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Nuclear Future Is Now as Biggest Profit for Exelon: Real M&A

Exelon CEO John Rowe
John Rowe, chief executive officer of Exelon Corp. Photographer: Andrew Harrer/Bloomberg

Exelon Corp. is trying to pull off its largest takeover by acquiring more nuclear power plants -- less than two months after the industry’s worst disaster since Chernobyl.

The biggest U.S. operator of nuclear power facilities agreed to purchase Constellation Energy Group Inc. of Baltimore for about $7.9 billion in stock, giving the Chicago-based company stakes in five more reactors. Including net debt, the transaction would be Exelon’s first acquisition over $1 billion since 2002 after three deals fell apart in the past seven years, according to data compiled by Bloomberg.

While Exelon faces its biggest decline in earnings in a decade next year as higher-priced power contracts that it sold expire, Constellation’s nuclear assets will help Exelon boost profitability as environmental regulations increase costs for energy producers that own coal plants, according to Manulife Asset Management U.S. LLC’s Greg Phelps. The takeover, which will mark the end of John Rowe’s 11-year stint as Exelon’s chief executive officer, comes as the partial meltdown of Japan’s Fukushima Dai-Ichi plant in March prompts rivals such as NRG Energy Inc. to halt plans to build new reactors.

“It’s a bet on nuclear,” said Mark Bronzo, who helps manage $26 billion at Security Global Investors in Irvington, New York. The deal will allow the companies to “focus their energy and intention on those areas that will have a chance to make the greatest profit margins. It makes sense because there’s no appetite for people to build new nuclear plants,” he said.

Acquisition Cost

Paul Elsberg, a spokesman for Exelon, said the deal helps the company diversify its operations because it will acquire Constellation’s retail utility business in addition to the reactors. Larry McDonnell, a spokesman for Constellation, didn’t respond to phone calls and an e-mail seeking comment.

Including net debt of $2.65 billion, the acquisition value of Constellation was about $10.2 billion when it was announced April 28, data compiled by Bloomberg show. Constellation shareholders will get 0.93 Exelon shares for each share owned, or about $38.59 each based on Exelon’s closing price April 27.

The bid was 16 percent higher than Constellation’s average share price in the 20 days prior to the announcement and would enable Constellation’s investors to recoup all their losses in the past year, the data show.

Rowe, 65, plans to retire when the deal closes, according to the statement, handing over control of the combined entity to Christopher Crane, Exelon’s 52-year-old chief operating officer. Current Constellation Chairman and CEO Mayo Shattuck III, 56, will become executive chairman.

Earnings Outlook

Exelon’s per-share profit will decline 25 percent in 2012, according to analysts’ estimates compiled by Bloomberg, on expectations lower energy prices will trim revenue on future power contracts, said William Costello, a Dallas-based utility analyst and fund manager at Westwood Holdings Group Inc., which oversees $10 billion.

Natural gas futures have fallen more than 60 percent since July 2008, data compiled by Bloomberg show.

While Exelon said the Constellation deal will reduce its reliance on nuclear power, buying the nuclear assets now will strengthen Exelon’s dominance in the industry and bolster its profit as the economic recovery gathers pace and fuels demand for electricity, according to Security Global’s Bronzo.

Exelon earned 25.8 cents before interest and taxes for every dollar of revenue in the past 12 months, 46 percent higher than the average operating margin for U.S. integrated electric companies with market values greater than $1 billion, data compiled by Bloomberg show.

Best in Class

Constellation’s 6.7 percent operating margin was the lowest among the group, dragged down by its retail utility business and its nuclear assets that weren’t as well managed as Exelon’s, said Westwood’s Costello. The company wrote down the value of its plants co-owned with Paris-based Electricite de France SA in the third quarter of 2010, leading to a $1.41 billion loss.

“Exelon is probably the best nuclear power operator, so they can improve those operations,” Costello said. “They will be able to really help the Constellation team and run the assets a little bit better.”

The nuclear business may also benefit from the Obama administration’s attempt to impose stricter rules for air pollution. The Environmental Protection Agency last month proposed regulations limiting toxins such as mercury, arsenic and acid gases spewed from coal-fired power plants.

Clean Energy Benefit

The proposed rule may cost as much as $100 billion for the industry to comply, according to the Electric Reliability Coordinating Council, a Washington-based coalition of companies such as Atlanta-based Southern Co., the biggest utility owner by market value.

Constellation and Exelon were among companies that praised the EPA’s proposal. The Obama administration has identified energy sources such as nuclear, natural gas, wind and solar as “clean” because they produce lower emissions of carbon dioxide and other pollutants than sources such as coal or oil.

Exelon alone will earn an additional $800 million a year by 2015 because of the environmental regulations forcing the closure of coal-fired power plants, said Hugh Wynne, an analyst at Sanford C. Bernstein & Co.

The Constellation deal is valued at 6.9 times earnings before interest, taxes, depreciation and amortization of $1.48 billion, according to data compiled by Bloomberg. If the acquisition is successful, it would be the cheapest takeover of an integrated electric utility since 2001, the data show.

‘Cheap Side’

Exelon estimates cost and revenue benefits of the combination at $200 million next year, rising to $260 million after 2013, enough to boost profit by more than 5 percent that year, the company said yesterday on a conference call.

“They saw Constellation’s entire nuclear power generating fleet as being priced on the cheap side,” Manulife’s Phelps said.

Exelon’s deal comes after setbacks to nuclear reactor projects amid concern about the safety of atomic power.

NRG Energy, the largest U.S. independent power producer, this month halted its plans to build two new reactors at a Texas nuclear plant. The Princeton, New Jersey-based company cited diminished prospects after a March 11 earthquake and tsunami knocked out cooling systems at Tokyo Electric Power Co.’s Dai-Ichi plant, leading to the spread of radiation across parts of northern Japan.

More than 50,000 households were forced to evacuate and Tepco may face compensation claims of as much as 11 trillion yen ($135 billion), Charlotte, North Carolina-based Bank of America Corp. estimates.

‘Game Changer’

The No. 4 reactor of Chernobyl exploded 25 years ago this week, sending a radiation plume across Europe from what is now Ukraine. The meltdown killed at least 31 plant workers and firefighters in three months and forced the evacuation of a quarter of a million people in what was then the Soviet Union.

“The meltdown in Japan was a game changer,” said Matt McCormick, a money manager for Cincinnati-based Bahl & Gaynor Inc., which oversees $3.6 billion. “Right now, people are going to be overly cautious.”

Still, “as energy and commodity prices increase, nuclear is something that logically would come more to the forefront,” he said.

Constellation’s retail-utility business may help offset profit declines before energy prices recover.

Regulatory Hurdles

Exelon, which benefits from higher power prices, can protect itself during periods of low prices with Constellation’s retail business. At that division, earnings rise when prices are down, according to Angie Storozynski, a New York-based analyst for Macquarie Capital USA.

The acquisition still faces regulatory hurdles as the companies seek approval from utility overseers in Maryland, New York and Texas, in addition to federal regulators, Exelon said yesterday. Maryland officials have twice blocked takeovers of Constellation. The two companies are prepared for seven months of negotiations in Maryland, according to Shattuck.

“Most people recognize -- shareholders, regulatory authorities -- that the combined company is probably better,” said Security Global’s Bronzo. “It probably puts both companies on more solid footing. The approval will be very time consuming, but it will get done.”

Overall, there have been 8,062 deals announced globally this year, totaling $800.4 billion, a 24 percent increase from the $645.5 billion in the same period in 2010, according to data compiled by Bloomberg.

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