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Utility Commissioners / Wall Street Dialogue Hyatt Regency Jersey City December 10, 2004
Utility Commissioners / Wall Street Dialogue The Investment Bankers’  Perspectives on Regulation and the Utility Business
Investment Banker’s Perspective on Regulation and the Utility Business December 2004 Tom Osborne STRICTLY CONFIDENTIAL
Who is UBS? <ul><li>Presence in all major financial centers worldwide </li></ul><ul><ul><li>1,500 offices in 50 countries ...
UBS Global Power Group <ul><ul><ul><li>UBS is a leader in marketed common stock offerings in the utility sector </li></ul>...
The Role of Investment Bankers I ntermediary Investment Bankers Principal Research Brokers Capital Markets Sales & Trading...
Investor Perception of the Industry: Impaired but Improving Shift in value drivers, with the industry implementing  a back...
Sources of Funding  Equity and Debt issuances reflect utilities’ needs and  investors’ appetite Investment Grade Debt Comm...
Investors See Significant Risks Business Risks   <ul><ul><ul><li>Regulatory and legislative uncertainty </li></ul></ul></u...
Investors See Significant Risks Financial Risks   <ul><ul><ul><li>Overleveraged balance sheets </li></ul></ul></ul><ul><ul...
Rating Agency Shift <ul><ul><ul><li>Wider latitude to make judgment calls away from financial metrics </li></ul></ul></ul>...
Cost of Capital Reflects Perception of Risk Note: 1 Utility S&P credit rating index spread against the 10-Year Treasury Ut...
Cost of Equity <ul><li>Investors expected to focus on total return anchored by a strong dividend yield </li></ul><ul><li>I...
Regulation vs. Perceived Risk in the Utility Industry 1 4 7 10 13 0 1 2 3 4 6 7 8 State   Regulatory   Rating Corporate   ...
Avoiding the Vicious Cycle of Under-Recovery Restricted access to capital Higher borrowing costs Weaker credit metrics Nee...
<ul><ul><ul><li>During the merchant energy boom, investors and lenders offered aggressive transaction terms </li></ul></ul...
Regulatory & Legislative Wild Cards Regulatory <ul><ul><ul><li>National Energy Policy </li></ul></ul></ul><ul><ul><ul><ul>...
Balanced Regulation:  An Investor’s Check List Yes <ul><ul><ul><li>Clear, consistent policy </li></ul></ul></ul><ul><ul><u...
<ul><li>This presentation has been prepared by UBS securities LLC (“UBS”) for the exclusive use of recipient (together wit...
Contact Information UBS Securities LLC 299 Park Avenue New York NY 10171 Tel. +1-212-821 3000 www.ubs.com UBS Investment B...
Regulation and the Utility Business <ul><li>An Investment Banker’s Perspective </li></ul><ul><ul><li>December, 2004 </li><...
Deutsche Bank <ul><ul><li>One of the leading international financial service providers with about EUR900 billion of assets...
Global Energy and Utilities <ul><ul><li>Deutsche Bank has approximately 300 investment banking professionals focused on th...
Communication is the Foundation Electric Utilities Investment Banks  and Investors Regulators
Presentation Outline <ul><ul><li>There is a growing need for infrastructure investment in the US electric utility industry...
Infrastructure Investment  2005 – 2015 <ul><ul><li>Transmission expansion and upgrades </li></ul></ul><ul><ul><li>Environm...
Transmission <ul><ul><li>Additional transmission investment necessary to eliminate bottlenecks and other system constraint...
Environmental Controls <ul><ul><li>Long-term necessity to continue to reduce pollutant emissions at US power plants </li><...
Generation <ul><ul><li>New supply needs to be added to meet load and increase efficiency/reduce emissions </li></ul></ul><...
Customer Interface <ul><ul><li>Automated meter reading </li></ul></ul><ul><ul><li>Load control </li></ul></ul><ul><ul><li>...
