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November 7, 2001 



FirstEnergy and GPU Close Merger



By Will McNamara
Director, Electric Industry Analysis


[News item from PR Newswire] FirstEnergy Corp. (NYSE: FE) closed its merger with GPU Inc. on Nov. 6 and announced that members of its Board of Directors had been named. The effective date of the merger is Nov. 7, 2001. "With today's closing of our merger, we will begin operating as a larger, stronger company, better positioned to provide significant benefits to our customers, shareholders and employees," said FirstEnergy Chief Executive Officer H. Peter Burg.

Analysis: When compared to 2000 and 1999, 2001 has turned out to be a rather anti-climatic year with regard to merger and acquisition activity in the energy industry. In fact, when compared to the early days of deregulation, M&A activity has slowed from a flood to a slow drip. The days of combining two vertically integrated utility companies to gain scale and guarantee survival appear to be on the decline. Partnerships will still continue, of course, but they are now of a different breed than before and have become far more focused on a particular market niche. One exception to the rather uneventful M&A scoreboard this year is the just-completed $4.2-billion partnership between FirstEnergy and GPU, which reportedly will create an electric utility serving 4.2 million customers from Toledo, Ohio to the New Jersey shore. The two companies have positioned their partnership as creating the "premier supplier in a 13-state region." However, while one of the few interesting deals this year, the FirstEnergy / GPU partnership has not been without controversy, especially with regard to lingering financial obligations that GPU has in the Three Mile Island nuclear plant. 

First, let's establish the basics about this partnership. Akron, Ohio-based FirstEnergy has purchased Morristown, N.J.-based GPU Inc., paying a dividend of $0.42392 a share that will be payable on Nov. 28. FirstEnergy-itself a product of a 1997 merger between Ohio Edison and Centerior Inc. -is already an energy services holding company serving 2.2 million customers within 13,200 square miles of northern and central Ohio and western Pennsylvania. FirstEnergy also provides natural-gas service to approximately 50,000 customers in the Midwest and is involved in the exploration and production of oil and natural gas, and the transmission and marketing of natural gas, with resources that include proven reserves of 450 billion cubic feet equivalent of natural gas and oil-about 90 percent natural gas-and approximately 5,000 miles of pipelines. FirstEnergy also owns 7,500 miles of transmission lines, with 35 interconnections in 6 electric systems, and is a member of the Alliance RTO. FirstEnergy has a market capitalization of $8.1 billion, a P/E ratio of 12.99, and its shares currently are priced at $35.72. 

GPU Inc. is an international provider of energy-related infrastructure and services. Domestically, its three electric utility subsidiaries-doing business as GPU Energy-serve two million customers in Pennsylvania and New Jersey. Through the GPU International Group, GPU develops, owns and operates transmission and distribution facilities overseas. GPU has a market capitalization of $4.8 billion, a P/E ratio of 10.51, and on its last day of trading (Nov. 6) its shares were priced at $40.39.

From its inception, the primary objective of this acquisition was to enable FirstEnergy to become the premier regional energy and related services provider in the northeastern quadrant of the United States. A key part of this strategy is the expansion of the combined company's unregulated marketing opportunities, including the acceleration of a retail business that FirstEnergy gains by buying GPU.

After Nov. 7, FirstEnergy will begin operating as a registered holding company with seven electric utility operating companies-Ohio Edison, The Illuminating Company, Toledo Edison, Metropolitan Edison, Pennsylvania Electric, Pennsylvania Power, and Jersey Power & Light-which reportedly will comprise the fourth-largest investor-owned electric system in the United States, based on amount of customers. As noted the combined company has billed itself as the premier supplier in a 13-state region. Those 13 states are New York, Pennsylvania, New Jersey, Delaware, Maryland, Virginia, West Virginia, Ohio, Kentucky, Indiana, Michigan, Illinois, and Wisconsin. However, it is clear that, among these 13 states, the combined company has already established a particularly strong business in New Jersey, Pennsylvania and Ohio, where it will maintain a geographic presence of 23 percent, 28 percent and 49 percent, respectively. 

According to a presentation made by CEO Peter Burg earlier this year, the acquisition of GPU Inc. will "optimize FirstEnergy's generation portfolio," by, among other things, increasing its customer load and the utilization of its baseload units. Prior to the acquisition, FirstEnergy operated 16 power plants with a total system capacity of nearly 13,000 MW. Out of this total generating capacity, 58 percent (7,471 MW) is produced using coal; 29 percent (3,779 MW) comes from nuclear plants; 10 percent (1,273 MW) is fueled by natural gas or oil; and 3 percent (435 MW) comes from pumped-storage hydroelectric facilities. Through the acquisition of GPU, FirstEnergy reportedly will gain 1,155 MW in peaking generation and the opportunity for over 800 MW of capacity releases. Company information indicates that FirstEnergy produced nearly 70 million MWh of electricity over the last year. 

