Pepco and Baltimore Gas & Electric Co.'s star-crossed effort to become Constellation Energy collapsed yesterday as the two companies walked away from plans to merge into a $15 billion company. The aborted deal cost the companies two years and $100 million.
The companies began the merger process in September 1995 to gird themselves against what is expected to be a massive shakeout in the $212 billion electric power industry after which only a handful of the smarter, stronger players are expected to be left standing. The deal would have frozen electric rates and saved $1.3 billion over 10 years, the companies said. The companies proposed splitting the savings between shareholders and consumers, but regulators wanted consumers to have an even larger share and made that a condition of the deal's completion.
In the end, because the merger dragged on for so long and the pace of competition sped up, the utility companies opted to walk away from this deal, but analysts said both companies were candidates for future mergers. In the long run, the decision probably won't change the inevitable arrival of competition in the area. But in the short term, it could mean higher rates for consumers because the companies won't benefit from the savings they had anticipated from the merger.
"In a competitive environment, obviously the last thing you want to do is raise your rates," Pepco president and chief executive John M. Derrick Jr. said yesterday. But he added that lost opportunities for savings "will put upward pressure that otherwise would not have been there" on rates. As evidence of that, in November Pepco won approval for a $2.50-a-month increase in the average residential customer's bill in Maryland, saying it needed the increase because the merger still was pending.
"It's still a fertile field for mergers," said Derrick, who wouldn't rule out another merger or anything else for Pepco.
"I think that most companies of their size are not going to be able to go it alone, so I would assume that a few years from now there will be other combinations in the region that are likely to involve these companies," said Barry Abramson, an electric utility analyst with PaineWebber Inc.
But for now, Potomac Electric Power Co. and BGE are going it alone.
Despite the failure of the Pepco-BGE merger, the electric utility industry appears to be headed irreversibly down the path toward consolidation.
What persuaded the two companies to merge in the first place is a world in which businesses and homeowners may be able to shop for electricity in the same way consumers can choose a supplier of long-distance phone service.
As Pepco and B&GE announced the end of their plans to merge -- including plans to split the $100 million loss and write it off against earnings this year -- two other utilities yesterday unveiled plans to combine into a single company twice as large as the now-abandoned Constellation.
American Electric Power Co., a Midwestern powerhouse that serves seven states, including a portion of Virginia, said it would merge with Central and South West Corp., which serves Texas, Louisiana, Oklahoma and Arkansas. Together the companies would serve 4.6 million customers in 11 states.
One major factor in the decision by Pepco and BGE to call off their merger is the speed at which the state of Maryland appears to be moving toward competition, the companies said yesterday. The Maryland Public Service Commission issued an order earlier this month that would allow up to one-third of the state's customers to choose their power provider by April 1, 1999.
"There's just too much work involved" in getting ready for competition to merge and attempt to change regulators' minds about the conditions that should apply to the proposed merger, said Pepco's Derrick.
Pepco and BGE announced their plans to merge in September 1995. Last April, the deal won approval from federal regulators and conditional approval from Maryland. Several months later, D.C. regulators also approved the merger with conditions that the two companies said were unacceptable.
The regulatory process in Maryland was complicated further by a challenge to the state Public Service Commission's decision by the union that represents workers at Pepco.
Maryland PSC Chairman H. Russell Frisby Jr. said yesterday that the decision to call off the merger was "regretful" and that "due to the potential benefits for Maryland ratepayers" he hoped the companies might renew the process. But the letter signed by the two companies calling it quits was irrevocable, said Pepco spokeswoman Nancy Moses.
D.C. People's Counsel Elizabeth A. Noel said yesterday that calling off the merger "was the right thing to do." Noel, who represents consumer interests in utility proceedings in the District, said she doesn't object to mergers overall, but this was "the wrong marriage with the wrong partner at the wrong time" for Pepco.
Larry Alberts, who follows electric utilities for American Express Financial Advisors Inc., said that "it's somewhat expected at this point in time, after two years, that it would have collapsed. That's not to say that at some point in the future both of these companies might not be an acquirer or a target."
The cancellation of the merger puts other corporate decisions in limbo. For instance, Pepco has a contract to buy a piece of land near Ninth and G streets NW in downtown Washington where it planned to build a $90 million regional Constellation headquarters that would house 1,300 employees.
The company's lease on its current headquarters at 1900 Pennsylvania Ave. NW expires in 2002. "We are looking at all the options," said Pepco's Moses. But she said that occupying a new building would cost more than staying put.
But the collapse of the merger won't change development plans for a site near Annapolis that was the most likely headquarters location for the combined company, according to Randall M. Griffin, president of Constellation Real Estate Inc., a BGE subsidiary.
"If they had chosen to go there, that would have been nice, but it was not essential," Griffin said of the 10-story building his firm plans to construct just west of Annapolis near Route 50. Site work has begun on the land, and the company is awaiting building permits.
The proposed merger of AEP and CSW would create the largest utility company in the nation in terms of numbers of customers and power produced but not in revenue, a category in which Pacific Gas & Electric Co. would still be No 1. In addition to its 4.6 million customers in the United States, the two companies serve another 4 million customers in Britain, Mexico, Brazil and China.
Each share of stock in CSW would be traded for 0.6 shares of AEP, which would represent a 20 percent premium over the price of CSW as of Friday's close of business. The companies said the deal would save $2 billion in 10 years.
AEP chairman E. Linn Draper Jr. said he expects regulators to approve the deal in 12 to 18 months. Because AEP is essentially acquiring CSW and is undergoing no change in ownership itself, the deal only requires state regulatory approval in the four states in which CSW operates, according to Draper.
Unlike the the Pepco-BGE deal, which would have given the combined company more customers in Maryland than either company had separately, the AES-CSW deal represents "no increase in the number of customers in any one state," saidDraper. "There will be more footprints, but they won't be any bigger than the footprints that are already there," he said. Washington Post staff writer Maryann Haggerty contributed to this report.