Unregulated arms to make contribution Constellation unit, Potomac Capital have assets of $2.2 billion.

THE BALTIMORE SUN

An article in Tuesday's editions about Baltimore Gas and Electric Co.'s unregulated subsidiaries incorrectly listed the utility's Home Products & Services Inc. as a division of Constellation Holdings Inc. Home Products is a separate BGE subsidiary.

The Sun regrets the error.

When the Potomac Electric Power Co. and the Baltimore Gas and Electric Co. merge in early 1997, the combined utility will control unregulated subsidiaries with assets of $2.2 billion - a figure that is comparable to the area's largest thrift, Loyola Capital Corp.

Because they are unregulated, BGE's Constellation Holdings Inc. and Pepco's Potomac Capital Investment Corp., will be able to explore numerous and wide-ranging non-power-related businesses.

By combining the two holding companies as part of a plan to create the nation's ninth-largest power company with $15.1 billion in assets, BGE/PEPCO could take advantage of operating synergies to improve the subsidiaries' contributions to the overall utility's earnings per share, utility analysts and others said.

"Constellation has a great many tangible, active projects, while Potomac Capital Investment is a mostly passive investment vehicle," said Alex Hart, a utility industry analyst at Ferris, Baker Watts Inc., in Baltimore. "While Constellation's investment side now throws off income that in part funds some of those projects, with Potomac Capital, those tangible projects could receive an even greater influx of capital."

Constellation, created in 1985, is an umbrella group consisting of three entities: real estate development, investment and alternative energy development. The BGE subsidiary also is involved in the development of assisted living centers for senior citizens and appliance and electronic sales through 11 retail outlets.

Potomac Capital, by contrast, is primarily devoted to managing a $500 million portfolio of securities, which generated $35.1 million in pre-tax income in 1994, and airplane equipment leasing. In the past year, Potomac Capital has also attempted to enter businesses including telecommunications, data supply and retrieval, and the sale and installation of energy conservation equipment.

Since its inception in 1983 with a $145 million capital infusion from PEPCO, Potomac Capital has generated more than $240 million to the Washington-based utility's consolidated earnings, prior to a one-time charge earlier this year. Its long-term debt totals $1.1 billion.

Constellation, which received a $168 million investment from its parent, has contributed $160 million to earnings since its inception.

Last year, Constellation generated $13.7 million in net income (12 cents a share) - 7 percent - to BGE's earnings, while Potomac Capital contributed $19.1 million (16 cents per share) or 9 percent.

As the utility industry follows the banking and telecommunications industries into an era of competitiveness, unregulated subsidiaries become important because they offer opportunities to increase earnings without relying on government-approved rate increases, said Frank J. Setian, a partner at Barr, Devlin Associates Inc., the New York investment banking firm that advised PEPCO in the merger talks.

In announcing their proposed merger, both BGE Chairman and Chief Executive Christian H. Poindexter and Pepco Chairman and Chief Executive Edward F. Mitchell said they would "combine the operations of the subsidiaries when it makes sense to do so."

Analysts and industry experts point out that there would be immediate benefits from combining overlapping operations, such as their respective investment portfolios and alternative energy developments.

"There would be clear management and financial advantages," Mr. Setian said. "Presumably, they could get a better credit rating, which would lower their cost of borrowing funds. Both companies are substantial in their own right now. And while the ** merger was driven by the strategic rationale to combine the utility side, the subsidiaries are icing on the cake."

Constellation currently has $300 million in assets in 25 alternative power plants. Most recently, the company in July invested $9 million in a Bolivian power company. Potomac Capital's energy investments total $115 million. Most notably, it owns a portion of the largest solar-powered plant in the United States, located in California's Mojave desert.

Additionally, a Potomac Capital-Constellation merger would also provide opportunities to expand BGE's Home Products & Services division into the Washington metropolitan area, as well as its real estate development operations.

But both subsidiary operations have suffered setbacks in the past.

For Potomac Capital, its financial albatross resulted from its airplane leasing business, hit hard by that industry's prolonged decline. In May, PEPCO announced plans to take a one-time, $110 million after-tax charge to get out of the business, which in ++ 1994 produced $111.3 million in revenues. Over the next two years, Potomac Capital intends to sell 13 aircraft, which make up the bulk of the division's $730 million book value.

For Constellation, real estate holdings and the purchase of a Columbia developer, the KMS Group Inc., in 1988 caused the company to suffer losses in the wake of the market's collapse in 1990.

BGE has acknowledged that the real estate component, with $477 million in assets, including the 2,500-acre Piney Orchard planned community in Anne Arundel County, has failed to meet debt service on many loans and has been sustained by capital from the holding company.

But in the past year, Constellation's real estate group has sold two retail projects, entered partnerships to develop new retail centers, and competed to develop new industrial buildings for Saks Fifth Avenue, Time Warner Inc. and Starbucks Coffee Co.

And both have been the subject of investigations by regulatory bodies.

The District of Columbia Public Service Commission began its study of Potomac Capital last month after allegations were raised that PEPCO had subsidized the company beyond the $145 million that PEPCO has reported.

Although the D.C. PSC has no direct evidence that PEPCO has subsidized Potomac Capital, the commission decided to investigate after the issue was raised during hearings on a recent rate increase proposal.

Lawrence Crocker, acting general counsel of the D.C. PSC, said the commission next will schedule a series of hearings so that witnesses can speak and present evidence.

BGE recently won a unanimous decision from the Maryland PSC on the subsidizing issue. The case stemmed from complaints to the PSC from a group of heating and air conditioning businesses that claimed BGE was unfairly helping Constellation's Home Products & Services division with advertising and the use of the BGE name.

The PSC ruled that BGE's subsidiary competed as an independent operator and was not liable to pay ratepayers a 2 percent royalty on appliance sales and repairs.

What they own

BGE's Constellation Holdings Inc.

-- $477 million worth of real estate development.

-- $300 million in 25 wholesale power plants in the United States and South America.

-- 11 retail outlets for sales of appliances and electronics.

-- Assisted living centers for senior citizens.

-- Investments.

-- Alternative energy, including chilled water cooling.

Pepco's Potomac Capital Investment Corp.

-- $500 million portfolio of securities.

-- Airplane leasing with book value of $730 million, a business PCI is exiting.

-- $115 million in alternative electric power projects.

-- Data supply and retrieval.

-- Financing and installation of energy conservation equipment.

-- Telecommunications.

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