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Q&A: Mona Dajani, Baker & McKenzie - Part I

Baker & McKenzie recently won a headline-grabbing mandate as an advisor to United Airlines on its equity investment in a biofuel startup, Fulcrum BioEnergy. The Chicago-based global law firm represents lenders, sponsors, private equity players, tax equity investors, developers and underwriters in project financing deals and M&A transactions. In this exclusive interview with PFR, Mona Dajani, a partner at Baker & McKenzie’s banking and finance group who splits her time between Chicago and New York, talks about how the continuing transformation of the power industry is driving corporate restructuring (another client, E.On, is in the process of restructuring its generation portfolio), the potential for consolidation, and a potential uptick in M&A activity.

PFR: You represent investors, lenders and sponsors in the global energy transactional space. Do you see any trends that stand out to you with these clients in terms of transactions, structures or terms?

DAJANI: There has been a real focus on industry transformation — with transformative deals in the power and utility sectors.

There are a lot of moving pieces such as outdated infrastructure, increasing customer interaction, managing distributed generation, electricity demand, renewable energies, the price of oil, fuel prices, and a lot of forward-looking utilities and private equity infrastructure shops that are focused on power and utilities. They’re looking at defensive strategies to help utilities strengthen their balance sheets through cost reduction and leveraging, M&A synergies, and monitoring the playing field with new technologies and business models.

The other trend that I see is in the M&A space, where there are a lot of changes of ownership and corporate restructurings. We’re seeing, for example, utilities like Duke Energy, NextEra Energy and SunEdison have moved to break up their portfolios through various kinds of transactions including spin-offs, asset sales, and the creation of bond-like investment vehicles called yieldcos that hold generating assets with long-term supply contracts.

We’re also seeing a lot of industry change. For example, E.On, a major investor-owned utility, is splitting its business into two different cores, one that is focusing on renewables, and the other on conventional generation, to reflect differences in risk, business outlook and policy support.

PFR: Do you see a lot more room for consolidation in the sector, especially with newer players coming into the market, such as financial investors?

DAJANI: Yes. With the defensive strategies that I was talking about, companies want to strengthen their balance sheets. To do that, they are monitoring the playing field, discussing the risks of new technologies and business models. With respect to acquisitions of utilities, it’s not just small and mid-sized. There is also a very large one right now — the Exelon-Pepco merger — and there are a lot of deal cost-savings and synergies. Both the utilities and these new purchasers, the financial investors, benefit from steady cash flows, and smart deployment of capital to improve customer value, which also includes studying the impact of new technologies.

PFR: It seems that we’re talking about an industry that’s really in transition. It’s dealing with a lot of uncertainty—low interest rates, fuel and oil prices and the impact of distributed generation on utilities. How do you see that shaking out in the next couple of years—short to mid-term?

DAJANI: I think the only ways utilities can survive is to change. With respect to new financial investors, private equity players, and infrastructure investors, there are going to be a lot of changes of ownership in the power sector. We’re seeing, for example, NiSource, which owns both regulated gas and electric utilities, and gas midstream assets, spin off their midstream business. We also saw Dominion Resources offer midstream assets like the Cove Point LNG export project to the public through an initial public offering just to fund the construction. There are going to be a lot of changes going on structurally to make companies more competitive. We’re seeing a lot more infrastructure, private equity firms and financial investors thinking that they can really put some more capital and cost-saving synergies in place.

PFR: I’ve noticed from your profile you have done a tremendous amount of high profile M&A in the energy space. What transactional trends are you seeing in the power and energy sector?

DAJANI: Well, besides the yieldcos, there are huge changes going on in the electric power sector. Declining demand, aging infrastructure, rising environmental compliance costs, and shifting customer expectations. There is competition coming from distributed generation providers and other market entrants, and declining rates of return on equity. In the natural gas distribution sector, local distribution companies are facing high capital expenditures and their rates of return are falling. At the same time, because of low oil prices, we’re seeing a huge supply of shale gas, and local gas distribution companies scrambling to work out the implications for their operations. All of these factors are making the existing business model change.

There are going to be disruptive changes, and some of these are going on now. In the future, although right now it’s not booming, I do see that M&A activity is going to be a compelling and expedient strategy for delivering value in the near-term, and managing strategic risks in these businesses. There is still some risk with M&A, because right now we have challenging regulatory requirements. We have long approval timelines and there are uncertainties concerning the boundaries of the alternatives available to them.

Some companies are going to have trouble quantifying the benefits or what the savings will be. But those that are really going to succeed, like the Exelon-Pepco merger, are the M&A deals and corporate restructurings that are revealing expanding opportunities that will benefit both customers and shareholders. These will be synergistic cost savings which typically go to customers in a regulated market, but it will also be an impetus for more M&A activity. These transactions will then yield more competitiveness, innovation, increased reliability and resilience, making it easier to comply with environmental and other regulatory mandates. We are in a changing marketplace and I think we’re going to see an uptick for power and utilities and regulators to re-evaluate how these companies can execute critical elements of their strategy, while simultaneously benefitting their shareholders and customers.

Check back next week for the second instalment of this Q&A.