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Mergers and Acquisitions in the United StatesScott HemplingApril 20171.The changes: Ownership concentration and business complication2. The actions causing the changes: Mergers of monopolies, undisciplined by effective competition3. The detriments from the changes: Monopoly perpetuation, efficiency loss, financial leveraging and customer risk4. Regulatory' acquiescence: Visionlessness, deference, and a tragedy of the commons5. Solutions: Align current corporate structures, and future acquisition activity, with a public interest visionLISTNUM 1 \l 1The changes: Ownership concentration and business complicationIn 1980, the industry looked like this: Over 100 single integrated utility monopoly systems, most confined to electricity, simple corporate forms with the utility owned directly by individual shareholders. In 2016, the industry looked like this: 50 systems, having an array of characteristics, with a range of ownership, business mix, and corporate structure. We can understand the change by looking through different lenses.LISTNUM 1 \l 2Concentration: Chronological and geographical LISTNUM 1 \l 3Concentration refers to a reduction in the number of utility companies controlling assets used for utility service. Consolidation occurs when two more utility companies owned separately become owned in common, or when one utility (or its holding company owner) acquires the utility assets of another. Concentration eliminates the separate ownership of utility assets or utility businesses, thereby concentrating control of assets within fewer independent owners. LISTNUM 1 \l 3Chronological viewLISTNUM 1 \l 4From 100 to 50 in 20 years.LISTNUM 1 \l 4Acceleration: Mergers of the previously merged of the previously mergedLISTNUM 1 \l 5(Pepco + Delmarva), (Commonwealth Edison + PECO)LISTNUM 1 \l 5[(Pepco + Delmarva) + Atlantic City], [(Commonwealth Edison + PECO) + BG&E] LISTNUM 1 \l 5The effect this trend, from mergers of unmerged to mergers of merged, is to increase the size of the transactions:LISTNUM 1 \l 3Geographic view: Regional, national and international LISTNUM 1 \l 4 \s 1Intraregional: Fifty still sounds like a lot. But it looks different if you look within a region, and perhaps within a state (since a state does not know well the companies in other states)LISTNUM 1 \l 5 \s 1In the MidAtlantic region, Potomac Electric, Atlantic City and Delmarva, all midatlantic utilities, are now part of a single holding company, PHI Holdings. [update to reflect Exelon]LISTNUM 1 \l 5Northeast Utilities, which own Connecticut Light and Power, Hartford Electric Company, Western Massachusetts Electric Company and Holyoke [INSERT correct name], has since the 1990s acquired Public Service of New Hampshire and Boston Edison.LISTNUM 1 \l 4Crossregional: Mergers have joined companies from different regions, as when Carolina Power and Light (North Carolina and South Carolina) merged with Florida Power Corp.; Berkshire Hathaway purchased MidAmerican (Iowa CHECK), Pacificorp (Washington, Oregon, Utah,, Idaho, California) and Nevada Power; and American Electric Power (7 states) merged with Central and South West (four states). LISTNUM 1 \l 4International: IberdrolaUI; MacquarieCLECO; National GridRGE and others.LISTNUM 1 \l 2Complication: Five dimensionsComplication refers to the extent to which a utility's corporate family differs from a conventional utility whose sole or primary business is serving retail customers. Complication has five dimensions: types of owners, business activities, corporate