File No. 70-9545
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.
Amendment No. 2
To
FORM U-1
APPLICATION
UNDER THE
PUBLIC UTILITY HOLDING COMPANY ACT OF 1935
Energy East Corporation
P.O. Box 1196
Stamford, Connecticut 06904-1196
and
Merger Co.
c/o Energy East Corporation
P.O. Box 1196
Stamford, Connecticut 06904-1196
(Name of company or companies filing this statement and address of
principal executive offices)
Kenneth M. Jasinski
Executive Vice President and General Counsel
c/o Energy East Corporation
P.O. Box 1196
Stamford, Connecticut 06904-1196
Telephone: (203) 325-0690
(Names and addresses of agents for service)
Copies to:
Frank Lee, Esq. Adam Wenner, Esq.
Huber Lawrence & Abell Vinson & Elkins
605 Third Avenue 1455 Pennsylvania
Avenue, N.W.
New York, New York 10158 Washington, D.C. 20004
Telephone: (212) 682-6200 Telephone:(202) 639-6500
This Amendment No. 2 to the Form U-1 of Energy East
Corporation is being filed
to amend Item 6 by adding the exhibit listed below:
Item 6. Exhibits and Financial Statements.
The following exhibit is being filed with this Amendment No.
2:
NO. DESCRIPTION METHOD OF FILING
D-2 Order of Connecticut Department of Filed herewith.
Public Utility Control Approving a
Change of Control.
<PAGE>
SIGNATURE
Pursuant to the requirements of the Public Utility Holding
Company Act of 1935, the undersigned companies have duly caused this
Amendment No. 2 to be signed on their behalf by the undersigned
thereunto duly authorized.
Energy East Corporation
Date: December 17, 1999 By /s/ Kenneth M. Jasinski
Kenneth M. Jasinski
Executive Vice President
and General Counsel
Merger Co.
Date: December 17, 1999 By /s/ Kenneth M. Jasinski
Kenneth M. Jasinski
Vice President, Secretary
and Treasurer
EXHIBIT D-2
STATE OF CONNECTICUT
DEPARTMENT OF PUBLIC UTILITY CONTROL
TEN FRANKLIN SQUARE
NEW BRITAIN, CT 06051
DOCKET NO. 99-07-20 JOINT APPLICATION OF ENERGY EAST CORPORATION
AND CONNECTICUT ENERGY CORPORATION FOR
APPROVAL OF A CHANGE OF CONTROL
December 16, 1999
By the following Commissioners:
Linda Kelly Arnold
Jack R. Goldberg
Glenn Arthur
DECISION
TABLE OF CONTENTS
I. INTRODUCTION 1
A. SUMMARY 1
B. BACKGROUND OF THE PROCEEDING 1
C. CONDUCT OF THE PROCEEDING 1
D. PARTIES AND INTERVENORS 2
E. PUBLIC COMMENT 2
II. APPLICANTS' EVIDENCE 2
A. DESCRIPTION OF ENERGY EAST CORPORATION 2
B. DESCRIPTION OF CONNECTICUT ENERGY CORPORATION AND ITS
SUBSIDIARIES 3
1. THE SOUTHERN CONNECTICUT GAS COMPANY 3
2. CNE ENERGY SERVICES GROUP, INC. 3
3. CNE DEVELOPMENT CORPORATION 4
4. CNE VENTURE-TECH, INC. 4
C. DESCRIPTION OF THE TRANSACTION 4
III. POSITION OF OCC 6
IV. DEPARTMENT ANALYSIS 7
A. FINANCIAL SUITABILITY OF ENERGY EAST 7
B. TECHNOLOGICAL AND MANAGERIAL SUITABILITY OF ENERGY EAST 8
C. AFFILIATE TRANSACTIONS 9
D. SAFE, ADEQUATE AND RELIABLE SERVICE 10
E. MANAGEMENT AND OPERATIONS POST MERGER 12
F. PRICE 13
1. COMPARATIVE STOCK PRICE PERFORMANCE 13
2. COMPARABLE PUBLIC COMPANY ANALYSIS 13
3. DISCOUNTED CASH FLOW ANALYSIS FOR PER SHARE VALUATION14
4. ANALYSIS OF SELECTED PRECEDENT TRANSACTIONS 15
5. PRO FORMA ANALYSIS OF THE MERGER 15
G. OPERATION AND MAINTENANCE EXPENSES AND SYNERGIES 16
H. GOODWILL/ACQUISITION PREMIUM 16
I. TRANSACTION COSTS 18
J. COMPETITIVE MARKET ISSUES 18
K. RATE PLAN ALTERNATIVE 19
V. FINDINGS OF FACT 20
VI. CONCLUSION AND ORDERS 22
A. CONCLUSION 22
B. ORDERS 23
DECISION
I. INTRODUCTION
A. Summary
In this Decision, pursuant to Section 16-47 of the General
Statutes of Connecticut and Sections 16-1-65A and 16-1-65B of the
Regulations of Connecticut State Agencies, the Department of
Public Utility Control approves the joint application of Energy
East Corporation to acquire control of the Connecticut Energy
Corporation. The Southern Connecticut Gas Company is a wholly-
owned subsidiary of the Connecticut Energy Corporation. The
Department found that Energy East Corporation has the financial,
technological and managerial suitability and responsibility to
control a public service company. In addition, Energy East
Corporation is found to be able to provide safe, adequate and
reliable service to the public through the public utilities'
plant, equipment and manner of operation.
B. Background of the Proceeding
By joint application dated July 22, 1999 (Application),
filed with the Department of Public Utility Control (Department)
pursuant to Section 16-47 of the General Statutes of Connecticut (Conn
Gen. Stat) and Sections 16-1-65A and 16-1-65B of the Regulations of
Connecticut State Agencies (Conn. Agencies Regs.), Energy East
Corporation (EEC or Energy East) and Connecticut Energy
Corporation (CEC or Connecticut Energy; jointly, Applicants)
requested that the Department approve the change of control of
CEC to EEC (Merger). According to the Application, the proposed
change of control transaction is structured as a merger of Merger
Co., (Merger Sub) and CEC. CEC will merge into Merger Sub, with
Merger Sub being the surviving company. Merger Sub, which will
be renamed Connecticut Energy Corporation, will continue to
conduct CEC's utility operations as a direct, wholly-owned
subsidiary of EEC. As a result of the transaction, Merger Sub
will become a wholly-owned, first-tier subsidiary of EEC, with
The Southern Connecticut Gas Company (SCG or Southern) becoming a
first-tier, wholly-owned subsidiary of Merger Sub. After
consummation of the Merger, Southern will become an indirect,
wholly-owned subsidiary of EEC; therefore, there is no merger of
public service companies. Application, p. 6.
C. Conduct of the Proceeding
By Notice of Hearing dated August 11, 1999, and pursuant to
Conn. Gen. Stat. Section 16-47, a public hearing was held in this matter
on September 9, 1999, at the Department's offices, Ten Franklin
Square, New Britain, Connecticut. The hearing continued at the
offices of the Department on September 23, and 27, 1999, at which
time it was closed.
The Department issued a draft Decision in this docket on
December 8, 1999. All parties were provided an opportunity to
file written exceptions to and present oral arguments on the
draft Decision.
D. Parties and Intervenors
The Department recognized Energy East Corporation, One
Canterbury Green, Stamford, Connecticut 06904-1196; Connecticut
Energy Corporation, 855 Main Street, Bridgeport, Connecticut
06604; and the Office of Consumer Counsel, Ten Franklin Square,
New Britain, Connecticut 06051, as parties to this proceeding.
The United Steel Workers of America Local 1200 and the
Connecticut Natural Gas Corporation requested and were granted
intervenor status.
E. Public Comment
There were no written or oral comments from the public on
this Merger.
