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With Pepco Deal, Exelon Moves to Calmer Waters

Brett Feldman — May 2, 2014

As a former Exelon employee, I don’t find the announcement of Exelon acquiring Pepco a surprising development.  A wave of consolidation has hit the utility industry since the recession began in 2008, with larger companies with stronger balance sheets looking to take over vulnerable entities.  Pepco may not have been in obvious peril, but it has recently earned less than its allowed return on investment, making the Washington, D.C.-based investor-owned utility a likely target for acquisition.

Exelon has agreed to buy Pepco for $6.8 billion, creating the largest utility in the Northeast. After the merger, Exelon’s utilities will serve 10 million customers and have a combined rate base of $26 billion, putting it close to Duke Energy as the largest utility customer base in the country.  

Steady as She Goes

Exelon’s stock and earnings have taken a beating the past couple of years, due to the exposure of its nuclear and coal plants to flattening electricity prices brought about by weak economic growth and strong shale gas expansion.  When it acquired Constellation for $7.9 billion in 2012, Exelon was counting on the competitive generation and supply segments as the growth leaders of the business, while the regulated utilities were just the hull of the ship keeping it afloat.  The opposite occurred, however, as low energy and capacity prices sank the baseload generation business to the point where Exelon is considering retiring several nuclear plants and made the retail supply business, which thrives on volatility, a strategy in limbo.  Texas-based Energy Future Holdings Corp. (EFH) recently declared bankruptcy due to similar failed bets.  Price spikes this past winter and future capacity price increases in New York and New England may present a glimmer of hope (Exelon’s stock is up over 30% this year), but those factors involve plenty of risk and a long-term horizon, as well.

So, now the pendulum swings back to the safer, regulated side of the business.  Acquiring Pepco makes geographic sense, as it expands Exelon’s reach down the I-95 corridor from Philadelphia to Baltimore to Washington, D.C.  There will certainly be opportunities for overhead and personnel savings to be found among the various headquarter locations, as well.  Already an expert in the PJM wholesale energy marketplace on the Eastern Seaboard, Exelon has a long familiarity with the region’s public utility commissions.  There really is not much downside for Exelon, aside from valuing the business appropriately.

This is not a sexy deal in terms of being a beachfront for new business models or technology breakthroughs.  It is simply a back-to-basics, balance sheet-stuffing, risk-reducing measure to steady the helm in current market conditions.  If the opposite of a polar vortex occurs this summer, maybe the merchant business will come roaring back to the fore.

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