Duke Energy-Progress Energy merger aims to cut costs, bills

New firm good for business, but approval key is 'showing customers are no worse off.'

CHARLOTTE OBSERVERJanuary 11, 2011 

  • Duke Energy and Progress Energy would have to pay huge termination fees if they try to break off their merger for rival offers, according to the merger agreement filed with the Securities and Exchange Commission.

    Progress would owe Duke $400 million if it chose another suitor, while Duke would pay Progress $675 million if it went with another partner, according to the agreement. Such fees are typically designed to scare off other companies from trying to break up a merger.

    CNBC, citing people familiar with the situation, reported that Virginia-based power company Dominion Resources, after learning of the merger plans, on Friday sent letters to both Duke and Progress with "soft" offers to buy each at a 10 percent to 15 percent premium on their stock prices. In the letters, Dominion said it would not make a public offer, suggesting the company isn't willing to wage a campaign to break up the deal, according to CNBC.

    Duke spokesman Tom Williams declined to comment.

    The leadership lineup

    The Duke Energy-Progress combination would be led by 13 executives - seven from Duke and six from Progress, according to an organizational chart released by the companies.

    Duke Energy chief executive Jim Rogers would serve as executive chairman, advising the CEO on strategy, playing an "active role" in government relations and serving as the company's "lead spokesperson on energy policy," according to the companies. Progress CEO Bill Johnson would serve as CEO of the combined company.

    The chief financial officer would be Duke's Lynn Good, while the "chief integration officers" would be Duke's A.R. Mullinax and Progress' Paula Sims. The other Duke executives tapped for roles at the combined company are Marc Manly (general counsel), Jennifer Weber (chief human resources officer), Dhiaa Jamil (nuclear generation) and Keith Trent (commercial businesses). The Progress executives assigned posts are Mark Mulhern (chief administrative officer), Jeff Lyash (energy supply), John McArthur (regulated utilities) and Lloyd Yates (customer operations).

    Johnson told analysts that other leadership posts will be named in coming months.

    Executive payouts?

    Williams, the Duke spokesman, declined to comment on whether the merger triggers "change-in-control" provisions that could provide millions of dollars in payouts to executives if they leave the company after the deal is completed. Williams said that information will be disclosed by the company today.

    According to annual proxy filings, Johnson would be in line for the biggest change-in-control sum - $22 million from severance, the vesting of stock awards and other payments - if he leaves after a merger. If the deal is considered a change in control for Duke, Rogers wouldn't receive severance payments but would benefit from the vesting of stock awards and options worth $3.9 million.

    According to a filing made by Progress on Monday, if Johnson leaves for good reason or is terminated without cause within two years of the deal's completion, he is eligible for severance under the company's "change-in-control" plan. If he leaves in the third year, he would be eligible for severance under his employment agreement. Johnson's having to move to Charlotte would not be considered "good reason" for leaving the company, according to a term sheet. Johnson would also be in line to receive a $1.1 million.

    Rick Rothacker

Duke Energy's corporate marriage with Raleigh's Progress Energy, forming the nation's biggest electric utility, will better equip it to retire obsolete plants, build new ones and meet demands for cleaner energy.

But the expected cost savings from Duke's $13.7 billion stock-swap acquisition of Progress, confirmed Monday, may only blunt the pain of future rate increases for consumers.

The utilities do not expect the deal to result in lower power bills for customers, but company officials say it could offset the higher rates needed to build new power plants.

Customers' future bills are among the concerns prompting the combination, said Progress chief executive Bill Johnson, who would be the new company's CEO. "We feel like[we've got to] do everything we can to moderate, to mitigate any increase we can."

Consumer advocates may want more and press for rate cuts as regulators review the merger.

The new Duke Energy, which will keep its name and Charlotte headquarters, would serve 7.1 million customers in six states and have a $37 billion market capitalization. It would also be the nation's largest nuclear power generator.

State and federal regulators, as well as shareholders, still have to approve the deal. Company leaders said they aim to complete the merger by the end of the year, consummating a deal that began over a CEO dinner in July.

"The threshold thing you've got to show above all other things is that the customers are no worse off," said Edward Finley, chairman of the N.C. Utilities Commission. "Generally what you've got to show is that there's no harm to the customers and hopefully a benefit to customers going forward."

Carolinas customers will benefit from $600 million to $800 million in expected savings over the first five years, the companies estimated, largely through savings on fuel costs and the ability to deploy their combined fleet of power plants more efficiently.

But those savings will temper forecasts for higher rates. "We see a world when the real price of electricity is going up after being flat for the past 50 years," Duke CEO Jim Rogers said Monday.

