Whispers Surround Illinova

But whoever wants to buy the southern Illinois power producer had better be willing to take on an aging nuke plant as well.
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Even a utility is looking for a way to get rid of Clinton.

Decatur, Ill.-based

Illinova

(ILN)

is looking to rid itself of an old nemesis, the 950-megawatt Clinton Nuclear Generating Station. The parent of Illinois Power, Illinova announced in December it would either mothball the plant -- which has been offline since Sept. 1996 -- or sell it, likely for significantly less than its current book value of $1.6 billion. Whichever choice, the company wants out of the nuke business. "Illinova will exit the nuclear business," says company spokesperson Shirley Swarthout. "The plant will either be sold or permanently shut down."

So who besides Saddam Hussein would want an old nuclear power plant? Two companies, actually:

PECO

(PE) - Get Report

, which currently holds a management contract to operate the Clinton plant, and

Entergy

(ETR) - Get Report

. Both are interested in buying aging nuclear power plants, leading many analysts to expect a deal by the end of 1999.

But the company has been deafeningly quiet about Clinton's disposition. That has led some to speculate that something larger looms. "Illinova isn't likely to survive on its own," says one utility insider. "The delay in announcing the sale of Clinton suggests a bigger deal is in the works."

Company statements lend credence to the possibility Illinova is for sale. "Both

Entergy and PECO have said they are interested," says Swarthout. "However, there are a number of companies -- five or six -- that have expressed interest as well." When asked directly about the discussions with other companies, Swarthout adds, "Even if I knew the full range of the discussions, it is our policy not to discuss strategic issues."

A Small Power Base

Illinova isn't exactly a powerhouse in the electric business. With only 3,400 MW of capacity serving about 650,000 customers in central and southern Illinois, Illinova pales in comparison to its northern neighbor,

Unicom

(UCM)

, the parent of Chicago's Commonwealth Edison, and

Ameren

(AEE) - Get Report

, the parent of St. Louis' Union Electric. As Illinois moves toward deregulation, larger utilities will look to grow with smaller brethren serving as fuel.

Already,

CILCORP

(CER)

, the parent of Central Illinois Light, has been purchased by Arlington, Va.-based

AES

(AES) - Get Report

and Omaha based

CalEnergy

(CE) - Get Report

has purchased

Mid-American Energy

(MEC) - Get Report

, an Iowa-based utility with operations in Illinois. "It's not a question of if, it's a matter of when," says

BT Alex. Brown

analyst Ed Tirello of Illinova's sale.

Many analysts think Illinova needs a partner. "We believe Illinova's latest analyst meeting failed to instill confidence about the company's long-term stand-alone earnings capability," wrote

Merrill Lynch

analyst Steven Fleishman in a recent report. While he rates the stock a long-term buy, the rating is based on Fleishman's belief that the company has "strategic attraction," another way of suggesting the company will be sold.

Roger McOmber of

Lehman Brothers

also rates Illinova a buy, and the company appeared on Lehman's "10 Uncommon Values" list. "We view Illinova as a prime takeover target," says McOmber.

Interconnects Are the Key

"The suitor is likely in the neighborhood," says Tirello, who thinks Unicom and Ameren would be the most likely candidates. According to

Resource Data International's

David Wagman, any Unicom deal would likely include Clinton. "Unicom already has the largest nuclear fleet in the United States. They might make a play for Clinton and the company."

Conversely, Ameren has little interest in additional nuclear assets and any deal for Illinova would send Clinton packing -- likely in a three-way deal involving either of the two nuclear consolidators. "In many ways, Ameren makes a lot of sense," says Tirello. "The only issue is whether it proves difficult to deal the nuclear plant in the transaction."

An immediate combination between Illinova and other regional interconnection partners is unlikely. AEP is in the midst of merging with

Central and SouthWest

(CSR)

, Mid American is in the process of assimilating its combination with CalEnergy, and CILCORP is being acquired by AES. TVA is a government-owned power company.

Regardless of the suitor, the transaction is likely to provide investors a significant premium -- a departure from many recent utilities takeovers. Lehman's McOmber has a price tag of 38 while Merrill's 12-month price target is 30. Dan Ford of HSBC Securities says a sale of Illinova would likely occur at a 25% premium to current prices, implying a price of 33.

Other Flickering Lights

While both Unicom and Ameren seem to be the front-runners, two other possibilities deserve mention. First,

Cinergy

(CIN)

, an Ohio-based utility might look to expand into Illinois. "Cinergy is always on the prowl," says Tirello. He also suggests a foreign suitor might make a play. "There have already been two deals involving foreign utilities announced and more are on the way," Tirello says. "They don't understand the regulatory environment so they are willing buyers."

Regardless of the bigger picture, Clinton is toast. It is likely the disposition of Clinton will be finalized at Illinova's February board meeting. The bigger question of the company's future may also be decided. For investors, a combination could bring a very happy Valentine's Day.

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