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Company’s management seems committed to appealing against PSC judgment. Management continues to consider Pepco merger as key in achieving Exelon’s goal of re-balancing asset portfolio. Recent PSC decision to reject proposed merger has adversely affected Exelon’s plans to grow regulated operations. Exelon has to make important decision regarding capital deployment. Company’s risk profile has also increased. U.S. utility companies have been making aggressive efforts to increase their regulated business operations exposure, as forward power prices remain weak. Exelon Corp. (NYSE: EXC ) has also been working to expand its regulated operations, in an attempt to provide stability to its revenues and earnings. Consistent with its efforts to increase regulated operations, the company has been directing capital investments towards regulated operations. However, the company’s plans to increase regulated operations are adversely affected, as the Public Service Commission (PSC) of the District of Columbia rejected the proposed $6.8 billion Exelon-Pepco merger; Exelon does have a right to appeal against the judgment. However, Exelon’s future growth prospects will be seriously affected if the proposed merger is not completed. Therefore, I recommend investors to stay on the sideline until some clarity appears on the merger. Overhang Prevails Exelon’s financial performance in recent years has been volatile mainly because of weak and volatile forward power prices. However, the company has been undertaking prudent strategic decisions in recent years by focusing on increasing its regulated operations, which remains an important source for the future earnings growth. Exelon is known as the largest operator of nuclear power plants in the country; however, cheap coal and natural gas have rendered nuclear power uneconomical. The company has been making capital investments to strengthen and develop its regulated operations, where regulators guarantee investment returns. Moreover, in the recent past, the company was working on the proposed $6.8 billion Exelon-Pepco merger to provide stability and growth for its future earnings. Exelon’s management expects that the proposed merger will increase Exelon’s regulated utility earnings contribution to 65%-70% up from the current level of almost 55%. However, recently, the PSC rejected the planned merger, stating that it is not in the ‘public interest’; the decision has weighed on stock prices of both Exelon and Pepco, and I think Exelon’s stock price will stay under pressure in the near term. Exelon plans to appeal against the judgment, as it has a right to appeal against the decision in 30 days. The rehearing process is expected to take 6 months. However, the merger rejection has increased Exelon’s business risk. I think the merger now has 50% probability of being completed, and the main reason for pessimism is that the PSC has outrightly rejected the proposal rather than offering conditional approval. The company can push for the merger by settling with key stakeholders and presenting a case that the merger will bring notable benefits to customers. Moreover, in anticipation of finalizing the merger, the company has already raised almost $6 billion in long-term financing, including $1.9 billion raised through equity issuance and $4.2 billion through senior note issuance. If the company’s merger efforts are not successful, Exelon will face earnings dilution from the financing. Also, capital allocations have now become a key question for the company. I think if the merger does not materialize, the company can opt to allocate $3-$4 billion for share buybacks. Therefore, going forward, the company has to make important decisions regarding wealth maximization for its shareholders, therefore, I recommend investors to keep an eye on the management’s future decisions, which could have a notable impact on Exelon’s stock price. Separately, the company has to make another important decision, whether it will continue to operate its nuclear power plants or close them. Electricity generation by Exelon’s nuclear power plant has been uneconomical because of cheap natural gas and coal. The company spends nearly $1 billion per annum on its nuclear plants to keep them operational reliably and safely. In my opinion, if the proposed merger is not completed, the company should continue to look for other options to expand its regulated operations, as regulated operations will augur well for its earnings stability and risk profile. Summation The company’s management seems committed to appealing against the PSC judgment. The company’s management continues to consider the Pepco merger as key in achieving Exelon’s goal of re-balancing its asset portfolio away from volatile unregulated business, with weak growth outlook, towards a more stable and growing regulated operations. However, the recent PSC decision to reject the proposed merger has adversely affected the company’s plans to grow its regulated operations and will weigh on its future earnings growth and stability. If the merger deal does not close, the company has to make an important decision regarding capital deployment and its future growth will be negatively affected. Also, the company’s risk profile has increased. Therefore, I recommend investors to stay on the sidelines and wait for clarity on the matter. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Scalper1 News
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