II. APPLICANTS' EVIDENCE
A. Description of Energy East Corporation
Energy East, a New York corporation, is an exempt public
utility holding company under the Public Utilities Holding Act of
1935 (PUHCA). Energy East was formed in 1997 as part of a
comprehensive regulatory restructuring plan for New York State
Electric and Gas (NYSEG) and became the parent of NYSEG on May 1,
1998. Energy East is an energy delivery, products and services
holding company with subsidiary operations in New York,
Massachusetts, Maine, New Hampshire, Vermont and New Jersey and
has corporate offices in New York and, since June 1999, in
Stamford, Connecticut. Energy East's nonutility subsidiaries
include Xenergy Enterprises, Inc. and Energy East Enterprises,
Inc., which invest in energy ventures and are providers of energy
and telecommunications services. As a holding company, Energy
East neither owns nor operates any physical properties.
Application, p. 10. EEC's consolidated 1998 adjusted revenues
were $2,499,418,000, with a net income of $194,205,000.
Application, pp. 11 and 12.
Energy East's principal subsidiary, NYSEG, is a public
utility company engaged primarily in purchasing,
transmitting/transporting and distributing electricity and
natural gas. As part of its corporate strategy of exiting the
baseload power generation business, it recently completed a
divestiture of all of its coal-fired electric generation
facilities. Additionally, NYSEG recently agreed to sell its 18%
nonoperating interest in the Nine Mile Point 2 nuclear plant
located in Oswego, New York. This transaction is expected to
close early next year. NYSEG's service territory, 99% of which
is located outside the corporate limits of cities, is in the
central, eastern and western parts of the state of New York.
NYSEG serves approximately 817,000 electric and 243,000 natural
gas customers. During 1996 through 1998, approximately 84% of
NYSEG's operating revenues were derived from electric service
with the balance derived from natural gas service. Application,
pp. 10 and 11.
Energy East also has announced a merger with CMP Group,
Inc., the Maine-based parent company of Central Maine Power
Company (Central Maine). Upon final approval of that merger,
Energy East will gain control of Central Maine, which serves
530,000 electric customers in Central and Southern Maine. The
transaction values CMP Group common equity at approximately $957
million and includes the assumption of $271 million in preferred
stock and long-term debt. According to the Applicants, the
transaction will have no adverse effect on Energy East's proposed
merger with Connecticut Energy. Application, p. 11.
Finally, Energy East announced a merger with CTG Resources,
Inc., the Hartford, Connecticut based parent company of
Connecticut Natural Gas Corporation. Connecticut Natural Gas
serves approximately 142,000 customers in 21 municipalities in
Connecticut, principally in greater Hartford and Greenwich. The
transaction values CTG Resources common equity at approximately
$355 million and includes the assumption of $220 million in long-
term debt. Again, the Applicants indicate that this transaction
will have no adverse effect on Energy East's proposed merger with
Connecticut Energy.
B. Description of Connecticut Energy Corporation and Its
Subsidiaries
Connecticut Energy, a Connecticut corporation, is an exempt
public utility holding company under the PUHCA. As such,
Connecticut Energy neither owns nor operates any physical
properties. Through its subsidiaries, Connecticut Energy is
engaged in operations principally in Connecticut, with retail
marketing of natural gas in Massachusetts, New Hampshire, Rhode
Island, Connecticut, and to a few customers in New York. Its
operating revenues totaled $242,431,000 for the fiscal year ended
September 30, 1998, with a consolidated net income for the same
period of approximately $19 million. It has four direct, wholly-
owned subsidiaries, all engaged in functionally distinct
operations, described below. Application, p. 4.
1. The Southern Connecticut Gas Company
Southern, a Connecticut public service company, is primarily
engaged in the retail distribution of natural gas for
residential, commercial, and industrial uses and the
transportation of natural gas for commercial and industrial uses.
Southern's predecessor companies, New Haven Gas Company and The
Bridgeport Gas Company, originally were incorporated in
Connecticut in 1847 and 1849, respectively. Southern was formed
in 1967 as a result of the merger of New Haven Gas Company and
The Bridgeport Gas Company. Southern serves approximately
158,000 customers in 22 Connecticut communities and has an
overall saturation ratio of 38% in these communities.
Application, p. 13, Exhibit 27; Ammann PTF, p.3. There are 10
municipalities in its service area that Southern does not serve.
Id.
2. CNE Energy Services Group, Inc.
CNE Energy, a Connecticut corporation, provides energy
products and services to commercial and industrial customers in
New England and to a few customers in New York, both on its own
and through its participation as a member in various energy-
related limited liability companies. Application, p. 13. CNE
Energy is not subject to the direct regulatory jurisdiction of
the Department.
3. CNE Development Corporation
CNE Development, a Connecticut corporation, markets natural
gas through equity participation in a natural gas purchasing
cooperative. Application, p. 13. CNE Development is not subject
to the direct regulatory jurisdiction of the Department.
4. CNE Venture-Tech, Inc.
CNE Venture-Tech, a Connecticut corporation, invests in
ventures that produce or market technologically advanced energy-
related products. It owns 100% of the member interest of CIS
Service Bureau, LLC, (CIS) a Delaware limited liability company.
CIS provides service bureau access to customer billing software
and other related services for local distribution and other
utility-type companies. Application, pp. 13 and 14. Neither CNE
Venture-Tech nor CIS is subject to the direct regulatory
jurisdiction of the Department.
C. Description of the Transaction
The Applicants state that the proposed change of control
transaction is structured as a merger of EEC and CEC. Merger
Sub, a newly-formed Connecticut subsidiary of EEC created
specifically for the purpose of consummating the transaction,
will merge with CEC with Merger Sub being the surviving entity.
After the transaction, Merger Sub, which will be renamed
Connecticut Energy Corporation, will become a wholly-owned, first-
tier subsidiary of EEC, with SCG, CNE Energy Services Group,
Inc., CNE Development Group and CNE Venture-Tech Inc. remaining
wholly-owned subsidiaries of CEC. Application, p. 6; Exhibit B,
p. 2. The Applicants claim that this change of control
transaction will not affect the Department's ability to regulate
the operations of Southern. Application, pp. 6 and 7.
To effectuate the transaction, EEC and CEC have executed an
Agreement and Plan of Merger (Merger Agreement) dated April 23,
1999. The proposed transaction will be consumated in accordance
with all applicable federal and state laws and regulations,
including, but not limited to, the Securities Act of 1933, the
Securities Exchange Act of 1934, the Hart-Scott-Rodino Antitrust
Improvement Act of 1976, and rules promulgated thereunder, the
Natural Gas Act, the Communications Act of 1934, the Public
Utility Holding Company Act of 1935 and the Connecticut Business
Corporation Act. In addition to the Department, the Merger must
be approved by Connecticut Energy shareholders and the Securities
and Exchange Commission (SEC) pursuant to PUHCA. The Merger
Agreement commits EEC and CEC to consummate the transaction once
all regulatory approvals are obtained. Application, pp. 7 and 8.
According to the Applicants, in the Merger each outstanding
Connecticut Energy share will be converted into the right to
receive cash, Energy East shares or a combination of cash and
Energy East shares.1 Application, p. 18. While each eligible
Connecticut Energy shareholder can elect the form of
consideration, this election is subject to proration and an
adjustment driven by tax considerations. Under the Merger
Agreement, 50% of all issued and outstanding Connecticut Energy
shares must be exchanged for cash and 50% must be exchanged for
Energy East shares. If Connecticut Energy shareholders who own
in excess of 50% of Connecticut Energy shares elect to receive
cash, the number of shares converted into cash will be less than
the number elected. Similarly, if Connecticut Energy
shareholders owning in excess of 50% of Connecticut Energy shares
elect to receive Energy East shares, the number of Connecticut
Energy shares converted into stock will be less than the number
elected. For tax reasons, Energy East may have to increase the
number of Connecticut Energy shares converted into Energy East
shares and decrease the number of Connecticut Energy shares
converted into cash. Application, pp. 18-19.
The per share cash consideration amounts to $42.00 in cash
without interest. The per share stock consideration is a number
of Energy East shares that will vary depending on the average
market price, which is the average of the closing prices of
Energy East shares on the New York Stock Exchange during the 20
trading days immediately preceding the second trading day prior
to the effective time of the Merger (Average Market Price). If
the Average Market Price is between $23.10 per share and $29.40
per share, then each Connecticut Energy share converted into
stock will be exchanged for $42.00 worth of Energy East shares.
