Necessity is the mother of invention. Ben Franklin, out in the lightning storm with a key tied to his kite, would tell you so. Most IROs in the electric utility sector would agree.
Once an industry of happily regulated monopolies, the electric business is now breaking apart around the globe and reforming itself under the influence of deregulation. Electric companies must learn the same thing their telecom neighbors did: how to compete. Deregulation and restructuring cause business strategies to change overnight and capital expenditures that were once hard numbers tied to wires and generators are now pooled in liquid reserve for the next buying opportunity. The traditional ‘widows and orphans’ stocks – so-called for their safe and consistent performance – have become some of the most unpredictable. In short, IROs have to roll with the times.
‘With deregulation and restructuring we’re now seeing utilities become a much more diversified sector,’ admits Scottish Power’s director of corporate affairs, Sue Clark. ‘You’ve got at one end some very aggressive, acquisitive players that are really positioning themselves as growth stocks. Then at the other end of the spectrum you’ve got companies that are focusing more on the regulated monopoly businesses, and those will continue to be valued on a yield basis.’
In Europe the single currency has revealed electricity cost differences from country to country and accelerated deregulation. The UK got a jump on many, beginning its movement toward privatization in 1990. Germany’s two largest electric companies, Veba and Viag, recently announced their merger in anticipation of full deregulation to become the country’s largest power provider. Meanwhile, most Scandinavian countries have already deregulated their utilities. Even the French, slower than their neighbors, have shown interest in the liberalized markets. Electricite de France acquired London Electricity, made a bid for National Power’s Drax power plant and expressed interest in buying the electricity supply business of the UK’s Seeboard. Across the Atlantic US deregulation continues from state to state – though not as quickly as some would like – and American utilities are showing an eager appetite for consolidation.
Accordingly, the investor relations practice is changing. IROs who have operated in regional territories are suddenly finding themselves on the phone with non-domestic analysts. Scott Hibbs, the director of IR at Oregon-based PacifiCorp, is one such electric utility IRO. ‘Given that we have international aspirations and are in the process of being acquired by Scottish Power, we have had international analysts and investors to consider,’ Hibbs says. He increasingly uses technology to help get his story out. Teleconferencing, in particular, helps to overcome the obstacle of time zone differences, he says. ‘It doesn’t replace face-to-face, eye-to-eye contact, but it’s a bigger component.’
Utility upside
With the removal of price controls and reduction of operating barriers, companies have active control of their electricity operations while customers are free to choose their suppliers based on price and quality. On the one hand, liberalization produces increased efficiency, higher standards of service and greater access. On the other hand, the industry is in chaos. M&A speculations abound as companies eye new territories, new customers and new services they can offer to existing customers. Risk is up and stocks are down. So far in 1999, the PE multiple of the Standard & Poor’s electrics index is 51.5 percent that of the S&P 500. In 2000, it’s expected to drop below 50 percent. These stocks are trading on average at twelve times earnings for the year 2000, or 25 percent to 30 percent below historical averages.
‘In the midst of deregulation, it’s important to know what your company’s going to be doing,’ advises Merrill Lynch’s utilities analyst Sam Brothwell. ‘This has been a vertically integrated industry and under regulation everything has been laid out for you. For instance, you didn’t have to worry about things like marketing. Your customers were handed to you. All of that is changing. So the ability to develop and articulate a focused strategy going forward is something that investors are very much looking for.’ In this regard, the IR departments at both Southern Company and Duke Energy Corporation draw praise.
As the world’s utility markets open up, companies have to decide whether to stay in their respective markets or branch out into new ones, with more companies favoring the latter. Worldwide, cross-border M&A rose about 36 percent to $49.9 bn in 1998, and 1999 shows that trend continuing. Most agree that the best tactic at present is to build economies of scale.
‘Other than the very largest, everyone has to think about getting bigger in order to not just survive but be successful,’ says Barry Abramson, utilities analyst at PaineWebber. ‘A lot of them can survive and just muddle along, but if they want to be successful, they have to be much bigger. There are too many other big companies in the sector looking to grab their market share.’
US companies have been the most active bidders for global deals. Over the last few years many, including Edison International and Dominion Resources, have gotten into the UK electricity business. American utilities tend to be large, which on the whole would position them well for international growth. But they are coming out of an extremely comfortable rate-of-return and regulatory environment, and need to adapt quickly to compete.
Good mates
UK companies have also joined in the trans-Atlantic mating dance. They may have an edge because they have adapted to competition over a longer period. British Energy, the UK’s largest electricity generator, entered into a joint venture with Peco Energy (now merged with Unicom); National Grid picked up New England Electrical Services; and Scottish Power acquired PacifiCorp.
UK acquirers have found challenges in owning US companies. For instance, most US electric companies are over 50 percent owned by retail investors, who would not naturally be long-term holders of an overseas stock. Scottish Power’s Sue Clark has worked hard to structure their acquisition with the US retail shareholder in mind. ‘We’ll be moving to quarterly reporting and quarterly dividends for our whole business, even though it isn’t a requirement,’ Clark explains. ‘It’s something we’re doing purely to ensure the US retail shareholder doesn’t feel any difference.’
