FILE NO. 70-9535
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
AMENDMENT NO. 4
TO
FORM U-1
APPLICATION/DECLARATION UNDER THE PUBLIC
UTILITY HOLDING COMPANY ACT OF 1935
NORTHEAST UTILITIES
174 Brush Hill Avenue
West Springfield, MA 01090-0010
(Names of companies filing this statement and addresses of principal
executive offices.)
NORTHEAST UTILITIES
(Name of top registered holding company)
Cheryl W. Grise
Senior Vice President, Secretary and General Counsel
Northeast Utilities Service Company
107 Selden Street
Berlin, CT 06037
(Name and address of agent for service)
The Commission is requested to mail signed copies of all orders, notices and
communications to:
Jeffrey C. Miller, Esq. David R. McHale Joanne Rutkowski, Esq.
Assistant General Vice President LeBoeuf, Lamb, Greene &
Counsel and Treasurer MacRae, L.L.P.
Northeast Utilities Northeast Utilities 1875 Connecticut Ave., N.W
Service Company Service Company Washington, D.C. 20009
107 Selden Street 107 Selden Street
Berlin, CT 06037 Berlin, CT 06037
The Application/Declaration in this File, as heretofore amended, is amended
and restated to read as follows:
Table of Contents
Item 1. Description of the Proposed Transaction
A. Introduction
1. General Request
2. Overview of Transaction
B. Description of the Parties
1. Northeast Utilities and its Subsidiaries
2. Yankee Energy System, Inc. and its Subsidiaries
C. Description of the Merger
D. YES Reasons for the Merger
E. NU Reasons for the Merger
F. Analysis of Certain Economic Impacts
Item 2. Fees, Commissions and Expenses
Item 3. Applicable Statutory Provisions
A. Section 10(b)
1. Section 10(b)(1)
2. Section 10(b)(2)
3. Section 10(b)(3)
B. Section 10(c)
1. Section 10(c)(1)
i. Retention of Gas Properties
ii. Retention of Other Businesses
2. Section 10(c)(2)
i. Efficiencies and Economies
ii. Integrated Public Utility System
I. Electric System
II. Gas System
C. Section 10(f)
D. Other Statutory Provisions - Section 6(a) and 7
Item 4. Regulatory Approvals
A. Antitrust (FTC and DOJ)
B. Connecticut Department of Public Utility Control
C. Other Regulatory Matters
Item 5. Procedures
Item 6 Exhibits and Financial Statements
a. Exhibits
b. Financial Statements
Item 7. Information as to Environmental Effect
Item 1. Description of Proposed Transaction
A. Introduction
This Application/Declaration seeks approvals relating to the proposed
combination of Northeast Utilities ("NU" or the "Applicant"), a registered
holding company under the Public Utility Holding Company Act of 1935 (the
"Act") and Yankee Energy System, Inc. ("YES"), currently an exempt holding
company under the Act, pursuant to which YES will merge with and into a to-
be-formed wholly-owned subsidiary of NU ("Merger Sub"). The merger is
referred to herein as the "Transaction" or the "Merger." Merger Sub will be
renamed Yankee Energy System, Inc. upon the effectiveness of the Merger, will
continue as an exempt holding company under Section 3(a)(1) of the Act and
will continue to file under the Commission's Rule 2 under the Act.
NU and YES believe that their combination provides a unique opportunity
for NU, YES and their respective shareholders, customers and employees to
participate in the formation of a competitive energy services provider in the
rapidly evolving energy services business and to share in the benefits of
industry restructuring which is already occurring in Connecticut and other
states. The energy industry, including both the gas and electricity segments
of the business, is evolving from an industry characterized by the presence
of regulated natural monopolies confined in their operations to prescribed
geographical service territories into a competitive industry in which
national and regional participants compete for the right to provide energy
services to retail customers who increasingly have a choice in their energy
supply needs. The result of these changes is the transformation of the U.S.
energy industry in which energy production, transportation/transmission and
distribution are reorganizing along national and regional functional lines.
NU and YES believe that, in the restructured and competitive energy
industry, the post-merger NU system will be well-positioned to compete with
other national and regional industry participants, a competitive position
that neither NU nor YES, acting alone, would be able to achieve. The Merger
will provide NU and YES with the ability to integrate their complementary
lines of business: retail and wholesale natural gas and electricity sales and
new merchant electric generation. A more complete description of the Merger
and its anticipated benefits is contained in the Joint Proxy and Registration
Statement on Form S-4 of NU and YES which is annexed as Exhibit c.1 hereto.
On October 13, 1999, NU and Consolidated Edison, Inc. ("Con Ed")
announced that they had agreed to a merger to combine the two companies. The
terms of their agreement are described in NU's Current Report on Form 8-K
dated October 13, 1999 and the Exhibits thereto. NU expects the Con Ed
merger to take 12 to 18 months to consummate, and presently intends to follow
its announced schedule to consummate the YES merger in the first quarter of
2000, assuming all approvals are obtained. The NU/Con Ed merger will be the
subject of a separate application to the Commission.
NU and YES believe that their combination offers significant strategic
and financial benefits to each company and to their respective shareholders ,
as well as to their employees and customers. These benefits include, among
others: (i) maintenance of competitive rates that will improve the combined
entity's ability to meet the challenges of the increasingly competitive
environment in both the electric and gas utility industry, (ii) over time a
reduction in operating costs and expenditures resulting from integration of
corporate and administrative functions, including the elimination of
duplicative positions, limiting duplicative capital expenditures for
administrative and customer service programs and information systems, and
savings in areas such as legal, audit and consulting fees, (iii) greater
purchasing power for items such as fuel and transportation services, general
and operational goods and services, (iv) more controlled expansion into non-
core utility businesses, (v) expanded management resources and ability to
select leadership from a larger and more diverse management pool, and (vi) a
financially stronger company that, through the use of the combined capital,
management, human resources and technical expertise of each company, will be
able to achieve greater financial stability and strength and greater
opportunities for earnings and dividend growth. NU and Yankee believe that
over time synergies created by the Transaction will generate cost savings to
the surviving company which would not be available to the separate companies
absent the Transaction.
The Transaction was approved by the Board of Directors of YES on June
14, 1999 and by the Board of Trustees of NU on June 8, 1999. NU and YES
submitted a joint application requesting approval of the Transaction to the
Connecticut Department of Public Utility Control (the "DPUC"), and on
December 29, 1999, the DPUC approved the transaction. NU and YES submitted a
combined proxy and registration statement on Form S-4 to the Securities and
Exchange Commission (the "Commission") under the Securities Act of 1933 and
the Securities Exchange Act of 1934 (the "Exchange Act") during the first
week of August, 1999, and the Transaction was approved by the Shareholders of
YES on October 12, 1999. NU and YES made the required filings with the
Antitrust Division of the U.S. Department of Justice and the Federal Trade
Commission under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as
amended on October 29, 1999 and requested acceleration of the waiting period.
The waiting period expired without comment. YES is also seeking the approval
of the Federal Communications Commission to transfer certain
telecommunications licenses necessary for the operation of YES' gas business.
See Item 4 below for additional detail regarding these regulatory approvals.
Apart from the approval of the Commission under the Act, the foregoing
approvals are the only regulatory approvals presently expected to be required
for the Transaction. In order to permit timely consummation of the
Transaction and the realization of the benefits it is expected to produce,
the Applicant requests that the Commission's review of this
Application/Declaration proceed as expeditiously as practicable.
1. General Request
Pursuant to Sections 9(a)(1) and 10 of the Act, the Applicant hereby
requests authorization and approval of the Commission for NU to acquire, by
means of the direct merger described below, all of the issued and outstanding
common stock of YES, a Connecticut corporation and an exempt holding company
with one subsidiary that is a gas utility company as defined in Section
2(a)(4) of the Act, all pursuant to an Agreement and Plan of Merger dated as
of June 14, 1999 by and between NU and YES (the "Merger Agreement"), a copy
of which is attached hereto as Exhibit b.1. The Merger Agreement provides
for the merger of YES with and into Merger Sub with Merger Sub to be the
surviving corporation. Upon completion of the Merger, Merger Sub will have
changed its name to Yankee Energy System, Inc. and will continue as an exempt
company under Section 3(a)(1) of the Act and will continue to file under the
Commission's Rule 2 under the Act. The Applicant also hereby requests that
the Commission approve (i) the formation of Merger Sub, (ii) the issuance of
a sufficient number of shares of NU Common Shares, $5.00 par value per share,
(the "NU Common Shares") to satisfy the stock portion of the consideration
payable (approximately $215 million) in connection with the Transaction,
(iii) the issuance of short- or long- term debt by NU in an aggregate amount
not exceeding $275 million to satisfy the cash portion of the consideration
payable in connection with the Transaction and to refund and replace debt
initially issued and (iv) the retention of certain utility and nonutility
subsidiaries.
2. Overview of the Transaction
NU proposes to cause (i) the organization of Merger Sub under the laws
of the State of Connecticut as a new wholly-owned first tier subsidiary of NU
and (ii) the issuance by Merger Sub and acquisition by NU of one hundred
shares of the common stock, par value $10 per share of Merger Sub for $1,000.
Pursuant to the Merger Agreement, YES will merge with and into Merger Sub.
Holders of the common stock of YES will receive consideration in cash and NU
Common Shares valued at $45.00 per YES share contributed to Merger Sub by NU.
Each YES shareholder can elect the form of consideration he or she would like
to receive, but this election is subject to proration and adjustment. Under
the Merger Agreement, 55% of all issued and outstanding YES shares will be
exchanged for cash, and 45% will be exchanged for NU Common Shares. If YES
shareholders owning more than 55% of YES shares elect to receive cash, the
number of YES shares converted into cash will be less than the number
elected. Similarly, if YES shareholders owning more than 45% of YES shares
elect to receive NU Common Shares, the number of YES shares converted into
stock will be less than the number elected.
Merger Sub, as a wholly-owned subsidiary of NU and as successor to YES,
will act as the holding company for NU's post-merger operating gas utility
subsidiary and related companies. NU's existing operating electric utility
subsidiaries, will remain direct operating subsidiaries of NU. Accordingly,
upon consummation of the Transaction, NU will be a registered holding company
owning an integrated electric utility system consisting of four electric
public utility companies and an integrated gas utility system consisting of
an exempt gas utility holding company owning one gas public utility company
and other nonutility subsidiaries. From time to time as necessary, NU will
file one or more additional applications-declarations under the Act with the
Commission with respect to future financing arrangements of the companies,
ongoing activities, and other investments of, and other matters pertaining
to, the combined company after giving effect to the Merger.
NU currently anticipates that the full amount necessary to fund the cash
consideration to be paid to YES shareholders will be financed through debt
issued by NU. NU requests Commission authorization to issue from time to
time through June 30, 2002, short or long-term debt securities in an amount
sufficient to satisfy the cash portion of the consideration in connection
with the Transaction, estimated not to exceed $275 million and to refund and
replace any and all debt securities initially issued. Such debt securities
may include notes, debentures and medium-term notes and/or borrowings from
banks and other financial institutions. Any long-term debt security would
have such designation, aggregate principal amount, maturity, interest rate(s)
or methods of determining the same, terms of payment of interest, redemption
provisions, non-refunding provisions, sinking fund terms and other terms and
conditions as NU may determine at the time of issuance. NU's consolidated
common equity ratio will remain above 30% after the initial issuance of debt
to finance the merger. However, under certain circumstances set forth in
File No. 70-9541 related to restructuring of the electric industry in New
England, NU's consolidated common equity ratio may, as allowed by Commission
order therein, decline below 30% for a short period of time. See, also, the
discussion in Item 3, subsection C.
The effective cost of money on short-term debt borrowings occurring
pursuant to the authorizations granted under the Application will not exceed
at issuance 400 basis points over the comparable term London Interbank
Offered Rate ("LIBOR") and the effective cost of money on long-term
borrowings pursuant to authorizations granted under the Application will not
exceed at issuance 400 basis over comparable term U.S. Treasury securities.
The maturity of indebtedness will not exceed 10 years from the date of
issuance and the underwriting fees, commissions, or other similar
remuneration paid in connection with the non-competitive issue, sale or
distribution of a security pursuant to the Application will not exceed 2.5%
of the principal or total amount of the financing.
B. Description of the Parties
1. Northeast Utilities and its subsidiaries
Northeast Utilities is the parent of a number of companies comprising
the Northeast Utilities system (the "System") and is not itself an operating
company. The System has traditionally furnished franchised retail electric
service in Connecticut, New Hampshire and western Massachusetts through three
of NU's wholly owned subsidiaries, The Connecticut Light and Power Company
("CL&P"), Public Service Company of New Hampshire ("PSNH") and Western
Massachusetts Electric Company ("WMECO"), and has additionally furnished
retail electric service to a limited number of customers through another
wholly owned subsidiary, Holyoke Water Power Company ("HWP"), doing business
in and around Holyoke, Massachusetts. In addition to their retail electric
service business, CL&P, PSNH, WMECO and HWP (including its wholly owned
subsidiary, Holyoke Power and Electric Company) (collectively, the "NU
Operating Companies") together furnish wholesale electric service to various
municipalities and other utilities throughout the Northeast. The System
serves approximately 30 percent of New England's electric needs and is one of
the 24 largest electric utility systems in the country as measured by
revenues.
North Atlantic Energy Corporation is a special-purpose operating
subsidiary of NU that owns a 35.98 percent interest in the Seabrook nuclear
generating facility ("Seabrook") in Seabrook, New Hampshire, and sells its
share of the capacity and output from Seabrook to PSNH under two life-of-
unit, full-cost recovery contracts.
Several wholly owned subsidiaries of NU provide support services for the
System companies and, in some cases, for other New England utilities.
Northeast Utilities Service Company ("NUSCO") provides centralized
accounting, administrative, information resources, engineering, financial,
legal, operational, planning, purchasing and other services to the System
companies. North Atlantic Energy Service Corporation has operational
responsibility for Seabrook. Northeast Nuclear Energy Company acts as agent
for the System companies and other New England utilities in operating the
Millstone nuclear generating facilities in Waterford, Connecticut. Three
other subsidiaries (Rocky River Realty Company, The Quinnehtuk Company, and
Properties, Inc.) construct, acquire or lease some of the property and
facilities used by the System companies.
In January 1999, NU added three new corporations to the System: NU
Enterprises, Inc. ("NUEI"), Northeast Generation Company ("NGC") and
Northeast Generation Services Company ("NGS"). NUEI, a direct subsidiary of
NU, will act as a holding company for the System's unregulated businesses.
NGC, a subsidiary of NUEI, will acquire and manage generating facilities.
NGS, another subsidiary of NUEI, will provide services to the electric
generation market as well as to large commercial and industrial customers in
the Northeast. Also in January 1999, NU transferred to NUEI the stock of
three other of its subsidiaries, making them wholly owned subsidiaries of
NUEI: Select Energy, Inc. ("Select Energy"), HEC Inc. ("HEC") and Mode 1
Communications, Inc. ("Mode 1")(1). These companies engage, either directly or
indirectly through subsidiaries, in a variety of energy-related and
telecommunications activities, as applicable, primarily in the unregulated
energy retail and wholesale commodity, marketing and services fields. In
addition, Select Energy Portland Pipeline, Inc., a subsidiary of NUEI was
formed as a single purpose Rule 58 subsidiary to hold a 5% partnership
interest in the Portland Natural Gas Transmission System Partnership, the
partnership that owns and operates the Portland Natural Gas Transmission
Pipeline. Lastly, Merger Sub, a to-be-formed wholly-owned direct subsidiary
of NU, will be created, upon approval by the Commission, in accordance with
section 2 above, to carry out the Merger and become a registered holding
company for the NU system gas operations.
__________________________________
(1) See, generally, Commission Orders dated November 12, 1998 (HCAR No. 26939)
and May 19, 1999 (HCAR No. 27029).
The System companies traditionally have owned and operated a fully
integrated electric utility business. Restructuring legislation in New
Hampshire, Massachusetts and Connecticut, however, will now require PSNH,
WMECO and CL&P, respectively, to separate the distribution and transmission
functions of their business from the generation function by mandating the
sale of fossil fuel and hydroelectric generation. In July 1999, WMECO closed
on the sale of its fossil generating plants. On July 6, 1999, CL&P and WMECO
announced the results of their auction of CL&P's non-nuclear generating
assets and WMECO's remaining non-nuclear generating assets. Approximately
2,235 megawatts of fossil-fueled generating assets will be sold to a third
party and 1,329 megawatts of hydro-powered generating assets will be sold to
NGC.
CL&P, PSNH and WMECO furnish retail delivery franchise service in 149,
198 and 59 cities and towns in Connecticut, New Hampshire and Massachusetts,
respectively. In 1998, CL&P furnished retail franchise service to
approximately 1.11 million customers in Connecticut, PSNH provided retail
service to approximately 422,000 customers in New Hampshire and WMECO served
approximately 196,000 retail franchise customers in Massachusetts. HWP
serves 32 retail customers in Holyoke, Massachusetts.
The following table shows the sources of 1998 electric revenues based on
categories of customers:
CL&P PSNH WMECO Total System
Residential 41% 32% 39% 41%
Commercial 37 27 35 34
Industrial 13 17 20 15
Wholesale* 7 23 5 9
Other 2 1 1 1
Total 100% 100% 100% 100%
* Includes capacity sales and sales from PSNH to CL&P and WMECO.
Competition in the energy industry continues to grow as a result of
legislative and regulatory action, technological advances, relatively high
electric rates in certain regions of the country, including New England, and
the increased availability of natural gas. These competitive pressures are
particularly strong in New England, where legislatures and regulatory
agencies in these states have been at the forefront of restructuring of the
electric industry. Changes in this industry are expected to place downward
pressure on prices and to increase customer choice through competition.
In April 1996, FERC issued its final open access rule (Order 888) to
promote competition in the electric industry. Order 888 requires, among
other things, all public utilities that own, control or operate facilities
used for transmitting electric energy in interstate commerce to file an open-
access, nondiscriminatory transmission tariff and to take transmission
service for their own new wholesale sales and purchases under the open access
tariffs. NU System Companies have one in place and take service under that
tariff. Order 888 also supports full recovery of legitimate, prudent and
verifiable wholesale stranded costs, but indicates that FERC will not
interfere with state determinations of retail stranded costs.
In a companion order to Order 888 (Order 889), FERC also required
electric utilities to develop and maintain a same-time information system
that will give existing and potential transmission users the same access to
transmission information that the electric utility enjoys, and required
electric utilities to separate transmission from generation marketing
functions pursuant to standards of conduct. The System companies are
complying with the requirements of Order 889. In 1998, the System companies
collected approximately $34 million in incremental transmission revenues from
other electric utility generators.
In April 1998, Connecticut enacted comprehensive electric utility
restructuring legislation. The legislation provides a clear path to
competition in the state, while permitting, subject to mitigation
requirements, utilities to recover their stranded costs. CL&P is subject to
this legislation.
Similar restructuring laws are planned or in place in both Massachusetts
and New Hampshire.
2. Yankee Energy System, Inc. and its Subsidiaries
Yankee Energy System, Inc. ("YES"), is a public utility holding company
incorporated in Connecticut in 1988. The Company is primarily engaged in the
retail distribution of natural gas through its wholly-owned subsidiary,
Yankee Gas Services Company ("Yankee Gas"), a Connecticut public utility
service company. Yankee Gas serves approximately 185,000 residential,
commercial and industrial customers in 69 cities and towns in Connecticut.
The Company is exempt from registration under the Act under Section 3(a)(2)
of the Act. YES is the holding company for Yankee Gas and four active non-
utility subsidiaries, NorConn Properties, Inc. ("NorConn"), Yankee Energy
Financial Services Company ("Yankee Financial"), Yankee Energy Services
Company ("YESCo") and R.M. Services, Inc. ("RMS"). These companies are
referred to collectively herein as "the Yankee Energy System." YES' business
essentially is confined to the ownership of its subsidiaries. Yankee Gas,
the principal subsidiary of YES, is a Connecticut corporation that purchases,
distributes and sells natural gas at retail in Connecticut.
All four non-utility subsidiaries are Connecticut corporations. NorConn
was formed in 1988 to hold property and facilities of the Yankee Energy
System. Yankee Financial, incorporated in 1992, provides customers with
financing for energy equipment installations. YESCo provides a wide range of
energy-related services for its customers. Through its YESCo Controls
division, incorporated in November 1996, such services include comprehensive
building automation with engineering, installation and maintenance of
building control systems. Through its YESCo Mechanical Services division,
customers are provided comprehensive heating, ventilation and air-
conditioning (HVAC), boiler and refrigeration equipment services and
installation. RMS was formed in 1994 to provide debt collection service to
utilities and other businesses nationwide. YES, Yankee Gas, Yankee Financial,
NorConn, and YESCo, are predominantly intrastate in character.
Yankee Gas purchases, distributes and sells natural gas to approximately
185,000 residential, commercial and industrial users in Connecticut. Its
service territory consists of 69 cities and towns, and covers approximately
1,995 square miles, all in Connecticut and all within the service territory
of CL&P. Until YES was formed in 1988, Yankee Gas' gas business was part of
the NU system and was operated by CL&P on a fully integrated and coordinated
part of the NU system companies. NU divested Yankee Gas in 1989 through the
spin-off to its shareholders of the stock of YES, and believes that the re-
combination of Yankee Gas and NU will be facilitated and enhanced by the
companies' shared past.
Yankee Gas' assets include distribution lines (mains and services),
meters, pumps, valves and pressure and flow controllers, all located in
Connecticut. Yankee Gas owns approximately 2,820 miles of distribution
mains, 133,033 service lines, and 185,000 active meters for customer use, all
located in Connecticut. Yankee Gas also owns and operates various propane
facilities and six gas storage holders, all located in Connecticut. Yankee
Gas also contracts for storage capacity with other energy and pipeline
companies. Yankee Gas operates the largest natural gas distribution system in
Connecticut as measured by number of customers and size of service territory.
Total throughput (sales and transportation) for fiscal 1998 was 47.1 billion
cubic feet. In fiscal 1998, total gas operating revenues were comprised of
the following: 47% residential; 26% commercial; 18% industrial; and the
remaining 9% other. Yankee Gas provides firm gas sales service to customers
who require a continuous gas supply throughout the year, such as residential
customers who rely on gas for their heating, hot water, and cooking needs.
Yankee Gas also provides interruptible gas sales service to certain
commercial and industrial customers that have the capability to switch from
natural gas to an alternative fuel on short notice. Yankee Gas can interrupt
service to these customers during peak demand periods. Yankee Gas offers
firm and interruptible transportation services to customers who purchase gas
from sources other than Yankee Gas. In addition, Yankee Gas performs gas
exchanges and capacity releases to marketers to reduce its overall gas
expense.
Yankee Gas sells gas to its retail customers under rate schedules filed
with and approved by the DPUC. Firm sales rates are subject to monthly
adjustments pursuant to a Purchased Gas Adjustment ("PGA") clause approved by
the DPUC. The PGA passes through to customers the cost of gas purchased by
Yankee Gas. The PGA is designed to collect or refund differences between
actual purchased gas costs and the costs included in Yankee Gas' base rates.
In 1997, the DPUC conducted a review of the Connecticut local distribution
companies' ("LDC") PGA mechanism to determine if any changes were warranted.