Duke plans to file North Carolina rate cases this year to recover costs of building a new coal-fired power plant, Cliffside, and natural gas-fired plants at its Buck and Dan River plants.

Rates are only part of that equation. Customer bills are also adjusted once a year to reflect fuel costs, and would reflect the hundreds of millions of dollars Duke expects to save in the Carolinas.

Best deal for customers?

Consumer advocates say they're not sure Duke is offering customers its best deal. The companies have not offered to lower rates, which would be expected with cost savings, said Robert Gruber, executive director of the North Carolina commission's Public Staff, which represents consumers.

"We will be seeking whether there should be other rate reductions," Gruber said. "Usually in mergers, as a carrot, they offer rate reductions, and they didn't offer that in this case."

Regulators or other parties to a merger proceeding could demand rate breaks, job protection for utility workers or other concessions in return for their agreement on a settlement.

"It's really just too early to know what will happen, whether the merger would be approved and - if it is - how long they would continue to operate Progress as a separate entity," said Ralph McDonald, a Raleigh lawyer who represents large industrial customers.

Because Duke's rates are lower than Progress' rates - $89 a month for a typical household compared with $102 - customers of the old Duke would not be happy to see their bills grow, he said.

Duke spokesman Tom Williams said the companies will continue to operate separately, with different rate schedules, for the foreseeable future.

'Tsunami' of needs

Rogers described "almost a tsunami" of capital needs facing both companies, including the need to replace aging power plants, meet stricter environmental standards and upgrade the grid.

"When we look at the challenges we face in the future, we realized that we're in a better position to meet those challenges together than as separate companies," he said.

The combined companies' larger profile will help attract low-cost capital, they said, and reduce credit risks. Together the companies have $9 billion in power plant construction under way.

Duke expects the merged companies to achieve annual operating savings, not including fuel, of 5 percent to 7 percent.

In an FAQ posting on its website, Duke said it anticipates there will be job reductions at both companies but that there is no "predetermined number or goal."

The reductions would be phased in after the merger over several years. The company will look to reduce layoffs through attrition, retirements and the management of open positions, Duke said. Rogers said the company could use voluntary buyouts and is "very conscious" of cutting jobs in a "fair way" to employees while also meeting its cost-cutting goals.

Analysts generally were receptive of the deal. Duke shares fell 21 cents, or 1.2 percent, to $17.58. Progress declined 73 cents, or 1.6 percent, to $43.99, the biggest drop in three months.

Paul Franzen, a utilities analyst with Edward Jones in St. Louis, called the deal a "modest positive" for both companies, but not big enough to lift stock prices. Investors will like the combined companies' shift further toward regulated markets, which offer more certain returns, he said.

Duke chief financial officer Lynn Good said the companies expect long-term earnings growth of 4 percent to 6 percent, consistent with past growth, along with improvements to dividends.

The deal will give Progress stockholders a 7.1 percent premium of the stock closing price on Jan. 5, before reports of the proposed merger drove up prices.

"I think the shareholders of Progress should be pleased with this deal," Johnson said.

Premium for Progress

David Grumhaus, a partner and utilities expert at the Chicago hedge fund Copia Capital, was not. "I don't like this deal at all if I'm Progress," he told Bloomberg News. "It's hard to see how they couldn't have held out for a bigger premium."

Kyle Okita, an analyst at Egan-Jones, and others said they don't expect regulators to kill the deal, just to demand some concessions from the companies, such as freezing rates for a period or protecting a certain number of jobs.

The Federal Energy Regulatory Commission will also review the proposed merger and its nuclear power generation.

Analysts said that the combined company might be better able to finance new programs and minimize the need to issue more debt. Purchasing Progress, which allows Duke to move into Florida, might also be a way for Duke to dilute Ohio's importance in its portfolio, said Brian Chin, an analyst at Citigroup. Duke has expressed interest in leaving Ohio, which is shifting toward a deregulated electric market, Chin said.

In a call with analysts, Rogers said the merger was not influenced by Indiana regulators' investigation of Duke. Jim Turner, who had run Duke's regulated electric and gas units, resigned last month after embarrassing e-mail showed a cozy relationships with a top Indiana regulator. Duke is seeking to recover the growing construction costs of its Edwardsport plant in that state.

Rogers said the deal is a positive for the states.

"It's easy to envision how we could have done a merger with another company and the headquarters could have moved out of the state," he told the Charlotte Observer. "So what you're creating for North Carolina is a certain permanency." Charlotte Observer staff writer Christina Rexrode contributed to this report.

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