For example, if the Average Market Price is $28.00, each
Connecticut Energy share converted into stock will be exchanged
for 1.5 Energy East shares. If the Average Market Price is less
than or equal to $23.10, then each Connecticut Energy share
converted into stock will be exchanged for 1.82 Energy East
shares, irrespective of the value of those shares. Finally, if
the Average Market Price is greater than or equal to $29.40 per
share, then each Connecticut Energy share can be exchanged for
1.43 Energy East shares, again irrespective of the value of those
shares. Application, pp. 18 and 19.
Based on the number of Connecticut Energy shares outstanding
on July 12, 1999, and assuming that the Average Market Price of
Energy East is between $23.10 per share and $29.40 per share, the
total value of consideration to be received by Connecticut Energy
shareholders is approximately $436.5 million. Energy East
anticipates funding the cash portion of the consideration with
internally generated funds or the proceeds from the sale of its
generation assets. Application, pp. 18 and 19. CEC engaged
Morgan Stanley to provide financial advisory services in
connection with the Merger. Morgan Stanley performed its
analysis using the methodologies of comparative stock price
performance, comparable public company analysis, discounted cash
flow (DCF) analysis, an analysis of selected precedent
transactions, as well as a pro forma analysis of the Merger.
Exhibit No. 2, pp. 36-38.
Using a comparative stock price performance methodology,
Morgan Stanley reviewed the recent stock price performance of CEC
and compared it to seven small capitalization local gas
distribution companies (LDCs) and the 30-year Treasury bond
price. Exhibit 10, p. 36. Using a comparable public company
analysis, Morgan Stanley compared financial information of CEC
and EEC with a group of LDCs deemed comparable to CEC as well as
a group comparable to EEC. Exhibit 10, pp. 36 and 37. Morgan
Stanley performed a DCF analysis of CEC and EEC for the period
1999 through 2003 based on financial projections provided by
respective managements. Exhibit 10, p. 37. Morgan Stanley also
analyzed selected precedent transactions that it deemed
comparable to the Merger using publicly available information.
Exhibit 10, p. 37 and 38. Finally, Morgan Stanley reviewed the
pro forma impact of the Merger on EEC's earnings per share and
CEC's dividends per share for the fiscal years ended 2000 through
2003. Exhibit 10, p. 38.
The Applicants are also proposing adoption of a rate plan
alternative (RPA) filed concurrently in Docket No. 99-04-18, DPUC
Review of The Southern Connecticut Gas Company's Rates and
Charges - Phase II. This RPA is comprised of, among other
things, a four-year term, limited cost deferrals, price caps for
residential sales customers (including gas costs) and pricing
options for non-residential sales customers, elimination of the
purchase gas adjustment clause with non-restricted hedging
activities, an earnings sharing mechanism, and adoption of
performance standards for measuring service quality. Application
p. 17; Bonner PFT, pp. 6-7.
Finally, the Applicants stress that Energy East makes a
number of commitments and statements of intention with regard to
the proposed Merger and any future gas utility operations in
Connecticut. Included in these commitments and intentions are an
intention or commitment to: (i) actively support competitive
natural gas markets, open to all qualified suppliers, while
maintaining the highest reliability and customer service
standards; (ii) use its strong balance sheet and the proceeds
from the sale of its generation assets to selectively grow CEC's
distribution business; (iii) not affect the ability of the
Department to regulate the operations of Southern; (iv) maintain
the headquarters of Southern and CEC in Bridgeport and continue
with Southern's local management; (v) effectuate any employee
reductions through attrition wherever possible (Merger Agreement
provides that Energy East will not make involuntary employment
reductions), and (vi) increase from current levels Southern's
infrastructure improvements, particularly cast iron and bare
steel main replacement, and charitable contributions to its
communities. Application, pp. 4-5 and 26.
III. POSITION OF OCC
The Office of Consumer Counsel (OCC) believes that the
findings of the Department in this proceeding must go beyond the
criteria set forth in Conn. Gen. Stat. Section 16-47(d). Specifically,
the OCC suggests that the Department's review also focus on: 1)
the effect of the Merger on competition; 2) the degree to which
the Merger benefits both consumers and stockholders; 3) the
degree to which acceptable customer protections are in place to
ensure effective cost control; 4) the effect of the Merger on
regulation, and 5) the degree to which factors benefiting
customers that compel approval of the Merger exist. OCC Brief,
p. 4; Larkin PFT, p. 2.
In analyzing the merits of the Merger using this proposed
criteria, the OCC finds the Merger to be lacking. In particular,
the OCC believes: a) the Merger will have a significant
dampening effect on competition, which can only be remedied if
CEC is (i) required to exit the merchant function, (ii) required
to provide nondiscriminatory open access to all qualified gas
marketers, and (iii) prohibited from being a commodity provider
on its own system; b) the Merger, as proposed, only benefits
shareholders since the Applicants have not and cannot show that
any benefits will flow to consumers from the Merger; c) that
additional customer protections need to be put in place to guard
against costs being or that may be allocated to Southern
inappropriately; d) that the Merger may make the effective
regulation of Southern more difficult, and e) that there are no
compelling benefits to ratepayers which would require the
Department to approve this Merger. As such, the OCC believes
that the Merger application should be denied. OCC Brief, pp. 5-
27.
IV. DEPARTMENT ANALYSIS
Pursuant to Conn. Gen. Stat. Sections 16-47(a) and 16-47(d), the
Department regulates the control and acquisition of a public
service company and specifically takes into consideration the
following guidelines in its evaluation of a proposed buyer's
suitability to own a local gas distribution company:
In each proceeding on a written application submitted
under said subsection (b) or (c), the department shall,
in a manner which treats all parties to the proceeding
on an equal basis, take into consideration (1) the
financial, technological and managerial suitability and
responsibility of the applicant, (2) the ability of the
gas, electric, electric distribution, water, telephone
or community antenna television company or holding
company which is the subject of the application to
provide safe, adequate and reliable service to the
public through the company's plant, equipment and
manner of operation if the application were to be
approved.
Conn. Gen.
Stat. Section 16-47(d)
Specifically, the Department must determine the suitability
of the proposed buyer. The buyer must have the level of
experience, financial resources and technological expertise to
enable it to assume the ownership, management and control of the
company to be purchased. The acquiring company must be able to
provide adequate service to the customers of this company.
A. Financial Suitability of Energy East
The Applicants stated that Energy East's total operating
revenues in 1998 were $2.5 billion, up 15% from the 1997 level of
$2.2 billion. Net income was $194 million in 1998, up 11% from
$175 million in 1997. Earnings per share were also up to $3.02
in 1998, an increase of 18% compared to earnings per share of
$2.57 in 1997. Application, Exhibit 11. Financial ratios for
Energy East for fiscal year end 1998 are as follows:
Pretax (EBIT) interest coverage: 3.7x
Total debt/total capital: 45.6%
Funds flow earnings before interest, taxes,
depreciation and amortizations(EBITDA) interest coverage: 5.2x
Funds from operations/total debt: 31.3%
Net (free operating) cash flow/average total debt: 21.8%
Net cash flow/capital expenditures: 2.6x
Application, Exhibits 10
and 11.
Energy East's total return in 1998 significantly outperformed the
Standard & Poor's 500 Index. The successful auction of NYSEG's
coal-fired generation facilities resulted in significant gains
that eliminated stranded costs, including nuclear costs. NYSEG's
nuclear operating risk and the risk of increasing decommissioning
costs would also be eliminated as a result of the recently
announced sale of NYSEG's 18% ownership in the Nine Mile 2
nuclear facility to AmerGen. Application, pp. 20 and 21.
According to the Applicants, Energy East's principal
subsidiary, NYSEG as the major debt holding entity in the EEC
organization, recently received a credit rating upgrade by
Moody's from Baa1 to A3 and an upgrade of senior secured debt by
Standard & Poor's from BBB+ to A. Application, p. 21; Response
to GA-7. The Department believes the reduced risk and the
significant cash from the sale of generating assets have put
Energy East in a position to expand its core business. Based on
the above cited record, the Department finds that Energy East as
a consolidated company has the financial strength to acquire
control of Connecticut Energy.
