Allegheny could prove ideal as Constellation takeover target

October 16, 2002|By JAY HANCOCK

WILL Constellation Energy's Mayo Shattuck try to take over his struggling rival, Hagerstown-based Allegheny Energy?

Of course, he would probably like to. Of course, he isn't talking about it. Of course, Wall Street is.

"I've heard rumors that Mayo called up there" to Allegheny, says Christopher Ellinghaus, an energy analyst with Williams Capital in New York. "The rumor I heard was that the call was not returned."

Wall Street merger gossip, to belabor the obvious, does not always coincide with reality.

But bosses at Constellation, parent of Baltimore Gas and Electric, have said they want to do acquisitions. They must expand Constellation into a nationwide electricity player or sell it to someone who is, analysts believe.

And few if any companies would fit better into Constellation's lineup than Allegheny, whose subsidiaries include Potomac Edison. Allegheny's 1.7 million electricity customers and $11 billion in assets could join Constellation's 1.1 million electricity customers, 600,000 gas customers and $13 billion in assets to produce a substantial mid-Atlantic dynamo.

Allegheny's five-state mountain territory could be spliced onto Constellation's mid-Maryland turf. Constellation could get the bulk to compete. And the people in Constellation's Pratt Street headquarters could get the kind of job security that doesn't come when your revenue is only $4 billion.

There are three problems, big but not necessarily insurmountable, with this scenario. Allegheny apparently doesn't want to be acquired. Constellation might not be able to afford it. And somebody else might beat Constellation to an Allegheny buyout.

Allegheny is a potential takeover target for the same reason sick wildebeests don't last long on the African veldt. Hurt by a fall in wholesale electricity prices and an ill-advised foray into the national electricity bazaar, Allegheny has seen its profit plunge, its credit rating sink below investment grade and its stock fall 90 percent.

At $600 million, the value of Allegheny's outstanding stock is much more affordable for a potential buyer today than the $6 billion the company would have commanded in May last year.

Even so, it's unclear how Constellation or many other energy companies could do an Allegheny deal, which would involve the assumption of billions in Allegheny liabilities as well as paying for the stock.

A debt-leveraged buyout would seem out of the question; investors regret many of the energy-industry bonds they already own and aren't in the mood to buy new ones. Likewise, Constellation has a decent balance sheet for a power company, but it is fairly close to the maximum capital-ratio limits allowed by some loan contracts and can't take on a ton of new debt.

The alternative - a stock swap - has problems, too. Shares of most energy companies have fallen recently, including Constellation's. Analysts suggested to me that Constellation's stock at $22.32 a share isn't valuable enough to finance an Allegheny takeover in a way that wouldn't hurt existing Constellation shareholders.

But the game isn't over, and the clock is ticking. Job 1 for Allegheny is to score up to $2 billion in refinancing and obtain new debt to maintain liquidity and cure technical defaults on some borrowings. It is negotiating with several banks and has promised to improve its cash position by reducing or eliminating its dividend.

Although spokesman Cynthia A. Shoop told me Allegheny has enough unencumbered assets to back the new borrowings, it is not obvious that the deal will get done.

The state of California might renegotiate a power-supply contract it holds with Allegheny, to Allegheny's detriment. Allegheny has said its profit in coming quarters will not meet expectations, but it hasn't said by how much. And, like many energy companies in the post-Enron world, Allegheny is feared to be holding derivatives contracts that could produce unexpected losses from its clouded trading operation.

All of those developments could produce new blowups.

"The thing that scares everybody away is: What are the monsters hidden under the bed at Allegheny's trading operation?" says Edward Metz, an energy analyst at SNL Financial in Charlottesville, Va.

Metz has thought about an Allegheny takeover by Constellation but thinks it would be "a little bit of a stretch." That could change, however, if Constellation's stock recovers or Allegheny runs into more problems.

A more likely bidder for Allegheny, Metz said, is Richmond, Va.-based Dominion Resources. Dominion and Allegheny declined to comment on my questions about takeover interest.

So did Constellation. But Constellation boss Shattuck, who until last year was chairman of investment bank Deutsche Banc Alex. Brown, is a deal maker by training and temperament. He's got to be thinking about it.

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