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First Energy's Latest Acquisition: Good Deal Or Dud?

Posted: Feb 18, 2010 10:13 AM by Greg Sushinsky

Tickers in this Article: AYE, DUK, ED, FE, SO

Electric utility company First Energy Co. (NYSE: FE) is buying Allegheny Energy (NYSE: AYE), which will result in a combined utility giant that even now spans portions of the Midwest and extends all the way to the east coast. The proposed $4.7 billion stock deal, along with the assumption of $3.8 billion in debt, will result in a company that should generate $16 billion in annual revenue and $1.4 billion in profit .

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First Energy, the Acquirer
First Energy is a holding company based in Akron, Ohio that has eight principal utility subsidiaries. The company has a nearly $12 billion market cap, and currently produces annual revenue of approximately $14 billion, with net income of $1.3 billion. First Energy began its current course of expansion years ago when, as Ohio Edison, it purchased First Energy, took over the name and became the dominant electric utility in northeastern Ohio. The company later purchased utilities in Pennsylvania and New Jersey, so it has spread out. Allegheny Energy is centered in Pennsylvania and West Virginia, so First Energy's regional footprint will edge out a little wider and deeper.

Allegheny Energy, the Acquired
Allegheny is considerably smaller, with a market cap just under $4 billion, revenue of $3.4 billion, and net income of just under $400 million. While the company is a potential geographic and strategic fit for First Energy, it has also been regarded as an underperformer. Obviously, this is the potential First Energy hopes to unlock, along with the cost savings and synergies implicit in such takeovers.

First Energy and Electrical Utilities
First Energy has seen flat revenues, as its recent quarter showed. For the fourth quarter, its revenue was $3.0 billion, down from $3.2 billion the same quarter a year ago, while net income dipped to $238 million from $332 million, or 78 cents earnings per share versus $1.09. This underscores that First Energy, like other electric utilities throughout the country, have struggled with the recession, because industrial and consumer electric use is down. First Energy's added problem is that it is centered in the Midwest, the heart of a long-term economic shift with a declining manufacturing and industrial base.

First Energy and Allegheny aren't alone in their struggles. Duke Energy (NYSE: DUK), which recently reported a profit increase despite flat revenue, has given a continuously downbeat economic forecast. Other major utilities that have struggled through the recession are beginning to pull out of this, though. Southern Company (NYSE: SO), for one, centered in Georgia, has earnings increases projected by analysts.

Will the Deal Work?
A situation is developing where consolidation looms in the industry, with major players looking to get stronger. By shoving together compatible operations and maxing out potential cost savings, First Energy's plan is obviously to push up both scale and performance. Can an old line electric utility in a non-growth geographical area win out this way? Difficult, but it's certainly possible, as Con Ed (NYSE: ED), for example, with its New York City footprint, is proving.

First Energy will have to clear regulatory hurdles and probably give rate concessions to get the buyout through, but once done, its management has shown an ability to manage its larger assets. The company could be positioned for greater strength, despite the industry's inherent difficulties, when the economy turns. Utilities are also edging outside of their geographic centers, something we'll no doubt see more of.

If It Works ...
The stock sells for a cheap multiple of just under 10.5 times current earnings and pays a dividend that currently yields 5.7%. If First Energy can get the deal through and it proves accretive long term, this could be a powerhouse utility in the making with an eye toward more acquisitions. (For additional reading about mergers and acquisitions, check out Biggest Merger and Acquisition Disasters and Accretion / Dilution Analysis: A Merger Mystery.)

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By Greg Sushinsky

Greg Sushinsky is a passionate independent investor, who has done his own research, analysis and investing for 20 years. One of his earliest investing memories was when he first saved and bought U.S. Savings Bonds with his own money as a small child. From there, he studied investing on his own and made small stock purchases as he grew as an investor.

Sushinsky still follows the markets, studies and reads widely in financial literature, and has written over 75 articles on investing. He is also a professional editor, whose work is published extensively in large-circulation magazines, digests and across the internet. In other pursuits, Sushinsky writes fiction and has a university degree in philosophy. To see more of Sushinsky's literary work, see http://writing.gregsushinsky.com/.

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