B. Technological and Managerial Suitability of Energy East
To determine the technological and managerial suitability of
Energy East to exercise control over Connecticut Energy and
Southern, the Department considered the operation of Energy
East's largest subsidiary, NYSEG. The Applicants testified that
NYSEG is a combination electric and gas corporation that provides
electric service to 817,000 customers in 149 cities and villages,
and 373 towns and provides gas service to 243,000 customers in 85
cities and villages and 143 towns. The electric systems
presently provide open access transmission and distribution to
large commercial and industrial customers. As of August 1, 1999,
all customers were able to choose their own electric supplier and
retain the transmission and distribution service provided by
NYSEG. In addition to having long provided bundled gas service
to its customers, the Applicants stated that the natural gas
system has provided transportation only services for large
customers since 1986 and for all customers since 1996. At the
present time, approximately 38% of the throughput of the gas
system is third-party gas. Application, pp. 21 and 22, Exhibit
11; Bonner PFT, p. 3; Response to Interrogatory OCC-106.
The Applicants also stated that NYSEG operates its gas
operations based on an operation manual that meets and exceeds
the safety code requirements of New York State and the U.S.
Department of Transportation, and that NYSEG responds to reports
of gas leaks within 60 minutes or less 99.8% of the time. NYSEG
operates its own meter testing lab with state-of-the-art
equipment and has a gas training department. The gas business
unit of NYSEG holds firm transportation on 11 pipelines and has
contracted for storage on three pipelines. NYSEG also owns and
operates the only high deliverability salt storage field in the
Northeast; located on Seneca Lake in New York. Id.;
Application, Exhibit 2.
The Applicants indicated that, as of year end 1998, NYSEG
owned and operated 55 miles of high pressure pipeline, 400 miles
of transmission pipeline, 4,000 miles of main, 3,200 miles of
services, and 1,195 regulator stations. NYSEG receives its gas
at 85 separate delivery points and continues to add new delivery
points each year as NYSEG expands its service territory. In the
last four years, NYSEG instituted service to 25 new franchise
areas in the state of New York, which is more system expansion
than all the other utility companies in New York have added in
the last 20 years. Application, p. 22.
The Department believes the managerial expertise and gas
industry acumen of the Energy East officers make them reasonable
partners in this Merger. Based on the above-cited record, the
Department finds that Energy East has the technological and
managerial suitability to acquire control of Connecticut Energy.
C. Affiliate Transactions
OCC, through its witness Mr. Larkin, expressed concern that
transaction controls among affiliated companies be in place prior
to the Merger. . Mr. Larkin concludes that such controls are
necessary to ensure against the possibility of ratepayers
subsidizing the operations of the parent company's other non-
regulated affiliates. Larkin PFT, p. 15; Tr. 9/27/99, pp. 266-
272.
CEC and Southern will remain subject to the orders in Docket
No. 77-08-28, Application of The Southern Connecticut Gas Company
for Approval of Corporate Reorganization and Merger and Formation
of a Holding Company - Reopening, dated May 21, 1997, which
govern affiliate relationships, cost allocation formulas between
affiliates, and dividend policy. Response to Interrogatory GA-9.
The Department at any time can perform an audit to evaluate
whether proper cost allocations are occurring. To facilitate
such an audit, the Department will order that SCG submit a
comprehensive cost allocation manual that compiles the cost
allocation procedures currently required and in place for the
Company. In addition, Southern's service agreements, which set
forth cost allocation methodology, and its code of conduct
between Southern and affiliates, will continue to control the
relationships among the CEC subsidiaries. Response to
Interrogatories OCC-25 and OCC-25 Supplemental. Furthermore, the
Department, after examining the code of conduct and the cost
allocation manual of EEC, believes there are sufficient detail
and suitable methodologies to provide for cost allocation, based
on the source of the cost and the principle of cost causation.
Late File Exhibit No. 6. Nevertheless, the Department herein
emphasizes the necessity for access to any and all books and
records of Energy East and its affiliates that the Department
deems necessary to: (i) verify all costs and revenues that are
ultimately allocated to Southern for recovery from ratepayers
and/or for determination of Southern's regulated earnings, and
(ii) verify that Southern assets, including its gas pipeline
contracts, are being managed consistently with Department policy,
including policies pertaining to competitive gas supply markets
in Connecticut. In light of concerns raised during the
proceeding regarding open access to pipeline capacity, the
Department will closely monitor any natural gas commodity or
interstate pipeline transmission or storage transactions between
Southern and any affiliate, and will take such regulatory action
as may be required to safe guard the public interest. Tr.
9/9/99, p. 235; Tr. 9/27/99, pp. 437 and 469. Also, EEC states
that it will file any allocation modifications affecting Southern
with the Department, which the Department finds necessary and
appropriate. Tr. 9/9/99, pp. 102-105.
The Applicants indicated that NYSEG has a restructuring
agreement with the New York State Public Service Commission that
provides the framework for affiliate rules, cost allocations and
code of conduct. Tr. 9/9/99, p. 131; Late Filed Exhibit No. 8.
In addition, NYSEG's cost allocation manual specifies the
accounting methodologies necessary to produce separations, and
guard against cross-subsidies and preferences to affiliates. Tr.
9/9/99, p. 99; Late Filed Exhibit No. 6. Based on the
aforementioned, and under the condition that the Department have
sufficient access to the books and records of Energy East and its
affiliates to audit all costs and revenues ultimately allocated
to Southern, the Department finds that Energy East has a suitable
framework, as part of its operating procedures, to protect
ratepayers of its operating utilities from abusive or
inappropriate affiliate transactions.
D. Safe, Adequate and Reliable Service
The Applicants believe that the ability of Southern to
provide safe, adequate and reliable service through its plant,
equipment and manner of operation will not be adversely affected
by the Merger, but rather will be enhanced. Southern would
continue to be headquartered in Bridgeport, operated
independently, and regulated as a public service company in the
manner prescribed by Title 16 of the Conn. Gen. Stat. It would
remain subject to various federal regulations, including
regulations that (1) provide for emergency authority and
curtailment allocations under the Natural Gas Policy Act of 1978
when pipeline supplies are limited and (2) establish certain
retail policies for natural gas utilities under the Public
Utility Regulatory Policies Act of 1978. Likewise, it would
continue to be subject to state safety regulations and the
Natural Gas Pipeline Safety Act of 1968 (Act) with respect to the
construction, operation and maintenance of its mains and
services. Finally, the liquified natural gas (LNG) facility of
CNE would continue to be subject to the Act as well as other
federal regulations pertaining to safety standards concerning
such facilities. Application, p. 25.
The OCC believes that there are no compelling benefits to
ratepayers that would require the Department to approve the
Merger. This reasoning is based on the premise that CEC and
Southern, its major operating subsidiary, are both financially
healthy and able to provide safe, adequate service. OCC Brief,
p. 24.
Upon completion of the Merger, the Applicants commit to the
continuation of safe, adequate and reliable service to the public
through Southern's plant, equipment and manner of operation.
Southern's maintenance and operation of its gas distribution
system facilities would not be adversely affected. Investments
in infrastructure, however, are expected to increase especially
in those areas of Southern's franchise territory where service
has not yet been extended and where cast iron and bare steel
mains need to be replaced. Application, pp. 25 and 26. The
Applicants stated that the combined experience and resources of
CEC and Energy East will enable Southern to accelerate
investments in marketing efforts and product development.
Application, p. 31.
Such investments would produce new energy-related products
and services intended to provide integrated energy solutions for
customers. As such, according to the Applicants, there would be
growth in gas services, a major objective of the Merger, which
would enhance the overall economic development of Connecticut.
Application, p. 31. OCC asserts that the Applicants have been
unable to show that there will be any growth in the franchise to
support this Merger. OCC Brief, p. 13. While the Applicants
were unable to give specific amounts for accelerated investment,
the increased financial resources of Energy East, its experience
with NYSEG, and its commitment to boost infrastructure
improvements should result in increased infrastructure
investments in Connecticut. Application, pp. 5, 30 and 31. The
Department will monitor Southern's and Energy East's activities
in this regard.