Investment Leads to More Rate Cases Capital  Investment Regulatory  Approval Earnings Cash Flow ROE Rising  Demand
Nominal vs. Real Price of Retail Electricity cents/kWh
How to Reduce Long-Term Cost of Capital <ul><ul><li>Constructive regulation that appropriately values risk </li></ul></ul>...
Themes for 2005 to 2010 <ul><ul><li>The real price of electricity for consumers will be rising, leaving regulatory risk hi...
Themes for 2005 to 2010 <ul><ul><li>Spark spreads will recover and building programs will resume in selected regions </li>...
CURRENT TRENDS IN THE POWER & UTILITY INDUSTRY CONFIDENTIAL December 2004 James F. von Riesemann Vice President, Lazard Fr...
Current Strategic Challenges and Opportunities 1
Industry Valuation Drivers:  Dividend Yield, LT Growth and Total Return  2
Value Compression Dynamics: Current Premium Industry Valuations 3 <ul><li>Source: FactSet and I/B/E/S. </li></ul>
Current Business Models  4
Industry Valuation Drivers:  Long-Term Growth 5 (a)  Based on rounded Lazard Core Utility Index median. As interest rates ...
Consolidation Strategy:  A Fundamentally Consolidating Industry 6 (a) Includes 66 Electric Investor-Owned Utility Holding ...
Benefits  <ul><li>SynergiesCost </li></ul><ul><ul><ul><li>Savings may help support &quot;funding&quot; of necessary invest...
Issues <ul><li>Synergy sharing / “clawback” </li></ul><ul><li>Regulators may negate rationale for merger </li></ul><ul><li...
Electric Reliability:  The Merger Solution <ul><ul><li>One “win-win” solution would be to create a comprehensive regulator...
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  1. 1. Utility Commissioners / Wall Street Dialogue Hyatt Regency Jersey City December 10, 2004
  2. 2. Utility Commissioners / Wall Street Dialogue The Investment Bankers’ Perspectives on Regulation and the Utility Business
  3. 3. Investment Banker’s Perspective on Regulation and the Utility Business December 2004 Tom Osborne STRICTLY CONFIDENTIAL
  4. 4. Who is UBS? <ul><li>Presence in all major financial centers worldwide </li></ul><ul><ul><li>1,500 offices in 50 countries </li></ul></ul><ul><li>Superior credit ratings from all major agencies </li></ul><ul><ul><li>Fitch—AA+  </li></ul></ul><ul><ul><li>S&P—AA+ </li></ul></ul><ul><ul><li>Moody’s—Aa2 </li></ul></ul><ul><li>Invested assets of US$1.78 trillion </li></ul><ul><li>Nearly 65,929 employees globally </li></ul><ul><ul><li>39% in the US </li></ul></ul><ul><li>Market capitalization of US$83 billion </li></ul><ul><li>Shareholders’ equity of US$29.6 billion </li></ul><ul><li>ROE of 31.9% (before goodwill) </li></ul>Investment Banking Equities FIRC (Fixed Income, Rates and Currencies) Private Equity (executed as UBS Capital) Wealth Management and Business Banking Private and Corporate Clients Institutional Asset Management Mutual Funds A global, integrated investment services firm
  5. 5. UBS Global Power Group <ul><ul><ul><li>UBS is a leader in marketed common stock offerings in the utility sector </li></ul></ul></ul><ul><ul><ul><ul><li>ranked #1 by total proceeds in the last five years </li></ul></ul></ul></ul><ul><ul><ul><ul><li>participated in more than 90 marketed utility common stock offerings </li></ul></ul></ul></ul><ul><ul><ul><ul><li>raised more than $35 billion in common equity offerings globally </li></ul></ul></ul></ul><ul><ul><ul><li>Over the past five years, UBS has participated in more than 290 utility debt offerings </li></ul></ul></ul><ul><ul><ul><ul><li>ranked #6 by total proceeds </li></ul></ul></ul></ul><ul><ul><ul><ul><li>raised more than $113 billion in debt securities globally </li></ul></ul></ul></ul><ul><ul><ul><li>In the past 10 years, UBS has advised on over $90 billion of M&A and advisory assignments in the US utility sector </li></ul></ul></ul>
