Merger chances darken Workers' challenge, regulators' ruling stall BGE-Pepco alliance

7 months late

Analysts see need to unite to survive takeover atmosphere

November 02, 1997|By Kevin L. McQuaid | Kevin L. McQuaid,SUN STAFF

Chris Poindexter thought he'd never address Baltimore Gas and Electric Co. shareholders again.

At an upbeat meeting in April 1996 at the Sheraton Inner Harbor Hotel -- what was supposed to have been the last such gathering in the utility's 180-year history -- the BGE chairman told stockholders how the company was ready for the future, thanks to its pending merger with Potomac Electric Power Co. of Washington.

But on Thursday morning, Poindexter was back at the Sheraton, nearly apologizing for the delay but at the same time telling anxious shareholders that the creation of Constellation Energy Corp. -- the product of the corporate marriage now 216 days past its scheduled wedding date -- is still less than certain.

"This year has been punctuated by a series of setbacks," Poindexter said. "As a result, we are still seeking resolution to the merger. But we remain steadfastly convinced that this merger, as proposed, is in the best interest of customers, our shareholders, our communities, our employees and the business community at large."

At the same time, Poindexter alluded to the disappointment over not having the merger completed, saying "but 1997 has been anything but predictable."

The lack of certainty is understandable, though.

That's because more than two years after BGE and Pepco decided to join forces, the utilities continue to face myriad obstacles, from a union court challenge contending that the $3 billion merger isn't in the public's interest to regulatory conditions that could cost hundreds of millions of dollars.

The regulatory hurdles -- in both Maryland and the District of Columbia -- are so arduous that BGE and Pepco have said Constellation might never become a reality unless they are altered significantly.

Should that occur, both BGE and Pepco could be forced to join with other power companies to stay competitive in the industry's fast-changing landscape.

Even recent victories associated with the BGE-Pepco alliance are laced with agony. Last week, for instance, a Baltimore County Circuit Court judge, siding with BGE and Pepco, rejected arguments by the International Brotherhood of Electrical Workers that the merger isn't in the public interest.

But the case is likely to be appealed to the state's Court of Special Appeals, where it could languish for months. And even if it isn't, BGE must contend with regulators bent on reducing electric rates by $48 million a year and a union threatened with extinction if the merger proceeds.

Those roadblocks are potentially so onerous, in fact, that most industry analysts believe the merger's chances are less than 50 percent.

Both companies, nevertheless, say they remain committed because the cost savings created by the new utility would benefit both customers and stockholders. BGE and Pepco also have spent more than $100 million to make the merger a reality, a sum that analysts believe makes walking away a difficult proposition.

Constellation, which would become the nation's ninth largest power concern with more than $15 billion in assets, also would brace the company against deregulation and the increased competition that would result.

Perhaps even more importantly, the merger would nearly eliminate the threat of a hostile takeover by a larger, out-of-state company, since its customer base of nearly one million would meet the threshold analysts believe will be required to remain independent at the start of the 21st century.

"They're both too small to succeed on their own," said Edward J. Tirello, a NatWest Securities Ltd. utility industry analyst who follows BGE. "As the markets open up and competition becomes the norm, they're going to realize they are far too small as they are. Separately, they're in big trouble."

As time goes by, however, analysts speculate utilities will require customer bases of between five and 10 million to stay viable.

"They don't have to merge, but strategically I see why they want to. It makes a lot of sense," said Ronald S. Tanner, a Legg Mason Wood Walker Inc. analyst. "They're looking at the industry as a whole, and they know that they have to get bigger in order to survive."

As a result, if the seemingly endless court challenges and regulatory hurdles doom the alliance between BGE and Pepco, both utilities are likely to eventually look for other partners.

The potential suitors -- for both sides -- would be numerous.

Pepco reportedly has had at least initial talks with Duke Energy Corp., the major North Carolina utility with more than $13 billion in assets and whose executives are Pepco alumni who remain close to the company. Virginia-based Dominion Energy Inc. also has expressed interest in expanding geographically.

On the other side, BGE long ago targeted Washington Gas Light Co. as a natural and logical merger candidate, according to internal company memorandum.

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