The Department is concerned about the cost of gas, which is
a major portion of ratepayers' monthly bills. The Department
believes that in this environment of unbundling and deregulation,
the size and financial resources of Energy East could enhance
Southern's ability to procure least cost gas. This is referenced
in the June 25, 1999 Value Line report on CEC that states that "
. . . ratepayers might also get lower gas prices through Energy
East hookups to five additional pipelines." Response to
Interrogatory GA-15.
The Applicants stated that recent Southern initiatives
intended to improve customer information, service and reliability
will not be adversely affected by the Merger. Application, p. 26.
The Applicants also stated that NYSEG employs a state-of-the art
call center with staff trained in customer service techniques to
support its large system operations and thereby maintain customer
satisfaction. Application, pp. 24-25; Response to Interrogatory
CA-5. According to the Applicants, even though NYSEG has a
complex and geographically spread franchise territory, it has an
85% customer satisfaction rating and the lowest Public Service
Commission complaint rate of any utility in New York state.
Bonner PFT, pp. 4 and 6; Response to Interrogatories CA-3 and CA-
4. The Department believes NYSEG has a demonstrated record of
customer concern through the following:
a. A Service Quality Performance Mechanism (SQPM) to assess
NYSEG's customer service performance. Application, p. 24;
Response to Interrogatory CA-12.
b. Use of an Overall Customer Satisfaction Index (OCSI) derived
from customer surveys conducted by an independent consultant, to
measure and manage customer service. Response to Interrogatory
CA-12.
c. Other studies of customer satisfaction as a management tool
to improve customer service operations. Response to
Interrogatory CA-4.
d. The practice of including customer satisfaction measures
into its employee incentive programs. Response to Interrogatory
CA-16.
The Applicants believe that Southern's customers would
benefit from NYSEG's advanced call center operations and
information technology. The Applicants indicated, however, that
they have not determined which NYSEG customer service practices
Southern would use to ensure better quality service and quicker
company response. Response to OCC Interrogatory 107.
The Applicants stated that the present process by which the
Department addresses customer inquiries and disputes and apprises
Southern of these complaints will not change. Response to
Interrogatories CA-9 and CA-10. Except as required by State
statutes or regulations, Southern must notify the Department's
Consumer Assistance and Information Unit at least ten days in
advance of any changes to the Company's customer billing and
complaint procedures.
E. Management and Operations Post Merger
Energy East plans to manage Southern as an autonomous
operating company enabling local Southern management to continue
to make business decisions. Southern will continue to be
headquartered in Bridgeport and management and operations will
remain under local control. Energy East stated that it has no
intentions or time frame for changing the location of Southern's
headquarters, management, and operations. Response to
Interrogatory CA-18.
Energy East intends to leave Connecticut Energy and Southern
in control locally as autonomous operating companies, with
decisions involving management, operations, and charitable giving
made locally. Energy East ascribes to the theory that management
closest to the customer, such as Southern's, should be
responsible for business goals and decisions on issues affecting
customer service operations. Response to Interrogatories CA-18
and CA-19.
Southern expects no adverse change in management or
operations as a result of the Merger. There would be no employee
layoffs as a result of the Merger. Any employee reductions that
result from the transaction would be accomplished through
attrition wherever possible. Response to Interrogatory GA-14.
The Merger Agreement provides that Energy East would not make
involuntary employment reductions. Southern's chief executive
officer would continue in that capacity for Southern and
Connecticut Energy. In addition, Connecticut Energy's Chairman
and CEO would become an officer of Energy East with the title of
vice chairman and a member of the Energy East Board of Directors.
The existing Southern Board would continue as an Advisory Board
with remuneration for their services. Both Southern's
headquarters and Operations Center in Orange are subject to long-
term leases, which would be unaffected by the Merger. The books
and records relevant to Southern's utility operations would
remain in Connecticut. Furthermore, the Southern employees with
whom the Department interacts in response to consumer complaints,
operational issues, and regulatory matters would not change their
locations. The Department and the public would continue to have
access to Southern management after the Merger. Application, pp.
26 and 27.
In addition to the corporate headquarters of Energy East
recently having been established in Stamford, Connecticut, the
Merger Agreement stipulates that the corporate headquarters of
two of Energy East's unregulated subsidiaries, Xenergy
Enterprises, Inc., and Energy East Enterprises, Inc., would also
move to Connecticut after the Merger is completed. Application,
p. 27. Additionally, Energy East commits to a substantial
increase to a total of $500,000 annually in charitable giving in
Southern's franchise area. Application, p. 30; Rude PFT, p. 10.
Consistent with Department precedent, funding for these
charitable contributions would not come from ratepayers.
Response to Interrogatory GA-5.
F. Price
As part of its evaluation of the Merger offer from Energy
East, CEC engaged the services of Morgan Stanley to render an
opinion as to the fairness of the consideration to be received by
CEC shareholders. Application, Exhibit 2. Since the
consideration received has a direct bearing on the level of
goodwill/acquisition premium that may be reflected on the books
of Southern (see Section III. H.), the Department finds it
appropriate to review the opinion of Morgan Stanley and evaluate
the reasonableness of the consideration received. As such, the
Department has reviewed each of the valuation methodologies used
by Morgan Stanley and determines that a $42 per share price
acquisition price appears to be within a range of reasonableness.
1. Comparative Stock Price Performance
Morgan Stanley reviewed the recent stock price performance
of CEC and compared this to the small-capitalization natural gas
local distribution company index compiled by Standard & Poors.
Tr. 9/9/99, pp. 31 and 32; Late Filed Exhibit No. 2. In
addition, Morgan Stanley compared CEC's recent stock price
performance to the 30-year Treasury bond price. The following
table presents the change in stock prices for these groups, as
compared to the change in the price of CEC stock price over the
period from April 20, 1998, to April 20, 1999.
Percentage
Change
Small capitalization natural gas local distribution company
index. -9.7%
30-year Treasury bond price.................+6.4%
Connecticut Energy...................... .-9.6%
This comparison provides a perspective on the stock
performance of CEC relative to the selected indices. Tr. 9/9/99,
pp. 30-32. The Department believes this shows that CEC is
trading in a range similar to its peers. In addition, the 30-
year Treasury bond price provides a benchmark for alternative
investments. Both of these inputs are used to establish a fair
price.
2. Comparable Public Company Analysis
In its comparable public company analysis, Morgan Stanley
compared financial information of CEC with that of a group of
publicly-traded LDCs it deemed comparable with CEC (CEC
Comparable Group) in terms of scope of business and
capitalization size. Tr. 9/9/99, p. 35. This CEC Comparable
Group comprises CTG Resources, Inc., Laclede Gas Company, New
Jersey Resources Corp., NUI Corporation., Providence Energy
Corporation., South Jersey Industries, Inc., and Yankee Energy
System, Inc. After review of financial information, the
Department believes this group is comparable to CEC. Responses
to Interrogatories GA-31; OCC-2; and OCC-9; Late Filed Exhibit
No. 9. Morgan Stanley also compared financial information of EEC
with that of a group of publicly-traded utility companies (EEC
Comparable Group). This EEC Comparable Group is BEC Energy,
Consolidated Edison, Inc., DQE, Inc. and NiSource, Inc. After
review of financial information, the Department believes this
group is comparable to CEC. Responses to Interrogatories GA-31;
OCC-2; and OCC-9; Late-Filed Exhibit No. 9.
The table below presents, as of April 20, 1999, the
representative range or value for each of the ratios of price to
forecasted fiscal 1999 and forecasted fiscal 2000 earnings (based
on estimates of IBES International), price to book value as of
December 31, 1998, and the aggregate value to the last twelve
months (LTM) earnings before interests, taxes, depreciation, and
amortization (EBITDA), and the aggregate value to LTM earnings
before interest and taxes (EBIT).