  6. 6. The Role of Investment Bankers I ntermediary Investment Bankers Principal Research Brokers Capital Markets Sales & Trading <ul><li>Equity </li></ul><ul><li>Debt </li></ul><ul><li>Risk Management </li></ul><ul><li>FX/Commodities </li></ul>Advisory <ul><li>Mergers & Acquisitions </li></ul><ul><li>Corporate Finance </li></ul><ul><li>Restructuring </li></ul><ul><li>Capital </li></ul><ul><li>Risk Assumption </li></ul><ul><li>Proprietary Trading </li></ul>Corporations Governments Financial Institutions Private Equity Sponsors Clients (…need capital) Retail Investors Individuals Investor Clients (…have capital ) Institutional Investors Mutual funds Pension funds Hedge funds Asset Management
  7. 7. Investor Perception of the Industry: Impaired but Improving Shift in value drivers, with the industry implementing a back-to-basics strategy
  8. 8. Sources of Funding Equity and Debt issuances reflect utilities’ needs and investors’ appetite Investment Grade Debt Common Equity High Yield Debt Convertible Securities US10YR
  9. 9. Investors See Significant Risks Business Risks <ul><ul><ul><li>Regulatory and legislative uncertainty </li></ul></ul></ul><ul><ul><ul><li>Need for infrastructure investments </li></ul></ul></ul><ul><ul><ul><li>Pressure to improve reliability </li></ul></ul></ul><ul><ul><ul><li>Variable economic conditions/fluctuating demand </li></ul></ul></ul><ul><ul><ul><li>Increased exposure to volatile fuel and commodity markets </li></ul></ul></ul><ul><ul><ul><li>Lack of certainty around forward curves </li></ul></ul></ul><ul><ul><ul><li>Higher counterparty risk </li></ul></ul></ul><ul><ul><ul><li>Customer and/or asset concentration </li></ul></ul></ul><ul><ul><ul><li>Competitive pressures </li></ul></ul></ul><ul><ul><ul><li>Weak spark spreads caused by persistent generation oversupply in selected markets </li></ul></ul></ul><ul><ul><ul><li>Rising costs (fuel, pension, insurance, O&M) </li></ul></ul></ul><ul><ul><ul><li>Rate setting cycle </li></ul></ul></ul>
  10. 10. Investors See Significant Risks Financial Risks <ul><ul><ul><li>Overleveraged balance sheets </li></ul></ul></ul><ul><ul><ul><li>Volatile interest rates </li></ul></ul></ul><ul><ul><ul><li>Timely return on/of capital </li></ul></ul></ul><ul><ul><ul><li>Ability to attract capital to fund critical infrastructure improvements </li></ul></ul></ul><ul><ul><ul><li>Form of return (dividend versus growth) </li></ul></ul></ul><ul><ul><ul><li>Increasingly stringent rating agency standards </li></ul></ul></ul>
  11. 11. Rating Agency Shift <ul><ul><ul><li>Wider latitude to make judgment calls away from financial metrics </li></ul></ul></ul><ul><ul><ul><li>Reduced number of credit metrics </li></ul></ul></ul><ul><ul><ul><li>Raising the bar via “Business Position” rankings </li></ul></ul></ul>Focus on qualitative issues in addition to quantitative
  12. 12. Cost of Capital Reflects Perception of Risk Note: 1 Utility S&P credit rating index spread against the 10-Year Treasury Utility Credit Spread 1 Source: S&P, Bloomberg Companies with lower credit ratings have higher and more volatile cost of capital Utility Ratings - Sep 2001 Utility Ratings - Sep 2004
  13. 13. Cost of Equity <ul><li>Investors expected to focus on total return anchored by a strong dividend yield </li></ul><ul><li>If historical relationships hold, multiple compression may occur given interest rate forecasts </li></ul><ul><ul><li>an R-square statistic of 78.9% suggests high correlation between Treasuries and P/Es over the last 27 years </li></ul></ul>P/E Analysis Credit strength and financial flexibility will continue to be focal points 4.13% 12.5x 5.30% 14.4x
  14. 14. Regulation vs. Perceived Risk in the Utility Industry 1 4 7 10 13 0 1 2 3 4 6 7 8 State Regulatory Rating Corporate Credit Rating Average Below Average AA A BBB BB B Above Average Source: Analysis includes 94 utilities. Credit ratings by S&P as of 10/7/04. State Regulatory Ratings by Regulatory Research Associates as of 4/12/04 Utilities operating under constructive regulatory environments have received better credit ratings 1 3 5 2 1 2 3 2 1
  15. 15. Avoiding the Vicious Cycle of Under-Recovery Restricted access to capital Higher borrowing costs Weaker credit metrics Need for rate increases beyond original amount Less-than-adequate returns and under-recovery of prudent costs Shift in business-risk perception makes this all the more crucial
