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CEG deal appears 'less likely'

THE BALTIMORE SUN

If Wall Street is any guide, Constellation Energy Group and a Florida utility owner may be a step closer to walking away from their proposed merger as a result of lawmakers' decision to hold a special session over electric rates, and that could leave a smaller pot of money for politicians to draw from as they try to reduce a 72 percent rate increase.

Such a scenario also would likely handicap Baltimore's only Fortune 500 company by poisoning its chances of ever selling itself to a competitor and limiting its strategic growth options for years to come, analysts said.

Not since credit-card giant MBNA left Maryland for Delaware in 1982 as a result of a legislative dispute have lawmakers engaged in such brinkmanship with a corporation, state business leaders said. The dispute has made headlines beyond Maryland and focused a spotlight on how lawmakers are handling the crisis.

"This has significant financial implications for a major international company ... and its financial ability to operate, so the stakes are very high," said Donald Fry, president of the Greater Baltimore Committee.

The battle over rates has impaired Constellation's credit rating and sent its stock tumbling 9.6 percent for the year, erasing nearly $2 billion from its market value just before the merger with Juno Beach, Fla.-based FPL Group Inc. was announced.

Potentially billions of dollars are at stake for investors, as well as the long-term relationship between the state and a homegrown company that has added more than 1,000 jobs downtown in the past five years.

There are signs the company may already be positioning itself for life without FPL. Constellation announced yesterday that it was seeking to sell six natural-gas-fired power plants to reduce debt -- a move some analysts think is aimed at shoring up the company's balance sheet if the merger fails. The plants, which have an estimated value of $800 million, are all outside Maryland.

"I just think the deal is becoming less and less likely," said Raymond Moore, a utilities analyst with Shields & Co. in New York. "I could see that I would be surprised now if it went through."

Constellation said yesterday that it is selling the gas-fired power plants to focus its strategy on owning more nuclear and coal-fired plants, which are more valuable and cheaper to operate. The company said it makes sense to do the deal now because the market is favorable.

Lawmakers will meet in a special session next week to consider legislation to shift more money to ratepayers. A political furor has ensued since it was revealed in March that customers of Baltimore Gas and Electric Co., a Constellation subsidiary, face a 72 percent rate increase next month. That is when rate caps expire that were put in place six years ago as part of the state's plan for electric deregulation.

Options for ratepayer relief include replacing the Public Service Commission with tougher regulators; forcing the company to give back $528 million in so-called "stranded costs" it collected as part of deregulation; and requiring the company to lower its rates for a specified time, among other possibilities. The company has offered to give up as much as $600 million in merger-related savings for rate relief, but only if the FPL deal wins approval.

FPL could argue that any such moves would constitute a "ma- terial change" that would offer it a clear path out of the merger on the grounds that Constellation's future profitability is impaired.

"I think now more than ever this is a risk to FPL both politically and economically," said Mike Bedley, a partner with Davie, Fla.-based energy consultant APEX Power Services Corp.

A spokesman for FPL said the company has not changed its position on the merger.

"We believe in the strategic rationale for the merger," said Steve Stengel, a spokesman for the company. "We have said before that we were concerned with what was going on in Maryland and that we were watching what is happening very, very closely, and none of that has changed."

But analysts point to recent statements by both companies that suggest the two are distancing themselves from the deal. Executives of both companies started sounding less certain in their first-quarter conference calls with analysts, and Constellation CEO Mayo A. Shattuck III revealed last week that the two companies had stopped "merger integration" activities.

If the merger goes through, FPL would pay nearly $59 per share for Constellation. Yet the company's shares are trading at about $52 per share this week -- a sign investors don't think the deal will happen.

"There's an increasing bet on the part of the financial community that the merger may not happen," said Paul Fremont, a utilities analyst with Jefferies & Co. in New York.

Though Constellation would remain a strong company, there is considerable speculation in the financial community about what it would do if the merger fails, including selling assets, issuing more shares to raise money or, on the extreme end, spinning off BGE.

The $10.5 billion merger between Constellation and FPL was hailed in December as a blockbuster deal that would create a Fortune 100 company with the nation's second-largest utility portfolio. Constellation is already the nation's largest buyer and seller of power in unregulated markets. It has a huge trading operation in downtown Baltimore that was expected to blossom with the help of FPL's financial backing.

But the company's business model requires it to take huge financial positions in energy markets as it secures power supplies for the customers it serves nationwide. However, there are limits to how much credit financial institutions are willing to extend to Constellation as its trading operations continue to grow.

Combining with FPL -- a major utility owner with a secure, regulated source of income -- was one way for Constellation to solve its long-term balance sheet weakness. Absent that deal, analysts said, the company would have to find another way to erase debt and bolster its credit position, or risk making itself vulnerable to competitors.

The bigger threat to the company may be continued regulatory uncertainty in Maryland if legislators reconstitute the commission that oversees utilities in the state and take other steps to oversee the company's financial dealings, analysts said.

If lawmakers install PSC commissioners that are seen as overly advocating for consumers, the utility could sue on the grounds that it can't get a fair rate hearing because of regulatory bias, legal experts said.

In addition, the Fifth Amendment to the Constitution protects the company from being forced to sell power to customers for less than its cost to procure it.

"If they try to interfere with the regulatory process, the courts at some point are going to step in and say, 'Wait a second, what's going on here,'" said Bill Scherman, a former general counsel to the Federal Energy Regulatory Commission.

Once the legal maneuvering subsides, analyst said, BGE remains a solid business and one Constellation wouldn't be quick to throw away.

"I think it's premature to assume that the legislature and policymakers are going to bankrupt the company or impair it financially to such a degree that Constellation would consider abandoning it," said Paul Patterson, an analyst with Glenrock Associates.

paul.adams@baltsun.com

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