The most significant change approved by the DPUC was the authorization for
LDCs to pass on to customers the costs of the Connecticut Gross Earnings Tax
related to PGA revenues.
FERC Order No. 636. In implementing Order No. 636, the FERC recognized
that the restructuring of the pipelines' traditional services would cause
pipelines to incur transition costs in several areas. The FERC has permitted
certain transition costs to be recovered by the pipeline companies from their
customers.
In July 1994, the DPUC issued an order permitting the recovery of
transition costs billed by pipelines under FERC Order No. 636 through various
mechanisms authorized by the DPUC. Though September 30, 1998, Yankee Gas
has paid approximately $20.5 million of transition costs and an additional
$2.5 million are anticipated. To date, Yankee Gas has collected $46.3
million through a combination of credits received from pipeline refunds,
capacity release agreements, deferred gas costs credits, off system sales
margins and excess interruptible margins. The DPUC approved a settlement
agreement in January 1996 and an amendment thereto in October 1997 between
Yankee Gas and the Connecticut Office of Consumer Counsel that permits Yankee
Gas to retain over-collected transition cost credits to offset certain
deferred regulatory assets. As of September 30, 1998, excess collections of
approximately $25.8 million were applied against the deferred regulatory
assets specified in the agreement.
In January 1996, the DPUC, in response to Order No. 636, authorized the
Connecticut LDCs to offer unbundled firm transportation rates to its
commercial and industrial customers. The DPUC's decision permits Yankee Gas
to offer a variety of service options to its commercial and industrial firm
transportation customers. Yankee Gas implemented new firm transportation
rates and services in April 1996. In October 1998, the DPUC issued a
decision making a number of modifications to the commercial and industrial
firm transportation program. These modifications, effective January 1, 1999,
are designed to simplify and improve the program based on the initial firm
transportation experience. As of September 30, 1998, Yankee Gas had
approximately 3,100 customers under firm transportation service. The
migration by existing customers to transportation service will result in
decreased revenues for Yankee Gas, as that portion of revenues representing
gas costs will be borne directly by these customers who will purchase their
own gas directly. Yankee Gas, however, does not expect customer migrations
to transportation service to affect its net income because under DPUC
regulation, the cost of gas has traditionally been a pass through item with
no income impact. The DPUC's October 1998 decision did not address Yankee
Gas' revenue requirement.
Order No. 636 also authorizes LDCs to make off system sales or to
release firm pipeline capacity and Yankee Gas has engaged in these activities
to maximize revenues and for effective gas supply planning.
Yankee Gas faces competition from other gas suppliers. In the past,
LDCs did not directly compete with other suppliers of gas for retail
customers because the territories they serve are fixed by franchise.
However, since 1996 in Connecticut, other suppliers, who registered with the
DPUC, began marketing efforts within Yankee Gas' service territory to supply
the gas while Yankee Gas provides the transportation service necessary
through its distribution system. NU and YES believe that deregulation of the
sale of natural gas has created an opportunity for their commercial and
industrial customers to achieve savings on the purchase price of natural gas
by helping customers lower the purchase price of natural gas.
Federal regulation also permits customers within Yankee Gas' franchise
to connect directly with transmission pipelines and bypass Yankee Gas'
distribution system under blanket certificates granted by the FERC. These
certificates allow gas to be sold, but not necessarily delivered, in the
service territory of another LDC. Within Yankee Gas' service territory,
Yankee makes available its transportation services to move other parties' gas
through its distribution system. However, a Connecticut statute currently
prohibits an interstate pipeline from bypassing an LDC without the DPUC's
prior approval.
C. Description of the Merger
The Merger Agreement provides that YES will merge into Merger Sub, a to-
be-formed wholly-owned subsidiary of NU. Merger Sub will be the surviving
company and will continue to conduct YES' businesses as a direct, wholly
owned subsidiary of NU. Merger Sub will change its name to Yankee Energy
System, Inc. as part of the Merger. In the Merger, each outstanding YES
share (other than those that are held by YES shareholders who have not voted
in favor of the Merger and have properly demanded dissenters' rights) will be
converted into the right to receive cash or NU Common Shares having a value
of $45 per share of YES common stock. The total consideration to be paid by
NU for the outstanding shares of YES common stock will be approximately $478
million, based on approximately 10.6 million shares of YES common stock
outstanding. YES shareholders can choose to convert some or all of their YES
shares into cash and others into NU Common Shares.
Each YES shareholder can elect the form of consideration he/she would
like to receive, but this election is subject to proration and an adjustment
driven by tax considerations so that 55% of all issued and outstanding YES
shares will be exchanged for cash (or $263 million in the aggregate), and
45% will be exchanged for NU Common Shares having an aggregate value of
approximately $215 million. If YES shareholders owning more than 55% of YES
shares elect to receive cash, the number of YES shares converted into cash
will be less than the number elected. Similarly, if YES shareholders owning
more than 45% of YES shares elect to receive NU Common Shares, the number of
YES shares converted into stock will be less than the number elected.
The per share cash consideration amounts to $45.00 in cash, without
interest. The per share stock consideration is that number of NU Common
Shares equal to $45.00 divided by the average closing trading price of NU
Common Shares 20 trading days prior to the second trading day before the date
the Merger becomes effective.
The Transaction is subject to customary closing conditions, including
the approval of the Commission. In addition, if the Merger does not become
effective within 6 months after the date of YES shareholder approval, October
12, 1999, the per share merger consideration will be increased by $.005 per
day or approximately $.15 per month per share. Moreover, if the Merger is
not consummated by September 14, 2000, solely because of NU's failure to
obtain Commission authorization under the Act, YES can terminate the Merger
Agreement and NU would have to pay YES a "break-up" fee of $1.00 per share,
or approximately $10.625 million. The Merger Agreement also contains other
termination provisions as are customary in merger transactions generally.
The Transaction is designed to qualify as a tax-free reorganization under
Section 368 of the Internal Revenue Code of 1986, as amended.
The Merger Agreement contains certain covenants relating to the conduct
of business by the parties pending the consummation of the Transaction, which
are customarily contained in merger transactions generally. As a general
matter, among other things, YES must carry on its business in the ordinary
course consistent with past practice, and may not increase dividends beyond
specified levels or issue capital stock, all except as otherwise specified.
The Merger Agreement also contains customary restrictions on, among other
things, charter and bylaw amendments, capital expenditures, acquisitions,
dispositions, incurrence of indebtedness and certain increases in employee
compensation and benefits and affiliate transactions.
Following consummation of the Transaction, the NU Board of Trustees will
be expanded by two positions which will be filled by two current directors of
YES selected by NU. The board of directors of Merger Sub will consist of 7
directors, three of which will be current outside directors of YES designated
by NU and the other four will be selected by NU. Upon consummation of the
Transaction, members of the senior management of YES are expected to remain
members of senior management of either YES, NU or other NU subsidiaries.
NU and YES believe that the Merger will give the combined company the
platform it needs for growth in a region that is rapidly deregulating,
allowing the company to market its portfolio of energy products to a broad
customer base.
When the Merger is complete the companies expect the combined company
will have the following primary businesses:
o retail natural gas and unregulated electricity sales;
o electric and gas distribution;
o wholesale natural gas and electricity sales and electric
transmission; and
o electric generation.
The companies intend to integrate these complementary businesses,
subject to applicable state and federal regulatory requirements. The
complementary nature of these businesses will over time result in lower costs
and in improved service. These businesses will not only serve existing
retail and wholesale customers, but will reach out to new customers as a full
service energy provider as both gas and electricity deregulation proceeds.
Applicant expects to achieve enhanced revenues and net income in the future
through increased efficiency in providing energy to customers, whether gas or
electric, and more competitive rates.
In addition, the Merger will ultimately enable the combined company to
realize cost savings from elimination of duplicate corporate and
administrative programs, greater efficiencies in operations and business
processes, and streamlined purchasing practices.
D. YES Reasons for the Merger
YES has been seeking to position itself to take full advantage of the
increased growth of the gas business that is resulting and will result from
the increased competition in gas marketing and the deregulation of the
electric industry. Over the past several years, YES' Board of Directors had
reviewed strategic options available to the Yankee Energy System to take
advantage of these opportunities and provide benefits for its customers,
shareholders and employees. Among the options considered during this time
were (1) remaining an independent and small-sized company concentrated in the
business of gas distribution in Connecticut; (2) growing the company through
increased emphasis on diversification into non-regulated businesses; (3)
looking for a merger partner of similar size; and (4) looking for a merger
partner of larger size.
Prior to the third quarter of 1998, management's efforts were directed
primarily to diversification activities through YESCo and RMS. During the
fourth quarter of 1998, the RMS business was showing strong potential, but
YESCo's diversification efforts had not yielded the magnitude of earnings
growth necessary to justify further substantial investment by YES, given YES'
size. During this period, the pace of consolidation within the gas industry
had picked up and electric utility companies were showing increased interest
in acquiring gas utilities due to the perceived advantage of being able to
offer customers multiple energy products and services, utilizing both
electricity and natural gas in a growing competitive environment.
Accordingly, in the period October 1998 through April 1999, YES undertook
various activities to explore potential business combinations.
In concluding that the Merger was in the best interests of YES and its
shareholders, YES' Board of Directors considered a variety of factors,
including an analysis of the Yankee Energy System's businesses, current and
future financial condition, current earnings and earnings prospects, the
competitive business environment and changing regulatory environment facing a
relatively smaller company such as Yankee Gas; alternatives, including the
prospects of continuing to operate as a small sized independent gas
distribution company or attempting to acquire other smaller distribution
companies in New England; the per share consideration to be paid in the
Merger; and its assessment of NU's future prospects and business strategy.
Based on these considerations, the Board determined that the benefits
resulting from this Merger will position YES, as part of the NU System, as
one of the premier energy distribution companies and provider of energy-
related services in the northeastern United States.
E. NU Reasons for the Merger
The economic benefits achievable through the combination of natural gas
with electric power operations serve the public interest by enabling energy
suppliers to satisfy the needs of consumers more efficiently. Given the
fundamental structural changes in the industry, the proposed transaction
clearly provides NU with an efficient way to resume its involvement in the
natural gas business, which in turn will allow the NU System utilities,
including Yankee Gas, to remain competitive with the growing number of energy
services companies offering customers a choice of fuels to meet their energy
needs.
Following the Merger, the NU System electric utility companies will face
the same competitive forces from other electric suppliers as prior to the
Merger, just as Yankee Gas will face the same competitive forces it faces
today. NU believes that it is possible for the gas business of Yankee Gas to
grow since there is significant room for additional consolidations among New
England's many small gas utilities. Prospects for the growth of Yankee Gas
operations, with the increased financial flexibility and strength provided to
it as part of the NU System, are strong. The saturation rate for gas in the
towns served by Yankee Gas is 33%. Gas penetration in New England is 45%,
below the national average. Yankee Gas also has one of the most modern gas
systems in the region, with a high level of plastic and high-grade steel
pipes.
As an energy services company with electric and natural gas
subsidiaries, NU will be positioned to offer its residential, commercial,
industrial, and municipal customers the convenience and efficiency of service
by a single energy provider with reduced transaction costs incurred in
gathering and analyzing information, contacting energy suppliers, negotiating
terms of services and paying bills. At the same time, NU's shareholders and
employees will benefit from an energy service company that is better able to
respond to a competitive environment, better able to remain an attractive
investment opportunity for shareholders, and better able to remain an
appealing employer for utility employees.
This Merger also represents a logical step in reaching the goal of NU
senior management to strategically, financially and technologically position
NU to remain the leading energy company in the region and become within the
next few years one of the top five providers of energy products and services
and a major energy trader in the Northeast. As part of this strategy, NU
will retain its regulated transmission and distribution companies as the
foundation of the NU System. These operations represent NU's core
competencies and embody its century-old history of delivering power to its
customers. Since the natural growth of NU's regulated electric business is
limited, however, by the modest growth of electric consumption in New
England, NU has undertaken various initiatives to spur increases in revenues
from regulated operations. These initiatives include pursuing opportunities
for business expansion in both the electric and natural gas distribution
businesses by, for example, combining with natural gas utilities such as YES.
F. Analysis of Certain Economic Impacts
Filed herewith as Exhibit d.3 is an "Analysis of Certain Economic
Impacts of the Proposed Combination of Northeast Utilities (`NU') and Yankee
Energy System, Inc. (`YES')," which indicates the potential for the merger
achieving annual savings of $10.4 million by the end of 2001 and $13.7
million annually by the end of a five year transition plan. The $13.7 million
figure equates to the following percentages of Yankee Gas' 1999 financial
results:
Gas Revenues 5.0%
Gas Operating Revenue
Deductions 7.1%
Gas Gross Income 47.2%
Gas Net Income 85.6%
Although the DPUC has not yet allocated these potential savings between
YES, NU and shareholders (its Decision approving the merger made no findings
as to rates), the Commission has recognized for some time that the loss of
even small economies "may render a utility subject to significant erosion of
its competitive position." Note 56, Re New Century Energies, Inc., HCAR No.
26748 (August 1, 1997)(hereinafter, "NCE"). (See, also, the discussion in
Item 3 hereof). In NCE, the Commission recognized that strict adherence to
the old severance test in merger cases, a showing of crippling loss of
economies, was no longer applicable in a changing competitive environment.
In fact the loss of potential competitive benefits of keeping gas and
electric companies separate could now be seen as outweighed by the reality
that small separate companies could only survive by merging and achieving
economies of scale that could tip the balance in a highly competitive
environment:
"Increased expenses of separate operation may no longer be offset, as
they were in New England Electric System, by a gain of qualitative
competitive benefits, but rather may be compounded by a loss of such
benefits, as the Commission finds in this matter." NCE, p.54.
The Joint Application For Approval of a Change of Control of NU and YES
to the DPUC recited the beneficial aspects of the merger which the applicants
hope to achieve, including increasingly competitive gas and electric rates,
long-term operational cost savings, greater purchasing leverage, expansion of
combined non-utility businesses, greater financial stability and return for
shareholders and expansion of the Yankee Gas distribution system. See Exhibit
d.1, p.12. The proposed merger fits within the precedent established by NCE
and similar cases the Commission has recently decided.
Item 2. Fees, Commissions and Expenses
The fees, commissions and expenses paid or incurred, or to be paid or
incurred, directly or indirectly, in connection with the proposed transaction
by the Applicant are estimated to total approximately $10 million, as
follows*:
Accountant Fees $ 60,000
Fees for outside counsel $ 700,000
Investment Bankers' Fees
Credit Suisse-First Boston $ 5,100,000
Fees and Expenses relating to
Financing the Merger $ 3,700,000**
Hart-Scott-Rodino Fees $ 45,000
SEC Filing Fees relating to
Registration Statement on Form S-4 $ 229,000
Exchange Agent, Printing and delivery $ 400,000
NUSCO Fees $ 200,000
TOTAL $ 10,434,000
* estimated.
** Note that fees may be higher depending on the type and number of
financings but will not exceed the parameters set forth in Item 1.A.2.
None of such fees, commission or expenses will be paid to any associate
company or affiliate of the Applicant except for payments by NU for financial
and other services, to be performed at cost by NUSCO, an affiliated service
company.
Item 3. Applicable Statutory Provisions
The following sections of the Act and the Commission's rules thereunder
are or may be applicable to the authorization being sought hereunder by the
Applicant: 6(a), 7, 9(a), 10 and by reference Section 11.
To the extent that other sections of the Act or the Commission's rules
thereunder are deemed applicable to the Transaction, such sections and rules
should be considered to be set forth in this Item 3.
Section 9(a)(2) makes it unlawful, without approval of the Commission
under Section 10, "for any person . . . to acquire, directly or indirectly,
any security of any public utility company, if such person is an affiliate
[under Section 2(a)(11)(A) of the Act] . . . of such company and of any other
public utility or holding company, or will by virtue of such acquisition
become such an affiliate." Under the definition set forth in Section
2(a)(11)(A), an "affiliate" of a specified company means "any person that
directly or indirectly owns, controls, or holds with power to vote, 5 per
centum or more of the outstanding voting securities of such specified
company."
Yankee Gas and the NU Operating Companies are public utility companies
as defined in Section 2(a)(5) of the Act. Because NU, an "affiliate" of the
NU Operating Companies within the meaning of Section 2(a)(11) of the Act,
will acquire more than five percent of the voting securities of YES as a
result of the Transaction, and will thereby become an affiliate of Yankee
Gas, NU must obtain the approval of the Commission for the Transaction under
Sections 9(a)(2) and 10 of the Act. The statutory standards to be considered
by the Commission in evaluating the proposed transaction are set forth in
Sections 10(b), (c) and (f) of the Act.
As recognized throughout Commission decisions and in the comprehensive
report issued by the Division of Investment Management in June 1995 entitled
"The Regulation of Public-Utility Holding Companies" (the "Division Report"),
the framers of the Act understood the need and intended for the Act to be
interpreted in a flexible manner, taking into account changes in the nature
of the utility industry over time. While the Applicant believes that the
requested authorization is within existing precedent, changes in the industry
make the case for the transaction even more compelling. For example, one
change that the Commission has recently explicitly recognized is that "the
utility industry is evolving towards a broadly based energy-related
business." (Consolidated Natural Gas Company, HCAR No. 26512 (April 30, 1996)
As will be discussed in greater detail below, this fundamental evolution
influences not only the appropriate notion of what a utility system consists
of, but also affects the value of benefits gained by becoming a full energy
services utility system.
Furthermore, this Transaction also provides an opportunity for the
Commission to follow certain of the interpretive recommendations made in the
Division Report as well as certain of the Commission's recent precedents
concerning the formation of new holding companies consisting of both electric
utilities and gas utilities. A number of the recommendations contained in
the Division Report serve to strengthen the Applicant's analysis and would
facilitate the acquisition of YES by NU, thus creating a company better able
to compete in the rapidly evolving utility industry. The Division's overall
recommendation that the Commission "act administratively to modernize and
simplify holding company regulation . . . and minimize regulatory overlap,
while protecting the interests of consumers and investors," should be used
in reviewing this Application/Declaration since, as demonstrated below, the
Transaction will benefit both consumers and shareholders of NU and it is
anticipated that the other federal and state regulatory authorities with
jurisdiction over this Transaction will approve it as in the public interest.
The Applicant believes that this Transaction is in accord with the recent
Commission decisions approving the retention of gas properties by newly
merged combination electric and gas companies under a registered holding
company and also is consistent with, and furthers the policy, of fostering
the creation of competitive energy services companies as the energy industry
continues its evolution towards a more competitive market. It is noted that
in the precedents of the Commission approving a registered holding company
consisting of both an electric utility and a gas utility, at least one of the
merger partners in those transactions was already a combination electric and
gas company and the Commission was addressing the question of whether an
additional system could be retained by the principal system rather than
acquired. (See, WP Holdings, Inc. HCAR No. 26856 (April 14, 1998), New
Century Energies, Inc. HCAR No. 26748 (August 1, 1997). In the instant
situation, NU, a registered electric utility holding company, is acquiring
YES, an exempt gas utility holding company, and, thus, the Transaction is
the first time the Commission is presented with the question of whether a
"pure" electric registered holding company can acquire a "pure" gas company
where the approval being sought is of the acquisition not the retention. (As
noted below, the Commission has approved an exempt "pure" electric utility's
acquisition of an exempt "pure" gas utility. See, TUC Holdings, Inc., HCAR
No. 35-2674 (Aug. 1, 1997)).
The Applicant believes the Commission should approve the Transaction as
a matter of policy and as a matter of fairness and can approve the
Transaction as a matter of law. First, the Commission has already
acknowledged that the electric and gas industries are converging and that
separation of gas and electric businesses may cause the separated entities to
be weaker competitors than they would otherwise be together. (New Century
Energies, Inc., HCAR No. 26748 (Aug. 1, 1997)). The Commission has
recognized and accepted the changing nature of the energy industry and, in
particular, the fact that the combination of electric and gas operations in a
single company offers that company a means to compete more effectively in the
emerging energy services business in which a few cents can make the
difference between economic success and economic failure. WPL Holdings,
Inc., HCAR No. 26856 (April 14, 1998), aff'd sub nom., Madison Gas and
Electric Company v. Securities and Exchange Commission, (D.C. Cir. 1999). In
the present Transaction, the lost economies that would follow from denial of
approval for the Merger are substantial, both quantitatively and
qualitatively. Second, as indicated, the Commission has allowed exempt
holding companies to acquire gas utilities and thereby to become combination
companies, (see TUC Holding Company, HCAR No. 26749 (August 1, 1997), and
Houston Industries Incorporated, HCAR No. 26744 (July 24, 1997)), and has
allowed newly formed registered holding companies to retain their combination
assets. (See WPL Holdings, Inc., HCAR No. 26856 (April 14, 1998) and New
Century Energies, Inc., HCAR No. 26748 (Aug. 1, 1997)). Lastly, the proposed
Merger seeks to combine two utility companies that had previously operated as
a combination company for 22 years. The two companies share a rich history
and many employees of one company had previously worked for the other. This
factor should also be considered in determining whether the Merger is
consistent with public policy.
The Transaction satisfies all of the requirements of Section 10 and
should therefore be approved. Specifically, as the following discussion more
fully explains:
1. the Transaction will not tend towards interlocking relations or
the concentration of control of public utility companies to the
detriment of investors and consumers;
2. the consideration, including all commissions and fees, to be paid
in connection with the Transaction is reasonable;
3. the Transaction will not unduly complicate the capital structure of
the NU holding company system;
4. the Transaction is in the public interest and the interests of
consumers and investors;
5. the Transaction will tend towards the development of an integrated
gas utility system; and
6. the Transaction will comply with all applicable State laws.
A. Section 10(b)
1. Section 10(b)(1)
Section 10(b)(1) provides that, if the requirements of Section 10(f) are
satisfied, the Commission shall approve an acquisition under Section 9(a)
unless such acquisition will tend towards interlocking relations or the
concentration of control of public utility companies, of a kind or to an
extent detrimental to the public interest or the interests of investors or
consumers. The Applicant believes that the Merger will not tend toward
interlocking relationships or concentration of control that would be
detrimental to the public interest or the interest of investors or consumers
because (i) following the Merger, CL&P and Yankee Gas will remain subject to
regulation by the DPUC which operates pursuant to regulations specifically
designed to protect the public interest and the interests of consumers; (ii)
the Merger will not increase the size of the NU system dramatically and after
the Merger, NU will be a holding company comparable in size to or smaller
than other utility holding companies that the Commission has approved; and
(iii) as a result of the Merger, NU expects, over time, to achieve economies
of scale and efficiencies and expects to be able to compete more effectively
in the evolving utility industry, which will benefit both shareholders and
ratepayers and will be in the public interest.
Interlocking Relations. With regard to interlocking relations, any
merger, by its nature, results in new links between theretofore unrelated
companies. However, these links are not the types of interlocking
relationships targeted by Section 10(b)(1), which was primarily aimed at
preventing business combinations unrelated to operating synergies. Under the
terms of the Merger Agreement, following consummation of the Transaction, the
NU Board of Trustees will be expanded by two positions which will be filled
by two current directors of YES designated by NU. The board of directors of
Merger Sub will consist of 7 directors, three of which will be current
outside directors of YES designated by NU to serve on Merger Sub's board and
the other four will be selected by NU. In addition, members of the senior
management of YES are expected to remain as members of senior management of
Merger Sub or other NU system companies. This combination of existing NU and
YES management is necessary to integrate YES fully into the NU system and
will help NU realize the expected synergies from the Merger. In addition,
such continuity in management will help to assure the responsiveness of NU
management to local regulation and to other essentially local interests
(e.g., consumers, labor, etc.).
