The Takeout Menu Narrows

Mergers and acquisitions have figured prominently in the utility business since Thomas Edison threw the first switch. And industry consolidation will continue, regardless of trends in interest rates, the stock market, the economy, and politics.

(Click graph to enlarge.)

Most of these tie-ups have created stronger companies. Even Ohio Edison’s acquisition of Centerior Energy Corp in the 1990s—a deal I dismissed as “mindless”—ultimately resulted in a utility that made a decent amount of money for its investors: FirstEnergy Corp (NYSE: FE).

Why do mergers and acquisitions in the utility sector usually create value for shareholders?

Corporate cultures don’t differ too dramatically, nor do job functions and equipment; the lessons learned at one utility often apply elsewhere.

These transactions also bring economies of scale that make companies partners with their vendors, not merely customers. Consider electric utilities’ growing dominance of the market for renewable energy, a trend that has transformed First Solar (NSDQ: FSLR), SunPower Corp (NSDQ: SPWR) and other components manufacturers from potential disruptors to facilitators of an important secular growth opportunity.

Superior economies of scale also reduce utilities’ costs, making it less expensive to add to rate base and convert system investment into earnings.

Nevertheless, mergers and acquisitions didn’t figure prominently in the panel discussions or my conversations with management teams at the Edison Electric Institute’s 2017 financial conference.

In fact, several executives went out of their way to emphasize that acquisitions weren’t their first priority when it comes to capital allocation. Representatives from one large utility denied any interest in purchasing SCANA Corp (NYSE: SCG), which trades at book value after abandoning the Summer nuclear power project.

Several factors explain the waning interest in mergers and acquisitions.

Keeping to Themselves

For one, management teams expect investments in their own regulated franchises to generate better returns. Utilities are replacing aging facilities on a massive scale for the first time in decades, with inexpensive natural gas and renewable energy adding to rate base and reducing operating costs.