Price to Price to Price to
Forecaste Forecaste 12/31/98 Aggregate Aggregate
d 1999 d 2000 Book Value Value
Earnings Earnings Value To LTM To LTM
EBITDA EBIT
Connecticut
Energy 13.2-14.3 11.8-12.3 1.5 8.2-8.6 12.0-12.6
Comparable
Companies
Energy
East 13.9-15.9 13.1-14.4 1.8-2.9 5.5-7.9 8.7-12.6
Comparable
Companies
Connecticut 14.4 14.0 1.6 8.5 12.4
Energy
Energy 15.2 13.6 1.8 7.3 10.2
East
Morgan Stanley believes that this analysis shows, " . . .
Connecticut Energy is trading at a similar price to earnings
multiple as a similar earnings over cash flow, has a similar
multiple to book value. . . ." Tr. 9/9/99, pp. 34-36. As can be
seen, the values for CEC and EEC either fall within or are better
than the comparable company ranges presented. Morgan Stanley's
analysis appears reasonable.
3. Discounted Cash Flow Analysis For Per Share Valuation
Morgan Stanley performed a DCF analysis of CEC and EEC based
on financial projections provided by the respective managements
for each company for the period 1999 through 2003. Morgan
Stanley used unlevered free cash flow of each company calculated
as net income available to common shareholders plus the aggregate
of preferred stock dividends, depreciation and amortization,
deferred taxes, and other noncash expenses and after-tax net
interest expense less the sum of capital expenditures and
investment in noncash working capital. From this, Morgan Stanley
calculated terminal values by applying a range of perpetual
growth-rate multiples to CEC's unlevered cash flow in fiscal year
2003 and by applying a range of terminal price-to-earnings
multiples to EEC's unlevered free cash flow in fiscal 2003.
Morgan Stanley then discounted the cash flow streams and terminal
values to the present using a range of discount rates
representing estimates of the weighted average cost of capital
for both CEC and EEC. Based on this analysis, Morgan Stanley
calculated per share values for CEC ranging from $31.75 to $39.50
and for EEC ranging from $24.00 to $36.00. Response to Protected
Interrogatories GA-28, GA-29, and GA-30; Protected Tr. 9/9/99,
pp. 62-67. The Department analyzed this DCF methodology and
finds it acceptable based on workpapers and testimony of the
expert witness from Morgan Stanley.
4. Analysis of Selected Precedent Transactions
In its analysis of selected precedent transactions, Morgan
Stanley used transactions it deemed comparable to the Merger.
These transactions were:
a. Eastern Enterprises' acquisition of Colonial Gas Company;
b. Eastern Enterprises' acquisition of Essex County Gas
Company; and
c. NIPSCO Industries, Inc.'s acquisition of Bay State Gas
Company.
Morgan Stanley compared financial and market statistics of
these precedent transactions to the same financial and market
statistics of the Merger. The table below shows the
representative range for each of the ratios of price to LTM
earnings, price to book value as of December 31, 1998, aggregate
value to LTM EBITDA, and aggregate value to LTM EBIT multiples.
Price to Price to Aggregate Aggregate
Forecasted LTM Value Value
LTM Book to LTM to LTM EBIT
Earnings Value EBITDA
Precedent
Transaction 18.3-23.6 2.3-2.5 9.6-11.0 13.9-16.2
s
Based on these precedent transactions Morgan Stanley calculated
per share values for CEC ranging from $35.75 to $42.75. Response
to Interrogatory GA-31. The Department finds this analysis
reasonable based on the comparability of the companies and the
like transactions.
5. Pro Forma Analysis of the Merger
Morgan Stanley reviewed the pro forma impact of the Merger
on Energy East's earnings per share for the fiscal years ended
2000 through 2003. Morgan Stanley assumed completion of the
Merger at the beginning of this period and utilized stand-alone
earnings estimates for the fiscal years ended 2000 through 2003
based on IBES International, Inc., and publicly available equity
research projections prior to the inclusion of any synergies.
Based on such analysis, assuming no synergies, the Merger would
be 4.6% to 3.9% dilutive to Energy East earnings per share in
2000 through 2003. Application, Exhibit 10, p. 38.
In addition, Morgan Stanley reviewed the pro forma impact of
the Merger on the dividends per share to be received by
Connecticut Energy shareholders for the fiscal years ended 2000
through 2003. Morgan Stanley assumed completion of the Merger at
the beginning of this period and utilized stand-alone dividend
estimates for the fiscal years ended 2000 through 2003 based on
management projections for both Connecticut Energy and Energy
East. Based on such analysis, the Merger would be 2.8% to 11.9%
accretive to the dividends per share to be received by
Connecticut Energy shareholders in 2000 through 2003. Id.
The Department reviewed this pro forma analysis using IBES
forecasts and equity research projections. Responses to
Interrogatories GA-33 and Protected GA-34; Tr. 9/9/99, pp. 40-42.
The Department finds Morgan Stanley's conclusion to be reasonable
as to the effects of the Merger on the per share earnings of
Energy East and Connecticut Energy.
G. Operation and Maintenance Expenses and Synergies
The Department explored the concept of cost savings and
revenue enhancements as potential products of the Merger. The
Applicants believe they will achieve synergies in the form of
revenue growth and cost savings, but has yet to conduct a study
that can identify them at the account level. Responses to
Interrogatories OCC-6 and OCC-22. However, the Applicants have a
general idea of the manner in which the synergies will be
produced, including expansion of Southern's customer base, and
reductions to outside services and other administrative and
general expenses. Tr. 9/9/99, pp. 196 and 197. OCC provided pre-
filed testimony from its consultant who concluded that he was
unable to identify whether there would be cost savings. Larkin
PFT, p. 3. OCC believes that since these cost savings are not
now identifiable, the Merger is not in the public interest. Id.,
p. 5. The Department believes, based on the general synergy
areas identified by the Applicants, that expense savings and
revenue enhancements should result from the Merger and is
concerned that EEC has not been able to quantify any. The
Department will monitor the Applicants' performance in this
regard.
H. Goodwill/Acquisition Premium
The Merger transaction includes goodwill of approximately
$241,015,000, which is calculated as follows:
Purchase Price $435,688,000
Transaction Costs (to EEC for CEC) 4,500,000
Difference between Pension and
other Postretirement benefit (7,016,000)
obligation and the Fair value of
the respective plan assets
Deferred taxes on pension and 2,456,000
other post-Retirement benefit
obligation difference
Common Stock Equity (194,613,000)
Goodwill 241,015,000
Response to Interrogatory GA-26.
Once the transaction is consumated, Energy East believes
that under generally accepted accounting principles (GAAP) CEC's
books and records should reflect the actual purchase cost of its
net assets for business combinations accounted for as a purchase,
which includes the excess of the purchased cost over fair value
of the net assets, which is defined as goodwill. Southern
believes it should reflect on its books the assignment of its
portion of the total goodwill recorded by Connecticut Energy.
Energy East plans to have an independent consultant conduct a
fair market value assessment to determine the appropriate
allocation of the goodwill among CEC subsidiaries. Its
methodology for this allocation will be for CEC to record the
allocation of the excess of the valuation of each subsidiary over
its recorded investment in the respective subsidiaries. The
study must be concluded at or near the date of the closing of the
transaction for the assessment to be considered accurate. Thus,
the exact dollar amount of the goodwill CEC believes is allocable
to Southern would not be determined until that time. Response to
Interrogatory GA-19 Supplemental. SCG believes that the goodwill
allocated to SCG should be recorded in Account 114 of the
Uniform Systems of Accounts (USA) based on the representation of
its independent accountants that the recording of the allocated
goodwill on SCG's books and records is in accordance with GAAP.
Id.
SCG is not requesting that the amortization expense related
to goodwill/acquisition premium be included in operating expenses
for the purpose of determining the rates charged to customers,
and the Applicants further stated that there will be no impact on
rates as the result of the Merger. Response to GA-25. The
Department accepts SCG's intention that goodwill related expense
or investment will not be used for the purpose of determining the
rates charged to ratepayers.
Under the Applicants' proposed RPA, which will be considered
in Docket No. 99-04-18, the Applicants intend that the amount of
the amortization and the remaining unamortized balance of
goodwill be considered when determining whether SCG actual
earnings are subject to the proposed earnings sharing mechanism.
