`Bulk up or get bought' may be company choice

Constellation enters altered energy landscape dominated by giants

October 27, 2001|By William Patalon III | William Patalon III,SUN STAFF

With its corporate split-up plan overtaken by major shifts in the U.S. electricity market, Constellation Energy Group has been forced to backtrack and might have to choose between two fates: bulk up through a series of acquisitions or face the prospect of getting bought out itself, some industry experts say.

The U.S. power industry "probably will grow into an industry of all bigger companies," said Thorsten Fischer, an economist with Economy.Com in West Chester, Pa., who follows the country's utility sector. "It's more a matter of them consolidating to find efficiencies - operating efficiencies and efficiencies of know-how."

Constellation said yesterday that it had scuttled its plans to split the company into two independent companies - a merchant power company and a regional utility. It also announced an end to its partnership with investment banker Goldman Sachs Group Inc., paying the Wall Street firm $355 million to terminate the agreement.

The decision underscored how fast the landscape had changed since Constellation unveiled its break-up plan last October, just four months after electricity deregulation had begun in Maryland.

When the breakup was announced, Constellation and Goldman Sachs - which had signed on as a 17.5 percent partner in exchange for a $250 million investment - had ambitious plans for the power-generation business that was to carry the Constellation name. As an unregulated company, it would enter the high-risk but fast-growing business of selling electricity wholesale nationwide at the top price it could command.

The goal was for Constellation to get much bigger. With Goldman's help, Constellation would buy existing power plants and perhaps build others to serve markets where electricity reserves could be low during periods of peak demand.

The highly publicized plight of California was one reason there was such excitement about a once-humdrum industry.

An acute shortage of power and a flawed deregulation plan combined to create a nightmare of soaring prices, rolling blackouts and bankrupt utilities.

Similar, lesser problems appeared in other parts of the country, such as the Midwest, analysts say.

For merchant power producers, these power shortages signaled opportunity. To expand existing large power plants - and to build new ones - would take time.

Meanwhile, thanks to the Internet - and the high-speed telecommunications networks and giant server farms being installed at a record clip - industry leaders figured the demand for electricity had to keep rising.

Utilities began spinning off divisions that built or operated power plants, reckoning that the separate pieces would be worth more than the whole to investors. And they were correct. Investors pushed up the shares of these wholesale electricity providers far higher than the businesses were worth.

That kind of euphoria never lasts, said Jeffrey H. Gildersleeve, an energy analyst with Argus Research in New York.

New sources of electricity came on line in California, even as the economy's slowdown pushed down the demand for electricity - as well as the price. The merchant power business no longer appeared attractive. Stock prices dropped.

According to one study, the price/earnings ratio, or P/E - the price of a share of stock divided by earnings per share for a 12-month period - of pure-play power producers was 30 at the end of last year. Now, the average P/E is 12.

Mirant Corp., a power plant builder and operator recently spun off by the utility Southern Co., has seen its stock fall from about $47 in May to $27 as investor interest in power plant stocks cooled. Constellation's stock has fallen more than 40 percent since its plan to split was announced last year.

"A lot of companies last year tried to take advantage of a situation they saw lasting for several years, but the situation didn't last," said Michael Worms, an analyst with Gerard Klauer Mattison. "Now there is a slowdown of the economy, the effects of the [terrorist] attacks, and concerns about overbuilding power plants."

Argus' Gildersleeve thinks those factors cooled the interest in the plan pursued by Goldman Sachs and Constellation. Goldman was looking toward the spin-off, when Constellation would be an independent firm, unfettered by PSC regulation and able to prowl for acquisitions to make it bigger.

When those opportunities vanished, so did the partnership, Gildersleeve said.

"The basis for the relationship, the basis for the [split-up], was the merchant-power business," he said. "And that is in question right now. I have a feeling [Goldman] put a lot of pressure" on Constellation to scrap the partnership.

Ending the agreement "was a mutual decision based on a change in Constellation's business strategy," said Goldman spokeswoman Kate Baum.

Constellation must develop a new, go-it-alone strategy. With nearly $4 billion in annual revenue, Constellation is larger than the smallest utilities. But it's dwarfed by the largest ones, analysts say.

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