Duke Shows How to Get a Deal Done

Submitted by Investing Daily as part of our contributors program.

Duke Energy’s (NYSE: DUK) board ignited a firestorm in early July, when it replaced CEO Bill Johnson with Chairman Jim Rogers just hours after completing the Progress Energy merger. Last week, it took a giant step toward extinguishing any still smoldering embers by reaching a deal with North Carolina regulators that resolves several points of contention.

Under the agreement, Duke’s longtime boss Rogers will step down as Chairman and CEO by the end of 2013. A new board drawn equally from pre-merger Duke and Progress will choose his successor, with a target date of July 1. Neither Johnson nor Rogers is eligible for the job.

The company also promised several other “reassignments,” with the goal of meeting regulators’ desire to “restore the balance between legacy Duke and legacy Progress.” That includes keeping at least 1,000 employees in Raleigh, N.C., the former headquarters of Progress.

Duke has also agreed to defer an upcoming request for a rate increase until February 2013. And the company will guarantee customers an additional $25 million fuel-related cost savings, bringing total promised synergies from the deal to $675 million.

In return, North Carolina regulators will end their review of the Duke/Progress merger, which was launched immediately after the so-called “boardroom coup.” And by reaching a settlement–rather than dragging out controversy–the company also removes considerable uncertainty about future regulatory relations, which have historically been among the most constructive in the country.

The deal doesn’t at this time include North Carolina Attorney General Roy Cooper, who is investigating whether the CEO switch violated state law. Cooper has for several months tried to turn the controversy into a broader indictment of the state’s utilities. And he’s likely to remain a thorn in the side of the company and regulators as they iron out a rate deal next year.

But assuming the full North Carolina Utilities Commission approves the agreement on Monday as expected, it’s a very positive step for Duke after a troubled few months. And the same goes for other utilities operating in the state, including Dominion Resources (NYSE: D) and Piedmont Natural Gas (NYSE: PNY).

From a big-picture standpoint, the Duke deal is the first major regulatory development for utilities since the Nov. 6 election returned President Obama to office with essentially the same Congress. That vote also favored continuity on the state level. In fact, North Carolina had the only governorship to change hands, with a Republican replacing a Democrat.

Given the generally strong relations between utilities and regulators around the country over the past decade or so, continuity is positive from a utility standpoint.

This time, however, it comes along with a sluggish national economy that could face a huge negative shock on Jan. 1. My view is the odds still favor Congress and the president reaching a budget deal, and averting the package of automatic tax increases and spending cuts.

But until the US economy really starts to fire up, pressure on regulators to delay or derail utility rate increases is likely to intensify. Particularly at risk are companies operating in states where politicians have historically used utility bashing to score points with voters.

New York is one regulatory environment definitely flashing red for investors now. Governor Andrew Cuomo has set up a commission to investigate utilities’ response to Hurricane Sandy, with subpoenas expected for all of the state’s major power companies and harsh penalties promised for any alleged “offenders.”

Ironically, the Empire State’s worst performer during the crisis was the Long Island Power Authority (LIPA). Mr. Cuomo’s father, then-Governor Mario Cuomo, essentially set up LIPA by breaking up the former Long Island Lighting Co (LILCO). That was part of a deal that permanently shuttered the Shoreham nuclear power plant and sold off LILCO’s gas distribution assets to the former Brooklyn Union Gas. That company in turn became KeySpan Energy, which was acquired by Britain’s National Grid (London: NG, NYSE: NGG) in 2007.

National Grid in turn operates LIPA under contract and is widely blamed for the Authority’s failure to restore power for weeks following Hurricane Sandy. Public Service Enterprise Group (NYSE: PEG) will replace it as operator when its contract expires next year.

Of course, public power works properly in many parts of the country. The LIPA saga, however, is a very clear indictment of what happens when politicians and regulators constantly meddle with electric utilities under their jurisdiction. In such environments, it’s not just impossible for companies to do the necessary long-term planning to stay ahead of the curve. There’s not even any incentive to try.

It’s no coincidence New York utilities have some of the highest power rates in the nation, despite a comparative wealth of resources. Nor is it a surprise that reliability, customer satisfaction and even shareholder returns all historically have ranked among the industry’s worst.

The message could not be clearer for investors. If you’re going to buy utility stocks, don’t fall into the trap of believing one size fits all and that you can just pick anything.

Only companies that can recover system investment consistently over time will be able to reward customers with superior service at low rates, and shareholders with robust and reliable returns. The only way that’s possible is through good relations with regulators. And the only sector companies worth owning are those that have them. You can uncover several top dividend-paying utility picks in my free report.

This article by Roger Conrad was originally published on Investing Daily under the title, Duke Makes a Deal.