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Summary On August 25, the Public Service Commission of D.C., led by Chairwoman Kane, denied the Exelon-Pepco merger application; Pepco shares plunged 16.5%. The application review process lacked fairness, public interest factors misconstrued by the commission, and Chairwoman Kane failed to hold good faith negotiations. Exelon is likely to pursue legal action, and is in a good position to prevail. Public Service Commission of D.C. Denies The Exelon-Pepco Merger Application In what is being called one of the most misguided and inherently flawed decisions in the Public Service Commission of the District of Columbia’s 102-year history, the Commission denied the application for the proposed merger of Exelon (NYSE: EXC ) and Pepco (NYSE: POM ). The Commission, led by Chairwoman Betty Ann Kane, issued a press release and a summary of the decision suggesting the Commission held a thorough proceeding that began with the initial application on June 18, 2014. Over 14 months later, after reviewing submissions and comments and holding hearings, the Commission decided to deny the application and declared that “this decision is forever.” Unfortunately for Chairwoman Kane, such a bold statement is not based on fact, and exceeds the established authority of the Commission. (click to enlarge) (Source: Public Service Commission of D.C. website ) Since announcing the $6.8 billion transaction on April 30, 2014, Exelon and Pepco collectively have spent a tremendous amount of resources to secure all required regulatory approvals, and until August 25, had been successful in meeting the demands of all stakeholders in various jurisdictions. In order to close the transaction, Exelon has had to negotiate complex agreements with local regulatory agencies and commit to additional funding initiatives that total in the hundreds of millions, and has had to agree to other conditions. Through this lengthy process, Exelon and Pepco received regulatory approval from all of the following agencies: Virginia, New Jersey, Delaware, Maryland, and the Federal Energy Regulatory Commission. The only agency to deny the application was the District of Columbia, on August 25. (Source: Exelon Investor Presentation, April 30, 2014) Following the unusual and terse decision by the Commission, Exelon has announced that it is reviewing all of its options, and there are many options available to the company. The outcome of the Exelon-Pepco merger is far from over, and will likely lead to a lawsuit filed by Exelon against the Public Service Commission of D.C. A lawsuit by the company would have a very good chance of succeeding, which may lead to a negotiated settlement with the Commission. A negotiated settlement was always the option that was in the best interest of all parties, including the Commission, ratepayers and community activists. However, Chairwoman Kane’s unwavering political ideology and personal preference for dealing with the existing ownership and managerial structure of Pepco ultimately prevented the outcome that is in the public’s best interest. The very troubling aspects of the flawed decision by the Commission will likely be the center of attention over the next several weeks, and will be scrutinized in the Courts. Among the most egregious missteps by the Commission include: A Deeply Flawed Process in Reviewing the Application : The Commission decided early on that it did not favor the merger for reasons discussed at length here , and the proceedings held were merely a formality for a decision that had been made months ago. Rather than holding fair and objective proceedings, the Commission, working closely with the Office of People’s Counsel of D.C. , delayed as long as possible before issuing its final ruling that it had determined long ago with the hope that another jurisdiction or a legal action may unravel the transaction. This did not happen, so the Commission obscured their biased and subjective decision under a “public interest” theory. A deeper understanding of the public interest in the District of Columbia shows that the merger is a tremendous opportunity to help a vast number of poor and middle class inner city families. Commissioner Willie Phillips acknowledged this when he stated, “I am disappointed in the loss of many opportunities that could have achieved benefits for our local communities and across the region.” (click to enlarge) (Source: Public Service Commission of D.C. website) The Commission’s Reasoning to Support Decision is Inconsistent and Unsound, and Does Not Reflect the Economic Reality in the District of Columbia : The Commission refers to its statutory obligation and the seven public interest factors that must be considered and weighted to reach its decision, but it fails to acknowledge the economic reality of the District, which is essential in the first public interest factor. The District’s government, public officials, and regulators have continually failed to address the needs of inner city minorities, and the Commission’s August 25th decision is another example of this failure to serve in the public interest. Commissioner Willie Phillips would be the first to acknowledge this significant shortfall of the District’s government. We are surprised that Commissioner Joanne Doddy Fort does not also recognize the overwhelming lack of commitment by the Mayor and public officials to improving the lives of inner city minorities. Exelon’s commitment to local communities would provide substantial resources to those in need, and it is inexplicable that an activist Chairwoman Kane would allow her political ideology to prevail over the public interest. For example, in Maryland alone, the company agreed to spend “$66 million for residential rate credits, and $43.2 million for energy efficiency initiatives – 20 percent… dedicated to limited-income programs… $14.4 million in Green Sustainability Funds for Prince George’s and Montgomery Counties, and $4 million for sustainable energy workforce development programs.” The District has the ability to work with Exelon to provide similar initiatives for its citizens, but has thus far failed to make the commitment. The Commission’s Lack of Willingness to Negotiate in Good Faith and Failure to Act in the Public Interest : It is highly unusual for a single agency to outright deny an application for a transaction without holding significant negotiations with the applicants. The Commission merely dismisses the discussions and indicates “there was no settlement brought to the Commission that would have evidenced general agreement on those mitigating factors which would have satisfied the concerns of the parties.” Its stance on a settlement shows there was not a sincere attempt to engage Exelon and work together to the benefit of the public, ratepayers, and local communities. We believe that it is unlikely that the Commission’s decision will stand in a court of law, and in our view, Exelon will be successful in challenging the inherently flawed process of the Commission in reaching the erroneous decision. Shortly after the decision was announced, Exelon responded , “We continue to believe our proposal is in the public interest and provides direct immediate and long-term benefits to customers, enhances reliability and preserves our role as a community partner. We will review our options with respect to this decision and will respond once that process is complete.” It’s possible that the two sides will still reach a settlement prior to lengthy court proceedings, particularly since the Commission was deeply divided in its initial decision, and many of the flaws are now being exposed. Potential Outcomes for Shareholders of Pepco Pepco’s stock is now trading at $23.22 per share, and is up over 3% today. In our view, Exelon will file with the Commission within 30 days to reconsider its decision, and from there, if unable to reach a settlement with the Commission, the company will pursue legal action to have decision overturned. The best-case scenario is obviously a negotiated settlement, as the transaction would close relatively quickly, perhaps 30-45 days from now. But we think the probability of this outcome occurring is low (~10%). It is unknown how long a legal action would take, but we think Exelon has a strong case for the aforementioned reasons and would ultimately prevail, although this would likely happen in 2016. In our view, this scenario has an approximately 60% probability of occurring. (click to enlarge) (Source: Nasdaq) If Exelon were to suffer a defeat in the courts or decided to abandon the transaction if negotiations failed (30% probability), we would expect Pepco to trade anywhere from $19 to $21 per share. Given these potential scenarios, we will not add to our position at the current price. However, Pepco will continue to pay a dividend, and we will re-evaluate once Exelon decides on which option it will pursue to overcome this recent setback. Disclosure: I am/we are long POM. (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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