and ownership structure, financial structure and interaffiliate relationships. LISTNUM 1 \l 3Types of owners: utility holding company, private equity buyouts, nonutility companies.LISTNUM 1 \l 3Mix of business activitiesLISTNUM 1 \l 3Corporate structure: layers and governanceWho controls what?LISTNUM 1 \l 3Financial structure: debtequity ratio, consolidated and individualLISTNUM 1 \l 3Interaffiliate relationships: Who buys what from whom?LISTNUM 1 \l 1The actions causing the changes: Mergers of monopolies, undisciplined by effective competitionLISTNUM 1 \l 2 \s 1The transactions: From motivations to outcomes LISTNUM 1 \l 3 \s 1Internal motivations LISTNUM 1 \l 4 \s 1Focus on "growth" rather than serviceLISTNUM 1 \l 4Size mattersLISTNUM 1 \l 4Competitive positioningLISTNUM 1 \l 4Financial strengtheningLISTNUM 1 \l 5 \s 1Increase access to financial resources by growing company sizeLISTNUM 1 \l 5Strengthen the finances of a target company facing demand for new or improved infrastructure.LISTNUM 1 \l 5Strengthen a weaker company's financesLISTNUM 1 \l 4Diversification of riskLISTNUM 1 \l 5 \s 1Strengthen financial condition by diversifying income sources LISTNUM 1 \l 5Diversify "regulatory risk" by acquiring utilities in different jurisdictionsLISTNUM 1 \l 5Diversify investors' portfolio (Berkshire Hathaway adding stable utilities to its mix of other subsidiaries; NEE buying Oncor). LISTNUM 1 \l 5Diversify sources of income by adding unrelated businesses.LISTNUM 1 \l 4Increase target stock valueLISTNUM 1 \l 4Add similar companies to an existing portfolio of utilities LISTNUM 1 \l 4Increase acquirer's earningsLISTNUM 1 \l 4Reduce cost or enhance performance LISTNUM 1 \l 5 \s 1Get access to key inputs, for efficiency and for dominance LISTNUM 1 \l 5Reduce costs by achieving economies of scale or economies of scopeLISTNUM 1 \l 5Improve operations or reduce costs by combining one company's skills with another company's needsLISTNUM 1 \l 5Combine one company's skills with another company's needs.LISTNUM 1 \l 5Gain access to another company's technology to comply with environmental regulations.LISTNUM 1 \l 5Gain access to key inputs at cost rather that at costplusprofit (known as the "doublemarginalization" issue).LISTNUM 1 \l 5Increase economies of scale or scope.LISTNUM 1 \l 5Combine different load shapes.LISTNUM 1 \l 5Strengthen a weaker company's finances.LISTNUM 1 \l 5Gain better access to lowercost capital.LISTNUM 1 \l 5Diversify "regulatory risk" by operating in multiple markets.LISTNUM 1 \l 4Keep up with the JonesesLISTNUM 1 \l 4Fixer up, turn around and resellLISTNUM 1 \l 4Shift risks of failure to others LISTNUM 1 \l 3External stimuli LISTNUM 1 \l 4 \s 1Market "deregulation" LISTNUM 1 \l 4Low interest ratesLISTNUM 1 \l 4Flat demandLISTNUM 1 \l 4Future carbon regulation LISTNUM 1 \l 3Type of merger (market structure)LISTNUM 1 \l 4 \s 1Horizontal merger LISTNUM 1 \l 4Vertical merger LISTNUM 1 \l 4Horizontal and vertical merger combinedLISTNUM 1 \l 4Convergence merger LISTNUM 1 \l 4Market extension merger LISTNUM 1 \l 4Conglomerate mergerLISTNUM 1 \l 4Partial acquisitionLISTNUM 1 \l 3Type of merger (transaction structure)LISTNUM 1 \l 4 \s 1Method of combinationLISTNUM 1 \l 5 \s 1pooling of interestsLISTNUM 1 \l 5cash buyoutLISTNUM 1 \l 4Going public or private?LISTNUM 1 \l 4Structural level LISTNUM 1 \l 3Setting the price LISTNUM 1 \l 4 \s 1Auctioning to the highest bidderLISTNUM 1 \l 4Other proceduresLISTNUM 1 \l 3Financing options LISTNUM 1 \l 4 \s 1Acquiring with debt (relate to doubleleveraging)LISTNUM 1 \l 