In the end, Potomac Electric Power Co.'s future was determined largely by its size.
Surrounded by behemoths such as Virginia Power Co., Pepco's relatively limited area and small customer base made the Washington-based power company a likely target for a takeover in an industry that is aggressively moving toward competitiveness.
But by agreeing last month to merge with Baltimore Gas and Electric Co. to form the nation's ninth-largest utility, nearly 100-year-old Pepco ensures both that it will be in the vanguard of industry trends and to a certain extent control its destiny.
"BGE puts us in a position where we can be at the table with much larger utility companies, that neither Pepco nor BGE could do alone," said John M. Derrick Jr., Pepco's president and chief operating officer and the person designated to hold that title in the merged company. "Neither of us was particularly comfortable with the sea of big guys around us."
Indeed, industry experts and analysts say that sweeping changes being mandated by the federal government will result in tremendous consolidation, making Pepco -- and players like it, with fewer than 1 million customers -- vulnerable despite its nearly $7 billion in assets and a prosperous but limited geographic territory including Washington and its Maryland suburbs.
The industry's survivors, the analysts contend, will be the industry Goliaths that control vast geography and can generate savings through size, allowing them both to compete and to fend off hostile raiders. Pepco, with a shrinking urban core and mature suburbs, was unlikely to sustain any measurable growth in the coming years.
"There is a strong view out there that as competition becomes prevalent, bigger is better," said Bruce G. Humphrey, director of research for Cambridge Energy Research Associates, a Massachusetts-based industry consulting firm.
But the reasons for the pending corporate marriage go far beyond the fact that Pepco's 640-square-mile territory borders BGE's. More important to the fit are the shared management styles, corporate cultures and philosophies of the two utilities -- and the desire by Pepco to be proactive regarding pending industry changes.
"They just fit exceedingly well," said Doug Kimmelman, a Goldman, Sachs & Co. vice president and head of the investment banking firm's utility department who advised BGE in the merger talks. "Most importantly, they share a vision of the changes that are taking place in the industry, and the need to drive costs down. I think there are a lot of synergies to be gained."
Pepco's need to merge to survive has become the subject of intense debate within the industry since the strategic alliance with BGE was announced. Despite its small customer base of 670,000, Pepco had prospered for years through efficient management and adherence to conservative financial principles.
"When I was in the Massachusetts Public Service Commission, we used to use Pepco as the comparable utility and a model for a well-run company," said Lawrence D. Crocker, acting general counsel for the Washington Public Service Commission.
It also benefited from the Washington area's explosive growth as suburbs mushroomed in Prince George's, Montgomery and Charles counties, posting a historically solid financial performance. Today, more of Pepco's residential customers live in the suburbs than in the city of Washington.
But Pepco's performance has slipped of late. Last year, Pepco reported its net income fell 6 percent from 1993, to $227 million, on revenues of $1.8 billion. It also posted losses in the first two quarters of this year, the result of a more than $100 million after-tax charge Pepco took to eliminate an airplane leasing subsidiary -- one of the company's few daring ventures.
Stock slipped, dividend held
The stumble hurt the company's stock, which slipped from its 1994 high of more than $26 in January to $18.375 by the end of the year, and the stock continued to trade under $20 until merger rumors pushed it higher in the late spring.
Still, Pepco maintained its $1.66 per share dividend last year, despite criticism from some analysts who worried that the high payout ratio would eventually strain Pepco's ability to pay.
"Financially, there's nothing present now that would raise red flags, but a couple of years from now they could have faced real problems because of their dividend," said Alex Hart, a utility analyst with Ferris, Baker Watts Inc., in Baltimore.
"Pepco will be the larger beneficiary, at least in the short term, because they could have faced cash-flow pressures in the future. So the combination brings them some much-needed financial flexibility."
As have other utilities, Pepco has embarked on an intense cost-cutting campaign that has partially offset its earnings slump. Since 1989, the company has eliminated more than 700 employees, or more than 15 percent, of its work force, which now numbers 4,500.