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A Brief History of Diversification by Utilities
Electric utilities were once just that—utilities. Many also owned gas utilities, but had few, if any, nonutility operations. This began to change in the 1980s and that transformation continued into the 1990s. As interest rates began declining from their lofty levels of the early 1980s, so, too, did the allowed returns on equity that state regulators were granting in rate orders. Some companies decided that diversification into nonutility businesses would provide a better return on investment than they could obtain from their regulated utilities. Eventually, most utilities formed holding companies to better separate their regulated and nonregulated activities.
The track record of utility diversification is more bad than not. In fact, the term “diworseification” was sometimes used to describe the experience of many utilities. One key problem was that, instead of focusing on energy-related businesses, some companies made investments that had nothing to do with energy. An infamous example is the acquisition of Thrifty Corp. (the parent company of the Thrifty Drug Store chain) by Pacific Lighting (then the parent company of Southern California Gas) in 1986. The company sold Thrifty at a big loss in 1992. Another deal that did not work out was the purchase of MeraBank by Pinnacle West (PNW, then known as AZP Group, the parent of Arizona Public Service) in 1986. After the savings and loan crisis developed in the late 1980s, MeraBank collapsed in 1990.
Hawaiian Electric Industries (HE) has a mixed record of diversification. The company has proven that it is possible for a utility to have a successful bank acquisition. Hawaiian Electric bought American Savings Bank in 1988 and still owns the thrift. The company is earning a higher return on its investment in ASB than on its utility operations. On the other hand, the purchase of Hawaiian Insurance Group in 1987 and the startup of HEI Power (a developer of power projects in the Far East) in 1995 failed. The property and casualty insurer was written off in 1992, and HEI Power’s investments were written off in 2000 and 2001.
Sometimes, nontraditional diversification is successful. In 1995, Minnesota Power, now a subsidiary of ALLETE (ALE), surprised Wall Street when it announced a deal to buy ADESA, which runs auctions of used vehicles. Some investors were fearful that this would wind up as another failed diversification attempt by a utility, but it proved to be a good purchase. ALLETE spun off ADESA in 2004, and ADESA was acquired by a private equity group in 2007.
More recently, diversification by utilities has been steered toward energy-related businesses, such as wholesale and retail power and gas marketing. Even in this area, however, outcomes have been mixed. Sempra Energy (SRE) bought an energy-trading operation in 1998 and earned a very healthy return on its investment before exiting this business (due in part to high capital requirements) in 2010. By contrast, Avista (AVA) had an erratic performance in energy marketing, and sold the business in 2007. Other companies, such as Constellation Energy (CEG) and Integrys Energy (TEG), have reduced the scale and scope of their energy-marketing activities.
Today, some utilities still have highly diversified operations. Otter Tail Corporation (OTTR) has several nonutility subsidiaries, most of which have been hurt by the sputtering economy in the past few years. In many cases, however, utilities’ nonregulated operations consist largely of generating assets that the company retained, purchased, or built after the state or states in which they operate deregulated the power-generating function. After the largely unfavorable experiences of the 1980s and 1990s, few utilities are straying from energy-related businesses. All told, we consider this a good thing for shareholders.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.