Duke Merger Future Clouded by Rift With State Regulators

Duke Energy (DUK) Inc. faces a divided board, alienated regulators and demoralized employees as state officials investigate management upheaval following its $17.8 billion takeover of Progress Energy Inc.

Distrust and disagreement between the two now-joined companies was stoked by an 18-month merger process, with tensions flaring between chief executive officers in the six months before the deal closed July 2, Duke directors and Progress’s ousted CEO said at hearings before the North Carolina Utilities Commission last week.

The investigation is detracting from Duke’s integration as largest U.S. utility-owner, Ann Maynard Gray, Duke’s lead director, told regulators July 20. Gray led a board vote to replace Bill Johnson as Duke’s CEO the same day the merger closed. Duke’s former CEO James Rogers was reinstated in that position, replacing his rival from Progress.

“The board’s action appears to have triggered what we believe will be a months-long legal and regulatory quagmire,” Hugh Wynne, a New York-based analyst for Sanford C. Bernstein & Co. wrote in a July 20 note to clients. “The most significant headwind to earnings growth is the increasingly adversarial relationship between Duke Energy and its most important regulator, the North Carolina Utilities Commission.”

Duke, based in Charlotte, North Carolina, has 3.2 million of its 7.1 million customers in North Carolina following the merger. North Carolina’s attorney general also is investigating the last-minute CEO change and Duke shareholders have sued the board.

Integration Continues

Duke is taking steps to address frayed board relations and to fill the gap in its executive team caused by the departure of three of Johnson’s lieutenants, Tom Williams, a company spokesman, said in a telephone interview yesterday.

Gray plans to meet with the five former Progress directors who remain on Duke’s board later this week. Rogers has named Progress executive Lee Mazzocchi as its senior vice-president and chief integration officer, and Keith Trent to head its regulated utilities operation. Both replace Progress executives who stepped down after Johnson was forced out. A third position, chief administrative officer, won’t be filled.

“The integration process has not slowed down one iota due to the CEO change,” Williams said.

Exceeding Authority?

The North Carolina probes prompted retired Bank of America Corp. CEO Hugh McColl to question whether regulators were over- stepping their authority by second-guessing the board’s decision to remove Johnson.

The commission has the power to amend or rescind its June 29 order approving the merger, and officials at a July 20 hearing wouldn’t rule out requiring Duke to reinstate Johnson.

McColl was a party to a similar CEO swap in 1998 when he replaced David Coulter as CEO shortly after Charlotte-based Nationsbank Corp. acquired Bank of America.

“One of the principal functions of the board is to hire and fire the CEO,” McColl wrote in a letter to the editor of the Charlotte Observer, published July 22.’’ The people who wrote and adopted our corporate laws settled this issue long ago. If regulators insert themselves into matters of the board room, they chill the business atmosphere for our state.’’

The threats of protracted regulatory and legal backlash to the CEO shift have weighed on Duke’s stock. Its shares have fallen 5.2 percent to $66.22 since July 2, while the Standard & Poor’s 500 Utilities Sector Index rose 1.2 percent.

Trust Breach

“There has been a breach of trust with regulators and that’s one reason we’re cautious about the stock,” Marc De Croisset, a New York based analyst for FBR Capital Markets & Co., said in a telephone interview on July 20. “The investment cliche of utilities as stable and predictable is being shaken up by these hearings and everything that’s transpired.”

Johnson testified during last week’s proceeding that he lost his job because he insisted on completing the merger when Duke wanted to back out.

Rogers and Gray blamed poor performance by Progress and foot dragging by Johnson at disclosing information about a damaged nuclear reactor in Florida.

“For us to have a CEO in whom we don’t have confidence because of certain leadership styles was just not the right choice,” Gray said July 20.

Testimony during three days of hearings held by regulators in Raleigh, North Carolina, sharpened divisions between an already fractured board.

Divided Board

The five former Progress directors were overruled by 10 continuing Duke directors in the decision to oust Johnson, according to testimony by directors E. Marie McKee and James Hyler. McKee and Hyler, both carry-overs from the Progress board who supported former Progress CEO Johnson, told North Carolina regulators they are considering whether to resign.

“That Duke’s board appears to be comprised of two warring factions, the former Duke and former Progress directors, bodes ill,” Wynne wrote in his note to Sanford C. Bernstein clients. “Rogers’ ability to lead the combined companies may also have been eroded.”

Edward Finley, the commission’s chairman, told Rogers at a July 10 hearing he had damaged his credibility by not advising commissioners of the management turmoil as they held their final deliberations before approving the merger June 29.

The agency is not finished with its investigation, Finley said after testimony concluded last week. He asked Duke to appoint a liaison to the commission.

Settlement Possible

The agency’s options include a settlement, order or “no action,” said Sam Watson, general counsel for the commission, in an interview after the hearing.

The commission is hiring a consulting firm to aid its investigation, Watson said. The last time it did so was a decade ago when it brought in Grant Thornton LLP to audit Duke as part of a probe of the power company’s accounting.

The outcome of a ratings review by Standard & Poor’s may depend on the investigation, said Dimitri Nikas, a New York- based S&P analyst for Standard & Poor’s, which announced July 13 it may lower its rating on Duke’s debt.

Duke guaranteed regulators the merger would yield $650 million of savings for its North and South Carolina customers from more efficient operation of its plants within six and a half years. Analysts expect per-share profit excluding some items will rise to $4.43 next year, the highest since 2006.

Those goals may be more difficult to achieve for a company grappling with a regulatory investigation and potential litigation.

“I would say it is having an impact on our ability to gear up and get some of these things done,” Gray testified at last week’s hearing.

To contact the reporters on this story: Jim Polson in New York at jpolson@bloomberg.net; Mark Chediak in San Francisco at mchediak@bloomberg.net; Julie Johnsson in Chicago at jjohnsson@bloomberg.net

To contact the editor responsible for this story: Susan Warren at susanwarren@bloomberg.net

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