Duke/PanEnergy deal an M&A strategy shift

Barbara Saunders
Staff Writer

In a new twist on mergers and acquisitions motivated by the growing convergence of natural gas and power markets, Duke Power Co., a giant electric utility based in Charlotte, N.C., and Houston-based PanEnergy Corp., a giant natural gas pipeline and marketing concern, agreed to merge in a deal valued at $23 billion.

Analysts say the merger is different from other gas and power combinations in recent months-in part because of the sheer size of the two firms being merged and in part because it illustrates a strategy that could become more common in months to come.

It's the first merger between an electric utility and a gas company, analysts agreed, where an electric utility specifically has sought a gas-based partner without a local distribution company (LDC) able to serve the utility's existing customers.

It's also a combination that represents one of the biggest bids yet for national-vs. regional-market share in both the gas and power arenas.

"It changes the merger/acquisition picture among gas pipelines," said Carol Coale, vice-president and senior natural gas analyst for Prudential Securities Inc. in Houston. "It's the first we've seen where a pipeline without an LDC was acquired by an electric utility...Other mergers were electrics buying gas companies where they could directly serve customers through LDC affiliates. It's a shift in strategy that's very significant for the entire pipeline sector."

What's involved

Duke Power, one of the nation's largest investor-owned utilities, sells electricity at regulated rates to 1.8 million customers in North Carolina and South Carolina.

Through a joint venture with Louis Dreyfus LLC, Duke Power also ranks second in sales of unregulated wholesale power, with volumes of nearly 14.5 million MW-hr in the first three quarters of 1996, according to the latest filings with the Federal Energy Regulatory Commission.

PanEnergy operates one of the nation's largest natural gas pipeline systems, with about 37,000 miles of pipeline serving the Midwest, Mid-Atlantic, and New England regions.

In 1995, deliveries through PanEnergy's pipelines accounted for roughly 12% of total U.S. gas consumption. In addition, a unit of PanEnergy has recently become one of the nation's largest gas marketers through a merger with a unit of Mobil Corp. (OGJ, Sept. 16, p. 16). PanEnergy also has become a significant player in the unregulated power market through another affiliate, which currently ranks 13th in year-to-date power sales, with volumes of 2.07 million MW-hr during the first three quarters of 1996.

After completion of the merger, which the companies expect to take about 1 year pending shareholder and regulatory approvals, Duke Power will change its name to Duke Energy Corp. and PanEnergy will be a wholly-owned subsidiary of Duke Energy. Both companies' boards have approved a definitive merger agreement to create the integrated company, which would have total market capitalization of $17 billion in equity and $6 billion in debt and preferred stock.

Under the agreement, each PanEnergy share would be converted into 1.0444 shares of Duke Power, and PanEnergy's stockholders would own about 44% of the common stock of the combined company at closing.

Convergence impetus

"As the gas and electric markets have begun to converge, we have recognized a need to align ourselves with an electric partner," said Paul M. Anderson, president and chief executive officer of PanEnergy.

The merger will give PanEnergy a partner in the electric sector that is strong financially and skilled in engineering and global power asset management, he added. At the same time, he said, "Duke Energy will have the ability to offer physical delivery and management of both gas and electricity in multiple regions of the country."

William H. Grigg, chairman and CEO of Duke Power, said, "In our dramatically changing industry, we need to define ourselves by customers' needs, not by our traditional product offerings...We will continue to be committed to our core electric business...However, both Duke Power and PanEnergy realize that the convergence of the gas and electricity industries means that a combined company would achieve distinct advantages not available to either on a stand-alone basis."

Different alliance

The proposed alliance follows a rash of recent megamerger plans throughout the gas and electric industries.

Among the largest to date is Enron Corp's proposed bid to join forces with Portland General Corp. (OGJ, July 29, Newsletter). However, analysts cautioned not to compare the two deals too closely.

"That's a very different animal," said Ellen Lapson, senior director for Fitch Investor Service in New York, commenting on the Enron-Portland merger. "In that case, it seemed to us, one of the benefits Enron is seeking is physical delivery capability in the West Coast interchange. I believe they found it attractive to acquire a relatively small company among the smaller of the electric utilities in the West Coast interchange. It gave Enron physical access without having to take on a very big company."

By contrast, Lapson noted, the Duke-PanEnergy deal "is a very significant-sized merger on both sides of the house."

In terms of customer base alone, Portland General has about 600,000 customers, less than half of Duke Power's.

Strategy analysis

Analysts also noted that the proposed Duke-PanEnergy alliance marks a departure from typical electric utility mergers.

"You've previously seen mergers that are defensive in orientation, two utilities wanting to get bigger to fend off nasty guys," said Edward Krapels, director of Energy Security Analysis Inc. (ESAI), a Washington, D.C., consulting firm. This is the first proposed merger initiated by an electric utility, that's strategically "offensive" in nature, Krapels added.

Prudential's Coale concurred: "It's one of the first offensive mergers by an electric company to acquire a gas company. Others have been defensive, doubling up on customers."

Examples include Texas Utilities Co's . bid for Enserch Corp, as well as Houston Lighting & Power Co.'s bid for NorAm Energy Corp.

Both involve large electric concerns acquiring other large utilities with gas distribution and marketing capabilities.

"I look at this as wholesale-oriented, not oriented toward distribution," said Fitch's Lapson of the Duke-PanEnergy plans.

Another significant aspect of the Duke-PanEnergy merger is PanEnergy's involvement in the Sable Island gas project, said ESAI's Krapels.

"It pushes Sable Island gas into the New England region, which is gas-starved. It's one of the few regions that's retained a significant amount of oil-burning capacity."

As a result, Krapels said, the combined companies will be particularly well-positioned to negotiate BTU-based deals in the future, playing power prices off oil and natural gas prices to obtain the most attractive terms for customers.