4Acquiring with equity LISTNUM 1 \l 3Regulatory plan LISTNUM 1 \l 3The role of rating agencies LISTNUM 1 \l 2The absence of competitive market discipline LISTNUM 1 \l 3 \s 1Common to all mergers, whether in competitive markets or in monopoly markets: The target seeks the highest price, while the acquirer seeks the most profitable market opportunity at the lowest acquisition cost. The difference in expected market conditions, between a competitive market and a regulated monopoly market, produces a difference in constraints on the acquisition prices, unless regulatory policy replicates competitive market conditions.LISTNUM 1 \l 3In the regulated monopoly context, what is being bought and sold is control of a monopoly franchisea governmentgranted right to receive a relatively secure revenue stream in return for providing service that satisfies the commission's standards. How is the acquisition price determined?LISTNUM 1 \l 3In a competitive context, the constraint on the acquisition price is the market price and investment opportunities in the ultimate customer marketboth items determined objectively by the market. In the regulated monopoly context, the constraint on the acquisition price is the negotiators' expectations about the decisions the merged company can persuade the regulator to make about current and future price levels and current and future investment opportunitiessome of which decisions will be made in the merger approval proceeding by current regulators, and other decisions that will be made after consummation, by current and future regulators. LISTNUM 1 \l 3In utility mergers, the ultimate market is noncompetitive. Prospective acquirers still compete to buy the revenue stream from target shareholders. But unlike the competitive context, the winning acquirer's customers and their payments are guaranteed. So absent regulatory involvement, the acquisition competition is solely a competition to win the shareholders; it is not simultaneously a competition to win the customers. Absent regulatory involvement, the competition is judged by those target shareholders, whose goal is highest price. LISTNUM 1 \l 3The discipline on the acquisition price is not market price for the ultimate product, but the terms that will satisfy the regulator. Thus the acquisition strategy includes a regulatory strategya strategy to persuade the regulator of the terms, rather than a strategy for meeting the demands of the market at a lower price than competitors. The strategy must include subjective means of persuasion rather than objective efforts to beat the market price.LISTNUM 1 \l 1The detriments from the changes: Monopoly perpetuation, efficiency loss, financial leveraging and customer riskLISTNUM 1 \l 2 \s 1Perpetuation and extension of the monopoly roleLISTNUM 1 \l 2Foregoing of economies and efficienciesLISTNUM 1 \l 2Reduction in innovation LISTNUM 1 \l 2Misallocation of wealthLISTNUM 1 \l 2Rates exceed costLISTNUM 1 \l 2Increase in business riskLISTNUM 1 \l 2Increase in financial risk LISTNUM 1 \l 2Risks re quality of serviceLISTNUM 1 \l 2Risks re responsiveness to customers LISTNUM 1 \l 2Reduction in regulator's ability to regulateLISTNUM 1 \l 2Uncertainty for employeesLISTNUM 1 \l 2Summary: Corporate and governance structures that embody conflict between private interest and public interest LISTNUM 1 \l 1Regulatory' acquiescence: Visionlessness, deference, and a tragedy of the commonsLISTNUM 1 \l 2 \s 1Unreadiness: Vision, screens, expertise LISTNUM 1 \l 3 \s 1No affirmative vision for corporate structure LISTNUM 1 \l 3No