FirstEnergy Strikes $4.7 Billion Deal to Buy Allegheny Energy

For electric utility companies, business is usually stable: Electricity is one of the last services people turn off. But the fact remains that the recession has still been a drag on the industry as people and businesses have cut back on usage to save money. And that has utilities looking for ways to save money themselves.Mergers are a popular way for companies to find those savings, and Thursday brought a deal: FirstEnergy (FE) agreed to pay $4.7 billion for Allegheny Energy (AYE). It's an all-stock transaction and comes at a 31.6% premium over Allegheny's share price. FirstEnergy will also assume $3.8 billion of Allegheny's debt. The combined entity will be one of the biggest electric providers in the country.

FirstEnergy is the fifth-largest investor-owned electric system in the U.S., with 4.5 million customers in Ohio, Pennsylvania and New Jersey. In all, the company operates roughly 14,000 megawatts of capacity. Allegheny Energy generates roughly $3 billion in revenues and provides electricity to 1.5 million customers in Pennsylvania, West Virginia, Maryland and Virginia. It has about 9,730 megawatts of generating capacity.

As a combined entity, FirstEnergy-Allegheny Energy will have about $16 billion in revenues and $1.4 billion in profits, serving six million customers. It will also have a more diversified platform, with 28% of revenues coming from nuclear, 18% from subcritical coal facilities and 52% from supercritical coal facilities. Bear in mind that the latter are more efficient and environmentally friendly, an important consideration given the likelihood of increased regulations on carbon emissions.

On the financial side, the deal is expected to be accretive to earnings in the first year after the deal closes, which is expected to happen in 12 to 14 months. The debt load will be a reasonable 3 to 3.5 times EBITDA.

Regulators Likely to Slow Down Time Line

The proposed FirstEnergy-Allegheny Energy merger looks spot-on. It's a classic case of industry players bulking up and finding cost synergies. But the companies are also subject heavy federal and state regulation, which often makes it tough to pull off this sort of deal. Generally, regulators want to ensure there are no unwarranted price increases and that service levels are appropriate.

While there is not much market overlap between the two utilities, the fact remains that gaining regulatory approval can be dicey and time-consuming. If anything, the proposed time line to close the deal may be optimistic.

Still, given the current economic situation, this deal may be only the first of many in the sector. According to Karl Miller, founder of MMC Energy, with more than 250 mid- to large-size utilities across the U.S., the industry is well-positioned for a wave of consolidation.
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