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Monday, October 19, 2020

Why The Proposed Mega-Merger Of Energy Giants NextEra And Duke Is Unlikely To Succeed

In this election year, North Carolina has emerged as one of the most interesting energy states in the country. That’s in part due to its status as a “purple state,” with its basically 50/50 divide between the Republican and Democratic parties, and in part because the regulatory climate in the state is reflective of the shifting energy-related dynamics taking place across the country.

One good example of this relates to a proposed merger between two energy giants in which North Carolina’s regulators would play a key role. NextEra Energy, America’s largest electric utility, recently broached the idea of buying Duke Energy, one of the nation’s largest electric power holding companies. Duke
DUK
rejected the proposal, but NextEra
NEE
is still interested in the potentially massive deal. This deal would mean a $60 billion-plus combination of the two utility companies – the largest merger in the industry’s history. Even if Duke agreed to NextEra’s overture—which seems like a longshot at this stage—the obstacles to finalizing a deal of this magnitude are formidable.  

First, take a close look at the financial details. A hostile takeover of Duke would create a significant new debt burden for NextEra. As a recent Wall Street Journal opinion piece pointed out, “Despite its large market capitalization, NextEra’s balance sheet holds just $1 billion of cash and has relatively high leverage with net debt to earnings before interest, taxes, depreciation and amortization of 4.5 times.” This wouldn’t help NextEra’s cause of maintaining an investment-grade credit rating, which is a necessity in the eyes of regulators.

Second, NextEra would have to garner the support of North Carolina’s regulators, who are heavily influenced by the state’s political class. That likely won’t happen. When asked about the potential deal, North Carolina Gov. Roy Cooper (D) offered a full-throated endorsement of Duke Energy and its place in the state, implicitly rejected a hostile takeover bid from an out-of-state utility. “North Carolina is proud to be the home of Duke Energy,” said Gov. Cooper. “Duke has been an important partner in our economic development.”

And North Carolina regulators are just the tip of the iceberg: NextEra would have to gain approval from multiple state public utility commissions. These commissions are notoriously difficult to please – something that NextEra knows better than anyone.

In 2016, regulators denied NextEra’s $4.3 billion purchase of Hawaiian Electric Industries for not being “reasonable” or “in the public interest” (notably, Hawaii’s governor also opposed the deal). This resulted in a $90 million breakup fee and an additional $5 million in expenses—all paid by NextEra to Hawaii Electric Industries
HE
. The very next year, Texas regulators rejected NextEra’s $18.7 billion purchase of Oncor Electric Delivery. In Oncor’s case, the state regulator demanded NextEra accept certain corporate governance requirements. But NextEra declined, on grounds that it needed more direct operational and financial control.

The energy giant has also unsuccessfully attempted to acquire utilities in Florida and South Carolina, and 98% of Duke’s 2019 revenue came from North and South Carolina, Florida, and the Midwest. NextEra Chief Executive James Robo recently joked that small acquisitions aren’t worth it because the reward is not worth the “brain damage” of getting them approved by regulators. Ironically, this deal would create his biggest headache yet.  

Speaking of headaches, NextEra would also need approval from regulators in Kentucky, the Carolinas, and Ohio. According to S&P Global Market Intelligence, “State commissions generally look at the transaction’s potential impact on the commission’s regulatory authority, customer rates, operating performance and service quality, financial viability and access to capital, and the impact on the local economy.” The Federal Energy Regulatory Commission and Nuclear Regulatory Commission would also need to approve the deal, and the Department of Justice or the Federal Trade Commission may even review the acquisition for any potential antitrust issues.

Florida would likely prove to be NextEra’s most difficult hurdle. The state’s electric utilities served 8.1 million Floridians in 2019 – and 7.3 million of those customers got their power from either NextEra or Duke. This will cause serious monopoly concerns for regulators and public officials, to say the least.

A merger between NextEra and Duke is guaranteed to cause significant debt and involve massive expenses. Still, these costs are nothing compared to the “brain damage” that regulators will impose throughout the process.  

As S&P noted, “…there are no guarantees that a deal will succeed; unexpected occurrences can bring unforeseen issues to the fore, and a state commission can still be swayed by public sentiment.” An unsuccessful history with major acquisitions, strained relationships with regulators, and a gauntlet of necessary federal and state regulatory approvals leads to the only reasonable conclusion: there are too many obstacles to make the NextEra-Duke megadeal a reality.

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