Regulation. Both CL&P and Yankee Gas are currently, and following the
Merger will remain, subject to the jurisdiction of the DPUC with regard to
rates, terms and conditions for service, affiliate transactions, service
territory and various other matters. The level of regulatory authority of
the DPUC over CL&P and Yankee Gas will not be affected in any manner by the
Merger. Accordingly, the presence of continuing state regulation will help
to ensure that that the Merger will not have a detrimental effect on the
public interest or consumers. Moreover, rather than provide a means for
evading regulation, the Transaction, by virtue of the fact that YES will be a
part of a holding company registered under the Act, will in fact increase the
regulation to which YES is currently subject and not affect the regulation to
which NU is subject. In the Division Report at p. 73-4, the Division of
Investment Management recommended that the Commission approach its analysis
on merger and acquisition transactions in a flexible manner with emphasis on
whether the transaction creates an entity subject to effective regulation and
is beneficial for shareholders and customers, as opposed to focusing on
rigid, mechanical tests.
Concentration of Control. Section 10(b)(1) is intended to avoid "an
excess of concentration and bigness" while preserving the "opportunities for
economies of scale, the elimination of duplicate facilities and activities,
the sharing of production capacity and reserves and generally more efficient
operations" afforded by the coordination of local utilities into an
integrated system. American Electric Power Co., 46 S.E.C. 1299, 1309 (1978).
In applying Section 10(b)(1) to utility acquisitions, the Commission must
determine whether the acquisition will create "the type of structures and
combinations at which the Act was specifically directed." Vermont Yankee
Nuclear Corp., 43 S.E.C. 693, 700 (1968). As discussed below, the Merger
will not create a "huge, complex, and irrational system" of a type at which
the Act is directed, but rather will afford the opportunity to achieve
economies of scale and efficiencies which are expected to benefit investors
and consumers. American Electric Power Co., 46 S.E.C. 1299, 1307 (1978).
Furthermore, the Merger will restore a partnership between YES and CL&P which
existed for many years. The combination in that time operated efficiently
and effectively and did not constitute an "irrational" system.
Efficiencies and Economies. The Commission has rejected a mechanical
size analysis under Section 10(b)(1) in favor of assessing the size of the
resulting system with reference to the efficiencies and economies that can be
achieved through the integration and coordination of utility operations.
American Electric Power Co., 46 S.E.C. 1299, 1309. More recent
pronouncements of the Commission confirm that size is not determinative.
Thus, in Centerior Energy Corp., HCAR No. 24073 (April 29, 1986), the
Commission stated flatly that a "determination of whether to prohibit
enlargement of a system by acquisition is to be made on the basis of all the
circumstances, not on the basis of size alone." See also Entergy Corporation,
HCAR No. 25952 (December 17, 1993).
By virtue of the Transaction, NU and YES, as a combined company, will be
in a position to realize substantial opportunities to become a more effective
competitor in a rapidly deregulating and increasingly competitive energy
market that neither, acting alone, would be in a position to achieve. In
addition, the combined company will over time be able to produce capital
expenditure savings through the elimination of duplicate facilities and
activities, labor cost savings, administration and general savings and cost
of capital savings. These expected economies are described in greater detail
elsewhere in this Application. The combination of NU and YES offers the same
type of synergies and efficiencies that were sought and are now being
realized by the applicants (both exempt and registered) in TUC Holding
Company, HCAR No. 26749 (Aug. 1, 1997); Houston Industries Incorporated, HCAR
No. 26744 (July 24, 1997); WPL Holdings, Inc., HCAR No. 26856 (April 14,
1998); and New Century Energies, Inc., HCAR No. 26748 (Aug. 1, 1997).
Size. As of March 31, 1999, NU had total assets of $10.4 billion, while
for the year ended December 31, 1998, NU had operating revenues of $3.77
billion and 1.11 million utility customers in Connecticut (two other NU
subsidiaries serve approximately 422,000 and 196,000 customers in New
Hampshire and Massachusetts, respectively). As of March 31, 1999, YES had
total assets of $548 million, while for the year ended September 30, 1998,
YES had utility revenues of $284 million and approximately 185,000 utility
customers. On a pro forma basis, giving effect to the Merger, (i) as of
March 31, 1999, the combined assets of the Company would have totaled
approximately $11 billion; and (ii) for the year ended December 31, 1998, the
Company would have had combined operating revenues totaling approximately
$4.06 billion and approximately 1.29 million utility customers.
By comparison, the Commission has approved a number of acquisitions
involving larger operating utilities (see, e.g., TUC Holding Company, Inc.,
HCAR No. 26749 (Aug. 1, 1997), approving the acquisition and combination of
Texas Utility Company and Enserch Corporation, with combined assets at the
time of acquisition of approximately $24 billion, Entergy Corp., HCAR No.
25952 (Dec. 17, 1993), approving the acquisition of Gulf States Utilities by
Entergy, with combined assets at time of acquisition in excess of $21
billion; The Southern Company, HCAR No. 24579 (Feb. 12, 1988), approving the
acquisition of Savannah Electric and Power Company to create a system with
assets of $20 billion).
Competitive Effects: The Transaction will have no adverse effect on the
competitive environments in which NU's electric business operates. Following
the Transaction, NU's electric business will face the same competitive forces
from other electric suppliers as prior to the Transaction. The Transaction
will have no adverse effect on the competitive environments in which YES' gas
business operates. Following the Transaction, YES' gas business will face
the same competitive forces from other gas suppliers as prior to the
Transaction.
The NU Operating Companies do not generally compete directly with Yankee
Gas for several reasons. First, there is little substitution between gas and
electricity as energy sources in most industrial and commercial applications.
Technically, gas cannot be substituted for electricity on an instantaneous
basis because most industrial and commercial processes are energy-specific.
Thermal processes most often employ natural gas, while motor and machine
driven processes employ electricity. Where an industrial or commercial
application permits the use of either fuel, the substitution of one fuel for
another requires equipment investment and other expense that does not allow
substitution in response to relatively insignificant price changes. Most
often, the choice of fuel is dictated by numerous considerations in addition
to fuel prices, such as quality control, safety and environmental concerns.
For residential users, natural gas cannot be substituted for electricity in
lighting, refrigeration, and most household appliances. The amount of fuel
used for residential cooking is very small, and the choice of equipment tends
to be dictated by personal preference rather than by fuel price. Residential
customers generally choose fuel sources for heating based on many factors,
including equipment prices, reliability, service, the size of the home,
perceptions of energy efficiency and matters of comfort, convenience and
aesthetics, and not solely based on relative fuel price.
Second, there will be competition in the retail market for industrial
and commercial customers of natural gas in Connecticut. In the past, LDCs
did not directly compete with other LDCs for retail customers because the
territories they serve are fixed by franchise. However, since 1993, LDCs and
marketers began marketing efforts within the service territory of other LDCs
under blanket certificates granted by the FERC. These certificates allow gas
to be sold, but not necessarily delivered, in the service territory of
another LDC. Within Yankee Gas' service territory, Yankee makes available
its transportation services to move other parties' gas through its
distribution system. Yankee does not currently market gas in other LDC
service territories.
Federal regulation also permits customers within Yankee Gas'
distribution system to connect directly with transmission pipelines and
bypass Yankee Gas' distribution system. However, a Connecticut statute
currently prohibits an interstate pipeline from bypassing a LDC without the
DPUC's prior approval.
Following the Merger, the NU electric utility companies will face the
same competitive forces from other electric suppliers as prior to the Merger,
just as Yankee Gas will face the same competitive forces from other gas
suppliers it faces today. Because these utilities' competitive behavior is
shaped by competition with their respective energy "peers," and because the
NU Operating Companies and Yankee Gas rarely engage in direct competition in
any event, the Merger will have little or no adverse effect on competition in
a manner or to an extent detrimental to the public interest or the interests
of investors or consumers.
The Commission should also note that NU and YES have filed Premerger
Notification and Report Forms with the Antitrust Division of the Department
of Justice (the "DOJ") and the Federal Trade Commission (the "FTC") pursuant
to the Hart-Scott-Rodino Antitrust Improvements Act of 1974, as amended (the
"HSR Act") describing the effects of the Merger on competition in the
relevant market and it is a condition to the consummation of the Merger that
the applicable waiting periods under the HSR Act must expire and clearances
obtained. Such filings were made on October 29, 1999 and accelerated
termination of the waiting period was requested. The waiting period expired
without comment from either DOJ or FTC.
For these reasons, the Transaction will not "tend toward interlocking
relations or the concentration of control" of public utility companies, of a
kind or to the extent detrimental to the public interest or the interests of
investors or customers within the meaning of Section 10(b)(1).
2. Section 10(b)(2)
Section 10(b)(2) provides that an acquisition of securities or utility
assets should be approved, unless the consideration, including all fees,
commissions, and other remuneration, to whomsoever paid, to be given,
directly or indirectly, in connection with such acquisition is not reasonable
or does not bear a fair relation to the sums invested in or the earning
capacity of the utility assets to be acquired or the utility assets
underlying the securities to be acquired.
Fairness of Consideration: For the reasons set forth below, the
requirements of Section 10(b)(2) regarding consideration are satisfied in
this Transaction. In its determinations as to whether or not a price meets
such standard, the Commission has considered whether the price was decided as
the result of arms length negotiations (In the Matter of American Natural Gas
Company, HCAR No. 15620 (Dec. 12, 1966)), whether each of the parties' Board
of Directors has approved the purchase price, the opinions of investment
bankers (Consolidated Natural Gas Company, HCAR No. 25040 (Feb. 14, 1990))
and the earnings, dividends, book and market value of the shares of, the
company to be acquired (In the Matter of Northeast Utilities, HCAR No. 15448
(Apr. 13, 1966)).
The fairness of the consideration involved in the Merger is evidenced by
the fact that the amount of consideration paid to YES shareholders under the
Merger Agreement is the product of a process conducted by an investment
banker appointed by YES and extensive and vigorous arms-length negotiations
between NU and YES. The Merger Agreement was approved by the Board of
Trustees of NU and the Board of Directors of YES acting in accordance with
their fiduciary duties to shareholders and others. These negotiations were
preceded by thoughtful analysis and evaluation of the assets, liabilities and
business prospects of YES and involved careful due diligence by NU. These
negotiations concluded with the offer of consideration consisting of a
combination of cash and NU Common Shares in the amount of $45.00 per YES
share. As recognized by the Commission in Ohio Power Co., 44 S.E.C. 340, 346
(1970), prices arrived at through arms-length negotiations are particularly
persuasive evidence that Section 10(b)(2) is satisfied.
In addition, nationally-recognized investment bankers for each of NU and
YES have reviewed extensive information concerning the companies and served
as financial advisors to NU and YES. The financial advisor for YES has also
opined that the consideration is fair, from a financial point of view, to the
holders of YES common stock.
In light of these opinions and an analysis of all relevant factors,
including the benefits that may be realized as a result of the Transaction,
NU believes that the consideration payable to YES shareholders falls within
the range of reasonableness, and the consideration for the Transaction bears
a fair relation to the sums invested in, and the earning capacity of, the
utility assets of YES.
Reasonableness of Fees. NU and YES believe that the overall fees,
commissions and expenses incurred and to be incurred in connection with the
Transaction are reasonable and fair in light of the size and complexity of
the Transaction relative to other transactions and the anticipated benefits
of the Transaction to the public, investors and consumers; that they are
consistent with recent precedent; and that they meet the standards of Section
10(b)(2).
As set forth in Item 2 of this Application/Declaration, NU expects to
incur a total of approximately $ 10 million in fees, commissions and expenses
in connection with the Transaction. This total is solely an estimate, but NU
believes that the actual total will not vary significantly. NU believes that
the estimated fees and expenses in this matter bear a fair relation to the
value of its combined company and the strategic benefits to be achieved by
the Merger, and further that the fees and expenses are fair and reasonable in
light of the complexity of the Merger. By contrast, TUC and Enserch incurred
$37 million in fees, commission and expenses in connection with their
reorganization as subsidiaries of TUC Holdings, Inc., Cincinnati Gas &
Electric Company and PSI Resources incurred $47.1 million in fees,
commissions and expenses in connection with their reorganization as
subsidiaries of CINergy, and Entergy alone incurred approximately $38 million
in fees, commissions and expenses in connection with its acquisition of Gulf
States Utilities -- all of which amounts were approved as reasonable by the
Commission. See TUC Holdings, Inc., HCAR No. 26749 (August 1, 1997); CINergy,
HCAR No. 26146 (Oct. 21, 1994); and Entergy Corp., HCAR No. 25952 (Dec. 17,
1993).
Furthermore, based on a price for YES stock of $45.00, the Merger would
be valued at approximately $478 million (excluding the outstanding debt of
YES). The total estimated fees and expenses of $10 million represent
approximately 2% of the value of the consideration to be paid to shareholders
of YES by NU, and are consistent with percentages previously approved by the
Commission. See, e.g., Entergy Corp., HCAR No. 25952 (Dec. 17, 1993) (fees
and expenses represented approximately 1.7% of the value of the
consideration paid to the shareholders of Gulf States Utilities); Northeast
Utilities, HCAR No. 25548 (June 3, 1992) (fees and expenses represented
approximately 2% of the value of the assets to be acquired).
With respect to financial advisory fees, NU believes that the fees
payable to their investment bankers are fair and reasonable for similar
reasons. Pursuant to the terms of an engagement letter dated April 13,, 1999,
NU has agreed to pay Credit Suisse First Boston ("CSFB") a transaction fee of
0.75% of the total consideration paid to YES in connection with the Merger or
approximately $5.1 million. NU has also agreed to reimburse CSFB for its
out-of-pocket expenses, including all fees and disbursements of its legal
counsel and other advisors retained by CSFB, and to indemnify CSFB and
certain related persons against certain liabilities in connection with its
engagement, including certain liabilities under the federal securities laws.
3. Section 10(b)(3)
Section 10(b)(3) directs approval of an acquisition unless the
Commission finds that the Transaction will unduly complicate NU's capital
structure or will be detrimental to the public interest, the interests of
investors or consumers or the proper functioning of NU's system.
Capital Structure: The corporate capital structure of NU after the
Transaction will not be unduly complicated and will be substantially similar
to the capital structure of NU prior to the Merger and similar to those of
existing registered holding company systems approved by the Commission in
other orders. See, e.g., TUC Holdings, Inc., HCAR No. 26749 (Aug. 1, 1997);
CINergy, HCAR No. 26146 (Oct. 21, 1994); Centerior Energy Corp., HCAR No.
24073 (April 29, 1986); Midwest Resources, et al., HCAR No. 25159 (Sept. 26,
1990); and Entergy Corp., HCAR No. 25952 (Dec. 17, 1993);
In the Transaction, the common shareholders of YES will receive a
combination of cash and NU Common Shares in exchange for their share of YES
Common Stock. After the Merger, NU will own 100% of the common stock of YES
and there will be no minority common stock interest in YES or any of its
subsidiaries. The capitalization of NU's subsidiaries will not be affected
in any way. The debt securities of NU and its subsidiaries will not be
affected by the Merger. The debt of YES' subsidiaries outstanding at the
time of the consummation of the Transaction will remain outstanding without
change.
Set forth below are summaries of the historical capital structure of NU
for the year ended December 31, 1998 and of YES for the year ended September
30,1998 and the pro forma consolidated capital structure of NU (assuming the
Transaction had occurred at December 31, 1998):
NU and YES Historical Capital Structures
(dollars in thousands)
(as of 12/31/98)
NU YES
Total Common Equity $2,047,372 $164,992
Preferred Stock not
subject to mandatory redemption 136,200 -----
Preferred Stock subject
to mandatory redemption 167,539 -----
Long-term Debt (net) 3,282,138* 131,048
-------- --------
Total $5,633,249 $296,040
* All but approximately $ 158 Million is debt of NU's subsidiary companies;
Long-term debt of NU was previously approved by the Commission in
connection
with the PSNH Merger.
NU Pro Forma Consolidated Capital Structure
(Dollars in millions)(unaudited)
Common Stock $ 2,212,364 37%
Preferred Stock not
subject to mandatory redemption 136,200 2.24%
Preferred Stock subject
to mandatory redemption 167,539 2.76%
Long-Term Debt (net) 3,413,186 58%
-------- -------
Total
$ 5,929,289 100.0%
NU's pro forma consolidated common equity to total capitalization ratio of
37% approximates the common equity position approved by the Commission for
CINergy (39.5%) and comfortably exceeds the "traditionally acceptable 30%
level." Northeast Utilities, HCAR 25221 (December 21, 1990). See, also the
discussion in Item 1, subsection (A)(2).
Protected interests: As set forth more fully elsewhere in this
Application/Declaration, the Transaction is expected, over time, to result in
otherwise unavailable, cost savings and benefits to the public and to
consumers and investors of NU and YES, and will integrate and improve the
efficiency of the NU and YES utility systems. Moreover, as noted by the
Commission in Entergy Corporation, HCAR 25952 (December 17, 1993), "concerns
with respect to investors' interests have been largely addressed by
developments in federal securities laws and the securities market
themselves." NU and four of the NU Operating Companies are reporting
companies subject to the continuous disclosure requirements of the Exchange
Act and will continue to be so following completion of the Transaction, which
will provide investors with readily available information concerning these
companies. Likewise, YES has been and will continue to be a reporting
company post-merger. Furthermore, the Transaction is subject to state
regulatory approval, which will have been obtained prior to the consummation
of the Merger (see Item 4 - Regulatory Approvals, below).
The economic benefits achievable through the combination of natural gas
operations with electric power operations serve the public interest through
enabling energy suppliers to satisfy the needs of consumers more efficiently.
In Consolidated Natural Gas Co., HCAR No. 35-26512 (April 30, 1996), the
Commission acknowledged the nature of the market energy suppliers must
prepare to satisfy: "fundamental changes in the energy industry are leading
to an increasingly competitive and integrated market in which marketers deal
in interchangeable units of energy expressed in British thermal unit values,
rather than natural gas or electricity. To retain and attract wholesale and
industrial customers, utilities need to provide competitively priced power
and related customer services . . . . It now appears that the restructuring
of the electricity industry now underway will dramatically affect all United
States energy markets as a result of growing interdependence of natural gas
transmission and electric generation; and the interchangeability of different
forms of energy, particularly gas and electricity." The Merger is designed
to position the Applicant to be responsive to these emerging market
conditions and is therefore consistent with the public interest. For these
reasons, NU submits that the Commission would have no basis for making a
negative finding under Section 10(b)(3).
B. Section 10(c)
The relevant provisions of Section 10(c) of the Act state that,
notwithstanding the provisions of Section 10(b), the Commission shall not
approve:
(1) an acquisition of securities or utility assets, or of any other
interest, which is unlawful under the provisions of Section 8 or is
detrimental to the carrying out of the provisions of Section 11; or
(2) the acquisition of securities or utility assets of a public utility
or holding company unless the Commission finds that such
acquisition will serve the public interest by tending towards the
economical and the efficient development of an integrated public
utility system.
1. Section 10(c)(1)
i. Retention of the Gas Properties
Section 8 Analysis. Section 10(c)(1) requires that an acquisition not
be "unlawful under the provisions of Section 8." Section 8 prohibits
registered holding companies from acquiring, owning interests in or operating
both a gas and an electric utility serving substantially the same area if
prohibited by state law. The only state in which NU and YES have overlapping
service territories is Connecticut. There is no state law, regulation or
policy which would prohibit the Transaction provided that DPUC approval is
obtained. NU and YES have made the appropriate filing with the DPUC and
anticipate that the Transaction will be approved by the DPUC. Moreover, the
prior fear that a holding company such as NU would be able to greatly
emphasize one form of energy over the other based on its own agenda has
dissipated both because of the competitive nature of the energy market, which
requires utilities to meet customer demand for energy supply requirements or
risk losing the customer to a competing supplier (whether electrical or
natural gas is largely irrelevant, the ultimate customer requirement is for
energy), and because state regulators will have sufficient control over, a
combination company to ensure that it will act in the public interest.
Accordingly, the Transaction will not be unlawful under the provisions of
Section 8.
Section 11 Analysis. Section 10(c)(1) also requires that the
Transaction not be detrimental to the carrying out of the provisions of
Section 11. In pertinent part, Section 11(b)(1) generally confines the
utility properties of a registered holding company to "a single integrated
public utility system," either gas or electric. The Commission has stated
that it is not of the view that the Act "expresses a Federal policy against
combined gas and electric operations as such. The Act is concerned with
interstate holding company activities and within that area it prescribes
tests of retainability which must be met." WPL Holdings Inc., HCAR No. 26856
(April 14, 1998); New England Electric System, 41 S.E.C. 888, 892-93 (1964),
rev'd on other grounds; SEC v. New England Electric System, 346 F. 2d 399
(1st Cir. 1966), rev'd and remanded,384 U.S. 176 (1965); and New Century
Energies, Inc., HCAR No. 26748 (Aug 1, 1997). An exception to this
requirement is provided in section 11(b)(1)(A)-(C) (the "ABC clauses"). A
registered holding company may own more than one integrated system, if each
system meets the criteria of these clauses. WPL Holdings, Inc., HCAR No.
26856 (April 14, 1998). Specifically the Commission must find that (A) the
additional system "cannot be operated as an independent system without the
loss of substantial economies which can be secured by the retention of
control by the holding company of such system, (B) the additional system is
located in one or more adjoining states, and (C) the combination of systems
under the control of the single holding company is not so large . . . as to
impair the advantages of localized management, efficient operation, or the
effectiveness of regulation." The standards of each clause must be
satisfied. (WPL Holdings, Inc., HCAR No. 26856 (April
14, 1998) Note 29).
Section 2(a)(29)(A) defines an integrated public-utility system, as
applied to electric utility properties, to mean:
a system consisting of one or more units of generating plants and/or
transmission lines or distributing facilities, whose utility assets,
whether owned by one or more electric utility companies, are physically
interconnected or capable of physical interconnection and which under
normal conditions may be economically operated as a single
interconnected and coordinated system confined in its operations to a
single area or region, in one or more States, not so large as to impair
. . . the advantages of localized management, efficient operations, and
the effectiveness of regulation.
Section 2(a)(29)(B) defines an integrated public-utility system, as
applied to gas utility properties, to mean:
a system consisting of one or more gas utility companies which are so
located and related that substantial economies may be effectuated by
being operated as a single coordinated system confined in its operations
to a single area or region, in one or more States, not too large as to
impair . . . the advantages of localized management, efficient
operations, and the effectiveness of regulation: Provided, That gas
utility companies deriving natural gas from a common source of supply
may be deemed to be included in a single area or region.
In view of the separate definitions and their differing criteria, the
Commission has long held that gas and electric properties do not together
constitute an integrated system. (See SEC v. New England Electric System, 384
U.S. at 178, n.7 and the cases cited in that case (1965); WPL Holdings Inc.,
HCAR No. 26856 (April 14, 1998); and New Century Energies, Inc., HCAR No.
