Exelon Acquires Pepco for $6.8B

NEW YORK (The Deal) -- In the latest of a wave of utility mergers, Chicago giant Exelon (EXC) announced Wednesday it is picking up Pepco Holdings (POM) for $6.8 billion in cash, making it the top player along the mid-Atlantic.

The combination of Exelon's BGE in Baltimore, ComEd in Chicago and PECO in Philadelphia with Pepco's Atlantic City Electric in New Jersey, Delmarva Power in Delaware and Pepco in Washington, D.C., will serve 10 million customers with a rate base of $26 billion and further expand Exelon's regulated holdings, ensuring a balanced earnings mix as power prices recover, Exelon said.

The purchase works out to $27.25 per share, nearly a 20% premium over its closing price Tuesday of $22.79. Exelon said it anticipates the acquisition being "significantly" accretive to its adjusted earnings in the first full year after closing.

"Exelon and Pepco Holdings have a compelling strategic rationale for merging, given our geographic proximity and similar utility business models," Exelon CEO and president Chris Crane said in a statement. "Our cultures are an excellent match, with a shared focus on operational excellence, environmental stewardship, customer service and support for the communities we serve."

Pepco chairman, CEO and president Joseph Rigby said in a statement that Exelon has committed to provide what its customers most want: Investments in infrastructure improvements, philanthropy in its communities ($50 million over 10 years) and direct customer benefits of $100 million, or around $50 per customer, for rate credits, low-income customer assistance and energy efficiency measures. He added that Pepco also will benefit from being part of large urban utilities with a good emergency response record during major storms.

"Our shareholders will benefit from an immediate cash premium and employees should enjoy even more opportunities as part of a larger company," he said.

Exelon expects to complete the deal in the second or third quarter of 2015 if it clears Pepco shareholders and federal and state regulators, including the District of Columbia, Delaware, Maryland and New Jersey.

Tudor, Pickering, Holt & Co. Securities Inc. analysts think the deal is positive, but they're struggling to see accretion given that Exelon trades at 15.8 times 2016 earnings per share while Pepco is trading at 19.4 times (including the acquisition premium).

A lot of utilities are having a hard time finding growth, and funding much needed infrastructure improvements, due to lackluster demand for electricity, so they've been looking to expand through acquisition. Recent examples include Duke Energy Corp.-Progress Energy Inc., MidAmerican Energy Holdings-NV Energy Inc., Teco Energy Inc.-New Mexico Gas Co., Fortis Inc.-UNS Energy Corp. and Laclede Group Inc.-Alabama Gas Corp.-Missouri Gas Energy.

Exelon is in the same boat: It missed first-quarter earning targets by 7 to 11 cents per share, which Tudor Pickering attributed to generation outages during extreme winter weather that caused Exelon to buy expensive replacement power in the open market. However, the company reaffirmed its full-year guidance at $2.25 to $2.45 per share.

Analysts have named the following as potential targets: AGL Resources Inc., Pinnacle West Capital Corp., Vectren Corp., Cleco Corp., Empire District Electric Co., Scana Corp., Southwest Gas Corp. and Chesapeake Utilities Corp.

Exelon said the transaction is supported by a fully committed $7.2 billion bridge facility with Barclays plc and Goldman, Sachs & Co. It said it expects permanent financing to include Exelon equity issuance, long-term debt and corporate cash. The timing of the permanent financing is subject to several factors, including market conditions.

Crane will remain president and CEO of the combined company. Rigby, who previously announced his retirement, will remain in his roles at Pepco until the closing. Pepco will keep it regional headquarters in May's Landing, N.J.; Newark, Del.; and Washington, D.C.

Exelon has been acquisitive in recent years, paying $7.9 billion for Constellation Energy Group Inc. in 2012. However, in 2006, New Jersey regulators quashed its $25 billion purchase of Public Service Enterprise Group Inc. because of market-power concerns, and NRG Energy Inc. rebuffed its 2009 advances. It also failed in 2003 at picking up Illinois Power Co. for $2.2 billion.

Pepco has long been thought to be a takeover target. In July 2012, bond research firm CreditSights Inc. said it might be picked up by Richmond, Va., utility Dominion Resources Inc., which is thought to have gone after both Duke and Progress and lost out on nearby expansion when Exelon bought Constellation.

A source close to the situation said Dominion was not in the running to buy Pepco.

Pepco hasn't had the best luck at dealmaking. In 2010, it sold its Conectiv Energy unit to Calpine Corp. for $1.65 billion after buying it in 2001 for $2.2 billion.

Barclays' John Lange and Jay Hawthorn, Goldman Sach's Matt Gibson and Loop Capital Markets' Sidney Dillard are advising Exelon. A Kirkland & Ellis LLP team, including George Stamas, Mark Director, William Sorabella, Andrew Herman, Ashley Gregory, Christian Nagler, Kimberly Harkness, David Snyder, Kathryn Leonard and Howard Klein, is its legal counsel.

Lazard's George Bilicic and Frank Setian provided a fairness opinion and served as lead financial adviser to Pepco Holdings. Morgan Stanley's Jeffrey Holzschuh provided a fairness opinion to Pepco's board. Sullivan & Cromwell LLP's Joe Frumkin, Matthew Friestedt and Audra Cohen and Covington & Burling LLP's Michael Lefever, Kerry Burke, Robert Newman, Mike Francese and Spencer Walters are Pepco's legal counsel.

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