A Changed Edison Lights Up

Chairman John Bryson and fellow managers of Edison International went before investment analysts Oct. 13 to give unusually detailed projections about company profit in the next five years and how each division would achieve them.

Before they began their eight-hour presentation, Edison stock was selling at $24.25 a share. After they spoke, the stock began a rise that has taken it to $29.63 as of Friday, a 22% increase that has added $1.8 billion to Edison’s market value.

Bryson’s message to the Wall Streeters was simply that the company is not the sleepy utility they thought it was but a modern energy company that could increase earnings 12% a year in a post-regulation environment.

The analysts appreciated the visit and heard the message.

“They really laid out the company for us,� says analyst Edward Tirello of Deutsche Bank Alex. Brown.

Wall Street has since been taking a second look not only at Edison but also at other utilities.

Then last week master investor Warren Buffett intensified the focus on electricity by announcing that his holding company, Berkshire Hathaway, and an investment group would purchase MidAmerican Energy Holdings of Des Moines for about $9 billion.

MidAmerican owns generating plants in the Midwest, Britain, Indonesia and the Philippines, and supplies electricity in several countries.

Buffett, who has built a fortune estimated by Forbes at $31 billion through decades of shrewd investing, said of Berkshire’s purchase: “We buy good companies with growth potential at a fair price, and we’re willing to wait longer than some investors for that potential to be realized.�

Thus the electric industry appears to be awakening to a new period of growth and attractiveness to investors. Why this is happening and what it says for the outlook for consumers’ electricity bills, among other considerations, can be seen in the remaking of Rosemead-based Edison International.

“We have transformed the company,� Bryson explains. Edison International has taken capital earned from the sale of its own local generating plants and from recovery of costs of old facilities being retired in deregulation. “We have redeployed that capital so that now 70% of the assets that earn profit for Edison come from non-regulated businesses,� Bryson says.

The Southern California Edison utility division, having gone through deregulation and the sale of most of its power plants, is now basically in the regulated business of transmitting and distributing electricity to homes and offices. The utility still accounts for the bulk of Edison International’s earnings and is expected to contribute more than $400 million of the parent company’s anticipated $700 million in income for 1999.

And Southern California Edison will also grow in the next five years, under an incentive form of regulation that allows more profit for greater performance.

But most of Edison’s profit growth will be provided by Edison Capital and by Edison Mission Energy, the Irvine-based division that owns and manages generating plants in Asia and Europe and now in the United States.

Edison Capital foresees its profit rising from $130 million this year to $225 million by 2003, and Edison Mission Energy similarly forecasts profit rising from about $200 million to more than $400 million in the same period.

This is no overnight success, explains Bryson, 56, a Yale-educated lawyer who has headed Edison since 1990. Bryson earlier headed the California Public Utilities Commission and helped to found the Natural Resources Defense Council, a Washington environmental research group. (And he remains a member of the board of Times Mirror Co., parent company of The Times.)

The genesis of today’s company dates to the 1980s, when California regulators demanded that utilities buy power on long-term contracts from new suppliers. The intent was to encourage environmentally friendly power generation. The effect was to create a need for sophisticated analysis of power pricing so that contracts could be written.

Now the world has changed, and most electricity is supplied at prices that fluctuate each day and each hour. The skills that Edison Capital built up over a decade are much in demand as power companies and finance firms commit billions of dollars to building and operating electricity generation.

The same 1980s period also gave rise to Mission Energy as parent Edison reckoned it could construct and manage power plants better than most newcomers to the field.

In the early ‘90s, Mission built and contracted to operate power plants in the Philippines and Indonesia--a venture that is in difficulty now, along with all other foreign business in that country. It also bought power plants in Europe.

And in 1995, with deregulation being debated in the United States, Mission Energy paid $1 billion for First Hydro, a company in Wales that generated electricity by water power. Britain had already begun deregulating its electricity industry.

From operating the complex hydro plant, Mission Energy learned how to calculate local market demands for power and how to price it hour by hour. It was a forerunner of the system that now governs power sales in California, where generating plants sell their output into a pool and pricing is determined by continuous trading as in a financial futures market.

The experience in Wales gave Mission confidence, says Edward Muller, who heads the division. “And so we sifted opportunities to buy power plants in the United States for several years,� he says.