26748 (August 1, 1997)). As stated above, however, the Commission has held
that a registered holding company may own utility properties that are not
part of its principal integrated system only so long as they satisfy the ABC
clauses. (See., e.g., WPL Holdings, Inc.; United Gas Improvement Co., 9
S.E.C. 52, 65 (1941); and Philadelphia Co., 28 S.E.C. 35 (1948, aff'd, 177
F.2d 720 (D.C. Cir. 1949)).
It is clear that the Transaction will result in a combined system that
will not be detrimental to the carrying out of Section 11. The electric
utility system of NU (including CL&P, WMECO and PSNH) is presently
"integrated" within the meaning of Section 2(a)(29) of the Act and will
remain so after the Transaction. The Transaction will not affect the
physical interconnection of such electric utility system. Likewise, the area
of operations of such system will not be affected by the Transaction. The
gas operations of YES will be operated as a separate integrated system and
the Transaction, as discussed below, satisfies the ABC clauses. The
Applicant hereby requests approval of the Merger and the acquisition and
retention of the gas properties of YES.
ABC Clauses. Section 11(b)(1) of the Act permits a registered holding
company to control one or more additional integrated public utility systems -
- - i.e., gas as well as electric -- if:
(A) each of such additional systems cannot be operated as an
independent system without the loss of substantial economies which
can be secured by the retention of control by such holding company
of such system;
(B) all of such additional systems are located in one state, adjoining
states, or a contiguous foreign country; and
(C) the continued combination of such systems under the control of such
holding company is not so large (considering the state of the art
and the area or region affected) as to impair the advantages of
localized management, efficient operation, or the effectiveness of
regulation.
Each of these requirements is satisfied in this Transaction. The
acquisition is, therefore, appropriate on the basis of Section 11(b)(1).
Clause A. Clause A requires a showing that each of such additional
systems cannot be operated as an independent system without the loss of
substantial economies which can be secured by the retention of control by
such holding company of such system. The Commission has noted that, by its
terms, clause A of section 11(b)(1) requires the Commission to consider
whether an additional system can be operated as an independent system
"without the loss of substantial economies." The Commission has historically
given consideration to four ratios as a "guide" to determining whether lost
economies are "substantial" under Section 11(b)(1)(A). Specifically, the
Commission has examined the estimated loss of economies expressed in terms of
the ratio of increased expenses to the system's total operating revenues,
operating revenue deductions (excluding federal income taxes), gross income
and net income before federal income taxes. (See, e.g. WPL Holdings, Inc.,
HCAR No. 26856 (April 14, 1998); and New England Electric System, 41 S.E.C.
at 898-99).
In a number of early cases, the Commission considered the increases in
operational expenses that were anticipated upon divestiture, but also took
into account, as offsetting benefits, the significant competitive advantages
that were perceived to flow from a separation of gas and electric operations.
Among these was the assumption that a combination of gas and electric
operations is typically disadvantageous to the gas operations and,
conversely, the assumption that the public interest and the interests of
investors and consumers (the protected interests under the Act) are promoted
by a separation of gas and electric operations.
Utility companies and related entities are presently in the midst of, or
have completed, restructurings or major transactions designed to permit them
to become complete energy services companies, offering customers an array of
fuels to meet their complete energy needs through a "one-stop" energy
company, an industry shift that the Commission has expressly recognized.
Recently, the Commission has approved various transactions wherein a gas
company and electric company were combined. All of those transactions
demonstrate that market forces are pushing for the convergence of electric
and gas operations in one corporate entity; namely, a full service energy
utility company.
Thus, the traditional model of a vertically integrated gas or electric
utility company is becoming, in various regions of the country, obsolete and
evidence continues to mount that the model utility company of the near future
will be the one-stop energy company. Evidence of this trend in Connecticut is
the electric utility restructuring legislation passed in Connecticut in 1998
and which is intended to promote competition and a movement to an unregulated
energy market in Connecticut. The Commission has recognized this trend and
has heeded the Division's recommendation made in the Division Report to
"liberalize its interpretation of the "ABC clauses."
In the Division Report, the Division noted that "it does not appear that
the SEC's precedent concerning additional systems precludes the SEC from
relaxing its interpretation of Section 11(b)(1)(A)" and "that the utility
industry is evolving toward the creation of one-source energy companies that
will provide their customers with whatever type of energy supply they want,
whether electricity or gas." The Division recommended that the Commission
interpret Section 11(b)(1) of the Act to allow registered holding companies
to hold both gas and electric operations as long as each affected state
utility regulatory commission approves of the existence of such a company.
In the present situation, following consummation of the Merger, the
entire NU system will be operated as a single coordinated system to the
extent that there will be a significant degree of centralized services
(including accounting, financial planning and analysis, financial reporting,
human resources, information systems, insurance, legal, payroll, purchasing,
tax, treasury, billing support, facilities management, call center services,
construction and environmental services and general administrative services)
provided by NU subsidiaries. Thus, following consummation of the
Transaction, the NU system will consist of a large integrated electric
utility system and a smaller integrated gas utility system which together
will operate on a coordinated basis offering services to customers in
substantially the same area in the State of Connecticut.
Taking this industry evolution into account, it becomes clear that the
Transaction will provide NU with an efficient basis for entering into the
natural gas business and provide YES with greater financial and other
resources, allowing the NU system utilities, including YES, to remain
competitive with the emerging one-stop energy services companies. After the
merger, NU believes that it will be able to offer its customers a choice of
fuels (gas and/or electricity) to meet their energy needs at competitive
prices in a more economical and efficient manner.
As indicated above, in its analysis of the applicability of the ABC
Clauses to a specific transaction, the Commission has historically examined
the estimated loss of economies to the additional system expressed in terms
of the ratio of increased expenses to the system's total operating revenues,
operating revenue deductions (excluding federal income taxes), gross income
and net income before federal income taxes. (See, e.g. WPL Holdings, Inc.,
HCAR No. 26856 (April 14,1998); and New England Electric System, 41 S.E.C. at
898-99). Although the Commission has declined to draw a bright-line
numerical test under Section 11(b)(1)(A), it has indicated that cost
increases resulting in a 6.78% loss of operating revenues, a 9.72% increase
in operating revenue deductions, a 25.44% loss of gross income and a 42.46%
loss of net income would afford an "impressive basis for finding a loss of
substantial economies." Engineers Public Service Co., 12 S.E.C. 41, 59
(1942).
In New Century Energies, Inc., the Commission applied the ABC Clauses to
a proposed acquisition by a to-be-registered holding company. The Commission
reconsidered and rejected the emphasis in many of its earlier cases requiring
evidence of a severe, even crippling, effect of divestment upon the separated
system. The Commission stated that this approach is outmoded in the
contemporary utility industry. The Commission explained that as a result of
the convergence of the gas and electric industries now underway, separation
of gas and electric businesses may cause the separated entities to be weaker
competitors than they would be together. This factor therefore operates to
compound the loss of economies represented by increased costs. This view was
repeated in WPL Holdings, Inc. In WPL Holdings, the Commission noted that,
although franchised monopolies are still the rule, competition is increasing
and increased expenses of separate operation may no longer be offset, as they
were in New England Electric System, by a gain of qualitative competitive
benefits, but rather may be compounded by a loss of these benefits.
As indicated earlier, the Commission's decision in past precedents
pertaining to registered holding companies involved determining whether the
registered holding company (i.e. principally an electric system) could
retain a separate system (i.e. a gas system) after the combination of two
companies, at least one of which was a combined gas and electric company
prior to the business combination. The analysis of lost economies, then, was
measured as economies that would be lost as a result of the divestiture of
the gas properties of the holding company. These economies that existed for
the combination gas and electric company prior to the combination for which
approval was being sought were realized over time and accordingly they were
quantifiable by estimating the amount of expenses which would be incurred by
the gas company in order to create a stand alone company. These expenses can
be calculated, at least in part, at a specific point in time, post-
divestiture. In the NU/YES combination, neither company is a combination gas
and electric company. Accordingly, the economies which were lost in the
Commissions' precedents have not yet been realized. Consequently, the lost
economies in the instant situation should be measured as those economies that
are expected to be gained over time by the Merger but would not be realized
if the Merger were not approved. Economies lost upon the divestiture of a
gas company, however are not the same as economies immediately gained as a
result of a merger of two companies. Lost economies as a result of a
divestiture result from the need to replicate services once performed by the
combination company, the loss of economies of scale pertaining to physical
plant and office space and purchasing, and other factors. In an acquisition
or merger scenario, as exists here, these types of economies are realized
over time and often, as here, cannot be quantified as significant immediate
gains but rather as gains over time which will not be realized if the Merger
is not approved.
The combination of the gas operations of YES into the NU system are
presently expected to realize, after a period of four to five years,
significant cost savings NU currently expects that these cost savings will
amount to approximately $13.7 million annually. These potential cost savings
translate into lost economies, if the Merger is not approved. The amount of
annual cost savings, once realized, compare with 1999 gas operating revenues
of $276 million, 1999 gas operating revenue deductions (excluding
depreciation and other taxes) of $193 million; 1999 gas gross income of $29
million; and 1999 gas net income of $16 million.
As indicated above, although the Commission has declined to draw a
bright-line numerical test concerning lost economies, it has indicated that
cost increases resulting in a 6.78% loss of operating revenues, a 9.72%
increase in operating revenue deductions, a 25.44% loss of gross income and a
42.46% loss of net income would afford an "impressive basis for finding a
loss of substantial economies." As a percentage of Yankee Gas' 1999 gas
operating revenues ($276 million), the lost economies amount to 5.0%. As a
percentage of Yankee Gas' 1999 gas operating revenue deductions ($193
million), the lost economies amount to 7.1%. As a percentage of Yankee Gas'
1999 gas gross income ($29 million), the lost economies amount to 47.2% and
as a percentage of Yankee Gas' 1999 gas net income ($16 million), the lost
economies would equal 85.6%. The lost economies in relation to the gross gas
income and the net gas income are both higher than the standards set forth in
Engineers Public Service Co. while the lost economies in relation to gas
operating revenues and gas operating deductions are slightly lower.
In this matter, however, as in New Century Energies, Inc., other factors
operate to compound the loss of economies represented by the increased costs
set forth above. The Commission has previously taken notice of developments
that have occurred in the gas and electric industries in recent years, and
has interpreted the Act and analyzed proposed transactions in light of these
changed and changing circumstances (see, Consolidated Natural Gas Co., HCAR
No. 26512 (Apr. 30, 1996), New Century Energies, Inc., HCAR 26748, (August 1,
1997)). The Commission has repeatedly stated that it is of the view that
increased operational expenses are not alone sufficient to show satisfaction
of clause A (see, e.g., New Century Energies, HCAR No. 26748, Aug. 1, 1997,
New England Electric System, 41 S.E.C. 888, (1964), Standard Power and Light
Corp., HCAR No. 8242 (1948) (increased expenses are "not in and of
[themselves] determinative and cannot be regarded as conclusive proof of a
'loss of economies' in the amount of the increased expense"); and Engineers
Public Service Co., 12 S.E.C. 41, 62 (1942) (increased expenses are "not
necessarily equivalent to lost economies").
However, where in the past the Commission took into consideration the
benefits flowing from divestiture of the secondary utility, primarily in the
area of increased competition, the Commission has now recognized (see, e.g.
New Century Energies) that the gas and electric industries are converging
and, in these circumstances, separation of gas and electric businesses may
cause the separated entities to be weaker competitors than they would be
together. The Commission has previously noted that this factor now adds to
the quantifiable loss of economies caused by increased costs. The Applicant
believes that these factors must be considered in this situation and should
be viewed as a compelling factor in support of approval of the Merger.
NU's competitive position in the market would suffer because as the
utility industry moves toward a complete energy services concept, competitive
companies must be able to offer customers a range of options to meet their
energy needs. To date, the other two investor-owned LDCs in Connecticut have
announced business combinations with another utility, principally located
outside Connecticut. The same sort of merger and acquisition activity
concerning LDCs is also taking place in the other states of New England.
Given YES' size, it is apparent that it was necessary that YES combine with
another entity in order to continue to be a successful company. The Merger
allows YES to remain a part of a Connecticut utility system and will enable
NU and YES to offer their customers a significant and important option,
namely gas services. Refusal to approve the Transaction would compound the
increased costs described above because of a loss of qualitative competitive
benefits.
In addition, a substantial portion of the rationale for effecting the
Merger is the convergence of the electric and gas markets as the utility
industry evolves towards competition. NU and YES are seeking to create a
convergence company that will be an effective competitor. Limiting either NU
or YES to a single energy commodity through the refusal to authorize the
Merger would prevent each from realizing their combined competitive potential
and is not required as a matter of law.
The energy services company operating combination utilities offers a
wide range of benefits. For customers, an energy service company provides
the convenience and efficiency of service by a single energy provider and
reduces transaction costs incurred in gathering and analyzing information,
contacting energy suppliers, negotiating terms of services and paying bills.
For the communities in which an energy service company operates, combining
gas and electric operations simplifies community planning on energy-related
matters. For society, an energy service company is best able to ensure an
environmentally efficient allocation of energy. For utility shareholders and
employees, an energy service company is better able to respond to a
competitive environment and to remain an attractive investment opportunity
for shareholders and an appealing employer for utility employees.
Refusal to approve the Merger would also result in the loss to consumers
of the economies offered by the "energy services" approach of NU to the
utility business which would be realized if the Merger were approved. While
the losses cannot be fully quantified, they are clearly substantial. For the
energy services company, providing gas and electric products is only the
start of the job. Such a company must also provide enhanced service to the
consumer by providing an entire package of both energy products and services.
In this regard, the efforts of the NU system companies reflect a trend by
utilities to organize themselves as energy service companies which provide a
total package of energy services rather than merely supplying gas and
electric products. The goal of an energy service company is to retain its
current customers and obtain new customers in an increasingly competitive
environment by meeting customers' needs better than the competition. An
energy service company can provide the customer with a low cost energy (i.e.,
gas, electricity or conservation) option with a minimum of inefficient
subsidies.
As indicated, the proposed combination offers the Applicant a means to
compete more effectively in the emerging energy services business. The
Merger will not give rise to any of the abuses, such as ownership of
scattered utility properties, inefficient operations, lack of local
management or evasion of state regulation, that Section 11(b)(1) and the Act
generally were intended to prohibit. The Merger should have no effect upon
the ability of state ratemaking authorities to carry out their statutory
duties. As indicated earlier, the DPUC has approved the Merger and related
transactions.
As indicated above and in more recent Commission precedents, the
Commission has adopted a new model of regulation under the Act which permits
convergence of energy services under a registered holding company and which
promotes competition among energy providers. In New Century Energies, the
Commission relied on both increased expenses and the potential loss of
competitive advantages that could result from separation from the electric
system in approving the merger. The Applicant believes that, consistent with
recent prior practice, the Commission should approve the Merger, relying on
both the increased expenses set forth above and the loss of potential
competitive advantages if the Merger is not approved. For all of the
foregoing reasons, the Commission should hold that the combination of NU and
YES as described herein is lawful under the provisions of Section 8 and is
not detrimental to the carrying out of the provisions of Section 11.
(B) and (C) Clauses. Clause B of the ABC Clauses requires that the
additional system be located in one or adjoining states. This requirement is
met because the gas operations of YES are located in one state (Connecticut)
which is one of the states in which NU's electric properties are located.
Clause C requires that the combination of systems under the control of
the single holding company is not "so large . . . as to impair the advantages
of localized management, efficient operation, or the effectiveness of
regulation." This requirement is also met because the combination of the
gas operations under NU is not so large (considering the state of the art and
the area or region affected) as to impair the advantages of localized
management, efficient operation or the effectiveness of regulation. After
the combination, the electric operations of CL&P will continue to be the same
as it is today with some 1.1 million customers in Connecticut and will,
accordingly, remain the largest electric operation in the region. However,
the gas systems of YES are confined to a relatively small area, with only
185,000 customers. Moreover, based on data through December 31, 1998, and
giving effect to the Transaction, these gas assets will represent less than
5% of the total utility assets of NU, utility operating revenues for the gas
operations will represent only 7% of the total NU utility revenues as
compared with 93% for the electric operations; and customers of the gas
operations will constitute 14% of all NU utility customers while electric
operations will represent 86%. Moreover, as the Commission has recognized
elsewhere, the determinative consideration is not size alone or size in an
absolute sense, either big or small, but size in relation to its effect, if
any, on localized management, efficient operation and effective regulation.
Furthermore, the gas systems are confined to only part of one state and
will preserve the advantages of localized management, efficient operation and
effectiveness of regulation after the Merger. There are no additional gas
properties among NU system companies with which YES will be combined. The
gas properties after the Merger will be the same size as prior to the Merger.
Although the Merger will increase the size of the NU system, YES is located
in the same state where NU's largest electric utility subsidiary, CL&P, and
NU's corporate headquarters are located. Therefore, there will be no adverse
effect on localized management, efficient operation or effective regulation.
With respect to localized management, YES will be operated as a separate
subsidiary of NU and will continue to be headquartered in Connecticut and
management will remain in Connecticut, thereby preserving the advantages of
localized management. From the standpoint of regulatory effectiveness, YES
will be organized as a separate exempt holding company under the Act and will
consequently be subject to the regulation of the Commission under Section
3(a)(1) and Rule 2 of the Act, and Yankee Gas will continue to be regulated
by the DPUC, which will ensure the continued effectiveness of state
regulation. In addition, the DPUC must approve the Merger before it is
consummated thereby ensuring that the DPUC can continue to regulate the
combined system effectively. Finally, as detailed above, the gas operations
of YES over time will realize additional economies as a result of the Merger
as part of the NU system. Far from impairing the advantages of efficient
operation, the continued combination of the gas operations under NU will
facilitate and enhance the efficiency of gas operations.
ii. Retention of Other Businesses
As a result of the Transaction, the non-utility subsidiaries of YES
described in Item 1.B.2. above will become subsidiaries of Merger Sub and
therefore indirect subsidiaries of NU.
Standard for retention: Section 11(b)(1) permits a registered holding
company to retain "such other businesses as are reasonably incidental, or
economically necessary or appropriate, to the operations of [an] integrated
public utility system." Under the cases interpreting Section 11, an interest
is retainable if (1) there is an operating or functional relationship between
the operations of the utility system and the non-utility business sought to
be retained, and retention is in the public interest (see, e.g. Michigan
Consolidated Gas Co., 44 S.E.C. 361 (1970) aff'd 444 F.2d 913 (D.C. Cir.
1971)) or if (2) the business evolved out of the system's utility business,
the investment is not significant in relation to the system's total financial
resources, and the investment has the potential to produce benefits for
investors and/or consumers. (see, e.g. CSW Credit, Inc., HCAR No 25995
(1994); Jersey Central Power and Light Co., HCAR No. 24348 (March 18, 1987)).
In addition, the Commission has stated that "retainable non-utility interests
should occupy a clearly subordinate position to the integrated system
constituting the primary business of the registered holding company." (See,
e.g. United Light and Railways Co., 35 S.E.C. at 519). With respect to new
acquisitions, the Commission has interpreted Section 10(c)(1) of the Act to
mean that "any property whose disposition would be required under Section
11(b)(1) may not be acquired. (WPL Holdings, Inc., HCAR No. 26856 (April
14,1998)).
YES conducts non-utility operations through four active subsidiaries,
NorConn, Yankee Financial, YESCo and RMS. All four non-utility subsidiaries
are Connecticut corporations.
NorConn was formed in 1988 and its purpose is to hold non-utility
property interests that may be acquired by the Yankee Energy System. NorConn
owns YES' corporate office building and another service building and leases
both to Yankee Gas. There is clearly a functional relationship between the
operations of the utility system and NorConn, and retention is in the public
interest. (See, , New Century Energies, Inc., HCAR No. 26748 (Aug.1, 1997);
UNITIL Corp., HCAR No. 25524 (April 24, 1992); American Electric Power Co.,
HCAR No. 21898 (Jan. 27, 1981); and Commonwealth & Southern Corp., HCAR No.
7615 (Aug. 2, 1947)).
Yankee Financial, incorporated in 1992, offers energy equipment
financing for customers. Through a variety of programs, Yankee Financial
makes it possible for customers to acquire new equipment (i.e. gas, oil or
electric), upgrade existing equipment, and enhance the delivery of energy
services. Yankee Financial supports the growth of Yankee Gas and YESCo by
providing capital to fund the energy conversion needs of Yankee Gas'
commercial, industrial and residential customers as well as those of certain
noncustomers. Again, clearly there is an operating and functional
relationship between the operations of the utility system and the operations
of Yankee Financial, and retention is in the public interest. (See, New
Century Energies, Inc., HCAR No. 26748 (Aug.1, 1997); Central and South West
Corp., HCAR No. 26367 (Sept. 1, 1995); Entergy Corp., HCAR No. 25718 (Dec.
28, 1992); and Consolidated Natural Gas Co., HCAR No. 26234 (Feb. 23, 1995)).
YESCo provides a wide range of energy-related services for its
customers, including facility operations and maintenance, comprehensive
conversion equipment and control systems and mechanical and HVAC contracting.
Once again, there is clearly an operating or functional relationship between
the operations of the utility system and the business of YESCo, and retention
is in the public interest. (See, Columbia Energy Group, HCAR No. 26868 (May
6, 1998); Conectiv, Inc., HCAR No. 26832 (Feb. 25, 1998) and cases cited
therein).
RMS was created as a separate entity of YES in 1995 initially to provide
debt collection service to Yankee Gas and YESCo. Due to its excellent
performance, it began marketing its services to other utilities. In 1998,
RMS entered into a service agreement with Dun & Bradstreet Receivables
Management Services ("D&B"). Pursuant to the agreement, RMS will work with
D&B to provide consumer collections services to D&B's credit and collections
division, focused primarily on utility and telecommunications entities. With
the support of RMS, Yankee Gas has enjoyed one of the lowest uncollectible
rates among New England utilities. RMS satisfies the requirements of Section
11 as the RMS business evolved out of the system's utility business, and the
investment has the potential to produce benefits for investors and/or
consumers. The RMS business is a permissible activity under the "functional
relationship" test applied in Jersey Central Power & Light Company, HCAR No.
24348 (March 18, 1987). In that release, the Commission applied the
following three-prong test; whether: (1) the business had evolved in
connection with the system's utility business; (2) the investment in the
other business was not significant in relation to the system's total
financial resources; and (3) the investment had the potential to produce
benefits for investors or consumers. In this matter, the debt collection
service evolved in connection with debt collection services for Yankee Gas
and YESCo and there was little investment required to enable RMS to provide
these services to D&B and other businesses in relation to YES' total
financial resources. Lastly, the increased size of the business has the
potential to create benefits for customers and, ultimately, investors in
terms of lower costs to the system companies. The retention of RMS therefore
should be allowed because it satisfies the requirements of Section 11.