Because of the large retail component, IROs in this sector have to participate in individual investor oriented activities: attending investor fairs, accessing broker organizations and preparing fact sheets and annual report summaries that retail investors understand.
Simplifying explanation of a mercurial sector, however, is not so simple, and Clark has had to revise her approach to presentations. ‘What we’re now seeing in our IR activity is that the interim and the preliminary results presentations have become much more overviews, much more big picture, much more strategy-focused. Then we’ve tried to fill in at other times of the year with operational presentations so that we can drill down into the individual bits of the business.’
Dividend dilemma
Electric companies have had to tighten their dividends to invest in growth and diversification. That yield reduction, though, is not always well received by shareholder value proponents.
David Schanzer, utilities analyst at Janney Montgomery Scott and former IRO at Peco Energy, advises companies to emphasize their dividend policy. ‘Every presentation made, every interface with the financial community ought to begin and end with a statement about the common stock dividends.’ This should include payout ratios and goals, expected growth and dividends-to-earnings.
Furthermore, companies must communicate the policy honestly, even if it’s not what people want to hear. ‘If the dividend is no longer important, go out and tell people that,’ Schanzer advises, otherwise you’re going to have a very unhappy shareholder body when they do find out. ‘There’s an ethical issue here, because unfortunately retail investors are very slow to react. You can take out a full page ad in the Wall Street Journal – or even in their local paper – to tell them, and they still won’t know the dividend is being reduced until they actually get their revised check.’
From the institutional investors’ viewpoint, dividend cuts are not bad at all. They prefer growth in equity over yield which carries the burden of taxable income. Subsequently, institutional ownership of US electric companies has increased from roughly 25 percent to 45 percent in the last decade, with the most change occurring in the last three years.
Many IROs see pros and cons to this shift. ‘Your mom-and-pop investors don’t have a price target in mind,’ says Thomas Wohlfarth, manager of IR at Dominion Resources. His traditional shareholders tend to hang on through ups and downs, whereas institutions routinely drop a stock when it hits their target. The result is increased volatility. Wohlfarth wants investors who have a low turnover rate, and he believes his stock can attract this type of investor from both the retail and institutional sides. ‘We still have the dividend,’ he explains, ‘but we’re becoming more of a growth company. We really want people who accumulate our stock because they like the long-term prospects.’
In Europe, institutional holdings are also increasing, but for different reasons. For the year to June 1999, retail investment in Spain’s largest electricity distributor, Endesa, dropped from 58 percent to 27 percent. The euro did its part by eliminating exchange rate risks, while institutions chose equity over bonds because of plummeting interest rates, which in Spain dropped to 3 percent in 1999 from double-digit rates four years ago. Spanish companies like Endesa are flush with cash.
Miguel Temboury, Endesa’s North American IR director, coordinates communication from his New York office. One reason the company began global activities is because it had grown as large in Spain as regulation would permit. Endesa now has a 64 percent stake in Chile’s Enersis as well as businesses in Argentina, Brazil, Colombia and Peru. The IR department has people in Chile running day-to-day business, while the Madrid headquarters oversees global activities. ‘We continually monitor what we’re saying to our analysts to guarantee that we give exactly the same messages,’ Temboury explains. ‘We’re seeing more European utilities analysts exchanging information with those who cover Latin America.’
Endesa’s expansion into Latin America is wise. Not only are profit margins higher and competition weaker, but energy consumption is growing at twice the rate of developed economies. After telecoms, electric utilities are Latin America’s largest, most liquid stocks.
Global convergence
The World Energy Council predicts that by 2020 world energy demand will double, and the majority of that growth will come from the developing countries of Latin America and Asia. To meet this demand electric utilities are converging with a variety of other businesses.
Many companies, including British Energy, Pacific Gas & Electric, Duke Energy and Dominion Resources, bet on the gas-electric convergence. The combination lets each utility cross-sell to the other’s customers and helps to smooth out seasonal earnings cycles. Dominion’s Thomas Wohlfarth considers natural gas-fired electricity generation to be the energy choice of the future. Gas generation plants are environmentally friendly, inexpensive to build, and exempt from much of the resistance associated with nuclear or a coal-fired plants. Studies predict that by 2020, one-third of US electricity will come from gas, up from 15 percent in 1998. The proportion in Europe will be even higher, around 40 percent.
Gas is one of many aspects of diversification. Electric utilities are branching out to bulk up their customer base and cross-market a range of services. Southern Company offers wireless phone services, energy auditing and home security. Scottish Power has water and waste water services. It’s the UK’s top internet provider, and runs consumer electronic stores. Evidence points to a utilities supply industry eventually dominated by a few mega-merged competitors rallying strong brand banners in the fight for customer loyalty. Wall Street’s challenge will be in categorizing these giants.
As for restructuring, Janney analyst David Schanzer describes its impact on IR: ‘It drives me to distraction to see the amount of changes that go on in some IR departments – I’ve no idea who I’m supposed to talk to,’ he admits. ‘I end up talking to the CFO, which isn’t always what I want. I want to have the comfort level of knowing that I can reach the IRO directly and easily.’ Schanzer’s summary of industry changes: this is no longer your grandfather’s staid family car.
