Here’s a fact that should be irritating electric power investors and executives alike. The one industry that is absolutely essential to the so-called ‘new economy’ is electric power – just try accessing cyberspace when the power goes off. And yet, the more connected our economies become, the worse the stock market performance of electric power companies seems to be.
Over the past five years, while new economy stocks have soared and the overall US market is up over 300 per cent, the index of electric stocks has gained a meager 55 per cent. With a few notable exceptions, current stock prices virtually discount any potential for growth by these companies.
What should make this result particularly disturbing for investors is that there is so much potential for value creation in a $1.1 trillion (a1.2 trillion) global industry that is powering economies, households and businesses. In fact, a few industry players – notably Enron and AES in the USA and Centrica and National Grid in Europe – have performed much more like high-flying dot.coms (Figure 1).
The underlying potential in the electricity and natural gas industries and the bargain basement prices is starting to attract some of Wall Street’s biggest names. Warren Buffet, Bill Gates, and KKR have staked out entry positions, and other financial players are circling in search of opportunities.
So what needs to be done to realise the value potential of the electric industry?
A new mindset
The answer lies in making a mindset shift – from ‘bigger is better’ which has characterized the view of most companies in this asset-intensive business, to ‘smarter is better’. Success will be more about knowledge and skills than about plants and wires.
In the new economy, it is not the companies with the most tangible assets that win, but rather the players that are able to develop and leverage intangibles: skills, knowledge, brand, and relationships. For power companies, these intangibles can take the form of technology-specific operating skills, in-depth knowledge of regional generation markets, ability to exploit infrastructure assets and customer-specific usage patterns.
All of this rings particularly true for the generation segment of the power business. With deregulation, power generation and wholesale supply have become competitive. In this environment, a plant’s value is no longer measured by its undepreciated book value, as it was in a regulated world, but rather by its profit-making capability. That capability is maximized to some extent by efficient operations. It is not surprising, therefore, that superior nuclear operators PECO Energy, British Energy, and Entergy are actively consolidating nuclear plants.
For most generators, however, efficient operations will not be enough. They will need flexibility, market knowledge, and trading sophistication to optimize the use of each specific plant in the grid. Certain plants will be much more valuable – up to 40 per cent more – to the skilled operator/marketer than to the traditional utility owner because of the ability to capitalize on price volatility in unregulated markets. The players able to capture this value will be the winning consolidators of power plants.
Intangibles even matter in the regulated distribution – or ‘wires and pipes’ – part of the utility business. Traditional utility skills need to be applied in developing win-win regulatory solutions that provide incentives for continuously improving operations. Less well recognized, however, are a host of distribution-related opportunities. Regulators are likely to drive the continued unbundling of the regulated distribution business, and each segment is rapidly becoming a competitive opportunity.
The winners will have the business-building skills needed to leverage assets and relationships into growth businesses, the development skills needed to acquire other infrastructure companies at reasonable premiums, and the management skills needed to capture the synergies from combined operations.
Telecommunications is currently the hottest of the potential new wires and pipes businesses. Several consortia have recently been formed to add fibre optic cable capacity along electric and natural company rights-of-way. Companies such as Pepco are demonstrating that bringing new wires to the home, enabling enhanced telecom, Internet, and video services, represents a substantial opportunity for electrics. To capture this opportunity, power companies will need to leverage intangibles such as skills in forming alliances and local operations and brand recognition – and do so quickly.
Intangibles are also crucial to the retail business of selling power, natural gas, and other energy and non-energy products and services. Many companies suspect that their brands have value but fail to develop specific customer offerings that exploit this potential. Developing those offerings requires careful analysis of customer behaviour followed up with market experiments that are scaled up or killed as results suggest. These marketing skills are foreign to most traditional electric companies, and many have lost a lot of money because they failed to build the right market knowledge and capabilities.
Watch for the Internet-based marketers to move into this opportunity, perhaps in partnership with energy players.
An intangibles-first strategy makes sense at the corporate level as well as in the individual lines of business. The mindset of many electric company managements during the past decade has been to amass more physical assets through mergers and acquisitions.
The resulting buying binge has often left shareholders disappointed. In these situations, companies paid a high premium on the basis of aggressive assumptions about operating efficiencies and synergies that fail to materialize due to poor management. Companies, such as Enron, AES, and BG International (British Gas) that grew by leveraging skills, knowledge, and relationships have been much more successful.
Three organizational issues
Making the needed mindset change from tangibles to intangibles is easier to say than to do for many traditional electric and gas companies. Investors should be watching for efforts to address three organizational issues that are, for the most part, the legacy of operating in a regulated environment.
Shortage of talent is the first of these issues. Traditional utility companies have been slow to hire new blood from outside the organization. This hesitation often stems from not knowing what is needed, a reluctance to shake up the current organization, and lack of comfort with the new skills that are required (e.g. trading, deal making). In addition, few companies have developed their considerable internal talent very effectively. They often lack effective, objective evaluation and development processes. All of this results in too few people with skills and attributes needed to capitalize on new economy opportunities.
Companies that are serious about increasing talent will launch new entry-level hiring programmes to bring in future managers and ‘business growers’ and develop plans to provide the needed training and opportunities. Enron has hired hundreds of MBAs over the past decade (400 last year alone), which has given them an enormous pool of talent. Companies will also have to become comfortable with paying based on performance, rather than tenure and job category. Companies that are serious about talent will develop corporate-wide talent accelerator programmes to achieve the maximum potential of current employees.
The second organizational issue is an all-too-frequent low performance orientation. Traditional utilities are having difficulty shifting their aspirations to the ambitious goals of a growth company. Many still focus on near-term earnings to the exclusion of metrics better suited to growth companies.
The winning power companies of the future will align shareholders and management around higher growth aspirations. This will require transforming the shareholder base over time, as Enron has done. It will also mean changing compensation systems to put more at risk for executives and managers at all levels. Some managements have signalled their commitment to grow by establishing performance metrics externally, and they are often rewarded as long as they meet expectations.
The third issue is an organization structure geared to ‘command and control’, which often results in slow, bureaucratic decision making and stifles creative and entrepreneurial thinking. To overcome this, companies will need to move to an ‘enable and empower’ structure. One important step is to create separate organizational units to ensure that the growth ventures have the full responsibility – and accountability – needed to succeed. Many companies should also restructure their Boards of Directors to ensure an effective and demanding ‘partnership’ with the Board.
It is often argued that these three issues put traditional utilities at a significant disadvantage in developing an intangibles mindset. It is noted, for example, that top-performer AES, which highly motivates its skilled people with a decentralized, values-based culture, was a startup. It is equally important to note, however, that Enron started as a natural gas pipeline and has now become the premier intangibles-heavy company.
Making the mindset change from ‘bigger is better’ to ‘smarter is better’ is not only critical to success in the new economy, but well within the grasp of those traditional players who have the imagination and fortitude to pursue this new path.