A number of general considerations support NU's retention of the non-
utility businesses of YES as subsidiaries of Merger Sub. First, as indicated
above, the businesses in question provide benefits to customers, investors
and the public. Second, the Transaction is, at heart, a utility combination,
in which the non-utility businesses are small and only incidentally involved,
amounting, in the aggregate, to less than 11% of consolidated revenues of the
YES system for the fiscal year ended September 30, 1998 and less than 1% of
the pro forma 1998 consolidated revenues of the NU system after giving effect
to the Merger. Accordingly, the nonutility businesses sought to be retained
will clearly occupy a subordinate position to the integrated electric and gas
system which will constitute the primary business of NU. Third, this is not
a case in which an existing registered holding company system is acquiring
solely non-utility interests; rather, NU is only seeking authorization to
retain the non-utility interests held by YES before the Transaction. Lastly,
these non-utility subsidiaries existed as subsidiaries of YES when YES was
exempted from the Act and, after the Merger, will be held directly by Merger
Sub, a registered holding company under the Act, as successor to YES. For
these reasons, NU submits that the Commission should find that retention of
YES' non-utility systems as subsidiaries of Merger Sub is permitted under
section 11(b)(1).
2. Section 10(c)(2)
Section 10(c)(2) requires that the Transaction tend toward the
economical and efficient development of an integrated public utility system,
thereby serving the public interest.
i. Efficiencies and Economies.
The Transaction will over time produce economies and efficiencies
sufficient to satisfy the standards of Section 10(c)(2). Although the
anticipated economies and efficiencies will be fully realizable only in the
longer term, they are properly considered in determining whether the
standards of Section 10(c)(2) have been met. See American Electric Power Co.,
46 S.E.C. 1299, 1320-21 (1978). The potential benefits cannot be precisely
estimated; nevertheless they too are entitled to be considered: "[S]pecific
dollar forecasts of future savings are not necessarily required; a
demonstrated potential for economies will suffice even when these are not
precisely quantifiable." Centerior Energy Corp., HCAR No. 24073 (April 29,
1986).
Over time, the Merger is expected to yield several types of benefits:
(1) corporate and operations labor cost savings; (2) corporate and
administrative programs cost savings; and (3) non-fuel purchasing economies
savings. Within four to five years of the consummation of the Merger, NU
anticipates that the benefits will approximate $13.7 million in annual cost
savings. As indicated earlier in this Application, the Commission's
decisions in past precedents pertaining to business combinations of gas and
electric companies involved the combination of two companies, at least one of
which was a combined gas and electric company prior to the business
combination. In this situation, neither NU nor YES is a combination company.
Accordingly, the above-referenced benefits realized as a result of the Merger
will be available to YES and the rest of the NU system and consist of the
same $13.7 million in annual benefits which were classified as lost economies
in the analysis of the ABC clauses under Section 11(b)(1) earlier in this
Application. Subsequent to the Merger, however, any benefits realized by YES
will also benefit the NU system, including the operating subsidiaries.
Integration of Corporate and Administrative Functions: In the long term,
NU will be able to consolidate certain corporate and administrative functions
of NU and YES, thereby eliminating duplicative positions, reducing other non-
labor corporate and administrative expenses and limiting or avoiding
duplicative expenditures. These include savings related to information
systems, insurance costs, outside services, shareholder services, benefits
administration and other general and administrative overheads. The aggregate
cost of these items for the companies on a stand-alone basis is greater than
the cost will be to the combined new company. An example would be the hiring
of one outside professional service (external auditors, attorneys,
consultants, etc.) instead of two. A joint transition task force is
examining the manner in which to best organize and manage the businesses of
NU after the Merger and identify duplicative positions in the corporate and
administrative areas. It is anticipated that, as a result of combining staff
and other functions, NU will have somewhat fewer employees within several
years than NU and YES currently have in the aggregate. NU and YES are
committed to achieve cost savings in the area of personnel reductions through
attrition, strictly controlled hiring, and reassignment and retraining and,
to the extent required, severance and targeted early retirement programs. In
addition, some savings in areas such as insurance and regulatory costs and
legal, audit and consulting fees are expected to be realized.
Non-Fuel Purchasing Economies Savings: These are the savings which will
result from the new, larger company having greater purchasing power. As a
result of the Merger, YES will be able to coordinate its purchasing needs,
buy in greater quantity, negotiate with vendors and receive larger discounts.
Additional Expected Benefits: In addition to the benefits described
above, there are other benefits which, while presently difficult to quantify,
are nonetheless substantial. These other benefits include maintenance of
competitive rates and services, increased size and stability, coordination of
diversification programs and expanded management resources.
Maintenance of Competitive Rates: NU will be more effective in meeting
the challenges of the increasingly competitive environment in the utility
industry than either NU or YES standing alone due to the economies of scale
available to NU in the long term. The impact of these economies of scale
will help to position NU to deal effectively with increased competition with
respect to rates. The Merger, by creating the potential for increased
economies of scale over time, will create the opportunity for strategic,
financial and operational benefits for customers in the form of more
competitive rates over the long term and for shareholders in the form of
greater financial strength and financial flexibility.
Increased Size and Stability: The combination of NU and YES will create
a significantly larger company than YES. The increased size and stability of
such a larger company with operating utilities in three states will provide
YES with a greater chance to compete with other LDCs in Connecticut which,
after their mergers are consummated, will be part of a utility system much
larger than YES standing alone. In addition, through the use of the combined
equity, management, human resources and technical expertise of each company,
NU will be able to achieve greater financial stability and strength and
greater opportunities for earnings and dividend growth.
Coordination of Diversification Programs: NU and YES each have
significant non-utility subsidiaries, and NU, as a larger financial entity,
should be able to manage and pursue such subsidiary businesses more
efficiently and effectively. NU and YES currently engage in a number of
diversified businesses, some of which are complementary. To the extent such
complementary businesses are combined and able to collaborate in the pursuit
of market opportunities, benefits from economies of scale should be obtained
and thereby improve the performance of these businesses. Furthermore, due to
the larger capital base of NU after the Merger, the financial flexibility
will exist to support the existing businesses as well as to take advantage of
new business opportunities as they arise.
Expanded Management Resources: In combination, NU and YES will be able
to draw on a larger and more diverse mid- and senior-level management pool to
lead NU forward in an increasingly competitive environment for the delivery
of energy and should be better able to attract and retain the most qualified
employees. The employees of NU and YES should also benefit from new
opportunities in the expanded organization.
ii. Integrated Public Utility System
I. Electric System
As applied to electric utility companies, the term "integrated public
utility system" is defined in Section 2(a)(29)(A) of the Act as:
a system consisting of one or more units of generating plants
and/or transmission lines and/or distributing facilities, whose
utility assets, whether owned by one or more electric utility
companies, are physically interconnected or capable of physical
interconnection and which under normal conditions may be
economically operated as a single interconnected and coordinated
system confined in its operation to a single area or region, in one
or more states, not so large as to impair (considering the state of
the art and the area or region affected) the advantages of
localized management, efficient operation, and the effectiveness of
regulation.
On the basis of this statutory definition, the Commission has established
four standards that must be met before the Commission will find that an
integrated public utility system will result from a proposed acquisition of
securities:
(1) the utility assets of the system are physically interconnected or
capable of physical interconnection;
(2) the utility assets, under normal conditions, may be economically
operated as a single interconnected and coordinated system;
(3) the system must be confined in its operations to a single area or
region; and
(4) the system must not be so large as to impair (considering the state
of the art and the area or region affected) the advantages of
localized management, efficient operation, and the effectiveness of
regulation.
Environmental Action, Inc. v. S.E.C., 895 F.2d 1255, 1263 (9th Cir. 1990)
(citing In re Electric Energy, Inc., 38 S.E.C. 658, 668 (1958)). NU's
electric properties are physically interconnected and have been operated as a
single interconnected and coordinated system limited to a single region, the
states of Connecticut, New Hampshire and Massachusetts. Furthermore, the NU
system is not so large as to impair the advantages of localized management,
efficient operation and the effectiveness of regulation. Lastly, NU is a
public utility holding company registered under the Act.
II. Gas Utility System
Section 2(a)(29)(B) of the Act defines an "integrated public utility
system" as applied to gas utility companies as:
a system consisting of one or more gas utility companies which are so
located and related that substantial economies may be effectuated by
being operated as a single coordinated system confined in its operation
to a single area or region, in one or more states, not so large as to
impair (considering the state of the art and the area or region
affected) the advantages of localized management, efficient operation,
and the effectiveness of regulation: provided, that gas utility
companies deriving natural gas from a common source of supply may be
deemed to be included in a single area or region.
The YES gas properties are clearly an integrated system as they are part
of one company operated as a single coordinated system limited in its
operation to the State of Connecticut.
For the foregoing reasons, the provisions of Section 10(c)(2) are met.
C. Section 10(f)
Section 10(f) provides that:
The Commission shall not approve any acquisition as to which an
application is made under this section unless it appears to the
satisfaction of the Commission that such State laws as may apply in
respect to such acquisition have been complied with, except where the
Commission finds that compliance with such State laws would be
detrimental to the carrying out of the provisions of section 11.
As described in Item 4 of this Application/Declaration, and as evidenced
by the application made by the Applicant to the DPUC, NU intends to comply
with all applicable state laws related to the proposed transaction.
D. Other Statutory Provisions - Section 6(a) and 7
The issuance of stock by Merger Sub to NU, the issuance of NU Common
Shares in connection with the Merger and the issuance of the short or long
term debt to satisfy the cash portion of the consideration are subject to
Sections 6 and 7 of the Act.
Section 7(c) sets forth the requirements to be met for the issuance of
securities by registered public utility holding companies. Section 7(c)(1)
essentially requires that the registered company issue only common stock or
debt which is secured by a lien on a physical asset of the company or
indirectly secured by a physical asset of a subsidiary. Certain refunding
obligations are also permitted.
Under Section 7, the Commission shall not permit a declaration regarding
the issue or sale of a security to become effective unless it finds that:
(1) such security is (A) a common stock having a par value and
being without preference as to dividends or distributions over and having at
least equal voting rights with any outstanding security of the declarant; (B)
a bond (i) secured by a first lien on physical property of the declarant, or
(ii) secured by an obligation of a subsidiary company of the declarant
secured by a first lien on physical property of such subsidiary company, or
(iii) secured by any other assets of the type and character which the
Commission by rules and regulations or order may prescribe as appropriate in
the public interest or for the protection of investors; (C) a guaranty of, or
assumption of liability on, a security of another company; or (D) a
receiver's or trustee's certificate duly authorized by the appropriate court
or courts.
The NU Common Shares to be issued in connection with the Merger have a
par value of $5 per share and are of the same type and class of securities
which NU currently has outstanding and which is tradable on the New York
Stock Exchange. The common stock of Merger Sub to be issued to NU will be
the only class of stock of Merger Sub outstanding. As indicated earlier, NU
intends to comply with all state laws concerning the Merger and issuance of
shares, including the relevant Connecticut "blue sky" securities laws.
Accordingly, the provisions of Sections 6(a) and 7 are satisfied with respect
to both the issuance of common stock by Merger Sub to NU and the issuance by
NU of the NU Common Shares to satisfy the stock portion of the consideration
payable in connection with the Transaction.
In addition, subparagraph (2) of Section 7(c) permits other securities
to be issued if certain criteria are met:
"such security is to be issued or sold solely (A) for the purpose
of refunding, extending, exchanging or discharging an outstanding security of
the declarant and/or a predecessor company thereof or for the purpose of
effecting a merger, consolidation or other reorganization; (B) for the
purpose of financing the business of the declarant as a public-utility
company; (C) for the purpose of financing the business of the declarant, when
the declarant is neither a holding company nor a public-utility company;
and/or (D) for necessary and urgent corporate purposes of the declarant
where the provisions of [Section 7(c)(1)] would impose an unreasonable
financial burden upon the declarant and are not necessary or appropriate in
the public interest or for the protection of investors or consumers."
In order for the Commission to issue an order permitting the issuance
of a security not complying with Section 7(c)(1), Section 7(c)(2)(A) requires
that the proposed financing be for the purpose of effecting a merger, which
is plainly the case here. Alternatively, Section 7(c)(2)(D) requires that
the proposed financing (i) be for necessary and urgent corporate purposes of
the declarant, (ii) where the provisions of Section 7(c)(1) would impose an
unreasonable financial burden upon the declarant and are not necessary or
appropriate in the public interest or for the protection of investors or
consumers. NU submits that the proposed issuance of short or long term debt
is for the purposes of effecting a merger or, alternatively, for a necessary
and urgent corporate purpose in that it is for the financing of the cash
portion of the consideration payable in connection with the merger of YES
with and into NU. Also, compliance with the provisions of Section 7(c)(1)
would impose an unreasonable financial burden on the declarant by imposing a
more costly and unnecessary means of raising the needed capital. Compliance
with the provisions of Section 7(c)(1) is not necessary or appropriate in the
public interest or for the protection of investors or consumers.
1. The proposed debt issuance is required for a necessary and urgent
corporate purposes of the declarant.
The proposed financing is required to consummate the Transaction
which the Applicant believes is an urgent corporate purpose which will enable
the Applicant to compete effectively in the rapidly changing gas and electric
industry. As indicated earlier in this Application, the Commission has
already acknowledged that the electric and gas industries are converging and
that separation of gas and electric businesses may cause the separated
entities to be weaker competitors than they would otherwise be together. The
Commission has recognized that the combination of electric and gas operations
in a single company offers that company a means to compete more effectively
in the emerging energy services .
2. Compliance with the provisions of Section 7(c)(1) would impose an
unreasonable burden on the Declarant.
In the absence of an order under Section 7(c)(2)(D) permitting the
issuance of the short or long-term debt by NU, there would be three practical
avenues open to NU, as one of a few registered holding companies, to finance
investments in permissible energy-related businesses: common stock, short-
term debt and subsidiary level financing guaranteed by NU. All would impose
an unreasonable cost on NU when compared to the cost of long term financing
by NU. Long term debt issuance by NU would be the most efficient, least
costly and therefore most competitive means of raising capital for the
Transaction.
3. Compliance with Section 7(c)(1) is neither necessary nor appropriate
in the public interest or for the protection of investors or consumers.
The adequacy of the underlying assets and income stream will be
attested for by either the willingness of sophisticated institutions and
banks to provide funds to NU for this purpose or, in the case of rated
securities, the rating agency evaluating the debentures. Today rating
agencies and disclosure laws provide the investor with adequate information
concerning a security. The ownership of a debenture issued by a parent
holding company in a system where subsidiaries also have debt outstanding is
similar to that of a minority common stock holder. As was stated by the
Commission in the Release proposing amendments to Rule 52 to, among other
things, delete the requirement that common stock only by issued to the parent
company:
"The Commission, in the early years of the Act's history, was concerned
about the ability of the stock purchaser to evaluate without adequate and
verifiable disclosure, the potential disadvantages of owning a minority
interest. The situation is quite different now. Accurate information is
readily available to the investor though prospectuses, 10-K filings and other
public information, which allows the investor to make an informed decision as
to the advisability of purchasing a minority interest. Thus, the Commission
believes there may no longer exist valid reasons to prohibit the public-
utility subsidiaries of registered holding companies from financing in a
manner available to corporate subsidiaries generally." (See HCAR No. 25059,
dated March 19, 1990).
Thus, the Commission has quite clearly indicated that two-tier
debt financing may be appropriate today and compliance with Section 7(c)(1)
is not necessary for the protection of investors. As discussed above, some
debt financing by NU as part of an overall financing program is the most
efficient, least costly and therefore most competitive means for NU to fund
the cash portion of the consideration payable in connection with the
Transaction.
Section 7(d) sets forth specific findings that, if made, preclude
the Commission from permitting the application to go effective. None of such
findings should be made in connection with the authorizations sought hereby:
i. the security is not reasonably adapted to the security structure of the
declarant and other companies in the same holding company system;
At a 10-year targeted maturity date, NU anticipates that the cash
flow from YES will be sufficient to service and fully amortize the debt
issued.
ii. the security is not reasonably adapted to the earning power of the
declarant;
The ability of NU to meet its interest obligations hinges on the
earnings of its subsidiaries. NU will have the financial capacity to
discharge all of its payment obligations without adversely affecting the
operating companies.
iii. financing by the issue and sale of the particular security is not
necessary or appropriate to the economical and efficient operation of a
business in which the applicant is engaged or has an interest;
As discussed above, financing with short or long term debt offers
distinct advantages over alternative means of obtaining funding.
iv. the fees, commission, or other remuneration, to whomsoever paid,
directly or indirectly, in connection with the issue, sale or distribution
of the security are not reasonable;
As discussed above, the fees, commissions, expenses and margins
referenced in Item 1 and Item 2 are reasonable.
v. the terms and conditions of the issue or sale of the security are
detrimental to the public interest or the interest of investors or consumers.
The investor and public interest issues are discussed above.
For the above reasons, the Applicant request approval for the issuance
of short- or long- term debt in an amount not to exceed $275 million to
satisfy the cash portion of the consideration in connection with the
Transaction and for refunding purposes through June 30, 2002.
Item 4. Regulatory Approvals.
Set forth below is a summary of the regulatory approvals that NU and YES
have obtained in connection with the Merger in addition to the approval of
the Commission under the Act.
A. Antitrust Considerations
Under the HSR Act, NU and YES cannot consummate the Merger until each
has submitted certain information to the Antitrust Division of the DOJ and
the FTC. Additionally, each company must satisfy specified HSR Act waiting
period requirements. The required filings were made by NU and YES on October
29, 1999 and accelerated termination of the waiting period was requested.
The waiting period has expired without comment. The expiration of the HSR
Act waiting period does not prevent the DOJ or the FTC from challenging the
Merger on antitrust grounds. Neither NU nor YES believes that the Merger
will violate Federal antitrust laws. If the Merger is not consummated within
12 months after the expiration of the HSR Act waiting period, NU and YES must
submit new information to the DOJ and the FTC, and a new HSR Act waiting
period will begin.
B. Department of Public Utility Control
NU and YES have filed a joint application with the DPUC, seeking
authorization and approval of the Merger. A copy of the application is filed
as Exhibit d.1. The DPUC approved the merger on December 29, 1999. A copy
of the Decision is filed as Exhibit d.2.
C. Federal Communications Commission
YES has filed the necessary applications with the Federal Communications
Commission to seek approval to transfer certain telecommunications licenses
which it currently holds and which are necessary for the operation of YES'
gas business.
D. Other Regulatory Matters
NU and YES and their respective subsidiaries have obtained from various
regulatory authorities certain franchises, permits and licenses which may
need to be renewed, replaced or transferred in connection with the Merger,
and approvals, consents or notifications may be required in connection with
such renewals, replacements or transfers.
Item 5. Procedure
The Applicant respectfully requests the Commission's approval, pursuant
to this Application/Declaration, of all transactions described herein,
whether under the sections of the Act and Rules thereunder enumerated in Item
3 or otherwise. It is further requested that the Commission issue an order
authorizing the transactions proposed herein at the earliest practicable date
but in any event not later than February 1, 2000. Additionally, the
Applicant (i) requests that there not be any recommended decision by a
hearing officer or by any responsible officer of the Commission, (ii)
consents to the Office of Public Utility Regulation within the Division of
Investment Management assisting in the preparation of the Commission's
decision, and (iii) waives the 30-day waiting period between the issuance of
the Commission's order and the date on which it is to become effective, since
it is desired that the Commission's order, when issued, become effective
immediately.
Item 6. Exhibits and Financial Statement
(a) Exhibits
b.1 Merger Agreement between Northeast Utilities and Yankee Energy
System, Inc. dated as of June 14, 1999 (See Exhibit 1 in NU's
Current Report on Form 8-K dated June 14, 1999, File No. 1-
5324)*
c.1 Joint Proxy and Registration Statement on Form S-4*
d.1 Application to the Department of Public Utility Control*
d.2 Order from the Connecticut Department of Public Utility
Control
d.3 Analysis of Certain Economic Impacts
f.1 Legal Opinion*
g.1 Financial Data Schedule*
h.2 Form of Notice*
(b) Financial Statements*
* previously filed
Item 7. Information as to Environmental Effects
The Transaction neither involves a "major federal action" nor
"significantly affects the quality of the human environment" as those terms
are used in Section 102(2)(C) of the National Environmental Policy Act, 42
U.S.C. Sec. 4321 et seq. The only federal actions related to the Transaction
pertain to the Commission's declaration of the effectiveness of the
Registration Statement of NU and YES on Form S-4, the approvals and actions
described under Item 4 and Commission approval of this
Application/Declaration. Consummation of the Transaction will not result in
changes in the operations of NU, YES or any of their respective subsidiaries
that would have any impact on the environment. No federal agency is
preparing an environmental impact statement with respect to this matter.
Other Matters
Except in accordance with the Act, neither NU nor any subsidiary thereof
(a) has acquired an ownership interest in an exempt wholesale generator
("EWG") or a foreign utility company ("FUCO") as defined in Sections 32 and
33 of the Act, or (b) now is or as a consequence of the transactions proposed
herein will become a party to, or has or will as a consequence of the
transactions proposed herein have a right under, a service, sales, or
construction contract with an EWG or a FUCO. None of the proceeds from the
transactions proposed herein will be used by NU and its subsidiaries to
acquire any securities of, or any interest in, an EWG or a FUCO.
NU and its subsidiaries are in compliance with Rule 53(a), (b), and (c),
as demonstrated by the following determinations:
(i) NU's aggregate investment in EWGs and FUCOs (i.e., amounts invested
in or committed to be invested in EWGs and FUCOs, for which there
is recourse to NU) does not exceed 50% of NU and its subsidiaries'
consolidated retained earnings as reported for the four most recent
quarterly periods on NU's Form 10-K and 10-Qs. As of March 31 ,
1999, the ratio of such investment ($ 49 million) to such
consolidated retained earnings ($624 million) was 7.9 percent.
(ii) Ave Fenix (NU's only EWG or FUCO at this time) maintains books and
records, and prepares financial statements in accordance with Rule
53(a)(2). Furthermore, NU has undertaken to provide the Commission
access to such books and records and financial statements, as it
may request.
(iii) No employees of NU's public utility subsidiaries have rendered
services to the EWGs/FUCOs.
(iv) NU has submitted (a) a copy of each Form U-1 and Rule 24
certificate that has been filed with the Commission under Rule 53
and (b) a copy of Item 9 of the Form U5S and Exhibits G and H
thereof to each state regulator having jurisdiction over the retail
rates of NU's public utility subsidiaries.
(v) Neither NU nor any subsidiary has been the subject of a bankruptcy
or similar proceeding unless a plan of reorganization has been
confirmed in such proceeding. In addition, although NU's average
consolidated retained earnings ("CREs") for the four most recent
quarterly periods have decreased by 10% or more from the average
for the previous four quarterly periods (at March 31 ,1998 , NU's
CREs were $ 715 million; at March 31, 1999 NU's CREs were $624
million), NU's aggregate investment in EWGs/FUCOs at such date($ 49
million) did not exceed two percent of NU's consolidated capital
invested in utility operations ($124 million).
(vi) In the previous fiscal year, NU did not report operating losses
attributable to its investment in EWGs/FUCOs, unless such losses
did not exceed 3 percent of NU's consolidated retained earnings.
SIGNATURES
Pursuant to the requirement of the Public Utility Holding Company Act of
1935, as amended, the undersigned companies have duly caused this statement
to be signed on their behalf by the undersigned thereunto duly authorized.
