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In an exclusive SCIENTECH PowerHitters Interview, Cody Graves, CEO of 
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IssueAlert for  April 3, 2001 

Constellation Energy Pursues "Pure Play" Strategy

by Will McNamara 
Director, Electric Industry Analysis

Christian H. Poindexter, chairman and CEO of Baltimore-based Constellation 
Energy Group (NYSE: CEG), announced that it will create two "pure play" 
energy companies mid-to-late this year to focus exclusively on the North 
American wholesale market, and regional retail energy services in Maryland 
and the surrounding region. Both entities will become publicly traded 
companies before the end of the year. Constellation Energy Group is a holding 
company that includes a group of competitive energy businesses focused mostly 
on power marketing and merchant generation in North America, plus Baltimore 
Gas & Electric (BGE), a regulated energy company in Central Maryland. In 
2000, Constellation reported combined revenues of $3.9 billion and total 
assets of $12.4 billion. 

Analysis: Constellation's plan to separate into two publicly traded companies 
has been in the works for over a year. In early 2000 Constellation began a 
restructuring of its corporate identity, dividing its operations into two 
separate segments: one focused on its unregulated merchant energy business 
(wholesale power marketing and generation operations) and the other focused 
on retail services (including the regulated electric and gas utility, BGE). 
As part of this process, Constellation combined its diverse generation 
portfolio, power plant operations, and development efforts with its energy 
marketing and trading organization. The company has clearly stated that the 
primary reason for bifurcating its operations is to enhance shareholder 
value. Constellation has said that "the separation of the businesses will 
illuminate the specific investment advantages of each emerging company and 
allow investors to make decisions based on a clearer assessment of each 
company's balance of risk and return."  

Upon separation, the holding company of the merchant energy businesses will 
retain the Constellation Energy Group name. The holding company of the retail 
services businesses will become BGE Corp. Current shareholders will own 
shares in each company when the transactions are completed. In addition, the 
Constellation board of directors has approved a move to allow Goldman Sachs 
to become an equity owner of up to 17.5 percent in the unregulated business. 
Goldman Sachs has been a partner with Constellation since 1997, providing 
risk management and power marketing services.  

The split of the business can be seen as primarily benefiting Constellation's 
unregulated operations, which provide the real money-making opportunities for 
the company. In return, the high growth of the unregulated businesses and its 
new status as a stand-alone company is expected to benefit Constellation 
shareholders. Constellation Energy's merchant energy business is made up 
primarily of the following subsidiaries: 

Constellation Power Source, Inc.*wholesale power marketing and trading; 
Constellation Power Source Generation, Inc., which has ownership of 13 fossil 
and hydroelectric power plants formerly owned by BGE; 
Constellation Power, Inc. and subsidiaries*development and management of 
existing power plants throughout the United States; and 
Constellation Nuclear, LLC and subsidiaries*nuclear generation  and 
consulting.

Poindexter has said that delivering solutions to the company's wholesale 
customers is the foundation of Constellation's business (as opposed to the 
more traditional operations found on the regulated side). Further, the 
company's primary growth strategies center on the non-regulated domestic 
merchant energy business with the objective of providing new sources of 
earnings growth. The company is planning to divest generation assets in 
international markets such as Latin America and focus exclusively on its 
unregulated businesses in the United States. 

Toward that end, Constellation has focused over the last year on aggressively 
building its generation portfolio. Currently, the company controls more than 
9,000 MW of power capacity, and over the course of this year plans to add 
1,050 MW of gas-fired peaking capacity as well as complete a recently 
announced acquisition of 1,550 MW of the Nine Mile Point nuclear facility in 
New York. The goal for the merchant energy business, according to Poindexter, 
is to establish a portfolio of over 30,000 MW of electric generation 
facilities by 2005. Up until this point, Constellation's generation assets 
have been primarily based in a mixture of coal and nuclear, and for the most 
part located in the Northeastern United States. According to information 
directly from the company itself, Constellation's own fuel mix is 
predominantly coal (54 percent), followed by nuclear (40 percent). Oil, gas 
and hydro only represent a small percentage (6 percent) of Constellation's 
fuel mix. However, moving forward, it is expected that nuclear power will 
play an increasingly important role in Constellation's competitive strategy. 