In the last year, Mission has acted with force. In 1998, it paid $1.8 billion for a power plant in Pittsburgh that serves Pennsylvania, New Jersey and New York. The venture will bring Edison $30 million in profit this year, analyst Steven Fleishman of Merrill Lynch estimates, and perhaps $50 million in 2001.

This year Mission Energy is paying $4.8 billion to buy 12 coal and natural gas-fired power plants from Chicago-based Unicom, the parent company of Commonwealth Edison. Mission hopes to make $60 million in profit from operating those power plants next year and $100 million five years from now.

That’s good growth. Why can Mission Energy be so confident of growing profit? One reason is that it expects prices of electricity to rise because of a present shortage of generating capacity in the Midwest and East.

“There is a general acceptance that electricity prices will be increasing over time--how steeply is the question,� says Muller, 47, a Washington lawyer who joined Mission in 1993 after a stint as chief financial officer of Whittaker Corp.

“We have done our analysis on the assumption of a very gradual increase in prices,� he says. “If it is steeper, we will come out better, but we’re not banking on a big jump in prices.�

Mission is carefully choosing its markets, buying into the Midwest and East, where electricity prices have spiked during summer heat waves in recent years.

Edison reckons that by buying plants at a good price today and putting its knowledge to work in operating them, it will have low-cost production no matter how the market evolves.

What is going on is a rearranging of the nation’s electricity industry. Unicom, having sold its fossil-fuel plants to Mission, plans to merge with Peco Energy, the former Philadelphia Electric, to create a giant owner of nuclear generating plants. The idea is that by operating a great number of such plants, the company will achieve economies of scale and profit as a competitive seller of electricity.

Other companies are uniting to distribute power to homes and offices--Eastern Utilities Associates, now merging with New England Electric System, is taking this route.

In the short term, residential electricity customers can expect some confusion and higher prices, analyst Tirello says.

“By splitting generation from transmission and distribution, deregulation is setting up three companies where a single monopoly used to do the job,� he notes. “Three electricity bills spells higher prices.�

But competition from many suppliers vying to generate and deliver electricity should eventually bring prices down--as has happened in long-distance telephone service, says Michael Peevey, chairman of the Los Angeles-based New Energy Ventures division of AES Corp., an Arlington, Va., company that generates and markets electricity worldwide.

There are lessons to be gleaned from Edison’s transformation. One is that companies must anticipate. Other utility companies are now trying to develop a strategy for the deregulated environment. Edison already has one.

Another lesson is that in business today, companies are under constant pressure to increase their stock prices--and a company cannot hide its light under a bushel. Stock market analysts didn’t recognize Edison’s transformation until Bryson and the other Edison managers explained it to them.

Now Edison shares have risen, but the pressure hasn’t eased. The very fact that Edison Capital and Mission Energy are so successful is creating demands that Bryson create separate markets in stocks of the divisions--by spinning off, say, 20% of the two units to shareholders.

Analyst Kit Konolige of the investment firm Morgan Stanley, who says Edison “may be one of the few proven growth stories in the electric group,� believes nonetheless that pressure will build on Bryson to seize stock market value by offering separate stock in its divisions.

Bryson, who calls the company’s strategy “integrated growth,� believes that the divisions, including Southern California Edison, help one another. He sees the whole being more than a sum of its parts--and he may be thinking ahead to what his utility company needs.

The future of Southern California Edison may lie in acquiring neighboring utilities to achieve economies of scale, analysts say. If that is the case, Bryson will need the heft and the earnings of Edison Capital and Mission Energy. Having them under separate ownership could complicate acquisitions.

Typically, the stock market thinks of today but company management--and long-term investors--must look ahead.

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Brighter Light

Edison International managers recently gave investment analysts unusually detailed profit projections for the company and its main divisions. Table shows per-share earnings projections for Edison’s financing, power generation and regulated utility divisions--and for parent Edison International, with adjustments for parent company investments and administrative costs.

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Division 1999 2000 2001 2002 2003 Edison Capital $0.37 $0.43 $0.49 $0.58 $0.65 Mission Energy 0.58 0.74 0.91 1.13 1.15 So. Cal. Edison 1.26 1.40 1.47 1.44 1.75 Edison Int’l 2.01 2.25 2.55 2.85 3.20

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Source: Edison International

James Flanigan can be reached by e-mail at [email protected].