Id.
With regard to the inclusion of goodwill expense and
investment for the purpose of determining what, if any, earnings
are shared in the future, the Department will make no decision at
this time. Department will consider the issue of how goodwill
expense and investment should impact future earnings sharing in
the rate proceeding, recognizing that the Department has
generally treated intangibles, such as goodwill, recoverable
under general cost of service principles only to the extent the
intangibles arise from legitimate costs of doing business or are
required to bring about customer benefit, and then, only to the
amount of the legitimate costs or quantified level of customer
benefit. See Decision dated May 17, 1995 in Docket No. 93-12-24,
DPUC Review of Basic Cable Rates and Equipment Charges of Tele-
Media Company of Western Connecticut.2
In summary, this Decision does not obligate ratepayers to
fund any portion of acquisition costs and does not allow any
portion of amortization of the acquisition premium to be
considered in the setting of rates.
I. Transaction Costs
Estimated total transaction costs incurred by CEC for the
Merger are as follows:
Legal, solicitation and misc. $ 775,000
Restricted Stock Plan Vesting 2,054,340
Investment banker fees 3,740,000
Proxy printing and mailing 332,000
Total $6,901,330
Response to Interrogatory OCC-16.
The investment banker fees are based on the fee schedule
incorporated in the Morgan Stanley contract with CEC. Restricted
Stock Plan Vesting reflects the estimated value of outstanding
CEC restricted stock awards that vest on a change in control.
All other costs are estimates based on information available at
the time the proxy was filed with the SEC. Merger proxy, p. 77,
Note 8. CEC will not seek recovery of any of these costs from
SCG ratepayers. Response to Interrogatory OCC-7. The Department
concurs with this treatment of the transaction costs. The
Department notes that EEC's $4.5 million transaction costs are
incorporated into the calculation of the goodwill/acquisition
premium as described above in Section IV, H. Given Department
concurrence with CEC's position that the CEC transaction costs
should not be recovered from ratepayers, the Department will
thoroughly review the acquisition premium and goodwill issues in
Southern's next rate case and will exclude all CEC transaction
costs from the goodwill calculation, if any has been included.
J. Competitive Market Issues
John W. Wilson, an economist and a witness for OCC regarding
the effects of the Merger on competition, asserts this Merger
will reduce competition in the state. Wilson PFT, pp. 4-7. Dr.
Wilson based this on the Herfindahl-Hirschman Index (HHI), 3
which is the method used by the U.S. Justice Department and
Federal Trade Commission for determining market concentration
that results from a merger. By defining the relevant product
market as natural gas utility distribution service and the
relevant geographic area as the State of Connecticut, Dr. Wilson
calculates a post-merger HHI increase of approximately 2,000
points and a post-merger HHI of more than 5,000. Wilson PFT, pp.
6-7. Dr. Wilson's pre-merger market is comprised of Southern,
The Connecticut Natural Gas Company (CNG), Yankee Gas Services
(Yankee) and the City of Norwich (Norwich) while his post-merger
market assumes the acquisition of both Southern and CNG by Energy
East and is comprised of Energy East, Yankee and Norwich. Dr.
Wilson's results show levels that are well outside the guidelines
for mergers established by the Department of Justice and the
Federal Trade Commission. Wilson PFT, pp. 15-17. OCC concludes
that this reveals an unacceptable level of gas market
concentration by EEC as the parent. OCC Brief, p. 6. OCC
believes that the Department should reject the Merger unless both
Southern and Connecticut Natural Gas Corporation are ordered to
exit the gas merchant business in Connecticut. Wilson PFT, p.
22.
The Applicants believe that Dr. Wilson's testimony is not
relevant to this proceeding, ignores the fact that the Merger's
effects on competition will be examined in other forums by
federal agencies specifically charged with the enforcement of
antitrust laws, reaches improper conclusions because his choice
of relevant markets is too narrow and offers an illogical remedy
to counter the alleged effects of the merger. Joint Brief of
Applicants, pp. 25-29.
The Department notes that, relative to transportation
services, Southern, as well as CNG and Yankee, each has a legal
monopoly in its franchise area. Each will maintain its exclusive
franchise area, and transportation tariffs will continue to
require Department approval.
With respect to the gas commodity, there is currently
competition in the commercial and industrial markets pursuant to
Docket No. 97-07-11, DPUC Investigation into Issues Associated
with the Unbundling of Natural Gas Services by Connecticut Local
Distribution Companies, dated July 23, 1998; and Docket No. 93-03-
09, Application of The Southern Connecticut Gas Company for a
Rate Increase Reopening RE: Unbundling dated March 17, 1999.
There are currently 62 natural gas sellers (Marketers) registered
with the Department to do business in the state. Regarding
residential gas service, there is currently no unbundled service
available. As such, residential service remains a legal monopoly
subject to the Department's approval of all tariffs.
Notwithstanding the foregoing, the Department is cognizant
of the potential for market power concentration issues that could
occur when two or more dominant firms within a market combine, as
the OCC suggests with regards to the proposed transactions
between EEC and SCG and between EEC and CNG. There are various
methods of determining anticompetitive market power, the quality
of which depends, inter alia, on appropriately defining the
product and its geographic market. The record in this case does
not clearly establish that the burden of defining the appropriate
market or product has been met, particularly as it would pertain
to an anticompetitive impact in Connecticut. To the extent that
such issues pertain to a larger market area that may include some
or all New England States, the current proposal and related
proposed transactions by EEC are subject to examination on
antitrust grounds by federal agencies charged with such review.
Accordingly, an in-depth analysis of the competitive impact of
the proposed transactions will be performed by the federal
regulatory agencies charged specifically with such review. The
Department will condition its approval of the proposed Merger on
receipt of the required federal regulatory approvals of the
Securities and Exchange Commission, the Department of Justice
(DOJ) and the Federal Trade Commission.
K. Rate Plan Alternative
The RPA was requested in the instant proceeding as well as
in Docket No. 99-04-18, Southern's rate case. On the first
hearing day in the instant proceeding, the presiding commissioner
ruled that the RPA was more appropriate for consideration in and
would be taken up during the rate case proceeding. Tr. 9/9/99,
pp. 207-208. As such, the Department defers its ruling on this
issue to the Decision in Docket No. 99-04-18.
V. FINDINGS OF FACT
1. Energy East is a corporation created and existing under the
laws of the state of New York and has its principal office in
Stamford, Connecticut.
2. Energy East was formed in 1997 and became the parent of New
York State Electric and Gas (NYSEG) on May 1, 1998.
3. Energy East is an exempt public utility holding company
under the PUHCA.
4. Energy East is an energy delivery, products and services
holding company with subsidiary operations in New York,
Massachusetts, Maine, New Hampshire, Vermont and New Jersey.
5. CEC is a corporation created and existing under the laws of
the State of Connecticut and has its corporate headquarters in
Bridgeport, Connecticut.
6. CEC is an exempt public utility holding company from the
registration requirement of PUHCA.
7. CEC is a gas delivery, energy products and services holding
company with subsidiary operations principally in Connecticut and
with retail marketing of natural gas in Massachusetts, New
Hampshire, Rhode Island, Connecticut and New York.
8. Pursuant to the terms of the Merger Agreement, CEC will
become a wholly-owned, first-tier subsidiary of EEC, with SCG,
CNE Energy Services Group, Inc., CNE Development Group and CNE
Venture-Tech Inc. remaining first-tier subsidiaries of CEC.
9. Merger Sub, a newly-formed Connecticut subsidiary of EEC
created specifically for the purpose of consummating the
transaction, will merge with CEC, with Merger Sub being the
surviving entity.
10. After the transaction, Merger Sub will be renamed
Connecticut Energy Corporation.
11. The Merger will be consumated in accordance with all
applicable federal and state laws and regulations, including, but
not limited to, the Securities Act of 1933, the Securities
Exchange Act of 1934, the Hart-Scott-Rodino Antitrust Improvement
Act of 1976, and rules promulgated thereunder, the Natural Gas
Act, the Communications Act of 1934, the Public Utility Holding
Company Act of 1935 and the Connecticut Business Corporation Act.
