announcement Monday that it will spin off its power-development and trading subsidiary may be the impetus, the spigot, for other utilities to do the same.
Northern States Power
announced it would sell 18% of its unregulated subsidiary,
, in an IPO later this year.
Other traditional utilities are sure to follow as they look for ways to unlock value for shareholders who have recently suffered through the uncertainties of utility deregulation and competition. Those uncertainties have caused traditional utilities like Southern and Northern States to lose ground in an otherwise robust market. That is all the more painful when independent power producers such as
have traded near all-time highs in the last six months while Southern trades at multiyear lows.
Looking for ways to boost sagging stock prices, Southern, NSP and others are attempting to follow the model of companies such as AES that are seen as new-era growth companies, not Old Economy utilities.
"Utilities with regulated holdings are mostly judged the same: bland," says
utility analyst Robin Diedrich. "It's become clear these companies will not get recognition for the growth unless they are pure plays. Spinoffs may be the only way."
Current pricing supports Diedrich's claim. While Calpine trades at 47 times earnings and AES at 64 times, both Southern and Nothern States trade between 13 and 14 times earnings. While the growth rates of the companies are disparate, current multiples of traditional utilities do not differentiate utilities with significant unregulated business from those that have simply stuck to their knitting -- providing power to captive customers under regulated rates.
The unregulated power business has burgeoned in recent years, a result of deregulation efforts across the U.S. and the push of innovative utilities to diversify revenue sources. Natural gas and power trading continue to grow. So does asset management, the purchasing of generation assets, as well as the business of providing power to those transmission and distribution companies that have the ability to sell the excess power on the open market.
To be successful as a stand-alone entity, a utility must be a major player in the unregulated world. Most important, ownership of generation assets is key to building the base of successful business. "Critical mass is key, you must have size and scope," says
Donaldson, Lufkin & Jenrette
analyst Jay Dobson. Southern fits that bill -- with control of generation assets in the Northeast, the upper Midwest, Texas and California, as well as being a top-tier trader of both natural gas and power. DLJ rates Southern a market perform and has done no investment banking for the company.
There are others. For example,
has hinted it will float an offering for its gas pipeline business, likely a precursor to a clean break for all of its unregulated businesses. Duke, like Southern, has developed a stable of generation assets to support its trading efforts. Duke is the second-largest natural gas marketer and eighth-largest electricity marketer. "Duke is a leader in the business with very smart management," says Diedrich. She rates Duke buy and has not provided banking services to the company in the past three years.
Other traditional utilities that may be exploring options similar to Southern and Northern States include the following:
- Constellation Energy (CEG) , the former
Baltimore Gas & Electric, is in the process of assessing options regarding a spinoff of its trading and marketing business, according to sources close to the company. Constellation is the 14th-largest power marketer in the U.S.
Utilicorp (UCU) may consider divesting its
Aquila Energy subsidiary. Aquila, one of the first power marketers from a traditional utility, was the third-largest gas and electricity marketer in 1999. Edward Jones' Diedrich says she is "somewhat surprised" the company hasn't been more aggressive in exploring options with Aquila.
Reliant Energy (REI) - Get Report, the former
Houston Industries, is another company considering options. Reliant is a top-10 gas and power marketer and has been diversifying its asset base, including adding a major presence in Southern California. However, Reliant may be taking a different approach. "The company appears to be more interested in selling slower-growing assets, creating a core-growth business," says DLJ's Dobson, whose firm has no banking relationship with Reliant and rates the company a market perform. "That's kind of the opposite strategy from Southern."
Edison International's (EIX) - Get ReportEdison Mission Energy subsidiary is among the largest independent power producers and a likely candidate for separation from its parent. "Mission Energy alone is larger than most independent power producers," says Diedrich. "They have the critical mass to be independent and it makes sense." She rates the company a hold and has not provided banking services to Edison International in the past three years.
Dobson says others to watch include the combined
, although its core business is moving completely toward unregulated operations. Most other companies, Dobson suggests, are too small to consider effective spinoffs. Dobson rates Peco a buy and does not cover the others. DLJ has not provided banking to any of the companies mentioned.
While opportunities to create value may exist, don't look for these utilities to all jump at once. "Utilities are, by nature, very conservative," says Diedrich. "Many may well hold off and see how it works for Southern, using them as a guinea pig."
And, don't look for dot-com-like premiums from the spinoffs. "These are still utility companies," says Dobson. "The separation makes a good deal of sense but it doesn't unlock that much value." He notes that while Southern stock gained about 10% on the news, it has since fallen back to pre-announcement prices. NSP actually lost value on Wednesday's announcement.
Dobson also worries that early expectations of companies like Southern may be unreasonable. "They will be compared to AES and investors will think discount," he says. "The question is, at how much of a discount to AES will these new companies trade."
Diedrich agrees, but says the valuation can't help but improve. "As part of a utility,
unregulated businesses have an even bigger discount. This has to be a better way."
Utility investors sure hope so.
Christopher S. Edmonds is president of Resource Dynamics, a private financial consulting firm based in Atlanta. At time of publication, Edmonds was long Southern and Peco Energy, 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