As noted, while the partnership between FirstEnergy and GPU is for the most part quite synergistic and has obtained its necessary regulatory approvals in a comparatively smooth fashion, the deal has not been completely without controversy. For instance, a Pittsburgh-based consumer group known as Citizen Power has expressed concern that the partnership will ultimately prove harmful for consumers of the combined company. Specifically, the group claims that FirstEnergy customers have already been paying $9 billion in stranded costs and could be forced to pay for additional charges associated with GPU's partial ownership of the Three Mile Island Nuclear plant. Despite the fact that the merger is now officially completed, Citizen Power reportedly has asked a Pennsylvania court to require state energy regulators in that state to reverse the approval of the merger. One of the group's arguments is that the Pennsylvania PUC did not require either FirstEnergy or GPU to demonstrate how the merger would benefit or otherwise impact the public and did not seek approval from the groups involved in GPU's restructuring agreement with the state. Other groups in Ohio have similar frustrations with the PUC in that state and are concerned about any increases in FirstEnergy rates that may occur as a result of payments that GPU is still making toward Three Mile Island. 

There is some public confusion surrounding GPU's holdings in Three Mile Island, which can be easily clarified. There are two nuclear units at the Three Mile Island (TMI) nuclear plant, Units 1 and 2. In late 1999, GPU sold TMI-1 to AmerGen Energy, the joint venture between PECO Energy and British Energy Co., for $100 million, which was about one-sixth of the book value for the unit. The ownership of the plant known as TMI-2 has remained with GPU. In 1979, TMI-2 was the site of the nation's worst nuclear accident, in which nearly half the uranium core melted. The TMI-2 unit is essentially dead and has not functioned since 1979. However, GPU has continued to keep the plant in a state of "monitored storage," and has encountered some expenses related to staff, etc., which continue to monitor the unit. The concern from some consumers, whether it is valid or not, is that FirstEnergy, which now owns TMI-2 due to its acquisition of GPU, will be picking up any residual expenses related to this unit. Specifically, TMI-2 is not scheduled to be decommissioned until 2014 at the earliest, and there may be some cleanup costs associated with the decommissioning that may exceed current estimates.

It is important to note that GPU has very little of its own generation assets. The company has followed a revised strategy over the last year that included the exit of the merchant energy business and a clear focus on the transmission and distribution sectors of the industry, as well as new non-regulated businesses. Another pending acquisition of some remaining GPU assets involves UtiliCorp's $2.1 billion offer for Avon Energy Partners Holdings subsidiary, the holding company for Midlands Electricity, which reportedly is the fourth-largest regional electricity company in the United Kingdom. This deal should move forward, although it was contingent on the completion of FirstEnergy's acquisition of GPU. FirstEnergy had previously established that it had no interest in retaining GPU's international assets, which include small holdings in Great Britain, Australia and South America. In addition, the offer makes sense for FirstEnergy, because it provides the company with available capital to pay down acquisition debt and possibly fund additional acquisitions. 

Moreover, FirstEnergy executives believe any possible negatives in its acquisition of GPU are outweighed by the positives. Again, the fundamental benefit of the FirstEnergy / GPU partnership is that it should create one of the leading-if not the leading-electric providers in a stretch of territory from Ohio to New Jersey. FirstEnergy gains significantly in the deal by acquiring GPU's customer base and the ability to optimize its own existing and growing generation arsenal. Plus, FirstEnergy also gains GPU's remaining generation capacity, which is rather minimal but does include about 1,155 MW in peaking generation. From a broad perspective, FirstEnergy and GPU have followed through with a rather smooth merger process, which certainly represents an atypical development against a landscape of terminated consolidated deals this year. 

UPDATE ON SAN FRANCISCO MUNICIPALIZATION VOTE: See the 11/6/01 IssueAlert  <http://secure.scientech.com/issuealert/article.asp?id=979>for a full description of Measures F and I that appeared on the ballot in San Francisco and Brisbane, Calif., in yesterday's election. Both measures related to municipalizing the electric system currently owned by Pacific Gas & Electric Co. According to data obtained from the San Francisco Department of Elections as of early morning on Nov. 7, voter turnout in the area was 25.16 percent. Measure F, which would create a Municipal Water & Power Agency in San Francisco only, passed by a very slim margin of 56,008 votes (51.02 percent) to 53,760 votes (48.98). The passage of this measure will create a new agency in the city of San Francisco (not a municipal utility district) that will not include the city of Brisbane. The agency will be governed by an elected seven-member board of directors and reportedly will replace the current jurisdictional oversight by the California Public Utilities Commission. 

Measure I, which would have created a Municipal Utility District (MUD) in both San Francisco and Brisbane, did not pass. However, it was defeated by a very slim margin of 53,865 votes (50.63 percent) to 52,524 votes (49.37 percent). 

It is not presently clear whether or not all of the absentee votes have been calculated in this election, and thus there is a good chance that the above tally may change in the next few days and could possibly alter the outcome of this election. 

While Pacific Gas & Electric Co. put a positive spin on the election results in a press release that is circulating today, the fact of the matter is that this was a very close election. While the city of Brisbane shot down the idea of a MUD, San Francisco is proceeding with a Municipal Water & Power Agency, which at some point may also attempt to seize the transmission and distribution assets of Pacific Gas & Electric Co. Without question, the public power debate in this area is far from over and in many ways has received a boost from this election. I will continue to follow the story and provide further updates that occur from regional analysis. 


An archive list of previous IssueAlert articles is available at
www.scientech.com <http://secure.scientech.com/issuealert/> 


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