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Friday, February 12, 2010

Shift on Climate Prompts FirstEnergy Deal

The Wall Street Journal

Does the road to FirstEnergy's surprise all-stock acquisition of Allegheny Energy run through Copenhagen and Massachusetts?

The failure of December's climate summit in Copenhagen dealt a blow to the prospect of U.S. carbon cap-and-trade legislation passing anytime soon. The death knell was last month's Republican victory in the Massachusetts Senate vote.

This has lifted a cloud, for electricity generators at least. Apart from recession, regulatory uncertainty has stayed their impulse to invest. Allegheny's $8.5 billion deal value, including assumed debt, pushes U.S. utility mergers-and-acquisition volume to its highest level since the second quarter of 2008, according to Dealogic.

The enlarged FirstEnergy's unregulated generation portfolio of 21 gigawatts will be 60% coal-fired. Two-thirds of that is made up of higher-efficiency coal-fired plants, relative to standard ones. More important, Allegheny's plants are predominantly in regions where coal-fired generation sets the marginal price of electricity. This mitigates the impact on profits should cap-and-trade come into force eventually, as costs would be passed through.

But if political prevarication removed a roadblock, a low price gave the green light. Even with a 32% premium to Wednesday's closing price, FirstEnergy is acquiring Allegheny for about 11 times 2010 earnings. Announced synergies, discounted, equate to only 7% of FirstEnergy's preannouncement share price, assuming regulators claw back half the gains for customers. That is a pittance for a big deal which will draw regulatory scrutiny in several states.

Rather than cost savings, FirstEnergy appears to be calling the bottom on the utility sector, which was second only to telecom stocks in having a dismal 2009. Given its own share price will spend the next year or so in regulatory purgatory, investors in agreement might consider buying some of its rivals instead.