If electricity distribution were music it would be pure rock and roll. If sector consolidation was an album it would feature the best of classic rock. With the upcoming release of the Distribution Review Panel's Report, the EDA asked me to identify some core strategic considerations for LDCs considering voluntary transactions. Having negotiated numerous successful LDC deals over the past 15 years, here are a few suggestions on key considerations. For me, the following songs nicely capture the mood around these strategic priorities.
Welcome to the Jungle – Guns N Roses
Investors and financiers are not dazed and confused when it comes to distribution utilities. They view LDCs as being akin to safe, long bonds. And why wouldn't they? In a world of record low interest rates and uncertain equity returns, LDCs have never been more attractive. With a regulated return of around 10 per cent and with many LDCs facing significant system renewal over the next few years, these combined ingredients make for a pleasing and powerful riff for those with a sophisticated ear. Expect significant premiums to be paid for the top prospects.
Because LDC mergers and sales don't happen often, the "cut and thrust" environment when doing a deal can be wild and unpredictable. Whether you are hunting for a merger partner or pursuing a sale or lease, the first critical step is to develop your deal plan. This is the "show me" document. It explains why you have selected the chosen path (merger, sale, lease, or some combination of these options), what the key elements of your strategy are (an open bid approach or a closed process involving a few predetermined suitors), and how you define success for your employees, customers, board of directors and shareholders.
Proceeding without a deal plan is, well, an appetite for destruction.
Long May You Run – Neil Young
LDCs are long-life assets. The starting line for any transaction is to understand the final destination - how a particular transaction will create value. The business plan that underlies the decision to pursue a transaction must demonstrate and assess the range of achievable benefits, how enhanced efficiencies will be harnessed, which costs can be reduced, why resulting rate impacts will be reasonable, why shareholder returns will be greater, and why service and reliability will be better.
Like the old 1948 Buick Roadmaster hearse Neil Young sings about in this song (which was Neil's first car), aging LDC equipment and an aging workforce continue to be real, pressing and ongoing concerns for utilities. I fully expect scale and scope benefits resulting from consolidated LDC capital plans and enhanced implementation of infrastructure and workforce renewal to feature prominently in future LDC consolidation talks.
Paranoid – Black Sabbath
Mistrust is your enemy in any deal. The proper communications strategy is critical for success. The right disclosure approach must be established to suit your utility and community. This includes both messaging within your organization and beyond to customers and other key stakeholders. You need to strike the right balance and tone. You want to ensure that your board of directors and municipal council get regular briefings but that they don't end up micro-managing the process and causing undue delay. You must ensure that key decision makers clearly understand all the relevant deal components and their implications. When you bring customers and the general public into the discussion, you must decide what the messages are for them and how you will address their concerns. Above all, special care and attention needs to be made in terms of dealing with your municipal shareholder and board of directors. The worst outcome is having fully negotiated a deal and then going before your board and shareholder for final approvals only to find them surprised and concerned about aspects of the proposed transaction.
Clear communications is also critical for your prospective partners. If you proceed by way of a competitive bid process, it is very important that everyone understands the rules of engagement at the outset. At the end of the process there will be one winner standing beside you and the rest will lose out. Transactions are time consuming, complicated and expensive, and no one who enters the race wants to be the loser. Participants are entitled to participate in a process that treats them fairly, honestly and which provides them with a full opportunity to give it their best shot.
Working Man – Rush
Open and ongoing communications with your employees is also particularly important in my experience. Your staff have mortgages, credit card bills and families to raise and worry about. LDC transactions are stressful on employees. Transactions take several months to complete and are a time of great uncertainty. Your deal may mean immediate staff reductions or reductions over time. So think ahead about how you will keep your staff and union in the loop. Regular updates should be part of your deal plan. Employees have their day-to-day jobs to do without being distracted about their future in a post-merger, sale or lease world – especially in today's economic climate. Even if no job reductions are contemplated it is critical that you let your people know what is going on, why you are doing it, what the expected outcomes are, and how you are addressing their concerns in a responsible manner. Being sensitive to the employee side of your deal doesn't only reflect good management practice - it is simply the right thing to do.
Lola – The Kinks
Make sure you do the proper amount of due diligence on your prospective partner. Do your organizations have compatible business cultures, a common approach to governance? Are the shareholders "singing from the same song-sheet" in terms of financial expectations and other core relationship issues? Likewise, the various merger, sale or lease proposals you receive must be carefully evaluated and scrutinized. When you go to your board of directors and your municipal shareholder for approvals, does everyone clearly understand the range of implications of the entire package – from the bottom line purchase price or share split, to debt restructuring requirements, to liabilities and contingent liabilities, head office location, impact on employees, other ongoing impacts on the community, the need for community advisory councils and critical question of rate harmonization – what happens to distribution rates under consolidation?
These implications need to be carefully considered to avoid settling on a dance partner only to have a nasty surprise when the houselights come on.
Heroes – David Bowie
Good transactions benefit both sides. Two LDCs become one and the sum should be greater than its parts. Employees need to be treated fairly and with respect, customers need to be assured that benefits to them are part of the deal equation, and shareholders must realize "value", which different communities will define in different ways. When considering a transaction here is a simple litmus test for you to ask yourself: after the proposed transaction is completed, when you walk down your main street will you be able to hold your head high knowing that your community is better off?
Dirty Deeds Done Dirt Cheap – AC/DC
To ensure a smooth, acceptable process and to capture the maximum benefits for your LDC and community, you require a team of lawyers who understand all the intricacies of these transactions (local and provincial politics, term sheets, bid process and documentation, due diligence, drafting commercial agreements, tax/PILS, employment, communications, stakeholder relations, rate design and regulatory approvals). You need a team who is creative, innovative and who can get the job done. There is no substitute for experience.
LDC transactions are often the largest and most significant commercial transactions that the shareholder municipality will ever encounter. You can be sure the spotlight will be on your deal in your community for a long time – regardless of your size or where you are located in Ontario. Choosing the right legal team for the job is crucial. Borden Ladner Gervais' Electricity Markets Group has more experience with LDC mergers and sales than any other law firm in Canada, including developing the first ever long term LDC lease in Ontario's history. So call me. Let's talk. And for those about to rock . . . we salute you!
Originally published in the EDA's November 2012 issue of the Distributor
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.