Constellation's merchant energy business was ranked fifth in the nation for 
sales of electric power in the third quarter of 2000, and the company is 
committed to expanding this growth. Revenues in Constellation's unregulated 
businesses totaled $1.14 billion for year-end 2000, almost half of the total 
revenues for the company. Segment earnings for 2000 reflected a shift in 
earnings from the regulated utility business to the non-regulated domestic 
merchant energy business as a result of the transfer of BGE's electric 
generation assets to non-regulated subsidiaries on July 1, 2000. 
Constellation believes that a reasonable range for 2001 earnings per share on 
a total company basis is $3.00 to $3.10. More than two-thirds of the total 
earnings is expected to come from the domestic merchant energy business, with 
the remainder coming from BGE and the other businesses that will comprise the 
new BGE Corp. as part of the business separation strategy. 

Meanwhile, BGE remains a consistent performer and in fact contributed the 
majority of Constellation's revenues over the course of 2000 ($2.13 billion 
out of a total of $3.9 billion). BGE's fourth quarter electric sales volumes 
increased nearly 7 percent as compared to 1999. This increase in the fourth 
quarter helped to offset a portion of the decline in electric sales 
experienced during the summer of 2000. BGE will remain a regulated provider 
of gas and electricity delivery services in central Maryland. However, as a 
regulated entity, Constellation apparently believes that BGE will not provide 
the same level of profit potential as the unregulated merchant business, and 
therefore the company wants to attract two different sets of investors.  

FERC approved Constellation's separation plan in early March. The company 
still needs to receive approval from the Nuclear Regulatory Commission and 
the Internal Revenue Service.  

Also related to Constellation's separation process is a change in the 
company's common stock dividend policy effective in April 2001. At that time 
Constellation's annual dividend is expected to be set at $.48 per share. 
After the separation, BGE Corp. expects to pay initial annual dividends of 
$.48 per share. Constellation Energy Group, as a growing merchant energy 
company, initially expects to reinvest its earnings in order to fund its 
growth plans and not to pay a dividend. 

Constellation's strategy falls into a growing trend among energy companies 
attempting to streamline their businesses for competitive markets. For 
instance, last fall American Electric Power (NYSE: AEP) announced its plans 
to restructure into two companies to support a new focus on power generation, 
marketing and trading. Under the restructuring, one corporation will hold 
AEP's utility and non-utility subsidiaries whose revenues are derived from 
competitive (unregulated) business ventures. The second corporation will hold 
AEP's utility subsidiaries (primarily Tsubsidiaries) that are subject to 
regulation by at least one state regulatory commission, or foreign 
subsidiaries subject to rates or tariffs regulation. It is not clear if AEP 
will opt to take both companies public. Linn Draper, AEP's CEO, has said that 
the company is reserving that decision until the end of 2001, the time at 
which he believes the restructuring will have received all the necessary 
regulatory approvals. 

In addition, just yesterday, Mirant (NYSE: MIR) completed its spin-off from 
parent Southern Company and is now recognized as a fully independent, 
publicly traded company. Mirant is a global competitive energy company with a 
leading position in both power generation and energy risk management and 
marketing. With an integrated business model, Mirant develops, constructs, 
owns and operates power plants and sells wholesale electricity, natural gas 
and other energy commodities. 

Other parent companies that have announced the spin-off of unregulated 
generation companies into stand-alone and possibly publicly traded companies 
include UtiliCorp, Reliant and Xcel Energy.  

As noted, the common driver behind the growing trend of spinning off 
high-risk, high-growth ventures into stand-alone companies is the hope of 
attracting two sets of investors. For instance, let's take a look at the 
Southern Company / Mirant example as Mirant has just completed its spin-off 
from Southern. Southern Company's P/E multiple is 10.48 compared to Mirant's 
29.14. The price earnings ratio is typically used to gauge a firm's measure 
of value and can be used to compare a company to its peers and industry 
average. The average P/E ratio of a traditional utility company is somewhere 
around 12.00. A P/E ratio much higher than the average signals that the 
company has a high-risk, high-reward profile. However, the general consensus 
is that the traditional utility investor does not have the risk-appetite for 
an IPP-type company. The IPP stock carries more risk than the average utility 
and does not guarantee a dividend payment. On the other hand, with risk comes 
reward. Consequently, companies such as Southern, Constellation and the 
others mentioned are finding that by splitting non-regulated and regulated 
businesses, they can attract two different sets of investors and safeguard 
any possible negative earnings impact that might spill over from one side of 
the business to the other.   

An archive list of previous IssueAlerts is available at
www.ConsultRCI.com




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