Business & Money

An analysis of the strategic implications of the re-basing of power and utility industry valuations.

Over the past several months, traditional valuation levels have re-emerged in the power and utility industry, with recent premium valuation metrics compressing significantly. This re-basing of industry valuations at levels more supportable by historical benchmarks and fundamental considerations of long-term growth and total return follows a two-year period of significant dislocation in the power and utility industry (and broader financial markets), during which dividend yield emerged as the primary value driver.

As considerations of growth begin to re-emerge in power and utility valuations, the industry again is confronting its historical dilemma: how to achieve long-term earnings growth that outstrips the intrinsic regulated utility growth profile of 1 to 3 percent. Following the collapse of the myriad of non-regulated growth platforms that precipitated recent industry-wide dislocations-most notably merchant energy-many utilities are again focusing on perhaps the most viable, broad-based and credible growth strategy: mergers and acquisitions.

Value-Dislocating Factors

Over the past two years, historical valuation parameters and metrics were dislocated by a unique confluence of economic, market, and industry-specific factors. The recession beginning in 2001, the post-bubble market collapse, and the overhangs of post-9/11 terrorism and war materially affected the general economy and equity markets. These factors triggered a classic "flight-to-safety" phenomenon in the capital markets, with utility securities and their perceived bond-substitute characteristics serving as a specific and traditional beneficiary.