  16. 16. <ul><ul><ul><li>During the merchant energy boom, investors and lenders offered aggressive transaction terms </li></ul></ul></ul><ul><ul><ul><li>Forward power curves have changed </li></ul></ul></ul><ul><ul><ul><li>Market requirements increase costs: </li></ul></ul></ul><ul><ul><ul><ul><li>higher degree of contract coverage </li></ul></ul></ul></ul><ul><ul><ul><ul><li>thicker layer of equity </li></ul></ul></ul></ul>No More “Trust Me” Initial Financing 2000 Refinancing 2004 Case Study: Calpine Construction Finance Company II (CCFCII) Investors are unwilling today to fund fully merchant activities
  17. 17. Regulatory & Legislative Wild Cards Regulatory <ul><ul><ul><li>National Energy Policy </li></ul></ul></ul><ul><ul><ul><ul><li>RTOs </li></ul></ul></ul></ul><ul><ul><ul><li>Genco market power analysis and ratebasing of production assets </li></ul></ul></ul><ul><ul><ul><li>Recovery of purchased power costs </li></ul></ul></ul><ul><ul><ul><li>Incentives for investment </li></ul></ul></ul><ul><ul><ul><li>Performance-based ratemaking </li></ul></ul></ul>Legislative <ul><ul><ul><li>National Energy Policy </li></ul></ul></ul><ul><ul><ul><li>Environmental controls </li></ul></ul></ul><ul><ul><ul><li>PUHCA reform </li></ul></ul></ul>
  18. 18. Balanced Regulation: An Investor’s Check List Yes <ul><ul><ul><li>Clear, consistent policy </li></ul></ul></ul><ul><ul><ul><ul><li>open access </li></ul></ul></ul></ul><ul><ul><ul><ul><li>recovery of known & measurable, prudently incurred costs </li></ul></ul></ul></ul><ul><ul><ul><li>PBR incentive mechanisms </li></ul></ul></ul><ul><ul><ul><ul><li>fuel cost sharing </li></ul></ul></ul></ul><ul><ul><ul><ul><li>potential for upside </li></ul></ul></ul></ul><ul><ul><ul><li>Timeliness </li></ul></ul></ul><ul><ul><ul><li>Integrated Resource Planning </li></ul></ul></ul><ul><ul><ul><ul><li>PPAs and generation additions </li></ul></ul></ul></ul><ul><ul><ul><li>Critical investment incentives </li></ul></ul></ul><ul><ul><ul><ul><li>FERC transmission incentives </li></ul></ul></ul></ul><ul><ul><ul><ul><li>adequate returns on new generation </li></ul></ul></ul></ul>No <ul><ul><ul><li>Inconsistent or unclear policy </li></ul></ul></ul><ul><ul><ul><li>Under-recovery of costs </li></ul></ul></ul><ul><ul><ul><li>Regulatory lag </li></ul></ul></ul>Risks are rising: Regulators play a crucial role in managing those risks
  19. 19. <ul><li>This presentation has been prepared by UBS securities LLC (“UBS”) for the exclusive use of recipient (together with its subsidiaries and affiliates, the “company”) using information provided by the company and other publicly available information. UBS has not independently verified the information contained herein, nor does UBS make any representation or warranty, either express or implied, as to the accuracy, completeness or reliability of the information contained in this presentation. Any estimates or projections as to events that may occur in the future (including projections of revenue, expense, net income and stock performance) are based upon the best judgment of UBS from the information provided by the company and other publicly available information as of the date of this presentation. There is no guarantee that any of these estimates or projections will be achieved. Actual results will vary from the projections and such variations may be material. Nothing contained herein is, or shall be relied upon as, a promise or representation as to the past or future. UBS expressly disclaims any and all liability relating or resulting from the use of this presentation. </li></ul><ul><li>This presentation has been prepared solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. The company should not construe the contents of this presentation as legal, tax, accounting or investment advice or a recommendation. The company should consult its own counsel, tax and financial advisors as to legal and related matters concerning any transaction described herein. This presentation does not purport to