standards that promote good couplings and discourage bad couplingsLISTNUM 1 \l 3Institutional gaps LISTNUM 1 \l 4 \s 1Issue expertise LISTNUM 1 \l 4Professional dialogueLISTNUM 1 \l 4Before vs. after studiesLISTNUM 1 \l 2How do merger strategists exploit this unreadiness?LISTNUM 1 \l 3 \s 1Emphasize positivesLISTNUM 1 \l 4 \s 1"Frame" the proposal as natural, normal, positive, LISTNUM 1 \l 4Use positive languageLISTNUM 1 \l 4Distract with "benefits" LISTNUM 1 \l 4Exploit asymmetrical knowledgeLISTNUM 1 \l 4Feign local knowledge NextEra CEO to the Texas Commissioners: "Perhaps I'll start with the issue of whether you know, the whole hometown issue, I'd like to address that. You know, obviously, I'm not from Texas. I think some of you know, though, that I'm my wife is from Texas. She grew up in Dallas….She's from Dallas. I actually was married in Dallas....Her whole family lives in Texas. My my wife's first cousin is actually the mayor of Waco, and they are all all of her family are customers of Oncor."LISTNUM 1 \l 3Downplay negativesLISTNUM 1 \l 4 \s 1Disregard or minimize the risksLISTNUM 1 \l 4"Our conditions eliminate the risks"LISTNUM 1 \l 5 \s 1Code of conduct LISTNUM 1 \l 5"Ringfencing" LISTNUM 1 \l 5Illusory conditions LISTNUM 1 \l 5"Eliminating all risk is not practical"LISTNUM 1 \l 4Diminish opponents and their argumentsLISTNUM 1 \l 4Use incrementalism: It's only one transaction LISTNUM 1 \l 3Limit regulatory discretionLISTNUM 1 \l 4 \s 1Pour the concrete earlyLISTNUM 1 \l 4Make it a "take it or leave it" propositionLISTNUM 1 \l 4Create deadline pressureLISTNUM 1 \l 4Induce intervenors' support with "offers" LISTNUM 1 \l 4Build extrarecord, outside political supportLISTNUM 1 \l 4Don't take "no" for an answerLISTNUM 1 \l 2How do commissions respond? Procedural reactivity and erroneous substantive decisionsLISTNUM 1 \l 3 \s 1Use reactive procedures LISTNUM 1 \l 3Commit conceptual errorsLISTNUM 1 \l 4 \s 1Wrong frameLISTNUM 1 \l 5 \s 1Fail to test the transaction against a vision for corporate structure and fitness to the commission's goals LISTNUM 1 \l 5Fail to see that the transaction is not about creating benefits but about moving wealthLISTNUM 1 \l 5Use other utility mergers as relevant comparisons, thus reasoning circularlyLISTNUM 1 \l 5View mergers as routine rather than foundationally structuralLISTNUM 1 \l 5Fail to see the commission as reviewing a purchasesale decision requiring an appropriate benefit/cost ratioLISTNUM 1 \l 4Underemphasize the long termLISTNUM 1 \l 5 \s 1Fail to see how approval constrains future commission decisionsLISTNUM 1 \l 5Tragedy of the commons: Ignore the cumulative effects of all the approvals, in favor of the specific incremental benefits of this single transactionLISTNUM 1 \l 4Defer to nonobjective considerationsLISTNUM 1 \l 5 \s 1Fail to see that market forces don't operate in the market for mergers; therefore, fail to replicate the forces of competitionLISTNUM 1 \l 5Adopt, by rote, the idea that "bigger is better" LISTNUM 1 \l 5Get distracted by "benefits" unrelated to the transaction LISTNUM 1 \l 5Confuse freedom to run the business with freedom to acquire or be acquired LISTNUM 1 \l 5Allow "settlements" to substitute for merger policyLISTNUM 1 \l 5Feel obligated to "balance" shareholder and customer interestsLISTNUM 1 \l 3Overestimate the direct net benefits, by counting benefits and costs incorrectlyLISTNUM 1 \l 3Underestimate the risksLISTNUM 1 \l 3Overestimate the protections from "conditions"LISTNUM 1 \l 3Misallocate benefits ("synergies," doubleleveraging, target