12. Energy East's nonutility subsidiaries include Xenergy
Enterprises, Inc. and Energy East Enterprises, Inc., which invest
in energy ventures and providers of energy and telecommunications
services.
13. NYSEG, Energy East's principal subsidiary, is a public
utility company engaged primarily in purchasing, transmitting and
distributing electricity and natural gas.
14. NYSEG's service territory, 99% of which is located outside
the corporate limits of cities, is in the central, eastern and
western parts of the state of New York and has an area of
approximately 19,900 square miles and a population of 2,400,000.
15. NYSEG serves approximately 817,000 electric customers and
243,000 natural gas customers.
16. NYSEG uses charts and other studies of customer satisfaction
as a management tool to improve customer service operations and
has built customer satisfaction measures into its employee
incentive programs.
17. NYSEG developed a Service Quality Performance Mechanism to
assess customer service performance and uses an Overall Customer
Satisfaction Index, derived from customer surveys conducted by an
independent consultant, to measure and manage customer service.
18. EEC's consolidated 1998 adjusted revenues were
$2,499,418,000, with a net income of $194,205,000.
19. NYSEG recently completed a divestiture of all of its coal-
fired electric generation facilities.
20. NYSEG recently agreed to sell its 18% nonoperating interest
in the Nine Mile Point 2 nuclear plant located in Oswego, New
York, which transaction is expected to close early next year.
21. Southern, a Connecticut public service company wholly-owned
by Connecticut Energy, is primarily engaged in the retail
distribution of natural gas for residential, commercial, and
industrial uses and the transportation of natural gas for
commercial and industrial uses.
22. Southern's service territory encompasses 32 municipalities.
23. Southern serves approximately 158,000 customers of
approximately 416,000 potential customers in 22 Connecticut
communities.
24. On behalf of CEC, Morgan Stanley conducted a valuation
analysis that encompassed standard valuation methodology using
comparative stock price performance, comparable public company
analysis, discounted cash flow analysis, analysis of selected
precedent transactions, and pro forma analysis of the Merger.
25. The total value of consideration to be received by
Connecticut Energy shareholders in the Merger, based on the
number of Connecticut Energy shares outstanding on July 12, 1999
and assuming that the Average Market Price of Energy East is
between $23.10 per share and $29.40 per share, is approximately
$436.5 million.
26. Each eligible Connecticut Energy shareholder can elect the
form of consideration he or she would like to receive, but this
election is subject to proration and an adjustment driven by tax
considerations.
27. NYSEG, the principal subsidiary of Energy East, recently
received a credit rating upgrade by Moody's from Baa1 to A3 and
an upgrade of senior secured debt by Standard & Poor's from BBB+
to A.
28. The Department and the public will continue to have local
access to Southern management after the Merger.
29. There will be an increase in charitable giving in Southern's
franchise area to $500,000 annually, which ratepayers will not
fund.
30. There will be no employee layoffs as a result of the Merger.
31. Total estimated transaction costs for CEC are $6,901,330.
32. CEC will not seek recovery of any transaction costs from SCG
ratepayers.
33. The Applicants will not seek to recover the acquisition
premium through rates charged to SCG ratepayers.
34. Through a vote on September 24, 1999, CEC shareholders have
approved the Merger with Energy East.
35. There are currently 62 natural gas sellers (Marketers)
registered with the Department to do business in Connecticut.
36. The Applicants proposed no changes to Southern's customer
service rules and regulations, policies, and practices.
VI. CONCLUSION AND ORDERS
A. Conclusion
Based on the record in this proceeding, the Department
hereby approves the acquisition of control of Connecticut Energy
Corporation by Energy East Corporation subject to the orders
below. The Department also concludes that the merged entity: 1)
will have the financial, technological, and managerial
suitability and responsibility to provide service; 2) will
possess the ability to provide safe, adequate and reliable
service to the public through the public service company's plant,
equipment and manner of operations; 3) will maintain the adequate
and local accessibility to management and operations; 4) will
undertake improvements to the existing infrastructure, including
an accelerated program of cast iron and bare steel main
replacement; 5) will increase the level of community investment
through increased charitable contributions, and 6) will provide
open, nondiscriminatory access to qualified gas suppliers. This
approval is granted subject to the Applicants receipt of all
required approvals from federal regulatory agencies.
B. Orders
For the following Orders, please submit an original and 12
copies of the requested material identified by Docket number,
Title, and Order Number to the Executive Secretary.
1. The terms and conditions under which this Department
approved the Merger Agreement shall be substantially as specified
by the Applicants and no further written material or oral
supplements to or material modifications of those terms and
conditions shall be executed without prior approval of this
Department. The Applicants shall notify the Department by March
31, 2000, that no material modifications were made to the terms
and conditions of the Agreement and whether the Merger has or has
not taken place.
2. The Applicants shall provide the Department with a copy of
the Certificate of Merger filed with the Secretary of the State
no later than March 31, 2000.
3. The Applicants shall file with the Department, when
available, all regulatory decisions regarding the Merger,
including those from the Department of Justice, the Securities
and Exchange Commission and the Federal Trade Commission.
4. No later than March 31, 2000, the Applicants shall provide
copies of all journal entries to the Department showing the
change of control.
5. No later than March 31, 2000, the Applicants shall provide
the Department with an exhibit showing the actual expenses,
broken down by type, incurred by all parties for this Merger
together with journal entries.
6. No later than March 31, 2000, the Applicants shall provide
the Department with current and ongoing authorization to access,
as the Department deems necessary, any and all books of Energy
East and its affiliates sufficient to: (i) verify all costs that
are ultimately allocated to Southern for recovery from ratepayers
and/or for determination of Southern's regulated earnings, and
(ii) verify that Southern assets, including its gas pipeline
contracts, are being managed consistently with Department policy,
including policies pertaining to competitive gas supply markets
in Connecticut.
7. On a going forward basis, from the date of this Decision,
the Parent, Energy East Corporation shall file with the
Department, when available, SEC Forms 10Q, 10K, 8K, quarterly
stockholders report, annual stockholders report.
8. The Applicants shall file with the Department for its
approval any modifications to current cost allocation policies
resulting from this Merger that affect CEC or Southern.
9. Except as required by State statutes or regulations,
Southern shall submit to the Department any changes to the
Company's customer billing and complaint procedures at least 10
business days prior to implementation.
10. Commencing January 31, 2000, and quarterly thereafter until
February 1, 2003, Southern shall submit quarterly reports to the
Department regarding the total number of complaints, broken down
by complaint type, reported to Southern by its customers.
11. No later than October 1, 2000, Southern shall submit a
report and/or plan on customer benefits achieved or expected to
be achieved by the Merger that includes expense savings and
infrastructure investments.
12. No later than July 1, 2000, Southern shall submit a
comprehensive cost allocation manual that compiles the cost
allocation procedures that are currently required and in place
for the Company.
_______________________________
1 Other than those that are held by Connecticut Energy
shareholders who have not voted in favor of the Merger and have
properly demanded dissenters' rights.
2 The Department notes that in the Decision just referenced, the
request under review was for inclusion of goodwill in rates and
ratebase for which the criteria stated above is a much greater
hurdle than it is relative to SCG's intention regarding
goodwill from its proposed Merger with Energy East..
3 The HHI is computed by summing the squares of percentage market
share of each firm in the market.
DOCKET NO. 99-07-20 JOINT APPLICATION OF ENERGY EAST
CORPORATION AND CONNECTICUT ENERGY CORPORATION
FOR APPROVAL OF A CHANGE OF CONTROL
This Decision is adopted by the following Commissioners:
Linda Kelly Arnold
Jack R. Goldberg
Glenn Arthur
CERTIFICATE OF SERVICE
The foregoing is a true and correct copy of the Decision issued by
the Department of Public Utility Control, State of Connecticut,
and was fowarded by Certified Mail to all parties of record in this
proceeding on the date indicated.
December
17, 1999
Louise E. Rickard Date
Acting Executive Secretary
Department of Public Utility Control