be all-inclusive or to contain all of the information which the company may require. No investment, divestment or other financial decisions or actions should be based solely on the information in this presentation. </li></ul><ul><li>This presentation has been prepared on a confidential basis solely for the use and benefit of the company; provided that the company and any of its employees, representatives, or other agents may disclose to any and all persons, without limitation of any kind, the tax treatment and tax structure of the transaction and all materials of any kind (including opinions or other tax analyses) that are provided to the company relating to such tax treatment and tax structure. Distribution of this presentation to any person other than the company and those persons retained to advise the company is unauthorized. This material must not be copied, reproduced, distributed or passed to others at any time without the prior written consent of UBS. </li></ul>
  20. 20. Contact Information UBS Securities LLC 299 Park Avenue New York NY 10171 Tel. +1-212-821 3000 www.ubs.com UBS Investment Bank is a business group of UBS AG UBS Securities LLC is a subsidiary of UBS AG
  21. 21. Regulation and the Utility Business <ul><li>An Investment Banker’s Perspective </li></ul><ul><ul><li>December, 2004 </li></ul></ul><ul><ul><li>Jay Dobson </li></ul></ul><ul><ul><li>Deutsche Bank </li></ul></ul>
  22. 22. Deutsche Bank <ul><ul><li>One of the leading international financial service providers with about EUR900 billion of assets </li></ul></ul><ul><ul><li>66,750 employees in 74 countries serving over 21 million customers </li></ul></ul><ul><ul><li>Significant investment banking practice in the US, Europe and Asia </li></ul></ul><ul><ul><li>Over 11,000 employees in the US focused on financial services and investment banking </li></ul></ul>
  23. 23. Global Energy and Utilities <ul><ul><li>Deutsche Bank has approximately 300 investment banking professionals focused on the energy and utility industries globally </li></ul></ul><ul><ul><li>Deutsche Bank is a leading manager of investment grade debt, high yield debt, equity and related derivative/structured products for the utility industry </li></ul></ul><ul><ul><li>Recently represented financial sponsors in acquisition of Texas Genco in $3.6 billion transaction </li></ul></ul><ul><ul><li>Extensive commodity trading business, currently well positioned to hedge commodity price risk and intermediate credit risk </li></ul></ul>
  24. 24. Communication is the Foundation Electric Utilities Investment Banks and Investors Regulators
  25. 25. Presentation Outline <ul><ul><li>There is a growing need for infrastructure investment in the US electric utility industry </li></ul></ul><ul><ul><li>Some of this investment will need to rate base treatment </li></ul></ul><ul><ul><li>Constructive regulation and good management reduces investor risk and therefore the cost of capital in the long term </li></ul></ul><ul><ul><li>Observations on the future of the industry </li></ul></ul>
  26. 26. Infrastructure Investment 2005 – 2015 <ul><ul><li>Transmission expansion and upgrades </li></ul></ul><ul><ul><li>Environmental controls to reduce pollutants </li></ul></ul><ul><ul><li>New generation supply </li></ul></ul><ul><ul><li>Technological improvements at the customer interface </li></ul></ul>
  27. 27. Transmission <ul><ul><li>Additional transmission investment necessary to eliminate bottlenecks and other system constraints </li></ul></ul><ul><ul><li>Growing demand for power requires investment in transmission system expansion </li></ul></ul><ul><ul><li>Increasing size of regional power pools would reduce power prices, but will require transmission investment </li></ul></ul><ul><ul><li>Utilization of new technology to control power flows and increase line capacity/reduce line loss is necessary </li></ul></ul>