shareholder gain)LISTNUM 1 \l 2Why do commissions behave this way?LISTNUM 1 \l 3 \s 1Passion gapLISTNUM 1 \l 4 \s 1Applicants maximize profit; regulators reduce harm LISTNUM 1 \l 4Applicants have a clear business purpose; regulators lack a policyLISTNUM 1 \l 4Applicants compare this transaction to the best possible transaction; regulators compare this transaction to the status quoLISTNUM 1 \l 3Deferential mindsetLISTNUM 1 \l 4 \s 1Accept the asserted business purpose, despite obvious evidence to the contraryLISTNUM 1 \l 4Accept the constraints sought by applicants LISTNUM 1 \l 4On disputed evidence, give applicants benefit of the doubt LISTNUM 1 \l 4Define the state's interest in terms of the utility's interestLISTNUM 1 \l 4Willingness to absorb risk on behalf of companiesLISTNUM 1 \l 4Confuse a desire with a need; see merger behavior as normalLISTNUM 1 \l 4Emphasize positives; understate negatives LISTNUM 1 \l 3"Weebees" LISTNUM 1 \l 3Insights from behavioral psychologyLISTNUM 1 \l 4 \s 1Framing is everythingLISTNUM 1 \l 4Common heuristicsLISTNUM 1 \l 5 \s 1AvailabilityLISTNUM 1 \l 5RepresentativenessLISTNUM 1 \l 5ConditionalityLISTNUM 1 \l 5Anchoring and adjustmentLISTNUM 1 \l 4Value theoryLISTNUM 1 \l 4Loss aversionLISTNUM 1 \l 4No sense of crisisLISTNUM 1 \l 4The role of irrelevant evidence in affecting predictionsLISTNUM 1 \l 2Contrast: The 45 commission rejections (out of around 100 applications) or merger failuresLISTNUM 1 \l 1Solutions: Align current corporate structures, and future acquisition activity, with a public interest visionLISTNUM 1 \l 2 \s 1Preparation: Mindset, resources and jurisdictionLISTNUM 1 \l 2Create vision: Needs, services, market structures, company typesLISTNUM 1 \l 3 \s 1The "public interest" applied to corporate structureLISTNUM 1 \l 3The populace's needsLISTNUM 1 \l 3Services that can fulfill those needsLISTNUM 1 \l 3Types of market structures that can efficiently supply those servicesLISTNUM 1 \l 3Types of companies that can most costeffectively, reliably and innovatively operate within those market structuresLISTNUM 1 \l 2Make rules: Rules align transactions with vision LISTNUM 1 \l 3 \s 1Standard for regulatory approvalLISTNUM 1 \l 3Type of transaction to approve LISTNUM 1 \l 4 \s 1Business purpose and type of merger LISTNUM 1 \l 4Characteristics of merger partner: LISTNUM 1 \l 4Procedure for finding merger partnerLISTNUM 1 \l 4Effect on competition: existing and future marketsLISTNUM 1 \l 3Conditions on transaction termsLISTNUM 1 \l 4 \s 1Purchase price in relation to book valueLISTNUM 1 \l 4Financing of the transactionLISTNUM 1 \l 4Who gets the gain? (gain = purchase price over market value)LISTNUM 1 \l 4Allocation of the actual savingsLISTNUM 1 \l 3Conditions on actions of the postacquisition entityLISTNUM 1 \l 4 \s 1Corp structure and governanceLISTNUM 1 \l 4Financial protections (ringfencing)LISTNUM 1 \l 4Service qualityLISTNUM 1 \l 4Future financingsLISTNUM 1 \l 4Future acquisitionsLISTNUM 1 \l 4Interaffiliate transactionsLISTNUM 1 \l 4Entry into monopoly and competitive businessesLISTNUM 1 \l 4Enforcement and remedies (including divestiture and spinoff)LISTNUM 1 \l 2Apply the rules: Four scenariosLISTNUM 1 \l 3 \s 1Existing corporate structures LISTNUM 1 \l 3Applicantinitiated proposalsLISTNUM 1 \l 3Commissionsolicited proposalsLISTNUM 1 \l 3Correction and enforcement LISTNUM 1 \l 4 \s 1Corrective actionsLISTNUM 1 \l 4Financial penaltiesLISTNUM 1 \l 4Divestiture and spinoffLISTNUM 1 \l 4Living will: DoddFrank ................
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