina Power's Urge to Merge

Some think this may just be the first step in the Carolina utility's attempt to bulk up.
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Another merger in the electricity industry could create a new energy powerhouse in the Southeast as Florida Progress (FPC) agreed to be acquired by Carolina Power & Light (CPL) - Get Report for $54 a share in cash and stock. The deal, valued at about $5.3 billion, creates the nation's ninth-largest electric utility, with 2.5 million customers and $6.7 billion in revenue. Carolina had just recently completed the purchase of North Carolina Natural Gas.

While the combination doubles the size of CP&L, questions loom regarding the price and whether the deal makes the combined companies a powerful player in the business. "It's not the worst transaction I've seen," says

Donaldson Lufkin & Jenrette

utility analyst Jay Dobson. "However, the price appears to be pretty rich in the near term. The question is, Does future growth justify the big price?" He rates both companies as market perform. DLJ has not provided banking for either company in the past three years.

CP&L is paying nearly 18 times Florida Progress' earnings and 2.7 times its book value, rich even by recent

standards. While CP&L says the deal will be accretive in the first year, analysts question the assumptions. "The numbers assume the combined company will be able to keep all of the merger savings in their rate base," says one buy-side manager. "Regulators aren't likely to let that happen." DLJ's Dobson calculates that after regulators carve out a share of the savings from the company's rate base, the deal should be dilutive to the tune of about 11 cents per share in the first year.

A bigger issue with the merger is whether there is any strategic benefit to combining two traditional, vertically integrated utilities into a larger one. While both companies have small telephony businesses and Florida Progress operates profitable shipping and rail businesses, the impact on the combined company's bottom line will be negligible. And in an era when investors are assigned greater value to unregulated businesses, a merger of traditional utilities isn't likely to excite investors for long, especially as major competitors overshadow the much smaller CP&L.

"To assume the merger creates a major competitor for the likes of

Duke Energy

(DUK) - Get Report

is 180 degrees incorrect," says Dobson. "This deal just creates a larger traditional utility. It's the merger of two regulated businesses, which may cause additional concerns over price."

While merger synergies should save on the expense side, the combined company remains a regulated utility in a region where deregulation has yet to provide serious growth opportunities. It also raises questions as to whether the combination is just a larger target for a new multidimensional energy services company.

Nor have recent electric-to-electric mergers caused investors to rush to the scene. The last announced major electric-to-electric

merger was

New Centuries Energy

(NCE)

and

Northern States Power

(NSP) - Get Report

. Since the merger was announced in March, New Centuries stock has dropped nearly 12% and Northern States has declined over 15%. "That merger was bigger in scope, and the stocks plummeted," says Dobson. With the uncertainty of regulatory action, investors have shunned utilities involved in mergers. That will likely be the case with CP&L as well.

"The only thing for sure is that Carolina will be dead money for quite a while," says our buy-sider. The shares of Florida Progress were up 5% in early afternoon trading, while those of Carolina Power & Light were off 6.2%.

Who's Next?

While talks of a partner for Florida Progress have swirled for months, the suitor most commonly heard was Britain's

PowerGen

, which has been looking for a partner in the U.S. for over two years. Dobson also says there is an outside possibility PowerGen might take another look at Flordia Progress, trying to top Carolina's bid. "Would PowerGen top the current bid? My gut says no, but the foreign utilities tend to be a bit more irrational," he says.

Nor is it likely that either Duke or

Southern

(SO) - Get Report

-- long considered the dominant players in the Southeast -- will react to the CP&L-Florida Progress merger. "It creates a larger competitor in an era of deregulation, but it's not significant to either," says Dobson. Added the buy-sider: "To say this creates competition for Duke or Southern is a stretch."

However,

Deutsche Bank Alex. Brown's

Ed Tirello suggests this may represent only one step in a process to bulk up CP&L's customer base, which puts other Florida and Carolina utilities in play. "This is the precursor for more deals," says Tirello. He says both

Scana

(SCG)

, a South Carolina electric and natural gas utility, and

Teco

(TE)

, the parent of

Tampa Electric

, might be the next targets of CP&L. He rates the shares market perform. Deutsche Bank Alex. Brown has not provided banking services to either company in the past three years.

There is one thing on which all analysts agree: Utility consolidation will continue. Says Tirello, "There is still more to come this year."

Christopher S. Edmonds is president of Resource Dynamics, a private financial consulting firm based in Atlanta. At time of publication, Edmonds' firm was long Southern, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Edmonds cannot provide investment advice or recommendations, he welcomes your feedback at

invest@cjnetworks.com.