  28. 28. Environmental Controls <ul><ul><li>Long-term necessity to continue to reduce pollutant emissions at US power plants </li></ul></ul><ul><ul><ul><li>SO2, CO2, NOx, mercury, particulates </li></ul></ul></ul><ul><ul><li>Additional federal legislation likely eventually </li></ul></ul><ul><ul><li>Could prompt retirement of high pollution, low efficiency plants despite low level of investment net of depreciation </li></ul></ul><ul><ul><li>Long-term approach has the ability to reduce costs through the use of technology and innovation </li></ul></ul>
  29. 29. Generation <ul><ul><li>New supply needs to be added to meet load and increase efficiency/reduce emissions </li></ul></ul><ul><ul><li>With two year planning and permitting lead time, new adds need to begin soon </li></ul></ul><ul><ul><li>Technological alternatives to gas like IGCC are almost economic </li></ul></ul><ul><ul><li>Regulated or deregulated </li></ul></ul>
  30. 30. Customer Interface <ul><ul><li>Automated meter reading </li></ul></ul><ul><ul><li>Load control </li></ul></ul><ul><ul><li>Two-way communications with customers </li></ul></ul><ul><ul><li>Desire to increase customer satisfaction </li></ul></ul>
  31. 31. Investment Leads to More Rate Cases Capital Investment Regulatory Approval Earnings Cash Flow ROE Rising Demand
  32. 32. Nominal vs. Real Price of Retail Electricity cents/kWh
  33. 33. How to Reduce Long-Term Cost of Capital <ul><ul><li>Constructive regulation that appropriately values risk </li></ul></ul><ul><ul><li>Management incentives to reward good management and recognize bad management </li></ul></ul><ul><ul><li>Communication between all parties is a critical foundation for low cost of capital </li></ul></ul><ul><ul><li>Cooperative regional approach to infrastructure </li></ul></ul>
  34. 34. Themes for 2005 to 2010 <ul><ul><li>The real price of electricity for consumers will be rising, leaving regulatory risk high but improving chances that regulators will support industry consolidation and rational synergy cost sharing </li></ul></ul><ul><ul><li>Major investments will be made in utility infrastructure and rate base assets, particularly in transmission and distribution </li></ul></ul><ul><ul><li>Environmental rules will become more strict, helping nuclear and coal gasification and leaving natural gas fired capacity on the margin in most regions </li></ul></ul><ul><ul><ul><li>Environmental control costs will add to rising capital expenditures </li></ul></ul></ul>
  35. 35. Themes for 2005 to 2010 <ul><ul><li>Spark spreads will recover and building programs will resume in selected regions </li></ul></ul><ul><ul><li>LNG imports will add supply, but demand growth will be higher, keeping gas prices and volatility relatively high </li></ul></ul><ul><ul><ul><li>Permitting and siting complications for LNG facilities could delay real impact on US commodity prices until late in the decade </li></ul></ul></ul><ul><ul><li>Deregulation will resume late in the decade, spurred by improvements in wholesale electricity markets </li></ul></ul><ul><ul><li>PUHCA will be repealed and industry consolidation will resume </li></ul></ul><ul><ul><ul><li>Regulatory control will be resolved with states maintaining influence </li></ul></ul></ul><ul><ul><ul><li>Synergy sharing will be more favorable </li></ul></ul></ul>
  36. 36. CURRENT TRENDS IN THE POWER & UTILITY INDUSTRY CONFIDENTIAL December 2004 James F. von Riesemann Vice President, Lazard Freres & Co. LLC
  37. 37. Current Strategic Challenges and Opportunities 1
  38. 38. Industry Valuation Drivers: Dividend Yield, LT Growth and Total Return 2
  39. 39. Value Compression Dynamics: Current Premium Industry Valuations 3 <ul><li>Source: FactSet and I/B/E/S. </li></ul>
  40. 40. Current Business Models 4
  41. 41. Industry Valuation Drivers: Long-Term Growth 5 (a) Based on rounded Lazard Core Utility Index median. As interest rates rise and dividend yield alone is no longer able to sustain current premium Industry valuations, investors will again begin to discriminate more on the basis of utilities’ total return propositions
  42. 42. Consolidation Strategy: A Fundamentally Consolidating Industry 6 (a) Includes 66 Electric Investor-Owned Utility Holding Companies.