Date: January 11, 2000
NORTHEAST UTILITIES
By /s/ David R. McHale
Name: David R. McHale
Title: Vice President and Treasurer
Exhibit d.2
STATE OF CONNECTICUT
DEPARTMENT OF PUBLIC UTILITY CONTROL
TEN FRANKLIN SQUARE
NEW BRITAIN, CT 06051
DOCKET NO. 99-08-02 JOINT APPLICATION OF NORTHEAST UTILITIES AND
YANKEE ENERGY SYSTEMS, INC., FOR APPROVAL OF A
CHANGE OF CONTROL
December 20, 1999
By the following Commissioners:
Jack R. Goldberg
Donald W. Downes
Linda Kelly Arnold
DECISION
I. INTRODUCTION
A. Summary
In this Decision, pursuant to 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 Northeast Utilities Corporation and the Yankee Gas
Services Company to acquire control of the Yankee Gas Services Company. The
Yankee Gas Services Company is a wholly-owned subsidiary of Yankee Energy
System. Northeast Utilities has the financial, technological and managerial
suitability and responsibility to control the Yankee Gas Services Company.
In addition, Northeast Utilities 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. Companies' Proposal
Northeast Utilities (NU) and Yankee Energy System (YES; together,
Companies), the corporate parent of Yankee Gas Services Company (Yankee Gas),
jointly request that the Department of Public Utility Control (Department)
approve the change of control of Yankee Gas to NU. The Companies request
that the Department determine that NU has satisfied the requirements of the
General Statutes of Connecticut (Conn. Gen. Stat.) 16-47 to become a holding
company of Yankee Gas. (Application) Specifically, the Companies request
that the Department find that: (a) NU, through its present operations
generally and through its operation of The Connecticut Light and Power
Company (CL&P) in particular, has demonstrated to the Department that it is
financially, technologically and managerially suitable and responsible to
acquire control of Yankee Gas; and (b) Yankee Gas will continue to provide
safe, adequate and reliable service to the public through its plant,
equipment and manner of operation.
C. Conduct of the Proceeding
By Notice of Hearing dated August 24, 1999, the Department conducted a
public hearing in this matter on September 3, 22, and 27, and October 8, and
19, and November 5, 1999, at its offices, Ten Franklin Square, New Britain,
Connecticut.
In separate letters dated August 13, 1999, YES and NU waived the
requirement of Conn. Gen. Stat. 16-47 that a hearing be held within 30 days
of the filing of the Application. In a letter dated September 3, 1999, NU
waived the requirement of Gen. Stat. 16-47(d) that the Department issue a
Decision within 120 days of the filing of the Application.
D. Parties and Intervenors
The Department recognized Northeast Utilities, 107 Selden Street,
Berlin, CT 06037-1616; Yankee Energy System, Inc., 599 Research Parkway,
Meriden, CT 06540; and the Office of Consumer Counsel (OCC), Ten Franklin
Square, New Britain, CT 06051, as parties to the proceeding.
E. Public Comment
No public comment was offered at any of the hearings.
II. COMPANIES' EVIDENCE
A. DESCRIPTION OF NU
NU, a Massachusetts business trust headquartered in Berlin, Connecticut,
is the parent company of the Northeast Utilities System (NU System) and a
registered holding company under the Public Utility Holding Company Act of
1935 (PUHCA). The NU System has approximately 1.7 million utility customers,
serving approximately 30 percent of New England's electric needs, and is one
of the 24 largest electric utility systems in the country as measured by
revenues. NU is not itself an operating company or a public service company.
As of March 31, 1999, NU had total assets of $10.4 billion, with operating
revenues of $3.77 billion for the year ended December 31, 1998. As of June
30, 1999, NU System companies had 9,034 full and part-time employees.
The NU System has furnished franchised retail electric service in
Connecticut, New Hampshire and western Massachusetts through NU's wholly-
owned operating company subsidiaries: CL&P, Public Service Company of New
Hampshire (PSNH), Western Massachusetts Electric Company (WMECO) and Holyoke
Water Power Company (HWP; collectively, NU Operating Companies). In addition
to their retail electric service business, the NU Operating Companies
(including HWP through its wholly-owned subsidiary, Holyoke Power and
Electric Company) also furnish wholesale electric service to various
municipalities and other utilities and participate in limited retail access
programs, providing off-system retail service.
Several wholly-owned subsidiaries of NU provide support services for the
NU System companies and, in some cases, for other New England utilities.
Northeast Utilities Service Company (NUSCO) provides centralized accounting,
administrative, information resources, engineering, financial, legal,
regulatory, operational, planning, purchasing and other services to the NU
System companies. North Atlantic Energy Service Corporation has operational
responsibility for the Seabrook nuclear power plant. Northeast Nuclear
Energy Company acts as agent for the NU System companies and other New
England utilities in operating the Millstone nuclear generating facilities.
Rocky River Realty Company, The Quinnehtuk Company, and Properties, Inc.
build, acquire or lease some of the property and facilities used by the NU
System companies.
The NU System also includes a number of non-regulated subsidiaries,
among them: NU Enterprises, Inc., a direct subsidiary of NU, which acts as a
holding company for non-regulated businesses; Northeast Generation Company,
formed to acquire and manage generating facilities; Northeast Generation
Service Company, which provides operating and environmental services,
preventative maintenance and other services to generators and large
customers; and Select Energy, Inc., a retail energy services and power
marketing company.
Other nonregulated NU subsidiaries include: HEC, an energy engineering
and design firm serving energy and water utilities and large consumers; Mode
1 Communications, which owns approximately 30 percent of NorthEast Optic
Network, Inc. (NEON), a fiber-optic telecommunications carrier; Select Energy
Portland Pipeline, Inc., formed to hold a five percent partnership interest
in the Portland Natural Gas Transmission System pipeline that has recently
commenced operations in northern New England; and North Atlantic Energy
Corporation, which owns 36 percent of the Seabrook nuclear generating plant.
B. DESCRIPTION OF YES
YES is a public utility holding company incorporated in Connecticut in
1988 to acquire the gas utility assets and operations held by CL&P. Prior to
the formation of YES, the gas business now owned and operated by Yankee Gas
was part of the NU system and was operated on an integrated basis as part of
CL&P. In 1989, the Department approved the spin-off of YES in the Decision
dated December 21, 1988, in Docket No. 88-04-28, Application of The
Connecticut Light and Power Company for Approval of Steps Regarding
Divestiture of Gas Business. YES is primarily engaged in the purchase and
retail distribution of natural gas to residential, industrial and commercial
customers in Connecticut through its wholly-owned subsidiary Yankee Gas.
YES, headquartered in Meriden, Connecticut, is the holding company for Yankee
Gas and four active non-utility subsidiaries.
Yankee Gas, a Connecticut public service company under the Department's
jurisdiction and the principal subsidiary of YES, purchases, distributes and
sells natural gas to approximately 185,000 residential, commercial and
industrial users in Connecticut, of which approximately 170,000 are also CL&P
customers. The Yankee Gas service territory of 69 Connecticut cities and
towns, covers approximately half of Connecticut's land area, all within the
service territory of CL&P. Yankee Gas owns approximately 2,820 miles of
distribution mains, 133,000 miles of service lines; service facilities
located in Meriden, Waterbury, Torrington, Mystic, Shelton, Bethel and
Danielson; various propane facilities with a combined storage capacity of
approximately 245,000 million cubic feet (Mcf); and six gas storage holders.
All of these assets are located in Connecticut. Yankee Gas provides firm gas
sales service to customers who require a continuous gas supply throughout the
year, and interruptible gas sales to some commercial and industrial customers
that have the capability to switch from natural gas to an alternative fuel on
short notice. Yankee Gas also offers firm and interruptible transportation
services to customers who purchase gas from sources other than Yankee Gas.
YES conducts non-utility operations through four subsidiaries: NorConn
Properties, Inc., which holds property such as the YES headquarters building
in Meriden and a Yankee Gas service building in East Windsor; Yankee Energy
Financial Services Company, which provides equipment and home improvement
financing to energy consumers and municipal utilities across the country;
Yankee Energy Services Company, which provides building automation services,
heating, ventilation and air conditioning, boiler and refrigeration equipment
services and installation; and R.M. Services, Inc., created initially to
provide debt collection service to Yankee Gas, but now marketing services to
other utilities and to Dun & Bradstreet Receivables Management Services, and
providing consumer collection services focused primarily on utility and
telecommunications businesses.
C. DESCRIPTION OF TRANSACTION
1. Merger
Through the proposed change of control transaction (Merger), YES would
merge with and into Merger Sub, a to-be-formed wholly-owned subsidiary of NU
that would be created solely for purposes of effecting the Merger. Merger
Sub would take on the name and operations of YES upon the effectiveness of
the Merger. Upon consummation of the Merger, YES would become a first-tier
subsidiary of NU and would continue to own all of the outstanding common
stock of Yankee Gas as well as its related non-utility businesses. Although
Merger Sub would be the surviving company, upon the Merger it would change
its name to Yankee Energy System, Inc. and continue to act as a holding
company for YES' utility and non-utility operations after the Merger. There
is no direct or indirect merger of public service companies. CL&P, a
Connecticut electric distribution company, would remain a direct operating
subsidiary of NU. Yankee Gas and CL&P would continue to be subject to
regulation by the Department. Application, p. 6.
The transaction would be consummated pursuant to an Agreement and Plan
of Merger dated as of June 14, 1999, by and between NU and YES (Merger
Agreement). The Companies seek to close the Merger by late 1999 or in
January 2000. Since NU would indirectly own 100 percent of the common stock
of Yankee Gas after the Merger, this Application requests Department approval
of the acquisition and exercise of control by NU over Yankee Gas. Id.
The Merger was approved by the YES Board of Directors on June 14, 1999,
and by the NU Board of Trustees on June 8, 1999. Application, p. 14. The
Merger was approved by YES shareholders on October 12, 1999. NU/YES Brief,
pp. 6-7.
On a pro forma basis, giving effect to the Merger, the combined company
would serve approximately 1.3 million utility customers, with combined assets
of approximately $11 billion as of March 31, 1999, and approximately $4.06
billion in combined operating revenues for the year ended December 31, 1998.
Response to Interrogatory EL-6.
2. Stock Exchange Process and Value
The Merger Agreement provides that holders of outstanding YES shares can
choose to convert their YES shares into cash, into NU common shares having a
value of $45 per share of YES common stock, or some combination of shares and
cash.(1) The per share consideration of $45.00 represents a premium for YES
shares of approximately 38 percent over the $32.50 per share price of the
Yankee shares on June 14, 1999, the last trading day before the announcement
of the Merger. NU intends to fund the cash consideration to be paid to YES
shareholders with internal resources. To the extent necessary, NU contends
that it will have access to sufficient short-term and long-term capital
financing at reasonable rates to meet its obligations under the Merger
Agreement. Id., pp. 14-15.
(1) This excludes those shareholders who do not vote in favor of the Merger
and have properly demanded dissenters' rights under Connecticut law.
The Merger would be accounted for under the purchase method of
accounting in accordance with generally accepted accounting principles. The
purchase price would be allocated to YES utility and non-utility assets and
liabilities based on their estimated fair market values at the date of
acquisition. The difference between the purchase price, representing fair
value, and the recorded amounts would be shown as a plant acquisition
adjustment (for the regulated business) and goodwill (for the unregulated
businesses) on the consolidated balance sheet. Id., p. 15.
After the Merger, NU would own 100 percent of the common stock of YES
and there would be no minority common stock interest in YES or Yankee Gas.
The capitalization, or debt securities of CL&P or any of the other NU
subsidiaries would not be affected by the Merger. The outstanding debt of
Yankee Gas and the other YES subsidiaries at the time of the consummation of
the merger would remain outstanding without change. Id., pp. 15-16.
Completion of the Merger requires, among other things, that two-thirds of the
outstanding YES shares vote to approve the Merger Agreement. On October 12,
1999, YES shareholders voted to approve the Merger. Late Filed Exhibit No.
1. NU shareholders are not required to approve the Merger. Application, p.
15.
3. Post-Merger Operations
Following consummation of the Merger, the entire NU System, including
YES and Yankee Gas, would be operated as a single coordinated system. The
Companies anticipate a significant degree of centralization of services with
respect to such areas as accounting, financial planning and analysis,
financial reporting, human resources, governmental affairs, regulatory
relations, corporate communications, information systems, insurance, legal,
payroll, purchasing, tax, treasury, billing support, facilities management,
call center services, engineering, construction and environmental services
and general administrative services. Application, pp. 16-19.
Following the Merger, the NU Board of Trustees would be expanded by two
positions to filled by two current outside directors of YES. After the
Merger, the Board of Directors of YES would consist of seven directors, three
of whom will be current directors of YES. The senior management of YES,
including the senior management of Yankee Gas, is expected to be unchanged by
the Merger. Id., p. 17
The Companies project that approximately 50 YES positions would overlap
with positions new held by NU System employees and could be eliminated over
time. However, the Companies do not anticipate that any NU or YES employees
will be laid off as a result of the Merger. It is expected that as a result
of expanded business opportunities, as well as natural attrition and
potential for reassignment, current employees would have an opportunity to
continue to be employed in the combined companies. Id., p. 17, Morris PFT,
p. 7.
III. DEPARTMENT ANALYSIS
A. BACKGROUND
Pursuant to Conn. Gen. Stat. 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:
(1) the financial, technological and managerial suitability and
responsibility of the application, (2) the ability of the gas,
electric, 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. . . .
B. EFFECT OF THE ANNOUNCED NU MERGER WITH CONSOLIDATED EDISON
In its brief, OCC argues that the Department should deny the
Application, without prejudice, until such time as the proposed merger
between Con Ed and NU is brought before the Department.(2) OCC bases this
argument on the Decision in Docket No. 99-07-07, Application of BHC Company
for Approval to Own Common Stock of the Village Water Company of Simsbury,
November 3, 1999. In that Decision, the Department held that two
concurrently running dockets, one an application by Village Water Company
(Village) to sell land and the other an application for change in control of
BHC Company (BHC) warranted a denial without prejudice of the Village
application. The Department notes that it was only the failure to obtain
approval of the transfer of the land that constituted an absolute legal bar
to approving the Village acquisition. The issue of BHC's change of control
supported the Department's conclusion, but the issue involved a degree of
subjectivity. In the Decision now before the Department, the proposed merger
of Con Ed and NU has not reached the point where an application has been
filed with the Department. Under these circumstances, it is much more
possible that the merger will not take place or that the filing of an
application will be delayed. Either of these events would lead to
significant prejudice to the applicants in this case. Thus, the Department
does not find Docket No. 99-07-07, above, controlling and will not deny the
instant application on those grounds.
(2) The Con Ed/NU merger was announced on October 13, 1999, but no request
for approval has been filed with the Department.
C. FINANCIAL SUITABILITY OF NU
In recent years, the financial hardship of the Millstone outages was
reflected in the lowered credit ratings of NU and its major subsidiaries, The
Connecticut Light and Power Company (CL&P) and Western Massachusetts Electric
Company (WMECO).(3) By April, 1997, Moody's had downgraded CL&P and WMECO
first mortgage bonds to below investment grade.(4) As a result of these
financial hardships, the NU Board of Trustees suspended dividends as of the
second quarter of 1997. Following the restart of Millstone Units 3 and 2,
respectively, the financial condition of NU and its major subsidiaries
improved. In the first six months of 1999, NU had earnings of $18.7 million
($0.14 per share), compared to a loss of $11.7 million ($0.09 per share) for
the first six months of 1998. Application, p. 25. During 1999, the bond
ratings of CL&P, WMECO and Public Service Company of New Hampshire (PSNH)
were upgraded to investment grade by Standard & Poor's and Moody's investor
rating services. Response to Interrogatory OCC-15. The Department finds
that as a result of its financial upgrades, NU would be able to attract
capital at reasonable rates and is financially suitable to acquire control of
Yankee Gas.
D. FINANCIAL IMPACT ON YANKEE GAS
The Companies contend that the Merger would not change the financial and
business risk of YES. After the Merger, YES would operate as a first level
subsidiary of NU. YES and its main subsidiary, Yankee Gas, would operate in
the same geographic area and be subject to the same regulatory control by the
Department, operate in the same competitive environment and have the same
customer base as without the Merger. Response to Interrogatory OCC-25.
The Companies argue that the Merger would produce positive changes in
Yankee Gas' capital structure and financial strength as synergies flow to the
operating profit of Yankee Gas. These synergies would be in the form of
expense savings as well as revenue enhancements. The Companies contend that
the Merger would enable Yankee Gas to gain a greater access to capital,
allowing Yankee Gas to become more aggressive in obtaining new investment to
expand its system and to pursue opportunities in marketing and other related
areas. Application, p. 19.
YES indicated that subsequent issuances of long-term debt would be
evaluated primarily based on cost to determine the appropriate issuer.
Response to Interrogatory GA-8. Yankee Gas' short-term credit facility is
expected to expire at the time of the Merger and Yankee Gas would have the
option either to renew that facility or utilize NU credit facilities.
(3) See Docket No. 97-05-12, DPUC Financial and Operations Review of The
Connecticut Light and Power Company, Decision dated December 31, 1997, pp.
56-58.
(4) The bond ratings of PSNH had been below investment grade since 1994.
See response to Interrogatory OCC-15.
Response to Interrogatory GA-8. Yankee does not provide reports or documents
to any rating agencies and so is not currently rated by them. Response to
Interrogatory GA-4.
The Department believes that the immediate financial effect of the
Merger on YES and Yankee Gas is negligible since NU plans to operate YES and
Yankee Gas as a subsidiary with a separate capital structure for ratemaking
purposes. That YES would operate as a first level subsidiary of NU appears
to be the only difference in the overall risk environment of YES, and this
effect would be minimal. YES and Yankee Gas capital structure would likely
remain unchanged and therefore financial risk will remain unchanged.
The Department believes that the Merger may provide Yankee Gas with
greater flexibility in accessing capital. Yankee Gas' ability to obtain
long-term debt would be largely unchanged if it continues to access long-term
debt on a stand-alone basis. However, YES indicated that the cost of future
issuances would be evaluated to determine the appropriate issuer, which
suggests that a merged company could provide alternatives to Yankee Gas
issuing stand-alone long-term debt. The ability of Yankee Gas to enter the
NU Money Pool would provide Yankee Gas the opportunity to access short-term
credit on a more flexible and cost-effective basis.(5) Tr. 9/22/99, pp. 43-
44. Whether the Merger would afford Yankee Gas greater access to equity
capital would depend in part on NU's dividend policy and NU's future
commitments to the expansion of the gas distribution system. NU has stated
that it has not devised a dividend policy to accommodate the Merger of YES.
Response to Interrogatory GA-12.
E. TECHNOLOGICAL AND MANAGERIAL SUITABILITY OF NU
NU claims that its senior management has substantial experience in
managing gas operations. Michael Morris, prior to joining NU as president
and chief executive officer (CEO), served as president and CEO of Consumers
Energy, which had 1.6 million natural gas customers. Morris PFT, p. 2. Two
other NU senior managers have had substantial experience in the gas industry.
Response to Interrogatory GA-20. NU asserted that it would retain the
current YES management, so that Yankee Gas would continue to benefit from its
experience. NU believes that merging with YES would broaden the management
pool, thereby enhancing managerial effectiveness. Response to Interrogatory
EL-1. According to Charles Gooley, President and CEO of YES, NU has
successfully overcome the significant financial and managerial challenges of
the prolonged Millstone nuclear generating plant outages. He also pointed
out that both NU and YES share a common identity as Connecticut-based
companies, and prior to 1989, the two companies had a long history operating
as an integrated company serving electric and gas customers. Gooley PFT, pp.
5-6.
(5) The NU Money Pool is a short-term borrowing arrangement among NU
subsidiaries.
NU has faced significant management challenges in the operation of its
nuclear plants in the last several years. Decision dated July 30, 1997, in
Docket No. 96-10-06, DPUC Investigation into Whether the Connecticut Light
and Power Company Fulfilled its Public Service Responsibilities with Respect
to it s Nuclear Operations. However, the Department believes that NU has
overcome many of these challenges. The Department concludes that NU is
managerially capable to operate as a holding company for Yankee Gas.
F. SAFE, ADEQUATE AND RELIABLE SERVICE
The Companies describe Yankee Gas as a well-run public service company,
providing superior service to its customers. They point out that for the
second year in a row, Yankee Gas has been cited by the American Gas
Association as an industry leader in accident prevention and safety. Yankee
Gas is the only Connecticut LDC to receive this citation, and has one of the
lowest incident rates in the country among companies of similar size. The
Companies state that the ability of Yankee Gas to provide safe, adequate and
reliable service through its plant, equipment and manner of operation would
be enhanced by the Merger. Application, pp. 26-27.
YES operating headquarters and service centers would remain in
Connecticut after the Merger. NU expects to retain existing YES and Yankee
Gas management and employees. Id., p. 27. Yankee Gas would continue to be
subject to State safety regulations and the Natural Gas Pipeline Safety Act
of 1968 with respect to the construction, operation and maintenance of its
mains and services. The Companies contend that Yankee Gas' service quality
would be enhanced through the increased financial flexibility, a larger pool
of managerial resources and potential future cost-savings that are expected
to result from the Merger. Id., pp. 26-27.
The Department finds that the record evidence indicates that after the
Merger, Yankee Gas would be technically and managerially able to operate its
gas facilities safely. NU has had a long history operating an integrated
electric and gas company. As indicated in Section III.E above, NU's current
senior management has substantial experience in managing gas operations and,
importantly, Yankee Gas would still be subject to the same safety
requirements with regard to the construction, operation and maintenance of
its mains and services. The Department finds that NU is capable of providing
safe, adequate and reliable service to the public.
G. SERVICE QUALITY
In the Application and during the proceedings, the Companies made
several commitments to improving and enhancing customer service for
customers. Application, p. 18. The Companies report that the non-financial
benefits to Connecticut customers that would result exclusively from the
Merger include NU and YES customers' access to both Companies' call centers,
payment locations and payment agents. However, no evidence was entered into
the record to support the conclusion that these non-financial benefits would
occur. According to the Companies, customers would be able to place
emergency calls and customer service inquiries into both Companies' call
centers, which would reduce emergency and inquiry response time. The
Applicants' Transition Teams (ATTs) have not determined when and by how much
the emergency and inquiry response time would be reduced. The Companies
contend that customers would also have access to a greater number of payment
centers and payment agents over a larger geographical area. The Companies
did not state the current number or estimate the total number of payment
agents and centers that YES and NU to which customers would have access. Tr.
10/8/99, pp. 347-350.
The Companies contend that NU would provide access to its state-of-the-
art Customer Information Center Technology (CICT), which would provide an
important technological benefit to YES. Customers would benefit since the
Global Positioning System component of CICT would allow a dispatcher to
assign the next service order to the technician who is closest to the
customer requesting assistance. This feature would also be available to
customers with emergencies as well as those with routine appliance repair
calls. The Companies anticipate that they would be able to respond more
quickly; however, no evidence was entered into the record to substantiate
their expectation. Tr. 10/8/99, pp. 367-368. YES and NU stated they are
both in the early stages of understanding the capabilities of electronic
commerce to support customer service; however, they maintain that customers
would be able to use electronic services from home to pay their bills and to
have service inquiries addressed, such as meter reading services. The Gas
Research Institute, an organization that assesses and tracks gas customer
service trends and demands, has examined services that could be provided over
the Internet. The Companies maintain that customers would be interested in
using electronic commerce technology such as automated billing and meter
reading services to address utility concerns. Tr. 10/8/99, pp. 347-348.
