NEW YORK ( TheStreet) -- Duke Energy ( DUK) agreed to acquire Progress Energy ( PGN) on Monday in a $13.7 billion all-stock deal, which would create the largest U.S. utility company if regulators in North and South Carolina approve the deal.The combination of the two utilities would result in a company serving 7.1 million electricity customers and with 57,000 megawatts of generating capacity. Utilities are facing considerable cash needs related to the upgrade of aging infrastructure, incorporation of smart grid technology, construction of new clean coal, gas and nuclear power plants, and, in general, the cost of environmental regulation. Duke estimated an economies of scale savings in the range of $600 to $800 million over the next five years, but that is to be passed on to rate payers. A bigger utility wouldn't just generate cost savings for rate payers, though, but potentially increase earnings and dividends paid to shareholders of the combined utility. The all-stock deal valued Progress at a modest 6% premium when announced. In the last year, Progress shares gained 11%, while Duke shares rose 3.5%. The stocks of the utilities did not respond enthusiastically to the deal, but the entire utility sector was down on Monday. The 2% declines at Progress Energy and Duke Energy were at the larger end of a losing day among utilities. With the 2% decline in the value of Duke Energy shares, the deal premium was 4% during trading on Monday.
"This is a fairly valued deal," said Travis Miller, utilities analyst at Morningstar. The biggest threat to the deal is regulators voting against the acquisition, as has occurred with several big utility deals in recent years. The Morningstar analyst said that given the $600 to $800 million which Duke Energy is estimating it can save rate payers if the acquisition is approved, the ability to drive upgrades of utility infrastructure, and the fact that regulators in the Carolinas have a "fairly constructive regulatory environment," the deal has a good chance of succeeding, even as regulation remains the biggest hurdle to any transaction in the utility sector. "This deal puts the combined entity into a good spot as the largest utility in the U.S.," the Morningstar analyst said. Miller noted that both utilities have aggressive investment plans and the deal will provide them with a stronger balance sheet, a ton of cash flow and cheaper financing options.
While the deal would also reduce Duke's portfolio exposure to the de-regulated market -- an advantage if prices remain where they are today -- the management teams at Duke and Progress Energy are betting on the deal being a strategic positive in terms of driving cost savings in the Carolinas and Florida. More M&A in the utility sector isn't unlikely. "Duke Energy CEO Jim Rogers has said throughout his career that there is consolidation opportunity in the sector, and he's made it a career strategy to consolidate, and we will see further consolidation," Morningstar's Miller said. "I wouldn't be surprised to see more deals given the level of growth investment required, from improving wire infrastructure to improving transmission grids, adding smart grid and, at the level of generation, converting the fleet from older emissions-intensive coal plants to cleaner burning more efficient plants," the Morningstar analyst said. -- Written by Eric Rosenbaum from New York.
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