  43. 43. Benefits <ul><li>SynergiesCost </li></ul><ul><ul><ul><li>Savings may help support &quot;funding&quot; of necessary investment infrastructure </li></ul></ul></ul><ul><ul><li>Fill growth gap </li></ul></ul><ul><ul><li>Portfolio diversity </li></ul></ul><ul><ul><li>Regulatory diversity </li></ul></ul><ul><ul><li>Enhance management, address succession issues </li></ul></ul><ul><ul><li>May reduce cost of capital </li></ul></ul><ul><ul><li>Enhance balance sheet and investment flexibility </li></ul></ul><ul><ul><li>Equity premium considerations (Modified MOE or acquisition) </li></ul></ul><ul><ul><li>Market acceptance of recent mergers </li></ul></ul><ul><ul><li>Sector valuation </li></ul></ul><ul><ul><li>Benefits of scale (generation, trading and marketing, retail, cost of capital, absorb errors, etc.) </li></ul></ul>Consolidation Strategy: Competing Considerations
  44. 44. Issues <ul><li>Synergy sharing / “clawback” </li></ul><ul><li>Regulators may negate rationale for merger </li></ul><ul><li>Federal regulatory uncertainty </li></ul><ul><li>Transmission policy </li></ul><ul><li>Market power </li></ul><ul><li>Growth gap not permanently filled </li></ul><ul><li>Some diversity may create more issues than benefits (e.g. lack of familiarity with new regulators) </li></ul><ul><li>Time to close (especially relates to regulatory delay) </li></ul><ul><li>Headquarters issues </li></ul><ul><li>Management issues </li></ul><ul><li>Historical issues </li></ul><ul><li>Quality of currency received; evaporating premium </li></ul><ul><li>Market focus on yield, back-to-basics </li></ul><ul><li>Strategic imperative not “life or death” </li></ul><ul><li>Sector valuation </li></ul>Consolidation Strategy: Competing Considerations
  45. 45. Electric Reliability: The Merger Solution <ul><ul><li>One “win-win” solution would be to create a comprehensive regulatory environment supportive of utility consolidation that directs a significant portion of the derived merger synergies toward infrastructure investment </li></ul></ul><ul><ul><ul><li>If 50% of merger synergies were directed towards investment in reliability and the top 100 utilities merged to create only 50, it could result in as much as $50 billion in derived cost synergies allocated towards system investment </li></ul></ul></ul><ul><ul><li>In an environment with many pressures that may otherwise require rate increases, rate increases to fund investment may be politically challenging </li></ul></ul><ul><ul><li>Directing the shared cost savings in a merger could, therefore, create benefits for all constituencies </li></ul></ul><ul><ul><ul><li>Regulators: achieve significant reliability spending while avoiding/mitigating rate increases </li></ul></ul></ul><ul><ul><ul><li>Ratepayers: avoid shouldering the entire burden of infrastructure investment </li></ul></ul></ul><ul><ul><ul><li>Utilities and shareholders: benefits of cost efficiencies, economies of scale and improved financial strength </li></ul></ul></ul><ul><ul><li>Investment ultimately requires an appropriate return; if rate increases are unpalatable, then access to the embedded economies of scale from Industry consolidation could ease the burden of infrastructure investment and create benefits through further system reliability and financially stronger utilities </li></ul></ul>8

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