The Companies assert that business decisions regarding customer service
would be executed as they have been in the past. YES and NU managers would
continue to make decisions from their respective local service centers. The
ATTs are examining the YES customer service organization to determine whether
changes should be made. Response to Interrogatory CA-2.
NU stated that according to the 1998 Department Scorecard,(6) it was one
of a handful of regulated companies achieving a reduction in the number of
complaints to regulators by more than 25%. The total number of utilities
that reduced the number of complaints to regulators was not specified.
(6) The Department Scorecard is a computation of utilities' customer
complaints to the Department, organized into several categories of consumer
service.
Application, p. 24. However, due to increased collection activities to
reduce the number of uncollectible accounts, NU experienced an increase in
complaints to the Department in 1999 to date. Response to Interrogatory CA-
22.
The Department has reviewed the Companies' responses to interrogatories
regarding Customer Service Practices and Policies and Rules and Regulations.
The Companies' customer service practices and procedures are sufficient and
allow for the efficient and timely handling of customer complaints and
inquiries. The ATTs have not determined if there would be any changes to the
bill and the billing process. Late Filed Exhibit No. 7. Yankee Gas will be
ordered to submit to the Department for review and approval any proposed
changes to its customer service policies and procedures, Rules and
Regulations, pursuant to Section 16-19 of the Conn. Gen. Stat. Yankee Gas
will also be ordered to submit to the Department for review and approval any
proposed changes to its billing format.
H. POST-MERGER MANAGEMENT AND OPERATIONS
1. Post-Merger Transition
As described in Section II.C.3, following the Merger, the NU System,
which would include YES and Yankee Gas, would be operated as an integrated
system. It is expected that the senior management of YES, which includes the
senior management of Yankee Gas, would remain unchanged. Application, pp.
16-19. The Companies project that approximately 50 YES positions overlapping
with NU System positions could be eliminated over time. However, the
Companies expect that employees would have an opportunity to be reassigned in
the combined companies. Id., p. 17, Morris PFT, p. 7.
To oversee the transition process, NU and YES have established 11
functional transition teams to design and oversee the Merger process in the
following functions: operations, corporate planning/accounting/ finance/
internal audit/investor relations, human resources, information technology;
unregulated subsidiaries, corporate communications, sales and marketing
(regulated), facilities/fleet, governmental affairs, regulatory affairs, and
legal/environmental safety. The Companies expect that the recommendations of
the functional transition teams, along with the implementation plans will be
finalized in the first quarter of 2000. Once finalized, the overall
recommendations will be discussed by the Merger Transition Team, which is
responsible for managing the transition project and making recommendations to
the Merger Steering Committee, which is co-chaired by NU's and YES's Chief
Executive Officers. The Steering Committee will make final decisions on
implementation of the transition. Response to Interrogatory OCC-36.
The Department will continue to monitor the integration of the combined
corporate functions as it pertains to the operations of Yankee Gas. The
Companies are directed to report to the Department on the progress of the
functional transition process as indicated in Section V.B.
2. Capital Expenditure Plan
NU has proposed to expand the current Yankee Gas distribution system as
a result of the Merger. Application, p. 19. The Companies have argued that
this expansion would be a major benefit of the Merger. Application, p. 19.
The Companies also contend that Yankee Gas would have greater access to
capital, which would facilitate the financing of a capital expansion. Id.,
p. 19; Response to Interrogatory OCC-51.
NU has described several opportunities to expand natural gas service.
NU points out that there are a number of proposed gas-fired electric
generation plants in New England, which would increase demand for natural
gas. The percentage of homes heated with natural gas in New England is less
than the national average, 31% versus 54%; NU views the relatively low use of
gas heating as an opportunity for expansion. NU foresees that the expanding
natural gas infrastructure would open access to natural gas to areas in New
England, increasing the use of natural gas in all end-use sectors. NU
anticipates that its non-regulated subsidiary, Select Energy, will market
natural gas and assist in the expansion of sales. NU also anticipates
expansion of regulated sales through the acquisition of additional LDCs.
Response to Interrogatory EL-4. Mr. Gooley, testified that NU's greater
resources and name recognition would facilitate the more rapid expansion of
gas service into unserved areas. Tr. 9/22/99, pp. 64-67.
The Department views expansion of gas infrastructure as an important
consumer benefit to the Merger by offering a broader menu of energy choices
for customers. A key ingredient in offering consumers more choices is NU's
commitment to cost-effective expansion of the Yankee Gas distribution
infrastructure. However, NU offered no specific expansion plan for gas
infrastructure. Tr. 9/22/99, p. 65. Although NU has not proposed how the
Yankee Gas system would be expanded, the Department expects that the
investment in the Yankee Gas capital budget would increase from its most
recent five year-projections of $135,000,000. In the last Yankee Gas rate
case its capital expenditure budget for 1997 through 2001 was projected to be
$135,000,000. Decision dated July 9, 1997, in Docket No. 96-08-05, DPUC
Financial and Operational Review of Yankee Gas Services Company. The
Department will review the expansion plans carefully and the proposed capital
budgets for Yankee Gas in that company's next rate case.
3. Affiliate Agreements
Yankee Gas currently has one service agreement with an affiliate. RM
Services, Inc. provides collection services to Yankee Gas for certain active,
inactive and uncollectible accounts. Response to Interrogatory OCC-16.
However, NU expects that YES would enter into a service agreement with NUSCO
consistent with NUSCO's agreements with NU's other subsidiaries. Response to
Interrogatory OCC-8. Following consummation of the Merger, the entire NU
System, including YES and Yankee Gas, would be operated on a consolidated
basis.
OCC argues that an affiliate agreement between YES and NU should be in
place before the Department approves any merger. OCC Brief, p. 26. In the
alternative, no affiliated transaction should be allowed to occur subsequent
to the merger absent the Department's approval of a fully defined affiliate
transaction agreement. OCC Brief, p. 27.
The Department concurs with OCC. The Company did not present sufficient
information to assure the Department that the transactions between the
affiliates that might occur are appropriate. The Companies should not engage
in any affiliate transactions until an affiliate agreement is in place.
Further, Companies must submit all proposed affiliate agreements to the
Department for review prior to the agreements becoming effective.
The Department herein emphasizes the necessity for access to any and all
books and records of NU and its affiliates that the Department deems
necessary to: (i) verify all costs and revenues that are ultimately
allocated to Yankee for recovery from ratepayers and/or determine Yankee's
regulated earnings, and (ii) verify that Yankee assets, including its gas
pipeline contracts, are being managed consistently with Department policy,
including policies pertaining to competitive gas supply markets in
Connecticut. The Department will closely monitor any natural gas commodity
or interstate pipeline transmission or storage transactions between NU and
any affiliate, and will take such regulatory action as may be required to
safeguard the public interest.
4. Cost Allocations
The National Association of Regulatory Utility Commissioners (NARUC) has
adopted guidelines for cost allocation and affiliate transactions. Late
Filed Exhibit No. 13. NU's current procedures incorporate many of the NARUC
recommendations with respect to accounting for affiliate transactions. Tr.
11/5/99, p. 701. NU believes that the differences between its practices and
NARUC's recommendations pertain to rules that would be one-sided and
therefore inequitable to the regulated companies. Tr. 11/5/99, pp. 693-695,
701. NARUC recommends that services provide by a regulated company to a non-
regulated company be charged at the higher of cost or market while services
provided by a nonregulated company to a regulated company be provided at the
lower of cost or market. The same would apply to the transfer of capital
assets between affiliates. Tr. 11/5/99, pp. 693-695. NU views two NARUC
recommendations, those regarding the appropriate amount to charge for
affiliate transactions and the amount at which capital assets should be
transferred between regulated and unregulated companies, as asymmetrical or
unbalanced. NU charges affiliate transactions at cost, whether the regulated
company is providing or receiving those services. Id. NU believes that it
is appropriate to use a balanced approach that applies the same rules to
regulated and unregulated affiliates. NU/YES Brief, p. 37.
Although the Department has examined affiliate transactions in rate
cases and has participated in SEC audits of affiliate transactions affecting
the NU System, OCC does not believe that either entity has done enough to
protect customers against affiliate abuse with holding company systems. Tr.
10/19/99, pp. 543-545, 579-582. OCC believes that the Department should
ensure that specific rules that deal with affiliate transactions are in place
to protect the public interest. Id., p. 547. Further, OCC believes that the
Department should decide whether to apply the NARUC guidelines as being in
the best interest of customers. Tr. 10/19/99, p. 583.
The Department has reviewed NU's allocation methods in prior CL&P rate
cases and generally has no major concerns with the methods or the specific
allocators used. The Department directs NU to allocate costs to YES and its
subsidiaries in the same manner it currently allocates them to all other NU
System companies. The Department will review the cost allocation
methodologies specific to Yankee Gas in the next Yankee Gas rate case.
I. VALUATION OF YES
YES employed the firm SG Barr Devlin (Barr Devlin) to act as its
financial advisor for the proposed Merger. Barr Devlin provided a written
opinion to YES's Board of Directors dated June 14, 1999, which stated that
the Merger consideration, in particular, a $45 per share price, was fair from
a financial point of view to of Yankee common stock shareholders. Barr
Devlin used the valuation methodologies described below.
1. Stock Trading History
Barr Devlin reviewed the historical prices and trading activity of YES
shares and NU shares and compared them to (a) the Standard and Poor's Utility
Index; and (b) an index of common stock prices of selected natural gas
distribution utilities (or their holding companies). This comparison
provides a perspective on the stock performance of YES relative to the
selected indices. Barr Devlin's Fairness Opinion Back-Up Book, pp. 8 - 14;
Application, Exhibit 10, p. 27; Protected Response to Interrogatory OCC-3.
2. Publicly Traded Comparable Company Analysis
Barr Devlin compared selected financial information and ratios for YES
with the corresponding financial information and ratios for a group of
publicly-traded local gas distribution companies, which Barr Devlin
considered to be comparable to Yankee. Barr Devlin selected these companies
because they possessed the general business, operating and financial
characteristics representative of the local gas distribution company industry
in which Yankee operates. The comparable companies are as follows:
AGL Resources, Inc. NUI Corporation
Atmos Energy Corporation ONEOK, Inc.
Cascade Natural Gas Corporation Peoples Energy Corporation
CTG Resources, Inc. Piedmont Natural Gas Company
Indiana Energy, Inc. Providence Energy Corporation
Laclede Gas Company SEMCO Energy, Inc.
New Jersey Resources Corporation South Jersey Industries, Inc.
NICOR, Inc. Washington Gas Light Company
Northwest Natural Gas Company
Application, Exhibit 10, p. 27.
YES submitted additional financial data to support the conclusion of
Barr Devlin that this group is comparable to YES. Response to Interrogatory
GA-34; Protected Response to Interrogatory OCC-3.
Barr Devlin determined these ranges of multiples for the comparable
companies based on the following financial ratios:
1. common stock market value as a multiple of:
a. net income for the 12-month period ended March 31, 1999;
b. projected net income for the 12-month period ended December 31,
1999;
c. projected net income for the 12-month period ended December 31,
2000; and
d. book value for the period ended March 31, 1999;
2. aggregate market value (defined as the sum of the common stock market
value, plus any preferred stock, debt, capitalized lease obligations and
minority interests, minus cash and cash equivalents) as a multiple of:
a. earnings before interest and taxes for the 12-month period ended
March 31, 1999; and
b. earnings before interest, taxes, depreciation and amortization
for the 12-month period ended March 31, 1999.
Applying these multiples to the corresponding data for Yankee (as
reported and also on a weather normalized basis), this analysis produced
reference values of $17.66 to $31.62 per share of YES common stock with a
weighted average value of $25.21.
Application, Exhibit 10, pp. 27 and 28; Barr Devlin Fairness Opinion Back-Up
Book, pages 15 through 17; Protected Response to Interrogatory OCC-3.
3. Discounted Cash Flow Analysis
Barr Devlin performed a discounted cash flow analysis (DCF) under the
assumption that Yankee Gas performed according to the operating and financial
projections, as provided by management, for the period 1999 through 2003.
Barr Devlin used this DCF methodology to calculate an estimated range of
reference values for YES stock. To calculate this, Barr Devlin took YES'
projected cash flows during each year of the projections 1999 through 2003,
together with the estimated value of YES at the end of 2003, then discounted
to the present using discount rates in the range of 6.0% to 7.0%. Barr
Devlin estimated values at the end of 2003 for YES by applying multiples that
were derived from those of comparable public companies, which are as follows:
Earnings before interest and taxes...............................0.7x-12.0x
Earnings before interest, taxes, depreciation and amortization. 7.2x-8.2x
Book value.......................................................1.44x-1.88x
Net Income.......................................................13.9x-15.9x
Barr Devlin Fairness Opinion Back-Up Book work papers, pp. 18-23; Protected
Response to Interrogatory OCC-3; Protected Late Filed Exhibit No. 3.
This DCF analysis produces reference values of $23.69 to $41.06 per
share of YES common stock with a weighted average value of $33.14. Exhibit
10, p. 28. Thus, the $45 per share price is above the DCF-estimated
reference values.
4. Comparable Transaction Analysis
Barr Devlin reviewed transactions it deemed comparable involving
acquisitions of natural gas distribution utilities or their holding
companies. Barr Devlin chose these comparable transactions because they were
viewed as strategic combinations of companies that possessed general
business, operating and financial characteristics representative of utilities
in the industry in which Yankee operates. These comparable transactions
were:
Pennsylvania Enterprises/Southern Union Company;
Southwest Gas Corporation/ONEOK, Inc.;
Connecticut Energy Corporation/Energy East Corporation;
Public Service Company of North Carolina/SCANA Corporation;
North Carolina Natural Gas Corporation/Carolina Power & Light Company;
Colonial Gas Company/Eastern Enterprises;
Essex County Gas Company/Eastern Enterprises; and
Bay State Gas Company/NIPSCO Industries, Inc.
Application, Exhibit 10, p. 28
Barr Devlin determined implied ranges of multiples from the comparable
transactions based on the following financial ratios:
1. Implied consideration to be received by the smaller company's
shareholders as a multiple of its:
a. net income for the most recent 12-month period available;
b. projected net income for the current fiscal year;
c. projected net income for the next fiscal year; and
d. book value for the most recent period available;
2. Implied aggregate consideration (defined as the sum of the implied
consideration, plus any preferred stock, debt, capitalized lease
obligations and minority interests, minus cash and cash equivalents) to
be paid by the larger company as a multiple of the smaller company's
a. earnings before interest and taxes for the most recent 12-month
period available; and
b. earnings before interest, taxes, depreciation and amortization for
the most recent 12-month period available.
Barr Devlin also calculated the implied percentage premium to the
smaller company's shareholders by dividing the offer price over the one-day
and one-month unaffected stock market prices for their shares. Protected
Response to Interrogatory OCC-3.
Applying such multiples and premiums to the corresponding data for
Yankee (as reported and also on a weather normalized basis), this analysis
produced reference values of $25.43 to $46.63 per share of YES common stock,
with a weighted average value of $36.53. Application, Exhibit 10, p. 29.
Using the comparable company analysis, the $45 per share price is well above
the weighted aggregate value of $36.53, and from the perspective of YES
shareholders, is more than fair.
5. Pro Forma Analysis
Barr Devlin analyzed the pro forma effects of the merger on Yankee
shareholders for the period 2001 through 2003. This analysis was based upon
earnings estimates for Yankee and NU from First Call Corporation as of June
11, 1999, without giving effect to possible benefits, which might be realized
following the merger. For Yankee shareholders that receive NU common shares
in the merger, the analysis showed substantial improvement in earnings per
share, with a slight improvement in expected dividends per share. Barr
Devlin Fairness Opinion Back-Up Book, pp. 27-30; Protected Response to
Interrogatory OCC-3.
6. Conclusion on Valuation of YES
The Department has reviewed each of the above valuation methodologies
and their supporting work papers and finds that Barr Devlin used standard
financial models to estimate a valuation of YES. The Department believes
that YES has exercised due diligence in obtaining a valuation of its company.
The fairness opinion of Barr Devlin is directed toward the YES Board of
Directors and not Yankee Gas ratepayers. Barr Devlin restricted its opinion
to a definition of fairness from a financial point of view of the Merger
consideration as a whole. This fairness opinion does not consider the
allocation of cash, stock, consideration, or a combination of cash and stock.
The Department finds that the price of $45 is fair to the financial
interests of YES shareholders since it is well above the parameters of price
as established in the Barr Devlin methodologies. The Department views the
$45 as producing the substantial goodwill/acquisition premium, discussed in
Section III.I.
J. EFFECT OF MERGER ON YES'S AND NU'S OPERATING COSTS/SYNERGIES
The Companies assert that the Merger offers significant savings in
operating costs and synergies. They anticipate that the Merger will result
in increasingly competitive gas and electric rates and long-term, synergy-
related cost savings that would not be available to the separate Companies
absent the Merger. These savings are expected to be realized over a period
of several years, rather than immediately after the Merger. Savings include
reduced operating costs and expenditures resulting from integration of
corporate and administrative functions, elimination of duplicative positions,
reduction of duplicative capital expenditures for administrative and customer
service programs and information systems, and savings in areas such as legal,
audit and consulting fees. The Companies also expect the Merger to result in
longer term benefits from greater purchasing power for items such as fuel and
transportation services, and general and operational goods and services.
Application, p. 19.
NU assembled a team of internal specialists to conduct due diligence on
YES to develop an estimate of the costs that could be reduced in functional
areas as a result of the Merger. The savings projections developed by the
team were generally based on consolidating duplicate services and leveraging
the buying power advantage NU has over YES due to its size. Wiater PFT, p.
3. Preliminary analyses indicate that over time operation and maintenance
(O&M) expenses could be significantly reduced for a combined NU and YES
system. By the end of the fifth year following the Merger, projected
combined O&M expenses would be approximately $10 million per year lower than
the five-year forecast provided to NU by YES for the Merger due diligence
review. The due diligence process was conducted in May 1999, during a one-
week period. Id. Tr. 9/22/99, p. 76; Protected Response to Interrogatory
OCC-1.
NU and YES have assembled merger functional transition teams to develop
a more detailed review of the Companies' operations and produce a better
estimate of the potential merger savings than was developed during the due
diligence process. Additionally, the teams will prepare a multi-year plan for
integrating the Companies. Expectations about the source, amount and timing
of potential savings would ultimately be based on a multi-year time line. It
is expected that the majority of those savings would be allocated to YES.
Wiater PFT, pp. 4-6.
The Companies emphasized that there is no guarantee that savings would
ever be realized. Synergy assumptions are only preliminary and are likely to
be refined and modified by functional transition teams over the succeeding
months. They are not firm or reliable. However, it would take considerable
time before actual synergies are realized, and the amount and source of those
synergies cannot now be predicted. Wiater PFT, pp. 5-7. The Company has
proposed to retain savings until transaction costs are recovered and to
address the savings and costs of the Merger in a future rate proceeding.
Response to Interrogatory EL-11.
OCC believes NU and YES have identified only modest amounts of possible
Merger savings, and that the Companies' witnesses have emphasized that such
savings are not certain to occur. OCC Brief, p. 8. OCC cites the lack of
empirical evidence to support the existence of future customer benefits,
enhanced customer service, reduced customer bills and other anticipated
benefits. The only groups that will definitely benefit from the Merger are
NU and YES shareholders and senior management. OCC Brief, p 31.
OCC further argues that the fundamental economics of the Merger have
undergone important changes in light of the announced Con Ed/NU merger
agreement. The economic assumptions in the Application are no longer
accurate. OCC Brief, pp. 8-9. Absent the Merger, OCC believes that NU and
Yankee Gas, which are the major regional electric and gas utilities in the
region, would become even more significant competitors than they are today.
As competitors, they would be forced to reduce costs and achieve efficiencies
in the market. OCC Brief, p. 17.
The Companies claim potential annual savings of that would build to $10
million five years after the Merger. These estimates are based on NU's one
week due diligence review of YES data in May 1999. Ten million dollars
represents a 15.3% savings in YES average O&M costs of $65.3 million per year
for 1994 through 1998. Response to Interrogatory OCC-24. The Companies
provided very few additional details on savings in response to
interrogatories and cross-examination. They testified that it would be
months before the 11 functional transition teams could identify detailed
savings. Final results would not be known until early 2000, after the
Decision for this proceeding is issued. Late Filed Exhibit No. 7.
In Late Filed Exhibit No. 5, NU projected annual savings increasing to
$12.3 million five years after the Merger. This exhibit contained optimistic
annual growth escalators of 3.5% for savings and 2.5% for sales after the
Merger, which exceeded the YES sales base estimate (without Merger) by 250%.
NU did not provide supporting documentation on how the higher escalation and
growth rates are to be achieved. Further, NU did not identify the savings by
company or their respective unregulated subsidiaries.
The Companies currently have different methodologies to allocate costs
among their affiliates. Response to Interrogatory OCC-27. The basis for
allocating charges to YES would be evaluated by the individual teams
developing plans for integrating the businesses. Response to Interrogatory
OCC-18. The Companies have not formulated plans in sufficient detail
relating to the future operation of YES as a subsidiary of NU. Response to
Interrogatory OCC-28.
The Companies have described the potential for administrative cost
reductions, which is one aspect of the Merger that would benefit customers.
However, the Companies are unwilling to commit to a rate reduction. NU
requests that the savings resulting from the synergies first be used to pay
the cost of the Merger. Morris PFT, p. 8. Under the NU proposal, given the
cost of the Merger, such treatment would ensure that no savings would accrue
to ratepayers for many years.
The Companies have identified estimated cost savings associated with the
Merger. Should the Merger be completed, NU must file an update of the
projected Merger savings identifying the source of all regulated savings in
detail as well as savings of its unregulated affiliates. Although the
Companies' savings projections and details of affiliate transactions are
vague, they are not a statutory condition that would prevent Department
approval of the Merger.
K. CHARITABLE DONATIONS
NU represents that it anticipates no changes to the level of charitable
donations by Yankee Gas as the result of YES becoming a subsidiary of NU. NU
stated that there had been no discussions between NU and Yankee Gas that
would indicate a change of policy with regard to Yankee Gas' charitable
donations. Tr. 9/27/99, p. 260. In Docket No. 99-07-20, Joint Application
of Energy East Corporation and Connecticut Energy Corporation for Approval of
a Change of Control, Decision dated December 15, 1999, p. 12, and Docket No.
99-08-09, Joint Application of Energy East Corporation and CTG Resources,
Inc. for Approval of a Change of Control, Application, p. 25, the applicants
have committed to substantial increases in charitable donations above the
respective companies' recent level of donations. The Department deems it
appropriate that the NU and YES commit Yankee Gas to increasing and
maintaining its charitable donations by 10% above the average of its most
recent three-year donation levels, to be funded by the Companies'
shareholders.
L. GOODWILL/ACQUISITION PREMIUM
The purchase price is approximately $314,156,000 in excess of YES's net
assets acquired and upon consummation of the Merger would be recorded in
Account 114, Utility Plant Acquisition Adjustments, of the Connecticut
Uniform System of Accounts. A breakdown is as follows:
(000's)
Purchase Price, assumed value of common stock and cash
Consideration (based on 10,653,457 YES shares outstanding at $ 479,406
June 30, 1999, at $45 per share)
Estimated Direct Costs to be incurred in consummating the 8,000
Merger
487,406
Net Assets of Yankee Energy System (173,250)
Excess of purchase price over net assets acquired $ 314,156
Response to Interrogatory OCC-21
The above calculation is based on the Accounting Principles Board (APB)
Statement Number 16, which addresses accounting for business combinations,
whereby an acquiring entity is required to allocate the purchase price over
the fair value of the assets acquired less the liabilities assumed. Response
to Interrogatory GA-18. This accounting methodology is known as the purchase
method of accounting. Under this methodology, the purchase price would be
allocated to the YES regulated utility and unregulated nonutility assets and
liabilities based on their estimated fair market values at the date of
acquisition. The purchase price in excess of the amounts recorded on the YES
books will be shown as a plant acquisition adjustment for the regulated
utility and goodwill for the unregulated businesses on the consolidated
balance sheet. Application, p. 15.
The Companies are not seeking specific ratemaking treatment for the
acquisition premium in this docket. Response to Interrogatory OCC-22. The
Companies intend to address the savings of the Merger, along with the
associated costs, in a future rate proceeding. Response to Interrogatory EL-
16. The Companies are requesting that the Department recognize that the
synergies should be applied first to pay the costs of achieving the Merger.
According to Mr. Morris, "[w]e are requesting that the Department in its
order provide us an opportunity to recover some of the acquisition premium by
retaining the synergy benefits until the merger's costs are paid." Morris
PFT, p. 8. NU's rationale is that the Department should provide the two
companies with a reasonable opportunity to earn both a return of and on the
investment made in connection with this merger since, without that
investment, there would be no synergies to share and no benefits to
customers, employees, and the State of Connecticut. Wiater PFT, p. 8;
Responses to Interrogatories OCC-22 and OCC-60.
OCC argues that the acquisition premium is not an actual cost and since
the benefit of the premium/acquisition adjustment flows to stockholders, they
should bear these costs. OCC Brief, p. 20.
The Department determines that it is appropriate for NU shareholders
rather than its ratepayers to bear the cost of acquisition premium of the
Merger. As noted in Section III.I, the Merger is in the best financial
interests of current YES shareholders. NU has estimated annual synergies
rising to $10 million within five years, but the Companies have requested a
Yankee Gas rate freeze so that none of these savings would be passed on to
ratepayers. It is only under the most optimistic assumptions of the synergy
estimates (discussed in Section III.J above) that Yankee Gas ratepayers could
receive benefits in the long-term to offset the $314 million acquisition
premium. NU has readily acknowledged that the estimated synergy benefits may
not materialize.
With regard to the inclusion of the goodwill/acquisition premium for the
purpose of determining what, if any, earnings are shared in the future, the
Department will make no decision at this time. The Department will consider
the issue of how goodwill expense and investment should impact future
earnings sharing in a future 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.
In summary, this Decision does not obligate ratepayers to fund any
portion of goodwill/acquisition premium costs and does not allow any portion
of amortization of the acquisition premium to be considered in the setting of
rates.
M. EXPENSES OF EMPLOYMENT AGREEMENTS AND CHANGE OF CONTROL AGREEMENTS
The Companies have entered into an employment agreement with Mr. Gooley
and NU has agreed to offer to enter into binding employment arrangements with
the following senior YES officers: J. Kingsley Fink, Mary J. Healey, Thomas
J. Houde, Steven P. Laden, James M. Sepanski and Murry K. Staples. NU will
enter into these binding employment arrangements on the closing date with
those persons who have accepted the offers. At the effective time, these
employment arrangements will replace each executive's existing agreement with
Yankee. Application Exhibit 10, p. 33.
Under the terms of Mr. Gooley's employment agreement, NU will employ Mr.
Gooley as president and chief executive officer (or in a similar capacity) of
the surviving company after the Merger for a period of at least three years
at a salary not less than his Yankee salary prior to the Merger and an
entitlement to benefits and incentive compensation programs commensurate with
NU senior executives. If the surviving company terminates his employment
without cause and he delivers a written release of any claims against the
surviving company, NU and other related parties, Mr. Gooley would receive a
severance package consisting of cash, stock options and other benefits. Id.
Exhibit 10, pp. 33-34. The proposed employment arrangements with the other
named officers offer them compensation and benefits not less than what they
receive from Yankee immediately prior to the effective time, subject to
upward review to match the standard terms for officers of NU subsidiaries
generally. The employment arrangements provide executive officers with a
severance payment if their employment is terminated or altered substantially
within two years of a change in control. Exhibit 10, p. 34. Id.
According to the Companies, the employment agreement and employment
arrangements are potential costs are not in rates at present and would be
potentially recoverable in the future only in a rate case; there is no
current direct cost incurred by ratepayers. Tr. 9/22/98, pp. 60 and 61. OCC
expresses concern that, ""[I]f any management severance costs are incurred
due to the purchase, they will be included within the premium/acquisition
adjustment, thereby increasing costs which the Companies desire to recover
from ratepayers." OCC Brief, p. 23. The Department agrees that these costs
should not be borne by ratepayers and will require in the next Yankee Gas
rate case a detailed accounting of any costs that may arise.
N. TRANSACTION COSTS
Estimated transaction costs that YES is currently expensing to Account
923, Outside Services Employed, are as follows:
YTD Estimated Total
7/31/99 Additional Merger
Legal $ 342,949 $ 96,251 $ 439,200
Investment Banker Fees 1,444,066 1,996,000 3,440,066
Shareholder Expenses 553,602 553,602
Other/Misc. 425,000 425,000
Total $1,694,066 $3,163,802 $4,857,868
Response to Interrogatory OCC-11.
NU estimates that it will expense approximately $558,310 in merger
costs. However, NU also estimates that it will accrue transaction costs for
future recovery as follows:
YTD Total
8/31/99 Projected
Legal Services $ 431,057 $1,000,000
Bank Services 1,292,221 3,838,471
Regulatory and Filing Fees 66,514 111,514
Other Services 45,452 2,491,706
Total
$1,835,244.00 $7,441,691.00
Response to Interrogatory OCC-11.
NU indicated that ratepayers would not be responsible for the costs that
are being expensed currently because they are being recorded on the books of
the holding companies, YES and NU, and not the regulated operating company,
Yankee Gas. Response to Interrogatory OCC-11.
The Department has determined that transaction costs associated with the
Merger shall not be borne by Yankee Gas ratepayers.
O. EFFECT OF THE MERGER ON COMPETITION
OCC contends that the Merger would have a detrimental effect on the
energy industry in Connecticut, eliminating the head-to-head gas versus
electric competition in the Yankee Gas service territory. Further, a Con
Ed/NU merger would dramatically alter the competitive impacts of an NU/YES
merger since Con Ed has over one million natural gas customers. According to
OCC, it is senseless for the Department to evaluate the NU/YES merger without
taking into account how the Con Ed/NU merger will affect the competitiveness
of energy markets in Connecticut. OCC Brief, p. 12.
According to OCC, even absent consideration of the Con Ed/NU merger, an
NU/YES merger would weaken competition in Connecticut by eliminating a
potential new competitive entrant. According to OCC, "NU will no longer face
Yankee Gas as a competing fuel threat nor will Yankee become a competitive
electricity supplier under open distribution access." OCC Brief, p. 13.
In developing his analysis, OCC witness, Dr. John Wilson relied on the
U.S. Department of Justice and Federal Trade Commission's 1992 Horizontal
Merger Guidelines (Guidelines), which are a screening tool used to evaluate
the effect of Mergers on competition. Dr. Wilson offered several
calculations of market power to support his assertion that market
concentration would increase as a result of the Merger. By defining the
relevant market to include gas and electricity as well as coal, wood, waste
and solar, Dr. Wilson calculated that the Merger would raise NU's share of
all BTUs sold in the CL&P service area from about 24.7% to approximately
41.8%. Defining the market as gas and electric energy only, the Merger would
raise NU's market share from 42.1% to 71.4%. For customers in the Yankee Gas
service area, these percentages would be higher. Wilson PFT, Exhibit JWW-1,
pp. 1-4; OCC Brief, p. 13. Dr. Wilson also presented analysis in which the
Herfindahl-Hirschman Index (HHI) increased from approximately 1,000 to over
1,900 as a result of the Merger; an HHI of greater than 1,800 is defined as a
"highly concentrated" market.(7) Exhibit JWW-1, pp. 2-4.
OCC also questions whether the proposed Merger, by increasing firm size,
would lead to greater efficiencies and lower costs. Dr. Wilson presented a
statistical model that suggested that for a sample of 147 U.S. investor-owned
electric utilities, larger utilities had higher rather than lower per-kWh
costs. Exhibit JWW-2.
NU/YES argue that the Guidelines are not useful for analyzing mergers
subject to economic regulation. They point out that that the Guidelines
define a market as "a product or group of products in a geographic area in
which it is produced or sold such that a hypothetical profit maximizing firm,
not subject to price regulation." They point out that the Guidelines apply
only to firms that are not subject to price regulation. They emphasize that
Yankee Gas and CL&P prices would continue to be subject to price regulation
by the Department. Therefore, the Merger does not pose a competitive threat.
NU/YES Brief, pp. 24-25.
The Companies also take issue with Dr. Wilson's definition of relevant
product market. They pointed out that as of January 1, 2000, Connecticut
consumers would be able to choose electric suppliers from a company outside
of the CL&P service territory or out-of-state. Had Dr. Wilson used the state
of Connecticut as his relevant market, the concentration indexes and HHIs
would have been lower. Id., p. 27. Lastly the Companies claim that Dr.
Wilson overestimates market concentration by not including potential
entrants, as required by the Guidelines. Id., p. 30.
The Department is cognizant of the potential for market power
concentration that could occur when two or more dominant firms within a
market combine, as the OCC claims with regard to the proposed Merger between
NU and YES. There are various methods of determining anticompetitive market
power, the quality of which depends, inter alia, on an appropriate definition
of the product and its geographic market. The record in this case does not
7) The HHI index has been traditionally used by the U.S. Justice Department
and Federal Trade Commission as a measure of market concentration.
clearly establish that the burden of defining the appropriate market or
product has been met, particularly as it would pertain to an anticompetitive
effect in Connecticut or a geographic portion thereof. To the extent that
the product market may pertain to a larger market area that includes some or
all New England states, the proposed NU/YES Merger is 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.
P. COMPANIES' PROPOSED RATE FREEZE
The Companies have requested a "quiet period" for rates for "some period
of time" following the Merger. They contend that NU has made a significant
investment in the Merger in the form of an acquisition premium and benefits
from the Merger, in the form of synergies, are expected to emerge over time.
The Companies are therefore requesting a rate freeze during which time NU
would be permitted to use merger-related savings to offset its acquisition
premium.
OCC has argued that a requested rate freeze is a "poorly disguised
circumvention of the Connecticut statutes." OCC Reply Brief, p. 4. OCC
points out that pursuant to Conn. Gen. Stat. 16-19g, the Department is
required to review the returns of utilities based on a 12-month rolling
average. In the event that a utility's earnings exceed its allowed rate of
return by 100 basis points or more, the Department is required to conduct an
overearnings review.
OCC is correct that a request for a rate freeze cannot override the
Department's requirement to conduct a rate review under Conn. Gen. Stat.
16-19g. The Companies' request for a rate freeze is hereby denied, without
prejudice, in this docket.
IV. FINDINGS OF FACT
1. YES is a corporation created and existing under the laws of the State of
Connecticut and has its corporate headquarters in Meriden, Connecticut.
2. Yankee Gas, a Connecticut public service company wholly-owned by Yankee
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.
3. Yankee Gas has approximately 185,000 residential, commercial and
industrial users in Connecticut, of which approximately 170,000 are also
CL&P customers.
4. During 1999, the bond ratings of CL&P, WMECO and PSNH were upgraded to
investment grade by Standard & Poor's and Moody's investor rating
services.
5. In the post merger environment Yankee Gas would operate as a first level
subsidiary of NU.
6. Yankee Gas 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.
7. The Companies proposed no changes to their customer service practices
and policies.
8. Compared to 1998, during 1999 there has been an increase in the number
of NU complaints filed with the Department to date due to increased
collection activities to reduce the number of uncollectible accounts.
9. Companies' proposals for improving service to customers from the Merger
have not been fully identified or developed by the Companies' Transition
Teams.
10. In the last Yankee Gas rate case, Docket No. 96-08-05, the capital
expenditure budget for the years 1997 and projected through 2001 was
projected to be $135,000,000.
11. To oversee the transition process, NU and YES have established 11
functional transition teams to design and oversee the Merger process.
12. Yankee Gas currently has one service agreement with an affiliate.
13. Following consummation of the Merger, the entire NU System, including
YES and Yankee Gas, will be operated on a consolidated basis.
14. NARUC has adopted guidelines for cost allocation and affiliated
transactions.
15. NU charges affiliate transactions at cost, whether the regulated company
is providing or receiving those services.
16. NU's price of $45 per Yankee share payable in cash or NU common shares
is subject to proration if Yankee shareholders owning more than 55% of
Yankee shares elect to receive cash or if Yankee shareholders owning
more than 45% of Yankee shares elect to receive NU common shares.
17. Barr Devlin used the following valuation methods as the basis of its
fairness opinion: stock trading history, publicly traded comparable
company analysis, discounted cash flow analysis, comparable transaction
analysis and pro forma merger analysis.
18. NU assembled a team of internal specialists to conduct due diligence on
YES to develop an estimate of the costs that could be reduced in
functional areas as a result of the merger.
19. The NU due diligence process projected a lowering the combined annual
O&M expenses by approximately $10 million by the end of the fifth year
after the merger.
20. The purchase price for YES in excess of YES's net assets acquired is
approximately $314,156,000.
21. The purchase price in excess of the amounts recorded on the YES books
will be shown as plant acquisition adjustment for the regulated utility
and goodwill for the unregulated businesses on the consolidated balance
sheet.
22. The Companies are not seeking specific ratemaking treatment for the
acquisition premium in this Docket.
23. NU and Yankee have entered into an employment agreement with Charles E.
Gooley.
24. NU has agreed to offer to enter into binding employment arrangements
with the following senior officers: J. Kingsley Fink, Mary J. Healey,
Thomas J. Houde, Steven P. Laden, James M. Sepanski and Murry K.
Staples.
25. YES' transaction costs are estimated to be $4,857,8686.
26. NU estimates that it will expense approximately $558,310 and accrue a
total of approximately !The Formula Not In Table in transaction costs
associated with the Merger.
V. CONCLUSION AND ORDERS
A. CONCLUSION
Based on the record in this proceeding the Department hereby approves
the Merger of NU and YES, subject to the orders below. The Department
further 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 company's plant, equipment and manner of
operation if the application (3), will increase the level of community
investment through increased charitable contributions, (4) will maintain and,
where economically justified, expand the gas infrastructure, (5) and will
provide open, nondiscriminatory access to qualified gas suppliers.
Recovery of the acquisition premium by Yankee Gas ratepayers is denied.
The Companies' request for a rate freeze is also denied.
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 approves the Merger
Agreement shall be substantially as specified by the Companies 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 Companies shall notify the
Department by April 30, 2000, that no material modifications were made
to the terms and conditions of the Merger Agreement and whether the
Merger has or has not taken place.
2. No later than April 30, 2000, if the Merger takes place, the Companies
shall provide copies of all closing documents. If the Merger does not
take place, the Companies shall provide an explanation as to why it did
not.
3. No later than April 30, 2000, the Companies shall provide copies of all
journal entries to the Department showing the effect of the Merger.
4. No later than April 30, 2000, the Companies shall provide the Department
with an exhibit showing the actual expenses, broken down by type,
incurred by all parties for the Merger together with journal entries.
5. The Companies shall submit all proposed affiliate agreements to the
Department for review prior to them becoming effective.
6. NU shall allocate costs to YES and its subsidiaries in the same manner
it currently allocates costs to all other NU System companies.
7. The Companies shall submit to the Department any changes to their
billing format, customer service policies and procedures, Rules and
Regulations, pursuant to Section 16-19 of the General Statutes of
Connecticut and ten days prior to implementation.
8. Commencing January 31, 2000, NU shall submit quarterly reports to the
Department regarding the total number of complaints, broken down by
complaint type, reported to YES by its customers.
9. Commencing February 1, 2000, NU shall maintain a rolling three years'
written record of complaints received from its customers. The record
shall include the name, address, telephone number, account number,
nature of the complaint, and description of how it was resolved.
10. A report detailing the customer benefits achieved by the Merger,
including the measurements used prior to and after the Merger, shall be
filed with the Department no later than September 1, 2000.
11. No later than 30 days after the Merger takes effect, the Company shall
file an update of the projected merger savings identifying the source of
all regulated and unregulated savings.
12. NU shall file its expansion plan for gas infrastructure no later than
six months after the effective date of the Merger.
13. Yankee Gas shall maintain its charitable donations by 10% above the
average of its most recent three-year donation levels.
14. The Companies shall file with the Department the final implementation
plan on the merger transition process as described in Section III.H.1.
DOCKET NO. 99-08-02 JOINT APPLICATION OF NORTHEAST UTILITIES AND
YANKEE ENERGY SYSTEMS, INC. FOR APPROVAL OF A
CHANGE OF CONTROL
This Decision is adopted by the following Commissioners:
Jack R. Goldberg
Donald W. Downes
Linda Kelly Arnold
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 forwarded
by Certified Mail to all parties of record in this proceeding on the date
indicated.
Louise E. Rickard Date
Acting Executive Secretary
Department of Public Utility Control
Exhibit d.3
Analysis of Certain Economic Impacts of the Proposed Combination of
Northeast Utilities ("NU") and Yankee Energy System, Inc. ("YES")
At the time of the original U-1 Application/Declaration, NU anticipated that
the cost savings from the proposed merger of YES and NU could approximate $10
million annually. A team of internal specialists at NU determined this
estimate during its due diligence process prior to the public announcement of
the proposed combination of NU and YES. Since that time, a joint transition
task force comprised of representatives from both companies has been
evaluating the operating and administrative functions of NU and YES. This
joint task force consists of eleven Functional Transition Teams that have the
general responsibility of identifying opportunities to increase efficiencies,
eliminate duplication and provide improved customer service.
At this time, each of the Functional Transition Teams has presented draft
recommendations to the co-chairs of the Transition Teams. These individuals
are currently reviewing the recommendations and will present the
recommendations to the Transition Steering Committee, consisting of Messrs.
Morris, Gooley and other officers of each corporation, who will review,
challenge and may further refine the recommendations.
It is currently expected that this process will result in final
recommendations approved for implementation by the end of January 2000. The
implementation process would commence subsequent to closing of the merger.
Applicant believes that the analyses of economies, efficiencies and customer
service performed by the various Functional Transition Teams are sufficiently
developed at this stage of the process. These analyses support $10.4 million
of annual savings by the end of 2001, gradually increasing to $13.7 million
annually at the end of a five-year transition plan. These savings relate
primarily to the gas utility operations of Yankee Energy which has
historically incurred $60-65 million of operation and maintenance expenses
annually. It is expected that certain costs will be incurred in the first two
years of transition of approximately $5 million. Although the Connecticut
Department of Public Utility Control has approved the merger itself, by
Decision dated December 29, 1999, Docket No. 99-08-02, the Decision made no
findings on allocation of merger savings between NU and YES and YES' rates
will not be immediately impacted.
A more detailed description of the activities and findings of the Functional
Transition Teams follows:
Functional Transition Teams
1. Information Technology/Information Systems
The primary functions of this team were to evaluate processing
capabilities and processing infrastructure within each organization and
also assist other functional teams in evaluating "common" application
software used by each organization and make recommendations based upon
those evaluations.
NU and YES have very different information technology operating
capabilities. YES currently outsources substantially all of its
mainframe processing needs, as well as certain support services with a
third party provider while NU maintains in-house data processing
capabilities and generally supports its personal computer network with
internal resources.
The most significant conclusions of this team, in terms of cost savings,
is to migrate YES' outsourced mainframe environment to existing NU
resources, combine support services staff and reduce the application
development and maintenance staff level consistent with the reduced
requirements of migrating "common" application software into one system
for the combined entity.
2. Finance, Accounting, Financial Planning and Auditing
This team reviewed the major activities performed within these functions
and have developed recommendations consistent with their evaluation.
Generally, transaction-processing matters currently performed by YES in
the accounting, treasury and, to a lesser extent, financial planning
area, will be absorbed by existing NU resources. YES will maintain a
smaller, analytical focused financial reporting and planning group.
Additional savings are anticipated from the elimination of duplicative
activities and third party fees in the areas of shareholder services,
transfer agents and outside auditors.
3. Transportation and Facilities
This team evaluated the existing provisioning of transportation
resources
(i.e., fleet management) and facilities for each organization. Due in
large part to overlapping service territories and redundant capabilities
within each organization, savings are expected to be achieved through
combination of existing transportation departments, as well as reduced,
combined operating and administrative space requirements.
4. Legal, Environmental, Safety and Insurance
This team evaluated current practices within each organization and
determined that opportunities exist to improve service efficiencies and
eliminate duplication of activities. Specifically, a substantial part of
legal services at YES currently provided by outside law firms will be
absorbed by existing internal resources at NU. Further, additional
efficiencies are expected in insurance coverages, as YES current plans
will transition to existing NU plans where economies of scale benefits
can be achieved.
5. Other Areas (including Purchasing, Human Resources, Regulatory and
Government Affairs and Corporate Communications)
Each of these areas were evaluated in a manner similar to the other
functional areas with the focus of improving efficiency and service to
customers. The primary drivers of cost savings estimates are (1)
increased purchasing power of the combined entity (2) elimination of
redundant or duplicative functions not necessary in the combined entities
and (3) transfer of certain transaction processing functions currently
performed at YES to similar functions provided by NU entities.
The accompanying Exhibit I summarizes the financial impacts of
Applicant's current plans related to the proposed combination of NU and
YES.
As a percentage of Yankee Gas' 1999 gas operating revenues ($276 million),
the annual combined savings at the end of the five-year period of $13.7
million amounts to 5.0%. As a percentage of Yankee Gas' 1999 gas operating
revenues deductions (excluding depreciation and other taxes) ($193 million),
this amount is equal to 7.1%. As a percentage of Yankee Gas' 1999 gas gross
income ($29 million), this amount equals 47.2% and as a percentage of Yankee
Gas' 1999 gas net income ($16 million), this amount would equal 85.6%.
EXHIBIT 1
ESTIMATED SAVINGS BY FUNCTION
(Millions)
ANNUAL CAPITAL
FUNCTION MERGER COSTS (1) EXPENSE EXPENDITURE
SAVINGS SAVINGS
2001 2004
1. Information Technology
/Information Systems $5.0 $3.7 $4.8 $1.0
2. Planning and Budget/Finance
Accounting/Internal Audit 2.5 2.5
3. Facilities/Fleet .2 1.8
4. Legal/Environmental/Safety 1.5 1.7
5. Other Areas 2.6 2.9 .5
TOTALS $5.0 $10.5 $13.7 $1.5
(1) Estimated direct merger costs
to close duplicate facilities and
exit redundant contracts.
